TELSTRA GROUP LIMITED — AGM Information 2005

Oct 12, 2005

13 October 2005

The Manager

Company Announcements Office Australian Stock Exchange 4^th Floor, 20 Bridge Street SYDNEY NSW 2000

Office of the Company Secretary

Level 41 242 Exhibition Street MELBOURNE VIC 3000 AUSTRALIA

Telephone 03 9634 6400 Facsimile 03 9632 3215

ELECTRONIC LODGEMENT

Dear Sir or Madam

NSW Country Press Association AGM - speech by Mr Doug Campbell, Group Managing Director - Telstra Country Wide

Please see attached speech to be delivered tomorrow by Mr Doug Campbell.

Yours sincerely

Pour la brack

Douglas Gration Company Secretary

Telstra Corporation Limited ACN 051 775 556 ABN 33 051 775 556

Address by Doug Campbell Group Managing Director Telstra Country Wide NSW Country Press Association AGM October 14, 2005

Thank you for the invitation to speak today. Given the continuing focus on telecommunications it seems timely for me, as the head of Telstra Country Wide, to take this opportunity to clarify our position on regional telecommunications.

• There has been an ongoing debate on this subject for some months now and I'm pleased that the subject is finally getting an airing and the serious questions that need addressing are being discussed.

As our CEO has said, we need to foster debate and dialogue because the answers we come up with today will have lasting consequences.

I would like to raise three inter-related areas for consideration:

• Whether the fair and equitable nature of the current arrangements for setting telecommunications prices which are based on the operation of city/rural cross subsidisation, are sustainable;

• The effects of the current regulatory ruling requiring de- $\bullet$ averaged prices for the lease of Telstra's copper wires, and the impact of this on Telstra's ability to continue to crosssubsidise services in the bush; and
• The effect of regulation uncertainty on the capacity of $\bullet$ Telstra, and other carriers, to provide next generation technologies.

To put this debate in the proper perspective, it is necessary to consider the historic development of telecommunications in Australia.

Going back to the days of the PMG, the Government determined that the most appropriate way to ensure that the bulk of the population had the opportunity to be "on the phone" was to create a Government-owned monopoly. Adequate investment was obtained by mandating average prices across all services to create a cross subsidy between profitable city-based customers and the high costs of providing services to rural/remote customers.

The industry was opened to competition in the 90s, exposing Telstra to new pressures to operate more efficiently and improve service performance. The effect of efforts to improve productivity can be seen through a reduction in staff from over 90,000 in the 1980s to around half this figure now, including contractors. There has been an accompanying significant reduction in average telecommunications prices over this period.

The aim of regulatory measures in the 90s was to set prices for wholesale access to Telstra's network that would allow competitors to make sufficient profit to encourage them to develop their own network infrastructure.

But the impact of the wholesale pricing strategy has been to entrench what we in the industry call a "re-sale" mentality. Rather than invest in significant alternate infrastructure for basic access services, competitors have used cheap access prices to sell their own-branded services over Telstra's copper network.

Technology development and the regulatory focus have now shifted toward facilitating a more aggressive form of competition $$ setting wholesale prices at which Telstra's competitors could access the unbundled local loop, or ULL. ULL is the lease of copper wires from the Telstra exchange to customer premises.

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Under the ULL scenario Telstra's competitors install their own equipment in Telstra's exchanges in order to take over the "last" mile" relationship to customers' homes and business premises. As a result, other carriers can provide customers with basic telephone services and broadband products from their own equipment, piggybacked on Telstra's network or bypassing Telstra's network on their own inter city network.

The competitor essentially pays Telstra to lease the copper pair, and it's the proposal by the ACCC for the pricing of this arrangement that is causing Telstra considerable concern - as the ACCC's proposal will inevitably undermine the system of fair and equitable pricing that the general community expects, with consequential negative effects on rural customers.

Rather than set the prices on an average cost across Australia, the proposal is to set the prices based on local costs. This would be done by placing all customers in one of four "bands" based on population density, with costs in each band averaged, but dramatically different between bands.

Therefore depending on the exchange to which you are connected your carrier could have access to wholesale pricing for that copper line at \$13 a month in metropolitan/urban areas up to \$144 in rural/remote areas.

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It is only a matter of time before these wholesale price differences flow through to retail prices. There will be intense competition in urban areas, with Telstra's competitors having access, under current proposals, to prices below Telstra's own costs. Telstra will be forced to drop its access prices to compete.

However, nowhere in this regulatory change has any consideration been given to how Australia will cope in the future without the inherent cross subsidy between the city and the bush as we move to a new access regime and new technologies.

So far the assumption has been that Telstra has "enough fat" to absorb the loss of this cross subsidy. Even today analysts and commentators suggest that the answer to this question is simply that Telstra has to reduce costs by laying off another 8,000, 16,000 or however many thousands of employees to reduce the cost base.

Somehow Telstra is expected to not only continue to assist competitors but also maintain and continuously improve high levels of service to the bush, as well as provide for new evolving telecommunications with minimal government assistance. Achievement of these conflicting goals would mean that Telstra

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was, indeed, a "Magic Pudding" – but "Magic Puddings" are only fantasies found in children's stories.

Let me make it very clear that Telstra does not and will not resile from its historic and vital role, nor its statutory or regulatory obligations, to provide services to the bush. That is not the question. The question is not will Telstra remain "in the bush"? The question is - who will pay to ensure that current telephony as well as future technology will be economically available to the bush?

If Telstra has to compete under these proposed ACCC conditions for both basic voice services as well as future services across broadband, we will need to drop our monthly access charges in the Metro/urban areas.

While on the surface this may sound good, this will require that we recover the lost revenues through a combination of improved productivity and increasing the monthly access charges in the rural/remote areas. Alternatively, the Government would have to introduce highly expensive Budget measures to cross subsidise these customers to maintain parity in prices.

The explanation for this is simple arithmetic – there are over $7$ million customers in Metro/urban areas and only 680,000 customers in rural/remote areas.

Our competitors have argued that they contribute to the Universal Service Fund to offset the provision of services by Telstra to the bush. However the competitor contributions are miniscule compared to the actual costs, and it completely ignores the reality of the existing cross subsidy that Telstra collects from city customers to help pay for the high costs in the bush.

For instance in October 1999, the ACA estimated the cost of providing the USO services at \$548 M per annum for the 1997/98 year, following an extensive modelling exercise. In spite of this, the total USO industry contribution for 2004/05 has been set by the regulator at \$211.3 M of which Telstra contributes \$143M. Thus we benefit by about \$68 M per year from the fund which by regulation is decreasing each year.

Based on the numbers of city customers versus country customers under the ULL pricing being proposed, the cross-subsidy between the city and the bush is costed somewhere between \$600M and \$800M per year just for basic telephone service $-$ in addition to those individual, remote, uneconomic services that the USO fund purports to address.

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So the ACCC proposal that Telstra be required to de-average the cost of leasing ULL services to competitors will result in a massive loss to Telstra that is not in any meaningful way compensated for by the USO industry fund.

A simpler, fairer and more practical system would be to maintain average prices based on average costs for access such as we do today. If the current system isn't broken, why fix it?

ULL pricing is undoubtedly one of the most important questions facing the regulator and the Government today in meeting the needs of customers in the near-to-medium term.

But what of the long-term future, and the incentives/barriers to investing in emerging technologies and new networks?

Australia is facing critical competition policy decisions and we are encumbered by 1990-type regulations when taking decisions on major new investments for the 21^st century. What we instead desperately need are new policies and new regulations for the new investment necessary for this new century.

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In the future customers, both city and country, will be looking for sufficiently high-bandwidth to run interactive digital television services, have access to telemedicine and improved educational opportunities.

This will require the development of new infrastructure such as fibre to the node $-$ meaning costly investment in the rollout of optical fibre from the exchange to road-side sub-exchanges $-$ in order to deliver broadband speeds up to 10 times the maximum currently available through ADSL.

But who will make this multi-billion dollar investment given current regulatory uncertainty? The Trade Practices Act as it stands means that Telstra or any other carrier could be forced to open a new network to competitors – allowing them to piggy back on our hard work. Not only that, regulated prices for competitor access to that new network may not allow sufficient return on investment.

Is it any wonder then of news this week that Australian investment firm Babcock and Brown Capital chose Ireland for its first major telecommunications investment $-$ a company spokes person quoted as saying in Ireland, 'much like New Zealand, there is a much more benign regulatory environment'.

When Australian money is heading overseas to support another country's telecommunications future, we really need to question if we have the correct regulatory environment to ensure the best outcomes for Australian consumers and the nation as a whole as we seek to keep pace with international developments in telecommunications.

Each of the issues I have mentioned $-$ the current city-rural cross subsidy arrangements that underpin the community's position on the need for fair and equitable pricing, the impact of the ACCC's de-averaged pricing proposal on Telstra's ability to maintain that cross subsidy, and the Trade Practices Act disincentive to investment in future networks – has an important impact on the delivery and affordability of services.

However, taken in combination, they have potentially devastating ability to see Australian consumers $-$ and Australia as a highly competitive trading nation - fall behind the rest of the world in terms of access to new and emerging technologies.

I hope you will join with us in considering and debating these important issues so that your readers in rural and regional Australia can be alerted to and also participate in resolving this important public policy dilemma.