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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.


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.


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.


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*



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


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.




Top-down FAC(CCA) Model*

*Depending on what current cost information is gathered, alternative forms of depreciation, can be used


Service costs

Routinginformation/

allocation rules

Mapping Resinate dep ‘n

Lifetime 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.




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.



Costing Module


common costs)


allocation rules

Mapping



Network design rulesand information

Hybrid model



Historicaccounting data

Historicoperational data


common costs)


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


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.


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

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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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Cost standard in use

LRIC FAC/FDC Other


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Type of model

Bottom-up Top-down Hybrid Other


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Actual or hypothetical oporator modelled?

Actual Hypothetical Both NA


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18 Model Timescale

Historic Forward looking Whole liftime Other


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

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18Output thime period

Single Year Multiple Year


0

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Which services are modelled?

Incoming voice All voice services All services including data


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Description methodology

Economic Annuity International benchmark CCA N/A


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Does the model contain efficiency adjustments?

Yes No N/A


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

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If included are direct retail costs allocated to MTR’s

Yes No


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30Which technologies are covered?

GSM GPRS CDMA 3G Edge Other


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Direct retail costs included in model?

Yes No N/ADeveloping Developed


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

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30

Are fixed common costs included?

Yes No N/A


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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


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Are up front licence fees included?

Yes No N/A


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

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Is up-front licence fee recovered in full if included in the model?

Yes No Dont know


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On-going licence fees included in the model?

Yes No N/A


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Valuation method used for ongoing licence fees

Historic cost Current value International benchmark Other Not given


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What valuation method is used licence?

Historic cost Current value International benchmark Other N/A



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

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Network extemality included in model?

Yes No N/A Not given


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One-off cut or glide path?

Glide path One-off cut N/AOne-off cut followed by glidepath


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.

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Is the retail cost of calls regulated?

Yes No N/A


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Is regulation of the retail market planned for the future?

Yes No N/A



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

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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


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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