BT split is on the cards as Ofcom asks the awkward questions

Telecoms giant faces demerger as rivals clamour for regulator to take action

For followers of the telecoms industry tomorrow morning will mark a very special day. The industry regulator, Ofcom, will pose what for many is the ultimate question. Should BT Group be split asunder, its businesses carved up and the resulting bits left to fight for survival on their own?

For followers of the telecoms industry tomorrow morning will mark a very special day. The industry regulator, Ofcom, will pose what for many is the ultimate question. Should BT Group be split asunder, its businesses carved up and the resulting bits left to fight for survival on their own?

Although competition academics will be drooling over the prospect of months of debate, there are crucial issues for the consumer arising from Ofcom's review of UK telecoms as well as for the economy's competitive position as a whole.

After all, if you are contemplating splitting up BT then you are tinkering with a crucial piece of the country's infrastructure. Get it wrong and you run the risk of damaging the efficiency and value of the economy's communication network.

But at the same time BT is still the monolith it was when privatised 20 years ago. BT Retail, whose chief executive is Pierre Danon, has 73 per cent of the residential fixed-line phone market while BT Wholesale, run by Paul Reynolds, is still the gate keeper to the country's main communications artery, the copper wire network.

As a result, the former state monopoly still has a dominant market position which, according to BT's critics, does not foster competition. Consumers are getting a raw deal as a result.

The charts show just how big the two main constituent parts of BT are. BT Retail has a £13.3bn turnover and underlying profits of £1.6bn, as measured by earnings before interest, tax, depreciation and amortisation (ebitda). BT Wholesale has turnover of £11.3bn and underlying profits of £3.8bn plus annual capital spending of £1.6bn.

While the stakes could not be higher, both for consumers and for business, there are other, equally highly charged arguments. Does Ofcom have the legal right to split up BT and do BT shareholders actually want their business split in two?

These are some of the major questions that will be asked by Ofcom tomorrow when it sets out phase one of its strategic review of UK telecoms.

Since coming into being at the start of the year Ofcom has been limbering up for tomorrow's big announcement. As the new power in the land, it wants to get to grips with the businesses it is policing. It is conducting a similar exercise in broadcasting - it is also the country's media regulator.

Phase one of the review will be posing all the difficult questions and then seeing what the industry and consumer groups have got to say. Phase two will be to measure what sort of deal we get as consumers from our telecoms companies compared with both other countries but also other industries, such as electricity and gas. Phase three, hopefully to be revealed before Christmas, will provide Ofcom's answers and decisions on how this £50bn industry is governed.

While there are dozens of big issues to address, including what's going on in the mobile phone business and the cable industry, all roads tend to lead back to BT and its position at the heart of both the industry's infrastructure and its dominance as a retailer.

It is BT's rivals trying to sell residential phone services who have been the most vociferous in calling for BT to broken up. Ian El-Mokadem, the managing director of Centrica Telecoms, said: "Today BT is benefiting from an unfair advantage due to its integrated structure of wholesale and retail. BT Wholesale charges BT Retail half what it charges everyone else for a local call. BT Wholesale is being used to obstruct the competition.

"But also BT Wholsesale is being held back in developing itself as a business in its own right. When I go into see Paul Reynolds at BT Wholesale as a customer with what should be a very compelling proposition for him, nothing seems to happen. My perception is that a conflict of interest comes into play within BT.

"BT Wholesale getting too close to me might allow Centrica to take market share away from BT Retail, which as a single group BT won't allow to happen."

Mr El-Mokadem points to the break-up of British Gas between its wholesale and retail components as a huge success and a valuable precedent for Ofcom. Consumers enjoy lower gas prices thanks to more effective competition while shareholders have been left with stakes in three companies, a retailer (Centrica), an energy business (BG Group) and a utility (NationalGrid Transco).

"What surprises me," said Mr El-Mokadem, "is why BT shareholders are not clamouring for this."

As the chart shows, the company's share price has been going nowhere for a long time. However, investors have not been calling for a split because of the risks involved in executing a demerger strategy.

David Rowe is chief executive of Easynet, a company that provides broadband internet access to businesses which has to make use of BT's network. While he might appear to be a winner from a demerged BT, he is not so sure the benefits necessarily outweigh the costs.

"A BT Retail set up on its own and allowed to compete on the same basis as its rivals would unleash a monster. Consumers might benefit but I'm not sure companies would.

"I think it would take years to unravel the two parts. Is it healthy to have a weakened BT from customers' and industry's point of view? Maybe up to a point but there are advantages of having a strong incumbent that is well regulated. It is good to have a strong core provider of your industrial backbone. You don't want to go down the route of the US electricity industry."

In places such as California, energy deregulation has been accompanied by blackouts on a huge scale as financially stricken companies struggle to stay afloat.

Bill Allen, the chief executive of Thus, an alternative telecoms provider once part of Scottish Power, is similarly sceptical. "The biggest disadvantage in separating wholesale from retail would be the UK economy which would lose from service innovation.

"The people arguing for a split, such as Centrica, are essentially retailers who do not fundamentally provide new innovations. They are in the market because the regulator has allowed certain services such as residential phone lines to be re-badged and re-sold under different names."

That BT itself is against a split goes without saying, although Ben Verwayen, its chief executive, was keeping his power dry yesterday waiting for tomorrow's pronouncements from Ofcom.

However, it does warn that keeping retail together with wholesale is one of the few reasons why a company like BT is encouraged to invest in its infrastructure network.

It argues that everyone has access to its network, which is kept up to date and cutting edge because it has to compete in the retail market as well.

BT Retail's competitors meet this argument with derision. They insist there is clear cross-subsidy between BT Wholesale and BT Retail, to the detriment of retail competitors.

Getting to the bottom of this will be at the heart of Ofcom's consultation process starting tomorrow and culminating in December. Mr Verwayen and the BT board must be getting worried that it is going to be a very unhappy Christmas.