If Vodafone and Three merge, it will be the first time that the UK telecoms market would have less than four network operators since Orange and One2One entered the market in the early 1990s. The CMA would nowadays be expected to block 4-to-3 mergers, especially where there is little chance of a new market entrant, but this deal is occurring in a highly regulated industry. We should expect this deal to be treated as being in a class of its own.
We are still a couple of months away from the CMA’s provisional decision in this case, so we do not know whether the concerns raised in the Phase 1 decision will be sustained at Phase 2. I believe that the CMA’s 243-page Phase 1 decision was its longest ever (any readers who can point me to a longer one should please get in touch). This may suggest that they sought to front-load the substantial lessening of competition (SLC) analysis to make room for plenty of discussion about merger efficiencies and, if necessary, remedies at Phase 2. They certainly did far more work – and to a much higher standard – than was required for a robust Phase 1 decision. It would be a significant turnaround for the CMA to clear the deal unconditionally.
In the latest of a series of blog posts on this interesting case, I therefore look ahead to an aspect of the possible remedies that might be debated if the CMA finds that the deal would be expected to result in an SLC and if the CMA does not accept the parties’ efficiencies argument. One or more SLCs obviously aren’t inevitable at this stage. But, if one or more SLCs are found, we should expect a lot of debate about the creation of a new fourth player.
Creating a new fourth player
In the European 4-to-3 telecoms deals over the last decade or so, network operators have needed to commit to detailed remedies packages unless they were able to convince the European Commission that one of the merging parties would exit the market absent the deal – this was the route through for the T-Mobile/Tele2 case in the Netherlands.
Remedy packages have tended to manufacture a new fourth player of some kind in order to restore the competition lost as a result of the merger. The remedies vary in their depth, but a typical remedy would involve a merging party divesting spectrum and network capacity, offering national roaming agreements, and/or making its site infrastructure available for a new player.
These types of remedies are contentious in the telecoms sector – it is not hard to find high-quality research papers that take strongly divergent views on their successes and failures. Ofcom’s chief economist has publicly noted their chequered past and has said they would need to see a “real demonstration” that there will be a “different story” to previous occasions where they have not worked well.
Would this sort of remedy nevertheless work for Vodafone and Three in the UK? As we will see below, past cases have shown that it is difficult to find a willing new entrant, or that it will successfully replace the competition lost as a result of the merger. There are some well-established virtual network and fixed broadband operators in the UK, so there are potentially some highly plausible candidates to be a new fourth player.
But, it is difficult to see how a fourth player that is less experienced in the UK market, less well-resourced and less asset rich than its competitors would recreate the level of competition we see in the market today, especially if network quality is now a key competitive factor. Even then, it is not clear how a new player would solve the network sharing issue that is described in detail in the CMA’s Phase 1 decision.
Will a new fourth player turn up? [Germany’s 2014 telecoms merger (and Austria and Ireland)]
Past cases have shown that finding a fully-fledged fourth player is far from straightforward.
In 2014, the Commission approved a merger in the German telecoms market between Telefónica Deutschland (operating under the O2 brand) and E-Plus on the condition that they would help make way for a new fourth player. There was an imminent spectrum auction, but this failed to produce a new fourth player. Telefónica therefore agreed to sell some of its mobile network capacity to Drillisch, a virtual network operator.
A virtual operator is inherently weaker than a fully-fledged fourth player, and there are doubts that Drillisch could ever become a fully-fledged network operator. Drillisch now has a market share of around 7%, which suggests that it remains a fringe player. Experts seem to doubt that its virtualised 5G network performs as well as a traditional network.
This German merger is not the only time that we have seen difficulties in finding a fourth player. When Hutchison 3G Austria and Orange Austria merged, it was also cleared subject to various divestiture commitments aimed at ensuring the entry of a new fourth player. Again no new network operator ended up entering the market. The same happened in Ireland. No new player took the deal that arose from the Hutchison 3G UK and Telefónica Ireland merger.
In the current case of Vodafone/Three, the CMA might worry that a similar remedy might face similar problems. A speculative remedy would not satisfy the provisions of the CMA’s published remedies policy. When the CMA assesses a potential remedy, it will consider whether the remedy has an acceptable risk profile. The CMA will only accept those that have “a high degree of certainty of achieving their intended effect”.
If it seems too risky to accept a remedy without a new player lined up, the CMA may therefore reduce the risk profile by insisting on an upfront buyer before issuing any final remedy.
Could a new fourth player be identified up front? [Italy’s 2016 telecoms merger]
If the merging parties find a credible fourth player who is willing to sign up before the CMA’s final remedy decision, they could perhaps improve the remedy’s risk profile.
In 2016, the Commission approved another 4-to-3 deal, this time in Italy. Hutchison and Wind were allowed to merge on the condition that they would pave the way for a new fourth network operator. By the time the Commission was conducting its review of the transaction, the merging parties had already entered into an agreement with the new entrant, Iliad—an established network operator in the French telecoms market. The Commission therefore considered not only the substance of the commitments, but also the identity of the proposed new player.
A similarly structured remedy was seen in the very recent Orange and MásMóvil merger in Spain, where the parties committed to divesting spectrum to Digi and enabling Digi to build its own network. Notably, MásMóvil was arguably not a fully-fledged network operator pre-merger, and Digi was uniquely well placed to step up, so this case is perhaps distinguishable from Vodafone/Three.
The trouble with drawing inspiration for the Vodafone/Three merger from these sorts of cases is that they presuppose the existence of a new challenger wishing to enter a new market, which is not always a straightforward task—as we have seen above in the Germany, Austria and Ireland examples above.
In any case, even if a fourth player can be found, there is no guarantee that the remedy taker will have the scale needed to address the lost competition. After entering the market as a fourth player, Iliad reportedly struggled to reach profitability. Even after a period of strong price competition, Iliad had around half the subscribers of the leading three operators. It recently offered to buy Vodafone, arguably implying that it thinks it lacks sufficient scale.
Could a new fourth player succeed in the UK?
It is difficult to find an example of a new entrant in recent times who has clearly prospered, even with strong support from regulators. In addition to the above European examples, Dish in the US and Rakuten in Japan seem both to have struggled to attain a strong position in the market. Every country has its own characteristics, but it does not seem to bode well that there are no clear examples of success.
The merging parties in the UK would need to explain to the CMA why a new fourth player would prosper where they apparently could not. If anything, the presence of the networking sharing agreements also makes the UK seem a particularly difficult market for a new fourth player. Some of the potential candidates would be able to leverage a good brand, a loyal customer base and strong market positions in neighbouring markets, but many people would start from a position of scepticism that they could achieve the scale that the merging parties claim is needed to compete in this market in the face of three entrenched incumbents.
Under the UK merger control regime, when the CMA assesses the effectiveness of a remedy in addressing an SLC, its merger remedies guidance states that it seeks to “re-establish the structure of the market expected in the absence of the merger”. It is difficult to see how switching a fully-fledged network operator for a virtual network operator, which can only be in a weaker position, would be consistent with the CMA’s published guidance (which it has a legal obligation to abide by).
The parties have been making their case to merge on the basis that, amongst other things, scale is needed to enable Three to remain competitive in the future. If this is the case, why would any other network operator want to enter the UK market on a sub-scale basis?
Conclusion
If remedies are required in this case, it is far from clear how introducing a new fourth player would “comprehensively” solve the loss of competition (this is the CMA’s statutory duty once an SLC has been found). Each country has unique characteristics, but past decisions at the EU level do not seem to bode well for the positive case. It will be a high hurdle to jump should the parties not have a potential new player lined up, and even if they do, it will still take some work to show that such a player is going to thrive.
In recent years, the CMA has taken a hard line on how to interpret the word “comprehensive”. It has been unwilling to entertain remedies that would reduce a “substantial lessening of competition” to a mere “lessening of competition” (c.f. Sainsbury’s/Asda, Veolia/Suez and others). It has insisted on the total removal of the identified problem. Replacing a fully-fledged fourth player with a record of strong price competition (i.e. Three) with a weaker fourth player (i.e. a new entrant or a super-MVNO of some kind) would not normally be the type of remedy the CMA accepts. And even then, it would not seem to solve the network sharing problem that the CMA described in its Phase 1 decision.
It is tempting to see the CMA’s merger investigation as an “all or nothing” decision, but we will have to wait and see.