COMPETITION TRIBUNAL OF SOUTH AFRICA
Case No: 51/LM/Jun06
In the matter between:
Telkom SA Limited Acquiring Firm
And
Business Connexion Group Ltd Target Firm
Panel : D Lewis (Presiding Member), Y Carrim (Tribunal
Member) and U Bhoola (Tribunal Member)
Heard on : 1216 March 2007, 2830 March 2007, 02 April2007,
1825 May 2007 and 2122 June 2007
Order issued on : 28 June 2007
Reasons issued on : 20 August 2007
NonConfidential version of Reasons for Decision
Approval
1]This transaction constitutes a large merger as defined in terms of the
Act. In terms of section 16(2)(c) of the Act, the Tribunal prohibited this
transaction on 28 June 2007. The reasons for our decision follow.
The parties
2]The primary acquiring firm is Telkom SA Ltd (“Telkom”). Telkom is a
telecommunications services provider and is listed on the
Johannesburg Securities Exchange as well as the New York Stock
Exchange.1
3][2] The primary target firm is Business Connexion Group Ltd
1 For a shareholding structure of Telkom please see page 2 of the Commissions report.
1
(“BCX”).2 BCX is an Information and Communications (“ICT”) company
and is listed on the Johannesburg Securities Exchange. 3
The transaction
4]In terms of the proposed transaction, Telkom intends to acquire the
issued share capital of BCX . 4 The proposed transaction will be
implemented by way of a scheme of arrangement in terms of section
311 of the Companies Act No.61 of 1973.
Activities of the parties
5]Telkom is the incumbent provider of fixed line Public Switched
Telecommunications Services (“PSTS”) and it offers fixed line voice
and data services. Telkom is also a key player in the market for Value
Added Network Services (“VANS”). Until recently, Telkom was the de
jure monopoly provider of fixed line infrastructure and services.
6]BCX is active in the Information and Communications Technology
(“ICT”) sector and it provides ICT based services to a broad range of
clients, including JSElisted organizations, government and medium
sized companies. BCX describes itself as a “leading integrator of
competitive, innovative and practical business solutions based on
Information and Communication Technology.” 5 BCX provides network
related IT services, network design and implementation services, WAN
2 For the ownership structure of BCX please see a diagram on page 9 of the Commission’s
report.
3 The shareholders having more than a 2% shareholding in BCX Group are: Liberty Life
Association of Africa Ltd 11.19%; Shareholder Not Within Limit 8.59%; Public Investment
Commission (“Stanlib”) 4.77%; Public Investment Commissioners 4.67%; Sanlam Institutional
Special Opportunities Fund 3.01%; Public Investment Commission Equity (“ Futam”)
2.64%;Sanlam 2.54%; Deutsche Securities Scrip Collateral Account 2.35%; Business
Connexion Technology 2.22% and Comparex Holdings Share Purchase Trust 2.20%.
Connexion Technology 2.22% and Comparex Holdings Share Purchase Trust 2.20%.
4 Other than the BCX shares held as treasury shares, shares held by the Comparex Holdings
Share Purchase Trust and shares held by the BCX Share Incentive Trust
5 BCX website, www.bcx.co.za
2
management services as well as business applications to large
enterprises. It is a CISCO accredited organisation. 6
Background to hearings
7]The Commission had recommended that the merger be prohibited. A
number of objections had been received. Three parties, namely
Internet Service Providers Association (“ISPA”), Dimension Data PLC
(“Didata”) and Gadlex (Pty) Ltd (“Gadlex”) were admitted as
interveners in the Tribunal’s proceedings. ISPA and Didata were
opposed to the merger, Gadlex was in support of it.
8]The hearings in the matter took place on 1216 March 2007; 2830
March 2007; 02 April 2007; 1825 March 2007 and 2122 June 2007.
9]The following witnesses gave evidence: Dr Giulio Federico 7; Mr
Hendrik Arnoldus Matthyser 8; Mr Micheal Afred Sewell 9 ; Mr Arnold
Esias Van Huyssteen 10; Mr Peter Anthony Watt 11; Dr Angus Hay 12; Dr
Setumo Mohapi 13; Mr Derek Wilcocks 14; Mr Micheal Brierley 15; Mr Ewan
Sutherland16; Mr James Hodge 17; Professor Emanuele Giovannetti 18
and Mr Stephen Bosman 19.
10]ISPA is a voluntary industry association established to represent the
6 For more details on BCX’s business activities see its website and the Commission’s
Recommendation.
7 Economist CRA International
8 Executive: Business Integration Services, Telkom
9 Group Executive, Outsourcing BCX
10 Executive: Product ManagementRetail Marketing, Telkom
11 Chief Executive Officer, BCX
12 Executive Head of Strategy: Neotel
13 Director of Telecommunications: ICT Works (Pty)Ltd
14 Services Director of Dimension Data
15 Chief Executive Officer: MTN Network Solutions (Pty)Ltd
16 Independent Telecommunications policy analyst
17 Economist: Genesis Analytics
18 Associate Professor, School of Economics, University of Cape Town
19 Chief Strategy Officer, Gijima AST
3
interests of South African Internet Service Providers. ISPA members
are competitors of Telkom and, in some cases, of BCX. ISPA members
are also customers of Telkom. 20
11]Didata is a specialist IT services and solutions provider that assists and
advises its clients in respect of the planning, building, maintenance and
support of their IT infrastructures as well as rendering WAN
management services. Didata is also a customer of Telkom and
competes with it in the downstream MNS market.
12]Gadlex Holdings is BCX’s black economic empowerment partner and
has a 25% shareholding in this company.
13] The Commission’s investigation revealed that the transaction
has horizontal, vertical and portfolio dimensions. In its analysis of the
proposed transaction the Commission found that Telkom and BCX
overlap in the market for the provision of electronic communications
services in the submarket for managed network services (“MNS”).
According to the Commission, the merger will lead to the removal of an
effective competitor, and a high market share for the merged entity in
the MNS market, which will enable it to act unilaterally without regard
to its competitors’ behaviour. ISPA shared this concern.
14]The Commission, ISPA and Didata also submitted several theories of
harm in relation to the vertical and conglomerate effects of this merger.
The opponents of the merger argued that post merger, the merged
entity will have the ability and the incentive to
1. Engage in input foreclosure of its rivals in the downstream MNS and
ITS markets, who rely on leased lines as inputs, through raising
rivals costs, refusal to supply, margin squeeze, frustration of
20 See page 51 of the transcript.
4
access, quality degradation and delays in installation and fault
repairs;
2. Engage in customer foreclosure by influencing customers to divert
demand away from Neotel’s 21 infrastructure and PSTS services;
3. Engage in mixed bundling of PSTS, MNS and ITS services which
will give rise to anticompetitive effects.
15]In addition the Commission submitted that the merger was taking place
in an industry which had until recently been dominated by Telkom’s
monopoly. The introduction of competition to Telkom, in the form of
Neotel, was in its nascent period and any accretion of market share by
Telkom in the MNS market or any competitive advantage it acquired
over its rivals across the three relevant markets would have a
substantial impact on an industry plagued by high prices and
bottlenecks. The Tribunal was asked to protect the first shoots of
competition by prohibiting this merger. ISPA argued that the merger
was taking place at a time when the industry is moving towards
convergence and that the MNS market was the battleground for
convergence. Any enhancement of Telkom’s ability to deter entry or
expansion of it rivals– through any of the strategies discussed above
would lead to a substantial lessening of competition. Didata submitted
that, through this acquisition, Telkom sought to extend its monopoly
into the new converged space as well as protecting its current
monopoly in infrastructure and PSTS services.
16]Gadlex, argued that Telkom no longer had a monopoly in the
infrastructure market and that in any event there were technical
substitutes for fixed leased lines in the MNS market. The merging
parties submitted that the vertical theories of harm raised by the
Commission and the objectors would not result in the effects claimed
Commission and the objectors would not result in the effects claimed
21 Neotel is the newly licensed competitor to Telkom. It was previously known as the second
national operator (SNO).
5
by the Commission because inter alia, they were either not merger
specific, were mutually exclusive and would not be profitable for
Telkom. They argued further that the horizontal overlap between
Telkom and BCX was too small to raise competition concerns. In any
event, they submitted, if the Tribunal had any concerns about the anti
competitive effects of the horizontal overlap, they would offer a
divestiture of BCX Communications (“BCX Comms”) 22, a subsidiary of
BCX, as a remedy.
BACKGROUND TO THE TRANSACTION
17]This transaction takes place in the ICT industry which is currently
undergoing rapid regulatory changes.
18]A common thread that runs through the opposing parties’ submissions
is that the telecommunications sector has only recently experienced
the introduction of competition through the licensing of Neotel and the
deregulation of the industry. However to a large extent, Telkom still
remains the de facto monopoly supplier of infrastructure and domestic
and international PSTS services. It is also a dominant player in the
MNS market. All three parties suggest, in different permutations, that if
Telkom were permitted to acquire BCX, this would lead to a lessening
of competition in the MNS and ITS markets. In addition it would enable
the merged entity to utilize a number of strategies in order to retard
Neotel’s expansion into the PSTS and MNS markets and hence retard
competition in the telecommunications sector. They do not suggest that
the merger will prevent Neotel’s entry into the market, but argue that
its expansion and therefore the introduction of competition in the
sector, across all three markets, will be reduced or retarded.
22 BCX Communications is a subsidiary of BCX through which BCX offers an IP VPN
product.
6
19]It is now generally accepted that the industry is moving towards
convergence. This trend towards the convergence of voice and data
services, broadcasting and telecommunications, and fixed and mobile
services – with a single integrated receiver and number that allows the
subscriber to move seamlessly between networks – paves the way for
a new complex and integrated value chain of services and service
bundling opportunities which has supplanted the classically linear value
chain. It is anticipated that in future all services will originate from
infrastructure that may be composed of multiple and distinct networks
that seamlessly integrate to create a modern information backbone
known as Next generation Networks, NGNs. 23 NGNs allow for lower
cost, IPbased services to be transmitted over single platforms. These
developments require that any valuechain analysis of operators,
services or ICT companies be dynamic, flexible and openended.
20]A major implication arising from these trends is the huge increase in
available transmission capacity, historically a scarce resource. This
effectively means that the marginal cost of the network capacity that is
required to provide carriage services is insignificant and may even be
approaching zero. Network infrastructure is increasingly being
characterized as a fixed cost. The implication of these trends for the
global telecoms industry is that networked business models will
increasingly be based on services rendered rather than on basic
connectivity. Basic connectivity in the context of convergence is the
transmission of bits and bytes and is regarded as a commodity. In
conjunction with the changing dynamics of the telecoms industry, to the
role of regulation has extended from concentrating on consumer
role of regulation has extended from concentrating on consumer
disputes, universal services issues and price setting to much broader
role of regulating the sector to enable competition.
23 See 2006 South African ICT Sector Performance Review Link Public Policy Research
Paper No 8, January 2007.
7
21]An important factor to bear in mind is that while the industry is moving
towards convergence it continues to remain a network industry
characterized by network externalities. In such industries, initial
market leaders – whether these are in technical innovation or in high
value subscribers tend to be favoured. The communications sector,
as much is it driven by rapid technological developments still remains a
network industry , a factor which seems to have been completely
overlooked by the merging parties in their arguments and expert
testimony.24 Whether the industry is moving towards an information
industry or convergence, driven by changes in technology, the
applicable economic laws do not change. Technological advances may
result in new markets or require that we define the boundaries of those
markets differently, but the basic economic principles in relation to
network industries remain durable over time. 25
22]In this transaction we have concluded that the merger will result in a
substantial lessening or prevention of competition in the MNS market,
which has been described as the battleground for convergence. In our
view this transaction is an attempt by an erstwhile monopolist to thwart
the beneficial impact of deregulation in the form of greater economies
of scale and scope for rival MNS providers and lower costs for
customers. It is also an attempt by an erstwhile monopolist to stifle
innovation in order to maintain its hitherto monopoly margins in
infrastructure and voice services
23] While we note that the merger, if it had been approved, could have
had some detrimental impact on Neotel in it’s entry or expansion in
both the infrastructure and MNS market, we signal our concern that the
merger is, in part for this very reason, likely to result in cooperation
merger is, in part for this very reason, likely to result in cooperation
24 CRA’s economic arguments and calculations took no account of a dynamic market or a
market characterized by network effects.
25 See in this regard Shapiro & Varian “ Information Rules – A strategic guide to network
economies” Harvard Business School Press, 1999
8
between Neotel and Telkom in relation to warding off the threats posed
by the deregulation of the MNS market and the consequent growth in
competition and innovation in that market. We express the concern
that the acquisition could have provided Telkom with an unregulated
subsidiary through which it would seek to evade regulation.
24]We also find that the merger is taking place in a pivotal segment of the
ICT sector which has a significant impact on the international
competitiveness of South African firms generally, and that the merger
is likely to impact negatively on the public interest.
25]We turn now to consider the impact of the deregulation announced by
the Minister in September 2004 and some recent regulatory
developments in the sector. However as a prefatory remark, we
suggest that the word “convergence” be used with a degree of caution.
Convergence is the new buzzword and those that are familiar with the
ICT industry tend to use it as shorthand for many things, which may not
necessarily translate easily into competition law analysis. For
example, in this transaction, it was often remarked that the MNS and
ITS markets are converging. While there is a technological
convergence of voice and data in the telecommunications sector which
is resulting in a new integrated offering in the MNS or ITS market, this
is not equivalent to saying that the MNS and ITS markets are
converging into one market.
26]The deregulation of VANS by the Minister is also referred to as
convergence, not wholly inaccurately. What is meant here is that the
technical convergence of voice and data, which was commercially
available previously but was restricted by regulation, can now be
deployed. However the sharing, subletting, and ceding of
deployed. However the sharing, subletting, and ceding of
infrastructure is not necessarily convergence but is now possible as a
9
result of deregulation. Convergence of the sector does not necessarily
translate into consolidation of the sector, which denotes a specific
economic concept in relation to market structure.
27]Convergence may result in an expansion of the services that constitute
the MNS market, and would include services that were previously
located in the ITS market, but the markets for purposes of competition
law analysis are themselves not necessarily converging. There will
always be IT companies who provide equipment and hardware and
utility applications but who do not provide MNS solutions to
enterprises.
28]For ease of convenience and purposes of completion, we have
included in annexure A a glossary of terms used by us in these
reasons.
Dynamic regulatory environment
29]Until recently the telecommunications sector was dominated by a fixed
line monopoly in the form of Telkom with limited competitive activity in
the MNS market.
30]Telkom SA Ltd started out in 1991 as a state owned enterprise housed
in the then Department of Posts and Telegraphs. 26 Under the old
Apartheid regime, it provided services to the residential and corporate
market on the basis of the policies of that regime. Hence it was rare
indeed to find residential telephone services in black townships. The
Postmaster General and the Department of Posts and
Telecommunications, retained general regulatory functions and
continued to regulate the telecommunications industry until the
26 The Post Office Amendment Act 85 of 1991 provided for the establishment and
incorporation of Telkom SA Limited and the South African Post Office Limited. Prior to that
telecommunications services were rendered by the Department itself.
10
Telecommunications Act 103 of 1996.
31] After 1994 the democratic government embarked on the
formulation of a democratic policy process for the telecommunications
sector. This process culminated in the 1996 White Paper and the
subsequent Telecommunications Act 103 of 1996
(“Telecommunications Act”) and led to the modernization of
telecommunications in South Africa. The government adopted a policy
of managed liberalization in which it envisaged that Telkom would be
partially privatized and be granted a period of exclusivity in return for
universal service obligations. In 1996, 30% of Telkom was sold to the
Thintana Consortium LLC (“Thintana”), a partnership between
Malaysia Telecom and SBC Communications (“SBC”). SBC is an
experienced American telecommunications company which cut its
teeth in the AT & T stable. 27 Telkom was granted a fiveyear period of
exclusivity in its license with an option to extend it for a further year if
certain conditions were met. In return Telkom was under an obligation
to roll out a certain number of lines to underserviced areas (which at
that stage constituted the vast majority of South Africa) and to make
contributions to the Universal Service Fund. In negotiation with the
then Minister of Communications, Telkom agreed on a rate regime 28
which regulated some aspects of its retail tariffs. As part of the
agreement with government Telkom also invested in the SAT3/WASC/
SAFE submarine cable system, which provides increased fibre optics
transmission capability between South Africa and international
destinations. It also concluded a shareholders agreement with
government, the provisions of which are still secret.
32]In that same year, in accordance with international best practice, an
independent regulator, the South African Telecommunications
independent regulator, the South African Telecommunications
27 It was spun off as part of the AT& T divestiture which took place on 1 January 1984.
28 This was referred to as the Minister’s Determination in the 1996 Act
11
Regulatory Authority (“SATRA”) now Independent Communications of
South Africa (“ICASA”) was established to regulate the
telecommunications sector. Part of its legislative mandate was to set
standards, issue spectrum and service licenses, produce an annual
frequency plan, approve equipment (all of which was previously done
by the department), arbitrate disputes between licensees and prescribe
fees and tariffs for markets in which there was insufficient
competition.29
33]The effect of Telkom’s exclusivity rights was that it continued to be the
sole supplier of domestic and international PSTS services in South
Africa. All other telecommunications operators and service providers
were required to obtain their facilities from Telkom and no other
licensee could provide local, national and international voice services.
The only area of competition (apart from competition in customer
premises equipment) was in the provision of value added network
services but this was also restricted by legislation.
34]Value Added Network Service (VANS) was a license category in the
1996 Act. Many services could be provided under this license
category, including managed network data services and internet
services. VANS providers would purchase infrastructure from Telkom
and render services to enterprises over networks designed and
constructed by them in accordance with their clients needs. However,
in terms of s40(3) of the Telecommunications Act VANS could not
provide voice, could not use Voice over Internet Protocol (VoIP), and
could not resell, sublet or cede the infrastructure leased from Telkom.
35]By 2002, Telkom had rolled out some 2.8 million lines but had
disconnected some 70% of these. 30 While access to telephony had
disconnected some 70% of these. 30 While access to telephony had
29 These are referred to as rate regimes.
30 See Telkom Annual Report 2001 .
12
improved for previously disadvantaged South Africans and the country
experienced improvements in teledensity, this was largely due to the
success of mobile services. At the end of Telkom’s five year
exclusivity, South Africa had experienced a net decline in fixed line
penetration and internet . Telkom’s pricing structure was considered to
be excessive and was widely thought to be adversely impacting growth
in the South African economy. 31
36]In 2002, the Minister issued an ITA 32 for a second national operator, a
competitor to Telkom. Telkom elected not to extend its exclusivity
period.33 The licensing of the SNO as it was known then began in
2002 and ended on 09 December 2005.
37]Neotel has the same rights in its license as Telkom does 34 but in
addition has the right to use Telkom’s infrastructure for a period of two
years. In preparation for its entry and to enable it to compete in a
market dominated by Telkom, ICASA promulgated a number of
regulations which set out rights and obligations in relation to number
portability and carrier preselect between Telkom and Neotel.
38]Neotel’s licensing process has been extremely drawn out and at the
time of the writing of these reasons, it seemed to have experienced
numerous internal and external hurdles to launching its commercial
operations. 35
39]In September 2004, several announcements made by the Minister of
31See, William H Melody, Vodacom Visiting Professor in ICT Policy & Regulation, LINK
Centre, Graduate School of Public and Development Management, University of
Witwatersrand, November 2002, “Assessing Telkom's 2003 Price Increase Proposal ”. See
also report by Genesis Analytics on behalf of the South African Foundation, April 2005.
32 Invitation to Apply
32 Invitation to Apply
33 In 2004, Thintana sold its shares to the Public Investment Corporation (“PIC”) which sold
onto the Elephant Consortium. http://brainstorm.itweb.co.za/online/ReadStory.asp?
StoryID=152675
34 See the definition of PSTS services in the 1996 Act.
35 See Dr Hay’s evidence and the debates in Parliament regarding Infraco.
13
Communications propelled the industry into probably its most dynamic
phase ever. In terms of these announcements, mobile operators could
utilise any fixed lines that may be required for the provision of the
service including fixed lines made available by Telkom or any other
person providing a PSTS. Value Added Networks Services could carry
voice using any protocol; they could render their services by means of
telecommunications facilities other than those provided by Telkom and
the Second National Operator. They and PTNs were now entitled to
cede or assign the right to use, or to sublet or part with control or
otherwise dispose of telecommunications facilities used for the
provision of value added network services. All of these were to be
effective on 1 February 2005. The Minister explained that the two
important policy objectives driving the announcements were the need
to lower the cost of doing business in South Africa and to liberalise the
ICT sector. In furtherance of these objectives, she was promoting
choice for service providers, efficient usage of bandwidth and growth in
the value added network services . 36
40]The Electronic Communications Act (“ECA”) came into effect on the
19th of July 2006. The ECA repealed the Telecommunications Act. The
ECA is part of the new converged regulatory framework for the ICT
sector aimed at lowering costs of access to the ICT sector and
increasing the efficiency of telecommunications services provisioning in
the country. The ECA seeks to inter alia, promote convergence in the
broadcasting, broadcasting signal distribution and telecommunications
sectors, provide the legal framework for convergence of these sectors,
make new provision for the regulation of electronic communications
services, electronic communications network services and
services, electronic communications network services and
broadcasting services, provide for the granting of new licences and
new social obligations, provide for the control of the radio frequency
36 See the Minister’s Announcements dated 2 September 2004.
14
spectrum and provide for continued existence of the Universal Service
Agency and Universal Service Fund.
41]However, despite the recent regulatory initiatives designed to liberalise
the telecommunications sector, we must not lose sight of the fact that,
to date, Telkom has a virtual monopoly of fixed line South African
subscribers, whether these are corporate or residential. This should
come as no surprise since until recently it enjoyed a de jure monopoly
status and for all intents and purposes continues to remain the
overwhelming dominant supplier of infrastructure in this market, and
provider of local, national and international telecommunications in the
country. Equally important, and as a consequence of its monopoly
status, Telkom has the largest footprint of infrastructure in the country.
Its network runs to some thousands of kilometres and it is able to
access every small and large town through its extensive local loops. It
has been, and still remains, on the one hand the sole supplier of
infrastructure and connectivity to other players such as mobiles, PTNS
and VANS, and, on the other hand, a competitor of VANS.
42]We turn now to consider the impact of the deregulation on the MNS
market.
Deregulation: Dynamic MNS market
43]The MNS market consists of a range of services rendered by service
providers to large organizations, whether these are private or public
bodies. Managed network service providers as they are called provide
managed data communications services to enable organizations to
communicate between head offices and their branches over a wide
area network (WAN).
15
44]Services that would typically be transmitted over WAN would include
intranets, data communications, internet access and business
applications.
45]WANS are constructed as physical private networks from dedicated
leased lines. The infrastructure that constitutes a WAN was obtained
exclusively from Telkom, and by far the overwhelming majority are still
currently provided by Telkom. The manner in which infrastructure was
supplied was also controlled by Telkom. 37
46]Prior to 1 February 2005, MNS services were provided to an
organization in two ways. WAN service providers such as BCX did not
provide their services in terms of a VANS licence (they did not provide
a network) but provided these services to customers on their
premises.38 Such a WAN provider provided both network related and
IT services for enterprises in relation to their WAN, as well as other IT
services in the form of business applications and equipment. These
WANS are referred to as enterprise owned WANS.
47]Service providers known as VANS, 39 also provided WAN services to
organizations but rendered these over their own networks. This is why
they required a license from ICASA. Internet access services
constitute a large part of the business of VANS.
48]The price of the leased line, whether this was an access line or a core
network line, was regulated as a retail price to VANS 40 and constituted
37 See evidence of Mr Brierley where he explains Telkom’s requirements that VANS submit
agency agreements signed by their clients which required details of the customer and
installation addresses. See page 1674 of the transcript.
38 VANS was a license category in the now repealed Telecommunications Act of 1996.
Service providers rendered MNS services to enterprises on their own networks, which they
obtained from Telkom. WAN service providers provided MNS services on a client’s network,
obtained from Telkom. WAN service providers provided MNS services on a client’s network,
which was also constructed from lines leased from Telkom.
39 This license category is likely to be converted to an ECS license under the new ECA
40 Telkom did not provide them with a wholesale price on the basis they were not public
16
approximately 6065% of the cost of the services rendered by VANS. 41
VANS obtained the leased lines from Telkom and recovered the costs
thereof from their clients, making no margin on the cost of bandwidth.
The cost of leased lines for enterprise owned WANS was borne directly
by the client itself. 42
49] The manner in which these lines could be utilized by VANS or the
clients themselves was restricted by the Telecommunications Act
which led to underutilized capacity and high communications costs.
Since Telkom owned the infrastructure and to a large extent retained
control over it, 43 service level agreements, which regulated the services
associated with the bandwidth and dealt with issues of network
performance levels, downtime, fault repairs etc, were also limited by
the extent of the service levels Telkom would offer together with the
bandwidth. VANS provided their clients with a back to back service
level agreement, being limited to Telkom’s undertakings and
performance.
50]During this period, organizations obtained their communications
services from a number of providers. An enterprise could and in terms
of the restrictions was compelled to buy different components from
different suppliers. All infrastructure and access lines had to be
obtained from Telkom (whether the MNS service was provided by a
VAN or not), certain services could be obtained from an ITS provider,
others such as internet access could be purchased from a VANS
provider. In addition other communications needs, such as fixed line
voice services could only be purchased from Telkom. If a large
organization decided to outsource all or some of its communications
operators but service providers.
41 See evidence of Mr Brierley and Mr Van Huyssteen on page 1203 of the transcript
42 See evidence of Mr Sewell and Mr Brierley.
42 See evidence of Mr Sewell and Mr Brierley.
43 See evidence of Mr Brierley above. Also transcript page1722 and Hodge’s witness
statement on page 41.
17
requirements, it generally tended to appoint a single service
aggregator, who would manage all the other service providers on
behalf of it. 44
51]Developments in technology in the VANS segment gradually permitted
services to be provided in the form of shared networks. 45 The
technology was known as VPN technology. 46 The early developments
in this technology were legally challenged by Telkom on the basis inter
alia that it constituted an infringement of Telkom’s exclusivity and the
restrictions that were in place on value added network services in
terms of the Telecommunications Act of 1996. 47 In 2002, ICASA ruled
that VPN technology was a value added network service, could be
provided by a licensed VAN provider and was not in contravention of
the Act. 48 Despite challenging ICASA’s decision in the High Court and
refusing to connect AT&T until a court order was sought against it,
Telkom itself launched its VPN Supreme product in 2003. 49 However,
the regulatory restrictions and the unfriendly framework remained in
place until 1 February 2005. 50
52]On 1 February 2005, following the announcements by the Minister of
Communications, the aforesaid restrictions on VANS were removed.
53]The deregulation brought about regulatory certainty and immediate
44 See for example the AngloGold Ashanti service agreement with BCX which requires BCX
to provide a range of services to it, including services sourced from Telkom. See page 3687
of the record
45 These were provided by VANS providers
46 Virtual Private Network, see our discussion below on the difference between enterprise
owned WANS and VPNS
47 See Telkom v Internet Solutions 14 June 2002 and Telkom v AT & T 21 June 2002. See
pages 18751922 ISPA Trial Bundle 5
48 Telkom SA Ltd v AT&T Global Network Services 21 June 2002
48 Telkom SA Ltd v AT&T Global Network Services 21 June 2002
49 Telkom brought a review application against ICASA in the IS matter. AT&T brought an
application in the High Court to compel Telkom to abide by ICASA’s decision and to provide it
with connectivity.
50 See Mr Sewell’s evidence on why BCX chose not to enter the VANS space at that time
page 881 of the transcript.
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benefits to enterprises. VANS 51 are now able to sublet, cede and re
sell infrastructure leased from Telkom and are also allowed to use
VoIP, leading to economies of scale and scope. Organisations can still
have their own private network but the costs of that investment could
be shared with others. In addition they can transmit voice in the form
of VoIP over their network. Obviously the more enterprises that can
share a network the cheaper it would be. They would also benefit from
the network effects of onnet calls. The consequence of this reduction
in costs is that enterprises are more willing to outsource their WAN
needs in order to obtain the benefits of sharing it with others.
54]This has led to a movement away from the strings model of WAN –
where each branch of the organisation had to be connected to the
other branch and head office in linear fashion to a cloud model of
WAN, ie the VPN. In the cloud model, the service provider builds a
core network to which each branch connects to a VANS POP 52, as
opposed to connecting directly together. Branches and head office can
then talk to each other through the core network. In addition more
than one organisation can use the provider’s VPN. Significantly, in
addition to all the traditional services that could be transmitted over the
WAN, organisations can now transmit voice in the form of VoIP.
55]It is not surprising therefore that the VPN model is demonstrating
phenomenal growth not least because it represents an immediate cost
benefit to enterprises long suffering under high communications costs.
According to BMIT 53 the enterprise market is ripe for a migration from
WAN to outsourced VPN solutions. BMIT estimates that the VPN
sector will grow by 24% annually and that by 2008, will constitute 67%
sector will grow by 24% annually and that by 2008, will constitute 67%
of the MNS market. Migration usually occurs at a time when a
51 Which would be classified as an ECS licensee in terms of the ECA.
52 POP stands for Points of Presence
53 BMIT is a market analyst in IT, Telecom and Banking and arrives at industry reports
through data and views obtained from industry participants as well as from reported figures.
19
company is scheduled to upgrade its legacy network (due to large
switching costs involved). The International Data Corporation (“IDC”) 54
estimates that “in the coming years a number of large contracts that
drive growth rates sky high in the beginning of this millennium will be
renewed”.55 However not all enterprises will necessarily move to an
outsourced VPN offering. Some very large enterprises may still desire
to maintain a PTN/enterprise WAN or have some measure of control
over their network because of security or reliability concerns. 56
Telkom’s own staggering growth in VPN suggests that this will be the
predominant form of the new WAN, a more cost effective, outsourced
integrated WAN.
56]Furthermore, growth in data revenue and more so now that the
convergence of voice and data is legal over the internet, is seen as the
future growth segment in the telecommunications industry. Internet
access and value added services such as managed data network
services continue to exhibit the strongest growth rates, a trend that will
continue over the forecast period. 57
57] Since economies of scale can be achieved the cost of bandwidth for
enterprises has declined and fewer leased lines need to be purchased
from Telkom. Due to this, enterprises are now likely to spend more on
their ICT value added services than on connectivity. However greater
economies of scale and scope have also improved margins for MNS
providers. With declining costs of connectivity and the consequent
increase in outsourcing and spend on value added services, MNS
providers have had to reconsider their offerings in the market in order
to meet the challenges of deregulation. This has encouraged entry by
54 IDC is a subsidiary of the International Data Group which collates and analyses data for
the ICT sector.
the ICT sector.
55 See BMTT South African IT Services 20062010 Forecast and 2005 Vendor Shares” Item
29 page 1539 Telkom Discovery Bundle File 4
56 See Telkom VPN Supreme Product Plans
57 See 2006 BMIT on page 1408 Telkom Discovery Bundle file 4
20
companies that have been involved in the MNS market into the VPN
segment.
58] Prior to the deregulation in the MNS market, when an enterprise
decided to outsource its communications and data services, such
outsourcing took place in various permutations. The enterprise could
outsource any component or all of its data communications needs
whether this was the network, the management thereof and its IT
services. Very large organizations, such as national government
departments, would issue a tender in relation to such outsourcing. The
more outsourcing an enterprise did, the larger the number of service
providers, the more it required the services of a single service
aggregator.
59]The development of an integrated package such as the VPN in the
converged market now enables an MNS provider to approach its
customers with an offering that would include all of the components of
that integrated package. The MNS provider can now offer
infrastructure, managed data services, internet, voice and any other
number of services that could be integrated into a VPN. A service
provider could of course, continue in the same old way and procure or
subcontract those elements in the package which it itself could not
provide from others. However such subcontracting would cut into its
margins.
60]In order for an MNS provider to compete effectively in the dynamic
MNS market and to reap the benefits of deregulation (in the form of
lower connectivity costs) it needs to “own the customer” and earn as
much margin as it can. MNS providers that have credibility in
outsourcing and a closer clientvendor relationship are likely to more
easily gain entry to a client’s decision makers. A company such as
easily gain entry to a client’s decision makers. A company such as
BCX with its range of skills is likely to win an outsourcing contract and
21
own the customer. However, it would need to ensure that it keeps as
much of the margin it can. BCX acquired Bidnet for precisely this
reason – as long at didn’t own a VPN network itself it would always
have to rely on Telkom or other VPN players to partner with, hence
giving up margin that it could otherwise retain.
61] In the context of the dynamic MNS market, rather than a static one,
the acquisition by BCX of Bidnet can be seen, not as a move by an ITS
company into the telecommunications space but rather as an
expansion by an MNS provider, with ITS capabilities, in the MNS
market.
62]Needless to say the deregulation of VANS represents the greatest
threat to Telkom, as it does to Neotel. It has created “arbitrage” in the
market for fixed line connectivity (bandwidth) and voice . 58 MNS
providers can now sell shared bandwidth, VoIP, internet and other data
services. The legalization of VoIP has also introduced retail price
competition in national and international voice services, which were
previously part of Telkom’s PSTS monopoly services.
63]The combination of a loss, on hitherto extremely high margins on
leased lines and voice revenue in Telkom’s most lucrative market 59 –
the large enterprise market – poses a far greater threat to Telkom than
the entry of Neotel does. Telkom has been able to assess, on its own
calculations, that Neotel is expected to gain some 810% of Telkom’s
58 From a review of the Telkom strategy documents, it appears that the word “arbitrage” is
used in a number of situations – it is used to describe the fact that a customer can buy a
cheaper WAN & voice on a VPN rather than an enterprise owned WAN and fixed voice
services; or it refers to the fact that voice services can now be provided more cheaply (in the
form of VoIP) than Telkom’s fixed voice services; or that MNS rivals can now provide VoIP
over bandwidth that was traditionally bought for data communications or that MNS rivals could
achieve economies of scale on bandwidth thus reducing Telkom’s margins. See in general
Telkom 2010 Strategic Plan. Also ISPA file 1 pages 332334
59 See the evidence of Wilcocks in which he explains that all the profitability of in the
telecommunications sector is from the top 350 companies. See page 1517 of the transcript.
22
total fixed line market. However the loss to Telkom attributable to de
regulation in the MNS market is is more difficult to predict and would
be a function of the number of high value subscribers and the relative
network size of its rivals in the MNS market. Telkom also stands to lose
revenues in the most profitable segment of the MNS market namely
internet services. This is because enterprises, once they decide to
migrate to a VPN, and in order to maximize savings, are likely to also
migrate to an internet service provided by their VPN service provider. 60
This is also the segment of its business in which Telkom will
experience significant retail price competition, Neotel already having
indicated that it does not intend to compete with Telkom on the basis of
price.61
64]This is why Telkom needs to “own the customer” and disintermediate
the market ie it needs to swiftly remove as many MNS rivals as
possible.
65]Mr Matthyser, on behalf of Telkom, certainly appreciates the impact of
the deregulation when he states:
“The VANS deregulation in my opinion, has a bigger impact on
the success of Neotel than what the acquisition of BCX would
have on the feasibility of Neotel”. 62
66]While Mr Matthyser was making this statement to suggest that the
merger will have minimal impact on Neotel, the impact of the de
regulation applies equally to Telkom.
60 See evidence of Mr Brierley on pages 16821683 of the transcript. BCX is already
providing internet services.
61 See also South African Telecommunications Sector Performance Review 2006 by Steve
Esselaar, Alison Gilwald and Christoph Stock page 38
62 Matthyser page 531
23
Rationale for the transaction
67] We start our enquiry by considering Telkom’s rationale for the
transaction. In its filing papers the merging parties state that:
“ Telkom’s main reason for proposing the transaction is that the
proposed transaction will diversify Telkom’s revenue streams
into new revenue streams that Telkom can grow in order to
replace voice revenues which are expected to decline as a
result of increasing competition. Telkom expects revenue in the
IT services sector generally to grow, and that a presence in the
IT services sector will enable Telkom to benefit from this.
Telkom also believes that there are ancillary benefits to be
obtained from extending its range of existing services to
complementary services in the IT sector. The proposed
transaction will enhance Telkom’s ability to offer its customers
endtoend solutions across the ICT value chain. Telkom’s
strength has to date been in voice, managed data networks and
internet access, while BCX offers a complementary service
offering.” 63
68]Mr Matthyser on behalf of Telkom, who has been integrally involved in
the acquisition of BCX, submits that Telkom anticipates that it will lose
revenue as a result of Neotel’s entry, convergence (deregulation of the
industry) and further price regulation of Telkom by ICASA. Telkom
estimates that it will lose approximately 10% of its total market share of
63 See page 1361 item 4 of the record. According to Telkom the three main ancillary
benefits that are expected to accrue to Telkom from providing a broader range of IT services
are :The first benefit is that it will enable Telkom to meet the preference of some corporate
customers for the convenience of having a single aggregator of their ICT inputs( commonly
customers for the convenience of having a single aggregator of their ICT inputs( commonly
referred to as “single service aggregation” or “bundling”);the second ancillary benefit is that
operating as a single services aggregator will result in delivery of a better service, due to
improved interaction between the various providers of the different aspects of the overall
service offering. The third benefit is that of efficiency, whereby the total cost of providing the
overall service should be reduced through the alignment of functions between Telkom and
BCX in order to avoid duplication .
24
the PSTS market to Neotel, its newly licensed competitor and needs to
diversify and find alternative streams of revenue. According to
Matthyser, the acquisition will enable Telkom to plug some of the
revenues losses it expects with the entry of Neotel. The loss of
revenue as a result of competition from Neotel is estimated at R5bn
over 5 years. Matthyser says that Telkom expects to lose more
revenue as a result of increased regulation by ICASA but the
acquisition of an IT company will at least plug some of the revenue
lost. Telkom also claims that many PSTS operators internationally
have had to diversify their revenue streams in the face of deregulation
and competition and have vertically integrated into IT companies.
69] Mr Matthyser also claims that Telkom has been trying to build its
internal ITS unit with very little success.
70] However, throughout the hearing, we were told by a number of
witnesses, including the merging parties’ expert witness that the
margins in the ITS sector were very low. These low margins were
used as a basis by the merging parties’ expert witness to demonstrate
why input foreclosure would not be a profitable strategy for Telkom to
pursue in the downstream ITS market for which leased line is an input.
We were also told by the merging parties and their expert witness that
barriers to entry were very low in the ITS market and that the market
was highly fragmented.
71]Given these two factors – low margins and low entry barriers it is
difficult to believe that Telkom couldn’t, with its enormous resources
and deep pockets, enter the ITS market organically and why it was
willing to pay a premium of approximately 25% for the acquisition of a
company for such small margin gain. Mr Matthyser, when asked to
company for such small margin gain. Mr Matthyser, when asked to
explain this, could not provide a satisfactory answer but testified that
25
“even when the deal was contemplated, it was on the basis of covering
revenue losses at the acknowledgement of making very little new
margin or getting small incremental margin benefits from the deal over
three years”. 64
72]Mr Wilcocks on behalf of DD testified that he was not persuaded by the
reasons Telkom had provided for the acquisition of BCX. In his view,
the ITS industry’s profits constituted only R1.3 billion, and was a low
margin, highly fragmented industry. 65 This translated into a fraction of
Telkom’s own revenues, i.e. Telkom’s return on sales is approximately
30% as opposed to that in the ITS sector of only 2.5%.
73]Says Wilcocks: 66
“In my view if Telkom is faced with a reduction in profits that in
my view are monopoly profits that is has enjoyed for many
years, it really has two choices. One is that it could try and find
other profits in other areas, substitutes if you will for this. And
my understanding is that Telkom has publicly announced that is
the reason why it wishes to acquire Business Connexion to
diversify its earnings base. Now from the figures that I submitted
previously it would seem to me that that is going to be incredibly
difficult to achieve. It doesn’t seem to be a logically coherent
argument to me, because if you look at the spreadsheet that
shows the company’s earnings you will notice that Telkom’s
earnings are about R9.8 billion, Business Connexion earnings in
its last reporting period were about R110 million, so even a
miniscule reduction in Telkom’s profits can’t possibly be
substituted by Business Connexion’s profits. ”
64 Transcript page 531
65 Transcript page 1515
66 Transcript page 1521
26
74]He therefore believes that Telkom’s main objective is to retard the rate
at which this reduction of its monopoly profits will take place. 67
75]Mr Watt, the CEO of BCX did not testify initially, as was expected. He
only appeared before the Tribunal after his retirement and resignation
from BCX had been announced. In his stead Mr Sewell, testified on
behalf of BCX. However Mr Sewell had not been involved in any of the
negotiations around the transaction and could not provide us with any
firm view of BCX’s rationale for the transaction. 68
76]When Mr Watt eventually appeared before this Tribunal he denied any
involvement by the Board in Telkom’s offer to BCX and indicated that
this was a direct approach to shareholders. According to him the
Board was now simply implementing a decision taken by shareholders.
Accordingly he expressed no view about the strategic rationale for the
transaction for BCX. However correspondence between Telkom and
BCX’s deputy CEO show that Mr Watt, contrary to his evidence, under
oath before the Tribunal, had personally indicated his willingness to
negotiate a higher offer from Telkom and was familiar with the content
of the discussions between Telkom and BCX shareholders. 69
77] A strategic document prepared by the deputyCEO of BCX indicates
that BCX considered three options for its future, in light of convergence
which had increased competition in the market. It had the option to go
it alone, merge with Didata or go in with Telkom. Whether or not this
was presented to the BCX board was unclear. Mr Watt however
conceded that “some of those issues had been discussed”. 70
67 Transcript page 1894
68 At best Mr Sewell could only speculate about the strategic rationale for the transaction.
69 Telkom had made an initial offer of R R7.60 per share which had been rejected by the
Board. See Mr Watt’s evidence on page 2308 of the transcript.
Board. See Mr Watt’s evidence on page 2308 of the transcript.
70 See Mr Watt’s evidence on page 2312 of the transcript
27
78] Telkom’s own internal high level strategy documents paint a different
picture of why it seeks to acquire BCX.
79]A constant theme that is found in Telkom’s strategic documents is that
it seeks to defend its core market against competition and
convergence by offering end to end solutions, consisting of bundled
products to clients, on a long term basis, at discounts. Its aim is to own
the customer and to increase the costs of customers switching to
rivals. 71
80]In its internal document, Corporate Strategy document titled “2006
Update of Telkom’s 2010 Strategic Plan”, it states:
“We aim to counter arbitrage opportunities , defend fixed to
mobile revenue stream and counter revenue erosion to the SNO
and other competitors such as VoIP providers , through
strategies including long term contracts, bundled discounts
packages, calling plans as well as volume and term discounts.”
(Our emphasis) 72
81]In its document “Corporate Strategy Telkom’s 2010 Strategic Plan”,
Telkom identifies as one of the benefits to be gained from acquiring an
ITSP “ cross selling opportunities: An ITSP will allow for cross selling
and bundling opportunities in the Telkom segmented markets”. 73.
82]In its VPN Supreme Product Plan Telkom also identifies its
weaknesses in customer relationship skills as well as in network
administration, network support and systems integration and the urgent
need to acquire these.
71 See page 990 item 6.2.3.8 of the record
72 See page 331 ISPA file 1
73 See page 1021 of the record
28
83]In addition, Telkom, in anticipation of further regulation by ICASA and
more competition seeks to evade regulatory scrutiny. It seeks to locate
the acquired ITSP in a separate subsidiary for the following purpose
“A separate subsidiary will allow for more flexibility in pricing as
it will not be subjected to the rules of regulatory accounting and
costing. This entity would also not be under close scrutiny from
the Competition Commission. This will allow for more room on
bundling of products and services.” 74 (Our emphasis)
84]Further we see that all discussions of acquiring an IT company are
located in Telkom’s data strategy, identified as a major driver of future
growth in the convergence space, for its corporate or middle to large
enterprise customers. 75
85] It identifies that the government segment is where Telkom is most at
risk of losing significant market share and says that :
“ It is expected that government will pass as much of their
business as possible to the SNO to strengthen the new entrant
and to facilitate attracting an SEP for the remaining 25%
warehouse equity stake.”
86] And further it expects the SNO to “ cherry pick corporate and business
customers that are concentrated in the metropolitan areas to secure
quick and profitable market share gains.” 76
87]Dr Federico, under cross examination, agreed that Telkom’s objective
74 See Telkom’s 2010 Strategic plan item 7.2.4.3 in page 1021 of the record
75 Competition Commission Bundle 1A, Item 1, page 31
76 Exhibit “I” page 21.
29
was not so much the ITS margins themselves, but what IT can do in
combination with what Telkom already has. 77
88]A picture thus emerges of the real rationale for the merger. Telkom is
not seeking to find alternative streams of revenue.
89]Under cover of an unregulated subsidiary, employing a range of
strategies, Telkom seeks, through this transaction, to remove arbitrage
opportunities in leased line and voice segments. It wants to defend its
monopoly revenues in its core markets, namely fixed line voice and
infrastructure, from the impact of deregulation (convergence),
competition and further price regulation in the corporate and middle to
large enterprise segments of its business.
90]Telkom, identifies that convergence presents it with the threat of
arbitrage and declining voice revenues and that it needs to “own the
customer” in order to defend and grow its margins. It identifies the
need to remove these disruptive rivals that pose the greatest threat to
its margins and “disintermediate” the MNS market. 78 In addition, it
seeks to increase the cost of switching by its customers to its rivals
with various strategies.
91]The speed with which Telkom needs to respond to convergence is
crucial for it, in light of the pending entry of Neotel and the expansion of
firms in the MNS market. If Telkom does not remove credible MNS
competitors and gain access to their customers, it stands to lose the
most lucrative segment of its business. Alternatively it will be providing
Neotel with an opportunity to partner with any of these enterprises and
take a greater share of the MNS market than that predicted by Telkom.
77 Transcript 264 and 266
78 See Telkom slide 40 of the Bain & Company presentation entitled “Telkom Data Services
Strategy” dated 7 August 2002 on page 1268 Telkom Discovery Bundle 4.
30
Relevant Market Definition
The industry
92]Markets defined for purposes of Competition Law analysis are not
necessarily the same as those understood by lay persons. Nor are
they necessarily the same as those found in license categories that
may be identified by regulators. In this particular transaction for
example, the ECA identifies various categories of licenses, which
would require authorization and a degree of regulatory oversight,
depending on the nature of that license. ECNS 79 are licensees that are
authorized to rollout infrastructure. The equivalent license category in
the Telecommunications Act would be both fixed line and mobile
operators. ECS 80 are licensees who provide value added services over
facilities ostensibly obtained from an ECNS. A sector specific regulator
may elect to licence certain categories of services or equipment above
others for a number of reasons such as maintaining technical
standards, quality of services, universal service obligations,
environmental or health issues and spectrum requirements. However
for purposes of competition law analysis market definition relies on a
number of factors inter alia demand side substitution, supply side
substitution, functionality and nature of the product.
93]It was common cause between all the parties that the transaction
involves three relevant product markets all of which fall within the
broader market for the provision of information and communications
technology services to corporate or middle to large enterprises or
organisations in South Africa. 81 The three markets involved are the
supply of telecommunications infrastructure or basic connectivity,
79 Electronic Communication Network Services
80 Electronic Communication Services
79 Electronic Communication Network Services
80 Electronic Communication Services
81 The Commission identified other relevant markets such as network equipment. See the
Commission’s recommendation.
31
which would correspond with the ECNS license category in the ECA
and the two downstream markets referred to as the Managed Network
Services Market (“MNS” market) and Information technology services,
(“the ITS market”). While MNS in the form of VANS is regulated by
ICASA,82 IT services are unregulated. 83
94]It was also common cause that the relevant product markets were in
relation to the provision of infrastructure and services rendered to large
enterprises or oganisations, whether private or public bodies, with
multiple sites and which utilized wide area networks for their managed
data communications.
95]The Commission, in the course of the proceedings indicated that it
wanted to define an additional downstream product market, namely
hosted data centres. The Commission requested information from the
merging parties in the course of the hearing. The merging parties
eventually, after being ordered to do so by the Tribunal, provided the
Commission with the information requested. At the end of the
proceedings and after argument was heard, the Commission did not
pursue the competition implications of the horizontal overlap between
Telkom and BCX in relation to off—site data centres but made its
analysis available to the Tribunal. We deal with the issue of hosted
data centres later in these reasons.
96]We deal with each of the relevant product markets, taking into account
the dynamism and changes being brought about by regulatory
initiatives.
Infrastructure market (ECNS)
82 Will probably be regulated as an ECS under the ECA
83In its recommendation the Commission identified several other product markets in relation
to which it found no competition concerns. See page 20 of the Commission’s
Recommendation
32
97]The first layer consists of the upstream market for the supply of
telecommunications infrastructure. The basic components of a fixed
line telecommunications network infrastructure are the access
segment, which connects a business premise to a local exchange
(POP), the backhaul to the metropolitan switching centre and the trunk
segment, which provides long distance connectivity between POPs,
including international trunk. The access segment, which connects the
customer to the nearest exchange, is also referred to as “the last mile”.
Leased lines are used by MNS providers in order to, construct their
networks and access lines for their clients to connect to the nearest
POP. If the MNS provider did not own a network, leased lines were
used by their customers to construct a WAN.
98]Until May 2002, Telkom, a public switched telephone network
(“PSTN”), was the de jure monopoly supplier of infrastructure and
leased lines to the industry. All operators and MNS providers that
relied on connectivity for rendering services to their clients were
obliged to obtain their leased lines from Telkom, whether these lines
were part of their core network or access lines. Telkom also provided
national and international voice and data services.
99]Dr Mohapi, on behalf of Gadlex, argued that Telkom was no longer a
monopoly provider of leased lines. According to him there were large
competitors such as Neotel that had entered the market with a nation
wide network and could provide fixed leased lines, whether these be
access or trunk. The recent deregulation by the Minister of the supply
of fixed lines meant that PTNs such as Transnet and Eskom, and
mobile operators could also provide spare leased line capacity to MNS
providers.84 In addition there were a range of alternative technologies
providers.84 In addition there were a range of alternative technologies
(substitutes) for fixed leased lines which should be taken into account
by the Tribunal. Furthermore, both Telkom and Gadlex submitted that
84 See the Minister’s announcements of September 2004.
33
in their opinion ECS providers would in the future be able to self
provide leased lines and that ICASA was currently engaged in an
inquiry to determine this matter. 85
100]Hence it was argued that the market for the supply of infrastructure
should include fixed leased lines such as Diginet, which could be
supplied by both Telkom and Neotel (which had already entered the
market) and possibly PTNs and mobile operators, as well as wireless
alternatives such as WiMAx and Sentech’s Biznet, and last but not
least the selfprovisioning of such lines by ECS providers themselves.
We consider each of these in turn.
101]Neotel a competitor to Telkom, was licensed in 2006 and enjoys the
same rights as Telkom does to provide wholesale and retail
infrastructure services, leased lines for access and traditional voice
and data services, However, despite Neotel’s entry into the market, it
seems common cause between the parties, except for Gadlex, that
Telkom is still de facto the monopoly provider of fixed
telecommunications infrastructure in South Africa.
102]Dr Federico, the merging parties’ expert, testified that he had assessed
this transaction on the basis that Telkom had a near monopoly position
in PSTS and he had placed no emphasis on the role of Neotel. He
was also of the view that Telkom had significant market power and
enjoyed dominance in the markets relevant to this transaction. 86 Even
Telkom itself is confident that Neotel will only be able to take 10% of its
market share. 87 By inference, Telkom anticipates that at the end of the
next 5 years, it will still have 90% of the fixed line market.
103]Dr Hay, in his evidence, confirms that Neotel was not yet present in
any substantial way as a competitor to Telkom. He states:
85 See Matthyser evidence, transcript page 728.
86 Transcript page 420
85 See Matthyser evidence, transcript page 728.
86 Transcript page 420
87 See Telkom’s presentation to analysts in which it said it was not going to drop prices
drastically because it expected Neotel to take on 10% of the fixed line market. See Exhibit “H”
34
“Look, I think in broad terms if one looks at the access network
capabilities, essentially what one has available in the market is
Telkom. There is simply no other player, ourselves included,
who is able to substitute services and without making any
commercial statement, Sentech is also similarly unable to do it
on any scale.” 88
104]Neotel at this stage mainly offers wholesale services in the form of
wholesale Internet and a global voice transit service through Teleglobe.
Neotel’s geographic coverage presently is approximately 0.5% of
South Africa’s land area which includes the four main cities
Johannesburg, Pretoria, Cape Town and Durban. It aims to reach 15%
coverage within ten years. 89 Neotel currently employs 120 people as
opposed to Telkom’s 26000 employees. He testified that Neotel has
secured a national and metropolitan backbone network entirely
independent of Telkom’s network. However Neotel is not currently
able to provide country wide access to large organisations with
multiple business sites and that if it is approached for such services it
would have to use Telkom’s infrastructure. 90 Dr Hay testified further
that despite Neotel having access to Eskom’s and Transtel’s network,
through the process of integrating the various shareholdings, these
networks were not appropriate for cities and metros. This is because
historically those networks serviced their internal needs. Eskom’s
network for example is typically connected to power stations and does
not go anywhere near cities or end customers. Eskom and Transnet
have been building over the last few years, a backbone within the
metros with very few end points. 91 Furthermore, while Neotel has the
right to obtain network services from Infraco, the terms of that access
had not yet been finalized. 92
had not yet been finalized. 92
88 Transcript page 1158
89 Transcript page 1116
90 Transcript page 1121, 1388
91 Transcript page 1166
92 The Infraco Bill was still being debated in Parliament.
35
105]In addition, Neotel has no local or “last mile” infrastructure. The last
mile or the local loop represented a greater barrier to entry for any new
entrant. It is much more difficult to roll out a local loop than it is to roll
out trunk or national capacity in the telecommunications. 93 While Neotel
has a right to access Telkom’s last mile infrastructure for a period of 2
years, it had as yet not been able to conclude a framework agreement
with Telkom for access to its local loop.
106]Hence even though Neotel’s license entitles it to provide leased lines to
any operators or downstream firms it has been unable to do so.
Contrary to Dr Mohapi’s contention that Neotel represents a substantial
potential competitor to Telkom, Neotel itself doesn’t regard itself as a
formidable competitor to Telkom in the future. According to its business
plan, Neotel expects to gain only between 89% of Telkom’s market
share within the next 5 years. Initially it was projected that Neotel
would grow its market share to 10% within 5 years but in light of the
many regulatory delays and its slow entry this will not be achieved.
107] Furthermore, MNS providers do not currently regard Neotel as an
alternative supplier of last mile access to Telkom’s monopoly. Mr
Brierley of MTNNS says that if had he any choice he would buy from
alternative suppliers but that to date he had not found such supplier
yet:94
“….As soon as someone can offer me a competitive service of
the right price, with the right SLA and the right reliability, I will
buy such services, but what I don’t see in this market and I
should know this market, I’ve been in this market a long time,
and buying transmission is a huge part of my business. I mean
in our business the cost of transmission is the cost of our
93 Rolling out a local loop meant digging up streets and pavements at a huge inconvenience
93 Rolling out a local loop meant digging up streets and pavements at a huge inconvenience
to the public. It also required various authorizations from municipalities. Trunk capacity on
the other hand could be rolled out above ground.
94 Transcript page 1577 1578
36
business. So any saving I can make in cost of transmission is
very favourable to my business. I just haven’t found any
alternate suppliers that I can either trust, fibre price right or fibre
quality of the service that they’re providing correct.”
108]This was confirmed by Wilcocks when asked to assess the ability to
migrate from Telkom to Neotel: 95
“Part of the difficulty I have in answering this particular question
is to the best of my knowledge Neotel has yet to provide a
single service to any enterprise customer. I can speak from
personal experience around Internet Solutions that we have
approached Neotel on several occasions with a view to
obtaining services from them and we have yet to obtain such
services…”
109]Adequate and appropriate service level agreements which consist of
performance obligations and warranties in relation to network reliability,
downtime, repairs, etc are crucial for large organisations, in order to
ensure that their data is being managed to the requisite standard
110]Both Mr Brierely and Mr Wilcocks stated that apart from Telkom they
have not been able to find an alternative source of fixed leased lines
together with appropriate SLA’s, whether these be from Neotel or
PTNs and mobile operators.
111]Dr Mohapi testified that various municipalities, such as Ekurhuleni,
Tshwane, Johannesburg and Cape Town, were currently upgrading
their infrastructure and are planning to provide fixed line services to
businesses in competition with Telkom as well as looking for
opportunities to establish wireless broadband networks. It was
submitted in the press that Cape Town Municipality would not provide
95 Transcript page 1581
37
last mile services directly but would be providing the backbone so that
other telecommunications providers can lease from them. It is
therefore not clear exactly what services Municipalities will in future be
offering or when this will be available.
112]Some municipalities have been awarded PTN licenses and can thus
build their own private telecommunication networks. The recent
announcement by the Minister suggests that PTNs can resell their
spare capacity to MNS providers. A particular example of the Cape
Town municipality was used by Gadlex to support both the fact that
municipalities are rolling out PTNs but that they were doing so with Wi
Max to become completely “independent” of Telkom. However, the
Cape Town tender has already been legally challenged by Telkom. 96
Very little detail concerning the Municipalities’ future commercial plans
was submitted.
113]Hence from a supply side of fixed line infrastructure, there is literally no
other provider, apart from Telkom, that can provide leased lines with
appropriate SLAs to the downstream MNS providers.
114]The question remains whether there are any substitute products
available in the market that could offer downstream service providers
an alternative choice to Telkom’s fixed line infrastructure, i.e. access to
the last mile.
115]Dr Mohapi testified that wireless, in the form of WiMAX, presented a
viable alternative to last mile fixed line access, for Diginet lines. The
fundamental advantage of wireless technology is that it creates a local
loop without the need to “dig up the earth” and lay multiple cables.
Telkom, Neotel, Sentech and iBurst have been issued with a license
for WiMAX services. Dr Mohapi lists these entities as competitors to
Telkom or alternative suppliers of leased lines, albeit wireless.
96 Telkom has launched legal challenges and objections against the decision of the Cape
96 Telkom has launched legal challenges and objections against the decision of the Cape
Town Municipality.
38
116] There is however, considerable uncertainty as to the ability of wireless
technologies to provide reliable business class capacity on a scale that
will satisfy the increasing demand of large corporate clients who need
dedicated reliable links of more than 2 Mbps to connect their WANs or
VPNs.
117] Mr Brierley, Mr Wilcocks and Dr Hay all disagreed that WiMax was a
suitable alternative for the needs of large organizations. They
submitted that WiMax was used mainly as a complementary
technology to fixed leased lines and was usually deployed in small
offices and home use (SOHO) or for limited internet access. Telkom
itself uses WiMax as an alternative to ADSL which is deployed as a
service for SOHO organizations and consumers as opposed to Diginet
lines which are used for large organisations. 97.
118]Dr Mohapi, under cross examination, agreed that WIMAX is not
comparable in quality and reliability to fixed line as far as large
corporate and their need for bandwidths of more than 2 Mbps, i.e. 155
Mbps, are concerned. 98
119]There seems to be some consensus that currently WiMax, does not
offer a viable alternative for fixed line infrastructure at the top end of
the corporate market, i.e. where 155 Mbs is required.
120]Other factors that render WiMAX an unsuitable substitute for fixed line
access lines are limited availability to establish high sites, limited
bandwidth availability, reliability and quality and large capital
investments into infrastructure. WiMax also operates on the basis of a
shared base station. Hence the ability for it to serve large
organization’s needs is limited by the number of users utilising the
base station at the same time. While radio engineering can ameliorate
that problem to some extent this is limited.
97 Transcript page 1752
that problem to some extent this is limited.
97 Transcript page 1752
98 Transcript page 1370 and Mohapi’s supplementary witness statement par 101.
39
121]Significantly, WiMax is not offered with the same level of warranties
and Service Level Agreements that Diginet is offered because as
Sewell points out: 99
“Wireless is generally not as reliable as VIVA. 100 It’s affected by
weather to some extent. So it wouldn’t be one’s first choice as
the main link that you would use in an online environment .”
122]Mr Brierley explained that because wireless is transmitted through the
air it is affected by weather and climate in ways that would not happen
with a piece of copper that runs underground. 101 Telkom, in its own
documents, indicated that it does not consider, for instance, iBurst a
competitive threat in the corporate market due, largely, to the WiMAX
technology involved. 102
123]From all of the above statements it is clear that WiMax is not an
appropriate service for connecting the multiple sites of large corporate
customers and that it would only, as technology stands today, be used
as a backup to fixed lines. Hence we do not consider it to be a
substitute for the relevant market under consideration namely the large
enterprise or organization.
124] However even if we were, for purposes of argument, to share Dr
Mohapi’s views and assume that WiMax is a suitable technical
alternative to fixed line connectivity for large organizations, a further
barrier to entry in relation to such alternative technologies is the
availability of spectrum. To date the bulk of this spectrum has been
allocated to Telkom, Neotel, Sentech and WBS. It remains to be seen
how ICASA will allocate the remainder of the spectrum. Municipalities
such as Cape Town who are desirous of rolling out WiMAx networks
face the same difficulty of obtaining spectrum. Didata has been
99 Transcript p 773
100 Mr Sewell was referring to fixed line technology.
101 Transcript page 1688
100 Mr Sewell was referring to fixed line technology.
101 Transcript page 1688
102 See Telkom’s Corporate Strategy document in Commission’s record page 1021.
40
lobbying ICASA to allocate the entire remaining spectrum to one entity,
namely itself. 103 However if ICASA did so, this would amount to
granting DD the right to selfprovide its infrastructure albeit in the form
of wireless connectivity, which brings us to the issue of self
provisioning.
125] ICASA has been asked by the Minister to conduct an enquiry into
which of the ECS licensees, if any, are to be granted the right to self
provisioning. In the hearings held by ICASA in this inquiry, Telkom
made extensive submissions to ICASA opposing the granting of such
rights to ECS. It was therefore surprising and downright dishonest of
Mr Matthyser to submit to this Tribunal that Telkom supported self
provisioning by ECS licensees. 104 Dr Hay on behalf of Neotel testified
that Neotel would challenge such a decision by ICASA. 105 Hence any
granting of WiMax spectrum to an ECS licensee is likely to be
challenged by a number of operators, including Telkom and Neotel,
and ECS rivals in the event that ICASA chose to grant rights only to
some and not others.
126]As far as Sentech is concerned, it only offers one product called BizNet
as an alternative to Diginet or similar fixed leased lines. However, Mr
Brierley and Mr Wilcocks testified that Sentech could not provide an
alternative to Telkom. 106 The product did not come with equivalent
warranties and SLAs. So even if Biznet was a technical substitute to
fixed lines, Sentech was not able to provide large customers with
103 See DD/IS submissions to ICASA on WiMax spectrum allocation. See Exhibit 1A and 1B
104 Indeed Telkom maintained throughout these proceedings that it was not opposed to ECS
licenses being granted the right to selfprovide infrastructure. It was only towards the end of
the proceedings that Telkom supplied the Tribunal with a copy of its submissions to ICASA
which confirm Telkom’s position to be quite contrary to that argued by its counsel and by its
witnesses.
105 See evidence of Dr Hay in which he states that Neotel paid a lot of money for its license
and will challenge ICASA’s decision since such as decision would convert an ECS licensee
into an ECNS licensee. See page 1127 of the transcript.
106 Mr Brierley testified that for MTN NS , out of its [confidential] leased lines, [confidential]
were obtained from Telkom and only [confidential] from Sentech
41
appropriate SLAs. Mr Wilcocks testified that Sentech in fact was in
disarray and was still attempting to obtain funding from government for
migration to digital broadcasting in preparation for 2010.
127]We were urged, during argument, to also take judicial notice of various
public statements made by mobile operators indicating their intention to
enter the fixed line market. In our view, if we are to have regard to
them at all, those statements confirm that wireless connectivity is not a
complete substitute for wireline connectivity –especially so in a
converging market –and that mobile operators in fact did not have
spare capacity to supply to MNS providers. Their decisions also
confirm that Neotel was not a credible alternative supplier of fixed
infrastructure.107 Even if we were to consider their intentions as
potential entry into the infrastructure market, such entry would hardly
be timely given the length of time it takes to roll out fixed line
infrastructure and provide access lines with appropriate SLAs.
128]Dr Mohapi, himself acknowledges that despite all the theoretical
possibilities of alternatives and substitutes argued by him, there was
no certainty as to their actual availability .108
129]In conclusion, we find that for services provided to large enterprises or
organizations that require communications between multiple sites
across the country, there are no suitable technical substitutes for fixed
line infrastructure. Even if for the purposes of argument, we accept
that WiMAx was a perfect technical substitute for fixed leased lines, it
is not a commercial substitute for fixed leased lines since it comes with
no warranties and SLAs. At best it can be used as a complement to
fixed lines in limited circumstances. In addition, Neotel, mobile
fixed lines in limited circumstances. In addition, Neotel, mobile
operators and PTNs are not viable alternative suppliers of fixed lease
line capacity. Telkom is thus the overwhelmingly dominant –a near
107 Both Vodacom and MTN stated that they were planning to roll out fixed lines because of
Telkom’s high bandwidth prices.
108 See paragraph 63.2 of his witness statement
42
monopoly supplier of fixed line infrastructure in this market.
The MNS market
Market Definition
130]The second relevant market is the downstream MNS market.
Managed network services consist of a diverse range of valueadded
services which are rendered on top of the transmission of data by a
leased line to an organisation over its wide area network, whether the
WAN is an enterprise owned WAN or provided by a VAN provider.
131]It was common cause that LAN services were not included in the
market definition. LANs link the various desktops in a single office to
an office server while WANS allow organizations to transmit data
between multiple sites in a secure and efficient way, without having to
rely on the public telephone network, which is provided by Telkom.
LANS are not a substitute for WANS.
132]A corporate can build its own WAN, referred to as a private enterprise
WAN, and outsource the management thereof to service providers. Or
it can outsource all of it to a provider that owns a network and can
provide services to it. MNS providers that own their own network are
called VANS 109 and require a license from ICASA.
133]The outsourced network is referred to as a shared Virtual Private
Network (VPN). (See our discussion on the development of the VPN
model). This allows MNS providers to supply WAN services to various
clients using their own VPN offerings. In order to offer these services
109 The equivalent category in the ECA is the ECS license category.
43
MNS providers must build their own backbone networks, referred to as
a VPN cloud, using high bandwidth leased lines (i.e. Diginet lines) from
Telkom. A VPN backbone network has various POPs, i.e. access
points from which customers’ sites can then connect into the service
provider’s network. Customers connect to these POPs using local
Telkom access lines that connect the customers’ sites to the nearest
Telkom local exchange, the “last mile”, which in turn connects to the
MNS provider’s POP. A further management component is then added
which involves running networks so that traffic is prioritized according
to the particular application, ensuring that security needs are met and
to ensure good quality service. This all depends on the service level
agreement (SLA) that the customer selects.
134]Accordingly, from a supply side perspective, WANS and VPNs are
substitutes for each other, the one being an enterprise owned wide
area network, the other an outsourced wide area network, both
providing the enterprises which have more than one site, with
managed communications services. The provision of both types of
wide area networks require a similar range and depth of skills such as
network design and implementation, network support, management of
Telkom for access lines, as well as additional management support. 110
135]A typical managed organizational WAN is built up using the following
layers, each of which may be provided by a different service provider:
• Level 1: basic telecommunications services consisting of the
provision of transmission capacity between two points (e.g. leased
access lines).
• Level 2: endtoend telecommunications services involving physical
and logical layers such as routers and switches that make service
available for use. This would include the provision of managed
available for use. This would include the provision of managed
bandwidth, virtual private networks (VPN), frame relay and ATMs.
110 See Hodge expert report, CRA expert report, and Commission’s recommendation.
44
• Level 3: Physical and logical management of customer’s network
and premises devices, often referred to as “managed data network
services” or network outsourcing services. These include services
such as internet access, VPN solutions, hosting services, voice
over Internet Protocol, security backup, firewall intrusion detection
etc.
136]Defining the outer boundaries and relative market shares in this market
proved to be a difficult exercise indeed. The difficulty is caused to
some extent by the different ways in which companies report their
revenues and the complex range of services that could conceivably
constitute “managed network services”. As can be seen from the
layers identified above, MNS services could constitute a combination of
any of the components of the three layers. The only element that is
easy to exclude is layer one namely access lines. However, even this
exercise can be marked with a measure of double counting because of
the different ways in which companies report their revenue figures. 111
Nevertheless, it was common cause between the parties, which is also
reflected in the manner in which BMI collates its figures, that at the
very least the definition of MNS did not include revenue figures for
access lines. This would accord with the notion that access lines did
not constitute “managed services” because they are viewed as basic
connectivity.
137]The Commission defined the relevant product market as the market for
the provision of WANs and VPNs including the management layer. In
relation to the layers identified above, this would include layers 2 and
3. Hence the MNS market would include the rendering of services
such as designing, building and implementing or configuring the WAN,
the VPN shared backbone, the necessary equipment (primarily routers)
the VPN shared backbone, the necessary equipment (primarily routers)
111 BMI –T itself points to some instances of double counting for access lines in its own
estimates.
45
and the network management element. 112
138]The merging parties, on the other hand, submitted that there were two
possible market definitions for the MNS product market. They argued
that the MNS market can be defined as a VPN and in particular the IP
VPN market (narrow definition) or it can be defined as only the
management component of all WANs, whether these were IPVPNs,
VPNs or enterprise owned WANs. In support of their arguments, they
provided the Tribunal with revenue figures which were ostensibly
drawn from internal Telkom and BCX management accounts.
However, neither BCX nor Telkom, despite having had ample
opportunity to do so, provided the Tribunal with any supporting
documentation verifying the revenue figures utilized by their witnesses,
nor did they provide the expert witnesses of the Commission or IPSA
access to these internal management accounts form which it was
claimed these figures were drawn. Neither did they clarify what
component of layers 2 and 3 of WAN constituted their definition of
“management of the network”. For example, they did not clarify
whether the management component included only services such as
metaWAN services or it included the monitoring of the performance of
network equipment such as that indicated in the Telkom CNC
product.113
139]Both the Commission and ISPA argued that network equipment such
as Cisco routers should be included in this definition since these are
integral to the design and implementation of the network, In addition
the industry reports complied by BMIT included these in its market
analysis. However the merging parties argued that necessary
equipment such as Cisco routers should not be included in the
equipment such as Cisco routers should not be included in the
definition. They pointed out that separate contracts are awarded for
112 See Ispa Heads page 27.
113 See the features of the CNC product on the Telkom website.
46
equipment and management services in tenders and that Telkom itself
offers a management service called CNC which provides services to
clients on nonTelkom VPNs.
140]It is not surprising that the merging parties would insist that necessary
equipment such as Cisco routers should be excluded from the
definition since that was the basis upon which they distanced
themselves, unconvincingly in our view, from the now infamous Bain
slide (to which we will return). The Bain slide was relied upon by the
Commission in its investigation to assess the relative market shares of
Telkom and BCX in the MNS market.
141]In order for us to assess whether or not equipment such as routers
ought to be included in the market for “managed network services” we
considered the industry norms relied upon by BMIT and the evidence
of industry participants placed before us.
142]Mr Brierley testified that MNS providers only buy level 1, that is the
dedicated leased lines or pipes, which is at the bottom of the WAN or
VPN. He testifies further “As soon as there is a management
component in the pipe you are in layer 2 or layer 3”. 114
143]Telkom itself sells Cisco routers with its VPN Supreme product, which
are programmed or configured by it. 115 Furthermore, the Telkom
website suggests that the special CNC product also includes
equipment maintenance and monitoring of WAN equipment for swift
restoration of configuration. This suggests that it is difficult to separate
out management of necessary equipment such as routers from the
management of the network itself. 116
114 See Brierley page 1669
115 See Telkom VPN Product Plan
116 See Telkom’s CNC product offering on its website and its special features.
47
144]In its industry reports BMI excludes access line revenue to the extent
that it can but includes revenue for equipment such as routers.
145]Telkom itself, despite distancing itself from the Bain slide seems to
have relied upon the figures in an assessment of the competitive
landscape in data services, excluding access line revenue figures, as
stated on that slide which on their version includes relevant equipment
for each type of service. The Bain slide makes a clear distinction
between access lines, LAN, WAN and internet services.
146]We do not rely on the assertion made by Telkom that network
equipment constitutes a separate relevant market on the basis of large
tenders issued by organisations. An organisation may seek to issue a
tender for separate aspects of a network for any number of reasons,
including budget management, price transparency, and improved
service provider management or in furtherance of objectives of their
supply chain management, which may require a promotion of BEE or
small businesses.
147]What is however clear from the evidence of the industry reports and
participants in the industry, including Telkom, MTN NS and ISPA is that
network equipment such as Cisco routers, is considered to be part of
managed network services and is included in the revenue figures
which are used as a basis for calculation of relative market shares.
148]This is not a surprising outcome since network equipment in the
context of managed network services forms an integral part of that
service. Routers and switches are not sold independently of the
network design or the managed bandwidth and the manipulation of
data that a customer seeks to achieve over that network. Routers and
switches do precisely what an organisation wants its network to do for
switches do precisely what an organisation wants its network to do for
it – they are installed and programmed according to each
48
organisation’s needs. The number of routers or switches sold to an
entity will depend on the design of its WAN which in turn depends on
the enterprise’s geographical spread and its priorities. Configuration of
the routers and switches is considered to be part of managed network
services.
149]The evidence also suggests that the management component of the
service relates not only to managing the network (the managed
bandwidth) but also the routers and switches.
150]On this basis we conclude that the evidence firmly points towards the
fact that the industry norm for defining MNS includes both layers 2 and
3 of the WAN organizational layers identified above. We find that the
relevant MNS market includes the provision and management of
enterprise WANs and VPNs including IPVPNs and necessary network
equipment such as routers and switches, but excludes Telkom’s
access lines.
151]Both Telkom and BCX are present in the MNS market. BCX has
recently entered the VPN segment of the market via its acquisition of
Bidnet’s VPN, now trading as BCX Comms. It therefore participates in
the MNS space via two routes, through BCX Comms and also, through
BCX in which its WAN management services and network services are
located
Market shares in the MNS market
152]The Commission based its original market share estimates of Telkom
and BCX on the 2002 Bain presentation, a document that had been
prepared for Telkom and which had been provided to the Commission
by Telkom.
49
153]According to the Commission, Telkom had a 31% share of the MNS
market and BCX 9.1%. The Commission’s calculations were based on
the size of the MNS market of R2.2billion as reflected in the Bain slide.
On the basis of this horizontal overlap the Commission concluded that
the merger will give rise to competition concerns.
154]In the course of the hearings the relative market shares of Telkom and
BCX became moving targets. The merging parties attempted to
suggest that BCX’s market share was less than 3% and Telkom’s
market share seemed to take on organic qualities. In his expert report
Dr Federico states that Telkom’s market share was closer to 35%. By
the end of the proceedings the market share was closer to 40%.
155] The merging parties attempted to distance themselves from the Bain
slide by insisting that the figure was inflated due to inclusion of
equipment sales and hence the 9.1% calculated by the Commission
was an overestimation of BCX’s market share. Mr Matthyser in
response to a question as to whether the revenue figure included
equipment was not able to provide a clear explanation of how he
arrived at the figure of R2.2bn. 117
156]However a careful consideration of the Bain slide indicates that the
information reflected on it was sourced from no less than four
independent sources. A note on the slide indicates that the sources
were BMIT, IDC, Ovum and Bain analysis. These are reputable
international companies providing research and data to the industry as
well as strategic consulting services. In addition the figures, drawn
from the other three different sources seem to have been analysed by
Bain, rather then merely transposed. These were the figures that
Telkom itself relied upon to assess its competitive position in the WAN
Telkom itself relied upon to assess its competitive position in the WAN
117 See page 587 in which Matthyser gives an answer that he “must have made a mistake,
must have done the wrong thing”, rather than explaining how he arrived at the figure.
50
segment of the market. In our view, the Bain slide, despite the
merging parties’ efforts to distance themselves from their own internal
documents, represents a reliable starting point.
157]Another source which was used was the BMI report of 2006 for Data
Services. The Commission was only alerted to this document well into
the hearing, although Telkom knew of the existence of this document
much earlier. Based on this BMI report, the total size of the MNS
market was R2.88 billion in 2005. 118 However, it seems that even these
figures are not completely accurate and may be overstated. BMI
estimates that it has overstated the market by R250 million and that the
total market, excluding leased lines, should be approximately R1.583
billion.119 BMI states that defining and estimating a market size for this
market segment is considerably complicated because the terms ‘IP
VPN means different things to different people’. 120
158]Telkom’s expert, CRA, estimated that the total MNS market is R1.45
billion, having adjusted the total BMI figure of R 2.88 billion to exclude
R1.45 billion for access line revenue. 121 This calculation was based on
the Telkom assumption that the MNS revenue is split equally, i.e.
50:50, between access revenue and MNS revenue. CRA also submits
in its report that Telkom’s share of the MNS market was R810 million.
However these figures were unverified. Telkom had not granted the
Commission or intervenors access to its management reports and no
document supporting these figures was filed by Telkom with the
Tribunal.
159]Mr Van Huyssteen, on behalf of Telkom, in his evidence confirmed that
118 Telkom Bundle File 4 page 1419
119 Transcript page 214
120 Exhibit F page 8.
121 CRA report page 85 of the witness bundle
51
the access and MNS revenue split is 65:35 rather than 50:50. 122 This
was corroborated by CRA in its expert report. 123
160]Mr Hodge, who had based his calculations on revenue figures
submitted by the merging parties in these proceedings, estimates the
total MNS market at R735 million. To arrive at this amount he adjusted
the BMI figure for the Total MNS market of R2.88 billion downwards to
R2.1 billion. 124 Of that 65% was deducted as the portion attributed to
revenue derived from access lines (the revenue split being 65:35). 125
The Total MNS market is therefore R 735 million. 126 Hodge confirmed
that the same result was obtained by working bottom up on the basis of
the R810 million figure provided by Telkom. 127
161]Telkom criticized ISPA’s R 735 million indicating that it should be much
larger, namely R 2.2 billion as stated in the BMI report. 128 According to
it, ISPA should have included the amount of R1.1 billion for equipment
sales in respect of WANs as well as the R 400 million for the network
management component of WANs undertaken by other suppliers in the
market.129 However, ISPA claims that the R1.1 billion seems to include
all IT equipment such as desktops, screens laptops etc. while for
purposes of the MNS market the relevant equipment would be Cisco
networking equipment. 130
122 Transcript page 1203
123 CRA expert report page 50 par 127
124 The R2.1 billion was calculated by adjusting the BMI’s estimate of the total market
revenue of R2.88 billion by subtracting the possible overstatement of Telkom’s size (the
difference between R1.33 billion as calculated from the BMI report and the unverified R810
million as supplied by Telkom), as well as the double counting of access lines. Ispa Heads
page 29. Ispa also calculated the total MNS market backwards starting at Telkom’s market
share claim. This “bottomup” approach is set out in the Schedule to ISPA’s Heads, page
share claim. This “bottomup” approach is set out in the Schedule to ISPA’s Heads, page
108, Driver 3. This method calculates the total market as R 742 million.
125 As verified by both Mr Brierley and Mr Van Huyssteen
126 See Hodge’s testimony, transcript page 2140.
127 Transcript page 2138
128 See table 5 page 13 of the BMI report in Telkom’s Bundle 4 page 1427.
129 Transcript page 2649 and 2830
130 Both Telkom and BCX supply Cisco Networking equipment and both are Cisco Gold
Partners. CRA Report of 15 June page 18. CRA refers to the R 1.1 billion in its expert report
52
162]Neither Telkom, nor BCX made any attempt to furnish the Tribunal with
any verified revenue information. Instead they attempted, once again,
to distance themselves from the evidence given by their own
witnesses.131 Mr Van Huyssteen’s evidence that the revenue figure
was 65:35 was unambiguous and corroborated by other witnesses.
163]The Tribunal has to consider the best evidence placed before it. It
appears to us that ISPA’s calculations, based on the evidence by
witnesses, industry reports and the revenue figures submitted by the
merging parties themselves, constitute the best estimate of the size of
the MNS market. We therefore accept that the total MNS market is
approximately R 735 million. This amount does not include revenue
earned from the rental of access lines.
Telkom’s market share
164]Telkom initially estimated its MNS market share as 35% and by the
end of the hearing it submitted estimates of between 35 to 40%.
Telkom based its market share on Internal Management Accounts.
However these calculations were never discovered to the Commission
or ISPA and Telkom could therefore not be crossexamined to verify
the figures. Telkom’s estimate of its market share, based on more
recent information produced by it in February 2007, in the management
on page 55 of the witness bundle.
131 The merging parties attempted to “clarify” Mr Van Huyssteen’s evidence at the time when
Mr Hodge made his calculations by producing a subsequent affidavit by Van Huyssteen, after
he had been crossexamined, reexamined and released by the Tribunal. The contents of
that affidavit were not subject to crossexamination because the merging parties did not recall
the witness. Accordingly we have no regard to it.
53
only layer is 37% and for IPVPN 40%. 132
165]It is ISPA’s contention that Telkom’s market share is well in excess of
40% while the Commission estimates that it is closer to 50%. 133
166]According to the Commission BMI has estimated Telkom’s 2005
market share at 55%. 134 Dr Federico however chose to ignore this
estimate, stating in his expert report that BMI had overestimated
Telkom’s market share as it includes revenue from leased lines
provided directly by Telkom to customers using services provided by
other MNS players. 135 Mr Rogers for the Commission disagreed with Dr
Federico’s conclusion on this indicating that Brian Neilson of BMI had
told him that BMI may have overstated Telkom’s MNS revenue of
R1.583 billion by R 250 million, due to double counting, thereby
decreasing the figure to R1.383 billion, thus representing a market
share of 51%. This estimate, according to the Commission, also finds
resonance in Telkom’s VPN Supreme product plan for 2006/72007/8,
apparently produced in February 2006 where it is stated that Telkom’s
share of the IP VPN market in South Africa was 45%. 136. Based on this
the Commission argues that Telkom’s overall MNS market share must
be greater than 4045% and thus closer to 50% since IP VPN is only
one of many WAN products that Telkom offers. 137
167]ISPA considered two possible methods for calculating Telkom’s market
132 See Matthyser evidence, transcript p423 and Van Huyssteen evidence transcript page
981 and 1323.
133 Scholars such as Theron and Boshoff indicate that since 2002, Telkom has significantly
expanded its data services by moving into managed data networking services. As of 31
March 2005, according to them, Telkom was managing 11961 data sites on behalf of
corporate and business customers, a 55% rise compared to March 2003 . See N.M. Theron
corporate and business customers, a 55% rise compared to March 2003 . See N.M. Theron
and W.H. Boshoff: Vertical Integration in South Africa Telecommunications: A Competition
Analysis.
134 See Telkom bundle file 4 page 1424
135 This he derived from notes to another table, table 2 on page 5, in the BMI document .
136 Exhibit U page 6, par 2.1.5
137 Others include ATM and Frame Relay.
54
share in the MNS market. It first calculated Telkom‘s market share as
38.5%, based on Telkom’s unverified total 2005/6 MNS revenue of
R283 million which it divided by the total MNS market size of R735
million. However it was of the opinion that this market share was too
low if one took into consideration Telkom’s internal documents. It
therefore also considered what Telkom had said about its own market
share based on its various MNS products. Telkom’s VPN Supreme
Product Plan 2007/2008, dated February 2007 estimates its market
share of the IP VPN segment at between [35%45%] and its X25
Product Plan 2007/2008, dated 10 March 2007, state its market share
in this segment as between [65%75%]. Based on the BMI revenue
figures Telkom’s combined market share in the Frame/Cell segment
amounts to 75%. 138 ISPA therefore concludes that based on these
figures Telkom’s market share in the MNS market must be in excess of
40%.
168]All of the above suggests that Telkom’s market share is likely to be
higher than 40%. 139 ISPA on the basis of its earlier calculations
provides us with a market share of at least 38.5%. If we have regard to
all the evidence put before us, Telkom’s market share seems to be in
the range of 38.5% 51%.
BCX’s market share
169]Telkom alleges that BCX is a very small player in the MNS market in
that it has only recently entered the VPN segment. At the end of the
138 See ISPA heads page 34 par 54.3
139 In Exhibit I, page 108 for instance Telkom indicates that it has 60% of the market while
VANS and ISP’s capture the balance.
55
proceedings Telkom argued that BCX’s market share was between
2.2% to 3.2% in the MNS market. 140 Mr Sewell on behalf of BCX
stated that BCX”s revenue from its traditional WAN management
activities amounts to only R15 million, which represents a market share
of 4% of the WAN metamanagement segment. 141 This figure excludes
revenue from BCX Comms for 2005/6 in the VPN segment of R70
million. However, the figure of R15million could not be found in the
BCX financial documents that had been discovered. Under cross
examination Mr Sewell conceded that BCX’s revenue figure for MNS
could be higher than R15m depending on how MNS was defined and
that the revenue figure could include revenue for network design and
implementation.142
170]The Commission, at the end of the proceedings seems to have
suggested that BCX’s market share was smaller than initially assessed
but not by much more than that put forward in its recommendation.
171]ISPA, utilizing the evidence that had been put before the Tribunal by
the merging parties themselves, and the BMI data, estimates BCX’s
MNS market share at 8.7%. Based on the sum of the various
components as set out below, it calculates BCX’s total revenue from
the MNS market share as R63 million. 143
1) Revenue earned from designing, building and implementing
WANs: 4% of R143.7 million, i.e. R6 million; 144 plus
2) BCX Comms’ contribution to the MNS market through the
provision of VPN services: R27 million (a proportion of the R70
140 Unterhalter in his heads at page 44 refers to the BMI report of 2006. It is however unclear
exactly how he calculated these percentages.
141 See Telkom bundle 4 page 1419, table 2 and 1415 table 1. “WAN metamanagement”
which is defined as high level WAN management services provided by system integrators
which is defined as high level WAN management services provided by system integrators
such as BCX and Dimension Data etc, of which the total market revenue of 2006 was
estimated at R 416 million.
142 See transcript page 956 957
143 See ISPA heads page 30, 42 to 45
144 Transcript page 2621
56
million figure after access lines are deducted); 145 plus
3) BCX’s WAN equipment sales (and presumably lease): 10% of
R150 million, i.e. R15 million; 146 plus
4) Network Management: R15 million. 147
172]It then divides the R63 million by the total MNS market of R 735 million
arriving at a market share of 8.7%. 148
173]Mr Hodge indicated that he had consulted with industry participants
and had formed the view that BCX in the traditional WAN space was
not an insignificant player and that it would accord with the estimated
market share that ISPA had calculated. 149
174] At the last minute of the proceedings, Mr Watt suggested that the
revenue figure of BCX Comms included access line revenue. This was
never suggested before by any party and indeed, once again could not
be verified. Moreover this was directly contradicted by Mr Sewell who
stated that in the main, BCX”s clients and not BCX, had a direct
relationship with Telkom regarding access lines. 150
175]On the basis of industry sources, the evidence before us and the
revenue figures provided by the merging parties’ themselves, we
conclude that ISPA’s calculation of BCX’s market share of 8.7% is a
fair estimate – and notably not too far off from that reflected in the Bain
slide.
176]In conclusion we find that Telkom’s relative market share in the MNS
145 Transcript page 2294 and CRA report page 56 of the witness bundle.
146 Transcript page 2295
147 CRA report page 54 of witness bundle. ISPA argues that it is “abundantly” clear that
BCX’s MNS revenue of R15 million was purely the management layer and did not include the
revenue earned by BCX for designing, building and implementing or configuring WANs. The
amount is not verified.
148 Hodge’s estimate of the total MNS market as explained in the transcript pages 2138 and
2140.
149 Transcript 2159
150 Transcript 886.
57
market is between 38.5% 50%. BCX’s market share is at least 8.7%.
177]The Commission and ISPA identified Didata as the largest competitor
to Telkom in the MNS market. Mr Brierley and Mr Wilcocks both ranked
Didata as the next largest player, after Telkom, in the MNS market. 151
Mr Brierley identified Verizon and MTN NS as the next significant
competitors, after DD, to Telkom, but his evaluation was done in the
context of only the VANS (VPN) segment and not the entire MNS
market. None of the parties provided market share figures for these
two entities in the MNS market. However neither Verizon nor MTN NS
provide the range of services that DD and BCX provide, such as
outsourcing, enterprise owned WAN, metaWAN management and
systems integration services.
178]On the basis of the Commission’s calculations Didata, as the largest of
these competitors, had a market share of approximately 13%. Hence
BCX, with a market share of at least 8.7%, compared to the DD’s share
of 13%, can hardly be considered to be an insignificant player in the
MNS market.
The ITS market
Market definition
179]The third product market is the Information Technology Services
market (“ITS” market) which can be divided into several submarkets
namely Application Management, Information Systems Outsourcing,
Network and Desktop Outsourcing Services, Hosted Application
Management and Hosted Infrastructure Services.
151 See , Brierley evidence transcript page 1705, Wilcocks transcript page 1788
58
180]ITS relates to the provision of services to large corporate buyers of
services such as planning, managing and supporting software and
hardware required to run their computing requirements. It generally
includes a central (or distributed) data centre where the organizational
database and some utility and enterprise applications reside, and a
number of distributed computing sites at each office location which
would include the servers, personal computers and peripherals such as
computers. An organization can choose to either supply all of its IT
requirements internally (onsite) or it could outsource all of its
requirements to a specialized ITS company (hosted infrastructure).
181]Some IT services are dependent on connectivity as a direct input to
function namely Data Centre infrastructure management, WAN
management and desktop management. It appears to be common
cause that for purposes of this merger the relevant product market
includes access based IT services.
182]BCX is an IT company that is primarily involved in the provisioning of IT
services (though it also acts as a reseller of hardware and software).
Its revenue is split roughly between services (69%) and products
(31%).152 Its business is split into outsourcing services, technology
infrastructure, business applications and communication. It conducts
the majority of its activities onsite at the customer’s premises but also
provides remote hosting and/or infrastructure management services at
its data centres. 153 Offsite or remote data centres rely on a leased
line to connect an offsite data centre to a company WAN. BCX
operates 4 data centres, two newly commissioned data centres at
Midrand, one at Crown Mines and the other in Durban. Notwithstanding
Midrand, one at Crown Mines and the other in Durban. Notwithstanding
152 See the BCX 2006 Operational Review on its website
153 These may involve BCX hosting and managing the customer’s own equipment at BCX’s
data centre, or the customer choosing to manage its own equipment which is merely housed
at BCX’s data centre, or BCX managing the customer’s ITS requirements using BCX’s own
equipment housed at BCX’s data centre.
59
its large investment in the Midrand centres, BCX claims that the
majority of its clients in general favour onsite support over remote
service provision via a centralized data centre. As a result, the offsite
data centres account for a small proportion of outsourcing revenues.
Market shares in the ITS market
183]All the parties agree that BCX is the largest player in this market.
Telkom only recently entered this market and is regarded as a small
player.
184]Dr Federico estimates BCX’s market share to be 12.2% of the total ITS
market and 17.7% of the outsourcing segment. 154 The merging parties’
concede in their Heads that BCX’s market share could be as high as
19% if one removed the smaller customers from the BMI estimate. 155 If
the same exercise is done for the Outsourcing activities BCX’s market
share would increase to approximately 20%.
185]According to the Commission BCX’s market share in Outsourcing is
approximately 18%. The Commission also identities a sub segment
within the Outsourcing market namely Information Systems
Outsourcing, where BCX is particularly strong. It estimates that BCX’s
share is 33.3%. BCX itself indicates that its share of this segment has
grown from 33.3% to 38.5%. Mr Sewell who is the Head of
Outsourcing, in March 2006, indicated in an interview with Moneyweb
of BCX’s aim to grow its market share from 30% to 50% in this
segment.156
186]The BMI 2005 report on the IT sector estimates BCX’s market share in
the ITS market as 12.2% and 17.7% of the Outsourcing market. 157
154 Table 2 and 3 of the CRA report
155 See Telkom Heads page 65 par 152
156 Commission’s Heads page 23.
157 Telkom Bundle file 4 page 1490
60
187]Based on the above we estimate that BCX’s market share in the ITS
market is between 12% and 19% and a market share of between
17.7% and 20% in the Outsourcing segment. What is however
accepted by all is that BCX is the largest player in the ITS market.
188]The ITS market is not a concentrated market. There are other players
in this market such are Dimension Data, AST, Arivia.kom, IBM, EDS
CSC and BTG. BCX competes with Gijima and DD in the outsourcing
market
Data Centres
189]The Commission in the course of the proceedings argued that there
was an additional relevant market of offsite or remote data centres.
MNS providers and ITS providers offer to host data centres for their
clients. In the context of declining costs of connectivity and a migration
to an outsourced VPN model as a result of the Minister’s
announcements, MNS and ITS providers now offer to host a client’s
data on a shared basis. This has resulted in economies of scale and
lower data management costs for enterprises. The Commission had
requested information from a range of providers of remote data
centres, including the merging parties. Both Telkom and BCX resisted
this request but eventually submitted the requested information at the
direction of the Tribunal. After argument, the Commission did not
pursue a prohibition of the transaction on the basis of a lessening of
competition in the market for data centres. We make no finding on
whether offsite data centres constitute a separate relevant market for
purposes of competition evaluation. However, if this transaction would
have been approved, one of the effects of the merger would have led
to the merged entity being the dominant provider of offsite data
centres with a market share of between 36% 42%. 158
190]Having identified the relevant markets we turn to assess the
190]Having identified the relevant markets we turn to assess the
158 See page 3 of Commission’s supplementary notes on data centres and vertical arithmetic
61
implications for competition.
191]At the outset we note that in this transaction the merging parties did not
rely on any efficiencies as a defence. While there were some cost
savings to be achieved, no dynamic efficiencies, as are required to be
shown for purposes of section 12 A (2) were shown or relied upon. 159
Competition Evaluation: Horizontal effects
192]In general, relative market shares are utilized by competition
authorities to assess whether a transaction between rivals would
require closer scrutiny. Market shares on their own are merely a first
glance of the relative market positions of rivals in that market and the
levels of concentration in a market. On their own they do not
conclusively tell us about competitors’ ability to exert a competitive
constraint on each other. However certain levels of concentration and
changes in concentration as a result of a merger act as thresholds for
competition authorities to scrutinize mergers more closely. 160
193]Section 12A(2) requires the Tribunal, when it determines whether a
merger is likely to lead to a lessening or prevention of competition, to
assess the strength of competition in the relevant market and the
probability that firms will behave competitively or cooperatively , taking
into account any factor relevant to competition including factors such
as the dynamic characteristics of the market, including growth
innovation and product differentiation, ease of entry into the market,
including regulatory barriers and whether the merger will result in the
removal of an effective competitor. 161
159 See Trident Steel (Pty) Ltd and Dorbyl Limited, Tribunal case no: 89/LM/Oct00
160 For example, in the US a change in HHI above 100 points as a result of a merger in a
particular market usually triggers closer scrutiny. An HHI measurement of more than 1800
particular market usually triggers closer scrutiny. An HHI measurement of more than 1800
usually denotes a concentrated market.
161 See s12A
62
194]Let us recall the arguments put forward by the parties in relation to the
horizontal overlap between Telkom and BCX. The merging parties
argued that the horizontal overlap between Telkom and BCX, due to
BCX’s allegedly small share of the MNS market, was so insignificant
that the merger would not lead to a substantial lessening of
competition. In the event that the Tribunal was nevertheless
concerned about the horizontal overlap, counsel for the merging
parties indicated that his clients would divest of BCX Comms.
195]ISPA argued that the horizontal overlap was significant and that the
relative market share of 8.7% was an understatement of BCX’s
strengths and effectiveness as a competitor to Telkom in the
convergence space. The merger would result in the removal of an
effective competitor. In the convergence space, there were fewer
service providers and with network externalities the merger would lead
to more significant long term adverse effects than what was indicated
by the initial increase in the levels of concentration.
196]The Commission argued that while BCX had a smaller market share
than was initially estimated, in its view BCX was poised to become a
credible and formidable future rival to Telkom in the dynamic MNS
market which was moving towards convergence and the VPN offering.
197]We turn to consider whether BCX, despite its relatively small market
share, is an effective actual and credible future competitor in the MNS
market.
Removal of an effective competitor
198]In this particular matter, the analysis requires us to evaluate BCX’s
63
strengths, not as a potential competitor poised to enter a new market,
but its strengths in the current MNS market, as well its future prospects
in a market that is moving towards a VPN offering. The assessment of
BCX’s credibility as a future competitor is analogous to an enquiry of
sufficiency162 traditionally undertaken by competition authorities in their
assessment of potential competition. The future prospects of BCX
cannot be assessed on the basis of pure conjecture but necessarily
requires us to take into account the intentions of the company as
articulated in its projections, its business plans, it internal high level
documents, the views of competitors and where available third party
industry sources and any unique qualities it may possess. 163
199]The Commission argued that there was sufficient evidence to
demonstrate that, even though BCX may have a smaller share in the
current MNS market than initially suggested, BCX was poised to
become a formidable competitor to Telkom in the VPN segment of the
market. This is because BCX has a large client base which it intends
to migrate to its VPN. Its VPN is technologically more advanced than
its competitors and the BCX Board has signalled its commitment to
expansion in the VPN market by making a substantial investment in
upgrading the network and adopting a strategic plan. The removal of
BCX would thus remove a significant future or potential competitor to
Telkom in the VPN segment of the market.
200]The merging parties further urged the Tribunal to take into account, in
the assessment of this merger, the intended entry of Neotel in the MNS
market. They argued that the removal of a competitor such as BCX
162 See below where we set out the enquiry to assess the entry of Neotel in the MNS market.
The enquiry is undertaken by asking three critical questions, whether entry is likely, timely and
sufficient.
sufficient.
163 See in this regard the EC guidelines which provide that even if a competitor has a small
share of the market, any unique qualities that it may possess may be taken into account in
order to assess its effectiveness or credibility as a competitive. See Exhibit “7” EU Guidelines
(2004/C31/03) paragraphs 5860.
64
would be largely offset by the entry of a large potential competitor
such as Neotel. We deal with this issue later.
201] On behalf of the merging parties, Mr Sewell of BCX, attempted to
persuade the Tribunal that BCX as an existing MNS player in the WAN
segment of the market was not a credible competitor to Telkom. 164 In
addition, he submitted that in the VPN segment BCX was extremely
small and its future prospects were not as good as Mr Van Rensburg
thought. Mr Van Rensburg was the Group Executive Strategy of BCX
Comms at that time. Mr Sewell and counsel for the merging parties
referred to the fact that BCX Comms had only one significant client,
namely Bidvest, on its VPN and that its revenues had not grown much
since it had acquired the VPN from Bidvest as evidence of its meagre
presence and weak prospects in the VPN segment, which was going to
be the product of choice in the future MNS market.
202]BCX’s strengths in the WAN segment of the MNS are undisputed. It
prides itself on its metaWAN services and has secured contracts with
large companies such as AshantiGold worth hundreds of millions of
rands.165 BCX itself, despite Mr Sewell’s self –flagellation in support of
a low market share figure, considers itself as a leading and credible
organisation in network related services as reflected in its claims on its
website “ Our proven track record spans over 20 years and includes
the design and implementation of 6 of the largest networks in South
Africa…… Business Connexion Networks has highly skilled people to
provide strategic planning, thought leadership, network architecture,
design, configuration and implementation skills in traditional data
networks as well as in fully converged data, voice and video
164 See the section dealing with market definition
164 See the section dealing with market definition
165 Mr Sewell also conceded during cross examination that BCX is offering WAN solutions to
Ashanti Gold of more than R500m over 5 years – this for services only despite his earlier
claim of R15 million as the market size of BCX Comms in the Wan market . See Mr Sewell’s
evidence on page 905 of the transcript .
65
networks.”166
203] BCX’s credibility and reputation are known to its competitors. Mr
Bosman on behalf of GijimaAST regards BCX as its strongest
competitor saying “ So certainly for years and I would love that it wasn’t
the case, but unfortunately in competitive situations the Business
Connexion communications’ capability is not insignificant if I can put it
that way .”167
204] As far as its VPN business is concerned, BCX doesn’t consider itself
as a minnow. In its Annual Report of 2005 BCX claims “ The second
acquisition was that of the network business of Bidvest National
Network Solutions, which will enable Business Connexion to operate
as a VANS provider, offering an end to end converged data and voice
solution to its large outsource client base without having to rely on third
parties. The acquisition gives the company a foothold in the R70 billion
telecoms market and compliments its leadership status in the R 40
billion IT market…. .”168
205]BCX’s internal documents reveal it had committed an amount of R84
million to its VPN investment, over three phases. 169 In the first phase
of the plan, R26, 229,485 was spent on upgrading the network. By the
end of that upgrade, BCX could boast “the largest privately owned
NGN”.170 In addition, BCX had formed partnerships with VANCO 171 and
Storm Telecom 172 to increase its range and depth of skills. Its strategic
documents reveal that it had every intention of approaching its client
base with its VPN offering as an endtoend solution for their client’s
166 See BCX website.
167 Transcript page 2587
168 Transcript page 2352
169 See BCX Communications NGN page 1779 ISPA trial bundle file 5
170 See Exhibit “G”
171 It had formed a partnership with VANCO in order to obtain global reach in IP connectivity.
172 The partnership with Storm was in relation to the transmission of VoIP.
66
communication needs. 173
206]By acquiring Bidnet, and upgrading the network, BCX now owns the
most advanced VPN, in the country. 174 According to Graham Damp –
Chairman of McCarthy Group IT Steering committee: “ The MPLSVPN
solution provided by BCX is not only providing advanced security
features but also unmatched service levels and redundancy, aspects
which are businesscritical to the McCarthy Group”. 175 Mr Sewell
himself indicated that not only does BCX offer a high level of IP in
terms of networking it also has employed one of the “top guys”, as he
puts it “ We have really got one of the top guys in the country in that
particular business that does that. ”176
207]Despite the insistence by Mr Sewell and counsel for the merging
parties that BCX had only one major client, namely Bidvest and that
this demonstrated that it was a very insignificant player in the VPN
market, the evidence suggests otherwise. Bidvest is one of the largest
logistics organizations in the country. This is probably why we see that
BCX has 15 POPs linking 1007 client sites, it has over 40 VPN clients
and more than 40 000 users. Its corporate clients include companies
such as Bidfreight Management Service, McCarthy Limited, Fedex,
Waltons, Crown National, Excitement Stores, Island View Storage and
Radiospoor, to name but a few. 177
208]In its business plan BCX Comms reports to its Board in April 2006
when motivating its proposed R85 million expansion programme for
BCX Comms’ NGN: “ our pipeline includes Sasol, Edcon, Ellerines,
173 See BCX Communications NGN page 1783 ISPA trial bundle file 5
See Exhibit “B”
174 See Mr Watt’s comments that BCX owned the most advanced NGN in the country. Watt’s
presentation to Telkom, Commission discovery bundle 1B page 1066.
175 See Competition Commission Bundle 1B page 1070
175 See Competition Commission Bundle 1B page 1070
176 Transcript page 887
177 Watt’s presentation to Telkom, Commission discovery bundle 1B page 1066, 1069.
67
SARS, Nampak, Metcash, Group 4, Santam and PHP Billiton, amongst
others. These are all very significant networks that will utilize a
significant portion of the new capacity being created through the
capital investment in upgrading the network. We are confident that our
first year’s revenue and 60% of year two’s revenue will be secured
through these clients mentioned above”. 178
209]More importantly, Telkom itself considers BCX as a formidable
competitor. In Telkom’s internal documents it refers to BCX’s strengths
as a competitor in the VANS sector and lists as BCX’s strengths its
strong customer base, including Government contracts, Outsourcing
prominence, Networks (LAN/WAN management) prominence. 179 It
also identifies BCX’s networking arm as one of the “ dominant
competitors” in the MNS sector. 180 In 2004 Telkom identified
Comparex Africa Networks (now BCX) as one of four competitors in
the MNS market saying: “ all four competitors are either involved in or
preparing themselves to offer next generation networks such as VPNs,
voice networks, voice over IP, etc….. Order of competitive strength,
first Dimension Data, second Comparex Africa Networks (BCX), third
AST Networks, fourth Arivia.com. ” 181 Telkom was of the view that
“Business Connexion has a strong customer base, including
government contracts, outsourcing prominence, networks, LAN, WAN
management prominence, strong BEE credentials, areas of
competition, security, Nanotech and ERP systems. ”182
210]Despite a vast body of high level documentary evidence suggesting
that Telkom considered BCX as a formidable competitor, and BCX
considered its own prospects in the new MNS space to be excellent,
Mr Sewell attempted to downplay all of these activities suggesting that
178 Also see Ispa trial bundle 5 page 1783.
178 Also see Ispa trial bundle 5 page 1783.
179 ISPA bundle file 7 page218
180 Commission’s bundle file 1B, page 743
181 ISPA bundle file 7 page 217 and transcript page 922.
182 Transcript page 924 and ISPA bundle file 7 page 218.
68
they were the optimistic plans of one person, namely Mr Van
Rensburg, and were unrealistic.
211]However no internal strategic documentation could be found to support
Mr Sewell’s views. Nor did CRA in its report suggest this. Mr Watt
himself confirmed under cross examination that it was BCX’s firm
intention to enter and expand in the MNS market through the
acquisition of Bidnet. 183
212]So we see in 2006, BCX was regarded as a particularly successful
company due to its strong existing relationships with clients, a large
blue chip client base and the breadth and depth of its service offering.
By acquiring Bidvest’s network and upgrading it to an NGN, BCX had
become a significant threat to Telkom. Not only did it have the most
advanced network suitable for convergence, it had access to some of
the largest enterprises in the country, with aggressive plans to migrate
these clients onto its VPN. 184
213]Heavy weather was made, both by Mr Sewell and the merging parties’
counsel of the fact that BCX Comms’ revenues and customer base had
not grown much more than the initial revenues at the time of BCX
acquiring it from Bidvest. During the upgrading period of the network, it
is conceivable that BCX Comms would not enjoy a rapid growth in
revenues or customer base. However its subsequent difficulties seem
to have been caused more by Telkom’s presence and influence in the
business of BCX than by BCX Comms.
214]Prior to these hearings, Telkom and BCX had already conducted
“integration meetings” attended by both BCX and Telkom employees,
in which they attempted to outline areas of duplication and integration.
183 See Watt’s evidence on page 23452348 and 2351 of the transcript
184 Transcript page 131
69
Named persons in both organizations were given responsibilities to
address identified areas that needed some form of action. Telkom was
also reportedly going into customer meetings with BCX. 185 In the
course of this, two critical complaints were raised by BCX Comms, the
one being that BCX executives were promoting the Telkom VPN
product above that of BCX Comms, and the other that Telkom had
taken away a significant client, from BCX. The second complaint was
considered of sufficient importance by the BCX Board to consider
seeking damages from Telkom. 186 The Board agreed that the
damages to BCX were a reality, a fact confirmed by Mr Watt. 187 Mr
Watt also confirmed that the uncertainties created by the Telkom deal
had put a brake on BCX Comms’ progress. He also confirmed that
Telkom had attempted to cut BCX Comms out and the probabilities are
that Telkom used the merger as a tactic in its attempts to retard BCX
Comm’s expansion and gain access to its clients. 188
215] It seems that Mr Van Rensburg’s concerns came to pass. Telkom
had taken clients away from BCX. By giving Telkom the extent of
involvement in its business operations and holding “integration
meetings” BCX executives had, unwittingly or not, let the fox into the
chickenrun.
216]While we are unable to determine what impact the presence of Telkom
executives and employees had on the growth prospects of BCX
Comms, we can say with certainty that at that time, Telkom seemed to
know more about BCX’s business than did its own Board. 189 Telkom’s
conduct in relation to BCX’s clients clearly demonstrates that it sought
to win the customer by any means , even at the risk of causing a rift
185 See Exhibit “B”
186 See ISPA trial bundle file 5 page 1808
187 See Watt 23742375
188 See Watt’s evidence on page 2301 and 2393 of the transcript
187 See Watt 23742375
188 See Watt’s evidence on page 2301 and 2393 of the transcript
189 See comment made by a BCX Board member on page 1812 ISPA Trial Bundle File 5
70
between itself and its prospective subsidiary. Moreover, the merger for
all intents and purposes had been implemented without authorization
from the Tribunal.
217]Telkom’s assessment of BCX’s strengths is seemingly not
exaggerated. In the dynamic MNS market, BCX is considered to be
better positioned than most others to become an effective and
profitable competitor to Telkom. BMIT, the leading industry analyst,
forecasts that some service providers seem to be better positioned
than others. In particular it states that:
“Various high level IT services are provided by System
Integrators …including DD and BCX. These companies provide
services that span the gap between IT services (application
level management) and telecoms services, typically in the form
of supervisory operational management of inter alia wide area
networks. Didata for example provides such services to large
corporate customers over and above the services provided by
its subsidiary IS, Telkom and others.” 190
218]BMIT explains the role and distinct advantage that system integrators
such as BCX and Didata have over their rivals in the dynamic MNS
market. According to BMI:
“System integrators are important influencers of data services
within their corporate customers, assisting them with supplier
selection and drawing up specifications for service level
agreements.”, and that “the opening up of the telecoms market
to more competitors in future and the simultaneous extension of
expanded privileges to existing players (like VANS to provide
inter alia voice services) has paved the way for greater
participation by …..IT system integrators such as Business
190 Extracts from IDC/BMI –T Report: “SA Data Services Market Forecast and Analysis
2006”, licensed to Telkom giving its view of the evolving market.
71
Connexion.”
219]And further, BMI forecasts as follows:
“The future is bright for managed services. Companies are
more inclined to opt for an endtoend solution and there are
very few players able to do that in South Africa. The line
between carriers and system integrators is blurring and
enterprises are looking for partners that can take a holistic view
of their network and application infrastructure from a tactical
point of view……….. System integrators are best positioned
to provide bundled services, while telecom operators are not
credible .. . system integrators are most likely to reap bundling
benefits like churn reduction and high margins. ” 191
220]Hence we see that, BCX as an MNS provider is better positioned than
the traditional VANS or even Telkom to own the customer and take a
large slice of the margins to be earned in the MNS market. The only
other firm seemingly placed better than BCX seems to be Didata which
also has a similar range of skills but a larger VPN. However, BCX’s
leading position in outsourcing places it in a far better position to take
margin away from both Telkom and its other MNS rivals.
221]In this dynamic market and the migration towards the VPN package,
which as we discussed above requires a range of skills on the part of
the service provider, it is hardly surprising that BCX is poised to take
margins from the traditional VANS.
222]BCX has credibility in outsourcing and a proven track record in network
design, implementation and support. Its services have always been
rendered at a client’s premises, over the client’s networks and hence it
191 See exhibit F: BMI T Special Study SA Managed Network Services Market 20032008
(released in Feb 2004) page 31
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enjoys a closer clientvendor relationship than a traditional VAN. It has
built and managed some of the largest private networks in the
country.192 In addition it has been a meta WAN or single service
aggregator for very large enterprises, rendering services to them which
run unto hundreds of millions of rands. 193 It is seen as a partner of
choice194 and is, together with Gijima and DD, often shortlisted or
awarded large outsourcing bids. It plays an advisory role to the client,
advising it on choices in technology and applications. 195 The fact that it
also renders IT services and business applications to it customers
enables it to better understand its clients business and needs. In
addition, and in order to respond to the converging offerings in the
MNS environment, BCX can now offer the most advanced VPN in the
country which is located in its division BCX Communications. It also
stands to become a major VoIP provider in South Africa. 196 Last but not
least it has a blue chip client base which includes some of the largest
corporations in the country and government departments or institutions
and which it plans to migrate to its VPN.
223]In short, BCX has both the range and depth of skills that enable it to
become a credible competitor to Telkom, and to any other MNS
provider, in the MNS market, whether this is in the large outsourcing
contracts that are put out on tender or the smaller contracts. These
skills are not located only in BCX Comms but are spread across BCX’s
business as a whole.
224]BCX’s strengths as described above would pose a greater threat to
Telkom in an industry characterized by economies of scale and
network externalities. Once BCX would have successfully migrated its
192 See the discussion on relevant MNS market definition and some of BCX’s strengths that
192 See the discussion on relevant MNS market definition and some of BCX’s strengths that
are dealt with there.
193 See BCX’s service agreement with AngloGold Ashanti on page 3687 of the record.
194 See BCX Annual Financial Results Presentation August 2006
195 See Wilcocks evidence on page 1798 of the transcript. See also exhibit F.
196 BCX Presentation Aug 2006 above
73
large high value clients onto the most technologically advanced
network in the country, Telkom would have greater difficulty, because
of network effects, in winning those clients over. 197
225]Thus we conclude that BCX, with its range and depth of skills, presents
a highly credible competitor to Telkom in the dynamic MNS market.
BCX may only have a market share of 8.7% but industry forecasts
place BCX and DD as the most likely to take margin in the
convergence space. This would probably explain why Telkom in the
first instance identified only two suitable acquisitions, namely DD and
BCX. It attempted to acquire DD first, even though it was advised of
the huge risk of competition veto before it approached BCX. DD has a
larger VPN though its subsidiary IS. Indeed the overlap between
Telkom and DD was estimated at that time to be very large. 198 Telkom
was not successful in removing its largest rival namely Didata. It
sought then to remove the other significant competitive threat to it in
the convergence space, namely BCX.
226]By acquiring BCX, Telkom will have removed an effective competitor in
the MNS market and a significant threat in the VPN segment of the
MNS market. In addition, as noted above Telkom, by acquiring BCX,
specifically, rather than any other smaller MNS rival or ITS company
Telkom will be able to provide the range and depth of skills which no
other rival in the MNS market possesses. It will also be able to acquire
BCX’s credible network design, implementation and support skills and
target BCX’s large blue chip client base that BCX brings with it.
227]Owning the customer is paramount for Telkom in the MNS market –
because it is the most profitable segment of its business and it is the
only market in which it faces, due to arbitrage and VoIP as a result of
only market in which it faces, due to arbitrage and VoIP as a result of
197 See our discussion on barriers to entry where we deal with the issue of network effects.
198 See Telkom Document entitled “NDIZA” April 2005 on page 645 of the record
74
deregulation, the greatest possible loss of monopoly margins in leased
lines and voice. By acquiring BCX it not only has access to BCX’s
WAN customers, but is also placed in a far better position to win
customers of its other rivals.
Neotel’s entry in MNS market
228]We have been urged by the merging parties to consider the potential
entry of Neotel into the MNS market as a factor to be considered in the
evaluation of the merger. They argue that Neotel has all the same
rights as Telkom, has a large national network and has experienced
partners in the form of VNSL 199 and will be supported in its rollout by
Infraco. The merging parties argue that Neotel will be a formidable
competitor in the MNS market because it will on the one hand be able
to provide infrastructure to itself and other MNS rivals and will be able
to leapfrog technology with its strategic partners which will enable it to
cherry pick large enterprises.
229]It’s possible that Neotel is the only potential MNS rival that could exert
a competitive constraint on Telkom provided it enters the market with
as large a network as the Telkom network and an equivalent offering .
In other words, will Neotel’s entry be likely, timely and sufficient.
230]In the US, when competition authorities assess the impact of a merger
on competition in a relevant market, they consider whether there is any
likely new entrant which will post merger, exert a significant competitive
constraint to offset the reduction in competition caused by the merger.
The assessment is not done in a vacuum or on the basis of mere
conjecture. It is usually done by asking three critical questions, is entry
by a potential competitor going to be likely, timely and sufficient. 200
199 VNSL refers to Videsh Sanchar Nigam Limited, an Indian privatized telecoms company
and a subsidiary of TATA Group. TATA Group holds 51 % in VSNL.
and a subsidiary of TATA Group. TATA Group holds 51 % in VSNL.
200 The US merger guidelines examine entry by asking three questions; is it going to be
75
231] In its initial business plans, Neotel indicated that it would be seeking to
target wholesale, corporate and government as clients rather than the
domestic or residential market. Dr Hay confirmed that it was Neotel’s
intention to enter the MNS market. 201 Hence we accept that its entry is
likely.
232]However, all the evidence seems to suggest that Neotel is far from
entering the MNS market in a manner that is both sufficient and quick
enough to exert a significant competitive constraint on Telkom. As far
as its network is concerned, Neotel has not yet been able to develop
an efficient or appropriate national network 202 and has yet to finalise
the terms of access to the infrastructure in Infraco. 203 For purposes of
entry into the MNS market, sufficient enough to pose a credible
competitive constraint to Telkom , Neotel would have to be able to
provide its retail customers with a national network containing a large
number of POPS, access lines with appropriate SLAs and a range of
value added services. Neotel has already indicated that it does not
have an appropriate national network.
233]Instead, it seems that if Neotel wanted to enter the market quickly, it
will have to rely on Telkom’s infrastructure to do so. 204 The most
important aspect of Telkom’s infrastructure that Neotel would like
access to is Telkom’s local loop. 205 Dr Hay on behalf of Neotel testified
timely, likely and sufficient. We have followed this approach in some of our decisions, see for
instance Xstrata South Africa (Proprietary) Limited and Egalite (Proprietary) Limited and
International Carbon Holdings (Proprietary),Case No: 54/LM/Jul04.
201 It would be expected of a new entrant to cherry pick markets and target high value
customers initially.
202 See the section on relevant market definition and evidence of Dr Hay on page 1148 of
the transcript.
the transcript.
203 At the time of the writing of these reasons, the Infraco Bill was still being debated in
Parliament. See also evidence of Dr Hay at 1128 and 1147 of the transcript.
204 See evidence of Dr Hay at 1148.
205 The local loop, also known as the last mile, is that part of the network that connects the
customer’s premises to a local exchange closest to the customer’s premises. The last mile
does not only include copper wires but also the ducts, the switching centres etc (Put in what it
76
that while Neotel enjoyed this right, no special regulations were
promulgated by ICASA to regulate this. Accordingly any aspect of this
right was to be regulated by the Facilities Leasing Regulations of
ICASA. In addition, Telkom had refused to conclude a holistic
infrastructure sharing agreement with Neotel but had instead stated
that it would consider Neotel’s request on a case by case basis
234]If we are to understand Dr Hay’s evidence correctly, it seems that
Neotel is likely not to be able to access much of Telkom’s infrastructure
in the local loop in the next two years. Whether the difficulties in the
negotiations between Telkom and Neotel are as a result of Telkom’s
conduct or Neotel’s internal difficulties, what is clear is that Neotel is
unable to plan with certainty which geographic areas it can target (if it
doesn’t know whether it will access to Telkom’s local loop) and is
nowhere near being actually able to share Telkom’s infrastructure. If it
is able to share some of it, it will be doing so with difficulty. Hence,
Neotel will have to roll out its own local loop, which will take much
longer, or wait until the local loop is unbundled by the Minister.
According to the committee convened by the Minister of
Communications, local loop unbundling is scheduled to be completed
at the end of the next four years , hardly something that is timely
enough.206
235]At this point in time Neotel’s likely entry cannot be relied upon as
presenting a competitive constraint on Telkom in the MNS market or to
prevent the market from tipping towards Telkom. Indeed its prolonged
difficulties suggest that it will take much longer than initially expected
for Neotel to enter the MNS market and to an extent sufficient enough
for Neotel to enter the MNS market and to an extent sufficient enough
to pose a competitive constraint on Telkom. If it sought to enter the
consists of) As discussed above in telecommunications, the last mile is often the single most
significant barrier to entry for a new entrant.
206 In this regard, see the Minister’s announcements and the report published by the Local
Loop Unbundling Committee on the Department’s website.
77
retail MNS market quickly it would, seemingly, also have to rely on
Telkom’s infrastructure.
236]Hence, Neotel’s entry may be likely but it is unlikely to be timely or
sufficient to offset the likely harm to competition caused by this
merger.
Barriers to Entry
237]As discussed above this transaction is taking place in the context of a
dynamic regulatory environment and a dynamic MNS market in which
enterprises are already experiencing the consequences of innovation
in the form of convergence.
238]In this market, innovation has been released from some of its
regulatory restrictions and has brought lower costs of communications
for enterprises and has allowed competition to emerge in the MNS
market. However, MNS providers are now challenged to invest across
the horizontal value chain in order to compete effectively for ownership
of the customer and accordingly the margin.
239]Mr Van Huyssteen and Mr Hodge explained that the migration towards
the VPN model has resulted in a decline in the number of service
providers and increased barriers to entry. 207 This is largely because
the VPN product is more complex and requires a wider range and
depth of skills on the part of the MNS providers. Mr Hodge further
identified that network externalities were a concern in the convergence
space.
240]The telecommunications industry in general is characterized by high
207 See Genesis, witness statement page 313314 and Van Huyssteen evidence on page
1038 of the transcript.
78
barriers to entry. In addition, it is characterized by network effects 208 in
that the value of the product to the customer increases with the number
of people using the same network. A network becomes more
attractive to customers as it enlarges and as it enlarges, more
customers are attracted to it. The obvious reason for this is that
customers can communicate with more people on the same network at
a lower cost.
241] A VPN is nothing more than a network that offers a range of services
to a client. Prior to deregulation in the MNS market the range of
services were restricted to data communications services. After the
deregulation a VPN provider can now provide voice services through
VoIP as well and can achieve economies of scale.
242]While there are limitations of both economies of scale and scope to a
VPN, technological innovation and deregulation has virtually created a
number of “ mini telco’s” that can provide enterprises and
organizations with most if not all of their communications needs 209 at a
fraction of the cost to that previously incurred by them . However,
meaningful economies of scale and lower costs can only be achieved
by a VPN if it has a large enough network and subscriber base and is
able to provide the reliability of connectivity. As a network its initial
fixed costs would be high but its average costs would decline with
increasing subscribers. 210
243]Accordingly, once a VPN provider has made the initial investment in its
core network, it needs to attract more and more customers in order to
recoup the cost of its investment. In essence, VPNs are private
communications networks owned by MNS providers and shared
208 As are IT and information network industries.
208 As are IT and information network industries.
209 Organisations may elect to have fixed line voice services in addition to VoIP for security
or quality reasons
210 See Genesis witness statement page 315 316
79
between a few large enterprises that now effectively compete with the
large public network of Telkom. If Telkom does not own the customer
directly, the only margin it could make is on the price of leased lines,
which is already being threatened by the economies of scale achieved
by deregulation and interconnect fees when VoIP calls from these
VPNs break out of their network onto Telkom’s network.
244]The more customers that Telkom owns on its VPN in the MNS market,
the greater the barriers to entry for its rivals due to network effects. In
the MNS market, Telkom is already the largest MNS provider. It has
both the largest number of customers and the largest physical network.
It is also able to provide SLAs directly to its customers rather than
though a back to back arrangement with other MNS providers. The
merger will enable Telkom to add a significant share of the MNS
market onto its network. At the same time, the acquisition of BCX’s
unique metaWAN and customer relationship skills will enable Telkom
to able to target BCX’s large client base. Customers will be attracted
to the Telkom VPN offering because of its physical size, its large
subscriber base, its range and depth of skills, credibility in outsourcing
and the fact that it can obtain SLA’s directly with Telkom rather than
through an intermediary. 211
245]The merger will thus create a snowball effect, because in the first
instance the merged entity, due to the economies of scale and range of
depth of skills it can offer to VPN customers, will be better placed than
any of its competitors to capture future growth through new
customers.212
246]Telkom’s additional strategy, of locking customers into long term
contracts, in order to increase switching costs, will keep its subscriber
contracts, in order to increase switching costs, will keep its subscriber
211 The ease with which Telkom could win Sasol away from BCX is an example of this.
212 This advantage will be increased by its ability to bundle and offer other products such as
fixed line voice .
80
locked in for a longer period of time. In other words, the MNS market is
likely to ‘tip’ towards Telkom.
247]A tipping of the market towards the Telkom offering would increase
barriers to entry and expansion for new and existing players. A large
network in itself is a high barrier to entry for competitors or new
entrants. A market which is tipped towards the one major network
increases these barriers. 213 It is far more difficult and at times
prohibitively expensive for rivals to gain customers – and market share
– away from the largest network. Such high barriers are likely to lead
to smaller MNS players exiting the market, deterring the expansion of
others and leading to a further concentration in the market. Thus,
Telkom through the merger will gain a much larger share – if not
almost all of it of the MNS market than the nominal combined market
shares of Telkom and BCX would indicate as a result of network
externalities.
248]In addition to the barriers to entry and expansion created by network
effects, the MNS market is also characterized by other high barriers to
entry. While some segments of the market, such as resale of internet
services enjoy lower barriers to entry, entry barriers in the MNS market
are relatively high.
249]The first and most fundamental barrier to entry is the availability of
infrastructure in the form of leased lines with appropriate SLAs. This
still constitutes a bottleneck for entry. 214 Until recently, the cost of
bandwidth constituted 60—65% of the cost of rendering a VAN service
and there are few credible alternatives. As discussed above, Telkom is
213 See Bishop and Walker: The Economics of EC Competition Law 2 nd Edition page 38.
See also MCI Worldcom/Sprint – Comp/M.174 [2000] and Genesis Witness Statement page
317.
See also MCI Worldcom/Sprint – Comp/M.174 [2000] and Genesis Witness Statement page
317.
214 This would be a barrier for the class of providers previously known as VANS and remains
so for the new MNS provider in the VPN business.
81
to date the de facto monopoly provider of fixed line infrastructure. An
MNS provider, whether an existing player or a new entrant has to rely
on Telkom, its major competitor, to provide it with an essential input. 215
250]A common thread that runs through the barriers related to
infrastructure is that the barriers consist not only of the lack of
alternatives to Telkom, which is also a competitor to these MNS
providers, or the price at which it is available but also because the
SLAs associated with an alternative product or technology are not
adequate for the needs of large organizations. 216 To date, there are no
effective alternatives to the bandwidth and SLAs being supplied by
Telkom to MNS service providers.
251]Barriers to entry for MNS providers servicing large organizations are
higher than for those servicing smaller enterprises. Large
organizations have many different branches across the country.
Hence they would require a large network, reliability of connection and
appropriate service level agreements. MNS providers require technical
network design and implementation skills as well as skills and
resources to effectively manage mission critical information for these
organizations.
252]Costs of switching have also increased. Once an organization has
outsourced all of its communications needs to a VPN provider,
including its internet and intranet services, switching to another VPN
provider or switching back to an enterprise WAN involves much higher
switching costs than in the preconverged environment. 217 If the
customer is locked into long term agreements or has together with its
215 Telkom offered VANS a wholesale price for bandwidth in the course of these
215 Telkom offered VANS a wholesale price for bandwidth in the course of these
proceedings. Prior to that, VANS were charged a retail price for leased lines.
216 See evidence of Mr Brierley on page 1573 and 1578 of the transcript, Mr Wilcocks on
page 1518 and 1537 to 1538 of the transcript.,
217 See evidence of Mr Van Huyssteen on page 1206 of the transcript and Hodge expert
report page 26 paragraph 64
82
VPN, obtained bundled voice and mobile services, the costs of
switching would be much higher.
253]Regulatory barriers in the form of license requirements and spectrum
scarcity continue to persist and it is uncertain to what extent these
would be ameliorated by the ECA license conversion processes
intended by ICASA.
254]Hence, while the MNS market is dynamic and displaying growth and
innovation, barriers to entry have increased. The product is more
complex and requires a greater range and depth of skills on the part of
the MNS provider. A large organization which intends to outsource its
communications needs will require a service provider to meet all of its
network and data communications needs, as well as security and fire
walling. In addition the MNS market is characterized by network
effects. An acquisition of a large customer base from a rival by a large
VPN provider such as Telkom is likely to tip the market towards Telkom
which will result in further barriers to entry.
Unilateral effects
255]Post merger, the merged entity will be a dominant MNS provider, with
the largest physical network, the largest customer base, the ability to
provide SLAs directly to customers, the ability to bundle all required
services for a VPN and the ability, through the credibility of its new
subsidiary to target customers of its rivals. Telkom will enjoy a distinct
competitive advantage to its MNS rivals, including Neotel. Because
the dynamic MNS market is analogous to a network market, it is likely
that network effects will occur which will tip the market towards Telkom.
256]In our view, post merger, Telkom will be able to act independently of its
83
rivals in this market in a number of ways. In order to limit the impact of
deregulation and convergence on its monopoly margins on
infrastructure and voice, Telkom needs to limit migration to innovative
products such as virtual private networks. Telkom could, after it has
gained sufficient market share of MNS customers, simply raise the
price of the VPN offering without suffering any loss.
257]As long as the total cost of the VPN offering, remains cheaper than the
total cost of reverting to an enterprise WAN, including cost of switching,
an organization is unlikely to switch suppliers in the face of a non
transitory increase in price. Switching is also unlikely to occur because,
in the first instance there is not yet an alternative service provider with
an equivalent offering in the market – and from all accounts will not be
there in the near future. Secondly an organization would prefer to stay
on a larger network so that a large percentage of its usage remains on
net rather than the more expensive offnet calls. Thirdly, switching
costs are high and the more of its communications needs that an
organisation has outsourced to its VPN provider the higher that cost.
258]Alternatively, Telkom could raise the prices of any of the component
services selectively in order to increase its margins without running the
risk of customers switching away. For example, it could raise the price
of its VoIP calls to a price higher than its closest rival. Customers
would be unlikely to switch away because VoIP is part of the integrated
package and would still want to benefit from economies of scale of a
large network. In fact it is uncertain whether a customer will be able to
opt out of one of the components of an endend solution. Telkom
could apply this pricing strategy to any of the services it provides over
the VPN, including internet services.
the VPN, including internet services.
259]Telkom could also engage in a number of other unilateral acts, without
regard to its competitors’ behaviour. Since Telkom is the
84
overwhelmingly dominant supplier of infrastructure and by all accounts
Neotel will only have about 10% of that market at the end of five years,
Telkom, once it has captured the customer and has gained market
power, through increased market share and snowball effects, could
simply increase the retail price of its leased lines to its retail customers.
During the course of the hearings Telkom invoked ICASA’s regulation
of its leased lines repeatedly saying that it couldn’t raise its prices
without suffering a loss on another service. This was raised by Telkom
in the context of input foreclosure of its rivals in the MNS and ITS
markets. However, the issue has relevance in the consideration of
unilateral effects as well.
260]While Telkom’s retail prices are regulated by a pricecap formula, the
regulation applies to a bundle of services. It could easily increase the
price of its leased lines and decrease the price of another service eg
voice in which it is already facing declining revenue and/or recover
margins from VoIP which is not part of the regulated bundle.
261] An important aspect of the retail price regulation is that it has a price
cap. Operators are prevented from increasing their prices beyond that
which is capped. However Telkom, like other regulated entities is not
prevented from discounting its products provided they do not engage in
undue discrimination. Telkom could sell its Diginet lines at a discount
from the list price (which it clearly intends to do). Where large
contracts are negotiated in private or in a bundle, 218 as happens in the
South African market, discriminatory pricing is hard to detect. 219 Once
it has captured the customer, and gained market share in the MNS
market as it plans to do, it only needs to increase the price to the
customer back to its list price. Indeed Telkom’s bundling and
discounting strategy that it intends to deploy, together with any of the
218 As intended by Telkom
219 See evidence of Wilcocks.
85
others at its disposal, is aimed at obscuring prices to the customer. 220
262]Another factor to bear in mind when assessing Telkom’s ability to raise
the price of leased lines to its customers is the pending regulation of
Telkom’s wholesale prices. ICASA intends to regulate Telkom’s
wholesale prices on the basis of LRIC. 221 Currently, Telkom’s
wholesale services include the supply of infrastructure to operators, as
well as network services including termination services. It is likely that
VANS or MNS providers will urge ICASA to include their leased lines
into Telkom’s wholesale services.
263]Telkom’s internal documents indicate that it in fact will seek to lobby for
wholesale price regulation rather than retail price regulation. 222 While
this may seem surprising conduct on the part of a monopoly seeking to
maintain its monopoly margins 223 it is not surprising in the context
where the monopoly seeks to own the ultimate customer and to dis
intermediate the market. Once Telkom has been able to win
customers away from its rival MNS providers its margins will be earned
directly from the customer rather than from the sale of leased lines to
other MNS providers. Instead of raising wholesale prices, Telkom can
then simply raise retail prices to customers, namely the high value
large enterprises, who will have very few alternatives in a tipped
market.
264] Telkom itself in its VPN Supreme Product Plan states its intention to
220 See the statements by Mr Wally Beelders, a long time senior employee of Telkom, who
claims that Telkom intends to obscure its prices by bundling.
221 Long run incremental costing is an economic model utilized by regulators to determine a
theoretical cost of an efficient operator, using various assumptions. These processes are
usually drawn out and require extensive negotiation between regulators and operators.
usually drawn out and require extensive negotiation between regulators and operators.
222 See Telkom’s 2010 Strategic Plan on page 1017 item 7.1.3.2
223 Of course there is no certainty as to when ICASA will be able to regulate Telkom’s
wholesale services and whether or not the regulations will be contested by Telkom. See
annexure A on difficulties encountered by regulators with LRIC pricing.
86
limit migration from WAN to VPN–
“Cross elasticity will be controlled by the following mechanisms,
which will limit mass migration to VPN Supreme:
Aggressive volume and term discounts on FrameExpress
The Diginet special to provide more bandwidth at a
reduced pricing level” 224
265]Thus we see that Telkom is already engaging in price manipulation to
stifle innovation and to prevent the beneficial consequences of de
regulation from flowing to enterprises. It intends to reduce the prices of
legacy bandwidth such as Diginet lines, both to the retail customer and
to the wholesale customer, with the ultimate intention of limiting the
migration to a VPN model.
266]This seems to accord with BMIT forecasts that Telkom is unlikely to
promote VPNs in the MNS market because of economies of scale that
can be achieved on infrastructure and the consequential lower margins
for Telkom. 225
267]As discussed above, the MNS market is the only segment in which
Telkom stands to experience any price competition. Its attitude to price
competition from Neotel has already been made clear by Telkom in the
cold light of its profitability and EBIDTA projections made to analysts
on 8 March 2007 when it stated that it will not engage in drastic price
cuts because it expected limited competition from Neotel. 226 It is in the
MNS market, due to convergence and the deregulation of VANS, that
Telkom is experiencing considerable competition. 227
224 See VPN Supreme Product Plan 2006/2007 dated Feb:2006, page 13 paragraph 2.3.3.2
225 See Exhibit F page 34
226 See Exhibit H
227 See for example the websites of IS, MWeb, Storm Telecom, mycostsavingscall – all of
which offer VoIP calls at a considerable discount to Telkom’s voice calls.
87
268]Its attitude to competition from MNS rivals is also discernible in its high
level internal documents where it records that it seeks to remove
arbitrage opportunities and to defend its margins in its core markets,
infrastructure and voice, 228 and seeks to eliminate competition from
independent ISPs. 229 Defending a margin necessarily means ensuring
its continuity as before or regaining it from rivals to whom it may have
initially lost some market share. Telkom’s entire business plan
envisages an extension of Telkom’s monopoly in the new environment
but especially so in its core markets, namely infrastructure and voice in
the middle to large enterprise segment of its business. 230 Telkom can
only do this by, in the immediate term, gaining customers from its
rivals, increasing barriers to entry and expansion for rivals, and in the
future raising prices of the VPN services to its customers.
269]Customers on Telkom’s VPN are unlikely to switch from it in the event
of a nontransitory increase in VPN prices post merger, whether this be
for the network, leased lines or the component services such as VoIP,
because there would be no credible competitors to Telkom in the
infrastructure market, limited competition in the MNS market, high
barriers to entry in the MNS market and high switching costs for the
customer. In addition, because of the likely occurrence of network
effects in this market, customers would be reluctant to switch to a
smaller but equivalent provider. Countervailing power, if any, on behalf
of customers in the face of such dominance and lack of suitable
alternatives is negligible.
270]Hence this merger is likely to result in higher prices for the consumer
and a stifling of innovation. It is also likely to lead to the exiting of
228 See above.
229 See above
228 See above.
229 See above
230 See all the relevant documents mentioned above as well as Telkom 2010 Business Plan
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smaller MNS rivals or limit the expansion of existing rivals due to
network effects and increased barriers.
Cooperation with Neotel
271]As discussed above Neotel is likely to enter both the infrastructure and
MNS markets. In its initial marketing plans, Neotel revealed its
intention to focus on the corporate and large enterprise market.
However, Neotel’s prospects in both the infrastructure and MNS
markets have been affected to such an extent that it has already
adjusted its market penetration projections downwards. 231 Telkom
shares the view that Neotel’s ability to compete with it has been
considerably weakened. 232 In addition Neotel, an already weakened
competitor, now faces robust competition from other MNS rivals in the
MNS market due to deregulation and convergence. An acquisition by
Telkom in the large enterprise market is likely to add to Neotel’s woes.
Neotel has already been blunted and this transaction is likely to blunt it
further, making Neotel a natural ally for Telkom, both in not competing
with Telkom, and in warding off the threats they both face in the large
enterprise segment of the MNS market. Neotel has already indicated
that it will stand shoulder to shoulder with Telkom and will not engage
in price competition at the infrastructure level. Both Neotel and Telkom
have objected to the proposal that MNS providers of VPNs (who would
be classified as ECS licensees in the new framework) be permitted to
selfprovide their infrastructure. Neotel has indicated that it will
challenge a decision by ICASA if necessary. 233 It is highly likely that
Telkom and Neotel will coordinate their efforts to disintermediate the
MNS market of smaller rivals. Neotel, in its position of new entrant and
underdog is likely to take up the cudgels against ICASA, instituting
underdog is likely to take up the cudgels against ICASA, instituting
231 See evidence of Dr Hay
232 As evidenced by Telkom’s statement to analysts that it will not be engaging in drastic
price cuts, due to the decreased projections for Neotel.
233 See evidence of Dr Hay
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legal challenges to protect its margins in the infrastructure and MNS
markets. In return, Telkom is likely to grant Neotel favourable terms of
access to Telkom’s infrastructure and local loop – as it has already
done in termination rates. 234
Conclusion on horizontal effects.
272]In conclusion, we find that merger between Telkom and BCX will lead
to the removable of a credible and effective competitor to Telkom in the
dynamic MNS market. Despite the fact that BCX’s current market
shares have been significantly understated, all indications are that it is
uniquely poised to become a formidable competitor in the MNS market
by a combination of its range and depth of skills as well its expansion
into the VPN segment of the market.
273]The acquisition of BCX will not only remove an effective competitor to
Telkom but will enable Telkom to gain access to and target the large
client base of BCX. The merger is likely to lead to network effects and
a tipping of the MNS market towards Telkom. Barriers to entry and
expansion will be increased and deter new entry or will lead to the
exiting of smaller rivals.
274]The merger will result in higher prices for customers and a stifling of
innovation in the MNS market.
275]As succinctly put by ISPA’s counsel –
“The merger comes at a critical time in the market for managed
network services. Specifically the strong trend towards IPVPN
solutions, a service with fewer service providers, which exhibits
strong scale and network effects to the benefit of initial market
234 Telkom has agreed with Neotel on termination rates for voice calls at the level that Neotel
sought.
90
leaders, suggests that the longerterm impact of the merger will
be more detrimental to competition than any initial increase in
concentration.”235
276]As indicated at the outset the merging parties did not rely on any
efficiencies as a defence to a finding of a substantial lessening of
competition. Accordingly we find on the basis of the horizontal
concerns, the merger is likely to lead to a substantial lessening or
prevention of competition.
Proposed divestiture of BCX Comms
277]During the course of the proceedings, the merging parties submitted
that in the event that the Tribunal found a likelihood of a substantial
lessening of competition on the basis of the horizontal overlap between
Telkom and BCX, they tendered the divestiture of BCX Comms, in
order to alleviate any harm to competition. No formal resolutions on
the part of the BCX Board were submitted. The merging parties’
counsel after being pressed for a formal authorization could not provide
any. On 11 June 2007 the merging parties submitted a draft divestiture
order and a resolution by Telkom’s executive committee.
278]Mr Rogers on behalf of the Commission argued that the condition is
entirely unacceptable because BCX Comms’ competitive potential is
inextricably linked to its status as a subsidiary of BCX, South Africa’s
leading ITS company. Cut adrift from BCX, BCX Comms would be
deprived of the advantages which BCX sought to exploit through the
Bidnet acquisition and its investment in an NGN. In his view the draft
order will not take the substance of the matter any further.
235 ISPA heads page 49, para 83.
91
279]BCX has located its VPN business in BCX Comms. While it has a
large number of clients on its VPN, we have no evidence whether
these clients are owned by BCX Comms or BCX. Nor does it appear
that BCX Comms acts alone in servicing a client. Mr Sewell’s evidence
seems to suggest that when a client is approached by BCX Comms,
BCX Comms would still rely on the other divisions of BCX such as
network services and outsourcing to assist it in meeting the client’s
specific needs. Conversely when any other division approached a
client it would offer a client a range of services consisting of services
from other divisions, and would approach its other divisions to provide
these services. In addition, BCX Comms relies on BCX to provide it
with the financial resources required to upgrade and market its
network. While BCX has several business units, the evidence
suggests that these divisions are interdependent and all rely on each
other to promote each division’s business, as well as the business of
BCX as a whole. No evidence was put before this Tribunal that BCX
Comms had sufficient skills and resources to be a viable stand alone
business, or what the prospects of finding a suitable buyer in the
proposed time frame were or whether there was any serious interest
expressed by independent third parties to acquire this business. 236
280]More importantly, and as the evidence has shown, BCX’s strengths as
a competitor and its ability to, in the converged space, take margin
from Telkom, is not only found in BCX Comms but are to be found in
the whole of BCX. BCX’s network design and implementation skills,
its access to customer premises, its track record in outsourcing, its
metaWAN management services and its large blue chip client base
metaWAN management services and its large blue chip client base
are all found across the whole of BCX, not just in BCX Comms. These
are the skills and strengths that pose the largest threat to Telkom in the
236 In fact it seems to have borne a greater share of the damage caused to BCX by Telkom’s
offer and its involvement in the business of BCX by losing key personnel and large
customers.
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dynamic MNS market and which Telkom seeks to acquire for its own
strategy in the MNS market.
281]In our view a divestiture of BCX Comms will not remedy the likely harm
to competition that will arise as a result of the acquisition of BCX. In
fact, on the contrary, the separation of BCX Comms from BCX may
achieve exactly what was intended by Telkom by this transaction. BCX
Comms separated from BCX would not have the large client base nor
the range and depth of skills in outsourcing and systems integration.
BCX, separated from BCX Comms on the other hand, would not have
the largest privately owned NGN in the country and the track record of
serving one of the largest logistics companies in the country.
Vertical Effects
282]Many arguments were put to us by the Commission, ISPA and DD on
the various vertical effects of this transaction. The merging parties
urged this Tribunal to disregard the opponents’ arguments on the basis
that these were inter alia mutually exclusive, not profitable or not
merger specific.
283]In our view there is no need for us to make a finding on any of these
since we have already concluded that the transaction is likely to result
in a substantial lessening or prevention of competition in the MNS
market.
284]However, while we make no finding on the vertical effects of this
transaction, and here we must emphasise that we make no finding on
these, we share Mr Rogers’ concern that Telkom has already pre
figured a number of tactics that it intends to deploy against existing and
future rivals in both the upstream infrastructure market and the MNS
market. A cursory glance at some of Telkom’s high level documents
93
reveals that it inter alia intends raising its rivals costs, eliminating
competition from the SNO and VoIP providers, bundling ITS, MNS and
PSTS products, crossselling and increasing its customer’s switching
costs and locking customers into long term contracts. Telkom of course
does not need to deploy all of these tactics or use any instruments
available to it all at the same time or against all of its rivals. All it needs
to do is deploy some of them some of the time against some of its
rivals. This wide range of instruments available to Telkom certainly
raises additional concerns. Telkom’s reputation in the industry
suggests that it will not hesitate to deploy any of these against existing
or new rivals. 237
285]A further concern, in addition to all the tactics Telkom has stated it
intends to deploy in order to defend and extend its monopoly is that it
intends to maintain BCX post merger as an independent subsidiary, for
purposes of regulatory evasion. While the Commission raised this as a
possible concern, not much evidence was led to show the various
possible ways that Telkom could achieve this.
286] In the telecommunications space, there are strong arguments for
preventing monopolies that are subject to cost regulation from entering
downstream unregulated markets. Brennan argues that regulated
entities that are subject to cost regulation often seek to integrate
vertically into unregulated markets in order to increase the costs of the
regulated entity and still make monopoly profits and thereby evading
cost regulation. 238
237 See evidence of Hodge and Wilcocks in which it was alleged that Telkom was delaying in
installation of its leased lines, would not let any other MNS rival inspect the network when
there were technical problems and was engaging in quality degradation. See also affidavit of
there were technical problems and was engaging in quality degradation. See also affidavit of
Weeks setting out the number of complaints lodged against Telkom. For an understanding
go how easily quality degradation can occur see also MCI Worldcom – COMP/M.174 [2000]
ECComm 24
238 Brennan, T, “ Why regulated firms should be kept out of unregulated markets:
understanding the divestiture in US v AT&T ”, The Antitrust Bulleting, Fall 1987.
94
287]The ITS market is unregulated. While some IT services rely on leased
lines as an input, IT services are also an input to networks. Telkom
intends to utilize BCX, located in a separate subsidiary, as the provider
of all its IT services, which will be a cost to the regulated entity. The
regulated entity can inflate those costs to itself which it will be able to
present to the regulator as legitimate costs. BCX is unregulated and
the regulator will have no oversight over its pricing policies and
practices.
288]By locating BCX as an IT subsidiary – not an MNS provider – in the
highly fragmented IT industry, with relatively low barriers to entry, 239
and in which ostensibly relative market shares and dominance are
harder to define, it could more easily ward off allegations of exploitative
and exclusionary conduct on the part of its unregulated subsidiary.
289]It is not possible to anticipate the various strategies that would be
available to Telkom to evade regulation in the limited circumstances of
these proceedings. However, the acquisition of BCX would have
certainly provided Telkom with a strategic enabler, a mechanism,
through which it could implement any such strategies.
290]Accordingly we find that the merger is likely to lead to a substantial
lessening or prevention of competition in the MNS market on the basis
of the horizontal evaluation only. However, we express the concern
that Telkom may have available to it a range of instruments which it
could deploy against its rivals and that it seeks to evade regulation by
entering related but unregulated markets. We turn to consider whether
the merger can be justified on any public interest grounds.
239 As compared to the MNS market
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Public Interest
291]Section 12A(1) of the Act mandates an examination of the impact of
the merger on the public interest. Note that the public interest enquiry
is mandated whether or not the preceding competition analysis finds a
substantial lessening of competition. That is to say, a positive impact
on the public interest may be grounds for justifying a merger that, on
an analysis of the competition and efficiency impact, is likely to
substantially lessen competition, just as a negative impact on the
public interest may justify prohibiting a merger that passes muster on
competition grounds.
292]The public interest factors that we are required to consider are
specified in Section 12A(3) which provides that
When determining whether a merger can or cannot be justified
on public interest grounds, the Competition Commission or the
Competition Tribunal must consider the effect that the merger
will have on –
1. a particular industrial sector or region;
2. employment;
3. the ability of small businesses, or firms controlled or
owned by historically disadvantaged persons, to become
competitive; and
4. the ability of national industries to compete in
international markets.
293]The Commission contends that the merger impacts negatively on the
public interest. However, the merging parties have not invoked public
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interest arguments in favour of the merger. And because we have
found a likelihood of a substantial lessening of competition under, what
counsel for the merging parties refers to as ‘the statutory standard
relevant to the competition issues’, and because no countervailing
positive public interest impact is asserted, there is, strictly speaking, no
need for a further examination of possible negative public interest
implications. However our decision to prohibit this merger, although, in
our view, adequately grounded in the competition analysis, is bolstered
by the negative impact that, we find, the merger will have on the public
interest. Accordingly, we will briefly examine the Commission’s
contention that the merger’s negative impact on the public interest,
specifically its impact on ‘a particular industrial sector’ and on ‘the
ability of national industries to compete in international markets’
provides additional grounds for prohibition of the merger.
294]The Commission argues that:
Even if it were thought that the extent and likelihood of harm to
Neotel is too uncertain to justify a definite finding of a substantial
lessening of competition on the probabilities, the tribunal would
be entitled to have regard to the fact that Neotel’s successful
entry and the need for increased competition in the
infrastructural market are vitally important to the public interest
both in respect of the telecommunications sector (s12A(3)(a))
and in respect of the international competitiveness of South
African industries (s12A(3)(d)). 240
295]The Commission continues:
It cannot be too strongly emphasized that approval for this
merger is being sought at an extremely critical and sensitive
240 Commission HOA para 156
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stage of the development of South Africa’s ICT market. 241
296]Counsel for the merging parties characterizes the Commission’s public
interest argument in the following terms:
(It) would say we favour particular competitors entering markets
under particular conditions, and so even if the ordinary
consideration of mergers isn’t met under the statutory standard
relevant to the competition issues, we take a particular view
about competition in this market in respect of this competitor
and treat this as a residual public interest concern. 242
297]In essence the merging parties argue that a weak competition finding is
not strengthened by casting the harm that it generates as harm to the
public interest as defined by Section 12A(3) rather than harm to
competition or, as the Act terms it, a likelihood of a substantial
lessening of competition.
298]While we agree with the merging parties’ general contention, we
nevertheless insist that, in this instance, there is a clear relationship
between, on the one hand, our competition finding (that is, our finding
of a likely substantial lessening of competition in the MNS market) and,
on the other hand, harm to the public interest, specifically, as the
Commission alleges, arising from the mergers’ impact on a ‘particular
industrial sector’ (12A(3)(a)) and on ‘ the ability of national industries to
compete in international markets’. (12A(3)(d)). We emphasise that
harm to competition does not always impact negatively on the
categories of public interest specified in Section 12A(3). However,
when the competition harm accrues in markets as pivotal to both the
ICT sector and the overall economy as the PSTN market or the MNS
market then it is reasonable to postulate that both the prospects for the
241 Commission HOA para 157
241 Commission HOA para 157
242 Transcript p2701, our emphasis
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sector and for the economy as a whole may well be threatened by the
merger’s negative impact on competition. This postulate is underlined
by the timing of the merger – as we have already elaborated, the
merger is, in our view, an attempt to undermine the benefits of
deregulation and related introduction of new technologies. This flies
directly in the face of public policy, a public policy that is intended,
largely through deregulation, to promote an efficient ICT sector that
would play an important role in underpinning a competitive economy.
In short, in our view, the public interest impact does indeed relate to
the particular markets implicated in the merger and, as the
Commission’s heads of argument would have it, to the ’ extremely
critical and sensitive stage of the development of South Africa’s ICT
market’.
299]A similar issue has arisen in a previous decision of the Tribunal. In the
Medicross/Primecure merger the Tribunal’s held that the regulatory flux
and uncertainty surrounding an embryonic market segment in the
broad healthcare sector demanded particular circumspection from the
regulators, all the more so because of what the Tribunal characterized
as the heightened ‘public interest’ in the healthcare sector. Our
decision to prohibit this merger was influenced by these
considerations.243 However, the Competition Appeal Court held that:
It is extremely difficult to determine the weight which the
Tribunal gives to these public interest grounds in its probabilistic
enquiry. But, as I have already said, these issues should have
been of no relevance to the first stage of its enquiry which
needed to examine the evidence relating to the proposed
merger’s impact upon competition. These public interest
merger’s impact upon competition. These public interest
considerations would have been more appropriately considered
during the second phase in terms of section 12A(3), as the need
243 11/LM/March05 paras 712
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to consider public interest grounds is a separate and
subsequent inquiry to that of the primary determination .244
300]In short, the CAC has not held that these ‘public interest’
considerations have no place in merger analysis. The CAC has held
that we erred in conflating the competition and public interest
considerations. It has accordingly decided that broader public policy
related concerns – in Medicross these deriving from the nature of the
product or service in question and the broader sectoral context of the
transaction are to be considered in the public interest enquiry rather
than the competition enquiry.
301]Nor is it surprising that the CAC has affirmed that these considerations
have a place in merger analysis. It would be a particularly abstracted
regulator that blinded itself to the broader characteristics of the market
under examination to, inter alia, the nature of the product or service
rendered or to the broader policy environment. Indeed the Act has
underlined their pertinence by their explicit incorporation in Section
12A(3) of the Act, the provisions of which are simply an amalgam of
social and distributional concerns (e.g. employment, regional impact)
and industrial policy considerations. The industrial policy
considerations such as the impact upon the sector (S 12A(3)(a)) and
on international competitiveness (S12A(3)(d)) require that we take a
view on the nature of the product and on broader policy considerations.
If the merger under examination had been in the silk scarves segment
of the apparel market we may have been disinclined to consider the
transaction’s impact on the broader clothing sector or the knockon
effects on international competitiveness. However, the incontrovertible
facts are, firstly, that the merger under examination is taking place in a
facts are, firstly, that the merger under examination is taking place in a
pivotal segment of the ICT sector with implications for the sector as a
244 55/CAC/Sept05 para 23, our emphasis
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whole, secondly, that the ICT sector has an unusually significant
impact on the international competitiveness of South African firms
generally, and thirdly, it is widely accepted that the character and
effectiveness of the regulatory framework plays an important role in the
development of the broader ICT sector, most specifically the
telecommunications components thereof.
302]It is no exaggeration to claim that barely a week passes without a
major public or business figure confirming these latter assertions. No
less a representative of the public interest than the President himself
has strongly emphasized the importance of business process
outsourcing in South Africa’s industrial strategy and his frustration at
the constraining role played by telecommunication costs, and Telkom
pricing in particular, in the development of this market. 245 These views
are graphically endorsed by the CEO of Reuters, one of the world’s
largest global financial information providers, who has explicitly and
publicly attributed his company’s reluctance to invest further in South
Africa to the cost and quality of Telkom’s service. 246 It would be a
simple matter to supplement these views with those of other public
figures and business leaders. 247
303]We have elsewhere in this decision considered Telkom’s approach to
245 See ‘Interview with Thabo Mbeki’, Financial Times 3 rd April 2007
246 Business Day 17 th January 2007
247 Note that both parties have sought to make something of the contents of a letter from the
Department of Communications.(See Commission’s record page 2125 2130) One
paragraph of this letter expresses the view that competition is likely to be impaired by the
transaction, while the concluding paragraph expresses the view that the sector will benefit
transaction, while the concluding paragraph expresses the view that the sector will benefit
from the transaction. While it is tempting to simply dismiss this as evidence of confusion on
the DOC’s part, in fact the former paragraph articulates a negative view of the transaction on
competition grounds, while the latter paragraph expresses a positive view on industrial policy
or public interest grounds. What is certainly manifest in these opposed contentions is a
characteristic industrial policy view that conflates the health of a sector with the fortunes of the
dominant player or ‘national champion’ and the view that these considerations should trump
the lessening of competition. We disagree with the general proposition although in specific
cases it may be valid. However in this instance, it is clear that the view of the policy makers is
that the appropriate industrial policy with respect to the ICT sector is deregulation to promote
competition, a public policy choice that is likely to be undermined by the merger.
101
regulation. Suffice to state that it has, as commercial rationality clearly
dictates, left no stone unturned in its efforts to maintain and extend its
erstwhile statutory monopoly. This merger is, as we have already
elaborated, another such attempt to thwart the introduction of
competition. This has been a basis for prohibiting the merger on
competition grounds. That the merger attempts to counter the impact
of deregulation, public policy’s preferred mechanism for the
introduction of competition, is further ground for prohibition on public
interest grounds.
304]Thus while the competition and public interest analyses are, following
the CAC decision in Medicross, not to be conflated, nor can they be
hermetically sealed from each other in the manner contended for by
the merging parties. Low levels of competition in a
telecommunications market impact upon the growth prospects of the
broader ICT sector and on the competitiveness of the comprehensive
universe of ICT users and these considerations are clearly captured in
the specified public interest criteria provided for in Section 12(A)3.
Contrary then to the claim of the merging parties, the manner in which
we have considered the public interest implications of this transaction
does not amount to a second bite at the competition cherry, they are
not, in other words, invoked to support a weak competition case.
Rather they demonstrate the link between impaired competition, on the
one hand, and on the other, compromised national industrial policy
objectives, notably the emergence of a deregulated ICT sector
characterized by robust competition and underpinning a competitive
South African economy.
305]This then is the basis for our contention that our decision to prohibit
305]This then is the basis for our contention that our decision to prohibit
this merger on competition grounds is significantly bolstered by the
public interest impact. In this particular instance, should we have
102
erred in prohibiting a merger whose anticompetitive impact may have
been less than ‘substantial’ –the consequences of our error pale into
insignificance against the implications of approving a merger whose
combined consequences may be both to impair competition, and, given
the particular nature of the products implicated and, given their role in
economic growth and development, to harm the public interest as
expressed in the health of the ICT sector and the competitiveness of
the many sectors of the economy who utilize its products and services
as vital inputs.
Conclusion
306]As we have stated earlier on in these reasons, in our view an
assessment of this transaction in accordance with section 12A(2) has
required us to consider a number of factors. We have considered this
transaction in the context of the deregulation of the VANs industry
which has led to economies of scale and scope for both customers and
MNS providers.
307]The deregulation of the VANs industry has led to an immediate benefit
to customers in the form of lower communications costs. It has also
led to the growth of the MNS sector and increased competition in that
sector. MNS providers have invested in the horizontal value chain by
moving into the VPN segment in order to provide their clients with all
their communications needs. Most significantly it has introduced retail
price competition in national and international voice services.
308]We have found that it is from MNS rivals that Telkom anticipates any
considerable retail price competition and threats to it’s hitherto
monopoly margins in infrastructure and voice.
103
309]In our view this transaction is not an attempt by Telkom to plug some
revenue losses or find alternative revenue streams in the face of
competition and convergence. Rather it is an attempt by an erstwhile
monopolist, to thwart the beneficial impact of deregulation in the form
of greater economies of scale and scope for rival MNS providers and
lower costs for customers. It is an attempt by an erstwhile monopolist
to stifle competition and innovation in order to maintain its hitherto
monopoly margins in infrastructure and voice services and to extend its
monopoly into the space of convergence.
310]On the basis of the horizontal overlap only, we have held that the
transaction will lead to the removal of an effective competitor to Telkom
in the MNS market because BCX, as an MNS provider, is uniquely
poised to become a formidable competitor to Telkom in the dynamic
MNS market in which the VPN is becoming the product of choice. It
stands to take away margin from Telkom because it enjoys the
confidence of its client’s decision makers, has a track record in network
design, implementation and management that spans 20 years in the
MNS market and is a credible systems integrator, being the leading
outsourcing firm in the country.
311]Due to network effects, the acquisition of BCX would have enabled
Telkom to gain a much larger share of the MNS market, and would
have had a more detrimental impact on competition, than that indicated
by the initial increase in concentration levels. Together with Telkom’s
strategy to lock customers into long term contracts, this would have led
to the MNS market tipping towards Telkom. The already high barriers
to entry and expansion in the MNS market would have increased by
this thereby constraining the expansion of rivals, even possibly leading
this thereby constraining the expansion of rivals, even possibly leading
to exiting of smaller rivals and deterring the entry of new rivals.
104
312]Neotel’s entry in the MNS market is likely. However due to its own
internal and external difficulties, its entry is unlikely to be timely and
certainly not sufficient to offset the harm caused to competition as a
result of the merger.
313]We have also held that the acquisition will enable Telkom to engage in
unilateral conduct to the detriment of its retail customers. High
switching costs and network effects will discourage customers from
switching away from Telkom’s VPN offering in the event of a non
transitory increase in price.
314]While we note that the merger, if it had been approved, would have
had some detrimental impact on Neotel in the MNS market, and that it
may have blunted an already weakened competitor even further, we
find that the merger is likely to result in cooperation between Neotel
and Telkom, both in relation to competition with each other and in
warding off the threats posed by other MNS rivals.
315]No efficiencies were relied upon by the merging parties and we have
found the proposed divestiture of BCX Comms does not address the
harm to competition arising from this merger. The divestiture of BCX
Comms, contrary to alleviating any harm to competition occasioned by
this merger, may in fact allow Telkom to achieve what it sought with
this merger.
316]Accordingly we have found that the merger, on the assessment of the
horizontal effects alone, will lead to a substantial lessening or
prevention of competition in the MNS market.
317]In an assessment of the impact of this transaction on the public interest
as defined in s12A(3), we find that our decision to prohibit this merger
on competition grounds is significantly bolstered by the impact of this
105
merger on the public interest.
318]We did not find it necessary to make any further findings of harm to
competition arising from the vertical effects of this merger. We have
however expressed the view that the number of instruments available
to Telkom, its stated intention to deploy these and its current conduct
towards its MNS rivals gives us more reasons to be concerned about
the impact of this merger on the MNS market.
319]We have also expressed our concern about Telkom’s intention to
utilize BCX as a he mechanism to evade regulation, whether this is
further regulation by ICASA or scrutiny by the Commission.
320]The merger is accordingly prohibited.
____________________
Y Carrim Date
D Lewis and U Bhoola
Tribunal Researcher: Rietsie Badenhorst and Jabulani Ngobeni
For Telkom: Adv DN Unterhalter SC with Adv J Wilson instructed by Werksmans
For Gadlex: Adv M Du P van der Nest SC with Adv H Shozi instructed by MNMR
Attorneys
For ISPA: Adv A Cockrell with Adv A Gotz instructed by Webber Wentzel Bowens
For Dimension Data PLC: Adv A Subel SC and Adv R Bhana instructed by Stein
Scop Inc
For the Commission: Adv O Rogers SC and Adv NH Maenetjie instructed by the
Competition Commission
106