The ACCC has released a draft determination to authorise NBN-Co acquiring Optus’s cable customers and the decommissioning the Optus HFC network. The document is an interesting read – but in my opinion, reaches the wrong conclusion.
As background, the Optus HFC cable was originally rolled out in the mid-1990s and currently passes about 2.4m homes in Brisbane, Melbourne and Sydney. It has about 0.5m subscribers. See the draft determination around paragraph 2.9 and following for details. The Optus cable has been upgraded so that its broadband services are about the same speed as the ‘entry level’ NBN services (see paragraph 2.22).
Given the Telstra-NBN deal, the Optus cable is the only fixed-line alternative to the NBN. The NBN wants to eliminate this potential source of competition and according to John Durie, Optus gets $800m from the deal. This will make Optus very happy. I have no idea what is the book value of the cable – but it would be relatively low. Optus lost the Telstra-Optus cable wars in the mid-1990s and its cable network has presumably never recovered its original cost. But that is history (or in economic terms, sunk costs). The ACCC evaluation must be on the future costs and benefits of the NBN-Co – Optus arrangement.
Overall, the ACCC gets the analysis spot on. It recognises that the NBN project will continue with or without the Optus arrangement. And in the absence of the arrangement, Optus will continue to be a limited competitor to the NBN but will probably, over time, have its customers move to the NBN anyway (see paragraph 3.60).
So why do I disagree with the ACCC’s conclusion? Remember that the test for authorisation is that the public benefits outweigh the public detriments. The ACCC argues that this test is meet. But in my opinion, the main public benefit that drives this conclusion is simply not a public benefit.
The ACCC’s lists three public benefits from the agreement. The latter two – some cost savings due to orderly migration and some environmental benefits – appear trivial. So the draft decision relies on the first public benefit summarised in paragraph 3.138.
The ACCC considers that the HFC Agreement is likely to result in benefits to the public from reduced duplication of infrastructure expenditure as a result of the cessation of operational and capital expenditure on the HFC network which is greater that the expenditure which NBN Co would incur in serving these same customers. The ACCC considers that these benefits are likely to be material.
Sounds good – so why is it wrong?
Remember that the Optus wires are already up and the NBN wires will be rolled out regardless of the ACCC’s decision. So the duplicated expenditure is NOT in the basic (natural monopoly) infrastructure but in operations and maintenance. Optus will keep on servicing its customers so long as the benefits to those customers outweigh the cost (i.e. they can charge them more than the operations and maintenance (O&M) costs). Those customers will have the option of the NBN but will choose not to take it. So those customers must value the Optus service at more than the O&M costs that could be saved by those customers moving to the NBN.
Why will they value the Optus service at more than the cost? No idea! Why do some people like red cars and some people like black cars? Why do some people like apples and others like oranges? Or, in the case of the NBN and Optus, why do some people like Royal Gala apples and some like Pink Lady apples? No idea! It is their preferences. But we know these values and preferences by observing the customers’ behaviour. And if the market shows us that those customers prefer to use Optus’s network – and to pay more than its on-going costs to keep using it – despite there being a perfectly good NBN alternative, then the economic conclusion is clear. The benefits to those customers outweigh the costs.
In brief, if the market keeps the Optus cable alive – even if only temporarily – then any ‘benefit’ from reduced expenditure of closing the Optus cable prematurely is necessarily outweighed by the loss to those customers who would have chosen to buy the services of that cable. So the main ‘public benefit’ is not a benefit at all.
The ACCC has fallen into the trap of ‘market design’. Suppose I can show you that it is cheaper to make just one type of car. After all, then we could have one big factory and save duplicated production costs. You might argue against this as we would have a monopoly and car prices would go up. So let’s get rid of any price effect and ask the following: is closing down all other car operators a benefit even if the car prices do not change?
Customers like choice and their actions in the market place show that they value that choice at more than any cost savings. As Henry Ford showed, if uniformity is cheap enough then many people will be happy with uniformity. So the cost savings of uniformity could outweigh the benefits to consumers of choice. But we need a market test to show this. And on the ACCC’s own analysis, Optus will continue in the absence of the agreement with the NBN-Co. So on that basis, there is no public benefit of avoiding on-going O&M costs. Rather there is a public loss because Optus’s customers, who for whatever reason prefer to stay with Optus rather than shift to the NBN, lose their benefits of that choice.
Should this be a lost ‘benefit’? Of course! It is the most basic economic benefit that there is. Consumers have preferences and buy things that they individually value at more than the market price. That is the source of all consumer surplus. So the NBN-Co – Optus arrangement will lower consumer surplus on the basis of the ACCC’s analysis.
The ACCC notes a number of public detriments from the NBN-Optus arrangement including a loss of competitive tension (see paragraphs 3.199 to 3.202). But my argument above is not about competitive tension. It is more basic. It is about consumer surplus and is simply based on revealed preference.
Should this reverse the ACCC decision? Yes! The Tribunal has noted that the relevant net benefit must be material and not trivial (se paragraph 3.207). But if the ‘benefit’ of avoided on-going O&M costs are recognised as a loss of consumer surplus rather than a ‘benefit’, then either the benefits of the arrangement are outweighed by the costs or the net benefit is trivial. So the ACCC should decline the authorisation.
In summary, the ACCC analysis misclassifies a benefit. By forgetting the most fundamental role of markets – to shift products to people who value those products at more than they cost – the ACCC has misclassified a loss of consumer surplus (a detriment) as a cost saving (a benefit). It is an easy mistake. But it needs to be rectified in the final decision. Which means that the arrangement should not be authorised and the fate of the Optus cable should be left to the market.