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John Ure Associate Professor and Director
TPR, Social Science Research Centre, University of Hong Kong
Director, TRPC Pte Ltd (Singapore)http://www.trpc.biz
Economic regulation, cost methodologies and tariff regulation in the Asia Pacific region
ITU/BDT Regional Economic and Financial Forum of Telecoms/ICTs for Asia Pacific
Kuala Lumpur, 28 September 2015
1
The Message The Agenda
Four broad themes1.The transition from PSTN to broadband and the need for economic regulation
2.Economic multipliers of network Investment
3.The driving role of competition
4.How economic regulation works
Economic regulation is essential for making the transition from narrowband TDM networks to broadband all-IP Next Generation Networks (NGN)
Network access issues (costs and access points) are key to non-discrimination
2
ASEAN Internet Penetration 2009-2013: key role of BWA
• Source: ITU World Telecommunication/ICT Indicators database
3
Country SwitchC4
Local SwitchC5 MUXLocal Switch
C5MUX
AAccess
NNode
DDigital
SSubscriber
LLocal
AAccess
MModule
IP Router
IP Router
IP
Router
Gateway Gateway
DDigital
SSubscriber
LLocal
AAccess
MModule
AAccess
NNode
CircuitSwitchedPSTN
NextGenerationNetwork
Simplified Architectures of TDM and Next Generation Network and their ‘Type 1” interconnection
Source: Cisco4
CustomerPremises
Equipment
Outside Cables
CustomerBuilding
Core Networks
Local Telephone Exchange
Internet Service
Providers
Internet & Intranets
M56K
M ADSL
SDSLAM
SDSLAM
PSTN
ATM 1
ATM 2
M56K
M56K
M56K
INTRANET
INTERNET
ISP 1
ISP 3(Private)
ISP 2
FW
ToISPs
SLU
M ADSL
‘’Type 2’ interconnection between PSTN and broadband networks5
Why economic regulation?
• Fulfil policy objectives for economic growth, employment, trade, foreign investment, etc. Incentivize investment in network extensions, upgrades and
new networks (NGNs, BWA, etc.) => network innovations Competitive pricing and service innovation
• Open markets drive competition, investment and innovation = “contestability” Remove barriers-to-entry (hidden subsidies, discrimination,
review licensing conditions, including inter-modal entry, etc.)
• Constraints can be historical or political Incumbent power sustained by partial state-ownership?
6
Quick overview of multipliersFixed TDM Teledensity Impact of 10% investment
PSTNs
OECD average (2004) 30% 2.8% increase in GDP
USA (Roller & Waverman, 2001) 40% 7.8% increase in GDP
Hong Kong (Ure, 1997) 33% 1.15% increase in GDP
Mobile Networks
Torero et al. (2002) 5-15% 0.3% increase in GDP
Waverman et al (2005) 10% 5.9% increase in GDP
Sridhar & Sridar (2004) < 20% 7.0% increase in GDP
Kathuria et al (2009) – All – Low – High
10%< 25%> 25%
1.2% increase in GDP1.3% increase in GDP1.0% increase in GDP
Note 1: Research involves different methodologies, data sets, etc. Note 2: Is there evidence that multipliers grow as economies grow? Roller & Waverman suggest so.
7
Quick overview of multipliersFixed TDM Teledensity Impact of 10% investment
Broadband
Qiang, et al World Bank, 2009 10% 1.21% increase for DME1.38% increase for an EME
Crandall, W, W Lehr & E Litian, 2007 10% 2% increase in US non-farm employment
Arab emerging economies (Mona Badran, 2011)
10% 0.05% increase in GDP in Egypt and some emerging Arab economies
25 OECD countries (Czernich et al. 2009) 10% 2.7% - 3.9%
References: 1. Christine Zhen-Wei Qiang and Carlo M. Rossotto with Kaoru Kimura (World Bank ,2009) Economic impacts of broadband2. Crandall, W, W Lehr & E Litian, 2007. ‘The Effects of Broadband Deployment on Output and Employment’, Issues in Economic Policy, 6, July 2007. 3. Mona Badran (2011) The impact of broadband infrastructure on economic growth in Egypt and some Arab and emerging countries’ Economic Research Forum, WP 5914. Czernick et al (2009) ‘Broadband infrastructure and economic growth’ CESIFO WP No.2861 - see (3) for reference.
Note: Research involves different methodologies, data sets, etc. 8
Regulatory overviewParameters Examples
Policy objectives Investment and/or competition?
Market structure SMP vs. competitive
Economic regulation Implicit subsidies: FDC vs. LRIC
Accounting approach Historic vs. Current Cost
Techno/Engineering Legacy vs. NGN
9
Policy objectivesInvestment in broadband coverage
Across ASEAN < 5% using fixed broadband access; but around 30% using BWA (See slide 3 above)
Intra-modal competition
Wholesale/retail separations, equal access and LLUB models in different economies
Inter-modal competition
Around 30% using BWA in ASEAN; TV cable Internet access widespread
Broadband speeds Fixed/Mobile averages: Global = 23.4 Mbps fixed and 12.4 Mbps mobile Asia = 28.1 Mbps fixed and 10.9 Mbps mobileSee: https://www.techinasia.com/asia-internet-speeds-mobile-broadband/
Broadband affordability
10 ASEAN economies = 2 ‘affordable’, 5 ‘moderate’, 2 ‘expensive’, 1 ‘unaffordable’ISOC Report Unleashing the Power of the Internet http://trpc.biz/unleashing-the-potential-of-the-internet-for-asean-economies/
10
Market structure
Possible market condition Economic condition
11
Economic regulation & markets
Define markets Close substitutes and cross-elasticities of D/S; geographical scope, etc.
Standalone nets and services/ ‘intrusive networks’ (e.g. OTT)
Measures of ‘contestability’ and of barriers to entry
SMP End internal subsidies; cost-oriented pricing = caps, incentive-regulation, separations, etc.
Non-discrimination Reduce barriers-to-entry; Internal value-chain cost accounting to avoid profits squeeze, etc.
Inter-modal competition Liberalise licensing: unified and unlicensed
12
Accounting approachesAccounting practices Accounting dataHistoric cost accounts (HCA) Available from company accounts, but subject
to changed circumstances, depreciated assets, subsidised assets,‘etc.
Current cost accounts (CCA) ‘To market’ values can fluctuate; makes sense to use replacement costs, but depends on the cost item
Forward-looking costs Appropriate when new technologies with lower costs replace old
Accounting assumptions Length of depreciation periods, write-downs and write-offs, local accounting practices, etc… including ‘creative accounting’ and ‘bad’ practices such as capitalizing current costs!
13
Technologies/engineering‘Vintage’ Accounting dataTDM networks Core networks TDM in many developing
economies; customer access networks mostly copper + extensive mobile connections
Multi-modal competing network services
Copper POTS, ISDN, xDSL, FTTx, coaxial cable, Wimax, GSM, WiFi, satellite, etc. = different cost structures for different levels of competition for regulated services
Hybrid networks in transition From PSTN to end-to-end IP NGNs to HS-NGN and BWA
Transitional regulation How to design and manage? Sunset periods phasing out one set of economic regulations and phasing in another to create incentives? Parallel sets of regulations for TDM and IP? Just fade out TDM regulations? 14
Economic cost vs. implicit subsidies
Incremental Proportion of total costs attributable to the output of single service or network element
Standalone All costs attributable to single firm’s product; i.e. all costs incremental
FDC/FAC Total costs directly and indirectly (allocated common and joint) attributed to a sub-set of selected outputs
TSLRIC/ TELRIC
Incremental costs directly and indirectly (allocated components of common and joint) attributed to a sub-set of selected service or network element outputs
LRIC/LRAIC Incremental costs directly attributed to a sub-set of selected service
Allocation Ramsey Pricing (inverted ED) vs. MoU15
IncrementalCost
IncrementalCost
IncrementalCost
IncrementalCost
IncrementalCost
IncrementalCost
IncrementalCost
Service-specificFixed Cost
Allocation of Partof Joint &
Common Cost
Allocation of Partof Joint &
Common Cost
Allocation of allJoint & Common Cost
Allocation ofResidual of Joint& Common Cost
FAC-based allocation ofall Joint & Common Cost
All Joint and Common Cost
+
+
+
+
+
+
+
+
+
+
+
+
Service-specificFixed Cost
Service-specificFixed Cost
Service-specificFixed Cost
Service-specificFixed Cost
Service-specificFixed Cost
LRIC
TSLRIC/LRAIC
TELRIC
TELRIC+ uniform mark-up*
TSLRIC/LRAIC+Uniform Mark-up*
FDC/FAC *
Stand-alone Costs
Notes: 1. For TSLRIC/LRAIC the increment is defined as the total service. Hence, indirect cost elements are shaded while direct cost elements are not shaded. 2. In this example, FDC/FAC is assumed to be calculated based on forward-looking economic cost methodology. 3. The total costs of the 3 cost concepts identified by an asterisk (*), do not necessarily have to be equal as shown in this example. 4. Note the relative sizes of the costing concepts are indicative only and should not be taken as an approximation of an actual costs Source: Hank Intven (2000) ed. Telecommunications Regulation Handbook The World Bank
The Relationship Between Costs, Costing Methods and Allocations
16
Competitive network access pricing
• FDC or other methods (benchmarking, retail minus, etc.) used where no other data available to regulator
• Economic (incremental cost) principles used to eliminate implicit subsidies Core network services (upstream) such as routing, directory
services, bit-streams, etc. Interconnection pricing (Reference Interconnection Offer – RIO) Line leasing and unbundling (LLU)
• Non-discrimination (lower barriers-to-entry) Quality, location and timeliness as well as service and network
element pricing Margin squeezing (a form of own cross-subsidy)
17
Example of why price cap regulation requires separate identification of costs
• Telco offers Voice + DSL services…. but if Total Factor Productivity (TFP) is estimated to include both services then overall TFP will underestimate TFP in the sector where costs have fallen faster… assume RPI rose by 5%
Price cap = Retail price index – TFP = (5% - 4.6%) = + 0.4%Source: Testimony of Dr David Gabel on Behalf of the Maryland Office of People’s Counsel
Voice + DSL Growth rate Expense Share Weighted AverageCapital +2.0% 0.40 +0.8%
Labour +1.0% 0.40 +0.4%
Materials +1.0% 0.20 +0.2%
Total Input +1.4%
Total Output assume +6.0%
TFP +4.6%
18
Price cap regulation if costs are assigned to separate services
• By separating out the costs of DSL, the price cap for voice services indicates voice tariffs should fall by 2% rather than rise by no more than 0.4%
Price cap = Retail price index – TFP = (5% - 7.0%) = - 2.0%
Source: Testimony of Dr David Gabel on Behalf of the Maryland Office of People’s Counsel
• Telco 2: Total Factor Productivity for voice + DSL service
Voice-only Growth rate Expense Share Weighted Average
Capital +1.0% 0.40 +0.4%
Labour -3.0% 0.40 -1.2%
Materials -1.0% 0.20 -0.2%
Total Input -1.0%
Total Output assume +6.0%
TFP +7.0%
19
Cost-based prices for regulated services50:50 in Asia-Pacific – lowest ratio
• Source: www.itu.int/icteye
20
Based on 40/44Countries
Based on 16/21Countries
Based on 28/40Countries
Based on 32/43Countries
Based on 31/35Countries
Based on 154/195Countries
Based on 7/12Countries
Perc
enta
ge o
f re
spon
ses
Traditional wholesale cost-based services47H:40C Asia-Pacific
• Source: www.itu.int/icteye
21
Perc
enta
ge o
f re
spon
ses
Based on 32/44Countries
Based on 10/21Countries
Based on 14/40Countries
Based on 31/43Countries
Based on 23/35Countries
Based on 112/195Countries
Based on 2/12Countries
Advanced wholesale cost-based servicesCurrent costs more used
• Source: www.itu.int/icteye
22
Traditional retail cost-based services47C:40H in Asia-Pacific
• Source: www.itu.int/icteye
23
Perc
enta
ge o
f re
spon
ses
Based on 18/44Countries
Based on 7/21Countries
Based on 14/40Countries
Based on 16/43Countries
Based on 21/35Countries
Based on 79/195Countries
Based on 3/12Countries
Advanced retail cost-based services57C:27H in Asia-Pacific
• Source: www.itu.int/icteye
24
Traditional wholesale regulated services31C:27B in Asia-Pacific
• Source: www.itu.int/icteye
25
Perc
enta
ge o
f re
spon
ses
Based on 38/44Countries
Based on 15/21Countries
Based on 18/40Countries
Based on 32/43Countries
Based on 24/35Countries
Based on 132/195Countries
Based on 5/12Countries
Advanced wholesale regulated services29C:24B in Asia-Pacific
• Source: www.itu.int/icteye
26
Perc
enta
ge o
f re
spon
ses
Based on 23/44Countries
Based on 10/21Countries
Based on 14/40Countries
Based on 26/43Countries
Based on 17/35Countries
Based on 92/195Countries
Based on 2/12Countries
Traditional retail regulated services26C:22B in Asia-Pacific
• Source: www.itu.int/icteye
27
Perc
enta
ge o
f re
spon
ses
Based on 26/44Countries
Based on 10/21Countries
Based on 22/40Countries
Based on 21/43Countries
Based on 28/35Countries
Based on 112/195Countries
Based on 5/12Countries
Advanced retail regulated services28C:28B in Asia-Pacific
• Source: www.itu.int/icteye
28
Perc
enta
ge o
f re
spon
ses
Based on 22/44Countries
Based on 7/21Countries
Based on 17/40Countries
Based on 10/43Countries
Based on 15/35Countries
Based on 75/195Countries
Based on 4/12Countries
Conclusions• Economic regulation often seems like having to square a
circle: Encourage investment in networks (supply)Keep markets competitive (options)Keep prices affordable (demand)
• Cost-oriented wholesale prices simulate competitive forces – have the highest modal use (see charts)
• Retail tariff regulation in the absence of effective market choice – regulation methods more mixed (see charts)
• Non-discrimination essential to keep markets open
29
Thank You
30