© copyright incyte consulting 2008 establishing cost-based interconnection: regulatory challenges...

© Copyright Incyte Consulting 2008

Establishing cost-based interconnection: regulatory challenges and solutions

Presentation to Infofest conference Budva, 30 September 2008

David Rogerson

2© Copyright Incyte Consulting 2008

Agenda

Background to this presentation

What is cost?

How to measure cost

How to set interconnection rates

Overcoming objections

Questions and discussion

Good regulation:- understands the principle, - implements the practical, - anticipates the problematical

Good regulation:- understands the principle, - implements the practical, - anticipates the problematical


Background to this presentation


About Incyte Consulting

Incyte Consulting is a global consultancy that provides expert advice to policy makers, regulators, operators and investors on policy and regulatory issues in telecommunications.

We have offices in the UK and Australia, and our directors have worked on telecommunications policy and regulatory issues in over 40 countries worldwide.

From November 2007 to September 2008 we have been part of a consortium led by Great Village International Consultants advising Agentel on the regulation of tariffing and interconnection in Montenegro. The assignment was funded by EBRD.


Why interconnection charges need to be cost-based

In a competitive market interconnection is the fulcrum on which the market is balanced

Up to 40% of an operator’s costs may be

from interconnection

Interconnection costs for one operator are revenues for

another operator

Imbalance of market power means interconnection

charges cannot be left to commercial negotiation

Regulated interconnection rates have to be set with absolute

fairness


What is cost?


Cost changes need to referenceonly the services that an entrant

wants to purchase

Cost changes need to referencethe decision period of a normal

investment decision

Long Run Incremental Cost

LRIC is the “gold standard” for setting interconnection charges


What is LRIC?

LRIC is an economic cost concept designed to:

Encourage use of existing facilities where desirable

Encourage investment in new facilities where justified

Increasing desire for entrants

to build rather than buy

Decreasing desire for incumbent to sell

Interconnecttariff

LRIC

Neutralbenefits


In summary…

Cost models provide evidence of cost structures and a sound basis for price setting

LRIC provides the best balance in the interests of all stakeholders

LRIC has been adopted by various international bodies (e.g. The European Regulators Group ("ERG"), ITU) and widely implemented around the world

The Regulator

LRIC

Entrants

Government

Incumbents Consumers

Businesses

LRIC is international best practice for interconnection cost modellingLRIC is international best practice for interconnection cost modelling


How to measure cost


Top down models: adapt the operator’s accounts to meet the LRIC standard

Bottom-up models

model an efficient network based on a simplification of network design Benchmarks:

Compare prices with other countries that use LRIC

All are extensively and successfully used in both mobile and fixed markets around the world

Three approaches to LRIC modelling


Top-down LRIC models

Top-down models are typically used for incumbent fixed networks

Strengths

Based on actual costs

Accounts for cost minutiae

Includes capital and operating costs

Strong audit trail

Weaknesses

Accounting for potential efficiency gains

Requires substantial up-front investment

Data sources and data confidentiality

Historic costs only

Needs to be re-calculated annually


Bottom-up LRIC models

Bottom-up models are more commonly used for mobile networks

Strengths

Starts with the network elements required to deliver service increment

Accounts for theoretical operational efficiency

Avoids data confidentiality problems

Enables cost forecasting

Weaknesses

May not match actual costs

May omit to include some costs

Can’t easily deal with operational costs


Benchmarks

Benchmarks are at best temporary solutions and cross-checks

Strengths

Simple to develop and update

Transparent – all necessary data is generally published

Incorporates best practice efficiency

Weaknesses

Benchmark prices may not be cost-based

Does not account for variations in costs between countries

Leads to arguments about which countries to include


The Interconnection square

LRIC does not produce a single indisputable cost figure

There is room for regulatory policy manoeuvre

Rates should fit within the “Interconnection Square” …

… but where they fit is a matter of judgment.

Reasonable cost-based interconnect

charges

Top-down LRIC model

Bottom-up LRIC model

Internationalbenchmarks

Internationalbenchmarks


How to set cost-based interconnection rates


Glide paths smooth the transition to LRIC

LRIC rates are often well below starting levels

Interconnection prices may be set on a “glide path” to LRIC levels.

Typical glide paths are 3-4 years to allow smooth adjustment

They should be reviewed during the implementation period.

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Overcoming objections


In our experience:

The stakes are high:

There will be opposition in principle to LRIC from the incumbent operators

There may also be opposition from other parties when the LRIC-based charge proposals are announced

Being strong at the implementation stage will mean:

Competition will run that much more smoothly afterwards

There will be fewer and smaller battles in the future

Failing to go through with LRIC will mean:

Substantial focus of energies on interconnection disputes

Lack of focus on bringing the benefits of competition to customers


Operator tactic Regulator’s response

Argue that LRIC is too complex, too costly and shouldn’t happen yet

LRIC is the best approach in theory and supported by international

best practice

LRIC will undermine our financial viability

Show me an incumbent whose value has been hit by LRIC.

Whatever else, seek delays

Set reasonable timelines and stick with them.

Threaten court action over unreasonably low

rates.

Always leave room for a worse outcome if challenge is taken to

court.

Talking tactics


The End. Thank You

© copyright incyte consulting 2008 establishing cost-based interconnection: regulatory challenges...

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