Iliad's epic success with the local loop

Broadband access, Financial Times, 03/03/2004

The recent stock exchange debut of Iliad Group highlights the French company's success with a technology that in most countries has been a dismal failure - local loop unbundling (LLU).

LLU was first introduced in the late 1990s, to create a competitive market for digital subscriber line (DSL) technology, which upgrades ordinary copper telephone lines to carry high-speed internet traffic.

Those telephone wires are all owned and managed by the "incumbent" former state monopolies such as Deutsche Telekom, France Telecom, or BT.

So national telecoms regulators have to force them to grant access to rival companies, allowing them to place their equipment in local telephone exchanges and take control of the copper lines.

This should give them the flexibility to reduce prices and provide innovative services such as super-high speed connections or cheap internet-based phone calls.

Recently, Iliad has been doing exactly this. Using unbundled lines, Iliad offers its customers 2 megabits (million bits) per second internet access, and free national telephone calls for €29.99 (£20) per month. It can also deliver 50 television channels.

Emmanuel Georges, an Iliad customer says: "I've been a customer since 2002. Before, I was paying €45 (£30) for 512kbps [kilobits or thousand bits per second], and there were frequent technical problems. Now I get 2mbps for €30, and I only had a couple of days' downtime in 2003. It's excellent value for money."

According to its own figures, Iliad has 165,000 domestic subscribers using LLU. French telecoms regulator ART calculates that there were 273,000 unbundled lines at the end of 2003, provided by Iliad, LDcom, Telecom Italia, Cegetel and others.

With the exception of New Zealand, most industrialised countries have put the regulatory framework for some sort of LLU in place. But few have made it a commercial success.

Japan is the most advanced. Of the country's 9.9m DSL lines, 6.2m are provided by rivals to incumbent NTT, such as Softbank's Yahoo! BB.

In Denmark, where Cybercity has 50,000 unbundled lines, LLU represents around 10 per cent of the total broadband market, the highest percentage in Europe (excluding the exceptional case of Finland, where there are multiple local incumbents).

In most other countries, though, the uptake of LLU has been very restricted. Germany's QSC has some 10,000s of domestic customers connected to an unbundled super-high speed 2.3mbps DSL service aimed at online gamers and heavy peer-to-peer users.

But LLU accounts for only 2 per cent of Germany's DSL lines.

In the UK, fewer than 8,000 lines have been unbundled, by companies such as Easynet and Bulldog Communications, mainly serving business customers.

It's much easier to make money on business services, which can be bundled with other ISP services such as security and network management, and sold for relatively high prices.

The economics of broadband for consumers are less forgiving, and the price that incumbents charge for set-up and rental of local lines is crucial. In Japan, NTT charges rival operators a mere Y168 ($1.56, £0.83) per line per month, which has certainly helped unbundling take off there.

Some commentators argue that Iliad has prospered because the costs of hiring local loops from France Telecom (€2.86) is lower than other countries. Deutsche Telekom charges €4.77, while BT charges £4.47 (€6.75).

But Olivier Rosenfeld, Iliad's chief financial officer, challenges the view that their success is down to cheap copper. "If you take account of all the costs, France is in line with the market. It is not an exception."

Bernd Schlobohm, chief executive of QSC, agrees that the situation is more complex than the price of renting lines. "It's not the cost in absolute terms. The business model depends on the difference between the end user price and the cost of the copper."

With France Telecom charging consumers €45 per month, it was easier for rivals such as Iliad to undercut it and still make a profit, than it was for QSC in Germany, where DSL is available for as little as €9.95 per month.

Many failed unbundlers have blamed the unco-operative behaviour of the incumbents. They are in the odd position of being forced to help rivals steal their customers, so they have an incentive to drag their feet.

"It's an important skill to be able to handle the incumbent,' says Roland M Andersen, chief financial officer of Cybercity. "Some of the guys that failed did so because they didn't handle the processes the incumbent put in place."

Perhaps the crucial element is the fact that making a success of residential LLU requires heavy investment. Softbank's success comes at the cost of a Y166.2bn loss over two years.

Europe's successful LLU companies are unusual in their ability to raise money to finance the substantial investment required in what is still an unproven business model.

Iliad's founder Xavier Niel was able to invest some of the €38m (£28.5m) from the sale of his earlier business, WorldNet, to fund his bet on LLU. Cybercity managed to raise $53m (£28.5m) in 2001's highly unfavourable financial climate to fund its LLU expansion programme.

The technical and commercial success of French LLU has reawakened interest in the process. UK ISP Freeserve said in a recent statement that it "will be also looking to adopt the business model of the successful European unbundlers."

Some regulators are also trying to promote a half-way house to LLU, called bitstream. This allows rival operators to connect to the incumbent's network at different points between the local exchange and the backbone network.

These ongoing regulatory efforts, combined with renewed interest from operators and financial markets, could bring a new lease of life to LLU.

This will be good news for consumers, if the argument advanced by the telecoms industry is correct, that the LLU process is essential to maintain growth and innovation in the DSL market.

"We see that the markets where there is a viable unbundling or bitstream option are developing better in terms of the number of broadband customers and the services available," says Jonna Byskata, EU affairs manager for industry lobby group ECTA. "In Germany, for example, where you don't viable LLU or bitstream, there is evidence that the growth of broadband is slowing down."

It may, however, be too little too late. "This is a land grab," says Iliad's Mr Rosenfeld. "After 2005, market shares will effectively be set."

The company's heavily oversubscribed IPO on the premier marché of Euronext Paris raised €104.3m in late January. For Iliad, products based on LLU have been a powerful weapon to build market share. In other markets rivals will have to battle for a place in that land grab without it. They will face an epic struggle.