Why Vodafone’s megamerger could have a 3.9% problem

Receive free Telecoms updates

We’ll send you a myFT Daily Digest email rounding up the latest Telecoms news every morning.

Thank goodness for profiteering banks, greedflating supermarkets and hopeless water companies. If it weren’t for the UK’s vast choice of corporate villain candidates, telecoms companies might be getting more flak. 

You see the biggest mobile operators — almost all of them — have discovered a magic number. And that could create an awkward backdrop to competition regulators’ inquiry into the £15bn merger of Vodafone’s UK mobile business with CK Hutchison’s Three.

Telecoms companies impose inflation-linked price rises every year, even for customers in the middle of a contract. That practice is disliked by consumer groups, who argue that companies should shoulder inflation risk rather than customers, 60 per cent of whom don’t know what CPI and RPI measure. In 2020, with inflation close to zero and in a market where customers were using more and more data, BT moved first to add a supplement of 3.9 per cent to the inflation rate. 

Other companies liked the figure and followed suit. The big four mobile operators (BT through EE, Vodafone, O2 and Three) all use inflation plus 3.9 per cent as do some “virtual” operators such as Tesco, which have wholesale agreements to use others’ infrastructure. A special mention for Virgin Media and O2, which use the higher RPI inflation measure for their price rises and, conversely, for Sky, another virtual operator, which stands out as a big player that doesn’t add 3.9 per cent.

In a world of double-digit inflation, this has meant price rises of 14 per cent or more, which attracted the regulator’s attention. Ofcom said last week that its cost-of-living review had found understanding of in-contract price rises was low. It has previously urged providers to ensure price rises reflect increased costs.

The Competition and Markets Authority — which will review the Vodafone-Three deal in its antitrust capacity — has said there is “unlikely to be a direct connection” between providers’ costs and CPI or RPI.

The justification for the surcharge — that it is needed for investment after years where data demand surged and prices stayed flat — might pass muster were it not for the fact that so many companies’ careful examination of their spending needs has resulted in an identical figure. And that several “virtual” operators, who aren’t investing in networks, have done the same.

As Chris Pike, competition expert at economic consultancy Fideres, puts it: “It’s hard to believe these firms all face the same cost increases each and every year. Whether tacit or explicit, these look like they could be co-ordinated price rises, which obviously raises competition concerns and is the sort of behaviour made easier by mergers that increase concentration.”

Vodafone and Three, who announced their merger last month, argue that without economies of scale, the fiercely competitive UK mobile market doesn’t generate the returns needed to justify crucial investment, particularly in 5G networks. The deal would consolidate UK mobile network operators from four to three, a move resisted by regulators in the past, though attitudes have softened since a mooted O2 merger with Three was blocked in 2016. It is also seen by some as a test case for the argument that greater market power is required to attract higher investment.

The industry has a point about issues in the UK market, where prices have stayed low as data demand has surged. Virtual network operators are a new source of competition. They also get discounted wholesale deals from the same network operators they then undercut on retail prices.

But Vodafone has very much had its own problems. Its shares have underperformed the telecoms sector by 50 per cent over the past decade, note analysts at JPMorgan. Critics say it has neglected its core markets, is too centralised and lacks agility. Its return on capital is comparable to Three’s, despite having a much bigger market share.

Either way, the CMA’s investigation will take place against the backdrop of a telecoms market already showing signs of change, and intense scrutiny of price rises. Activist investor Cevian sold its stake in Vodafone in part because it thought the changing economic climate would make it harder for the group to get deals over the line with regulators. The 3.9 per cent can hardly help.

helen.thomas@ft.com