Freeserve Forces OFTEL to Reassess BT Broadband Pricing

June 30, 2003

On 16 April 2003, the UK Competition Appeals Tribunal (CAT) set aside OFTEL’s favourable pricing decision towards BT. The CAT ruled that OFTEL was wrong to dismiss Freeserve’s complaint filed in March 2002 alleging that BT had favoured its ISP, BT Openworld (BTOW). OFTEL had not given sufficient reasons for rejecting Freeserve’s complaint, and needed to consider Freeserve’s predatory pricing claim. In May 2003 BT then reduced the price of its wholesale Internet access product (presumably in order to pre-empt any remedial action by OFTEL), to the relief of ISPs in the UK and elsewhere in Europe. The CAT decision is symbolic – now at least in one important sector, wholesale broadband, BT’s enduring monopoly is being constrained. OFTEL is now reviewing the entire broadband market in time for the coming into force of the EU Communications Package on 25 July 2003.

Timeline of events

· 26 March 2002: Freeserve complains to telecoms regulator OFTEL about BT’s marketing of its retail ISP services.

· 21 May 2002: OFTEL rejects Freeserve’s complaint.

· 9 September 2002: Freeserve appeals OFTEL’s rejection decision.

· 11 November 2002: CAT allows Freeserve’s appeal.

· 16 April 2003: CAT overturns OFTEL’s decision to reject Freeserve’s predatory pricing allegations against BT.

· May 2003: BT reduces its broadband wholesale prices.

Internet access services

Freeserve’s original complaint related to BT’s abusive behaviour with respect to UK Internet access services. Freeserve competes against other ISPs in the provision of retail Internet access services in the UK. BTOW offers these services in competition with Freeserve. All ISPs rely on BT’s wholesale Internet access services. BT Wholesale sells to ISPs capacity on the BT network. ISPs such as Freeserve use the capacity obtained from BT Wholesale to sell broadband Internet access to retail customers who have a BT line installed on their premises. BT’s principal wholesale products, and the products at the heart of Freeserve’s complaint, were the IPStream family of products (notably IPStream 500).


In its original complaint to OFTEL, Freeserve alleged that BT had abused its dominant position, contrary to Chapter II of the Competition Act 1998. The complaint contained several allegations of abuse against BT, including unfair cross-marketing by BT of BTOW, and conferring an unfair first mover advantage on BTOW by giving BTOW advance notice of the 40% price cut on wholesale broadband access announced last year. Freeserve also alleged that BT had unfairly cross-subsidised BTOW’s predatory retail prices. Specifically, BT subsidies had allowed BTOW to provide short-term promotions, subsidised connection fees, and in some instances zero-cost connection to the consumer. Freeserve alleged unfair cross-subsidy on the basis that BT’s business case was not sustainable. BTOW was not generating sufficient revenues to cover its variable and long run incremental costs. BTOW’s predatory pricing could only be supported by cross-subsidy. OFTEL promptly rejected all allegations against BT for lack of evidence.

The importance of ascertaining dominance

In its detailed judgment, the CAT held, first, that OFTEL had failed to investigate Freeserve’s complaint properly. OFTEL had cut corners. In assessing whether BT had abused its dominant position, OFTEL had taken the approach that since BT had not committed any abuses there was no need to consider whether BT was dominant. OFTEL should have indicated the relevant market under consideration, and whether BT was dominant in this market.

Regulatory confusion

Whilst OFTEL may have been right to reject the bulk of Freeserve’s allegations for lack of evidence, according to the CAT OFTEL should not have rejected Freeserve’s predatory pricing allegation. OFTEL’s reasons for rejecting the predatory pricing claim were inadequate and confusing. The fact that OFTEL had closed a “margin squeeze” investigation earlier on in 2002 was not relevant to the predatory pricing claim. Margin squeeze was not the same thing as predatory pricing. Indeed, although inter-linked, margin squeeze, predatory pricing and cross-subsidy were distinct concepts. Further, the fact that several ISPs happened to have undercut BTOW’s alleged predatory retail price did not necessarily mean that there was sufficient retail margin to allow competition with respect to the cross-subsidy allegation. Other ISPs could have been forced to follow BTOW’s pricing policy in order to survive in the short term.

The CAT then went on to set out the scope of predatory pricing, margin squeeze and unfair cross-subsidisation. This is very helpful as these allegations have been made within the industry repeatedly, and some previous decisions have not contained consistent analyses or outcomes.

Cross subsidy

A cross-subsidy occurs where an undertaking uses revenues from one market to subsidise losses in another market. A cross-subsidy may be abusive, contrary to Chapter II of the Act, where a dominant undertaking’s revenues from an activity may be expected to fail to cover the costs associated with that activity over its economic lifetime, and the undertaking covers the losses with revenues from a market where it is dominant.

Margin squeeze

An abusive margin squeeze generally occurs where a dominant firm in an upstream market uses profits from its activities in that market to subsidise losses in a downstream market with the result that the margins of its competitors in that downstream market are “squeezed” and competition is adversely affected. A margin squeeze may therefore involve a particular kind of cross subsidy, such as where profits from the upstream market are used to fund losses in the “downstream” market.

Freeserve had provided OFTEL with a mock one-year business case for BTOW’s broadband business, showing that its retail Internet business was not sustainable over this period. OFTEL had rejected this on the grounds that one year’s worth of data was nowhere near long enough; many businesses make a loss in the first year of operation. Freeserve needed to show that BTOW’s business case was not sustainable over a longer period.

Predatory pricing

Broadly, the abuse of predatory pricing occurs where a dominant undertaking charges a price below cost with the likely effect of eliminating competition without objective justification. Specifically, the test for determining predatory pricing by a dominant telecommunications operator is two-fold: First, is the dominant undertaking pricing below its long run incremental costs (LRIC)? If not, is the dominant undertaking pricing below average total costs (ATC)? If there has been pricing below LRIC, then predatory pricing is assumed. If there has been pricing above LRIC but below ATC then the pricing will be regarded as predatory if there is an intention to eliminate a competitor.

According to the CAT, whilst OFTEL might have dispensed with the cross-subsidy claim, its decision showed that OFTEL had not even addressed Freeserve’s predatory pricing allegation. At the hearing, OFTEL argued that it had considered the predatory pricing allegation as part of the cross-subsidy analysis. The CAT criticised OFTEL’s approach. Even if OFTEL had considered the two together, there was no justification for this, and it was not clear that using the same approach with different variables could work in practice in any event. Predatory pricing did not necessarily involve a “cross subsidy” from one business to another, since the business concerned may simply finance its losses internally or by borrowings, or look to recoup the losses from the market place at a later stage. Finally, there had been no previous case law to the effect that predatory pricing was justifiable where the product in question was new and was therefore incurring start-up costs. Whilst the CAT was not denying that it may take some time for a new service, such as broadband, to reach profitability, OFTEL had not properly addressed the issue of predatory pricing and therefore OFTEL should reconsider this.

Regulators such as OFTEL will no longer be able to “do it their way”

The CAT’s decision has the following important implications:

· Regulators will be subject to intense legal scrutiny with respect to every EC or UK competition law investigation they undertake. Cases will no longer be able to fall into a regulatory backwater, and regulators will no longer be able to cut corners – in short, regulators will no longer be able to “do it their way”; and

· OFTEL has been given a very comprehensive roadmap for the investigation of complaints made under the Competition Act 1998. In future, if OFTEL, or any other regulator, fails to investigate complaints properly they will be challenged.

David Melville, Freeserve General Counsel, said he was “enormously reassured by the level of external scrutiny that the Tribunal was prepared to give to Oftel’s actions.” In addition to the high level of scrutiny demanded by competition law, David was also pleased that the Tribunal reinforced “the stringent duty upon regulators to properly and independently investigate complaints and to give reasons for their decisions.” It is hoped that OFCOM, the new media regulator which will subsume Oftel and the alphabet soup of other media regulators, will continue the CAT’s positive work in this regard.

Davina Garrod works in the competition law department at McDermott Will Emery.