For more than a decade I have followed the trials and tribulations of New Zealand’s third mobile operator, 2Degrees. This story started at a time when regulation in New Zealand (or more to the point, the lack of it) very much favoured the incumbent operator, at that stage called Telecom New Zealand.
From the very early days we expressed our concerns about a third player entering the market at a time when mobile was close to saturation and a duopoly was in place that would make life extremely difficult for a new operator to become profitable.
In the early 00s, the earlier regulatory regimes having failed to produce significant levels of competition, many governments had started to change the regulatory environment to include more prescriptive rules – this to prevent the ‘gaming’ of the regulatory system by the incumbents. And the new investors were betting on similar changes in the New Zealand mobile market as well.
At that time in most EU countries, and in Australia as well, a third operator’s licence was either sold to the highest bidder or selected via a beauty pageant. Such an approach gave the government the chance to provide strategic directions to the market, which could be used to foster the national interest.
New Zealand never took that approach. Instead they sold raw spectrum with no operating conditions attached – government officials thought this free market approach would attract a deep-pocketed competition reaction. Instead it attracted some entrepreneurs from Econet in Zimbabwe, who started what would later become 2Degrees.
In order to develop a viable business the new investors tried to persuade the regulator to issue a third operator’s licence. However, there was never a clear indication from the regulator that they believed it was in the national interest to foster the success of a third player.
Meanwhile the country became one of the most expensive places in the world in which to make a mobile phone call.
After years of fruitless negotiations Econet sold out to a new group of investors – led by Trilogy, this became possible after the government published its Mobile Market Review Paper in 2006 which promised and suggested regulatory change. However, there was nothing prescriptive in this paper and the new investors never went back to the regulator demanding them to implement the proposed actions.
Trilogy started without any prescriptive commitments like a mobile phone license and embarked on a capital intensive infrastructure plan. By that time mobile penetration in New Zealand had reached 100%, and we seriously questioned their plans at that time.
Without any real commitment regulatory protection the two incumbents (Telecom and Vodafone) made sure that they would not allow the newcomer a profitable chunk of the market. There was consistent delay as the most basic inter-carrier agreements had to be argued in public and at length; every input was argued for many years. Unusually, instead of arguing for regulatory leverage and securing what was promised by the government in their Market Review Paper, the new investors just continued to invest.
Despite the fact that the government saw that the new player was providing lower prices that were heralded as being good for consumers, it stuck to its ‘non-policy’ and failed to provide the protection needed for the company to maintain its competitive business model. It never used its review paper to investigate what needed to be done to allow the new entrant to become financially sustainable. Although the company showed it was a large and credible investor it still had no licence to operate.
It looked as though the government saw the third player as any other normal commercial business and therefore decided to leave it to the marketplace, the management and the shareholders to come up with a business model that would allow them to become successful – even though the incumbents had nearly 20 years of monopoly profits to protect their comfortable duopoly.
The incumbents successfully lobbied against any intervention and ‘gamed’ the officials involved in this process. This has also became clear in more recent regulatory decisions, such as selling spectrum at such high prices that only suited the incumbents, and never facilitating sharing arrangements and co-location in the way the government promised in its Market Review Paper.
There are plenty of international examples and evidence that such facilitation could have made all the difference to 2Degrees. Taxpayer subsidies for rural mobile infrastructure went to the incumbents, even further strengthening their iron grip on the market. From a distance at least, it looks like the government was never really interested in increasing competition in the New Zealand mobile market.
That being the case, it has been an uphill battle all the way, as 2Degrees was obviously unable to build a viable business model. It was rather late in entering the New Zealand market and as such had no opportunity to build up a significant number of good quality subscribers, or to get infrastructure equality.
Nevertheless the company has provided great outcomes for New Zealand which have led to lower prices, better services and more investment also by the incumbents. However, now more than a decade later, 2Degrees is still unprofitable and floundering. As in 2015 also, the 2014 public accounts still showed a business losing over $2m a month.
While one could argue about the pros and cons of a third player for the national interest, it has been pretty clear from the very early stages that there was not a lot of support from the regulator to treat 2Degrees like some of the other countries had been doing with their third operators, especially those countries with similar (smaller) economies like New Zealand.
So, like it or not, in the end the buck stops with the investors. At the launch of 2Degrees we clearly stated in our analyses that, with 100% mobile penetration and no regulatory support, it would be up to the company to make this work and that relying on regulations that perhaps might happen one day would lead to a very weak underlying business model.
So, after holding out for all those years, where to go now for 2Degrees?
The controlling owners are private equity companies whose role in life is to make money, not look after the national interest. The largest one, Trilogy, while having a good reputation and substantial experience, also had problems in its other two mobile markets: Bolivia and the Dominican Republic. While they may sell other assets and stay in New Zealand for the long haul, it is equally possible that eventually they will simply cut their losses – call it quits and leave New Zealand. The questions then will be what will happen with the third operator? And is New Zealand happy to revert back to a mobile duopoly, or as Spark and Vodafone would prefer, keep a 3rd hamstrung player in the market so they can claim that New Zealand is a competitive market?
2degrees has some good assets of spectrum, cell towers, call centres, brand, service reputation and billing systems but any new owner will face the same problems of market dominance and lack of regulatory support.
The first trip of any potential buyer will be to the regulator, to find out what its position is on the preferred market structure for the mobile industry in New Zealand. Will it, for example look at avoiding investments in infrastructure duplication, or will it maintain its lacklustre approach towards a third player? Or does it see this as being in the interests of a balanced market structure? In the complex and ever-changing telecoms market it is the regulator who sets this structure and nobody else.
Obviously we are a decade further on, and the question that now needs to be asked is what can be done so late in the game? As mentioned, in most other countries with a third operator these companies were able to become profitable decades ago, so what hope is there for New Zealand’s third operator? Aside from developments in mobile networks there are now also city-wide Wi-Fi networks, 5G is around the corner, and low power wireless networks are entering the market for IoT services. So any company operating in the mobile market, but in this case 2Degrees in particular, will need to have a strategic rethink about where it wants to go from here.
As there is an infrastructure and spectrum deficiency between 2Degrees on the one hand and Spark and Vodafone on the other, any buyer will have to make significant investments in order to build the essential new infrastructure and buy the spectrum needed to lift the company out of its rather miserable financial situation (making a loss and being cash-negative). Any such investments need, of course, also to be viewed within the context of the New Zealand marketplace (size of the market, business and revenue potential, market maturity, geography, etc.).
At the same time the regulator will need to take into account the market structure in which Spark and Vodafone operate and their very significant legacy advantages.
But it is also not in the national interest to acquire a rich new player who, simply through its financial power, wipes out the rest of the industry. It is, however, in the national interest to ensure that a viable third operator maintains a challenger position, forcing incumbents into competing on price, service and infrastructure. In this respect the rumoured interest in 2Degrees of the Australian Vocus company does make sense. It is also in the national interest to deliver regulatory frameworks that limit the misuse of market power by the incumbent operators, resulting in higher charges and fewer innovations for the people of New Zealand.
In general, it is highly unlikely that the regulatory system of New Zealand is now suddenly going to be changed dramatically, and this will certainly place a strain on 2Degrees in a search for new investors who are going to invest in the company.
There is always the hunt for a fire sale when start-ups are not making money. The problem is that whilst telecommunication assets are expensive a fire sale often only attracts a fraction of the original value. However Trilogy has coped with this challenge before when, back in the day, early in the 90s, it solved some big problems in the McCaw Wireless Empire in the USA and delivered a financial Houdini outcome – can it do that again?
It will also be interesting to see what will happen with the Maori minority investment in the company, held by the Hautaki group. We haven’t heard much from these investors in all of this. Could they perhaps persuade the government to come up with a more supportive policy for whoever the next third player in the mobile market will be? They were very supportive of 2Degrees at the start, but where are they now when the company needs their help?
So, again, very interesting times for the telecommunications market in New Zealand. As one can read from the above it is a complex market with many different facets, all interacting in one way or another. Whatever happens, 2Degrees has added a range of good assets to the market, lowered prices for consumers and lifted the level of customer service. This is now the new reality of the market and the company has set the level for future customer expectation and both the incumbents and the potential new owner of the company will have to take that into account.