Functional Separation

The question of structural separation was canvassed exhaustively within the European Commission in 2007/2008 with the Commission rejecting structural separation and recommending that national regulators use functional (operational) separation as a measure of last resort to ensure equality of access [1]. 

Functional separation puts infrastructure competition at risk, and could create a new monopoly in access. It is an intrusive remedy to the extent that it requires the NRA to get involved in the operational and management functions of the SMP operator; however, it might possibly simplify enforcement.

Vertical separation presents a clear trade-off between reducing discrimination versus irrecoverable efficiencies. The policymaker can address this trade-off by looking at the relative importance of access-based competition versus the efficiency losses associated with vertical separation. This is not a static analysis, because the factors change over time, requiring the regulator to reassess the costs of vertical separation in the future. Vertical separation is a low stakes gamble in water markets (where technology advances glacially), and a medium stakes gamble in electrical markets. In telecommunications, however, vertical separation is a high stakes gamble.

There are six degrees of functional separation between accounting and structural separation [2]:

Accounting separation 

  1. creation of a wholesale division
  2. virtual separation
  3. business separation
  4. business separation with localised incentives
  5. business separation with separate governance arrangements
  6. legal separation (separate legal entities under the same ownership)

Ownership separation (in whole or part)

The key difference between functional and structural separation is separate ownership of the separated organisations. By allowing common ownership of the network and service arms, functional separation facilitates coordination of investment decisions between the services and network elements. Efficient investment by new market entrants will be supported by the fact that with functional separation, they can rely on non-discriminatory access to all bottlenecks.

An objective of functional separation is “Equivalence of Access” which can constitute either EOI (Equivalence of Input; eg Openreach) or EOO (Equivalence of Output).

Examples of functional separation

In the UK, British Telecom created Openreach BT in 2005 to operate all its access networks. This spurred a new wave of investment and infrastructure-based market entry as evidenced by the explosion of local loop unbundled lines in UK which jumped from less than 100,000 in June 2005 to 6.2 million by November2009.

The UK experience shows a major benefit of functional versus structural separation is the ability to adjust the boundaries of separation over time; for example to allow Openreach to offer active-based fibre products.

In Poland in 2008, the incumbent Telekomunikacja Polska  separated into a retail unit and a wholesale unit. The wholesale unit has independent management, and a separate incentive scheme for employees based on sales performance at the wholesale level. Details were agreed with the regulator in late 2009 [3].

In Sweden, voluntary separation began as a dialogue between the PTS and TeliaSonera in 2007. A Bill passed in July 2008 applies functional separation to only copper network infrastructure; not fibre although TeliaSonera is obliged to offer unbundled access to dark fibre local access networks.

In Japan, a functional separation of NTT might not allow competitors to offer fully competitive products. A review of NTT’s organizational structure is on-going and a report looking at possible separation models is due out shortly.

END NOTES

[1] Following the review of the EU Framework, the Better Regulation Directive (November  2009)  introduced  functional  separation  as  a  non-standard remedy. The revision to the Framework also anticipates voluntary separation by an operator with Significant Market Power. For details, see Draft BEREC Guidance on functional separation under Articles 13a and 13b of the revised Access Directive and national experiences, BoR(10)44  http://berec.europa.eu/files/doc/berec/bor_10_44rev1.pdf, http://berec.europa.eu/files/documents/bor_10_44Rev1b.pdf

[2]Martin Cave, Six Degrees of Separation:  Operational Separation as a Remedy in European Telecommunications Regulation, Dec 2006 http://mpra.ub.uni-muenchen.de/3572/1/MPRA_paper_3572.pdf

[3] Poland - Agreement between the incumbent and regulator, 22 October 2009   http://www.en.uke.gov.pl/_gAllery/10/31/1031/agreement_TP_UKE.pdf

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