European telecoms regulation

Fair share: the definitive guide

 The Internet is wrong

  1. The European “fair share” debate

EU commissioner Thierry Breton (formerly CEO of Orange) is pushing for a legislative reform of the telecom sector that could materially change the functioning of the Internet. The reform, labeled with the persuasive name of “fair share”, aims to regulate investment costs in telecommunications networks, introducing a sort of mandatory cost sharing system amongst operators. The cornerstone of the new approach would consist of an Internet traffic pricing mechanism whereby major global Internet operators, the so-ccaled “Big Tech”  would have to provide telecommunications operators (“telcos”) with a sort of fee for the passage of Internet services on their networks. Obviously there is nothing official on the point but Commissioner Breton’s tweets as well as Commissioner Vestager’s statements suggest some major developments, the impact of which on the functioning of telecommunications and the Internet could be considerable, with significant consequences not only for operators but also for users and their rights. Consumers and civil rights associations, as well as politicians more sensitive to the issue, have already mobilized, fearing in particular risks for net neutrality. The proponents of fair share are however going ahead, because they consider this reform to be an essential tool to achieve the European connectivity goals of 2030. But let’s go in order, also in light of the public consultation that should be adopted in the beginning of 2023.

The fair share proposal stems from a stubborn debate fueled, since 1996 in general and with a historical confrontation at ITU in 2012, by some large European telcos which are part of the ETNO and GSMA associations. According to them, major US online platforms should pay for the transport of their services through the European telecommunications networks that connect them to users. “They use our networks and must therefore contribute to the costs” is the slogan of the proponents, who recall data according to which 50% of global Internet traffic is attributable to a few online operators, in particular Netflix and Google. The mechanism proposed by the telcos is the so-called “Sending Party Network Pays” (SPNP), in practice the model according to which the network from which Internet traffic is sent (an email, a file, a video streaming) must pay a fee to the destination network – exactly to what happened 20 years ago when you made a phone call with old technologies.

According to the fair share proponents, the contribution from the large Over the Top (hereinafter: “OTT”) would constitute a fair remuneration for the use of their networks by Internet operators who take advantage of them to reach the users to whom they sell the services. The proceeds of the fair share would therefore remunerate European telcos, whose earnings and profitability margins have been declining over the years, unlike some Internet operators who instead have become global champions in terms of turnover and market capitalization. These additional resources would be used by European telcos to finance the development of new very high-speed networks (above all in optical fiber and 5G) necessary to support the constant increase in Internet traffic, also in view of the new goals of the digital ecosystem (Metaverse, Quantum Computing , Artificial Intelligence, ecc.).

So far the discussion seems linear and arouses sympathy. However, by analyzing the fair share theory in more depth, and in particular looking at the proposed mechanism of the SPNP, inconsistencies and contradictions emerge. In addition, it appears that the proposed model is poorly suited to the market-based Internet ecosystem, in which IP traffic flows across networks without regulatory intervention. It is no coincidence that the Internet technical community has shown itself to be skeptical, if not even opposed, to the fair share theory. Even more, the European agency BEREC, which brings together national telecommunications regulators, has issued a preliminary opinion which is already intrinsically negative, pointing out that, rather than encouraging investments, the SPNP model “would simply lead to large players exploiting the last-mile telecom bottleneck to increase monopoly profits”. For similar reasons and competition concerns, ACT, the European association of commercial broadcasters, MVNO Europe (the association of mobile virtual operators) and Euro-IX (the European association of Internet Exchanges) declared themselves against it.

2. Vices (many) and virtues (few) of the fair share theory

Who uses whose networks?

This is precisely the starting point for understanding the validity of the fair share theory: who is paying for the transport of Internet services to users, whether it is a Netflix, Canal Plus or Dazn streaming service, a shared service or a search on Google? The answer is simple: it’s the users. To put it in the words of an authoritative neutral and independent expert, namely Frode Sorensen, president of the Norwegian regulatory authority: “End-users request the content and pay for the transfer of the content”.

Therefore, it is not correct to say that OTTs, including the large online platforms, are “using”  telecom networks of others; instead, one should state that telcos are providing these networks to their customers to allow them to access the Internet services they prefer. Users pay for this transport service to the telcos through their Internet subscription. The idea of making OTTs to pay for the so-called “usage” of the telecommunications network is therefore an expedient to get a double payment for the same transport service: first from the user, and then from the OTT. Incidentally, from a commercial point of view the double payment could also be agreed upon – the problem is whether to impose it by law as the proponents of the fair share would like. This is the cornerstone of the fair share proposal: since the market practice does not recognise such double payment, then telcos needs to obtain a legal basis to justify this pretention.

Paradoxically, innovative Internet services are essential for the roll-out of new (optical fiber and 5G) networks, as telcos often complain that new infrastructures remain unused because the users are stuck on the old ones (copper or 4G). Indeed, the best way to facilitate such migration is precisely the availability of increasingly attractive Internet services for users. Therefore, such services should be considered as drivers for telecommunications investments, not obstacles. In other words, telcos and online platforms find themselves in a mutually complementary situation where each needs the other, rather than in a supplier-customer relationship.

Who invests more in the digital ecosystem?

Proponents of fair share have produced numerous studies that quantify investments made by telcos in the telecommunications sector, even going so far as to specify the share that should be “repaid” by some large OTTs on annual basis. The latter were not long in coming and responded with a series of studies which show that they too invest heavily in the Internet ecosystem, not only in terms of data centres, technology and content, but also in the telecommunications networks themselves (in particular transport networks, submarine cables and satellites). An independent study commissioned by the German regulator BNETZ has highlighted how the telecommunications networks of the Big Techs are expanding more and more, while the traditional telcos are withdrawing and maintaining control above all of the local networks, in particular of the last mile which remains essential for connecting end users. In other words, in the global infrastructure market the balance of power is changing, so much so that the fair share seems, more than a simple request for compensatory measures, a rearguard battle by an industry, that of the telcos, which is getting slowly marginalized.

In any case, irrespective of the quantification of investments made by each operator, it seems difficult to justify the fair share theory simply on the basis of a mere list of costs. All operators invest according to their business model and it would be misleading to consider only some investments as worthy of consideration. The theory of fair share is in fact centered on access networks and missing the point that the digital ecosystem is broad, since it includes also the development costs of services (for example software and TV series), the international transport (submarine and backbone cables), data centers (for the cloud and for data management) at least – all these investments being interconnected and complementary. In such a complex scenario it is up to the operators to negotiate transport and interconnection costs in the myriad cases that may arise, given that there are thousands of interconnection relations, and often agreements are only verbal ones; however, it does not seem sensible to replace this composite and articulated commercial system with a rigid top-down regulation only because some players feel they can’t trade conveniently.

Symmetry and asymmetry of the Internet traffic

The fair share proposal also arises from the observation that Internet traffic is not equally distributed and instead it follows certain tracks (mostly from content providers to telcos) normally causing an imbalance in traffic, whereby telcos receive much more traffic than they send out. Indeed, this asymmetry is nothing unusual in the Internet sector. Telcos tend to have more inbound traffic because their users require “heavy” services, such as streaming and live shows, and they don’t produce as many. Symmetry was more natural in the old telephone world, where call flows between operators occupied in both ways dedicated resources. However, the Internet is different from telephony: networks put in contact operators that are different and complementary at the same time: they are different because some, the OTT, send out Internet services, while others, the telco, host the customers receiving these services; but they are also complementary because telcos cannot build and sell connectivity without these services requested by the final users. Of course, telcos could produce services by themselves and this what happened for some time, when the market was stagnating with offers limited to expensive voice, fax, sms, MMS and stupid ringtones. This was the Golden age of telcos. Then, at the end of ’90, users found out that Internet could offer much more than MMS and ringtones: e-commerce, music, social, videos, a world of fun that telcos were unable to provide. From this moment onward traffic asymmetry in the market became normal and it is no coincidence that the Internet access service was (and still now is) normally sold to users with a greater capacity in reception (download) rather than in emission (upload). Users were interested in services provided by Internet operators and requested telcos just to supply affordable and rapid connectivity to get them.

The above reasoning does not prevent telcos from asking for compensation if the incoming traffic of OTTs is abnormal. In reality, however, this rarely happens, because telcos have a primary need for the OTT services required by their broadband users. What is the use of an Internet subscription if not to take advantage of Internet services, especially the most sought-after ones and with the best possible quality? The payment cases normally concern the so-called interconnection kits, the costs of which are constantly decreasing as indicated in the annexes of this WIK study. Payments can also occur when IP traffic is not delivered directly to the destination network, but delivered to a carrier for transport or transit service. In short, the IP interconnection market has always worked on a commercial basis, which is why the idea of intervening with top-down regulation, just because some operators believe they are unable to negotiate in a convenient way, creates confusion for many.

A competition problem?

Commercial relations between OTT and telcos are normally based on the idea that anyone is responsible for its own infrastructure and bears the related costs: a content provider, for example, bears the production costs of its services as well as the routing of the same through its own data centers, networks and CDNs, all up to the point of delivery (the interconnection point) of the service/signal to the telco, which, on the other hand, is responsible for the costs of its own network, including access up to the customer.

The critical boundary is therefore the interconnection point between OTTs and telcos: there the parties should negotiate the price of delivery the IP traffic and, in the absence of an agreement, the interconnection does not take place. Then the “rejected” operator will normally deliver (for a price) its traffic to a transit carrier which will then better negotiate with the reluctant telco. Some telcos have told me and others that they cannot refuse interconnection, and therefore are forced to interconnect for free, because of net neutrality rules, but this is a fake news: operators are free to refuse interconnection for commercial reasons, unless they are dominant (and then competition rules apply). NB: interconnection is only mandatory for voice, not for data.

In IP interconnection markets, therefore, operators are not expected to charge the others for transport costs but – to tell the truth – there is not even a rule that prohibits it. Such commercial practices are not widespread because they are not recognised by the market. However, one could argue that such practices are imposed by dominant OTT as a result of an abuse of dominant position but, in that case, you would also expect a copious competition case-law showing that the main victims, i.e. the large telcos claiming for the fair share, are bringing such legal affairs in front of antitrust authorities. To the opposite, there is no such significant jurisprudence and, instead, it looks that some dominant telcos are putting in place restrictive practices towards smaller subjects, denying or charging smaller operators for interconnection (the so-called depeering, which occurred at least in Italy and Germany). As regards OTTs, they typically interconnect for free with everyone, without discriminating between large or small counterparties. To sum up, the market looks competitive with the exception of some potential abuses made by telcos, and not by OTTs. The pretention to regulate to protect the interests of some large telcos  sounds therefore hazardous.

It is just a problem of negotiation?

Interestingly, an important argument made by the fair share proponents consists in claiming that big OTT do not accept to sit and negotiate, therefore the fair share proposal substantially would aim at “encouraging” parties to negotiate and agree. However, this argument does not reflect the reality of the IP interconnection market, where thousand of agreements take place each year under commercial terms. In addition and as mentioned above, there are no evidence of market failures affecting this market, because the telcos themselves have not been able to claim significant antitrust cases (Deutsche Telekom has only recently announced to have sued Facebook in Germany).

The better understand, the “negotiation” argument seems to work in this way: big telcos considers that “termination” of the Internet traffic (meaning the transportation on their network) should be added on top of normal IP interconnection arrangements. Since the business practice does not recognise that value (because transportation over the telcos’ network has been already paid via the user’ subscription), telcos are trying to obtain a regulatory basis for that and, in case an agreement is not found that way, there should be a dispute resolution mechanism.  But what should be the price to be applied by regulators or courts? This is a dilemma, because in the absence of a commercial practice recognising this value, the price should be a political decision –  something which may increase the risk of competition distortions.

To sum up, the “negotiation failure” argument should be correctly read as “OTTs do not accept our terms” rather than as “they do not want to negotiate”. This request for regulatory help echoes the mechanism recently introduced by art. 15 of the  Copyright Directive 2019/790 reinforcing the contractual power of  publishers willing to negotiate ancillary rights with online platform – a controversial rule that has probably inspired the “negotiation argument” of the fair share proponents. However, the European Copyright directive does not go so far to impose a payment to be quantified through an appeal litigation. This is instead the effect of a similar copyright legislation enacted in Australia, where publishers have be entitled to be paid by OTT’s even in the absence of an agreement, namely via a judiciary settlement. This is probably the mechanism copied by the fair share proponent.

Is the fair share tax necessary for investments?

Indeed, it is doubtful whether such a tax is necessary for investment in the fixed sector. Many independent voices underline how investments in optical fiber are already in an advanced stage and, furthermore, there is a considerable availability of liquidity in the market from funds (both infrastructure and equity). Furthermore, big telcos themselves, when they report to investors, show a much rosier picture of the situation and it is therefore difficult to argue that the additional proceeds are needed for these types of investments. For the mobile sector, by contrast, the situation appears more complex, above all because it is not clear whether the mass market is willing to pay a higher price for 5G so as to justify the investments. Thus, the problem here is identifying a proper business case for 5G, rather than financing these networks, at least as far as the mass market is concerned. Given this uncertainty, it seems questionable to impose the compulsory financing of such networks on private individuals.

It has also rightly been pointed out that telco companies still have to build networks, since it is their core business, and that the cost of these networks is scarcely sensitive to the increase in IP traffic. So, once networks are built, the increase in IP traffic could not justify a fair share tax.

But the major objection to the “investment argument” is that fair share proponents remaining vague about the destination of the tax proceeds, in other words they are reluctant to set up an incontrovertible procedure to bind these resources to investments in new networks. The fair share model proposed by the European telcos envisages that the contribution of the OTTs ends up in the coffers of the companies, which could then use them at their discretion, therefore not only for investments, but also for other purposes (dividends, salaries for top managers, reduction of retail prices, investments in content, etc.). Here we could be faced with a potential distortion of competition, rather than an incentive to invest.

Furthermore, there would be the problem of operators who have already made and planned investments in fiber and 5G, without any support from the fair share tax. Paradoxically, these operators would be penalized for being the quickest to invest, while those who hesitated as long as possible, keeping the old copper and old-generation mobile networks running, would be rewarded.

How a fair share tax should eventually work

Thus, the investment argument is weak. To make it credible, it would be necessary to conceive the fair share tax in a different way than imagined by the proponents: the fee should be collected by public authorities and then distributed as public funds. This mechanism would ensure that these resources are spent only where they are actually needed, in compliance with state aid rules, and are not used for improper purposes, in particular to distort competition.

Furthermore, the taxation of OTTs should take place on the basis of objective and credible criteria which have to be technically consistent with the functioning of the interconnection market. Certainly not with the implausible argument of the “use of the networks” but, if anything, it could be argued that certain large OTTs should contribute more to the well-being of the European digital ecosystem, taking into account the revenues they derive from there and the effective taxation to which they are subjected.

3. The possible consequences of the fair share tax

In conclusion, a regulation obliging operators (OTTs or others) to pay a sort of Internet termination fee to reach customers hosted on telco networks does not seem justified as it would upset a market that does not need such a regulatory intervention. However, one may wonder what the specific practical consequences might be.

The consequences for the market

The IP interconnection markets would be impacted in various ways: OTTs opposing the fair share tax fair could decide not to deliver their services within the EU anymore and they would route it abroad, with the consequence that digital services would move away from the users, losing in quality and security. Such a consequence can already be seen in South Korea, where a sort of fair share regulation has already been in force since 2016: foreign OTTs have in fact started peering abroad, preferably in Japan or Hong Kong.

Furthermore, it would become much more complicated to peer due to the administrative accounting of traffic that is implicit in the fair share model, upsetting a market where instead traffic is normally exchanged with simple or even verbal agreements. The choices on the interconnection methods would no longer be dictated by private initiative, i.e. by commercial, technological and security interests, but by the need to adapt to the fair share regulation.

Competition could be distorted because some operators would be subsidized without any obligation to allocate such additional resources for investments in networks. The fair share tax could even be used to finance aggressive pricing.

The consequences for consumers and for net neutrality

Probably the higher cost of the fair share tax would at some point be passed on by OTTs to consumers, causing an increase in the prices of certain services. But this would not happen automatically, it is a choice of the OTTs which, moreover, are currently already increasing their prices for other reasons. However, some OTT would not be able to pass the increased costs to users, because of their business model, and in that case they could be forced to reduce the quality of the service or even to stop it, as it happened to Twitch in South Korea.

It has been discussed whether the fair share tax could violate the principle of net neutrality, in other words the freedom of users to choose and use Internet services without discrimination or constraints. Indeed, studies in favor of fair share represent telecommunications as a “two-sided market“, in practice an intermediary market between users and services. If this were the case, the risk of violating net neutrality would be very high.

However, at the moment this question cannot be answered in the absence of more precise information about the functioning of the fair share tax. The danger may exist should the tax work in a way to allow certain telcos not only to charge OTTs, but also to make certain Internet services more or less accessible compared to the basic “best effort” Internet offer, and without objective justifications. If, on the other hand, the fair share tax worked on the basis of objective parameters and without affecting the choice and accessibility of services by users, then the danger to net neutrality would be less or simply potential.

It must be said that proponents of the fair share tax have always publicly declared their intention to respect net neutrality. However, in the informal discussions in the corridors of Brussels it is perceived that net neutrality continues to be the regulatory framework most disliked by the large telcos, which would instead like to have the freedom to select and differentiate the contents accessible by users. So, the high attention from consumer and civil rights associations is understandable.

4. Fair share and the crisis in the telecom sector

The telecom crisis

The fair share debate arises from a major political issue regarding the functioning of the digital market, rather than from an investment disfunction. The frustration of some large European telcos pushing for the fair share tax essentially derives from the fact that the value chain of the Internet ecosystem has changed over time and for some operators it no longer appears fair, because it rewards more, in terms profitability, global OTTs that have become dominant in certain sectors or market niches, while telcos’ earnings tend to vanish due to price wars and the national patterns of telecom markets. In other words, for some large telcos the fair share debate constitutes a way to recover margins and profits, at the expense of some rich gigantic Internet companies, but without addressing the structural problems of the telecom sector, i.e. the rising costs, on the one hand, and the inability to set retail prices at an affordable level, on the other.

The subject of the “telecom crisis” is in any case controversial because this issue is not the same for all, as in the unhappy families of Anna Karenina: the financial situation of the major proponents of the fair share, i.e. Deutsche Telekom, Orange, Telefonica, Tim and Vodafone it is very different, between those who still make significant profits and those who are crushed by debt. The only point in common is the aspiration to obtain a part of the proceeds of big OTTs. It is not surprising that various European telcos have remained silent on the issue of fair share: some of them may not be convinced by ETNO’s and GSMA’s campaign, but nonetheless they are ready to exploit the opportunities, while others have taken sides against it: this is the case of smaller operators which see a danger in the fair share debate, to the extent that these relative proceeds could just be sued by some large operators to distort competition (by doing aggressive prices campaigns), for instance).

Something is wrong with the Internet, but the fair share theory does not address it

Irrespective of the validity of the fair share theory, the fact remains that the Internet ecosystem does not reward investments and market positions in a proportioned way, with this discrepancy being well represented by stock market capitalisations, where many OTTs normally reach much higher figures than those of traditional industries, including telecoms. But this is due, also, by a geographic factor: OTT are global players, while telcos are mostly local. And, to be precise, one should not believe  that the Internet is synonymous with success for everyone: most of the telcos that have tried to sell Internet services have not been successful, and many start-ups have gone bankrupt. On the other hand, it is rare to read of telcos that went bankrupt selling their traditional services (apart from international carriers during the Internet bubble of 2000).

Thus, something is wrong with the way the internet ecosystem produces wealth but, once the initial “skimming” has passed and setting aside the victims, at that point it produces an immense wealth for those who have reached the end. This is, however, nothing new to remark, especially when looking at the social and remuneration inequalities that have arisen from 2000 to today. “Capitalism is broken!” should big telcos shout, however they remain careful because their goal is just to receive a regulated subsidy, rather than reforming the system. The fair share theory does not address the issue of competition in online markets and does not prevent some OTTs from becoming bigger and bigger, so as to reach market capitalizations that equal the GDP of some sovereign states. Dominance provides such giants with formidable negotiating powers susceptible to alter normal commercial relations. However, unlike the fair share theory says, this is a problem mostly for small operators, not for large telcos, since the latter usually manage to win the best commercial agreements with US OTTs, as the cloud markets shows: large US providers have all partnered with large telcos.

The European Union has acted late against the effects of economic dominance of global OTT and has finally adopted the new competition rules of the Digital Market Act (“DMA”) which should, or at least try to, reinstate competition in the online market. However, irrespective the DMA will work or not, it would not be appropriate to use this new competition framework to address the fair share concept, given that this theory, in the intentions of proponents, does not aim to rebalance the power in the digital ecosystem, but only to subsidize some operators.

5. Conclusions

The fair share theory, implemented in particular with the SPNP mechanism, is technically problematic, because the idea to charge operators with an Internet termination is a political invention, without economic or competitive justification. This mistake could cause numerous collateral damages, upset markets that have always functioned correctly on a commercial basis, distort competition and undermine users’ rights from various points of view, including net neutrality. And there is no guarantee that the fair share tax could actually be used for investments in new fiber or 5G networks.

However, opening a debate about the opportunity for a greater contribution of the US Internet giants to the European Internet ecosystem should not be a taboo: Europe constitutes a huge market for them and there is a perception that they extract formidable profits from it, even as a result of the imperfect functioning of tax regimes vis-à-vis multinationals.

However, this potential contribution should be assessed on the basis of objective and credible criteria, respectful of competition and the functioning of digital infrastructures. It would not be permissible to create a regulated subsidy on selected operators. If anything, the fair share could be used to feed a state fund for the development of next-generation infrastructure (fiber and 5G).

In any case, a fair share tax will not cure the c.d. telecommunications crisis, nor can we expect global OTTs to come to the rescue of telcos to curb the sector’s decline in terms of profits, turnover and capitalization. Above all, greater commercial cooperation will be needed between telcos and OTTs, rather than a regulatory war, and provided that technological sovereignty and antitrust rules are respected. For the rest, the telcos will have to cope alone, experimenting new business models (for example network sharing or network separation), launching new innovative data-driven services (in the field of IoT, cloud, system integration and 5G) and possibly stopping the price war that has burned the value of the market.

The fair share debate will therefore continue, but perhaps we should think whether the reference to “fairness” is really and still appropriate. The big European telcos that coined the term are multinational companies listed on the stock exchange that make profits and distribute dividends. They are not used to apply “fair” prices to competitors and abhor any form of regulation, invoking the supremacy of the free market. Frankly, it is not clear why in cases where they are unable to achieve their commercial objectives under market conditions, then free market rules should be suspended and replaced by a fairness principle. As observed by a colleague of mine, it is interesting to see how the concept “you must co-finance my business without any legal basis” and “I don’t want my customers to pay a fair price for the product they purchase” has  degenerated into and been labeled with the euphemism “fair“.

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