It has become an article of faith that mega-mergers reduce competition and harm consumers. “Four players good, three players bad,” almost has become a mantra for competition watchdogs. It would be a mistake if the Competition and Markets Authority were to blindly stick to this orthodoxy when it scrutinises a deal that has the potential to shake up Britain’s mobile telecoms sector.
In June, Vodafone UK and Three UK agreed to merge in a deal that would create Britain’s largest mobile phone provider, ahead of EE and O2. If the deal is blocked, it risks consigning Britain to the digital slow lane.
Inevitably, there are fears that the merger will lead to customers paying more, but the particular characteristics of this networked industry suggest that pricing is just as likely to fall as it is to rise. Unlike most mergers, this combination would lead to a significant increase in supply, with the merged companies’ combined mobile spectrum deployed over a deeper and extended network.
The supply side is important in the mobile industry, given the high fixed-cost nature of that supply and hence a very low marginal cost for carrying new business. Already the operators compete aggressively for this incremental revenue and they’ll have to compete even harder to fill those higher-capacity networks in future.
Perhaps the area where they are having to compete most intensely right now is in attracting the business of the mobile virtual network operators, or MVNOs, such as Sky and Lycamobile, which don’t own their own networks but control about 17 per cent of the subscriber market. These can negotiate increasingly favourable rates from the network operators, given the network operators’ low marginal cost for new business and the MVNOs’ ability to move their subscribers between networks fairly readily. These MVNOs will benefit from the network operators fighting that bit harder to win incremental business in an even higher-capacity industry.
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Arguably more important than the outlook for pricing is that of network quality. Those network operators with low market shares can afford to fund only a certain level of investment — and an inferior network quality drives low market share, entrenching the challenging positions of the smaller players. This self-perpetuating dynamic has led to Three UK reporting negative cashflows in each of the past three years. Meanwhile, Vodafone UK generates a return on capital of about 2 per cent, considerably lower than the rate it could earn in a risk-free deposit account.
These lamentable financial returns may have damaging economic consequences. Three and Vodafone have neither the incentive nor the means to invest fully in the next generation of mobile phone services, while O2 and EE do not have the pressure of lower-tier competitors pushing them to invest more aggressively.
After a promising start, Britain is now lagging behind other developed economies in rolling out 5G. If Vodafone and Three are allowed to wither, Britain will fall even further behind, losing out on associated economic benefits and productivity gains.
By combining, Vodafone and Three would eliminate the significant costs of duplication, allowing them to earn a combined return close to their cost of capital and to focus their investment on a single, considerably enhanced nationwide 5G network, spurring their larger competitors, in turn, to invest more in their 5G networks.
Mobile phone networks are increasingly expensive to build and maintain and, regardless of the number of players in the market, owners have to continue to strive to fill capacity on their networks, rather than restrict it. With the enhanced capacity the merger will create, the operators will have to fight even harder for customers — through their own brands and via MVNO wholesale deals. The need to defray large fixed costs and the associated low cost of marginal business makes for an intensely competitive market and sets the telecoms industry apart from many other sectors. That is why four into three should go. In this case, less is more for consumers.
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Karen Egan is senior telecoms analyst and head of mobile at Enders Analysis
