analysis Has iiNet’s ongoing series of acquisitions harmed or helped the development of market competition in Australia’s telecommunications sector? It’s a difficult and complex question which will have a dramatic impact on the development of competition under the National Broadband Network scheme — and one which we will attempt to answer in this in-depth analysis of the ISP’s major buyouts over the past few years.

In November 2011, iiNet regulatory chief Steve Dalby made what some at the time considered to be a rather audacious claim: That his company’s lengthy and ongoing habit of buying up almost every rival ISP it possibly could in the Australian market had not hindered the level of competition in Australia’s telco sphere — but rather, it had helped it. “It’s just the opposite,” Dalby wrote in a comment on Delimiter at the time, responding to a claim by this writer arguing that iiNet’s activities, which has seen it acquire half a dozen of Australia’s major ISPs over the past half-decade and dozens of smaller firms before that, had contributed to the decline of competition in the sector. “We are strengthening competition,” he added.

Dalby wrote that in many cases iiNet had bought companies which had been “in decline and unable to compete” or unable to invest in their brands. Such companies, he said, had been unable to keep up with the trend of bundling content and telco services together through investing in their platforms, and had proven unable to keep their costs at a level which would allow them to put pressure on market giants such as Telstra or Optus.

“By increasing our scale,” Dalby argued, “we have been able to justify investment in infrastructure, new services, improved tools to improve customer satisfaction and are able to punch above our weight in negotiations with major suppliers. We are not contributing to the decline in competition, we may have reducing the quantity of brands in the market but we significantly improving the quality. That improvement is easily visible.”

However, despite Dalby’s statement at the time, the question of what impact iiNet’s activities have had on Australia’s telecommunications market has become more and more important over time. Just days after Dalby’s words in November last year, iiNet revealed it would acquire Canberra-based ISP TransACT. And a month later, in the week before Christmas, it added long-standing rival Internode to its growing cluster, shrinking the number of players in the market further and adding to speculation that competition in the sector will suffer in future.

In this article, we will seek to examine iiNet’s six most high-profile acquisitions, undertaken in the past six or so years, with a view to determining how the buyouts changed the activities of those companies in the market from the point of view of a consumer. We will also (although it is a difficult area) examine some of iiNet’s own organic activities, with a view to determining whether the company’s increased scale over the past few years has allowed it to put increased competitive pressure on larger players. The overall aim — although a difficult one — will be to draw a conclusion about what impact iiNet’s acquisitions have had on market competition as a whole.

What does ‘competition’ mean?

First, some background about what competition in the context of the Australian telecommunications market means.

From an economic standpoint, Australia’s marketplace for telecommunications services has clearly over the past decade, become an oligopoly. When the market was initially deregulated several decades ago, dozens or perhaps even hundreds of small ISPs entered the space, competing to provide a new service — Internet access. And as it became further deregulated in the late 1990’s, a variety of other firms entered the telephony and mobile markets, broadening the industry further.

Since that time, however, that market has become overwhelmingly dominated by just four major players — Telstra, Optus, TPG and iiNet, which have largely divided up the available market share in fixed telecommunications between them. A fifth player exists only in mobile — Vodafone.

A market of just three or four major players is virtually the definition of an oligopoly — which is differentiated from a more perfect market which would have a much higher number of players, or a monopoly (which Australia’s telecommunications sector used to be, under Telstra), which only has one player. Oligopolistic markets exhibit a more limited degree of competition than those with more players — but they obviously also exhibit some competition, which is generally an improved situation over that of a monopoly.

Another interesting facet of the market is that the companies are selling services which are direct replacements for each other (usually, broadband connections and telephone services). This is called ‘direct competition’ and is differentiated by economists from substitute competition (for example, butter competing with mayonnaise) and budget competition, which includes any product on which a consumer could spend their funds. Budget competition might exist between the book and film industries, for example, as consumers could theoretically choose to spend money on a new book or seeing a new movie.

In this context of an oligopolistic market with direct product competition, economic theory tells us that the most usual kind of competitive force is going to be non-price competition. In short, because everyone’s selling the same thing at around the same price, you compete by providing value-added services around that core value proposition.

And this is certainly what we see in Australia’s broadband market. Companies like iiNet, Optus and Telstra have, over the past decade, focused heavily on bundling products together for sale, adding features, providing better customer service and so on — because they find it hard to differentiate when they’re normally selling the same core product. Other companies — TPG being the major example — have competed in the market in a slightly different, but still consistent way. By providing more basic services, they have kept the cost down on their core offering.

With all of this in mind, it is possible to further refine the question of whether iiNet’s acquisitions have improved competition in the space or hindered it. We can now segregate that question into two, dealing separately with the matter of whether iiNet has innovated in the core telecommunications products which everyone sells (broadband and telephony services), and separately whether it has innovated in value-added services, and how its acquisitions have played into these two issues.

OzEmail

Although it had acquired dozens of smaller ISPs before that time (usually one or more per year from its formation in 1993), iiNet’s first major acquisition, and likely the one that first drew its acquisitive nature to widespread public attention, was the 2005 buyout of Australian ISP OzEmail.

OzEmail is virtually a poster child for Dalby’s claim that iiNet had bought many ISPs which had fallen into decline and been unable to compete. Due to the late entrance of Telstra into the Internet space, OzEmail was extremely dominant in Australia’s ISP market throughout the 1990’s, culminating in its 1999 sale to US telco giant WorldCom for an amount reported to be more than half a billion dollars. However, the company was mismanaged and suffered a late entry into the ADSL broadband market, which iiNet helped pioneer. In 2005 iiNet picked it up for a song — around $104 million.

In terms of our two benchmarks, it seems clear that iiNet’s buyout of OzEmail had only a minor impact on competition in the broadband sector in that OzEmail was not innovating in the market, nor acting as a strong competitor. iiNet’s removal of OzEmail from the market didn’t significantly impact consumers.

At the time (2005), the major competitive trend within Australia’s fixed telco sector was the rollout of ADSL infrastructure (DLSAMs) in telephone exchanges by Telstra’s rivals — iiNet, Internode, Netspace, Optus, AAPT and others. This is an example of those companies innovating in their core product (broadband) to get ahead of the major player in the market, Telstra. However, the buyout of OzEmail does not appear to have changed the way iiNet conducted its DSLAM rollout. In an article in the Age in February 2005, following the OzEmail announcement, iiNet chief executive Michael Malone said the company’s ADSL rollout plan — slated to hit 104 exchanges — was progressing ahead of schedule. “We’re an ISP and we will continue to concentrate on our core business, which is providing dependable connectivity to our customers,” he said.

The buyout of OzEmail did deliver iiNet some 342,000 new customers, boosting the company to third place in the ISP market. But it is unclear whether adding those predominantly dial-up customers to its ranks at that stage meant iiNet could negotiate better deals with suppliers and drive its prices down. Over the past decade, iiNet has maintained a position as a mid-priced supplier in the broadband market, and the addition of OzEmail to its ranks didn’t appear to change iiNet’s market offerings or strategy.

Westnet

iiNet’s next major acquisition (in May 2008) was fellow Perth-based ISP Westnet, a move which delivered it another 180,000 Internet subscribers. Like iiNet, Westnet had its own ADSL rollout plan, although it was vastly smaller. Its major innovation in Australia’s telco sector had been its focus on driving customer service outcomes — Westnet was known for having the best customer service in Australia.

Unlike with the OzEmail buy, the Westnet buyout did have a measurably negative impact on competition in Australia. This came in three areas.

Firstly, iiNet has harmonised Westnet’s broadband plans with its own. If you examine the two company’s product offerings, you will find they are pretty much exactly the same — same price, same services and so on. The acquisition reduced long-term consumer choice in the market. One major player started offering identical services to another major player. This reduces competition.

Secondly, the Westnet buyout gave iiNet a stranglehold — a market share of 30 percent, equal to Telstra, in the West Australian market where both Westnet and iiNet operated. This reduced the choice available to consumers in that market. And lastly, iiNet adopted Westnet’s stellar customer service techniques. Today, iiNet is known for its stellar customer service, as Westnet is. There is virtually no differentiation between the two companies when it comes to product or service offerings in the market. If you choose Westnet or iiNet, you’re going to get the same service. Previously, there was value-added service differentiation between iiNet and Westnet in the market. Today, there is not.

Netspace

Next, in March 2010, iiNet bought Melbourne-based ISP Netspace, which also had a substantial presence in Tasmania. This buyout delivered iiNet around 80,000 customers, as well as network infrastructure in Victoria and Tasmania. Like iiNet, Netspace had been an innovator in Australia’s broadband market, challenging Telstra in the core ADSL broadband offering with its own infrastructure, including rolling out fibre in Melbourne, developing IP telephony services and releasing innovative broadband plans.

However, again, as with the Westnet acquisition, iiNet’s buyout of Netspace visibly decreased competition in the market. Netspace had been a competitor to iiNet, with many consumers choosing between the pair and others such as Internode for services, but currently Netspace’s broadband plans, products and services are the same as iiNet’s. iiNet appears to have applied the same approach to Netspace as it did to Westnet — homogenising the ISP’s offerings and customer service strategies with its own in the long term.

Again, there is the question of to what extent the buyout allowed iiNet to gain scale and thus launch new products and services itself — a hard issue to interpret. However, with only 80,000 customers added to iiNet’s roster as part of the acquisition, it’s hard to see what having those customers on board would have allowed iiNet to do that it would not have been able to do before, with the more than half a million subscribers it already had. By 2010, iiNet already had development programs investing in new network hardware for customers (its BoB modems, for example), and it had already deployed innovative network services such as naked DSL, IP telephony and profile variability to customers. It appears that iiNet’s major initiative with Netspace, as with its previous acquisitions, was to port these value-added offerings to its new Netspace customer base while learning what it could from Netspace itself.

AAPT

In July 2010, iiNet bought the consumer division of struggling telco AAPT. This acquisition appeared pretty similar to the 2005 buyout of OzEmail, in that AAPT had not been a strong market competitor for some years, despite having rolled out its own ADSL infrastructure and having a substantial backhaul network to drive cost savings. The iiNet buyout only had a minor impact on competition in the market — as iiNet primarily gained customer accounts from the buyout, rather than much network infrastructure.

However, it is worth noting that iiNet’s Malone indicated shortly after the AAPT buyout that he planned to kill off the only consumer product offering which AAPT had which had been driving competitive outcomes in the market — its plans with “unlimited quota”. “All you end up with on unlimited are the leeches,” Malone said at the time. And, true to his word, iiNet did stop providing the unlimited plans in October 2010, removing a competitive offering from the market and diminishing consumer choice.

One element of the AAPT buyout had the potential to increase competition — iiNet’s acquisition of AAPT’s customer support centre in Manila. The fact that this call centre became part of iiNet’s support team meant it could compete a bit more strongly with larger companies such as Optus, which are believed to have operated offshore call centres for some time, due to their lower cost base. However, the impact on competition here is believed to have been minimal — as iiNet already had an industry leading customer service record and had also invested offshore in South Africa to bolster its headcount. And again, iiNet did not appear to modify its product or service offerings following the AAPT acquisition.

TransACT

In November 2011, iiNet bought Canberra-based ISP TransACT, which brought the company several fibre networks in Canberra and rural Victoria, as well as 40,000 new customers. This acquisition can be viewed as similar to the Netspace acquisition, in that it gave iiNet a strong position in geographies where it had not previously enjoyed a strong customer base, as well as a great deal of network infrastructure.

In this case, the acquisition of TransACT also has the potential to decrease competition in Australia’s telecommunications sector, although not much has yet changed in TransACT’s offerings since iiNet bought the company.

It is not clear yet to what extent iiNet will merge TransACT’s products and services with its own. However, over the next decade, the rollout of the National Broadband Network in the ACT will overbuild TransACT’s network, meaning it will be likely that the company’s mix of broadband, telephony and video entertainment services will increasingly be provided over the NBN infrastructure and not over its own network. If this occurs as planned, it seems very likely that iiNet will harmonise TransACT’s own offerings with its own, including standardising on the FetchTV IPTV platform which iiNet will provide through its own iiNet brand on the NBN and through those of its acquisitions, such as Westnet and Netspace.

There seems no reason why iiNet would maintain a separate IPTV platform and plan bundles for TransACT, when it uses different offerings for its other brands. When the same infrastructure is being used, likely the same products and services will be offered. In the long term, if this occurs, this integration will see a competing IPTV platform removed from the market, in favour of standardisation on the FetchTV platform. This integration may be substantially slowed down if the Coalition wins the next Federal Election and modifies the NBN project — which would mean TransACT would remain in the mid-term as a practical market competitor in Canberra and rural Victoria to its iiNet parent.

There is one further impact on competition from the TransACT acquisition. It may allow iiNet to more strongly compete in the Canberra market, due to the potential for iiNet to cut costs through using TransACT’s infrastructure in some areas, instead of leasing capacity from rivals such as Telstra. It’s not clear to what extent this is a factor in the TransACT buy. In addition, the TransACT buy may allow iiNet to push more strongly into providing business telecommunications services, competing with players such as Telstra, Optus and Macquarie Telecom in that market, which has the potential to increase competition in the business space.

Internode

Perhaps the biggest one in terms of competition. In late December last year, iiNet bought long-term arch-rival Internode, in a move which delivered it a large footprint of more than 200 DSLAMs in telephone exchanges, some 260,000 active broadband services and annual revenue of about $180 million. In addition, the move delivered iiNet one of the most well-regard telecommunications management teams in Australia, led by Internode founder and managing director Simon Hackett.

The acquisition of Internode is clearly a move which will decrease competition in Australia’s broadband market. iiNet and Internode have long competed very strongly, on both technological and commercial fronts. The two companies have been two of the driving forces behind the rollout of ADSL2+ equipment and speeds in Australia; as well as technologies such as Internet telephony, IPTV, value-added services such as quota-free content, gaming and file services, and more.

However, it has become very clear in the months since the acquisition was announced that iiNet and Internode are no longer competing with each other — but instead collaborating. Internode’s innovative data packs system for adding additional quota to your broadband connection has been ported across to iiNet’s plans, iiNet has abolished its on-peak/off-peak quota structure as Internode has, and the pair have given each other access to their respective ADSL network infrastructure.

Like iiNet’s move into Melbourne and Tasmania with Netspace and Canberra with TransACT, the move also solidifies iiNet as one of the largest players in a new market (South Australia), where the combined iiNet and Internode entity will now face only one minor rival — Adam Internet — alongside the normal larger rivals it competes with nationally — Telstra, Optus and TPG.

In a broader sense, the acquisition of Internode also reduces the need for iiNet to compete on technological grounds with other companies. In terms of developing new offerings to the market such as ADSL2+ broadband, IP telephony and other value-added services iiNet’s other major rivals (TPG, Telstra and Optus) have all been much slower than Internode. Internode has, in this sense, kept iiNet honest over the past half-decade, as the company’s development efforts have mirrored iiNet’s own. Without Internode acting as a stand-alone operator, there may be less incentive for iiNet to maintain the same pace in developing new product offerings. iiNet may continue to develop its offerings at a rapid pace through its own choice — but there is less practical need for it to do so, without the threat that Internode will get ahead.

There are, however, significant potential upsides to the Internode acquisition in terms of competition. The buyout may allow iiNet to speed up the pace of its technological development, by adding Internode’s expertise to its own. The addition of Internode’s infrastructure to iiNet’s may allow the company to compete more strongly for customers with its major rivals, and reduce its cost base further by virtue of its larger scale. The addition of significant management and technical talent may also help iiNet compete more strongly in future. And as of yet, Internode has not completely harmonised its broadband plans with iiNet, with the company signalling its intention to remain more independent than iiNet’s previous acquisitions have been able to.

If Internode does harmonise its broadband plans with iiNet’s at some stage, as Westnet, Netspace, AAPT and others have done, this would be to the significant detriment of competition in Australia’s broadband space. For many Australian consumers, especially early technology adopters, the choice of which ISP to use has long been one between iiNet and Internode. The merger of the two companies thus has the potential to reduce consumer competition further by a significant factor.

Mitigating factors and a conclusion?

If you specifically examine iiNet’s major acquisitions over the past half-decade or so, it seems clear that most of the buyouts have had at best a mildly negative impact on real-world competition in Australia’s telecommunications sector, while at worst they have removed a strong competitor from the market and removed a solid option from the list of choices of ISP which consumers have enjoyed.

In 2012, why bother buying telecommunications services from companies like Westnet or Netspace? They offer the same plans as iiNet does — if you want real choice, you need to look elsewhere — Telstra, Optus or TPG. And it is far from clear whether major players like TransACT and Internode will go the same way over the mid-term period or not. Certainly a number of Internode customers are currently fearful that the company’s products will be harmonised with those of iiNet eventually. And, given iiNet’s past history with most of its acquisitions, it’s a valid fear.

The argument that iiNet’s increased scale from the buyouts has given it the ability to invest further in its offerings is also not persuasive. Most of iiNet’s market innovations were in development, or even launched, before most of its major acquisitions took place. The company innovated strongly before 2005, when it acquired OzEmail, and then applied those innovations to its acquisition targets. This had the broad affect of benefiting many of the customers of those acquisitions, especially at companies which had stagnated (such as OzEmail and AAPT), but there is little evidence that iiNet changed its pricing, product offerings or any other feature of its services following major acquisitions. In short, some of the acquired customers benefited, but the competitive landscape generally suffered in the long term.

One further factor is disturbing. If you examine the history of acquisitions in Australia’s telecommunications space more widely, it seems clear that it is iiNet, not its major rivals (Telstra, Optus, TPG and Vodafone) which has most contributed to the creation of a strongly oligopolic structure in the sector. Telstra is mainly prohibited from buying rivals due to its already huge market share, and Optus has appeared very reluctant to acquire in Australia. TPG and Vodafone only engage in corporate transactions rarely.

As Australia moves into the world of the National Broadband Network, we can thank iiNet for the fact that only a handful of major players will be providing services over the NBN. If iiNet had not bought the number of ISPs which it has, Australia would have a handful more of nimble, innovative players to provide services over the NBN — companies such as Netspace, Westnet, TransACT and Internode, all of which innovated strongly in the local broadband market before being acquired by iiNet. These companies provided consumers with strong alternatives to iiNet and other ISPs in Australia but have now been consolidated under the one umbrella, reducing real choice for consumers in the market.

However, it’s not all bad news.

The mitigating factor when we look at iiNet’s acquisitive history in Australia, and its impact on competition, is that, as its regulatory chief Steve Dalby correctly noted, the company has acted as a very strong competitor towards larger, dominant rivals such as Telstra and Optus. Alongside TPG, iiNet provides a strong alternative to the majors when it comes to fixed telecommunications services. The launch of ADSL, ADSL2 and ADSL2+ services, the development of naked DSL and IP telephony, the increase in the quality of customer service, the provision of value-added services and the solidification of the process of migrating customers onto new ADSL infrastructure and off Telstra’s systems are all real improvements which Australian consumers can lay at iiNet’s door. Without iiNet, it is unclear what state of competition Australia’s telco sector would enjoy.

As Dalby himself wrote last year:

“I think we have been the epitome of competition in Australia, we innovate, we changed the shape of dial-up and then broadband with our pricing policies and our own DSLAMs, we introduced a quality VoIP offering to the masses, drove ‘Naked’, built a better modem in BoB, challenged Telstra’s wholesale pricing, reduced costs for the industry, introduced IPTV, put customer satisfaction at the centre of everything and contributed significantly to the public debate about copyright infringements, filtering, NBN applications, the digital economy and regulation.”

However, there is also one disturbing factor regarding this obvious layer of innovation which iiNet has brought to the market. It is very clear that iiNet was not the only company innovating in the areas which Dalby mentions — a number of its rivals, such as TransACT, Netspace, Westnet and Internode were also innovating in these exact same areas. With the removal of those companies from the market, the burden of innovation now rests much more strongly on iiNet’s shoulders alone.

In Australia’s telecommunications sector, Telstra and Optus have long been very reluctant to risk their current revenues by developing new and innovative services, and low-cost players such as TPG have no acted as product innovators in this space either, due to their low margins. With the removal of many of the innovators from the market and their inclusion under iiNet’s wings, iiNet currently faces vastly reduced pressure to continue innovating itself — and Australian consumers face a reduced choice between companies who are pushing for better products and services.

So what’s the answer to our initial question about iiNet? It’s a mixed bag. The company has acted as a strongly competitive force in Australia’s telecommunications market. However, it has also acted as a strongly anti-competitive force, and it’s at iiNet’s door that consumers must lay the sector’s current oligolopic structure.

Is four (perhaps five, with Vodafone) major players enough to guarantee decent competition in Australian telecommunications? History from the nation’s banking and retail sectors, which are similarly dominated by oligopolies, would suggest not. Time — and the rollout of the National Broadband Network — will give us a final answer.

Image credit: iiNet