Service Briefing Note

PSTN and intemet traffic is growing at a phenomenal rate in New Zealand. In March this year over 23% of residential local traffic was internet traffic, up from over 16% in April 1998. At an annualised rate intemet traffic hit 3 billion minutes in April this year. This growth rate is, if anything, accelerating rather than tapering off. A conservative forecast would see this proportion of traffic rismg to 40% of all local calls within 3 years. However, with the increasing levels of competition in the ISP market, and the growing demand from customers for flat rate pricing, we could easily hit this 40% figure within 12 months.

The move to flat rate pricing is exacerbating some alarming trends. The average length of an internet call is currently 22 minutes compared to 3 minutes for a voice call. However, this average length is steadily increasing. The average usage of those making internet calls is 23.5 hours per month. Again, this average is steadily increasing.

These factors are therefore feeding upon each other with a growmg number of customers using the intemet, an increasing average length of call and an increasing average number of hours per month per customer.

Most other countries have some form of charging for their residential local calls which acts as a natural break on inefficient usage of the intemet. With free local calls and a growing number of flat rate intemet users, New Zealand is seeing some quite alarming usage statistics. There are a growing number of very heavy, or indeed "excessive" users, with anecdotal evidence suggesting that many people simply leave the PC logged on to the intemet even when they are not using it simply to avoid the hassle of logging back on. This sort of behaviour clogs up an ISP's network making it more difficult for other users to get on and increases the incentive for those that are already logged on not to log off when they have finished.

Some of the excessive usage is borne out by analysis of the top decile of residential intemet users. The top 10% of users average 143.3 hours per month and account for 61% of all residential internet minutes. This skew towards heavy users is even more extreme when looking at the top 1% of users who average an incredible 416.2 hours per month and account for 18% of residential intemet minutes. Indeed there are a number of customers who have consumed over 700 hours in a month and hence have had their PC's logged on for every minute of every day for an entire month!

A further issue of concern to Telecom, in terms of intemet traffic, is the peculiar incentive created by our current interconnection arrangements that sees Telecom paying some carriers terminating a call between 1.5 and 2c per minute in peak periods. This means that if a carrier hosts an ISP then calls from Telecom's access customers which go to that ISP result in Telecom paying between 1.5 and 2c a minute to the other carrier. The huge imbalance of traffic with an ISP (ie. huge volumes of minutes going to the ISP and none going back) was clearly not envisaged in interconnection arrangements which have been negotiated in the past.

The incentives created by the interconnection arrangements have already lead to at least one carrier beginning to pay ISPs to generate local call internet traffic. This already occurs in the UK where ISPs provide for free intemet access funded by interconnection payments from British Telecom. However, given that British Telecom have charged local calls this is a sustainable economic model. In New Zealand we are already beginning to see payments to ISPs by carriers which will inevitably lead to customers being paid by ISPs to keep their PC's permanently logged on. We have made various forecasts of demand factoring in the three factors of free local calls, flat rate intemet pricing and interconnection incentives and can easily envisage growth scenarios which could well be impossible to sustain and hence bringing the Telecom network into jeopardy.

In summary, our view is that the current situation is unsustainable both in a network sense and in a commercial sense. In order to deal with this issue we have created a new service for ISPs that enables us to manage intemet traffic more efficiently. The proposal is as follows:

- Telecom is opening up a new number range 0867 XXXXX;

- ISPs and carriers will be able to use 0867 numbers on a non-discriminatory basis. By dialling an 0867 number the business or residential customer will be connected to their ISP of choice.

0867 intemet calls will be free for residential customers (excepting those who have elected to go onto one of our charged calling options). Business customers will continue to pay the standard local call charge.

In essence, we will continue to offer a free to call option to residential customers to connect to the intemet by dialling an 0867 number.

The significant advantage to Telecom from 0867 is that the calls will go through our Intelligent Network allowing for a significant advance in our ability to manage these calls in an efficient manner. For example, we will be able to balance call load between exchanges by using the intelligent routing functionality of the Intelligent Network and in times of extreme network overload we will be able to prioritise voice calls ahead of 0867 traffic. It is in times of network emergency or overload that internet traffic is particularly problematic for any network. The long holding time of the calls and the ability of PC's to "attack dial" every 5 seconds in order to get connected means that intemet traffic in times of overload can cause an avalanche effect which can bring down exchanges.

In order to create an economic incentive for customers to use 0867 calls we will be introducing a 2c per minute charge (GST inclusive) for PSTN local calls (not using 0867) made by residential customers to connect to the intemet. However to focus this incentive on heavy users the first ten hours of PSTN usage will not be charged for. However, we would envisage IPSs will look to encourage their customers to dial 0867 numbers. Consequently, Telecom has not budgeted to receive any revenue at all from this charge. Our purpose is the critical protection of voice telephony and efficient management of burgeoning network traffic.

We have obviously considered the Kiwi Share issues with this initiative. Telecom's strong legal advice is that calls to the intemet are not covered by the Kiwi Share: they were not part of "ordinary residential telephone service" when the share was struck; and intemet calls are not local telephone calls however that term may be defined. This is the view that the United States Federal Communications Commission came to when it made its authoritative ruling on intemet calls earlier this year. The culmination of this advice meant that Telecom was justified in imposing a charge on every call to the intemet. However, we have elected not to go down that route with this initiative, and instead have introduced the 0867 service option, which is a "local free-calling option" within both the spirit and letter of the Kiwi Share.

From an ISP perspective, there are a number of advantages from the 0867 service. By using the Intelligent Network we can offer a range of value added services to ISPS, such as load balancing between their various access lines and intelligent overflow and divert services. 0867 numbers should also be transferable between carriers. A substantial attraction to ISPs will also be the fact that they can use the same 0867 number in any local call area which they have a point of presence rather than a multitude of different local call numbers in different cities.

We have also budgeted for some marketing and communication assistance for ISPs to communicate these issues to their customers.

In respect of carriers, we will take calls from our access customers who dial an 0867 number used by another carrier and progress these calls to the interface of the Telecom and the alternative carrier's network. We will not charge for delivering these calls to the interface. Telecom will also pass calls from the carrier's network to 0867 numbers in the Telecom network free of charges. We would expect a reciprocal arrangement with other carriers.