BT broadband price cuts: How is it done?

BT CEO Ben Verwaayen has stunned a sceptical market by slashing broadband prices in half. How has he achieved what his predecessor said was impossible? And will he get away with it?

Broadband prices are based on cost. BT is not allowed to sell broadband for less than the cost of supplying it, and Verwaayen has publicly endorsed this many times.

So how has the cost of supplying broadband halved almost overnight?

BT says it's partly a result of falling equipment prices. The biggest piece of equipment in an ADSL network is something called a DSLAM, a device which looks like a small filing cabinet covered in flashing lights which sits in the local exchange and turns a phone line into a fat data pipe.

BT buys these from Fujistu and Alcatel, and the cost has fallen significantly in the past few months, believed to be around 50 per cent. However, most new subscribers will just be filling capacity on existing DSLAMs, so that can't be all of it.

BT claims that cheaper DSLAMs are just an enabling factor. The cost of broadband is largely determined by the number of subscribers - the more people who use it, the cheaper it is for all of them.

BT is now aiming to get a million customers to buy broadband, which it can only do with DSL prices below £20. Before the recent falls in DSLAM prices, BT thought that it couldn't get DSL prices that low. So it didn't feel it could get a million customers. So with fewer customers and more expensive equipment, the cost per customer was much higher.

As a BT spokesman put it: "With the old cost base, the cost for a million customers wasn't low enough to enable us to sign up a million customers."

So effectively, a small fall in equipment prices shifts the economic picture just enough to make a much bigger price cut possible.

So the credit for yesterday's cut probably goes to Ben Verwaayen, who now stands to replace Sven-Goran Eriksson as Britain's favourite foreign manager.

The BT spokesman said: "Over the past couple of months there is a new attitude with Ben at the top. He has been saying that we really should be going for a million customers."

The big question now, though, is whether the regulator, Oftel, will swallow it. A spokeswoman confirmed that Oftel "would have the ability to ask [BT] to raise prices if we find that they are cross-subsidising".

A source who had dinner with the ecommerce minister Douglas Alexander a couple of weeks ago said that he was pretty keen to make sure that these price cuts are delivered, even though he's not supposed to get involved in Oftel's decisions. In any case, it would take a brave regulator to stop them.

However, the move does seem to turn previous government policy on its head. The key objectives used to be to make Britain's broadband market "competitive and extensive". Low prices are great news, but they're not going to boost competition in one area in particular.

BT's two main broadband rivals are NTL and Telewest. Six months ago, Telewest's broadband internet offering was the most tempting on the market. Now it starts to look rather expensive, and with massive debts it's unlikely to want to cut its prices any time soon.

At a wholesale price of £15, BT seems certain to dominate the market. If the government is happy with BT having an effective monopoly on broadband, then why couldn't they have allowed BT to make these price cuts sooner?