BT's divisional FDs: Peter Cross, Karen Witts & Tony Chanmugam

“We describe it as changing the engines of a Boeing 747 while it’s still
flying,” says Peter Cross, chief financial officer of Openreach, the new
division created by BT Group in response to regulator Ofcom’s review of the
telecoms sector.

Cross is describing the previous six months of hectic restructuring that’s
been taking place within the group. Beside him sits Karen Witts who, as chief
financial officer of BT Wholesale, has provided 15,000 of Cross’s mostly
engineer-based staff.

Joining the party by conference call is Tony Chanmugam, chief financial
officer of BT Retail, the group’s biggest division in terms of revenue, which
has also provided Openreach with 15,000 of its engineers.

The previous six months of change at BT has seen one of the most fundamental
overhauls of a group’s infrastructure in British business history, never mind
BT’s. The three finance directors played varying, but, in each case,
significant, roles in this, ensuring that BT Group avoided a Competition
Commission inquiry, which would almost certainly have led to its forced break
up. Instead, a tome-like list of 230 undertakings were drawn up by BT and,
following a lengthy period of consultation, agreed with Ofcom. The results offer
a fascinating insight into the workings of a regulated industry and why heavy
regulation is so often needed.

The late American libertarian political thinker, Robert Nozick, was clear
where he stood on the impact regulation had on free-market economies. “The
trouble with government regulation of the market,” he said, “is that it
prohibits capitalistic acts between consenting adults.”

Ofcom is certainly guilty of prohibiting certain capitalistic acts being
performed by some of the BT divisions ­ Chanmugam is quick to point out that he
could achieve much better prices from alternative suppliers if the heavy
regulation was not there. But the telecoms sector is a unique space. Because BT
owns the last mile of cables to the customer (known as the local loop), some
regulation must exist to ensure they do not use this to their advantage
unfairly.

Over the years, BT has been on the receiving end of numerous accusations over
price-fixing and obstructive behaviour. Competitors would often complain that BT
Retail enjoyed an unfair advantage on both price and access to service
engineers. Strict regulation was therefore necessary to provide a level playing
field, and the 230 undertakings published by Ofcom in September are the
culmination of that. In time, it is hoped that Ofcom can reduce its regulatory
hand-holding of the sector and true free-market conditions should eventually
take over.

The undertakings cover details of such a granular level as the access that
BT’s competitors should have to engineer appointment books; how Openreach should
control its assets and what those assets are; who Openreach should employ; the
reporting lines to the BT Group board; suitable levels of capital expenditure;
how Openreach’s financial statements are laid out; and even remuneration and
incentive plans. Although initially drawn up by BT Group itself, the
undertakings were published for consultation. And BT’s rivals did not hold back.

“There should be no reference at all to BT in the Openreach brand,” said one
respondent. “The conditions relating to incentive remuneration should be
expanded to include pay rises,” said another. Several of BT’s competitors
insisted that a Chinese wall approach to separation did not go far enough and
full structural separation should have been pursued. Thankfully for BT, Ofcom
disagreed and viewed structural separation as overkill.

Separation speculation

Despite this, some sections of the media continue to speculate that Openreach
will eventually be separated from BT Group and be handed its own FTSE listing,
but it is a rumour that Cross rules out. “Nobody is addressing that question,”
he says. He goes on to say that because there is no corporate entity being
created, there are no tax issues for him to address and the property issues were
also at a minimum. It offers pretty conclusive proof that Openreach will remain
within the Group. Instead, BT and Ofcom decided the best way to create a level
playing field was to introduce a series of Chinese walls between the separate
operating divisions of the Group. “It’s a mammoth task, but not one that’s
impossible,” says Cross.

The first stage was to move 15,000 engineers each from BT Wholesale and BT
Retail over to Openreach. The entire fleet of vans will be re-branded and BT
engineers, by name at least, will cease to exist. Instead, Openreach engineers
will visit your home or business premises to upgrade or repair your equipment.
The one-off transition cost incurred by BT Group reached £70m.

While moving the engineers across was a “fairly smooth transition” the
business units within Retail and Wholesale had to be significantly restructured
as well. “Three units from Wholesale are coming under Openreach management at
the same time,” says Cross. “We’re also reorganising how that whole new team
operates, so instead of having four units within Openreach we’re blending them
together and fitting them into one unit, getting rid of the old walls. So it’s
quite complicated and it requires a lot of planning, reorganisation of
management structures and reorganisation of where the accounting is captured and
pointed.”

The whole restructuring has been a significant challenge to all three FDs.
“The strategic review has been taking place over about 18 months,” says Cross.
“We didn’t start working on understanding how the four units would inter-operate
until close to the end of the negotiations of the undertakings. So probably
about six months we’ve been working on it now.” He goes on to describe the
process, somewhat understatedly, as a “complicated and difficult process”.

But while the restructuring is a serious challenge, it actually holds
significant benefits to BT as well. Not least of these is that by creating
Openreach it will move much of the regulator’s gaze away from the remaining
parts of BT Group. “We put the economic bottle-neck assets, i.e. the network,
into Openreach,” says Witts. “That’s where the regulator will now focus its
attention and it will very much defocus attention from the rest of BT.”

Clearing the bottlenecks

It is a comment backed up by Andrew Heaney, the competition policy director
for broadband at Ofcom. “Ofcom’s review identified some enduring economic
bottlenecks where regulation is likely to continue to be necessary,” he says.
“In particular, this refers to parts of the fixed telecoms network, which BT’s
competitors cannot fairly replicate. One objective of the review has been to
focus regulation on these areas. The equality of access approach targets a level
playing field for competition, which will make it possible over time, to remove
regulation in other areas where such bottlenecks do not exist.”

All three finance chiefs have approached the Ofcom undertakings as an
opportunity for BT Group to streamline its business. “When I described the four
units coming together, and us dissolving the old wall around those four units,
that’s very important. That’s been done for operational reasons, and we’ve
described it as an outbreak of common sense,” says Cross. “So we think that it
makes real economic and operational sense for BT and our customers.”

Despite the enthusiasm shown by the three finance chiefs for the rulings and
the impact they will have on each of their businesses, there is no doubt that
they will be difficult, restrictive and in some cases uncompetitive to abide by.
In mid-December, Ofcom looked to increase competition in the Wholesale market.
It did so by increasing prices. So, from the beginning of this year, line rental
for BT Together Option 1 customers will rise from £10.50 to £11 and the price
that BT wholesale must sell those lines to its competitor telecoms providers was
reduced from £9.24 to £8.74. Running a business of the size and complexity of BT
is difficult enough and it is not made any easier when a third party is able to
change prices. 4BT Retail’s Chanmugam believes his division would be able to
negotiate far better deals with suppliers, for example, if the Ofcom
undertakings were not in place. “If this was a true open market operation that
didn’t have any regulatory restraints in it, in my view the level of prices that
Retail would get would be lower than we would currently get under a regulated
environment, simply because economies of scale are not allowed to impact,” he
says.

Chanmugam is looking for free market pricing to be re-introduced as soon as
Openreach is “well embedded”. While he is resigned to the fact that it won’t
happen immediately, he is hopeful that it could be reached in 12 to 18 months.
It was something that Heaney would not be drawn on, other than to confirm that
the regulatory barriers would be removed “over time”.

Ensuring that BT and its divisions abide by the undertakings is hugely
important, both to ensure that the sector develops as it should and that
competition is upheld. For that, BT has agreed to establish the rather
Orwellian-sounding Equality of Access Board. Comprised of three independent
members (Sir Bryan Carsberg, Stephen Pettit, and Dr Peter Radley), a BT senior
manager (Sally Davis) and its chairman (Carl Symon), who is also a BT Group
non-exec, the EAB is tasked with overseeing the implementation of the
undertakings, but will remain within BT, a decision that ruffled some feathers
among BT competitors.

Monitoring BT

“The role of the EAB is a general one of monitoring, reporting and advising
BT on BT’s compliance with the undertakings,” says Ofcom. But should a series of
KPIs that relate to the undertakings not be met, then the EAB must inform Ofcom
within 10 working days and, if need be, an action can be brought in the High
Court, according to Heaney.

As Stephen Carter, Ofcom’s chief executive, said on the day the undertakings
were agreed: “The new approach will allow different parts of the UK telecoms
market to make investment decisions with greater certainty about the nature and
impact of regulation. Alternative telecoms carriers can consider different
investment options with more confidence that they will be able to compete with
BT on a level playing field. BT will have greater clarity about the future
impact of regulation on their business.”

Although there is still debate over whether the undertakings have added
unnecessarily to the complexity of the sector, with opponents arguing that full
structural separation should have been pursued, all three FDs are confident that
they can work within the remit of the undertakings.“There are still a lot of i’s
to be dotted and t’s to be crossed in terms of some of the internal trading
flows within Wholesale, Retail, Openreach and Global Services,” says Cross. “But
the broad shape of the thing is getting clearer.”