European telco 'fair share' case looks ready to collapse

With his clipped German accent, Timotheus Höttges is unmistakably European. But Deutsche Telekom, the operator he manages, is these days mostly American, earning nearly two-thirds of revenues from its T-Mobile US business on the other side of the Atlantic. Its investment there explains why Deutsche Telekom outperforms Europe's other big telcos. And Höttges has few nice things to say about the continent of his birth. Markets are overly competitive, spectrum policy needs fixing and Internet giants don't make a "fair contribution" to the cost of the traffic they generate, he complains.

It seems to have escaped Höttges' attention that fair contribution or "fair share," as he and other telco bosses now call it, does not exist in the US, either. Indeed, the US is now moving to the opposite extreme of "net neutrality," which outlaws any blocking, throttling or paid prioritization of Internet traffic. The issue is a hot potato there, tossed back and forth between telco supporters on one side and "open Internet" champions on the other. Either way, it has made no difference to T-Mobile's stellar performance.

Höttges is by no means the only fair share grumbler. A coalition of telco CEOs this year signed a petition effectively urging Europe's political leaders to get tough on freeriding Internet giants. Disappointingly, the European Commission seems in no hurry to act before a new administration takes over in the mid-2020s. "We've seen the fair share debate get pushed out," an exasperated Höttges told analysts after Deutsche Telekom had just published its recent third-quarter results.

The telco premise is that inexorable growth in data traffic, generated by a cohort of big Internet companies, is forcing operators to invest more heavily in their networks. It is only "fair" that Amazon, Netflix and a few other "large traffic generators," as they are disparagingly called, should pay for the infrastructure they cannot do without. As reasonable as this argument might sound, it is bunkum.

Neither causation nor correlation

There are some philosophical objections. The telcos' own customers have already paid for the connectivity. With their service demands, and decisions about which Internet companies to use, those customers are the real traffic generators, say critics of the telco position. If Internet companies should pay for networks, why should telcos not contribute to the cost of Big Tech infrastructure, or fund the development of Internet content and services? After all, without it, their customers would have little use for high-speed networks.

But a fundamental flaw in the telco argument is the link operators have drawn between traffic and network costs. Their implication is these are rising in lockstep – that every new petabyte (1 million gigabytes) necessitates additional expenditure to fortify networks. The data certainly points to substantial year-on-year growth in the volume of petabytes carried over telco infrastructure, driven largely by enthusiasm for online video services. Unfortunately, for the telcos, it does not prove this is a primary cause of higher network costs. There is not even a correlation between this traffic growth and telco expenditure.

Recent financial updates by European telcos do not help their fair-share case. Spain's Telefónica is a standout example. It is one of the few big European operators to show yearly traffic levels in its annual reports. Back in 2017, its global networks carried 35,614 petabytes over the course of the year. By 2022, the volume had surged to 125,790. Yet Telefónica's annual operating costs, including depreciation and amortization, have fallen by €8.7 billion (US$9.3 billion) over this period.

Telefónica says the impact of traffic growth is felt in capital expenditure rather than overall operating costs. But its capital intensity – its expenditure as a percentage of sales – has dropped by two percentage points since 2017, to about 15% last year. On Deutsche Telekom's last earnings call, David Wright, an analyst with Bank of America, attributed this to the advanced rollout of fiber and decommissioning of old copper networks. "I think that is undoubtedly the driver of their industry-leading capex-to-sales ratios and that's, of course, a function of fiber being mature," he said.

Most of the upfront broadband investment is in the civil engineering required to lay new fiber lines, not the electronics that make them work. This copper-to-fiber upgrade, however, is a once-in-a-lifetime job, and some of Europe's biggest telcos are nearly done with it. At its capital markets day last week, Telefónica said it had "overcome" most investment requirements and expected a "progressive reduction" in capital intensity, to below 12% by 2026.

The message is similar at Orange. Publishing third-quarter results last month, the French operator guided for a "significant reduction" in capital expenditure this year, after slashing it by 6% for the first nine months. "It has started in France," said Mari-Noëlle Jégo-Laveissière, the CEO of Orange Europe, when asked if the completion of fiber rollout would lead to a fall in capital intensity. "The big investment is done for fiber."

In other words, the same telcos that demand fair share effectively plan to cut network investment despite there being no sign of let-up in traffic growth. Nokia thinks monthly exabytes (thousands of petabytes) carried on global networks will soar from 507 last year to 1,024 in 2026.

Deutsche Telekom's fast-growing US business has made even heavier cuts to spending this year, pumping just €7.6 billion ($8.1 billion) into capital expenditure for the first nine months compared with more than €10 billion ($10.7 billion) for the same part of 2022 (before spectrum investments). It has managed this despite gaining another 4.3 million customers since the start of the year.

Spending cuts by T-Mobile and other US operators have been extremely damaging to Ericsson and Nokia. Amid financial difficulties, the Nordic equipment vendors are laying off up to 22,500 employees, about 12% of their combined workforce. Both companies insist traffic growth will eventually force telcos to reopen their wallets. "Data traffic continues to grow 20% to 30% a year and it is only a matter of time before the networks will run out of capacity and then the operators will have to start investing again," said Pekka Lundmark, Nokia's CEO, on a recent call with reporters.

Regulatory suspicions

But others are not so sure about the telecom industry's arguments. Peter van Burgel, the CEO of the Amsterdam Internet Exchange, reckons the need to support peak traffic is the main driver of network investment, rather than total Internet traffic. "A lot of that data never travels across networks," he wrote in a recent LinkedIn blog. "During the corona pandemic for example, the processed volume of Internet data increased by about 40%, whilst peak traffic only increased by about 10-15%."

Ofcom, the UK telecom regulator, also views the telco arguments with suspicion. While a paper it released in October advised authorities to abandon some of their more draconian rules about net neutrality, Ofcom said there was no case today for any mandates on fair share. Its own examination of network costs is revealing.

For a start, it points out that any growth in traffic has little impact on high-speed fixed access networks, describing these as "generally invariant to traffic." This leaves the core and backhaul as the most traffic-sensitive costs, and these make up only 20% of total network expenditure. Using information it obtained from the UK's telcos, Ofcom worked out that core and backhaul expenses come to just £60 ($73) a year per user. This is about 12% of what the average BT customer spends on its broadband service each year.

The UK regulator concedes mobile is different and that traffic has a bigger influence on access network costs in this domain. But mobile accounted for less than a fifth of the monthly traffic carried over all networks last year, according to Nokia, and that proportion is not expected to change by 2026.

In more developed European markets, the gap between mobile and fixed looks considerably bigger. William Webb, the chief technology officer of a consulting group called Access Partnership (and a former Ofcom executive), recently calculated that an average UK home of about 2.2 inhabitants consumes around 500 gigabytes of data a month. The average mobile customer in the UK uses only six, he reckons.

"It is not fair share alone which will solve all our problems in this European situation," said Höttges on last week's earnings call. "It is a jigsaw of hundreds of elements of an old, tired regulation policy." He may be right to criticize Europe's regulators on their approach to competition and spectrum. But the fair share debate should be laid to rest.