Submission to Committee of Inquiry into Telstra Service Standards

This version: 17 May 2000

 

Telstra: structure, ownership and service

John Quiggin

Australian Research Council Senior Fellow

Department of Economics

Faculty of Economics and Commerce

Australian National University

 

 

EMAIL John.Quiggin@anu.edu.au

FAX + 61 2 62495124

Phone + 61 2 82494602 (bh)

+ 61 2 62578992(ah)

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Summary

Telstra's unsatisfactory service in rural and remote areas and the incoherence of its recent management decisions regarding Internet strategy reflect fundamental conflicts in Telstra's role, governance and objectives. Telstra's current structure involves the enterprise in a conflict of roles between the traditional role of a universal provider of access to telecommunications services for Australians, and management's aspirations for the firm to become a global player in the provision of telecommunications content services, such as pay-TV and Internet content services. This conflict in goals is overlaid by a conflict in governance arising from Telstra's status as a corporation with a majority government shareholding. The full privatisation of Telstra, as proposed by the Federal government would resolve some of these conflicts but would exacerbate others. The result would be continued inadequate service, particularly for rural and regional Australia.

The conflicts in Telstra's present roles, governance and objectives may be resolved bybreaking the corporation into two separate enterprises: a privately-owned provider of telecommunications content services, including the pay-TV and Internet businesses and the proposed international business; and a fully publicly-owned access provider operating and owning the local, long-distance, international and mobile telephony networks.

 

 

 

Telstra: structure, ownership and service

There is a good deal of evidence to suggest that Telstra's performance in the recent past has been less than adequate. The Performance Monitoring Bulletins of the Australian Communications Authority have identified numerous instances in which Telstra's service has fallen short of target levels, notably including fault clearance in rural and remote areas. Following considerable criticism and growing public opposition to privatisation, the management of Telstra has indicated that it will attempt to improve service standards, and some improvement is evident in the December 1999 Performance Monitoring Bulletin.

It is obviously important to gather information on the extent to which the decline in service standards has been halted or reversed in the short term. A more fundamental problem, however, is to determine the relationship between Telstra's service delivery and its ownership and organisational structure. To the extent that the decline in service standards may be attributed to recent changes in ownership and organisational structure, it is important to consider whether the proposed full privatisation of Telstra will mitigate or exacerbate these adverse effects.

In this submission, it is argued that Telstra's current structure involves the enterprise in a conflict of roles between the traditional role of a universal provider of access to telecommunications services for Australians, and management's aspirations for the firm to become a global player in the provision of telecommunications content services, such as pay-TV and Internet content services. This conflict in goals is overlaid by a conflict in governance arising from Telstra's status as a corporation with a majority government shareholding. The conflicts in roles and governance produce a conflict in objectives that is reflected in the incoherence of recent management decisions by Telstra.

The full privatisation of Telstra, as proposed by the Federal government would resolve some of these conflicts but would exacerbate others. The result would be continued inadequate service, particularly for rural and regional Australia.

The conflicts in Telstra's present roles, governance and objectives may be resolved bybreaking the corporation into two separate enterprises: a privately-owned provider of telecommunications content services, including the pay-TV and Internet businesses and the proposed international business; and a fully publicly-owned access provider operating and owning the local, long-distance, international and mobile telephony networks.

Conflict of roles

Telstra currently faces a substantial conflict between its primary role as a provider of access to telecommunications services, particularly those characterised by natural monopoly, and its increasing focus on the provision of various forms of communications content, including pay-TV and Internet services. To fill the first role properly, Telstra must make investment decisions to provide the most efficient telecommunications infrastructure. However, Telstra's role as a player in the content market inevitably pushes it to make strategic investment decisions which benefit Telstra rather than the community as a whole.

The conflict in Telstra's roles may be traced back to mistakes made in the early 1990s when policy was based on the notion of ‘facilities-based competition’. The result was that Optus, as the preferred competitor until 1997, was encouraged to duplicate Telstra's network. In the absence of any Universal Service Obligation, Optus inevitably focused its rollout of optical fibre cable on Sydney and Melbourne. Acting strategically, Telstra responded by duplicating, rather than complementing, the Optus network. Similarly, the government encouraged the creation of three separate digital mobile networks to replace the analog network previously shared by Telstra and Optus.

Rural regional Australia is still suffering the consequences of these policy errors. The expenditure on the optical fibre rollout would have been sufficient to provide service to all major cities and provincial centres in Australia. Instead, half the households in Australia are passed by two sets of cable and the other half by none. In the case of mobile telephony, rural Australia was deprived of the AMPS analog service in order to promote the development of three separate digital systems, all of which confined their service to urban centres. Telstra's recent deployment of CDMA services was costly and was technologically hampered by the unnecessary closure of the AMPS network.

More generally, it is clear that Telstra's strategic focus has led to the adoption of policies that disadvantage rural and regional Australia. A series of reports of the Australian Communications Authority have demonstrated a decline in service standards, at a time when the underlying technology has become steadily more reliable. Despite repeated denials, it is evident that this decline in service standards is primarily caused by reduced employment in maintenance services.

The cost savings resulting from staff cuts have benefited some users. However, Telstra has reduced its average prices only by the amount required under the regulatory cap, which in turn was calculated on the basis of the average rate of price decline before the introduction of competition. Since prices have been reduced by more than this average in markets where Telstra faces stiff competition (including the urban business market) it follows that prices for rural and regional services have fallen less than they would have if the policies of the 1980s had been maintained.

Another way of viewing Telstra's problem of conflict of roles relates to the concepts of natural monopoly and economies of scale and scope. Economies of scale and scope arise if a given set of services can be provided more cheaply by a single enterprise than by some combination of separate enterprises. Where economies of scale and scope are such that the entire market for a given set of services can most efficiently be supplied by a single enterprise, the enterprise is described as a natural monopoly.

The policies leading to the proposed privatisation of Telstra have been premised on the notion, widely held in the early 1990s, that the concept of natural monopoly is obsolete, and that ‘the day of big corporations and big governments is over’. This claim is the opposite of the truth, at least as far as corporations are concerned. A wave of mergers and alliances is reducing industries, including telecommunications, to a handful of global players. Some of these mergers are driven by corporate strategies aimed at enhancing monopoly power and are therefore undesirable. However, the merger wave would not be feasible if some element of natural monopoly were not present.

There is strong, though not unequivocal, economic evidence to suggest that the provision of local fixed-line telephone services is a natural monopoly and some evidence to suggest that there are economies of scope from the joint provision of local fixed-line services, mobile services and long-distance (including international) services.

There is, however, very little reason to suppose that these economies extend to the provision of telecommunications content, such as pay-TV and Internet services. The market for Internet services has historically been very competitive, and, in most countries, undertaken by fims other than telecommunications suppliers. Similarly, cable-TV services have normally acted as common carriers, rather than as suppliers of a bundle of access and content in Australia.

This picture has changed somewhat with recent mergers in the United States. However, these mergers have clearly been strategic, aimed at securing control of ‘choke points’ in the distribution network. The recent incident in which Time-Warner's cable subscribers were denied access to the Disney-owned ABC network following a commercial dispute is an indication of the problems that arise from the breach of the barrier between content and access.

Conflicts in governance

In the debates leading up to the partial privatisation of Telstra in 1996, advocates of partial privatisation maintained that no governance problems would arise and ridiculed the suggestion that a part-private, part-public Telstra would represent ‘the worst of all possible worlds’ in terms of governance. This view was repeated in 1998, though the selldown to 51 per cent ownership raised no issues of principle.

The government’s view has now changed radically. Treasurer Peter Costello was recently quoted (Australian 18/3/00) as saying that ‘ If Telstra is going to be caught in a position where it is half privately owned and half government-owned, I don't think that is going to be a good outcome. Telstra should all be either privately owned, or if people really think that nationalisation and government ownership is necessary they ought to have the courage of their convictions and nationalise it’.

The government’s handling of its status as majority owner of Telstra has been highly unsatisfactory. On the one hand, the relevant Minister, Senator Alston, has declined to use the majority public shareholding to direct the board to adopt policies that would benefit the Australian community where this might conflict with Telstra's stated objective of ‘maximising shareholder value’. On the other hand, it has been widely reported that Senator Alston used his influence to secure the appointment of a personal friend, Dr. Switkowski, as CEO. Moreover, Dr. Switkowski has openly urged his majority owner, the Australian public, to sell its shareholding, and public comment on his actions has frequently focused on its political usefulness, or otherwise, to the present government. Thus, Dr. Switkowski may be seen as having obligations to manage Telstra in the interests of any or all of:

The private shareholders of Telstra;

The Australian public, as the ultimate majority shareholders;

The Commonwealth government as the majority shareholder;

The relevant ministers as formal shareholders;

The Coalition parties as political allies; and

Senator Alston personally.
In this context, it is reasonable to describe Telstra as facing a crisis of governance.

Full privatisation of Telstra would resolve some of the present conflicts but would exacerbate others. Although the difficulties arising directly from government ownership of shares would be eliminated, the fundamental fact that Telstra, in its role as the dominant provider of universal service, is too important to be regarded as an independent private business would be unchanged. Direct government ownership would have to be replaced with more intrusive regulation of Telstra's performance than already exists.

A final observation in this context is that it is bad policy to deliberately introduce an unsustainable policy change, such as partial privatisation, in the hope that the resulting chaos will enforce the adoption of a desired radical reform, in this case, full privatisation. Yet on Mr. Costello's own admission, this is what has been done in the case of Telstra. Given the admission that the partial privatisation was undertaken on the basis of false or mistaken claims about the sustainability of this halfway house, the most appropriate response is to return to the status quo ante of full public ownership, then consider whether full privatisation can be justified.

Conflict of objectives

Telstra faces a basic conflict between the fiduciary obligation of its management to secure the best return possible for shareholders by all legal means, and the needs of the Australian community for socially optimal provision of telecommunications services. The conflict is particularly acute when it is observed that Telstra's management is obliged, among other things, to lobby governments for favourable regulatory outcomes. In particular, for any given set of community service obligations, Telstra's management is obliged to lobby for the largest possible CSO payment from government. Conversely, for any given payment, Telstra's management is obliged to lobby for the least costly set of service requirements. In particular, there is an inherent conflict between Telstra's stated goal of maximising shareholder value and the interests of telecommunications users in rural and regional Australia.

The conflict is exacerbated by the desire of Telstra management to pursue a strategy based on international markets for Internet services. In the context of this strategy, the only relevance of Telstra's Australian infrastructure business is its capacity to serve as a ‘cash cow’ to finance loss-making Internet ventures overseas. Partial public ownership provides a limited constraint on this kind of internal cross-subsidy. Full privatisation would exacerbate the conflict between the objectives of Telstra's managers and shareholders and the needs of the Australian public as a whole.

Resolving the conflicts

As Mr. Costello's comments, cited above, suggest, Telstra's current status is unsustainable. On the one hand, it is a natural monopoly provider of services that the majority of Australians want to remain in public ownership. On the other hand, its private-sector managers see themselves as constructing a global player in the market for telecommunications content. Clearly, the second goal can be pursued only at the expense of the first. Telstra is suffering from a conflict between two fundamentally different sets of roles, objectives and governance requirements.

Mr. Costello's comments also indicate there are only two feasible resolutions to the problem. Either Telstra's core services must be returned to full public ownership, or the entire enterprise must be privatised, with the inevitable result that the core function of providing telecommunications services to Australians will be reduced to the status of a cash cow used to fund the global ambitions of Telstra's management. Not only is the latter resolution undesirable, it is also unrealisable, in the absence of a Senate majority willing to support privatisation. Hence, Costello's argument points inevitably to the option of renationalisation.

The main problem for any policy of renationalisation is the need to take appropriate account of the interests of private shareholders. This does not mean that all such shareholders need to be rewarded with capital gains - the risk of loss is inevitable in purchasing shares, and buyers were given no assurance of full privatisation or rising profits. Nevertheless, it is, at a minimum, necessary that any acquisition be ‘on just terms’, as required under the Australian Constitution.

Fortunately, the high value attributed to companies involved in the ‘new economy’, provides a potential solution to this dilemma, even taking account of the recent market correction. Telstra's local, long-distance and mobile assets currently account for around half its market value. The other half, including pay-TV and Big Pond, is part of the ‘new economy’. The incoherence of Telstra's recent management is due as much to the internal conflict associated with the combined roles of content carrier and content provider as it is to the mixture of public and private ownership.

The breakup of Telstra into separate access and content enterprises would not only make good commercial sense, but would provide a simple route to renationalisation. Private shareholders could be offered two choices: either they could trade their existing shares for shares in the ‘new Telstra’ or they could offer their shares tothe government repurchase at a price equal to the average received in the two stages of partial privatisation. After disposing of any residual holding in ‘new Telstra’, full public ownership of the core telecommunications network could be restored without any net public outlay.

It would not be necessary to compulsorily acquire all the shares in the old Telstra to achieve the objective of renationalisation, provided the enterprise was returned to the status of a corporatised government business enterprise, with the clear understanding that it would be required to pursue the interests of the entire community where this might conflict with the goal of maximising shareholder value. Private shareholders who were willing to accept this objective could be guaranteed an appropriate return on their investment in the form of a flow of dividends and capital gains (through a public repurchase option) equal to the return on government bonds.

The desirability of breaking Telstra into separate access and content enterprises a has been recognised implicitly by the current management, in particular through the recent reorganisation into infrastructure and consumer divisions. However, the strategic decisions of the current management are distorted by their desire to facilitate full privatisation and maintain control of the lucrative monopoly components of the business. The correct division should be based on the separation of access (including all basic services to households and business) and content provision.

Conclusion

Telstra's current status as a partially privatised firm providing both natural monopoly telecommunications services to Australians and a range of telecommunications content services to Australian and international markets generates conflicts in roles, governance and objectives. Full privatisation of Telstra would resolve some of these conflicts but would exacerbate others. The only sustainable route to the provision of adequate telecommunications services to rural and regional Australia is the restoration of full public ownership of Telstra's core business - the provision of access to a comprehensive range of telecommunications services. This goal, though consistent with the objectives for which Telstra was originally established is inconsistent with the current vision of Telstra's managers in which the natural monopoly components of the business play the role of a cash cow, financing the creation of a global business focusing on the provision of telecommunications content.

The optimal strategy to achieve core policy objectives in telecommunications is the separation of Telstra into access and content enterprises. The access enterprise should be returned to full public ownership and the content enterprise fully privatised.