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The UK’s national fixed broadband network – wasteful duplication or effective competition?

You may have recently noticed construction workers from different businesses digging up the roads/pavements near where you live. You may also have noticed them laying fibre optic cables. Why has this been happening? Does it make economic sense for different companies to dig up the same stretch of pavement and lay similar cables next to one another?

For many years the UK had one national fixed communication network that was owned by British Telecom (BT) – the traditional phone landline made from copper wire. This is now operated by OpenReach – part of the BT group but a legally separate division. In addition to this national infrastructure, Virgin Media (formed in 2007 from the merged cable operators, Telewest and NTL) has gradually built up a rival fixed broadband network that now covers just over 50 per cent of the country.

Although customers have only had very limited choice over which fixed communication network to use, they have had far greater choice over which Internet service provider (ISP) to sign up for. This has been possible as the industry regulator, Ofcom, forces OpenReach to provide rival ISPs such as Sky Broadband, TalkTalk and Zen with access to its network.

Expansion of the fibre optic network

Recent government policy has tried to encourage and incentivise the replacement of the copper wire network with one that is fully fibre. This is often referred to as Fibre to the Premises (FTTP) or Fibre to the Home (FTTH). A fixed network of fully fibre broadband enables much faster download speeds and many argue that it is vital for the future competitiveness of the UK economy.

Replacing the existing fixed communication network with fibre optic cables is expensive. It can involve major civil works: i.e. the digging up of roads and pavements to install new ducts to lay the fibre optic cables inside.

Over a hundred companies, that are not part of either OpenReach or Virgin Media O2 (the parent company of Virgin Media), have recently been digging up pavements/roads and laying new fibre optic cables. Known as alternative network providers (altnets) or independent networks, these businesses vary in size, with many of them securing large loans from banks and private investors. By the middle of 2023, 2.5 million premises in the UK had access to at least two or more of these independent networks.

After a slow initial response to the altnets, OpenReach has recently responded by rapidly installing FTTP. The business is currently building 62 000 connections every week and plans to have 25 million premises connected by the end of 2026. In July 2022, Virgin Media O2 announced that it was establishing a new joint venture with InfraVia Capital Partners. Called Nexfibre, this business aims to connect 5 million premises to FTTP by 2026.

Is the fibre optic network a natural monopoly?

Some people argue that the fixed communication network is an example of a natural monopoly – an industry where a single firm can supply the whole market at a lower average cost than two or more firms. To what extent is this true?

An industry is a natural monopoly where the minimum efficient scale of production (MES) is larger than the market demand for the good/service. This is more likely to occur where there are significant economies of scale. Digging up roads/pavements, installing new ducts and laying fibre optic cable are clear examples of fixed costs. Once the network is built, the marginal cost of supplying customers is relatively small. Therefore, this industry has significant economies of scale and a relatively large MES. This has led many people to argue that building rival fixed communication networks is wasteful duplication and will lead to higher costs and prices.

However, when judging if a sector is a natural monopoly, it is always important to remember that a comparison needs to be made between the MES and the size of the market. An industry could have significant economies of scale, but not be an example of a natural monopoly if the market demand is significantly larger than the MES.

In the case of the fixed communication network, the size of the market will vary significantly between different regions of the country. In densely populated urban areas, such as large towns and cities, the demand for services provided via these networks is likely to be relatively large. Therefore, the MES could be smaller than the size of the market, making competition between network suppliers both possible and desirable. For example, competition may incentivise firms to innovate, become more efficient and reduce costs.

Research undertaken for the government by the consultancy business, Frontier Economics, found that at least a third of UK households live in areas where competition between three or more different networks is economically desirable.

By contrast, in more sparsely populated rural areas, demand for the services provided by these networks will be smaller. The fixed costs per household of installing the network over longer distances will also be larger. Therefore, the MES is more likely to be greater than the size of the market.

The same research undertaken by Frontier Economics found that around 10 per cent of households live in areas where the fixed communication network is a natural monopoly. The demand and cost conditions for another 10 per cent of households meant it is not commercially viable to have any suppliers.

Therefore, policies towards the promotion of competition, regulation, and government support for the fixed communication network might have to be adjusted depending on the specific demand and cost conditions in a particular region.

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Questions

  1. Explain the difference between fixed and wireless communication networks.
  2. Draw a diagram to illustrate a profit-maximising natural monopoly. Outline some of the implications for allocative efficiency.
  3. Discuss some of the issues with regulating natural monopolies, paying particular attention to price regulation.
  4. The term ‘overbuild’ is often used to describe a situation where more than one fibre broadband network is being constructed in the same place. Some people argue that incumbent network suppliers deliberately choose to use this term to imply that the outcome is harmful for society. Discuss this argument.
  5. An important part of government policy in this sector has been the Duct and Pole Access Strategy (DPA). Illustrate the impact of this strategy on the average cost curve and the minimum efficient scale of production for fibre broadband networks.
  6. Draw a diagram to illustrate a region where (a) it is economically viable to have two or more fibre optic broadband network suppliers and (b) where it is commercially unviable to have any broadband network suppliers without government support.
  7. Some people argue that network competition provides strong incentives for firms to innovate, to become more efficient and reduce costs. Draw a diagram to illustrate this argument.
  8. Explain why many ‘altnets’ are so opposed to OpenReach’s new ‘Equinox 2’ pricing scheme for its fibre network.