Calls to Mobile\ONP_10April_slides

Europe Economics’ View of Costs of Mobile Networks:

Oftel’s Response

Geoffrey Myers

Senior Economic Adviser, Oftel

ONP Committee Meeting, 10 April 2002

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Europe Economics’ View

• One key aspect of Europe Economics’ report is addressed….

• Cost of coverage is a large ‘joint cost’ – ‘common cost’ in Oftel’s terminology

• implies major issue about economically efficient recovery of common cost across different mobile services

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Summary of Oftel’s Rebuttal

• Properly analysed, joint/common costs are small

• EE’s approach is contrived and leads to highly misleading cost figures

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Mobile Network Costs - Some Key Features

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Radio Network

• Underlying cost function of the radio network is constant returns to scale– eg to double traffic capacity in an area,

double number of sites and costs

• Capacity added in modular ‘lumps’

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‘Coverage’ Costs (i)

• “Coverage is the capability or option to make a single call from any point of the network at a point in time” – EE report, page 21 (emphasis added)

• Great majority of so-called ‘coverage’ costs provide traffic-handling capacity– more than 80% (in UK)

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‘Coverage’ Costs

900 MHz 1800 MHzSite costs, NMS 18% 17%Capacity costs 82% 83%

Total 100% 100%

Capacity costs comprise: macrocell equipment (by far largest part of costs), TRXs, backhaul, BSCs etc

Source: Oftel’s LRIC Model, 2001

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‘Coverage’ Costs (ii)

• So-called ‘coverage’ costs only large because of modularity of initial traffic capacity deployment

• In absence of modularity, such capacity costs of ‘coverage’ would be (approx) zero for coverage purposes

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‘Coverage’ Costs (iii)

• So contrived and misleading to treat initial traffic capacity as coverage costs or as joint/common costs

• Should be treated as being incremental to traffic– in same way as all other traffic capacity

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Europe Economics’ Contrived View

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Costs of Base Station Capacity (simplified but realistic view)

Traffic

Cost

15

Apparent LRIC origination (5)

origination volume (10)

termination volume (10)

Apparent LRIC termination (5)15

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20

Cost of minimum capacity

deployment

11Note: Simplifications are use of illustrative figures; and smoothing modularities beyond initial capacity deployment.

Overstated Common Costs (i)

• Europe Economics’ approach: – LRIC of each of origination and

termination is apparently 5– joint/common costs are apparently 15,

given by cost of coverage

• So adding up these costs gives 25 – 5 + 5 + 15– But total cost is only 20

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Overstated Common Costs (ii)

• So, even accepting EE’s approach, size of joint/common costs is less than costs of coverage– equals 10 not 15 in illustrative example

(10 = 20 - 5 - 5)

• But even this revised level of joint/ common costs is highly misleading….

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Apparent Average Incremental Cost Below Marginal Cost (i)

• Europe Economics’ approach: – LRIC of each service is apparently 5– so LRAIC is apparently 0.5 (= 5 10)

• But marginal cost is 1 – at traffic levels beyond 15

• MC greater than apparent LRAIC

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Apparent Average Incremental Cost Below Marginal Cost (ii)

• Marginal cost above average cost seems to imply diseconomies of scale– But there aren’t!

• False implication suggests fundamental flaw in analysis

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Marginal Cost Pricing

• In example, if prices set equal to marginal cost, all costs would be recovered

• So there would be no fixed, joint or common costs

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Common Costs and Traffic Levels (i)

• Where traffic levels are above the minimum capacity…

• Capacity cost of coverage does not give rise to any fixed, joint or common costs– ie marginal cost pricing gives full cost

recovery

• What happens in practice?

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Common Costs and Traffic Levels (ii)

• In UK mobile networks most base station sites are traffic-driven

• All (or nearly all) in Vodafone’s and Cellnet’s networks

• Still some coverage-driven rural sites in networks of Orange and One2One– but rural sites are only about 20% of total

sites

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Conclusions

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Summary of Conclusions (i)• Long run marginal cost close to average cost in

UK mobile networks– so marginal cost pricing gives (close to) full cost

recovery

• Joint/common costs between services are small– eg 5% or less in 900 MHz networks

• Not surprising since radio network displays constant returns to scale

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Summary of Conclusions (ii)

• EE’s analysis is contrived and misleading view of costs– fails to recognise that >80% of so-called

‘coverage’ costs are costs of traffic

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Oftel Papers

• For further details, see Oftel papers to Competition Commission inquiry into Calls to Mobile– Network Common Costs– Oftel’s Response to Operators’ Comments

on Oftel’s LRIC model– http://www.oftel.gov.uk/publications/

mobile/ctm_2002/index.htm

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Calls to Mobile\ONP_10April_slides_final

Oftel’s Mobile Network Cost Model

• Available at http://www.analysys.com/ukmobilelric– Model in Excel 2000– Documentation

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