An international cable reality check

21:39, Nov 06 2012

The failure of Pacific Fibre to launch left many telecommunications commentators and broadband consumers disappointed.

Pacific Fibre would have provided competition for the Southern Cross Cable, leading to lower broadband prices, faster speeds, and bigger data caps in New Zealand. This would have benefited broadband users directly and provided a demand boost for the government's ultrafast broadband (UFB) programme. There could also have been productivity benefits from cheaper, faster broadband, such as expansion of our creative industries.

Pacific Fibre apparently failed because it was unable to attract sufficient capital from investors. That Pacific Fibre was not able to convince investors it could turn a commercially acceptable profit even if it only had one main competitor suggests that there is simply not room in the New Zealand market for more than one international cable system. In other words, the demand in New Zealand for international bandwidth, even if prices fall, is not sufficient to cover the significant costs of building another cable and provide a reasonable return on investment.

Additionally, the Southern Cross Cable has plenty of excess capacity. The government has painted this as positive news for UFB, saying that greater demand for broadband services can easily be accommodated by the Southern Cross Cable. However this assumes that such demand eventuates at current prices.

Furthermore, excess capacity is not always good news for competition, particularly in markets that are currently dominated by one firm. Excess capacity gave the Southern Cross Cable a credible threat to slash prices if Pacific Fibre entered the market, because the Southern Cross Cable could easily handle the additional traffic that lower prices would generate. Knowing this, investors would be understandably cautious about sinking cash into Pacific Fibre, and the excess capacity on the Southern Cross Cable is a useful moat to protect it from competition.

The fact that competition appears to be unworkable in this case suggests the government should consider alternatives to protect New Zealanders from monopoly pricing of international bandwidth. The normal recourse would be to regulate the prices that the Southern Cross Cable charges. This is done in other parts of the telecommunications sector such as local lines, and has successfully promoted competition – as shown by the number of retailers vying for broadband customers.

However, the Southern Cross Cable is headquartered in Bermuda and this raises jurisdictional issues for regulation. A glimmer of hope is provided by a recent High Court judgement that international airlines do operate in markets in New Zealand even if they are not based here, and thus are subject to our competition laws. Nevertheless, the government has so far showed little interest in regulation of the Southern Cross Cable.

If competition or regulation cannot work, what else can be done? Kim Dotcom’s plan to fund another cable by suing Hollywood studios is far-fetched. Back on Earth, the Telecommunications Users Association (TUANZ) has suggested a public network, possibly funded by a surcharge on telecommunications users.

Compared to direct regulation, building a public network could result in some additional costs of constructing a second cable that is not profitable on a commercial basis. But compared to the status quo, a public network could introduce competition and lead to lower prices that more closely reflect costs of supply. This would increase usage of broadband services, with benefits flowing from that usage.

The TUANZ idea of a telecommunications usage tax may not be the best approach to funding, as the surcharge itself may unintentionally stifle competition in other services. But the idea of a public network does have some merit, given that competition and regulation are not feasible. Further analysis should be done to determine whether the competition and productivity benefits outweigh the costs, and to examine alternative funding mechanisms.

Aaron Schiff is a director of consulting firm Covec.