Sunday 20 May 2012

Contents of module

Charging Principles

The adoption of a particular charging principle for interconnection depends upon the aims of policy. Operators will approach the issue as a business decision.

An incumbent may decide to raise the cost of interconnect as a barrier to entry for competitors, or may accept competition as inevitable and as good for growing the market. A new entrant will want a low interconnect charge, and has to decide between “build or buy”, building a separate network or buying interconnect and unbundled local loop circuits.

The regulator in Hong Kong has been guided by the policy objectives, as set out in Part Two, to encourage competition to achieve low cost high quality telecommunications services in the most economically efficient way, and maintain Hong Kong as a regional telecommunications hub.

It is important to establish from the outset this link between policy and choice of charging methodology because in purely financial accounting terms there are no abstract criterion which establishes any one as superior. From a financial point of view, fully distributed cost, long run average incremental cost, retail-minus and cost-plus pricing schemes can all produce satisfactory outcomes.

It is worth quoting directly from the Hong Kong TA the reasons why long run average incremental cost is favoured by the regulator in Hong Kong.

In choosing the most appropriate interpretation of the LRAIC, the TA will have regard to the policy objectives of the charging principles. One of the underlying principles is the interconnection charges should encourage operators to use resources efficiently and make the appropriate “build-versus-buy” decisions. Another underling principle is that the carrier providing the interconnection service should be fairly compensated for the costs incurred in the provision of the service. These principles are consistent with international best practices. (Statement No. 7 (Revised) Annex, p.9).

Interconnection Barriers

There are other ways the incumbent can deter interconnection besides high charges. They include long delayed negotiations and stalling tactics, the deliberate blocking of space in equipment rooms and exchanges to prevent co-location, the withholding of technical and traffic management information, the sabotage of circuits provided for interconnection, or the provision of poor quality circuits and restrictions on their capacity, and, if the incumbent is given a free hand to exploit their superior bargaining power, the insistence that the points of interconnection are restricted to locations which force the new entrant to pay the incumbent for technically unnecessary routings.

For example, new entrants may have the capability of providing their own long-distance routing of traffic but not the delivery over the “last mile”. The incumbent may nevertheless be able to insist the new entrant interconnects at the local exchange or toll exchange nearest the originating party. This forces the new entrant to pay a long distance transit as well as a far-end local loop fee, and this may be as much as 90 per cent of the call charge, leaving the new entrant with insufficient revenue to finance further network investment.

In Hong Kong the licence conditions of the FTNS outlaw such behaviour, although in practice policing and enforcing the regulations remains difficult because the regulator is bound to act with due diligence, which means the TA must make full inquiries as to the facts of the case before issuing a directive.

Facts are usually disputed and difficult to prove, so this takes time, which always works to the benefit of the incumbent who already has the customer. There is really no way around this problem if due diligence is exercised, and regulatory intervention is likely to be cheaper and faster than a legal process through the courts. Ultimately, facilities based competition is the best answer.

Interconnection Charging Principles

Despite these problems, interconnection fees remain of paramount importance in policy making. The TA’s Statement No. 7 (Revised), issued 18 November 1997 sets out policy for carrier-to-carrier charging principles:

  1. Carriers must pay for the costs they cause other carriers to incur when interconnecting: so each interconnect cost component must be analyzed for causation, and this implies the regulator has access to this information and is able to call upon the necessary resources to make an informed decision based on the data available. OFTA can call upon Government accountants and economists, but more frequently outsources these tasks to professional consultants.
  2. Shared responsibility between operators to interconnect promptly and efficiently: this is specified in licence conditions of FTNS carriers in Hong Kong.
  3. Carriers should share the costs of interconnect proportionately: where interconnecting carriers receive benefits from interconnection they should share the costs.
  4. Responsibility for charging should be assigned among carriers in such a way as it encourages the efficient use of resources and minimizes waste: the assignment of responsibilities should motivate operators to establish optimal points of interconnection, install appropriate levels of capacity for physical facilities and the use of each others’ facilities.
  5. Retail tariff arrangements will determine the direction of the payment flows between carriers: this refers to the fact that in Hong Kong local voice calls are covered by a flat rate retail price, so customers only pay for an average of outgoing calls, whereas value added services and mobile cellular calls (made and received) are call charged, so carriers retailing such services are required to pay the interconnecting
  6. Interconnection charges and other related transactions will be based on relevant costs: these costs will include the cost of capital so that carriers are fairly compensated, and will be costs caused by the use of facilities or services to achieve interconnection, of costs that could be avoided without the interconnection.
  7. Long run average incremental costs (LRAIC), including the cost of capital for assets used, will be the measure of relevant costs and related transactions: LRAIC is defined as the difference in the carrier’s total costs with and without the service or facility supplied, divided by the total output of the service or facility. The TA interprets the term ‘service’ to include all the associated shared costs which are part of the ‘service elements’ (separately identifiable services) of the entire conveyance service, excluding costs which are not. The TA is here assuming that there should be no difference in network costs between a call originated from (or terminated on) the same network or from a competing network.
  8. LRAIC excludes a mark-up for the recovery of shared costs common to all services: but the TA was willing to revisit this issue in relation to indirect fixed costs when the proportion of interconnection costs in the carriers’ businesses come to be known.
  9. Relevant costs should be determined with reference to the current cost measurement of assets: traditionally historical costs have been available, but current or replacement costs, and forward-looking costs are economically more efficient methods of comparing incumbents with the best practice of new entrants. The TA proposed to use current or replacement costs, but where these may rise above historical costs, historical costs would be used. In Hong Kong land prices, which are normally a very high proportion of capital cost, are frequently subject to rapid price movements and this is a provision to avoid distortion of interconnection service costs.
  10. Costs should reflect cause and effect relationships as far as possible: this is the economic treatment of cost, in contrast to a purely accounting treatment of cost. The economic view regards cost as measured by the most favourable risk-comparable opportunity foregone,3 so, for example, what benefit did the incumbent forgo when they spent money on provisioning their network for interconnection? The TA maintains an Accounting Manual updated quarterly with data supplied by the dominant FTNS, to monitor these costs.
  11. Interconnection and related services and facilities will be provided on a desegregated basis: an elemental service or facility is one that is separable within the network and can be independently costed. These services and facilities should therefore be made available on an unbundled basis for interconnection.
  12. Structure of interconnection charges should reflect the underlying behaviour of costs: so fixed costs should, as far as possible, be recovered through fixed charges, and variable costs through usage charges. In particular, a two-tiered structure of call-attempt and call-holding charges should be developed.
  13. All carriers must develop and administer cost based charges for transactions between them: but in cases where carriers agree not to charge each other the TA will waive this requirement if the outcome is not anti-competitive.

Physical Link and Network Conditioning Charges

LRAIC is used to cost the establishment of physical links for interconnection, including the costs of ports and datafill activities, and these are shared equally between the carriers.

Set up costs of links, if identifiable and causally attributable to interconnection, are recoverable through usage charges. A requirement for separate links for different types of traffic will be subject to technical review by the TA in the event of complaints.

Carriers are responsible for meeting all the costs of network conditioning of their own networks, including, for example, costs for ensuring network security and integrity, standardization, equal access, changes in the numbering system, provision of caller line identification, and so on.

Where any portion of these costs can be separately identified as attributable to the provision of interconnection, they are recoverable through usage charges.

These principles are equally applicable to conventional PSTN and ISDN. In the case of ISDN, where network upgrading is required to provide interconnection these costs are treated as attributable “network conditioning” costs. But costs incurred in meeting interconnection requests outside and beyond the licence requirements are chargeable in full to the requesting network.

Type II local loop interconnection physical link charges differ from Ttype I because the facilities already exist. The “build-buy” decision of new entrants is the issue at stake, so the interconnection charge should be neither too high as to over-compensate the incumbent for sunk capital investment, nor too low as to discourage a new entrant from building out an access network.

The TA therefore extends LRAIC principles to Type II interconnection, based on current cost measures of assets. LRAIC here includes both fixed costs, including historical sunk costs, and line dependent costs, such as installing and maintaining cable plant and associated loop equipment, which vary according to the number of lines.

The total LRAIC cost pool is then divided by the number of lines in a given configuration to derive a LRAIC per line. LRAIC charges also need to be desegregated into different components of the local loop, such as main distribution frame and the distribution points, as well as desegregated into different geographical areas to reflect the cost differences in different access network configurations, for example between urban, suburban and rural, between high density/ high rise and low density/ low rise.