Sunday 20 May 2012

Contents of module

Charging Principles

Broadband networks can be entirely new or can be upgrades and overlays on narrowband networks. Broadband capacity is available for PSTN-type services as well as broadband services.

This means that deriving an economically consistent approach to pricing broadband interconnection is complex because many of the costs incurred in network build out, operation and maintenance can be considered common or shared costs. The objective of interconnection charging is to balance the build-or-buy decision of new entrants, and where to place that balance is a matter of judgment.

Pricing needs to be sufficiently representative of the costs involved, including the cost of capital, to provide incentive to the incumbent to invest in their network, which in the short run is likely to be the only one available for most customers. This is the supply side of the argument. Pricing also needs to stimulate demand for broadband services, which in the longer run will encourage greater supply.

OFTA decided not to make a determination on Type II interconnection for three years after HKT begun offering ADSL broadband services in March 1998. Beyond February 2001 OFTA will consider making determinations.

The basis of these determinations has to be decided from four different models of charging principles which are set out in the Consultation Paper and summarized in OFTA’s 12 June 2000 paper. The following is a summary of OFTA’s views.

  1. Long Run Average Incremental Cost (LRAIC), which will take into account the unique business risk and rate of return involved in network investment. Because broadband capacity is shared the marginal cost of providing broadband interconnection would, on its own, not act as an incentive to investment. Therefore OFTA considers the “incremental cost” approach should be based on the incremental cost of the entire service, that is of all the service elements, in the long run, e.g. the costs of setting up and maintaining the entire local loop system. The costs of cables, ducts, the supporting facilities in the local exchanges should therefore be included as all these costs may be avoided in the long run if the interconnection were not provided. Costs can also include an adjusted cost of capital to reflect the market risk that is fair and compensatory. This would safeguard against interconnection charges being so low as to tip the build-buy decision too much in favour of buy. This version of LRAIC is the total element long run average incremental cost approach, or TELRAIC. OFTA can use consultants and benchmarks from other jurisdictions to determine what are the appropriate costs of capital, rate of return and risk premium involved.

  2. Fully Distributed Cost (FDC), which will include the long-run incremental cost plus the fully allocated common and/or joint fixed costs that are incurred at the entity level. This approach usually involves costs in the production of multiple products or services that cannot be separately attributed to individual product/service segments. OFTA will consider whether there are special circumstances where the FDC principle is especially applicable, for example where the interconnection service is provided to established competitors, or where it constitutes a substantial proportion of the business of the supplier of that service. But where new entrants face greater business risk and therefore higher costs of capital, these higher costs can also be factored into the LRAIC proposal above. The major drawbacks of the FDC model are that it fails to shadow market prices, and it results in higher interconnection prices which may retard new entry.

  3. Retail minus approach, which sets the price cap for interconnection at retail price minus costs incurred by the retail activities of the network operator’s in-house/affiliated service providers. It is appropriate for a fast growing and fully competitive market, reflecting contemporary cost structures, market rates of return, business risks, etc. It produces a neutral build-buy dichotomy, so disincentives are minimized. But if the market is immature and dominated by a few companies, then retail prices can reflect excess profits and interconnection prices will be higher than LRAIC. Alternatively, retail prices can be below cost to stimulate the market, and the interconnection price would not cover network costs. If wholesale prices were used instead, then the new entrant could not make a profit.

  4. LRAIC plus lost profit incurred by the lost opportunity to provide the broadband services by the network operator itself. This forms the basis of opportunity cost and also represents the principle of efficient component pricing rule, or ECPR. There was little support within the industry for ECPR, not least because it has not proved workable elsewhere. OFTA considers that ECPR perpetuates monopoly profits in network operators and compensates the operators for inefficiencies.