The setting of mobile termination rates - gsma.com · PDF fileLIST OF FIGURES Figure 1 –...
Transcript of The setting of mobile termination rates - gsma.com · PDF fileLIST OF FIGURES Figure 1 –...
The setting of mobile termination rates:Best practice in cost modelling
Contents
1 INTRODUCTION AND EXECUTIVE SUMMARY 31.1 Executive Summary 31.2 Keyfindings 3
2 BACKGROUND AND METHODOLOGY 42.1 PurposeoftheStudy 42.2 Approach 42.3 Regulatorycontext 42.3.1 Terminationasanenduringbottleneck 42.3.2 SMP/dominancefoundonindividualnetworks 52.3.3 Remedyofcost-orientation 52.3.4 Balancebetweenmarketregulationandmarketstimulation 5
3 BEST PRACTICE MODELLING 63.1 Overview 63.2 Costmodellingorinternationalbenchmarking 63.3 Typesofcostmodel 63.4 Importantmodellingissues 93.4.1 Averagevincremental 93.4.2 Topdown,bottomup,hybrid 103.4.3 Valuation/depreciationmethods 113.4.4 Historicvforward-looking 163.4.5 Singleyearvmulti-year 173.4.6 Whichservices 173.4.7 Allocationofcostsbetweenservices 173.4.8 Levelofefficiency 183.4.9 Newtechnologiesandservices 193.4.10 Actualoperatormodelsvhypotheticaloperatormodels 193.4.11 Spectrum 203.4.12 Costofcapital 203.4.13 Licencefees 213.4.14 Retailcosts 213.4.15 Fixedcommoncostdefinition 21
4 THE SETTING OF MOBILE TERMINATION RATES 234.1 NetworkExternality 234.2 Networkexpansionobjectives 264.3 Investmentincentives 264.4 Symmetricalvasymmetricalrates 284.5 Glidepath 284.6 Pass-throughofterminationratecuts 294.7 Price-settingprocess 29
2
5 CRITIQUE OF EXISTING COST MODELS 305.1 Overview 305.2 WorldBankmodel 305.2.1 Background/Overview 305.2.2 Easeofuse 305.2.3 Modelstructure 315.2.4 Costsincluded/costallocationrules 315.2.5 Depreciationmethodology 315.2.6 ModelOutputs 325.2.7 Conclusion 335.3 COSITUmodel 335.3.1 Background/Overview 335.3.2 Easeofuse 335.3.3 Costsincluded/costallocationrules 335.3.4 Depreciationmethodology 345.3.5 ModelOutputs 355.3.6 Benchmarkingcapability 355.3.7 Conclusion 36
6 OPERATOR SURVEY 376.1 Surveymethodology 376.2 Surveyresponses 376.2.1 Modelbackground 376.2.2 Keymodellingdecisions 386.2.3 Thesettingofmobileterminationrates 43
7 CONCLUSION 467.1 Regulationcomesinmanyshapesandforms 467.2 Manyissuesinmodellingandprice-setting–consultationiskey 467.3 Changetakestime 46
LIST OF FIGURESFigure1–TopdownFAC(HCA)modelschematic 7Figure2–TopdownFAC(CCA)modelschematic 7Figure3–Top-downLRIC(CCA)modelschematic 8Figure4–Bottom-upmodelschematic 8Figure5–Hybridmodelschematic 9Figure6–Costrecoveryunderdifferentdepreciationmethods 12Figure7–Unitcostunderalternativedepreciationmethods 13Figure8–COSITUmodelstructure 31
LIST OF TABLESTable1-IllustrationofcostrecoveryunderHCAdepreciation 11Table2–Illustrationofcostrecoveryandunitcostsunder differentdepreciationmethods 13Table3-ExampleofincentivescreatedthroughcostbasedMTRs 27Table4–UpliftinpriceofotherservicesrequiredduetoMTRsbelowcost 27Table5–WorldBankmodelcostrecoveryillustrationwithconstantassetprices 27Table6–WorldBankmodelcostrecoveryillustrationwithtrendingassetprices 31Table7-WorldBankmodeloutputs 32Table8-COSITUmodelnetworkelementsandothercostcategories 32Table9-COSITUcurrentcostadjustmentcalculationillustration 33Table10-COSITUmodeloutputs 35
LIST OF CHARTSChart1–Costmodeldevelopers 37Chart2–Reasonsforregulation 37Chart3–Costingstandardinuse 38Chart4–Typeofmodelinuse 38Chart5–Actualorhypotheticaloperator 38Chart6–Modeltimeperiod 38Chart7–Modeloutputperiod 39Chart8–Servicesmodelled] 39Chart9–Depreciationmethodology 39Chart10–Efficiencyadjustments 39Chart11–Technologiesincluded 40Chart12–Directretailcosts 40Chart13–Allocationofdirectretailcosts] 40Chart14–Inclusionoffixedcommoncosts 41Chart15–Treatmentoffixedcommoncosts 41Chart16–Inclusionofun-frontlicencefeecosts 41Chart17–Recoveryofup-frontlicencefees 42Chart18–Up-frontlicencevaluationmethodology 42Chart19–Inclusionofongoinglicencefees 42Chart20–Ongoinglicencefeevaluationmethodology 42Chart21–Inclusionofnetworkexternality 43Chart22–Pathofmobileterminationrates 43Chart23–Currentregulationofretailcallcosts 44Chart24–Futureregulationofretailcallcosts 44Chart25–Applicationofsymmetricalvs.asymmetricalMTRs 45Chart26–Convergenceofasymmetricrates 45
1.0 Introduction and Executive Summary
1.1 Executive SummaryThisreportwascommissionedbytheGSMAssociation(GSMA)andundertakenbyPricewaterhouseCoopers(PwC)toexaminebestpracticecostmodellinginthecontextofregulatingmobileterminationrates(MTRs).
ThesettingofregulatedMTRs1isacomplexandinvolvedtaskwhichislikelytorequiredetailedcostinganalysisandcarefulconsiderationofthewelfareandcompetitioneffectsofregulatoryintervention.
Hundredofbillionsofminutesareterminatedonmobilenetworkseveryyear,soitisnosurprisethattheissueofMTRshasattractedconsiderableattentionfromvariousinterestedpartiesincludinggovernments,consumerbodiesandthemedia. ThishasresultedinNationalRegulatoryAuthorities(NRAs),operators,andinmanycasesthecourts,devotingconsiderableefforttoansweringthefundamentalquestion–howmuchshouldanoperatorbeallowedtochargeforterminatinga callonitsnetwork.
Giventhecomplexityoftheanalysisrequiredtoanswerthatquestion,itisnotsurprisingthatNRAsandoperatorshaveconsideredanddevelopedawidevarietyofapproachesandanalyticalframeworkswithoutarealconsensusemergingacrosstheindustry,althoughcertainareasofcommonpracticehaveemergedashighlightedinthispaper.ThedebateaboutMTRswillcontinueformanyyearstocome,andthereisamoveincertainquarters,especiallyataEuropeanCommunitylevel,todevelopaconsensusregardinghowMTRsshouldbecalculated,inthehopethatthiswilldriveaharmonisationofratesacrossEurope.
ThispaperseekstohighlightthekeyissuesthatNRAsandoperatorsshouldconsiderbothwithrespecttohowtoestimatethecostofterminatingacallonanetworkandhowthecalculatedcostshouldfeedintoapricingdecision.Indetailingthekeyissues,whererelevant,weprovideouropinionastowhatwebelieveconstitutesbestpractice,althoughinmanycases,bestpracticewillbedeterminedbytheparticularsofthecountryinwhichterminationratesarebeingassessed.
Wehopethispaperwillcontributetoaconstructivedebatearoundtheprinciplesthatshouldbefollowedwhensettingterminationrates,andwillprovideNRAsandoperatorswithguidelinesastohowtheyshouldgoaboutassessingMTRs.ThesettingofMTRsisbestachievedinatransparentconsultative
processthatincludestheNRA,operatorsandotherinterestedstakeholders.Thispaperwillbemostapplicableatthestartofsuchaconsultation,andwillprovideaframeworkfordiscussingthekeyissuesthatneedtobecoveredbeforeMTRscanbeset;itcanneverbeasubstituteforeffectiveconsultationandconsidereddecision-making.
1.2 Key findingsThesettingofregulatedMTRshasattractedenormousattentioninbothdevelopedanddevelopingcountries,andmanydifferentapproachesandmethodologieshavebeendevelopedforthispurpose.Wehavesurveyedoperatorstogivecontexttothisreportandthesurveyresponsessupportourviewthattheindustryisalongwayfromachievingaconsensusregardinghowterminationratesshouldbeset.
Ouranalysisofthekeyissueshighlightsthecomplexityoftheissuesthatneedtobeconsidered,andinsomecases,thelackofclearbest-practiceeitherintermsoftheoryorapplication.However,therearesomeareaswherebestpracticehasemergedincluding:• Theuseofahybridmodel,• Theuseofeconomicdepreciation,• Theuseofaforwardlookingmodel
incorporatinghistoricdataasasensecheck,• Allocationofcostsbetweenservicesbased
onroutingfactors,• Networksareassumedtobeefficientin
competitivemarkets,• MTRsshouldbebasedonthetechnologies
inuse,e.g.2Gmigratingto3G,and• CutsinMTRsneedtobepassedontotheend
useriftheyaretohavethedesiredeffect.
Therearesomepubliclyavailablecostmodels,notablytheWorldBankmodelandtheCOSITUmodelthathavebeenused,especiallyinthedevelopingworld,toprovideNRAsandoperatorswithcostestimates.WebelievethesemodelsarenotappropriatelyspecifiedandshouldnotberelieduponforthepurposesofsettingMTRs.
WebelievethebestwaytosetMTRsistoengageinadetailedconsultativeprocess,withsufficienttimegiventoconsiderallthekeyissuesthatarediscussedinthispaper.
1 Inacallingpartypaysworld.Underareceivingpartypayregimecallterminationceasestobeabottleneck.
3
2.1 Purpose of the StudyPwChasbeencommissionedbytheGSMAtowriteareportonbestpracticecostmodellinginthecontextofregulatingMTRs.Inrecentyears,NRAsinmanycountries,especiallyinthedevelopedworldhaveundertakencostmodellingexercisesinordertosetefficientMTRs.ThelevelofMTRsinthedevelopingworld,wheremobilepenetrationhasoutstrippedfixedlinepenetration,isattractingmoreattentionandregulatorsarenowconsideringwhatstepsshouldbetakeninordertoregulateMTRsappropriately.Thispaperisintendedtoserveasaguidetobestpracticecostmodellingandhowsuchmodellingshouldbeusedtosetappropriatepricesforterminatingcallsonoperators’networks.Thereportsetsoutsomeofthekeyissuesthatshouldbeconsideredwhenembarkingonacost-modellingexercise.Insomecasesweprovideouropinionastowhatwebelievemodellingbest-practiceis.Inothercases,weprovideanexplanationofthevariousoptionsavailable,andunderwhatcircumstancesthedifferentoptionsaremoreorlessappropriate.
2.2 ApproachWehaveusedthefollowingsourcesofinformationincompilingthisreport:1 Ourexperienceofworkingwithmobileoperators
andregulatorsinover20countriesinthecontextofsettingcost-basedMTRs;
2 Publiclyavailableinformationonthewebsites ofNRAsandnetworkoperators;
3 Theresponsestoasurveythatwasdistributed tomobilenetworkoperatorsaspartofthis study;and
4 Thegenericcostmodelsthathavebeendevelopedandusedtoinformmobileterminationrates,especiallyinthe developingworld.
Muchofthebest-practicecostmodellingandpricesettinghasbeenestablishedinthedevelopedworld.Whilstmanyoftheissuesandmethodologiescanberelevantinthedevelopingworld,therearealsofurtherconsiderationswhichshouldbetakenintoaccount.Inthispaperwesetoutourviewastowhatbestpracticecostmodellingandpricesettingentails,andhowitmightdifferinthedevelopingworldduetoadditionalfactorsandconstraintsthatarenotobservedinthedevelopedworld,especiallywithregardstothecostsandeffortsassociatedwithdifferenttypesofsolutions.
2.3 Regulatory context2.3.1 Termination as an enduring bottleneckThereisadistincttrendamongNRAstojudgemobileterminationoneachoperator’snetwork tobeamonopolyservicerequiringregulation.IntheECregulationhasbeenadministeredunderthecommonregulatoryframeworkforelectroniccommunicationsnetworksandservices,withallNRAsrequiredtoperformamarketanalysisofVoice call termination on individual mobile networks (Market16). Notwithstandingthespecificsofthelegislativeandregulatoryenvironments,mobilecallterminationhasbeenamainfocusforNRAs’workregulatingmobileoperatorsandinmostcaseshasbeenjudgedtobetheonlyareaofmobileoperationsrequiring ex antepriceregulation.
Therearesomecircumstanceswherethecase forex antepriceregulationofmobiletermination fallsaway,e.g.underreceivingpartypays regimeswheremobileusersbearsomeorallof thecostofreceivingcalls.Inthiscase,andwherethereiseffectivecompetitionforcustomersandmobileoriginatedcalls,terminationchargeswillalsobecompeted.
However,receivingpartypaysregimesarenotthenormandhavebecomelesscommonoverrecentyears.Thisstudyspecificallyfocusesoncostmodellinganditsapplicationtoex ante price regulationundercallingpartypayregimes.
2.3.2 SMP/dominance found on individual networksRegulatorshavegenerallyconcludedthatcallterminationoneachindividualmobilenetworkisaseparatemarketandeachoperatorofthosenetworksenjoyssignificantmarketpower(SMP)/dominance3ofthatmarket.Consequently,NRAshaveimposedremediesontheoperatorstoameliorateorpreventmarketdistortionsresultingfromthepresenceofmarketpower.Remedieshaveincludedavarietyofobligationssuchasrequirementstointerconnect,transparencyofinterconnectionarrangementsandvariousreportingrequirements,butmostimportantlyarequirementtosetcost-orientedpricesforcalltermination.
2.3.3 Remedy of cost-orientationThemostimportantandintrusiveremedyappliedbyNRAsinregulatingcallterminationmarketsistheimpositionofcost-orientatedpricing.Typically,NRAsinterveninginpricesettingaimtoreplicatepricesthatacompetitivemarketwouldproduce.Thecomponentsofsuchanefficientpriceare: (a) incrementalcost(practicalproxyfor
marginalcost)(b) contributiontofixedandcommoncosts
(requiredtoensurefullcostrecoveryand maintaininvestmentincentives)
(c) externalityadjustment(discussedfurther atsection4.2)
Theimplicationsandpracticalitiesofthisremedyformthebasisforthisstudy.Inthisstudywelookatthekeyquestionsthatneedtobeansweredwhensettingcost-basedprices.AtahighleveleachNRAmustformaviewastowhatcostisandhowthatcostinformationshouldbeusedtosetmobileterminationrates. 2.3.4 Balance between market regulation and market stimulationTheimpositionofcost-basedpricinghastypicallyoccurredinmatureormaturingmobilemarketswheredemandformobileservicesislong-establishedandoperatorshavecompletedor nearlycompletedbuildingouttheircoveragenetworks.InthispaperwewillexploretheissuesNRAsshouldtakeintoaccountinthecontextofmobilemarketsthatareintheearlystagesofdevelopment,includingthedelicatebalancethatneedstobestruckbetweenmarketregulation andmarketstimulation.
2.0 Background and Methodology
3 Thepurposeofthispaperisnottoexaminedifferentregulatoryregimes.Assuch,termssuchasSMPanddominance,whichhaveslightlydifferentconnotations,areusedinageneralsenseandnotwithrespecttoanyspecificregulatoryorlegaldefinition.
2 NRAshavealsousedinternationalbenchmarking tosetMTRs.Webrieflydiscusstheroleofbenchmarkinginsection3.
4
2.1 Purpose of the StudyPwChasbeencommissionedbytheGSMAtowriteareportonbestpracticecostmodellinginthecontextofregulatingMTRs.Inrecentyears,NRAsinmanycountries,especiallyinthedevelopedworldhaveundertakencostmodellingexercisesinordertosetefficientMTRs.ThelevelofMTRsinthedevelopingworld,wheremobilepenetrationhasoutstrippedfixedlinepenetration,isattractingmoreattentionandregulatorsarenowconsideringwhatstepsshouldbetakeninordertoregulateMTRsappropriately.Thispaperisintendedtoserveasaguidetobestpracticecostmodellingandhowsuchmodellingshouldbeusedtosetappropriatepricesforterminatingcallsonoperators’networks.Thereportsetsoutsomeofthekeyissuesthatshouldbeconsideredwhenembarkingonacost-modellingexercise.Insomecasesweprovideouropinionastowhatwebelievemodellingbest-practiceis.Inothercases,weprovideanexplanationofthevariousoptionsavailable,andunderwhatcircumstancesthedifferentoptionsaremoreorlessappropriate.
2.2 ApproachWehaveusedthefollowingsourcesofinformationincompilingthisreport:1 Ourexperienceofworkingwithmobileoperators
andregulatorsinover20countriesinthecontextofsettingcost-basedMTRs;
2 Publiclyavailableinformationonthewebsites ofNRAsandnetworkoperators;
3 Theresponsestoasurveythatwasdistributed tomobilenetworkoperatorsaspartofthis study;and
4 Thegenericcostmodelsthathavebeendevelopedandusedtoinformmobileterminationrates,especiallyinthe developingworld.
Muchofthebest-practicecostmodellingandpricesettinghasbeenestablishedinthedevelopedworld.Whilstmanyoftheissuesandmethodologiescanberelevantinthedevelopingworld,therearealsofurtherconsiderationswhichshouldbetakenintoaccount.Inthispaperwesetoutourviewastowhatbestpracticecostmodellingandpricesettingentails,andhowitmightdifferinthedevelopingworldduetoadditionalfactorsandconstraintsthatarenotobservedinthedevelopedworld,especiallywithregardstothecostsandeffortsassociatedwithdifferenttypesofsolutions.
2.3 Regulatory context2.3.1 Termination as an enduring bottleneckThereisadistincttrendamongNRAstojudgemobileterminationoneachoperator’snetwork tobeamonopolyservicerequiringregulation.IntheECregulationhasbeenadministeredunderthecommonregulatoryframeworkforelectroniccommunicationsnetworksandservices,withallNRAsrequiredtoperformamarketanalysisofVoice call termination on individual mobile networks (Market16). Notwithstandingthespecificsofthelegislativeandregulatoryenvironments,mobilecallterminationhasbeenamainfocusforNRAs’workregulatingmobileoperatorsandinmostcaseshasbeenjudgedtobetheonlyareaofmobileoperationsrequiring ex antepriceregulation.
Therearesomecircumstanceswherethecase forex antepriceregulationofmobiletermination fallsaway,e.g.underreceivingpartypays regimeswheremobileusersbearsomeorallof thecostofreceivingcalls.Inthiscase,andwherethereiseffectivecompetitionforcustomersandmobileoriginatedcalls,terminationchargeswillalsobecompeted.
However,receivingpartypaysregimesarenotthenormandhavebecomelesscommonoverrecentyears.Thisstudyspecificallyfocusesoncostmodellinganditsapplicationtoex ante price regulationundercallingpartypayregimes.
2.3.2 SMP/dominance found on individual networksRegulatorshavegenerallyconcludedthatcallterminationoneachindividualmobilenetworkisaseparatemarketandeachoperatorofthosenetworksenjoyssignificantmarketpower(SMP)/dominance3ofthatmarket.Consequently,NRAshaveimposedremediesontheoperatorstoameliorateorpreventmarketdistortionsresultingfromthepresenceofmarketpower.Remedieshaveincludedavarietyofobligationssuchasrequirementstointerconnect,transparencyofinterconnectionarrangementsandvariousreportingrequirements,butmostimportantlyarequirementtosetcost-orientedpricesforcalltermination.
2.3.3 Remedy of cost-orientationThemostimportantandintrusiveremedyappliedbyNRAsinregulatingcallterminationmarketsistheimpositionofcost-orientatedpricing.Typically,NRAsinterveninginpricesettingaimtoreplicatepricesthatacompetitivemarketwouldproduce.Thecomponentsofsuchanefficientpriceare: (a) incrementalcost(practicalproxyfor
marginalcost)(b) contributiontofixedandcommoncosts
(requiredtoensurefullcostrecoveryand maintaininvestmentincentives)
(c) externalityadjustment(discussedfurther atsection4.2)
Theimplicationsandpracticalitiesofthisremedyformthebasisforthisstudy.Inthisstudywelookatthekeyquestionsthatneedtobeansweredwhensettingcost-basedprices.AtahighleveleachNRAmustformaviewastowhatcostisandhowthatcostinformationshouldbeusedtosetmobileterminationrates. 2.3.4 Balance between market regulation and market stimulationTheimpositionofcost-basedpricinghastypicallyoccurredinmatureormaturingmobilemarketswheredemandformobileservicesislong-establishedandoperatorshavecompletedor nearlycompletedbuildingouttheircoveragenetworks.InthispaperwewillexploretheissuesNRAsshouldtakeintoaccountinthecontextofmobilemarketsthatareintheearlystagesofdevelopment,includingthedelicatebalancethatneedstobestruckbetweenmarketregulation andmarketstimulation.
2.0 Background and Methodology
3 Thepurposeofthispaperisnottoexaminedifferentregulatoryregimes.Assuch,termssuchasSMPanddominance,whichhaveslightlydifferentconnotations,areusedinageneralsenseandnotwithrespecttoanyspecificregulatoryorlegaldefinition.
2 NRAshavealsousedinternationalbenchmarking tosetMTRs.Webrieflydiscusstheroleofbenchmarkinginsection3.
5
6
3.1 Overview ThissectionsetsoutthemostimportantissuesthatNRAsmustconsiderwhenembarkingonacostmodellingexercise.Thereisnotalwaysa‘correct’methodology,andeachoftheoptionswilltypicallyhavestrengthsandweaknesses.ItisimportantfortheNRAtounderstandthesestrengthsandweaknessesandadopttheapproachwhichismostapplicablegiventhespecificsoftheirlocalmarketconditions,includingdataavailabilityandthetimeandresourcesavailable.
3.2 Cost modelling or international benchmarkingInsettingMTRs,NRAshaveusuallyfollowedoneoftwoapproaches:cost-modellingorinternationalbenchmarking4.ThispaperdoesnotconsiderhowinternationalbenchmarkingstudiesshouldbeperformedortheirpossibleapplicationinthesettingofregulatedMTRs.ItisourviewthatrelyingoninternationalbenchmarkingforsettingMTRsisfraughtwithdifficulties5,andassuchshouldbeusedonlyasalast-choiceandthenpreferablyonlyasaninterimsolution,whenthedifficultiesofperformingaproperlyspecifiedcost-modellingexerciseprovetoochallenging.Therefore,thispaperadoptsthepresumptionthatcost-modellingissuperiortointernationalbenchmarking–aviewendorsedbytheactionsofmostNRAsthathavesetMTRs,andbythecommentsoftheEuropeanCommissionwithrespecttoNRAsthathaveusedinternationalbenchmarkingtosetMTRs,e.g.asdemonstratedbytheCommission’scommentsonthePortuguesedecisionthatrelied onbenchmarking:
TheCommissionconsidersthatacostorientationobligationisarobustmethodforpricecontrolinmobilecallterminationmarketswherethelevelofthemobileterminationratesisbasedonthecostsofanefficientoperator.TheCommissionnotesthatICP-ANACOMhasnotyetimplementedcostorientationaswasenvisagedduringitsfirstnotification(PT/2004/0129)butthatitsimplementationisapriorityfor2008.Giventheimportanceofregulatingmobileterminationrateseffectivelyandinaconsistentmanner,theCommissionencouragesICP-ANACOMtoworkincloseco-operationwiththeEuropeanRegulatorsGroupandtheCommissiontoarriveatacoherentapproachonthismatteracrosstheEU,andtorevisitananalysisinlightofacommonEuropeanapproachassoonasthishasbeenestablished.
Muchofthebest-practicecostmodellingandpricesettinghasbeenestablishedinthedevelopedworld.Whilstmanyoftheissuesandmethodologiescanberelevantinthedevelopingworld,therearealsofurtherconsiderationswhichshouldbetakenintoaccount.Inthispaperwesetoutourviewastowhatbestpracticecostmodellingandpricesettingentails,andhowitmightdifferinthedevelopingworldduetoadditionalfactorsandconstraintsthatarenotobservedinthedevelopedworld,especiallywithregardstothecostsandeffortsassociatedwithdifferenttypesofsolutions.
3.3 Types of cost modelBeforediscussingthemaincostmodellingissues,setoutbelowarehigh-levelschematicsshowingthedifferenttypesofcostmodelthatregulatorsandoperatorshaveusedininformingthelevelofMTRs.Thechoicesaroundtypesofcostmodelcanbebrokendownintothreekeyquestions:1 Shouldthemodelbetop-down,bottom-upor
acombinationofthetwo(ahybridmodel)?2 Shouldthemodelcalculateaveragecostsor
incrementalcosts?3 Shouldthemodelusehistoriccostvaluations
andstraight-linedepreciationorshouldadjustmentsbemadetoreflecteconomicorcurrentcostassetvaluationsandalternativedepreciationmethodologies?
Whilstmodelscanbeconstructedtoreflectallofthedifferentcombinationsoftheaboveoptions,presentedoppositearethemaintypesofmodelthatoperatorsandNRAshavetypicallyadopted.
Option 1 – Top down FAC/HC Figure1showsaschematicofthemoststraightforwardtypeofcostmodel.Costsaretakendirectlyfromtheoperator’saccountingrecordsandareallocatedtoservicesusingservicedemandandallocationrules.Inthistypeofmodel,thereisnodistinctionbetweenincrementalcostsandfixedandcommoncosts–theaveragecostapproach.
Figure 1 – Top down FAC(HCA) model schematic
IfanNRAoroperatorreliesonthisapproach,itiseffectivelymakingthreekeyimplicitassumptions:1 Thelevelofhistoricinvestmentremainsrelevant
forthesettingofprices;and2 Thedistinctionbetween,ontheonehand,
marginal(orincremental)costand,ontheotherhand,fixedcommonandjointcosts,isnotrelevantforthesettingofprices
3 Accountingdepreciationisareasonablemethodforschedulingrecoveryofcapitalcosts.
Option 2 – Top down FAC/(Current Cost valuation)6 Figure2showsanadditionalelementtotheFAC(HCA)model.Inthismodel,furtherinformationrelatingtothecurrentvalueofassetsiscollectedandanalysed.Thisallowsdifferenttypesofdepreciation,e.g.CurrentCostAccounting(CCA)andannuity-baseddepreciation,tobeconsidered.Ifannuity-baseddepreciationisused,informationregardingthefutureexpectedassetpricechangeswillalsoberequired.
Figure 2 – Top down FAC (CCA) model schematic
3.0 Best practice modelling
6 Weusethetermcurrentvaluationinthebroadsensetocapturedifferenttypesofvaluation/depreciationmethodologiesthatrequirearevaluationofassets,includingannuity-basedmethods,butnottheproxyforeconomicdepreciationmethodsthatrequirehistoricalandforecastdemandandotherinputs.
4 Internationalbenchmarkinghasalsobeenusedasa sense-checktoverifytheoutputsofacost-modellingexercise,butinsuchcasesitisthecost-modellingthatisultimatelyusedtosetMTRs.
5 Evenwhereallterminationratesinasamplearecost-basedandweretheresultofsimilarcost-modellingprocesses,wewouldstillexpectcostdifferencesbetweencountriesasaresultofanumberoffactors,includinggeography,disposableincome,accesstopower,securityrequirements,needtodeploybackhaulsatellitelinks,accesstowholesalebackboneproducts,availabilityofsite-sharing,etc.
7
3.1 Overview ThissectionsetsoutthemostimportantissuesthatNRAsmustconsiderwhenembarkingonacostmodellingexercise.Thereisnotalwaysa‘correct’methodology,andeachoftheoptionswilltypicallyhavestrengthsandweaknesses.ItisimportantfortheNRAtounderstandthesestrengthsandweaknessesandadopttheapproachwhichismostapplicablegiventhespecificsoftheirlocalmarketconditions,includingdataavailabilityandthetimeandresourcesavailable.
3.2 Cost modelling or international benchmarkingInsettingMTRs,NRAshaveusuallyfollowedoneoftwoapproaches:cost-modellingorinternationalbenchmarking4.ThispaperdoesnotconsiderhowinternationalbenchmarkingstudiesshouldbeperformedortheirpossibleapplicationinthesettingofregulatedMTRs.ItisourviewthatrelyingoninternationalbenchmarkingforsettingMTRsisfraughtwithdifficulties5,andassuchshouldbeusedonlyasalast-choiceandthenpreferablyonlyasaninterimsolution,whenthedifficultiesofperformingaproperlyspecifiedcost-modellingexerciseprovetoochallenging.Therefore,thispaperadoptsthepresumptionthatcost-modellingissuperiortointernationalbenchmarking–aviewendorsedbytheactionsofmostNRAsthathavesetMTRs,andbythecommentsoftheEuropeanCommissionwithrespecttoNRAsthathaveusedinternationalbenchmarkingtosetMTRs,e.g.asdemonstratedbytheCommission’scommentsonthePortuguesedecisionthatrelied onbenchmarking:
TheCommissionconsidersthatacostorientationobligationisarobustmethodforpricecontrolinmobilecallterminationmarketswherethelevelofthemobileterminationratesisbasedonthecostsofanefficientoperator.TheCommissionnotesthatICP-ANACOMhasnotyetimplementedcostorientationaswasenvisagedduringitsfirstnotification(PT/2004/0129)butthatitsimplementationisapriorityfor2008.Giventheimportanceofregulatingmobileterminationrateseffectivelyandinaconsistentmanner,theCommissionencouragesICP-ANACOMtoworkincloseco-operationwiththeEuropeanRegulatorsGroupandtheCommissiontoarriveatacoherentapproachonthismatteracrosstheEU,andtorevisitananalysisinlightofacommonEuropeanapproachassoonasthishasbeenestablished.
Muchofthebest-practicecostmodellingandpricesettinghasbeenestablishedinthedevelopedworld.Whilstmanyoftheissuesandmethodologiescanberelevantinthedevelopingworld,therearealsofurtherconsiderationswhichshouldbetakenintoaccount.Inthispaperwesetoutourviewastowhatbestpracticecostmodellingandpricesettingentails,andhowitmightdifferinthedevelopingworldduetoadditionalfactorsandconstraintsthatarenotobservedinthedevelopedworld,especiallywithregardstothecostsandeffortsassociatedwithdifferenttypesofsolutions.
3.3 Types of cost modelBeforediscussingthemaincostmodellingissues,setoutbelowarehigh-levelschematicsshowingthedifferenttypesofcostmodelthatregulatorsandoperatorshaveusedininformingthelevelofMTRs.Thechoicesaroundtypesofcostmodelcanbebrokendownintothreekeyquestions:1 Shouldthemodelbetop-down,bottom-upor
acombinationofthetwo(ahybridmodel)?2 Shouldthemodelcalculateaveragecostsor
incrementalcosts?3 Shouldthemodelusehistoriccostvaluations
andstraight-linedepreciationorshouldadjustmentsbemadetoreflecteconomicorcurrentcostassetvaluationsandalternativedepreciationmethodologies?
Whilstmodelscanbeconstructedtoreflectallofthedifferentcombinationsoftheaboveoptions,presentedoppositearethemaintypesofmodelthatoperatorsandNRAshavetypicallyadopted.
Option 1 – Top down FAC/HC Figure1showsaschematicofthemoststraightforwardtypeofcostmodel.Costsaretakendirectlyfromtheoperator’saccountingrecordsandareallocatedtoservicesusingservicedemandandallocationrules.Inthistypeofmodel,thereisnodistinctionbetweenincrementalcostsandfixedandcommoncosts–theaveragecostapproach.
Figure 1 – Top down FAC(HCA) model schematic
IfanNRAoroperatorreliesonthisapproach,itiseffectivelymakingthreekeyimplicitassumptions:1 Thelevelofhistoricinvestmentremainsrelevant
forthesettingofprices;and2 Thedistinctionbetween,ontheonehand,
marginal(orincremental)costand,ontheotherhand,fixedcommonandjointcosts,isnotrelevantforthesettingofprices
3 Accountingdepreciationisareasonablemethodforschedulingrecoveryofcapitalcosts.
Option 2 – Top down FAC/(Current Cost valuation)6 Figure2showsanadditionalelementtotheFAC(HCA)model.Inthismodel,furtherinformationrelatingtothecurrentvalueofassetsiscollectedandanalysed.Thisallowsdifferenttypesofdepreciation,e.g.CurrentCostAccounting(CCA)andannuity-baseddepreciation,tobeconsidered.Ifannuity-baseddepreciationisused,informationregardingthefutureexpectedassetpricechangeswillalsoberequired.
Figure 2 – Top down FAC (CCA) model schematic
3.0 Best practice modelling
6 Weusethetermcurrentvaluationinthebroadsensetocapturedifferenttypesofvaluation/depreciationmethodologiesthatrequirearevaluationofassets,includingannuity-basedmethods,butnottheproxyforeconomicdepreciationmethodsthatrequirehistoricalandforecastdemandandotherinputs.
4 Internationalbenchmarkinghasalsobeenusedasa sense-checktoverifytheoutputsofacost-modellingexercise,butinsuchcasesitisthecost-modellingthatisultimatelyusedtosetMTRs.
5 Evenwhereallterminationratesinasamplearecost-basedandweretheresultofsimilarcost-modellingprocesses,wewouldstillexpectcostdifferencesbetweencountriesasaresultofanumberoffactors,includinggeography,disposableincome,accesstopower,securityrequirements,needtodeploybackhaulsatellitelinks,accesstowholesalebackboneproducts,availabilityofsite-sharing,etc.
Accountinginformation, (Net Book
Value, dep’ n opex)
Cost categories Service demand
Service costs
Routinginformation/
allocation rules
Mapping
Top-down FAC (CCA) Model*
Accountinginformation, (Net Book
Value, dep’ n opex)
Current Cost Information (equipment nodes/equipment costs)
Top-down FAC (CCA) Model*
*Depending on what current cost information is gathered, alternative forms of depreciation, can be used
Cost categories Service demand
Service costs
Routinginformation/
allocation rules
Mapping Resinate dep ‘n
8 3.0 | Best practice modelling
Option 3 – Top down LRIC/(Current Cost valuation) ModelFigure3showsanadditionalelementtotheFAC(CurrentCostvaluation)model.Inthismodel,costvolumerelationships(CVRs)areusedtodifferentiatebetween,ontheonehand,incrementalcostsandontheotherhand,fixed,commonandjointcosts.Themodelwilltypicallybeconstructedtoallocatethefixed,commonandjointcoststotheincrementsorservicesoncetheincrementalcostshavebeenallocated.
Figure 3 – Top-down LRIC (CCA) model schematic
IfaNRAreliesonthistypeofmodeltheNRAhasadditionallyremovedtheassumptionthatthedis-tinctionbetween,ontheonehand,averagecostand,ontheotherhand,fixedcommonandjointcosts,isnotrelevantforthesettingofprices.
Option 4 – Bottom-up modelFigure4showsaschematicforabottom-upmodel.Abottom-upmodelwillrequireawidevarietyofinformationwhichwillallowthemodeltoproduceoutputsfordifferenttypesofcosting(averageorincremental)anddifferentmethodsofvaluationanddepreciation.Inourexperience,themostcommontypeofbottom-upmodelusedbyregulatorsisonewhichdistinguishesbetweenincrementalcostsandfixed,commonandjointcosts,andusesaneconomicdepreciationmethodology.Abottom-upmodelwillincludenetworkdimensioningrulestoestimatethesizeofthenetworkfordifferentlevelsofdemandandnetwork/servicequality.Thenetworkdesign rulescaneitherbehypotheticalbasedon industrybenchmarksorbasedonoperator-specificdata.Thisallowsdifferentlevelsofefficiency
tobeconsideredwithinthecontextofthe bottom-upmodel.
Thenetworkdimensioningrulesandqualityassumptionscanalsobeusedtogeneratethecostvolumerelationshipswhichareusedtodistinguishbetweenincrementalcostsandfixed,commonandjointcosts.
Figure 4 – Bottom-up model schematic
IfaNRAreliesonabottom-upincrementalcostmodelwitheconomicdepreciation,theNRAhasremovedalltheimplicitassumptionsthatwerenotedinrelationtotheFAC/HCAmodel.However,theuseofabottom-upmodelcanintroducenewelementsofuncertaintyandcomplexity.Insection3.4,weprovidesomemoredetailsontheseandotherkeymodellingdecisions,andwhererelevant,provideouropinionastowhichisbestpractice,orunderwhichcircumstancesdifferentoptionsarepreferable.
Accountinginformation, (Net Book
Value, dep’ n opex)
Current Cost Information (equipment nodes/equipment costs)
Top-down FAC(CCA) Model*
*Depending on what current cost information is gathered, alternative forms of depreciation, can be used
Cost categories Service demand
Service costs
Routinginformation/
allocation rules
Mapping Resinate dep ‘n
Lifetime Cost Information
(equipment nodes/equipment costs)
Current Cost Information (equipment nodes/equipment costs)
Hybrid model
*A bottom-up model can either be a FAC model, or if CVRs are used can be a LRIC model. The costing model can calculate annual depreciation under a veriety of methods including HCA, CCA, annuity and cash-flow based depreciation.
Cost categories information
Cost Volume Relationships (CVRs)
Costing Module
Service costs (Incrmental, fixed and
common costs)
Service DemandRouting information/
allocation rules
Mapping
9
Option 5 – A hybrid modelAhybridmodeliseffectivelyanextensiontothebottom-upmodelinwhichoutputs(annualnetworksizeandimpliedannualinvestmentandoperatingcosts)fromthemodelarecomparedwithanoperator’sactualdata.Wherematerialdifferencesareobservedchangescanbemadetothemodelinputsoralgorithmstoenhancetherobustnessandpredictivequalityofthemodel.
Figure 5 – Hybrid model schematic
AnNRAwilltypicallyrelyonahybridmodelifitisconcernedthatapurebottom-upmodelwillproduceresultsthatarenotnecessarilyconsistentwiththereal-worldconstraintsthatmobilenetworkoperatorsface.
3.4 Important modelling issuesThesectionbelowbuildsontheprevioussectionandalsodetailsanumberofspecificissueswhichneedtobeconsideredwhenbuildingamodelto setMTRs.
3.4.1 Average v incrementalAccordingtoeconomictheory,incompetitivemarketsthepriceofaserviceorproductwillequalthemarginalcostofprovidingthatproductorservice.Inthetelecomsindustry,ithaslongbeenrecognisedthattheshort-runmarginalcostofacallminuteisnotarelevantmeasurecostasthevastmajorityofcallminutesgeneratealmostnomarginalcostsuntilapointisreachedwhene.g.furtherinvestmentinthenetworkoranadditionalmemberofstaffisrequired.Forthatminute,themarginalcostwillbeexceptionallyhigh.Forthatreason,NRAshavesoughttofindapragmatic
solutionwhich,ontheonehandrecognisesthatanaveragecostapproachdoesnotfullyreflectprinciplesofcostcausality7,andontheotherhandismorepracticalthanmarginalcosting.
ThesolutionthatNRAshaveadoptedisincrementalcostingandmorespecificallylong-runincrementalcosting(LRIC).LRICmodellingdistinguishesbetweenthecoststhatareincrementalandthecoststhatarefixedcommonandjoint.Incrementalcostsaretypicallylowerthanaveragecostsinthepresenceofeconomiesofscaleand/orscope,butthesumofalltheincrementalcostswillnotequalthetotalcostintheeventthattherearefixedcommonandjointcosts.Inordertoensurefullrecoveryofcost,amethodologyforrecoveringthefixed,commonandjointcostsneedstobeimplemented.Fixed,commonandjointcostsarediscussedfurtherinsection3.4.15.
Inestimatingincrementalcosts,itiscrucialthat:theincrementsareappropriatelydefined,thecostcategoriesaresufficientlygranularandthecost-volumerelationshipsaresufficientlyrobust. Thesearecomplextasksthatshouldnotbe under-estimated.Itisourviewthatifeachofthesetaskscanbeperformed,thenanincrementalcostapproachofferssuperiorcostinginformationandinsightintotheeconomicsofamobileoperatorthananaveragecostapproach.ForthissuperiorinformationtobetranslatedintosuperiorMTRpricesettingrequiresanunderstandingofhowthefixedcommonandjointcostsaretoberecoveredacrossdifferentproductsandservices(includingmobiletermination).Thisisdiscussedinmoredetailinsection3.4.15.InourviewtheadditionaleffortandcostthatisassociatedwithaLRICmodelcomparedtoanaveragecostmodelisjustifiedifeithertheincrementalcostallocationissignificantlydifferent,inrelativeterms,fromtheaveragecostallocation,orfixedcommonandjointcostsarematerial,andtheirtreatmentismoredevelopedthanthesimpleEqui-ProportionateMark-Up(EPMU)8approach.
7 Anaveragecostapproachcanbeinconsistentwithcostcausality.Forexample,ifanassetgroupisusedbytwoservices,oneuses80%oftheassetgroup’scapacityandtheotheruses20%,anaveragecostapproachwillassumethatcostshouldbeallocatedintheratio80:20withoutconsideringwhetherthestructureoftheassetgroupmeansthatthe costofproviding80%capacityaresignificantlydifferent (onaunitbasis)toproviding20%capacity.
8 EPMUisthesimplestmark-upwherebythefixedcommon andjointcostsareallocated inproportiontotheincrementalcosts.
Lifetime Cost Information
(equipment nodes/equipment costs)
Current Cost Information (equipment nodes/equipment costs)
Hybrid model
*A bottom-up model can either be a FAC model, or if CVRs are used can be a LRIC model. The costing model can calculate annual depreciation under a veriety of methods including HCA, CCA, annuity and cash-flow based depreciation.
Cost categories information
Cost Volume Relationships (CVRs)
Costing Module
Service costs (Incrmental, fixed and
common costs)
Service DemandRouting information/
allocation rules
Mapping
Lifetime Cost Information
(equipment nodes/equipment costs)
Network design rulesand information
Hybrid model
Cost categories information
Cost Volume Relationships (CVRs)
Historicaccounting data
Historicoperational data
Service costs (Incrmental, fixed and
common costs)
Service DemandRouting information/
allocation rules
Mapping
Costing Modulereconciliation calibration
10
3.4.2 Top down, bottom up, hybridAtopdownmodelisbasedonactualaccountingdatafromtheoperator(s)andreplicatestheexistingnetworkandcoststructure.Thestrengthsofthisapproacharethat:• thedataisusuallyaccessibleandreliable• themodelwillreflecttherealityofcosts• themodeldoesnotexplicitlyhavetotryto
captureallthedifficultiesofdeployingamobilenetworkintherealworld
Theweaknessesoftheapproacharethat:• itisdifficulttoidentifyanddealwithany
inefficiencieswithintheoperator• itishardtomodelahypotheticaloperator
underthisapproach• themodelreliesheavilyondataprovided
bytheoperator(s),whichpresentsarisk ofmisinterpretationandinconsistencies betweenoperators
Abottomupmodelusesnetworkdesignalgorithmsanddemandassumptionstoreplicatethenetworkwhichwouldbebuiltbyanefficientoperator. Thestrengthsofthisapproachare:• Anefficientand/orhypotheticaloperatorcan
bemodelled• Themodeldoesnothavetodependondatafrom
individualoperators,asbenchmarks9,commonnetworkdesignrulesandaveragesofoperatordatacanbeused
• Asophisticatedmodelrunningmultipledemandandmarketevolutionscenariosisrelativelyeasytoconstruct
Themainweaknessesofabottom-upmodelare:• Thereisariskthatabottom-upmodelwill
over-optimisethenetworkdesignrulesand setanefficiencystandardthatisunachievable intherealworld
• Giventhatabottom-upmodeleffectivelystartsfromablankpieceofpaper,thereisariskthatrelevantcostswillbeomittedfromthemodel
• Themodelrequiresextensivedata,notallofwhichiseasilyavailableandassuchassumptionsareoftenrequired,resultingindoubtsovertherobustnessofthemodeloutputs
Itisalsopossibletobuildahybridmodel,where theresultsofabottomupmodelarecheckedagainsttop-downfinancialandoperatingdata. Thechecksareusuallyperformedintwosteps:firstlyacalibrationstepagainsthistoricoperationaldatatodeterminewhetherthemodelcanaccuratelypredicthowbigthenetworkshouldbeforagivenlevelofdemand.Secondly,thehybridmodelincorporateshistoricalaccountingdataforareconciliationsteptocheckifthemodelcanaccuratelypredicthowmuchshouldhavebeeninvestedinordertobuildtheappropriatelysizednetworkatdifferentpointsintime.
Ahybridmodelworksbestwhenthehistoriccostandoperationaldataareusedtovalidatetheassumptions,algorithmsandrelationshipsinthemodel,suchthatagreaterdegreeofreliancecanbeplacedontheforward-lookingelementsinthemodel.Thereisanassumptionthat,toacertaindegree,whatheldtrueinthepastwillholdtrueinthefuture,butthisisaneffectivemeansofproducingmodeloutputsthattakeintoaccountfuturedemandandequipmentpricescenarios,whilstsettinganefficiencystandardthatisknowntobeachievableintherealworld.
Inouropinion,thehybridmodelistheoptimalsolutionasitprovidesaviewonthelikelycostsofthenetworkgoingforward,hasbeentestedagainstactualperformanceinthepast,andhasflexibilitytoallowdetailedscenarioandsensitivitymodellingtobeperformed.IntheeventthataNRAwantstochooseasingleapproach,wedonotbelievethateitheratop-downorbottom-upapproachisinherentlysuperior.ANRAmustconsidermanyoftheotherissuessuchaswhetherahypotheticaloperatororactualoperatorismodelled,whetherthemodelshouldbehistoricorforward-lookingandonlyafterthoseissuesareclarifiedcanaNRAdeterminewhetheratop-downorbottom-upmodelrepresentsthebestsolution.
9 Benchmarksinthissenseareacceptableinthattheyareusedtofillingapsininputswhereactualoperatordataisunavailable.Thisisdifferenttousingbenchmarksforthesettingofterminationrates.
3.0 | Best practice modelling
11
3.4.3 Valuation/depreciation methodsThecostofanoperator’sassetbasecanbedividedintotwoelements–theopportunitycostoftheinvestment(“thecostofcapital”)andthedepreciationoftheassetbase.Inordertodeterminethelevelofthesecosts,avaluationordepreciationmethodologyisusedinamodel.Thereareseveralvaluation/depreciationmethodologieswhichcouldbeusedanditisnotuncommonforasinglemodeltocontainmorethanonevaluation/depreciationmethodology,withalternativeresultsproduced.
HistoricCostAccounting(HCA)depreciationmethodologiesonlyconsiderthecapitalisedpurchasepriceofanassetwhichisthendepreciateditsusefullife.ThemostcommonformofHCAdepreciationisstraightline,wherebytheannualdepreciationchargeisthepurchasepricedividedbytheusefullife.Alternativemethodssuchasdecliningbalancemethodsmayalsobeused.
Areturnoncapitalisthenaddedtotheaccountingdepreciationtogivethetotalcapitalcosts(returnofandoncapital).Thisiscalculatedastheopeningwrittendownvalueofassetsmultipliedbythecostofcapital(WACC).Thisensuresthatthepresentvalueofcostrecoveryatthetimeofinvestmentisequaltotheinvestment,therebygivinginvestorsafairreturn.HCAstraightlinedepreciationisthemethodologyusuallyusedinstatutoryfinancialstatements,whileHCAdecliningbalancedepreciationisfrequentlyusedfortaxpurposes.
Thetableontherightshowshowtheextrareturnisrequiredtoensurefullcostrecovery.Ifthecostissetasjustthedepreciation,anoperatorwillinvest100foranasset,butinpresentvaluetermswillonlyexpecttoachievecostrecoveryof79.Undersuchcircumstancestheoperatorwillnotinvestintheasset.However,whenareturnoncapitalisincludedintheallowablecostrecovery,thepresentvalueofcostrecoveryisequaltotheinvestmentintheasset.Undersuchcircumstances,theoperatorwillinvestintheassetknowingthattherewillbesufficientcostrecoverytocoverthecostoftheassetandtoprovideinvestorswiththeirrequiredreturnoninvestment.
Table 1 - Illustration of cost recovery under HCA depreciation
CurrentCostAccounting(CCA)depreciationmethodologiesinvolvetakingthecurrentcostoftheassetandtheusefuleconomiclifeatthevaluationdate.TheCurrentCostofanassetisdeterminedbylookingatthecostofpurchasingtheequivalentassetnow.Anumberofadjustmentsarerequiredtothehistoriccostdepreciationinordertocalculatethecurrentcostdepreciation.Holdinggainsorlossesmustberecognisedaswellassupplementaldepreciationtoreflectthefactthattheassethaschangedvalueintheperiodinquestion,andbacklogdepreciationtoreflectthefacttheassetwasbeingdepreciatedinthepastassumingadifferentassetpricewouldholdfortherestofitsusefullife,whichisnolongerdeemedtobethecase.
ThecurrentcostdepreciationmethoddescribedaboveisanapproachknownasFinancialCapitalMaintenance(FCM).Underthisapproach,thenetpresentvalueofcostrecoverywillequatetothevalueoftheasset,therebyensuringanoperatorgetsafairreturnonitsinvestment.AnalternativeapproachisOperationalCapitalMaintenance,wherebyunrealisedholdinggains/lossesandbacklogdepreciationarenotincludedintheallowablecost.Asaresultthecapitalcostsrecognisedinanyperiodwillnotrepresentthechangeineconomicvalueoftheasset.If,forexample,anassetisincreasinginvaluetheoperatorwillrecover(inpresetvalueterms)morethanitsinvestment,andthereverseistrueiftheassetisgoingdowninprice.ThedeviationfromeconomicprinciplesandthediscrepancybetweeninvestmentandpresentvalueofcostrecoverymeanstheOCMapproachisalmostneverused.
Asset 100
Life 4
WACC 10%
Yr1 Yr2 Yr3 Yr4
Depreciation 25 25 25 25
Present Value 79
Yr1 Yr2 Yr3 Yr4
Depreciation 25 25 25 25
NBV x WACC 10 7.5 5 2.5
Total Cost 35 32.5 30 27.5
Present Value 100
12
Economic depreciationEconomicdepreciationcanbedefinedasthedepreciationmethodologythatwillresultinthewritten-downvalueofanasset10atanypointin timebeingequaltothenetpresentvalueofthe cashflowsitwillgenerateinthefuture.Thisoutcomewouldbeexpectedintheeventthatthereisperfectcompetitionintheequipmentmarket aswellasthemarketinwhichtheoutputoftheassetisconsumed.
Whilstthehypotheticalworldofperfectcompetitionisnotobservedinreality,manyNRAshaveadoptedaproxyforeconomicdepreciationinthesettingofMTRs.AcommonformofeconomicdepreciationisbasedonthemethodologydevelopedbyOftelandAnalysysConsultingforthebottom-upcostmodelthatsupportedthesettingofUKMTRsin2002.Thisproxyforeconomicdepreciationrecoverscostsoverthelifetimeofthenetworkaccordingtotheprofileofdemandandequipmentpricechanges,subjecttotheconstraintthatthepresentvalueoftheinvestmentoverthelifeofthenetworkisequaltothepresentvalueofcostrecoveryoverthesameperiod.Byadoptinganetworklifetimeapproachtocostrecovery,thereisapossibilitythatthefullcostofanassetisnotrecovereduntilaftertheassethasbeendecommissionedwheretheoutputoffuturegenerationsoftheassetishigherbecauseitinheritsthehigherutilisationofitsancestors.Thisisnotconsistentwithafullycontestablemarketwhereanewentrantcouldenterthemarketandreachefficientscaleimmediately.However,ithasbeenarguedthatthisapproachstrikesabalancebetweenperfectcompetitivestandardandtherealitiesofaneffectivelycompetitivemarketwithsomebarrierstoentry.
Analternativeproxyforeconomicdepreciationisannuity-baseddepreciation.Aflatannuity-baseddepreciationmethodologywillresultinthecostrecoveryforanasset,i.e.thedepreciationplusthereturnoncapital,beingequalineveryperiodoftheasset’slife.Thisisasensibleoutcomewhenoutput,operatingcostsandequipmentpricesarestable.Intheeventthatequipmentpricesareexpectedtochangeoverthelifeoftheasset,atiltcanbeappliedtotheformulatoensurethatthecostrecoveryinanyperiodisequaltothecostrecoverythatanewentrantwouldseekhavingpurchasedanewasset11.
Summary of cost recovery methodsWehaveusedasimpleexampletoshowthedifferentcostrecoveryprofilesthatareobservedforasingleassetthathasausefullifeoftenyearsandwhosepriceincreasesby5%perannumandwhereoutputsincreaseassetoutinfigure6.
ThegraphsbelowshowthecostrecoveryprofilesunderHCA,FCM,FlatAnnuity,TiltedAnnuityandEconomicdepreciationaswellastheunitcost.Itshouldbenotedthatforsimplicity,weshowaneconomicdepreciationprofilethatonlytakesintoaccountthedemandfortheassetoveritslife.Thisistoshowtheimpacteconomicdepreciationhasonunitcosts.Inpractice,wewouldexpecttoaneconomicdepreciationmethodologytoalsoreflecttheextenttowhichtheasset’sreplacementcostchangesoveritslife.
Figure 6 – Cost recovery under different depreciation methods
10 AswiththeHCAapproach,thisistrueoncethereturnofcapital(openingwrittendownassetvaluexcostofcapital)isincludedinthetotalallowablecostrecovery.
11 Thisformoftilted-annuitycalculation,whereonlyequipmentpricechangesarecaptured,istheonethatismostcommonlyappliedinpractice.Thecalculationcanbeadaptedtocaptureallofthecashfloweffectsrelatingtotheasset,i.e.changesindemandandchangesinoperatingcosts.
40
35
30
25
20£
10
15
5
0
Cost recovery under different depreciation meathods
1 2 3 4 5Year
6 7 8 9 10
HCA CCA(FCM) Flat Annuity Tilted Annuity Economic Depreciation
3.0 | Best practice modelling
13
Figure 7 – Unit cost under alternative depreciation methods
Table 2 – Illustration of cost recovery and unit costs under different depreciation methods
£
0.50
1.00
1.50
2.00
0
2.50
Unit cost under alternative deprecation methods
1 2 3 4 5Year
6 7 8 9 10
HCA CCA(FCM) Flat Annuity Tilted Annuity Economic Depreciation
1 2 3 4 5 6 7 8 9 10
10 20 40 80 160 240 280 300 310 320
1 2 3 4 5 6 7 8 9 10
£10 £10 £10 £10 £10 £10 £10 £10 £10 £10
£10 £9 £8 £7 £6 £5 £4 £3 £2 £1
£20 £19 £18 £17 £16 £15 £14 £13 £12 £11
£2.00 £0.95 £0.45 £0.21 £0.10 £0.06 £0.05 £0.04 £0.04 £0.03
£100
1 2 3 4 5 6 7 8 9 10
£11 £12 £13 £14 £15 £17 £18 £20 £21 £23
-£5 -£5 -£6 -£6 -£6 -£6 -£7 -£7 -£7 -£8
£10 £9 £9 £8 £7 £6 £5 £4 £3 £2
£16 £16 £16 £16 £16 £17 £17 £17 £17 £17
£1.55 £0.79 £0.40 £0.20 £0.10 £0.07 £0.06 £0.06 £0.05 £0.05
£100
1 2 3 4 5 6 7 8 9 10
£16 £16 £16 £16 £16 £16 £16 £16 £16 £16
£1.63 £0.81 £0.41 £0.20 £0.10 £0.07 £0.06 £0.05 £0.05 £0.05
£100
1 2 3 4 5 6 7 8 9 10
£13 £14 £15 £16 £16 £17 £18 £19 £20 £21
£1.34 £0.71 £0.37 £0.19 £0.10 £0.07 £0.06 £0.06 £0.06 £0.07
£100
1 2 3 4 5 6 7 8 9 10
£1 £2 £5 £9 £18 £27 £32 £34 £35 £36
£0.11 £0.11 £0.11 £0.11 £0.11 £0.11 £0.11 £0.11 £0.11 £0.11
£100
Year
Demand (million minutes)
Year
HCA depn
Capital cost
Total cost
Unit cost
NVP
Year
FCM depreciation charge
Holding Gain/Loss
Cost capital
Total cost
Unit cost
NPV
Year
Flat Annuity
Unit cost
NPV
Year
Economic depreciation
Unit cost
NVP
Year
Economic depreciation
Unit cost
NVP
UEL (years) 10
WACC 10%
Price trend 5%
Investment £100
16
Inouropinion,thereisnosinglemethodofcapitalcostrecoverythatcanbeconsideredbestpracticeinallcircumstance.Inprinciple,aproperarticulationofeconomicdepreciationtakingintoaccount,interalia,outputlevelsovertime,capitalinputpricein(de)flation,operatingcostexpenditureovertimeistobepreferred.However,theassociatedinformationaldifficultiesmayarguefortheapplicationofasimplerproxy.WebelievethatHCAistheleastlikelytoprovideanappropriatetime-seriesofcostrecoveryandshouldonlybeusedifatop-downmodelisbeingusedandtherearestrongreasonstosuspectthatarevaluationoftheassetsandamovetoanalternativedepreciationmethodologywillnotleadtomateriallydifferentcosts.Intheeventthatdemandformobileservices,oratleastthosebeingconsideredinthecostmodel,hasbeen,orisexpectedtobefairlystable,amovetoannuity-basedorcurrentcostaccountingmethodscanyieldresultsthatarebroadlysimilartoaneconomicdepreciationapproach.Underthesecircumstances,thedecisionnottoimplementeconomicdepreciationcanbeappropriate.However,incountrieswhereexplosivegrowthindemandformobileservices,includingvoice,hasbeenobservedorislikelytobeobserved,economicdepreciationislikelytoprovideacost-recoveryprofilethatismostconsistentwithhowarationalcompanywouldseektorecovercostsinacompetitivemarket.
3.4.4 Historic v forward-lookingModelscanbepopulatedwithhistoricdata,13 forwardlookingdataoracombinationofthetwo.Theadvantageofhistoricdataisthatitisnotsubjecttoforecastuncertainty,andcanbegatheredrelativelyquickly.Themainshortcomingofhistoricdataisthatitisnotnecessarilyrelevantfortheperiodoverwhichpriceswillberegulated.Theshortcomingcanbeovercomeinanumberofways:• ANRAcanconcludethatthelikelychangesin
unitcostovertimearenotsufficienttojustifythemoreexpensiveandtime-consuminggatheringofforecastdata;
• ANRAcanusetheoutputsofahistoriccostmodelasthestartingpointforsettingregulatedMTRs,butbuildassumptionsabouthowcostwillchangeovertimeintothefinalpricedetermination.Atthesimplestlevelthiscananadjustmenttoreflecttheexpectedchangesindemandovertheforecastperiodcombinedwiththeexpectedlevelofcapitalinvestmentoverthatperiod(includinginvestmentsinnewtechnologies).Amoresophisticatedmethod willtakeintoaccountanyexpectedefficiencygainsinthatperiod;or
• ANRAcanacceptthatthemodelledcostbasedonpriorperiodsislikelytoexceedthecurrentcost.HowevertheNRAcanallowtheoperatorstoearneconomicprofitsontheirregulatedservices.Thiscanbeeitherbecausethoseexcessprofitswillbecompetedawayintheprovisionofserviceswherecompetitivepressuresareworkingstrongly,orbecausetheNRAexpectstheoperatorstousetheexcessprofitstofundnetworkexpansion/technologyrefresh.
Aforward-lookingmodelwillforecasttheexpectedcostfortheregulatedpriceperiod,whereasapurehistoricmodelwillnotpredicthowcostswillchangeovertimeandthereforetherewillbealagbetweentheobservedcostanditsapplicationtoprices.Aforward-lookingmodelwillhavethedesirablefeatureofmatchingthetimeperiodofforecastingwiththetimeperiodofregulation.However,asnotedabove,suchamodelismorecomplextobuild,hasmoreonerousdatarequirements,andislikelytotakelongertopopulatethanahistoricmodel.Additionally,thereissignificantforecastriskinherentinaforward-lookingmodel,includinguncertaintyregardingfuturedemand,take-upofnewservices,capitalequipmentandoperatingcostprice-trendsandcapitalinvestmentrequirements.
Amodelthatincorporatesbothhistoricandforward-lookingdatacanhelpovercomeproblemswithforecastuncertaintyifappropriatelyspecifiedtrendanalysisisusedtosense-checktheforecastassumptions.However,suchamodelwilladdtothemodelcomplexityratherthanreduceitandanysensecheckswillonlybemeaningfulintheeventthatthepastisconsideredagoodindicatorofthefuture.Nonetheless,giventhematerialityoftheissueofsettingMTRs,itisourviewthataforward-lookingmodel,withtheinclusionofhistoricdataasasense-check,istheoptimaltypeofmodelforinformingregulatedMTRs.However,wearealsoawarethatthisisamorecostlyandtime-consumingsolutiontoimplement.ModelspopulatedwithhistoricdataarealsorelevantinthecontextofsettingMTRs,aslongasNRAshaveconsideredhowtheobservedcostislikelytochangegoingforward,andwhatimpactthatshouldhaveonsettingaregulatedpriceforMTRs.
13Theissueofhistoricdatavforward-lookingdatashouldnotbeconfusedwithHistoricCostAccountingandCurrentCostAccounting.Evenunderahistoricperiodapproach,currentcostaccountingcanbeused,e.g.in2007anNRAcanusetheresultsfortheyearended31/12/2006,butrestatedtoreflectthecurrentcostofequipmentduringthatperiod.Likewise,aforward-lookingmodelcanreflectthelevelofcostthatislikelytobeobservedinafutureperiod,undertheHistoricCostAccountingconvention.
3.0 | Best practice modelling
17
3.4.5 Single year v multi-yearAnynumberofyearsmaybecoveredbythemodel.Asingleyearmodelhastheadvantageofbeingsimpleanddoesnotnecessarilyrequireforward-lookingassumptions,whichcanbedifficultandunreliable.AsitisunlikelythatanNRAwillcarryoutacostmodellingexerciseeachyear,theresultsofasingle-yearmodelwillhavetobeappliedtomultipleyears,perhapsusinganassumedpercentagereductioneachyear.Thisisaweaknessofthesingleyearapproachbecausetheuseofasingle-yearastheanchorpointformulti-yearregulatedpricesislessthoroughthanhavingamodelwhichcoversallyearsforwhichregulatedpricesarebeingset.
Amulti-yearmodelisnecessarilymorecomplexandrequiresmoreassumptionsaswellaspotentiallylessrobustassumptions.Amulti-yearmodeldoeshaveseveraladvantagesasitallowsMTRstobecalculatedfor,andappliedto,multipleyears,allowsamultiyeardepreciationmethodology–suchaseconomicdepreciation–tobeappliedandpermitsalternativenetworkdevelopmentstobemodelled.
Ultimately,thenumberofyearsinthemodelshouldmatchtheregulatorydecision.Ifcost-basedMTRsarebeingsetforanumberofyears,thenamulti-yearmodelshouldbeused.Ifacost-basedMTRisonlybeingsetforoneyear,thenasingle-yearmodelcanbebuilt,aslongasthatdecisionisnotinconsistentwithothermodellingdecisions,e.g.alifetimeeconomicdepreciationapproach.
3.4.6 Which servicesIfthemodelisbeingconstructedwiththesolepurposeofdeterminingthecostofmobiletermination,itwillstillneedtomodelotherservicesinordertocorrectlyallocatethecostbetweentheservices.ThisalsoallowsforsensitivitiesinvolvingalteringthepercentageofcostallocatedtoMTRs.Inouropinion,itisnotpossibletobuildameaningfulmodelwithoutconsideringattheveryleastallofthemainnetworkservices,namely;calltermination,callorigination(includingadistinctionbetweenon-netandoff-netcalls)andvalueadded/dataservices.Thisisnecessarytoensurearobustallocationofcostbetweenthedifferentservices.Foroperators/marketswithmoredevelopedservices,itmightbenecessarytosplitthevalueadded/dataservicesintofurthercategoriestoensureamorerobustallocationofcostsbetweenservices.Dependingonthemethodadoptedforallocatinggeneralbusinessoverheadsandretailcosts,theremightbeaneedtomodelasubscriptionserviceor
event.Withoutmodellingasubscriptionserviceitisdifficulttoallocatethegeneralbusinesscostswhicharecommonacrossbothwholesaleandretailservices.Byincorporatingtheretailcostsinthemodel,andallocatingthemtoasubscriptionservice,itispossibletoallocatethegeneralbusinesscostsacrossbothretailandwholesaleservices.SomeNRAshavechosennottoincorporateasubscriptionservicebuthaveallowedaproportionofgeneralbusinesscoststobeallocatedtowholesaleservices,withtheproportionbeingdeterminedbyanalysisexogenoustothemodel.
3.4.7 Allocation of costs between servicesThemostappropriatewayofallocatingcostsbetweenservicesistouseconsumptionorroutingfactors.Routingfactorswillallownetworkcoststobeallocatedaccordingtoboththelevelofdemandforaserviceandtheextenttowhichthatserviceusesthecostelementinquestion.Thesimplestexampleiswithrespecttomobilebasestations.
Table 3 – Example of allocating costs between services
Thetableshowsthaton-netcallsareallocatedmorecostperminutethatincomingoroutgoingcallsbecauseanon-netcallsrequirestworadionetworklegstofulfilthecall,whereasincomingoroutgoingcallsonlyrequireone.
Basedonmodelsthathavebeenconstructedusingroutingfactors,itiscommonforanincomingcalltobemorecostlythananoutgoingcalltoanothernetwork.Thisisbecausetherearesomenetworkelementsthatareusedexclusivelyforterminatingcalls(ormessages),e.g.theHLRandthelocationprocessingelementsintheMSCs.Additionally,asaresultoftypicalhandoverregimes,acalltoamobilenetworkwillbehandedovertothatmobilenetworkatthenearestpointofinterconnect,resultinginthemobilenetworkusingmoreofitscorenetwork,especiallytransmission,toterminatecallsthantooriginatecalls14.14 Thisisalwaystruefora
comparisonofincomingcallstooutgoingcallstoothermobilenetworks.Itispossiblethatoutgoingcallstofixednetworksarehandledonafar-endhandoverbasisandwillalsousemoreofthemobilenetwork’scoretransmissionandswitching.
1 Total base station cost 500
Incoming Outgoing On-net Total
2 Base station routing factor 1 1 2
3 Total minutes 100 50 150
4 Route-factored minutes (1x2) 100 50 300 450
5 Cost allocation (=4/sum(4) x1) 111 56 333 500
6 Cost per minute (=5/3) 1.11 1.11 2.22
18 3.0 | The developing country context
3.4.8 Level of efficiencyInthedevelopmentofregulationinthefixedindustry,itwasgenerallyassumedthatoperatorswerenotfullyefficientandwereabletobecomemoreefficient.Operatorsmighthavebeeninefficientbecauseof,forexample:• useofoutdatedassets• inefficientprocesses• excesscapacity• unnecessaryinvestment,oftenreferred
toasgold-platingofthenetwork
Thisraisesthequestionoftheextenttowhichoperatorsshouldbeallowedtorecovertheircosts.Ifregulationallowedoperatorstorecoveralltheircosts,regardlessofwhethertheywereefficientlyoccurredornot,therewouldbenoincentiveforoperatorstoreduceinefficiencies.Consumerswouldbepayingfortheinefficiencies,implyingthatconsumerwelfarewouldnotbemaximised.Inacompetitivemarket,thereisanaturalpressureonplayerstoreducetheirinefficienciesinordertoretaintheabilitytopricecompetitively.Regulationisintendedbothtocreatetheeffectofcompetitioninamarketandtopromoteconsumerwelfare.Neitheroftheseaimsisservedbyallowingoperatorstorecoverinefficientlyoccurredcosts.
Forthisreason,wherethereisaconcernthatanoperatorisinefficient,bestpracticemodellingentailsthatthoseinefficienciesarenotfullyrecoverable.Themechanismforimplementingthisprinciplevaries.Inatopdownmodel,theseeminglyobviousapproachwouldbetoidentifywhichofanoperator’scostsareinefficientlyincurredandremovethemfromthemodel.Inrealitythereisrarely,ifever,asimplewayofdistinguishingbetweenanoperator’sinefficientlyandefficientlyoccurredcosts.
Ifabottomupmodelisofahypotheticaloperatormodelisused,thennoinefficienciesshouldbeincorporatedinthemodelunlessthenetworkdesignrulesincorporateinefficiencies.
Inthemobileindustry,a prioriconcernsoverinefficienciesarerare.Unlikethefixedindustry,themobileindustryhaspredominantlydevelopedinacompetitiveenvironment,andevenwhenoperatorscouldhaveincentivetochargeabovecompetitivelevelsforindividualservices,thereislittleevidencetosuggestthatoperatorsalsohaveanyincentivetodeployinefficientnetworksorprocesses.Inouropinion,wheremobilenetworkshavebeendevelopedinacompetitiveenvironment,theNRAsstartingpositionshouldbetoassumethatthenetworkoperatorsareefficient,andnoadjustmentsshouldberequiredtotheirobservedcosts.
Inthedevelopingworld,itismorecommonforasinglemobilenetworktohavebeenestablishedoriginally,withcompetitiononlyarrivingatalaterdate.Undersuchcircumstances,itisnotsoclearcutthattheincumbentmobilenetworkwillhavedevelopedefficiently.Inthiscase,NRAsshouldseektoestablishwhetherinefficienciesarelikely.
Inordertodothis,theyshouldlookatsomeofthehistoricdriversofinefficiencies,e.g.rateofreturnregulation,andstateownership,anddeterminewhetherthoseconditionsarepresent,andiftheyare,theNRAwouldhavemorereasontoconductanefficiencystudytodeterminewhetheranyinefficienciesneedtoberemovedfromregulatedprices.Alternatively,theNRAcansetpricesbasedonthenewentrantcompetitiveoperatoraslongasthatoperatorhasreachedsufficientscale.
Therefore,theissueofefficiencymighthavemorerelevanceinthedevelopingworldforthetimebeing,butgiventheeverincreasinglevelsofcompetitioncombinedwithincreasedownershipofoperatorsbyprofit-seekingmultinationalgroups,wedonotbelievethatoperatorswillbeabletosustainanymateriallevelsofinefficiencyinthemediumtolongterm.
19
3.4.9 New technologies and servicesAnumberofoptionsarepossibleregarding whichtechnologiestomodel.Theseinclude:• 2Gnetworkonly• 2G/2.5G• 2G/2.5G/3G• 3Gonly
InmanyEuropeanjurisdictions,NRAshaveconcludedthattheycanignoreinvestmentin3Gnetworksonthebasisthatoperatorswouldonlyinvestin3Gifitisacheapertechnologyandtherefore,byonlyconsidering2Gand2.5Gnetworks,thereisnoriskthattheoperatorswillunder-recovercost.
Inthedevelopedworld,weexpectthisapproachtoslowlyunwindasmoreNRAsfollowOfcom’sapproachandexplicitlymodelthecostsof3Gratherthanrelyonsweepingassumptions.Wealsobelievethat2Gnetworksarelikelytoremaininserviceoverthemediumandlongerterm,thatNRAswillrarelyconsidera3GonlymodelforsettingMTRs.
Whilstweagreethatthereisana prioriviewthatatscale3Gnetworksshouldbecheaper(perunitoftraffic)that2G/2.5Gnetworks,thisisnotalwaysgoingtobethecase,especiallyinjurisdictionswheretherewereexpensive3Gspectrumauctions,orthe3Glicenceincludedmoreonerouscoverageobligationsthanunderthe2Glicence.3Gnetworkinvestmenthasbeenpredicatedonthetake-upofnewbandwidthintensiveservices.Thereisstillenormousuncertaintyregardingthedemandforthoseservices,andevenifthedemanddoesmaterialise,thetimingofthetake-upofnewservicescanimpactthetimingofcostrecovery–potentiallyleadingtohigherunitcostsintheshorttomediumterm15.Additionally,thereareshort-runcostsofrunningtwonetworksinparallel,migratingcustomersfromonenetworktotheother,andthendecommissioningtheobsoletenetworkequipment.ThesetransitionalbutunavoidablecostsshouldnotbeignoredwhensettingMTRs.
Inthedevelopingworldwheretherehasbeenlittledevelopmentof3Gnetworkstodate,wedonotbelievethistobeasignificantmodellingissue,andNRAswillrightlyfocusonthecurrent2Gtechnologiesthatareusedtoprovidemobileservices,althoughtherewillbesomecountrieswhere3GisbeingdeployedintheabsenceofxDSLtechnology.Insuchanevent,itwillbeimportanttounderstandwhichnetworkisbeingusedformobileterminationandtheextenttowhichnetwork
elementsarebeingusedtosupportbothvoiceanddataservices.
Inouropinion,whetherinthedevelopedordevelopingworld,NRAsshouldideallybaseMTRsonthetechnology/iesthatis/areusedtodelivertheservice.Intheeventthatmorethanonetechnologyisdeployed,thenacostmodelshouldincludebothtechnologies,andtotheextentthatitisaforward-lookingmodel,sensibleassumptionsshouldbemaderegardingassetlifetimesandthemigrationoftraffictothenewertechnology.Intheveryearlystagesofanewtechnology,itcanbeacceptableforanoperatortoignorethenewertechnology,aslongasthecostsbeingincurredareimmaterialandthenewtechnologyisnotexpectedtobewidelyusedindeliveringtheregulatedserviceintheperiodofregulation16.
3.4.10 Actual operator models v hypothetical operator modelsModelsvaryastothenatureoftheoperator(s)modelled.Somemodelsaimtoreplicatetheactualoperatorsinamarketandsomeemploya“hypothetical”operatorconstruct.Underthefirstapproach,themodelisdesignedtoincorporaterealdataaboutanoperator,suchasmarketshare,networktrafficandcoverageinformation.Alternativelya“hypothetical”operatorconstruct,wheretheparametersusedinthemodelarenotthoseofanyparticularoperator.Underthisapproach,thereisconsiderableflexibilityandthehypotheticaloperatormaytakeanynumberofforms,althoughitwilltypicallybeconstructedinaccordancewithcertainguidingprinciples.Forexample,theguidingprincipalmightbetoconstructan“average”operator,whichwouldthenbebasedontheactualoperatorsinthemodel.Anothercommonapproachistomodelanewentrantintothemarket(irrespectiveofwhetheranewentranttothemarketisactuallyanticipated).
Advantagesofactualoperatormodels• Capturesdifferencesbetweenindividual
operators• Allowsoperator-specificterminationcosts
tobecalculated
Advantagesofhypotheticaloperatormodels• Flexibility• Modeldoesnothavetocontainconfidential
operatordataandcanbepopulatedwith dummydataforpublicrelease
• Needonlymodelasingleoperatortoapply toallactualmarketoperators
15Thisisespeciallythecasewhereaccountingbaseddepreciationisusedandthereisarequirementtomeetneartermcoverageobligationsthatarenotjustifiedfromademandperspective.
16Forexample,wherea3Gnetworkisonlyexpectedtoaccountforaverysmallproportionofanoperator’stotalterminatingtrafficintheperiodofregulation.
20
Indecidingonaparticularapproach,aNRAshouldbemindfulofwhetherthereisanexpectationthattherearefundamentalcostdifferencesbetweenthedifferentoperators,andwhetherornotthesedifferencescouldbequantifiedinahypotheticalmodel.Iftherearedifferenceswhichcannotbeeasilybequantifiedinahypotheticalmodel,itisouropinionthatindividualoperatormodelsshouldbebuilttoensurethattheNRAreducestheriskofsettingaterminationratethatisunachievableforoneormoreoftheoperatorsinthemarket.Anexampleofthisisconsideredinthenextsectionwithrespecttospectrum.
3.4.11 SpectrumItisoftenarguedthatthebiggestsourceofenduringcostdifferencesbetweenoperatorsisspectrumallocations.Thesedifferencescanrelatetothequantityortypeofspectrumorboth.Itisgenerallyacceptedthatoperatorswithlowerfrequencyspectrum(e.g.900MHz)canachievethesamelevelofcoverageasanoperatorwithhigherfrequencyspectrum(e.g.1800MHz)withfewercellsitesduetothepropagationcharacteristicsofradiowaves.Assuch,whereoperatorsbuildnetworkswithareasthatarecoverageconstrained,ratherthancapacityconstrained,itisexpectedthatthelowerfrequencyoperatorswillhavefewersitesandceterusparibuslowercosts.
Anadditionaldifferencerelatestoradiowavepropagationcharacteristicsindenselypopulatedbuilt-upareas.Itisgenerallyacceptedthatlowerfrequencyspectrumisbetterabletopenetratedensematerialssuchasbuildings.Assuch,incapacityconstrainedareas,wherein-buildingcoverageisimportant,thelowerfrequencyoperatorswillbeabletoprovidethesamelevelofservice,intermsofavailabilityandquality,ashigherfrequencyoperators,butwithfewercells.
Basedonthetwodifferencesnotedabove,thereisanaprioriexpectationthatceterisparibuslowerfrequencyoperatorswillhavelowercoststhanhigherfrequencyoperators.Therearehoweveranumberofreasonswhythismightnotbethecase,including:
• Ifspectrumisauctionedefficiently,intheory,thecostsavingsfromlowerfrequencyspectrumshouldbebidawayintheauctionprocessthroughhigherpaymentsforlowerfrequency,untilthecostdifferentialisremoved.
• Lowerfrequencyoperatorsmighthavelessspectrumthanhigherfrequencyoperators.Underthesecircumstances,theoperatorwith
morespectrumwillhavetodeploylesssitestomeetcapacityrequirements,andtheobservedcostsofthehigherfrequencyoperatorcouldbehigherorlowerdependingonthebalanceofcapacity-constrainedandcoverage-constrainedareasinthenetwork.
• IthasoftenbeenthecaseinEuropethat900MHzoperatorsweretheearlyentrantsintothemobilemarket.Assuch,theydidn’tbenefitfromthelearningeffectsthatlaterentrantswereabletobenefitfrom,andthereforetheirnetworksmightbelessoptimal.Thisraisesaseparatesetofquestionsregardingefficiencystandards,butintermsofobservedoperator-specificcosts,couldbeareasonforcostdifferentialsbetweentheoperators.
Clearly,theissueofspectrumwillbespecifictoeachcountry,andeachNRAmustdeterminetheeffectactualspectrumallocationsarelikelytohaveontheoperators’actualcostsandbyextension,themostappropriatemodellingapproach,e.g.withrespecttoahypotheticalvactualoperatorapproach.
3.4.12 Cost of capitalAllLRICcostmodelsincludeacostofcapitalfigure.Itisusedtocalculatethefairreturnoninvestmentthatanoperatorrequires.Theactualfigureusedmustbeappropriatetothemarketandoperator(s)inquestion.SmallchangesinthecostofcapitalnumbercanhaveasignificantimpactonthelevelofMTRcalculatedbythemodel.Giventhatthecostofcapitalisusuallyoneofthemostmaterialsingleinputsinacostmodelconsiderablecareshouldbetakenindeterminingtheappropriatecostofcapitalnumbertobeused.Thecostofcapitalshouldtakeintoconsiderationtheriskinessoftheoperators’investmentsaswellasothereconomiceffectssuchascountryrisk.ACAPMapproachismostcommonandadvised.
Thecostofcapitalappliedmustmatchthecashflowswhicharebeingconsideredinthemodel.Typicallyacostmodelwillusepre-taxcashflows,andthereforeapre-taxcostofcapitalwouldberequired.Adetaileddescriptionofbestpractice CostofCapitalanalysisisoutsidethescopeof thisreport.
3.0 | The developing country context
21
3.4.13 Licence feesItistypicalforgovernmentstoissuelicencestomobileoperatorswhichallowtheoperatorstooffermobileservices.Anumberofdifferentfeestructuresareinplaceforlicences.Insomeinstancesasinglelicencefeeispayable,whereasinsomecaseanannualfeeispayable.Thechargesmaybefixedbytheissuinginstitutionormaybedeterminedbyothersmeans,forexamplebyauction.Thetreatmentoflicencefeesincostmodelsisanareaofongoingdebateandthereisconsiderablevariationbetweenmodels.Therearenumerouswaysinwhichlicencefeescanbehandledinacostmodel.Theymaybe:• recoveredacrossallservices• recoveredacrossspecificservices• excludedfromthemodel
Wherelicencefeesareincludedinthemodel,thevalueusedmaybeeitherbasedonactualfeespaidormaybea“fairvalue”estimate.Anexampleoftheformerwouldbetheuseoftheaveragevaluepaidbyoperatorsinalicenceauctionprocess,andanexampleofthelatterwouldbetheresultofadiscountedcashflowcalculationofthevalueoftheserviceswhichalicenceallowsanoperatortoofferorabenchmarkvaluationagainstothersimilarlicencesthathavebeenpurchased,e.g.onapriceperMHzperpopulationbasis.
Inouropinion,generallicencefeesaretypicallyacommoncostforthewholebusinessandshouldberecoveredinthesamewayasgeneralbusinessoverheads.Licencefeesthatspecificallyrelatetospectrumcanberecoveredinthesamewayasotherradionetworkassets.Licencefeestypicallyareincludedathistoriccost.WebelievethatthereisacertainamountofcircularityinrevaluingthevalueoflicencesupwardsandarrivingatahigherMTR.However,ifregulatorsaremindednottoallowanupwardrevaluationoflicencefees,thereshouldalsobeanaprioriexpectationthatlicencefeeswon’tberevaluedbelowtheirhistoriccost.
3.4.14 Retail costsSomemodelsincludedirectretailcostsandsomeexcludethemonthebasisthattheyarenotrelevanttothecostsofawholesaleservice.Hereweareconsideringretailcostswhicharespecificallyretail,e.g.salesandmarketing,dealercommissionsetc.,andnotcommonoroverheadcostssuchasaccounting,legalandhumanresources.Directretailcostsarealsodifferentfromoperatingwholesalebusinessprocessescosts,(wholesalebilling,wholesalecustomermanagement,wholesalecredit
management,etc.).OperatingwholesalebusinessprocessescostsaredirectnetworkservicescostsandtheyhavetobeconsideredinthedimensioningprocessoftheLRICmodel.Asabasicprinciple,retailcostsshouldbeallocatedtotheretailservicestheyaredirectlyrelatedtoasthesewouldnotbeincurredbyawholesaleoperator.Inouropinion,theyshouldnotberecoveredthroughMTRsinthefirstinstance.However,someretailcostscanultimatelybeallocatedtoMTRsthroughanetworkexternalitycalculation17.Thisiscoveredinmoredetailinsection4.1.
3.4.15 Fixed common cost definitionTherearetwobroadcategoriesoffixed commoncosts:1 Generaloverheadcostswhichareincurredto
supportallfunctionsandactivities.Examplesincludeheadofficebuildings(fixedassets)andfinance,HRandseniormanagementsalaries(opex).Aproportionofthesecommoncosts maybefixed.
2 Somenetworkcostswhichareinvariantwithrespecttodemandinthelong-runandsoarefixedandcommonacrossallnetworkservices.Thisissimilarto,butnotexactlythesameas, thecoveragenetwork.
Thekeyquestionsforregulatorstoanswer onthistopicare:• Whichcostsarefixedandcommon?• Istheleveloffixedandcommoncostmaterial?18
• Ifthefixedandcommoncostsarematerial, howshouldthosecostsberecovered?
Evenwherefixedandcommoncostshavebeenestimatedasasignificantproportionoftotalcosts,regulatorshavenearlyalwaysadoptedanequi-proportionatemark-up(EPMU)fortherecovery ofthosefixedandcommoncosts.ThemainalternativetoEPMUthatoperatorshavearguedforisRamseypricing,whichrecoversthefixedandcommoncostsininverseproportiontothesuperelasticityofdemandoftheservicesmodelled.
17InsomeinstancesNRAsmightchoosetoallocatesomeretailcoststonetworkservicesinsteadofperforminganetworkexternalitycalculation.
18Iffixedandcommoncostsarenotmaterialthemark-upmethodologywillnothaveamaterialimpactonthecostoftermination.
22 3.0 | The developing country context
ThetheoreticalbasisforRamseypricingasthemethodofensuringfullcostrecoverywhileminimisingthedistortiontoconsumptioncomparedtomarginalcostpricingarenearlyuniversallyaccepted.However,ithasseldomifeverbeenoperationalisedbyNRAsforthefollowingreasons:1 Theinformationaldifficultiesassociatedwith
estimatingelasticity’sofdemandmakeRamseypricingtoodifficulttoimplement;or,
2 TheprevailingstructureofpricesinthemobilemarketisnotconsistentwiththeassumptionsunderpinningRamseypricing,e.g.thatallservicesarepricedinaccordancewithRamseyprinciples19.
Inouropinion,theleveloffixedandcommoncostsislikelytobematerialformostmobilenetworks,especiallythosethatprovidesignificantcoverageinruralareas.WerecognisethedifficultiesofimplementingRamseypricing,butalsobelievethatadoptinganEPMUapproachimpliesthattheissueoffixedcommoncostrecoveryhasnotbeengivendueconsideration.
Thegrowthofdataservicesonmobilenetworksandtheassociatedeconomiesofscope,especially onUMTSnetworks,meanstheissueoffixedcommonandjointcostrecoveryisbecomingincreasinglyimportant.ThispointstotheneedforfurtherworkbyNRAsandoperatorstodevelopamethodologythatissuperiortoEPMUtoavoidlargeallocativeinefficiencies.
Webelievethatwithoutsignificantfurthereffortsfromtheindustryandregulators,especiallywithrespecttotheestimationofdemandelasticities,toovercometheperceiveddifficultiesofimplementingRamseypricing,EPMU,despiteitsshortcomings,willremainthedefaultmethodadoptedbynearlyallregulators.
Asnotedabove,webelievescaleandscopeeconomiesarepresentformobilenetworkoperators,andtherewillbecoststhatarefixedandcommonacrossanumberofservices,includingmobiletermination.Undersuchcircumstances,pricingallservicesatmarginalcost(orincrementalcostasaproxy)willresultinthefixedandcommoncostsnotbeingrecovered.Therefore,thepricingofsomeoralloftheseservicesneedstomoveawayfromthefirst-bestprincipleofmarginalcostingtoasecondbestwhichincludesanallocationofthefixedandcommoncosts.
InouropiniontheallocationoffixedandcommoncostsisbestachievedthroughaRamseyframework(withanappropriateadjustmentforexternalities,asexplainedinsection4.1).IntheabsenceofaRamseyframeworkforsettingprices,NRAsneedtoformanopinionontheappropriatemark-upregimetoensurethatfixedandcommoncostsarenotleftunrecovered.
19 EvenifunregulatedpricesarenotconsistentwithRamseyprinciples,itisalmostcertainthattheywillnotbeconsistentwiththeimplicitassumptionsofanEPMUapproach.Assuch,adoptinganEPMUapproachcanbecriticisedinthatitisalsoinconsistentwithhowpricesaresetforunregulatedservices.
23
TheprevioussectionsetoutsomeofthekeyissuesthatNRAsandoperatorsneedtoconsiderinarrivingattheirestimatesofthecostofprovidingtheMTservice.ThissectionsetsoutthefurtherissuesthatNRAsandoperatorsshouldconsiderinarrivingatthepriceofthatservice.Thekeyissuesare:1 Shouldthefinalpriceincludeanallowancefor
thenetworkexternality?2 Shouldthefinalpricebeabovecosttoencourage
theoperator(s)toinvestfurtherintheirnetworks?
3 Shouldthefinalpricebeabovecurrentlyobservedcosttoreflectfuturenetworkroll-outintolessprofitableareas?
4 HowlongshouldNRAsallowoperatorstotransitionfrommarket[current]pricestocost-basedprices?
5 Shouldterminationratesbesymmetricalorasymmetricalandifasymmetrical,forhowlong?
6 ShouldNRAsensurethatallcutsinMTRsarepassedontoconsumersbymandatinganequivalentcutintheretailcostofcallingamobilephone,especiallyfromafixednetwork?
Theaboveissuesreflectfourdifferenttypesofconsideration:• Isthereadifferencebetweentheobservedcost
andtheexpectedcostgoingforward?(2,3)• Shouldtherebeadifferencebetweencostand
priceintheshorttomediumterm?(4,5)• Shouldtherebeadifferencebetweencostand
priceinthelongterm?(1,potentially5)• Isthereaneedforanadditionalregulatory
mechanismtoensureconsumerbenefitsfromtheMTRregulation?(6)
Inunregulatedcompetitivemarketsthepricesofgoodsandservicesshould,overtime,equalthemarginalcostofproduction20includingareasonablereturnoncapital21.Ifamarketisnotregardedascompetitive,suchasinthecaseofindividualoperatormobiletermination,aregulatormayintervenetoensurethatpricesaresettomaximiseconsumerwelfareinthelongterm.The‘longterm’issomewhatambiguousbuttheguidingprincipleistoensurethatthemarketplayersareincentivisedtocontinuedevelopinginfrastructureandinvesting.Thisisoneofthereasonswhyaregulatorwouldincludeadjustmentstothebasiccostsofmobiletermination.Thefollowingsectionscoversomeoftheareasandoptionsthatareconsideredbyoperatorsandregulators.
4.1 Network ExternalityTheprevioussectionsetoutthevariousissuesrelatingtohowthecostsofthedifferentservicesprovidedbymobileoperatorsshouldbeassessed.However,ifNRAssetregulatedpricesequaltoorwithreferencetocostsalonethismaynotresultineconomicallyefficient(welfaremaximising)pricesforconsumers.Havingestimatedthecostsofthedifferentservices,NRAsmustdeterminewhetheritisintheinterestsofconsumerstotakeaccountofexternalitiesandtheirimpactontheefficientlevelofpricesformobileterminatingservices.
“Anexternalityisaneffect(i.e.acostorabenefit)thatimpactsonathirdpartybyadecision(i.e.toconsumeorproduce)takenbyanotherparty.Sincethiscost(orbenefit)doesnotaffectthepartythatmakesthedecision,thelatterdoesnot,ingeneral,takeaccountofthiscost/benefitinhisdecision.”22
Acommontypeofexternalitydiscussedinrelationtomobilenetworksisthe‘networkexternality’.Inthemobilemarketitisoftenargued,especiallyindevelopingcountrieswheremobilepenetrationisrisingrapidly,thatifamobilenetworkacquiresanewcustomerthenthereisamarginalsocialbenefitconferredontheentirenetworkcomprisinga‘privatebenefit’anda‘public’or‘external’benefit’.
Thereisanexternalbenefittoexistingmobilesubscribersandcallerstomobilesubscribersastherearemorepeopletocommunicatewith.Thisisinadditiontotheprivatebenefitthatthenewsubscriberthemselvesexperiences.Thereforeanewcustomermayconferapositiveexternalbenefitonthecommunications(mobileandfixed)sectorWhenapotentialnewsubscribermakesadecisiontojoinamobilenetworktheydonotnecessarilytakeintoaccounttheexternalbenefittheymaycreate.Theybasetheiracquisitiondecisionontheirprivatebenefitalone.Thereforetheremaybesubscriberswhodonotchoosetosubscribeatagivenpricebecausetheprivatebenefittothemistoolow,whereasiftheyweretotakeintoaccounttheexternalbenefitoftheirsubscriptiontheywouldsubscribe.Thesesubscribersrequireasubsidytoincentivisethemtojointhenetworkandtorealisethefullsocialbenefitoftheiracquisition.
20Whereinthelong-runallcostsarevariableunderconditionsofperfectcompetition
21Whatlevelofreturnofcapitalis‘reasonable’isoneofthequestionswhichneedstobeansweredbyindividualNRAs.Seecommentsinprevioussection.
22 Source:ITU,24-28January2005
4.0 The setting of mobile termination rates
24 4.0 | The setting of mobile termination rates
Inthepresenceofexternalities,andassumingapolicydesiretoaccountforexternalitieswithinthesector,consumerwelfarewillbeimprovedthroughtheapplicationofanexternalityadjustmenttoprices.Thisoperatesbychangingthebalanceofpricesacrossallmobileservices.Forexample,insteadofsettingthepriceforallmobileservicesequaltotheircost,thepriceforsomeservicesissetbelowcostandthisshortfallissubsidisedthroughincreasingthelevelofpricesforotherservices.Thischangeinthestructureofpricesaffectsconsumers’behaviour,takesintoaccountexternalitiesandmaximisesoverallwelfare.
Anoperatorcouldarguetoofferpricesatadiscountoroffersubsidies,forexampleonhandsetsoreventoengageinstrongmarketingactivities,toincreasethesizeofthemarketandboostwelfare.Ifpricesweresetatmarginalcosttherecouldbetoofewsubscriberstomobilenetworksandthereforethewelfareofsocietywouldnotbemaximised23.Ineffect,anoperatorcouldarguetoincludesomecontributiontocustomeracquisition,retentionand/ormaintenancecostsorgeneralsubscriber-relatedretailcostsinthemobileterminationrate.Thiswouldensurethatthereisanincentivetoattractnewcustomersandmaintainexistingcustomerswhichinturnincreasesocialwelfare.Theexistingcustomersbenefitandsoitcouldbejustifiedthattheypaytowardsthisbenefit.
Whilemanyoperatorsindevelopedcountrieshaverecognisedthetheoreticalvalidityofthenetworkexternalitiesargument,manyhavechosennottoapplyanexternalitysurcharge.Thisispartiallyduetothecomplexitiesinvolvedincalculatingtheoptimalmark-up24,butprincipallybecausedevelopedcountrieshavehighmobilepenetration(usually>90%),meaningthatthenumberofpotentialnewmobilesubscribersismuchsmaller,andalargerproportionofthesenon-subscribersarehighlyprice-insensitiveandthusunlikelytobemarginalnon-subscribers25.Thisreasoningislesslikelytoholdindevelopingcountrieswheremobilepenetrationissignificantlylower.
Inpractice,thenetworkexternalitywillbeabalancebetweenthesocialwelfaregainsfromincreasedsubscriberscomparedtothesocialwelfaregainsofincreasedusage.Dependingontherelativedemandelasticities,thereisthepossibilitythattheexternalitycalculationwillreducetheefficientcostofcalls(includingorspecificallyterminatingcalls)andincreasethecostofaccess/subscription.TheissueofexternalitieshasbeenwidelyconsideredbyNRAsandwhereexternalitieshavebeenincluded,theyhavetypicallyincreasedterminationratesratherthanreducethem.
Thefollowingsectionsconsidersomeexampleswhereregulatorspermittednetworkexternalities tobeincludedinthemobileterminationrate.
UK: Competition Commission/OfcomIntheUK,theissueofmobileterminationrateshasbeenreviewedonnumerousoccasions,startingwithOftelinthelate1990s,followedbytheCompetitionCommissionin2001andmorerecentlyOfcom.Inallofthesedecisions,thenetworkexternalityhasbeenconsideredingreatdetail,andtheconclusionhasbeenthatitisappropriatetoincludeanallowanceforthenetworkexternalityinthemobileterminationrate.
Ofcomhascontinuedtoapplyamark-upfornetworkexternalitiesandinthemostrecentreviewofmobileterminationratesstates:
“Inthepresenceofanetworkexternality,notenoughconsumersmaychoosetobecomemobilesubscribersfromtheperspectiveofsocietyasawhole.Totheextentthatnotallofthenetworkexternalityisinternalised,socialwelfarecanbeincreasedbyprovidingasubsidytosomeofthoseconsumerswhoarenotwillingtopaythefullpriceofsubscription.”
23 AGSMAstudyontheimpactofmobilenetworkgrowth,basedonthemethodologydevelopedbyLenWavermanshowedthata10%increaseinmobilepenetrationresultsinanannualGDPriseof1.2%(www.gsmworld.com/tax).
24Whilstcalculatingexternalitiesiscomplex,thesamecanbesaidformanyotherelementsofcostingandprice-settingandassuchisnotinitselfsufficientjustificationforignoringexternalities.
25 However,Ofcom’sempiricalstudyconcludedthat34%ofUKsubscribersaremarginal
25
Inthisreview,Ofcomhasallowedanexternalitysurchargeof0.3ppm.Thisis5.8%ofthetotalterminationchargeof5.1ppm(for2G/3Goperators).
Asnotedabove,thepurposeofthispaperisnottoprescribeamethodforcalculatingthenetworkexternality.AverydetaileddiscussionofthemethodsofestimatingthenetworkexternalitycanbefoundonOfcom’swebsite26.
SubsequenttotheCompetitionCommission’sdecisionin2002/03,someotherNRAschosetorely,inonewayoranother,ontheworkperformedbytheCommission.Thesearebrieflyexplainedbelow.
Greek decisionInGreece,EETTcompletedareviewofmobileterminationratesshortlyaftertheCompetitionCommissioncompleteditsreviewintheUK.EETTagreedwiththeCompetitionCommission’sconclusionthatanetworkexternalityshouldbeincludedinthemobileterminationrateandusedthesamemodelastheCompetionCommission,updatedwithGreekinputs,toestimatethevalue oftheexternality.
Italian decisionInItaly,Agcomhasrecognisedtheneedforanetworkexternality,butisalsoawareofthedifficultiesofcollectingtherightdataforasufficientlyrobustestimationofitsvalue.Inordertogetroundthisproblem,Agcom’sdecisiononMTRsstatesthatwheredataisproblematic,thenetworkexternalitycanbebasedonothercountrieswhichdisplaysimilarcharacteristicsintermsofmobilemarketsize,penetrationandnumberofoperators27.
Israeli decision28 TheMinistryofCommunicationcommissionedAnalysysConsultingtocalculatetheappropriateMTRsinIsrael.Inthedecisiondocument,theconclusionisreachedthatthenetworkexternalityisrelevant,butusingtheUKmodelwithIsraeli-specificinputs,theexternalitywasimmaterialin thecontextoftheestimatedcost-basedMTRs.
Implications for developing countriesDevelopingcountriesareinmanywaysverydifferentfromEurope.However,thatdoesnotmeanthattheexperiencefromEuropeisnotrelevant.InEurope,mobileoperatorsinitiallyenteredamarketwithhighfixedlinepenetration.Themobilemarketshavenotbeenasubstituteforfixedlinesandasthemarketsdevelop‘convergence’isthekeyphrasebetweenfixedandmobile.Inmanydevelopingcountriesthisisnotthecase.Fixedlinepenetrationtendstobelowandnewsubscribersaremorelikelytotakeupamobileserviceorafixedwirelessservice.Therefore,peoplemaybecontactableonamobilephoneonly.
Theserviceofferingandusagemayalsobesignificantlydifferent.Voicecallusagemaybelow,particularlyforlowincomeuserswhomayonlyusetheirmobileforincomingcalls.Thereisalsoevidenceof‘flashing’.Thatis,asubscriberwouldringanothermobilebuthangupbeforethecalliscompleted.Thereceiverwouldthenknowthatthecallerwantedtheirattentionwhichistheonlypointofthe‘flashing’.It’sevencheaperthansendinga“pleasecallme”SMS.Thefrequencyof‘flashing’ inAfricaissuchthatanumberofAfricanoperators,notablyCeltel,haveintroducedfree‘Callmeback’textmessages,arestrictednumberofwhichcanbesenteachday29.
Thereisasocialbenefittoincreasingthenumberofmobileuserseveniftheincrementalusershaveaverylowusageandthepriorityforowningamobileistoreceivecalls.Morepeopleareabletocommunicateandarecontactable.Theselowincomeincrementalcustomersaremostlikelyto bepre-paidusersbuttheystillgeneratesomeretail,fixedandcommoncosts.Howarethesecoststoberecoveredifthesubscriberdoesnotmakeanycalls?Therecouldbeajustificationforincludingasurchargetothecost-basedmobileterminationratetoensurethatmobileoperatorscoverthecostsofincreasingthemobilesubscriberbaseandincreasingsocialwelfare.
26 http://www.ofcom.org.uk/consult/condocs/mobile_call_termination/wmvct/annexd/
27 Refer-page5,paragraph25ofAllegatoA1(page101inpdfdocument)inthefollowinglinkhttp://circa.europa.eu/Public/irc/infso/ecctf/library?l=/italia/adopted_measures/it20050316/mkt_16pdf/_IT_1.0_&a=d
28 http://www.moc.gov.il/new/documents/about/analisis_10.2.05.pdf
29 Forexample,CeltelNigeriaofferspersonalcustomersuptotenfree‘callmeback’messagesperday:http://www.ng.celtel.com/en/personal-plans/user-guide/index.html
26
4.2 Network expansion objectivesIndevelopingcountries,andevenindevelopedcountrieswheremobilemarketsareexpanding,thereisanargumentthatthemobileterminationrateshouldbeabovetheestimatedcostofterminatingacallontheexistingsizednetwork.Mobileterminationratesatcostcouldrestricttheroll-outofnetworks.Anetworkoperatormayhaveareducedincentivetoexpandtheirnetworktosomeruralareas,road,trainlinesetc.Thecostsofbuildingcouldbeveryexpensiveandtheusageintheseareasmaynotbeenoughtojustifythecost30.However,itisnotobviouslythecasethathighMTRsarenecessarytoencouragenetworkexpansion.Theincentivestoinvestwillbeafunctionofanumberoffactors,ofwhichMTRsisone.ItshouldalsobenotedthatNRAsmightfinditdifficulttoensurethatabove-costMTRsareactuallyusedfortheintendedpurpose.NRAswillneedtodetermineamethodforpolicingsuchascheme,whichmightprovecostly.
Asinthenetworkexternalitysection,consideringthecostsofacquiringandmaintainingcustomers,welfarewillbemaximisedifthenetworksareexpanded.Thecostsassociatedwiththeexpansiontolowusageareascouldbepartlyrecoveredthroughthemobileterminationchargeasallmobileandfixedcustomersbenefitfromtheincreasesubscriberbaseandnetworkcoverage.
Optionstoconsider:• ExplicitsurchargeonMTRforfundingnetwork
expansion;• Explicitinclusionofnetworkexpansioncosts
withinthebasecostmodel.Ifusingabottom-upmodelthentheregulators/operatorsmustbecarefulnottoincludenetworkexpansioninthebasecostsandalsoaddasurcharge;
• Glide-pathtocost-orientatedratesallowstimeforoperatorstoexpandnetworks;
• Asymmetryinmobileterminationratesmaybereasonablefornewentrantsorforalaggingmobileoperatortoallowthemtimetobuildanetworktocompeteeffectively;and
• Newtechnologies.Forexample,asymmetryinterminationratesbetween2Gand3Gterminationtoallow3Gnewentrantstocompetewiththeestablishedoperatorswhiletheybuildoutanenhancednetwork.
Case study: MalaysiaMalaysia uses mobile termination rates as a means to compensate operators’ costs for rolling out their mobile network in areas that are mandated by the Government. Essentially, the Government has mandated national coverage or roll-out obligations through Time 1 and Time 2 requirements31.
According to the Report on Public Inquiry of Access Pricing, issued by the regulator MCMC in November 2005, the expenditure incurred in meeting the roll-out obligations are regarded as unavoidable costs that should be included in the LRIC calculation once incurred. As a result, the mobile termination rates have (gradually) increased annually between 2006 and 2008, reflecting the increased roll-out obligations.
4.3 Investment incentivesItispossiblethatacost-basedterminationratedistortsanoperator’sinvestmentincentives,suchthatitcurtailsitsnetworkroll-outintolessprofitableareas.Setoutbelowisasimpleexamplethatdemonstrateshowthiseffectmightoccur.Assumethatanewmobileoperator(NewCo)isenteringCountryAandhastobuildoutamobilenetwork.CountryAis400kmsqanditis50%citiesand50%countryside.Buildingamobilenetworkischeaperinthecitiesassomeinfrastructureisalreadyinplaceandtherearefewerproblemscausedbytheterrain[andpresumablymorecustomers/andrevenuesper$ofinvestment].NewCowillnaturallybuildthenetworkouttothehighvalueareasfirst,evenifitintendstoeventuallycoverthewholecountry.
Supposetheregulatorimposescostbasedterminationratesonceallthecitieshavebeencovered.Asthenetworkisnew,weassumethatallNewCo’sinvestmentisefficient.Wemakethefollowingadditionalassumptions:• Theaverageusefullifeis15years–HCA
depreciationisused.32 • Demandforservicesisconstantwithinageotype,
withCitieshavingdoublethedemandpersqkmcomparedtotheCountryside
• Halfoftheassetbaseisrecoveredovermobileterminationservices
30 Thedifferencesincoveragebetweenoperatorsmightbeanexogenouscostfactorthatcanbereflectedinasymmetricterminationrates.Thisisconsideredmoreinsection4.4.
31 MalaysiaCommunications&MultimediaCommission(MCMC),ReportonaPublicInquiryonAccessPricing(November2005),(http://www.mcmc.gov.my/Admin/FactsAndFigures/PublicEnquiryReport)
32 Althoughwehavenotincludedthecapitalcostinthesecalculations,thiswouldresultinaproportionalmark-uponallcosts.Itwouldnotaffecttherelativelevels.
4.0 | The setting of mobile termination rates
27
ThetablebelowshowsthatifacostbasedMTRissetaftercoverageofthecitieshasbeenachievedthentheratewillbe£0.021.Howeverasitismoreexpensivetobuildanetworkcoveringthecountryside,ifthisrateisappliedasthenetworkexpandsthenNewCowouldbeunabletorecoveritsinvestment.TheMTRrequiredinordertoachievefullcostrecoveryis£0.042oncethecountrysideiscompletelycovered.
Table 4 - Example of incentives created through cost based MTRs
Withtheseincentives,NewCowillchoosenot toinvestinanetworkintheCountrysideasthe lowMTRwillonlypermitunder-recoveryofinvestmentcosts.
IfMTRsaresettoolow,NewCowillhavetorecovertheadditionalcostsofservicingtheCountrysidethroughhigherpricesforotherservices.InthetablebelowweshowtheimpactofrecoveringthecostnotcorrectlyrecoveredthroughMTRsthroughotherservices.
Weassumethefollowing:• Thenetworkusbuiltoutovertheentirecountry• TheMTRissetatthecostbasedpriceforcities:
£0.021• Totaldemandforotherservicesisthesameas
totaldemandforterminationservices33
Table 5 – Uplift in price of other services required due to MTRs below cost
33 Inthisexamplewehavemadethesimplifyingassumptionthattheroutefactorsaresuchthatthedemandintermsofeffectiveminutesinthesameforallservices.
Scenario Cost not recovered through MTRs Depreciation in year Total demand Cost per minute
Cost based MTRs £150,000,000 £10,000,000 240,000,000 £0.042
MTRs at cost pride for cities £225,000,000 £15,000,000 240,000,000 £0.063
Uplift due to MTRs below cost: 50%
Geotype Cost per sq km Total cost Recovered through MTRs Depreciation in year Total demand MTR
Cities £500,00 £100,000,000 £50,000,000 3,333,333 160,000,000 £0.021
Countryside £1,000,000 £200,000,000 £100,000,000 6,666,667 80,000,000 £0.083
Total £750,000 £300,000,000 £150,000,000 10,000,000 240,000,000 £0.042
34 http://www.erg.eu.int/doc/publications/erg_07_83_mtr_ftr_cp_12_03_08.pdf
35 Insection3.2oftheERG’sdocumenttheyalsostate“Inanycase,regulatorsshouldbearinmindthatasymmetricregulationissustainableonlyonatransitionalperiod”.
28
Thisshowsthatthecostperminuteforotherserviceswouldneedtoincreaseby50%torecouptherevenuelostthroughincorrectpricingofterminationservices.Inthisexamplewehavemadethesimplifyingassumptionthattheroutefactorsaresuchthatthedemandintermsofeffectiveminutesinthesameforallservices.
AsweassumethatitisbeneficialforCountryAtohavealargernetworkasmorepeoplewillbeconnected,theregulatorshouldensurethatnetworkexpansionisnothaltedbyMTRswhicharetoolowtoensureareasonablereturnoninvestment.Weassumethattherearenoeconomiesofscaletobegained,sothenumbersabovewillbeanoverestimate,howeverthesewillnotbesufficienttocounterbalancethe50%upliftrequiredintheseofotherservices.
ThissimpleexampledemonstratesthatregulatorsmaychoosetosetMTRsabovethepreviouslydeterminedcostofterminationtoensurethatnetworkexpansionandinvestmentwillcontinueandtoensurethatoperatorsarenotforcedtoraisepricesforotherservicesinordertorecoupthefullvalueoftheirinvestment.
4.4 Symmetrical v asymmetrical ratesTheissueofsymmetrical(orasymmetrical)terminationrateshascausedmuchdebatebetweenoperatorsandNRAs.Presently,weobservesymmetricalterminationratesinsomemarketsandasymmetricalterminationratesinothermarkets.Nodefinitivepatternhasemergedintermsofsymmetryvasymmetryperse,althoughtherehasbeenacleartrendtowardsmoresymmetricalterminationratesoverthelastfewyears(particularlywhenwelookatthemembersoftheEuropeanUnion).ThisislargelyaresultoftheextensionofMTRregulationtoallmobileoperatorsratherthanjustthelargeroperatorsrecognisingthatterminationofcallsoneachnetworkisaseparatemarketandeachoperatorhasamonopolyofterminationtoitscustomers.
Economictheorysuggeststhatunderperfectcompetition,differentoperatorsofferingthesameservicewillchargethesameprice.WithregulatorsoftenattemptingtomimiccompetitiveoutcomeswhenregulatingMTRs,therecanbeanexpectationthatasinglemarketratewillprevail.However,withrespecttoMTRs,conditionsofperfectcompetitionarenotfullymet,e.g.whereterminationoneachnetworkisdeemedtobeaseparatemarket.Asaconsequence,theissueofsymmetricalorasymmetricalterminationratescannotberesolvedquicklywithreferencetoeconomictheory.
Inprinciple,theECisinfavourofsymmetricalterminationrates.TheERGhasrecentlypublishedacommonpositiononMTRsymmetry34.Thekeyconclusionreachedis:
“Terminationratesshouldnormallybesymmetricandasymmetry,acceptableinsomecases,requiresanadequatejustification.”35 Inouropinion,NRAsshouldnotcometoanyconclusionsabouttherelativecostsofdifferentoperatorswithoutperformingtheappropriatelevelofanalysis.ThiswillincludeanalysingallthemarketandcostinformationthataNRAwillgatherduringtheprocessofregulatingMTRs.OnlythenwillaNRAbeinapositiontoformviewonwhethersymmetricalorasymmetricalterminationrates are appropriate.
4.5 Glide pathAglidepathreferstoaregulatedpricecontrolwhereregulatorsrequireoperatorstoreduce pricesovertimeratherthanmandateanimmediatemovetothecost-orientatedlevel.Thisallowsoperatorstimetoplanforthedecreasedrevenuefrommobileterminationcharges,andoffersstabilityratherthanaone-offshockifthedifferencebetweentheexistingMTRandthecost-orientatedMTRisgreat.Thereareanumberofoptionsavailable.Thesearelistedbelowgoingfromthegradualtotheimmediate:• Glidepathfromcurrentpricestocost-orientated
orbenchmarkprices• One-offstepchangethenglidepathtocost-
orientatedorbenchmarkprices• Immediatemovetocost-orientated/
benchmarkprices
NHHinHungaryreducedasymmetryinaone-offstepandthenglidedtocost-basedtariffs.ThehighestMTRwasonlyallowedtobe20%higherthanthelowestinthemarketatthetimeofthefirstcut.Thereafterthedecisionrequiredalloperatorstoglidetoasinglecost-basedtariff.
GlidepathsarefrequentlyusedtoreduceasymmetriesinMTRsatthesametimeasapproachingcost-orientationprices.Inmaturemarkets,MTRsareusuallysymmetrical.Havingaglidepathcanbeseenasawaytoallowsmallerand/orlessefficientoperatorstimetogrowtheirmarketshareorimproveefficiencysotheyareabletocompleteeffectivelyoncetheMTRsareatacost-orientatedlevel.
4.0 | The setting of mobile termination rates
29
Theoptimallengthofaglidepathisamatterofdebate.Regulatorshavegenerallysetglidepathsofbetweenoneandthreeyears.TheUKhaspreviouslyusedfouryearchargecontrolperiodsduringwhichtheMTRsglidetothecost-orientatedrate.Spainhashadathreeyearglidepath.TheEuropeanCommissionhasstatedonanumberofoccasions36 thatwhileitsupportstheuseofglidepaths,theseshouldbeasshortaspossibleandinmanycaseshasencouragedNRAstoreviseglidepathswhichareovertwoyearslong.
Aglidepathmayalsobeaconsiderationinadevelopingmarket.Thecostbasedterminationmaybetoolowtoencouragenetworkexpansionanddevelopmentinnewservices.Iftheobjectiveoftheglidepathistoallowfornetworkinvestment,itispossiblethattheoptimalglidepathlengthwouldbelongerthanindevelopedcountries.
4.6 Pass-through of termination rate cuts TheprimarypurposeofregulatingMTRsshouldbetoincreaseconsumerwelfare37.IfitisdeemednecessarytocutMTRs,socialwelfarewillnotbemaximisedunlessthesecutsarepassedthroughtoconsumers.Ifthereiseffectivecompetitionintheretailmarketformobiletelephony,MTRcutsshouldbepassedthroughtoconsumers.
Asmobilesubscribers’decisionsareinfluencedbytheretailpricesthereisatendencyformobileoperatorstocompeteatthislevelandtheresultisthatterminationrevenuesaresharedbetweenmobileoperators.Areductioninthemobileterminationrateswillbepassedontothemobilesubscriber.However,ifthereisamonopolyinthefixedmarketthereislittleincentiveforafixedoperatortopassonanyreductioninmobileterminationcoststotheirownsubscribersas thereisnotsufficientcompetitioninretailfixed tomobilecalls.
Ifthereislimitedpass-throughoftheterminationratecutstotheconsumer,theperceivedbenefittosocialwelfarewillnotmaterialise.Therefore,theremaybeaneedtoregulatethefixedtomobileretailpricestoensurethatfixedlinecustomersreceivethebenefitofareductioninmobilecalltermination.Ifthefixedretailcallstomobileareregulated,forexample,aspartofapricecapbundletheremaynotbeavisiblereduction,andregulatorswillneedtobecarefultoensurethattheMTRcutsresultinthedesiredeffectsonthemarket.
4.7 Price-setting processWhilstthepurposeofthispaperisnottodeterminetheprocessaNRAshouldfollowinsettingmobileterminationrates,webelievetheissuescontainedhereindemonstratethecomplexityoftheissueandwebrieflydescribebelowthetypeofprocessaNRAshouldfollow.
WebelieveNRAsshouldalwaysadoptanopenconsultativeapproachwhenembarkingonarate-settingprocess.Theexactnatureoftheprocesswilldifferfromcountrytocountry,butwebelievethefundamentalfeaturesofanopen,consultativeapproachare:• Fulltransparencyofmodels,subjecttodata
confidentialityconcerns,andassociateddocumentation
• Sufficienttimeallocatedfortheprocess• Considerationofdifferentmethodologies• Effectiveconsultationincludingrespondingto
and,whereappropriate,actingoncommentsreceivedfrominterestedparties
• Verycleardecisionmakingincludingdetailedexplanationofthebasisforthedecisions
WhilstitisimpossiblethatallpartieswillultimatelybeinagreementabouttheNRA’sdecision,intheabsenceoftheabove,thereisastrongerlikelihoodthattheNRA’sdecisionwillbechallengedleadingtomoreregulatoryuncertainty.
36 ForexampleincommentstotheGreekNRA,EETT,theCommissionencouragestheNRAtoimposeashorterglidepathtocost-basedpricesthanthetwoyearsannouncedinthenotification–caseSG-Greffe(2006)D/203020
37 ThisassumesthattheleveldeterminedbytheNRAisasociallyoptimalone,andhastakenintoaccountboththecostingandpricingissuesthathavebeensetoutinthisdocument.
30
38 ThemodelanddocumentationisavailablefromtheWorldBankwebsite:http://publications.worldbank.org/ecommerce/catalog/product?item_id=2984189
39 TheauthorsarePaulNoumbaUm(WBI),LaurentGille(ENST),LucileSimon(BIPASA)andChristopheRudelle(BIPASA).
40 The‘phi’function
5.1 OverviewInthissectionwereviewtwopubliclyavailablecostmodelswhicharewidelyusedinthedevelopingworld;theWorldBankModelandtheCOSITUmodel.Bothoftheseweredesignedforuseindevelopingcountries,particularlyinAfrica.Wegivesomebackgroundtothemodeldevelopmentandcommentontheeaseofuseofthemodel,thedepreciationmethodologiesusedthemodelstructureandthemodeloutputs.
5.2 World Bank model5.2.1 Background/OverviewTheWorldBankmodel38wasdevelopedbytheWorldBankGlobalInformationandCommunicationTechnologiesDepartmentwithassistancefromBIPASA39in2003forusebyNRAsindevelopingcountriesacrossSub-SaharanAfrica.Theirstatedexpectationisthatthemodelwould beadaptedbyindividualNRAstosuittheir specificrequirements.
ThemodelcalculatesinterconnectionratesforbothFixedandMobileservices.Theinterconnectioncostsforfixedandmobilearecalculatedfromcompletelyseparateinputs.Themodelisabottom-upLRICmodelwhichisdesignedforsmallnetworksasiscommoninAfrica.
Asstatedinthemodeldocumentation,alargeamountofinformationisrequiredinordertopopulatethemodel.Theuserisrequiredtoenterinformationontrafficdemand,networktopology,andcostelementsamongotherthings.Itisnotimmediatelyclearwhatthesourceofthisinformationwillbe.
Thedemandassumptionsrequiredarecurrentusageandannualgrowthrate.Itappearsfromourattemptstorunthemodelthatthatnetworkassumptionsintermsofquantitiesaresupposedtocomefromoperatorsandthatnetworkassumptionsintermsofcostsaresupposedtobeforwardlooking,efficientcosts.Abasecaseforthiswouldbetousetheunitcostinformationprovidedbytherelevantoperators,howeverthismaynotbeanefficientlevelofcost.
5.2.2 Ease of useExtensivedocumentationisprovidedwiththemodelwhichexplainsbasiccost-modellingprinciplesandcontainsauserguide.Theuserguidenecessarilyassumesacertainleveloftelecomsknowledge,andisclearlywrittentobeunderstoodbytelecomspractitioners.
ThemodelisbuiltinMicrosoftExcelandiswellstructured,withinputcellsclearlymarked.Uponopeningthemodel,theuserispresentedwithamenuwithbuttonslinkingtoeachoftheassumptionsandoutputsheets.ThemodellanguagecanbesettoEnglishorFrench.Thereareanumberofvisualbasicmacrosinthemodelwhichrelatetotheresetfunction,thelanguagefunctionandtheeconomicdepreciationcalculation.40
5.0 Critique of existing cost models
31
Aswithallcostmodelsalargeamountofinformationisneededtofullypopulatethemodel.Themodelcontainsdefaultparametersforanumberofareas,suchasroutingfactors,howeveralternativeparametersmaybeenteredifavailable.
5.2.3 Model structureThemodelstructureforthefixednetworkisshowninthediagrambelow41,takenfromthemodeldocumentation.Thestructureforthemobilenetworkisverysimilar.Thisshowshowthedemand,networkandcostassumptionsflowthroughintonetworksizingandcostperservice.Themodelstructureforthemobilenetworkisessentiallythesame,butwithallthehypothesesbeingenteredononesheet.
Figure 8 – COSITU model structure
5.2.4 Costs included/cost allocation rulesThemodeldistinguishesbetweenincrementalandcommoncosts.Commoncostsarecalculatedasapercentageupliftontopoftheincrementalcost pernetworkelement.Thismeansthatthesepercentageswillneedtobecross-checkedagainstactualdatatoavoidover/underrecoveryofcommoncosts.ThedocumentationsuggeststhattheNRAsperformbenchmarkingstudiesonanappropriatelevelofuplift.
AkeyissuehereisthattheNRAsmayfailtocorrectlydistinguishbetweenincrementaland fixedcosts.Thiscanleadtoincorrectcostrecovery.
5.2.5 Depreciation methodologyThemodelconsidersEconomicCostsratherthanAccountingCosts.TheEconomicCostisdefinedasthecurrentcostofthemostefficientassettoperformtheservicerequired–inessencean MEAapproach.
Themodeluseseconomicdepreciation,whichisamulti-yeardepreciationmethodology;howeveronlyonesetofoutputsareproduced.Thedepreciationmethodologyusedinthemodelusesthecurrentcostofthenetworkassets(ormodernequivalent)astheinvestmentcostwhichisconvertedtoanAverageAnnualEconomicCostofinvestmentusingthe‘phi’formula,whichisdefinedwithinthemodel.ThisformulaisafunctionofthecostofcapitalandtheusefuleconomiclifeoftheassetandissuchthattheInitialinvestmentcostdividedbyphiresultsintheaverageannualeconomiccost.IfthisannualcostisrecoveredineachyearoftheassetslifethenthisresultsinfullcostrecoverywhendiscountedattheWACC.AnexampleusingaWACCof10%andaUELoffive yearsisgivenbelow.
Table 6 – World Bank model cost recovery illustration with constant asset prices
41 Source:WorldBankmodeldocumentation,pg32
Hypotheses
Traffic
Sizing
Cost
Result
DemandDemand
NetworkTech
RoutingFactors
FactRout
UnitCosts
UCosts
TrafficCapa
TransmissionExtr
InfrastructureCapa Intra
TotalsTxt
ResultsResults
SwitchingCosts Sw
TransmissionCost Tr
InfrastructuresCosts Infra
International investment (Year 0) £100WACC 10%Price trend 0%UEL 5Phi (UEL, 1+WACC) 3.37Annual payment (investment/phi) £26.38
Year 0 1 2 3 4 5Annual payment £26.38 £26.38 £26.38 £26.38 £26.38NPV (WACC, payment stream) £100.00
32 4.0 | Regulatory Policy for Mobiles in Developing Countries
42 CalculatedasUnitcost* Routefactor
Thisexamplecalculationshowsaflatannuity. Themodelalsoallowsforchangesinequipmentpricesovertime.WhilethisavoidsthefrontloadingofcostassociatedwithHCAdeprecation,itdoes nottakeintoaccountthechangesinthedemandprofileovertime.
Anexampleofthesameassetbutwithapricetrendwherethecostoftheassetdecreasesby5%eachyearisshownbelow.
Table 7 – World Bank model cost recovery illustration with trending asset prices
Thisshowsthatunderorovercostrecoveryoccursoncethepriceoftheassetischanging.Thisisaseriousweaknessofthemodelasthemajorityoftelecomsequipmentdoesexperienceasignificantchangeovertime.ThisisakintotheOCMapproach,althoughnotmathematicallyidentical, asdiscussedinsection3.4.3.
5.2.6 Model OutputsOutputsproducedbythemodelareunitcosts(perminute)foreachtypeofnodeandlink,interconnectioncostperminute,42inEurosand localcurrency,fortheinterconnectionservices listedbelow:
Table 8 - World Bank model outputs
Itshouldbenotedthattheroutefactorsforthemobilenetworkincludeon-net,off-netandfixedtomobilecalls.Thedefaultvaluesoftheseroutefactorsdonottakeintoaccounttherelativeusageofeachoftheseservices.Theusercancalculatenewroutefactorsofflineandinputthemintothemodel.Ifoneofasetofroutefactorsegusageofnodes(MSC,BSC,BTS)areenteredthentheentiresetmustbeenteredmanually.
SMSservicesandvalueaddservicesarenotincludedinthemodel.Thisisaseriousweaknessingiventhegrowthoftheseservicesinrecentyears–somenetworkcostsshouldberecoveredovertheseservicesratherthanovervoiceterminationandorigination.
Timeofdayadjustments(peak/off-peak/weekendrates)canbeappliedifdesired.Themodelcanautomaticallyproducesensitivitiesforthefollowinginputs:• Trafficatpeakhoursas%totaltraffic• Totallengthoftrenches• Totalstaff• Averageannualcostofemployee• Marketsurchargeratio• Gearinglevel
International investment (Year 0) £100WACC 10%Price trend -5%Discount rate (1+WACC)*(1-Price trend) 116% UEL 5Phi (UEL, Discount rate) 3.31Annual payment (investment/phi) £30.19
Year 0 1 2 3 4 5Annual payment £30.19 £30.19 £30.19 £30.19 £30.19NPV (WACC, payment stream) £114.43
FixedLocal levelSingle transitDouble transitTransitTransit international
MobileOriginatingTerminating
33
Theusercancomparetheoriginaloutputtothesensitisedlevelandkeeptheresultofthesensitivitiesasthenewbasecaseifrequired.
5.2.7 ConclusionWhiletheWorldBankmodelisreasonablyeasytouse,acertainleveloftechnicalknowledgeisrequiredinordertounderstandthemodel.ThemodelcanbeusefulinpromotingadetaileddiscussionaboutthetypesofdatawhichwouldberequiredfortheLRICcostmodellingprocess,andtheareaswhichshouldbeconsidered.However,asdiscussedabove,themodelhasweaknessesinrelationtothedeprecationcalculation,theroutefactorcalculationsandtheservicesincluded.Forthisreason,wewouldrecommendthatNRAsbuildtheirowncostmodelswhichcanbetailoredtothespecificneedsoftheirjurisdictionandwhichcantakeintoaccountthefactorslistedinsection3.
5.3 COSITU model5.3.1 Background/OverviewTheCOSITUmodelwasdevelopedbytheInternationalTelecommunicationsUnion(“ITU”)toassistregulatorsandoperatorsindevelopingcountriesinthesettingofinterconnectionrates. Themodelwasinitiallydesignedforfixed-networks.Thelatestupdate43,releasedin2004,incorporatesanoptionforbothfixedandmobilenetworks,howeverthemobilefeaturesareverylimited.Themajorityofthemodelisthesameforbothfixedandmobilenetworks.
Accordingtoinformationpublishedontheirwebsite44,ITUareplanningtoupgradetheCOSITUmodelin2007,althoughasofJanuary2008thishasn’thappened.TheupgradewillpotentiallyincludeoptionstocalculateinterconnectionratesforVoIPcalls,aswellasanexpansionofthemodel’smobilecapability.OurcritiqueoftheCOSITUmodelisthereforelimitedtothe2004version.
TheCOSITUmodelisasingleyear,FullyAllocatedCost(“FAC”)model.Themodelallocatesthecostofthenetworktotheinterconnectionservicesbasedoncostallocationrules.Thereistheoptiontoapplyan“adjustmentforcurrentcosts”whencalculatingNetFixedAssets,howeverwedonotbelievethemethodologyappliedisconsistentwithbestpractice.Thisisdiscussedinmoredetailinthe‘Depreciationmethodology’sectionbelow.
ITUprovidestrainingcoursesforregulatorsindevelopingcountriestointroducetheCOSITUmodel.Thesoftwareisavailabletotheseorganisationsatan80%discountandthefeaturewhichallowscoststobebenchmarkedagainstothersintheregionisonlyavailabletotheseusers.
Aswithanymodel,theoutputsareonlyasgoodastheinputs.Thereisnaturallyalargeamountofinformationwhichneedstobeinputtedintothemodel.Itisessentialthattheseinputsundergoafullqualityreviewinordertoensurethatthemodeloutputisrealistic.
5.3.2 Ease of useThemodelisbuiltinAccessusingWindowsGraphicalUserInterfaceandrequiresthedatatobeenteredinaspecificsequence.Thereareoftenfixedsequencesofwindowswhichauserhastonavigateinordertoadjustaparameter/input.Thiscanmaketheprocessratherunwieldy.Thesoftwareautomaticallysavesanychangestheusermakes.
5.3.3 Costs included/cost allocation rulesThecostsconsideredinthemodelmaybedividedintonetworkelementsandothercosts.Thesearelistedbelow.
Table 9 - COSITU model network elements and other cost categories
43 Edition2004,Version1.0–ServicePack2.Availablefromhttp://www.itu.int/ITU-D/finance/COSITU/index.html
44 http://www.itu.int/ITU-D/finance/work-cost-tariffs/events/tariff-seminars/havana-07/doc_0_carmen_en.PDF
Network elementsInternational TransmissionInternational SwitchingNational SwitchingAccess Network
Other costsCapital costsOther Common CostsInefficient Costs
32 5.0 | Critique of existing cost models
45 ReferredtoasamortisationthroughouttheCOSITUmodel
46 Forexample,iftheannualdepreciationchargeis£10 witha10yearlife,thechargewouldbe£5iftheactuallifewas20years.
TheuserisrequiredtoinputinformationonNetBookValues,AssetLivesandAnnualDepreciationchargesforthenetworkelementslistedabove.DataforeachofthenetworkelementscanbeenteredatthislevelorwitheachcategorybrokendownintoTelecommunicationsEquipment,EnergyEquipment,BuildingsandOtherInvestments.WefeelthatthisisstillveryhighlevelandyetNRAsmayfinditdifficulttodeterminetheappropriateallocations.Forinstance,ifabuildingisusedforbothnationalandinternationalswitching,whichcostcategoryshoulditbeallocatedto?
Ifitisnotpossibletogetasufficientlyrobustallocationoffixedassetcosts,themodelhasthefacilitytodownloadbenchmarkpercentagesplitsfromtheCOSITUserverforNetFixedAssetsandAmortisation.Thesearebasedonaweightedaverageofthepercentagesplitsforsimilarcountries.Unfortunatelythisserverhasbeenoutofactionsinceearly2006andthereisnoindicationofwhetherthisfacilitywillbere-instated.
Itisnecessarytoinputoperationalcostsintwodistinctsheets.SomeoperationaldatasuchasemployeecostsareenteredontheCostElementspageandsome,suchasadvertisingandbillingontheDirect,Indirect,CommonandSpecialcostspage.Carewillneedtobetakenthatcostarenotduplicatedorexcluded.
Athoroughreviewofthedatawillberequiredinordertocorrectlyascertainwhichcostsfallinwhichcategories.Thereisalsothepossibilitythatsomeopexwillbeinadvertentlyexcludedifitdoesnotfallwithinoneofthecategoriesabove.Itisthereforeimportantthatthecostswhichgointothemodelarereconciledtothetotalopexintheaccountingsystems.
5.3.4 Depreciation methodologyTheuserisrequiredtoentertheyearlydepreciation45charge,theaccountingassetlifeandtheexpectedassetlife.Thisdepreciationchargewillbecalculatedoutsidethemodelandwillmostlikelybetakenfromaccountingrecords.Themodelwilladjusttheaccountingdepreciationinproportiontothechangeinusefullife.46Thisadjustmentisdonebyscalingthedepreciationinproportiontotheusefullife.ThisimpliedthattheuserwillhaveusedHCAstraightlinedepreciation,asiscommoninaccountingrecords.
Depreciationchargesandusefullivesareenteredforeachofthefollowingcategories:InternationalTransmission,InternationalSwitch,NationalTransmission,NationalSwitch,NetworkAccessandOther.
ThemodelwillperformwhatiscalledanAdjustmentforCurrentCosts.Thecurrentcostadjustmentformulausedinthemodelisasbelow:
AMOisequivalenttoHCAdepreciation.Althoughcalledanadjustmentforcurrentcosts,thisadjustmentdoesnotresultincurrentcostdepreciation,norisfullcostrecoveryguaranteed.ThisisdemonstratedintheexamplebelowusingaWACCof10%,ausefullifeof5yearsandapricetrendof6%.Thereisnocostofcapitalin theformula.
ACC = AMO.
where:ACC is the adjustment current costsAMO is the amortization allowance8 is the average annual growth rate in the price of equipment4
is the average annual rate of currncy depreciationD is the amortization period
(1+8)D/2
(1- )D/2 -13
3
35
Table 10 - COSITU current cost adjustment calculation illustration
Themodelincludescapitalcostsseparatelyfromtheamortisationcalculations,(calculatedasWACC*totalcapital),howeverdebtandequityareindividualinputsandthereisnocheckthatthefundingisequaltotheassetbase.Asdemonstratedbytheexampleabove,andgiventhatthecostofcapitalisaseparateinput,thechanceofcorrectcostrecoveryislow.Themodelishighlylikelytounder-recoveroroverrecovertheinvestmentcost.Thefactthatthecostofcapitaliscalculatedseparatelyandplaysnopartinthedeprecationcalculationsisaseriousweaknessofthemodel,giventhatthepurposeofcostmodelsistoallowfullrecoveryofreasonablyincurredcosts.
5.3.5 Model OutputsTheoutputsofthemodelarecostoriented(ifaccessdeficitisnon-zero)orcostbased(ifaccessdeficitiszero)unittariffsfortheservicesbelow.Theunitprofitorlossforeachserviceisalsoshown.
Table 11 - COSITU model outputs
Themodelincludescapitalcostsseparatelyfromtheamortisationcalculations,(calculatedasWACC*totalcapital),howeverdebtandequityareindividualinputsandthereisnocheckthatthefundingisequaltotheassetbase.
Asdemonstratedbytheexampleabove,andgiventhatthecostofcapitalisaseparateinput,thechanceofcorrectcostrecoveryislow.Themodelishighlylikelytounder-recoveroroverrecovertheinvestmentcost.Thefactthatthecostofcapitaliscalculatedseparatelyandplaysnopartinthedeprecationcalculationsisaseriousweaknessofthemodel,giventhatthepurposeofcostmodelsistoallowfullrecoveryofreasonablyincurredcosts.
5.3.5 Model OutputsTheoutputsofthemodelarecostoriented(ifaccessdeficitisnon-zero)orcostbased(ifaccessdeficitiszero)unittariffsfortheservicesbelow.Theunitprofitorlossforeachserviceisalsoshown.
Basic telephone servicesUrbanInterurbanInternational OutgoingInternational IncomingSubregional OutgoingSubregional Incoming
Transit ServicesInternational to InternationalInternational to SubregionalSubregional to InternationalSubregional to Subregional
Basic telephone servicesNational Incoming SingleNational Incoming DoubleNational OutgoingNational to NationalInternational to NationalNational to International
AMO £20 6% 0%D 5ACC £3
Investment (year 0),1 £100WACC 10%UEL 5HCA depn £20
3
Year 1 2 3 4 5HCA depn (AMO) £20 £20 £20 £20 £20ACC £3 £3 £3 £3 £3Amortisation after ACC £23 £23 £23 £23 £23
NPV depn charges £87.70
Outputsaregivenfortheseservicesregardless ofwhetherthenetworkbeingmodelledisafixedlineormobilenetwork.Noexplanationisgiveninthemodeldocumentationregardinghowtheseoutputsshouldbeinterpretedifamobilenetworkisbeingmodelled.Thishighlightshowthemodelisnotatallsuitableforuseincalculatingmobileterminationrates.
5.3.6 Benchmarking capabilityOneoftheusefulfeaturesoftheCOSITUmodelhighlightedinthedocumentationisthebenchmarkingcapability.Thesoftwareshouldbeabletodownloadbothastandarddistributionof thefixedassetsandbenchmarkinterconnectionrates.Thefixedassetdistributionisforusewhentotalfixedassetsareknownbutitisnotpossiblesplitthecostsbetweenthecategoriesduetodeficienciesinavailableaccountinginformationorotherwise.Thetariffbenchmarkingallowstheusertoassessthereasonablenessofthemodeloutputagainstsimilarcountries.ThetariffdataiscollectedbyITUandstoredontheirserver.
ItappearsthatthisfeatureisnolongeravailableastheITUserverhasbeennon-operationalsince2006.ThesefacilitiesareonlyavailabletoTelecommunicationsRegulatorsandITU memberssoPwCwouldhavebeenunableto accessorcommentonthecontentevenifthe serverwasworking.
5.3.7 ConclusionTheCOSITUmodelisdifficulttouseand itwouldtakesometimetogetfamiliarwithit. Ithasclearlybeenbuiltforfixedlinenetworks withthemobilemoduleasasmalladdition. Thecostcategoriesarehighlevelanditisunclearwhetheroperatorswillbeabletoprovideasplit oftheircostsinthemannerrequired.Costrecoveryisnotautomaticanditisnotobvioushowthemodeloutputsshouldbeinterpretedinrelation toamobilenetwork.
Asaresult,wedonotfeelthattheCOSITUmodelshouldbeusedinthesettingofmobileterminationrates.NRAswouldachievemorereliableresultsbybuildingtheirowncostmodelwhichcanbetailoredtothespecificsofthenationalmarketinquestion.
5.0 | Critique of existing cost models34
6.1 Survey methodologyWeconstructedoursurveyinconjunctionwiththeGSMAworkinggroup.ThesurveywasdistributedtoGSMAmembersandwethankthosewhohavefoundthetimetorespond.
Thepurposeofthesurveywastoestablishthestateofregulationinarangeofcountries,specificallyinregardtoMTRs.Aswiththerestofthispaper,thesurveyfocusedonthedetailsofcostmodelling,theregulatoryregimecurrentlyinplaceandanychangesanticipatedinthefuture.
Thequestionsweredesignedtodeterminewhethercleartrendshaveemergedwithrespecttohowcostmodelsarebeingdeveloped,andhowthosemodelsarebeingusedtosetMTRs.Thenextsectionsetsoutthesurveyresponsesalongwithourcommentaryandclarifications.
6.2 Survey responses6.2.1 Model backgroundWereceived29responsestoouroperatorsurvey,12ofwhichwerefromdevelopedcountrieswiththeremaining17fromdevelopingcountries.ThedevelopedcountrieswereprincipallyEuropeanandthedevelopingcountriesprincipallyAfricanalthoughwedidreceiveresponsesfromotherpartsoftheworld.Wherewehavereceivedmultipleresponsesfrommorethanonecountrywehaveamalgamatedtheresultssothateachcountryisonlycountedonce.Asaresultoursamplesizeis 27countries.
Has your NRA developed a cost model itself or has your NRA directed you to develop your own model?Themajorityofrespondentshavebuilttheirowncostmodelasshowninthechartbelow.InanumberofAfricancountriesthiswasnotexplicitlyrequestedbytheregulator,howevertheregulatorwasbeginningtolookattheissueofMTRsandtheoperatorsfeltitwasnecessarytoincreasetheirknowledgeofcostmodels.AlargenumberofrespondentsusedthepubliclyavailablecostmodelfromtheWorldBankwhichtheypopulatedwithdatarelevanttotheirnetwork.
Chart 1 – Cost model developers
When was the most recent model built?Wherearesponsewasprovided,thecostmodelwasalmostalwayscompletedin2006and2007withanumberofrespondentsstatingthattheyortheNRAwaslikelytoupdatethemodelinthefuture.
Why did the regulator decide regulation was necessary?Thelistofreasonswhytheregulatordecided toregulateMTRsisvaried,asshowninthe chartbelow.
Chart 2 – Reasons for regulation
6.0 Operator survey
Who developed the cost model?
Working group 4%
NRC model 33%
Own model 52%
Both 11%
0
2
4
6
8
1
10
1
12
Why did the regulator deside regulation was nessessary
Stop transferfrom fixedto mobile
As a meansto achieving
equal market share
Stop crosssubsides
within mobile
Regulationrequiredby law
NRA wantedcostbased
prices
To improveconsumerwelfare
To increasethe level ofcompetition
Other
Developing Developed
37
6.2.2 Key modelling decisionsWhatcoststandardisusedinthemodel?Asshowninthechartbelow,aclearmajorityofoperatorsarecurrentlyusingLRICmodels.SomeoftherespondentshavecommentedthatthemodelwhichiscurrentlyusedinpricesettingisFAC/FDChoweverthereisworkinprogressonanewLRICbasedcostmodel.
Chart 3 – Costing standard in use
What is the type of model?Byfarthemostcommontypeofmodelisahybridmodel,althoughtherearestillafewcountiesinwhichothermethodsareused.Again,somerespondentshavecommentedthatalthoughthecurrentmodelmaybeeithertop-downorbottom-up,anewhybridmodeliscurrentlyindevelopment.
Chart 4 – Type of model in use
Is a hypothetical operator modelled or are actual operators modelled?Inthemajorityofcountriescostmodellinginvolvesmodellingahypotheticaloperator.TheanswerstothisquestionwillhavebeeninfluencedbythewideuseoftheWorldBankmodelwhichisahypotheticaloperatormodel.Whereahypotheticaloperatorwasmodelledtheoperatorwasdefinedasanefficientoperatorinallbuttwocountries.
Chart 5 – Actual or hypothetical operator
What time period does the model cover?Themajorityoftherespondentshadforwardlookingmodels:
Chart 6 – Model time period
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25
Cost standard in use
LRIC FAC/FDC Other
Developing Developed
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1
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16
18
Type of model
Bottom-up Top-down Hybrid Other
Developing Developed
0
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1
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14
16
Actual or hypothetical oporator modelled?
Actual Hypothetical Both NA
Developing Developed
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8
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1
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18 Model Timescale
Historic Forward looking Whole liftime Other
Developing Developed
6.0 | Operator survey 36
What time period does the model provide an output for?Themajorityofmodelsweresingleyearmodels(WorldBankmodelissingleyear):
Chart 7 – Model output period
What services are modelled?Themajorityofrespondentsstatedthatallservicesincludingdataareincludedinthemodel.Thiswasallbutoneoftherespondentsfromdevelopedcountries.InthiscasethereisaworkinggroupofoperatorsandtheNRAwhoaredevelopinganewmodelwhichwillmodelallservicesincludingdata.
Chart 8 – Services modelled
Which valuation/depreciation methodology is used?Themostfrequentlyuseddepreciationmethodologyamongourrespondentswaseconomicdepreciation,followedbythetiltedannuityapproach.Aswiththequestionrelatingtothetimeperiodofthemodel,theresponsestothisquestionwillhavebeeninfluencedbythewideuseoftheWorldBankmodel,althoughinouropinion,theWorldBankmodeldoesnotdeployeconomicdepreciationaswehavedefineditinsection3.4.3.
Chart 9 – Depreciation methodology
Are efficiency adjustments included in the model?Efficiencyadjustmentsarepresentinthemajorityofcountriesandappeartobemoreprevalentindevelopingcountries.(75%ofdevelopingcountries’modelshaveefficiencyadjustmentscomparedto18%ofdevelopedcountrymodels.)
Chart 10 – Efficiency adjustments
0
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18Output thime period
Single Year Multiple Year
Developing Developed
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15
20
25
Which services are modelled?
Incoming voice All voice services All services including data
Developing Developed
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8
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1
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14
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18
Description methodology
Economic Annuity International benchmark CCA N/A
Developing Developed
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14
16
Does the model contain efficiency adjustments?
Yes No N/A
Developing Developed
39
What technologies are included in the model?ThechartbelowshowsthetechnologiesmodelledGSM,GPRSandEDGEareunsurprisinglythemostcommontechnologiesmodelled.
Chart 11 – Technologies included
What is the cost of capital included in the model?Thecostofcapitalisanareawhereitisdifficulttocompareresponses,asthefigurecouldbepreorposttaxandinrealornominalterms.Themajorityofcountries(15of27)hadacostofcapitalexpressedinnominal,post-taxterms.Theaveragecostofcapitalfordevelopedcountriesappearstobeslightlylowerthanthatofdevelopingcountriesasexpected.Atableofthevitalstatisticsisgivenbelow.Pleasenotethatnoadjustmenthasbeenmadetocorrectforreal/nominalandpre/posttaxdifferences.
Are direct retail costs included in the model?Inthemajorityofcountries,directretailcostsarenotincludedinthemodel.
Chart 12 – Direct retail costs
If yes, are any direct retail costs allocated to mobile termination?Whereretailcostsareincluded,aproportionisgenerallyallocatedtoMTRs.
Chart 13 – Allocation of direct retail costs
0
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7
8
If included are direct retail costs allocated to MTR’s
Yes No
Developing Developed
0
5
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15
20
25
30Which technologies are covered?
GSM GPRS CDMA 3G Edge Other
Developing Developed
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8
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12
14
16
18
Direct retail costs included in model?
Yes No N/ADeveloping Developed
6.0 | Operator survey 38
Does the model include Fixed Common Costs?Fixedcommoncostsarealmostalwaysincluded inthemodel.
Chart 14 – Inclusion of fixed common costs
How are Fixed Common Costs treated in the model? Wherefixedcommoncostsareincludedinthemodel,themostlikelyallocationmethodisanEqui-proportionalmark-upbasedonapercentageofdirectcosts.
Chart 15 – Treatment of fixed common costs
Did the regulator consider using Ramsey pricing to allocate FCC?RamseypricingdoesnotseemtohavebeenconsideredbytheNRAsinthecountrieswehaveresponsesfrom.OnlyonerespondentreportedthatRamseypricinghadbeenconsideredbytheirNRA.
Are up-front licence fee costs included in the model?Allofourrespondentsfromdevelopedcountriesstatedthatup-frontlicencefeeswereincludedinthemodel,comparedtojustoverhalfthosefromdevelopingcountries.Someoperatorsstatedthattheupfrontfeeswereeitherfullyamortisedorthatnoup-frontfeewaspayable.
Chart 16 – Inclusion of un-front licence fee costs
0
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30
Are fixed common costs included?
Yes No N/A
Developing Developed
0
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How are FCC’s calculated
Coverage network
Specific assets
Assets that donot vary with
respect todemand in the
long-run
Absolute fixedvalue
% direct costs Other N/A
Developing Developed
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18
20
Are up front licence fees included?
Yes No N/A
Developing Developed
41
Are up-front licence fees recovered in full?Whereup-frontlicencefeeswereincludedinthemodel,amajorityofoperatorssaidtheywerefullyrecoveredorthattheydidn’tknow.ThissuggeststhattheoperatorsinquestionarepopulatinggenericorNRAmodelswhichtheydonotfullyunderstand.Anumberofoperatorscommentedthatthelicencefeewasoftenrecoveredthroughthefixedcommoncostsallocation.
Chart 17 – Recovery of up-front licence fees
What valuation methodology is used for licence fees?Allbutoneoftherespondentsstatedthatthevaluationmethodusedforthelicencewasthehistoriccostwhichtheyhadpaid.TheexceptionwastheUK,wheretheNRAhasconsideredarangeofscenariosusingdifferentlicencevaluations.
Chart 18 – Up-front licence valuation methodology
Are ongoing licence fees included in the model?Aswithup-frontlicencefees,allofthedevelopedcountryrespondentsstatedthatongoinglicencefeeswereincludedinthemodelwhereasthemajority ofdevelopingcountryoperatorsstatedthattheywerenot.
Chart 19 – Inclusion of ongoing licence fees
What valuation methodology is used for ongoing licence fees?Unlikeup-frontlicencefees,itismuchmorecommonforongoinglicencefeestobevaluedusinginternationalbenchmarking,particularlyindevelopingcountries:
Chart 20 – Ongoing licence fee valuation methodology
0
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Is up-front licence fee recovered in full if included in the model?
Yes No Dont know
Developing Developed
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On-going licence fees included in the model?
Yes No N/A
Developing Developed
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Valuation method used for ongoing licence fees
Historic cost Current value International benchmark Other Not given
Developing Developed
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20
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What valuation method is used licence?
Historic cost Current value International benchmark Other N/A
Developing Developed
6.0 | Operator survey 40
Is there a network externality calculation in the model?Asshowninthechartbelow,itarareforanetworkexternalityuplifttobeincludedwithinthemodel.Onaproportionalbasis,theexternalityupliftappearstobemorelikelytobepresentindevelopingcountries.Ofthefourcountrieswhereanetworkexternalitywasincludedinthemodel,thiswasthricethroughanexplicitcalculationandonceimplicitlythroughtheallocationofsomesubscriberacquisitioncoststoMTRs.
Chart 21 – Inclusion of network externality
6.2.3 The setting of mobile termination ratesHas a glide path or a one-off change been applied to mobile termination rates?Fromtheresponseswereceived,itappearsthataone-offcutinMTRsisthemostcommonoutcome.AlargenumberofrespondentssaidthatthisquestionwasnotapplicableastheregulatorhasnotyetreachedadecisiononMTRs.Inthesecasesthecostmodellingprocessisfrequentlyunderwayatthemoment.
Chart 22 – Path of mobile termination rates
0
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Network extemality included in model?
Yes No N/A Not given
Developing Developed
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One-off cut or glide path?
Glide path One-off cut N/AOne-off cut followed by glidepath
Developing Developed
43
How long (in years) is the glide path?Whereaglidepathwasimposed,thiswasoveraperiodof3or4years,althoughthismaybethelengthofthetimeframeconsideredbytheNRAratherthanthefulllengthoftheglidepath.Forexample,intheUK,Ofcomsetaninitialglidepathfortheperiod2003–2007andhasrecentlysetanewglidepathfortheperiod2007–2010.
Has the NRA regulated the retail cost of calls to mobile to ensure pass-through of mobile termination rate cuts? If not, is such regulation planned for the future?
InmostcountriestheNRAhaschosennottheregulatetheretailmobilemarkets,howeverseveralrespondentsstatedthatthisissomethingtheregulatorwasconsideringforthefuture.
Chart 23 – Current regulation of retail call costs
Chart 24 – Future regulation of retail call costs
Have symmetrical or asymmetrical rates been applied in the market?InthemajorityofcountriesMTRsaresymmetrical.Interestingly,twothirdsofdevelopedcountryrespondentssaidMTRswereasymmetriccomparedwith13%ofdevelopingcountryrespondents.
0
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Is the retail cost of calls regulated?
Yes No N/A
Developing Developed
0
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Is regulation of the retail market planned for the future?
Yes No N/A
Developing Developed
6.0 | Operator survey 42
If asymmetrical, will this continue beyond the current regulatory time frame?Indevelopingcountrieswhereratesareasymmetrictheywillstayasymmetricthroughoutthecurrentregulatoryperiod,whereasasymmetricrateswillconvergeinsomedevelopedcountries.
Chart 25 – Application of symmetrical vs. asymmetrical MTRs
Have NRAs allowed an uplift to mobile termination to contribute to the costs of network expansion?Noneoftheoperatorswhorespondedtoour surveysaidthatanetworkexpansionsurcharge wasexplicitlyincludedinMTRs,althoughoneoperatorsaidthattherewasadefactoacceptance ofthepractice.
Chart 26 – Convergence of asymmetric rates
0
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If MTR s are asymmetric, will this continue beyond the current regulatory timeframe?
Yes No
Developing DevelopedDeveloping Developed
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Symmetrical vs Asymmetrical MTRs?
Symmetrical Asymmetrical Not Given
Developing Developed
45
7.1 Regulation comes in many shapes and formsThesurveyresponsesshowthattheregulationofMTRshasbeendoneforavarietyofreasonsinavarietyofwaysproducingavarietyofoutcomes.SomeoftheNRA’sdecisionshavebeentheresult ofdetailedanalysiswhilstothershavemerely reliedonoff-the-shelfcostingpackagestosettheMTRs.Thereislittleevidencefromtheindustry thattheneedforregulatingMTRswilldisappear intheneartomediumtermsoitisintheinterests oftheindustryandalsothewidereconomythatNRAsmakecorrectdecisionsregardingthe settingofMTRs.
7.2 Many issues in modelling and price-setting – consultation is keyThispaperhasdemonstratedthatMTRsarethefunctionofnumerousinter-relatedcomplexfactors,andthereisno“correct”answerastohowMTRsshouldbeset.However,itisclearthatthereareincorrectdecisionsthatcaneasilybetakenandNRAsandoperatorsmustbemindfulofthemanypitfallsthatlieinwaitwhenembarkingonaMTRprice-settingexercise.ThereforeitisimperativethatNRAsconsult,thatoperatorsfullyengageintheconsultationandthatthefinaldecisionistransparent,understoodandsupportedwithrigorousanalysisandreasoning.
Thispaperhashighlightedareasofbestpractice,andtheiradoptionwillenhancetheharmonisationofcostmodellingandpricesettingforMTRs. Theseareasofbestpracticeinclude:• Theuseofahybridmodel,• Theuseofeconomicdepreciation,• Theuseofaforwardlookingmodel
incorporatinghistoricdataasasensecheck,• Allocationofcostsbetweenservicesbased
onroutingfactors,• Networksareassumedtobeefficientin
competitivemarkets,• MTRsshouldbebasedonthetechnologies
inuse,e.g.2Gmigratingto3G,and• CutsinMTRneedtobepassedontotheend
useriftheyaretohavethedesiredeffect.
7.3 Change takes time Thetransitionfromexistingratestocost-orientedratescanhaveabigimpactonthestructureofpricesforallmobileservices.ItissurprisingthatNRAsinthedevelopingworldhaveoftenchosentoinitiateaone-offpricecutinordertoarriveatcost-basedMTRs.ThisiscountertotheexperienceinEuropewhereoperatorshavebeengiventimetoadjusttheirpricesbeforecost-orientationisachieved.GiventherisksdetailedinthispaperofsettingMTRsbasedoncostwhennetworksarestillexpandingintoruralareas,webelieveNRAsindevelopingcountriesshouldcarefullyconsiderhowtheysetMTRsandoverwhattimeperiodtheydoit.
7.0 Conclusion
44
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