Is Rudd Bluffing On Broadband?

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The Rudd Government’s recent decision to spend up to $43 billion on a national broadband network is part surprising — and part highly predictable.

The plan seeks to deal with the fundamental problem of broadband policy in Australia. Today’s broadband market is dominated by the vertically integrated incumbent Telstra — and what it wants from broadband is not necessarily what serves the national interest.

As I have documented in my recently released book, Wired Brown Land: Telstra’s Battle for Broadband, two successive governments have wrestled with this problem since Sol Trujillo arrived as Telstra’s chief executive in mid 2005.

In August 2005, Trujillo proposed a national broadband network with a capacity of 6 megabits per second (Mbit/s), serving 98 per cent of Australian premises. The offer was made to the Howard government — on condition that it contribute $2.6 billion towards the rollout cost, and that it release Telstra from the existing requirement that its competitors may purchase "access" to the Telstra network.

When the offer was rejected, Telstra put forward a second proposal in November 2005 — a 12 Mbit/s "fibre to the node" network serving 4 million premises in the five big cities. Again Telstra’s proposal came with regulatory strings attached — and again it was rejected.

These two offers triggered a vigorous debate, within Australia’s telecommunications sector and more broadly, about the way forward for broadband in Australia.

Telstra’s smaller rivals banded together in a group called "G9" and proposed an alternative model in mid 2006. Under their model, one company ("NetCo") would build and own the national broadband network, and sell services on a wholesale basis to retail telephone companies and internet service providers. No one individual telecommunications retailer, Telstra included, could own a majority of NetCo.

Then Labor announced its broadband policy in March 2007 — drawing on both the Telstra and G9 models. The network design and economics came from Telstra. So the network was to be "fibre to the node" offering a speed of 12 Mbit/s, and there would be Government investment of $4.7 billion. This figure was drawn from Telstra’s August 2005 offer. (In a paper setting out the offer which was released to the stock exchange, Telstra had said its recommended option was a 6 Mbit/s network, but an alternative would be a 12 Mbit/s network, requiring a Government contribution of $4.7 billion.)

Labor’s ideas on market structure drew heavily on the G9’s model. Labor proposed a network half owned by the Government and half owned by a private sector company. Again, the network owner would sell services to retailers including Telstra. Without using the term, Labor was proposing "structural separation" of Telstra: that is, breaking it up into two components under different ownership — one the retail business and the other the network owner.

The idea behind structural separation is that an independently owned network business will eagerly sell wholesale services to every retail telephone company and internet service provider, thus stimulating competition at the retail level. By contrast, in today’s world Telstra is vertically integrated. That means that when Telstra’s retail business is competing against other companies like Optus, AAPT and Primus — and they in turn are buying capacity on Telstra’s network from Telstra’s wholesale business — the temptation is all too great for Telstra to make it hard for those companies to compete effectively.

Under Labor’s March 2007 policy, Telstra could have succeeded in owning 50 per cent of NetCo, but the Government would own the rest. So the ownership arrangements of NetCo, selling its network services, would have been different to those of Telstra, who would have been just one of the retailers buying that service. This would have meant a much more level competitive playing field — with Telstra retail on much more equal terms with its competitors than is the case today.

When Labor came to government and began to give effect to its policy, it faced some significant challenges. On the one hand, Telstra was not motivated to cooperate. On the other hand, for companies other than Telstra to build a fibre to the node network, they needed to use extensive elements of Telstra’s existing copper wire network.

To explain this point, today Telstra has a network of copper wires fanning out to nearly 10 million homes and businesses in Australia. Each copper wire is connected back to an exchange, and there are about 5000 exchanges across Australia. With a fibre to the node network, you replace much of the copper with optical fibre — but the network continues to use the existing copper wires for the last few hundred metres into the home. Result: anybody other than Telstra building a fibre to the node network must use Telstra’s copper.

In view of these issues, as I wrote in Wired Brown Land, Broadband and Communications Minister Stephen Conroy had three options late last year in deciding how to arrive at the ideal market structure: first, choose one of the proposals from Acacia, Axia or Optus to build the network; or second, abandon that tendering process and negotiate a better deal with Telstra whereby Telstra builds it but they accept the Government’s regulatory terms; or third, abandon the process and take the big stick to Telstra via new legislation.

Which brings us to Kevin Rudd’s announcement on Tuesday. The decision not to accept any of the three proposals — from Acacia, Axia or Optus — was highly predictable. The requirement to use the Telstra network presented significant challenges — particularly the risk of Telstra challenging the use of the copper network as an unconstitutional acquisition of property. While the law in this area is far from clear, the Commonwealth bureaucrats were clearly concerned about the risk the Government would have been exposed to as a result.

But if taken at face value, the decision to go with fibre to the premises — and to spend enormous sums of public money — certainly is surprising. The price tag is enormous — and the likelihood of significant private sector involvement is probably quite low. It is simply too hard to estimate the probability of getting a payback on the investment.

Perhaps the real intent of the decision is to shock Telstra back to the bargaining table — in other words, the Government is still covertly following the second option which I identified. It will certainly work to get Telstra talking — although any serious discussions will be delayed until after the new chief executive is appointed.

Can a deal be done though? The Rudd Government has now ratcheted up public expectations. Given the phenomenal expense involved, even if Telstra wants to co-operate, can it afford to? As a private sector company, can it put so much money into an investment which is unlikely to generate a commercial payback — or will it simply reallocate its capital to investing in, for example, developing markets in Asia?

Broadband has been a topic of intense political controversy since Sol Trujillo first proposed a new network in August 2005. It’s been a high stakes game since the outset; the Rudd Government’s new approach raises the stakes yet again.

With the brutal economics of fixed line telecommunications, the complex politics of heightened expectations, and the delicate dance between a fully privatised Telstra and a social democratic government — there will be few more fascinating issues over the coming months and years.

Wired Brown Land: Telstra’s Battle for Broadband by Paul Fletcher, is published by UNSW Press

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