Session 05: Introduction to economic principles governing the interconnection

1. Session 05: Introduction to economic principles governing the interconnection

2. General Introduction

3. Interconnection networks • Under a market in competition the interconnection: • Is a Right under fair terms for the new entrant and • An obligation for the dominant operator or having a SMP. • This interconnection obligation raises questions such as: • Technique: how to achieve concretely the interconnection • Legal: What kind of agreement must be concluded and •  Economics: Determining the interconnection tariffs.

4. Source: RTR by end of /2003 Quelle: Eigene Erhebung RTR (vorläufiger Stand 08/2003) Source: ITU

5. Principles to consider in setting tariffs for interconnection services (1/2)

6. Principles to consider in setting tariffs for interconnection services (2/2)

7. Objectives of tariff methods used

8. The most common aspects of regulation

9. Regulatory constraints on interconnected networks

10. Regulatory constraints on interconnected networks

11. New entrant Operator / operator with no SMP • new operators is not subject to an obligation to orient the tariffs to the costs • It is subject to no-excessive tariff obligation • The no-excessive may be understood in several ways: • no-excessive compared to the costs of the operator • no-excessive in relation to costs of an efficient operator • no-excessive under the impact of the tariff on the market, or in relation to the comparison with the tariffs of other operators • no-excessive tariff under international benchmarking

12. Operator with significant market power • An SMP operator has an obligation to orient the tariffs to the cost • This orientation is materialized by taking in consideration in particular the following elements : • Relevance of the costs • The valuation of assets • Respect of the links causality • Distinction between: • costs of general Network • Costs other services than the specific network interconnection • Costs specific network interconnection • Common costs • Approach to allocate the costs (historical cost, current cost, LRIC)

13. the relevant costs (1/3) The irrelevant cost related to : Trade Costs on advertising, marketing, sales, sales administration outside interconnection, billing and recouvry outside interconnection; The tax on profits; The non-recurring charges; Capitalised production; The provision for doubtful debts Replacement financial costs by the cost of capital

14. the relevant costs (2/3) • The marketing cost concerns in particular: • Acquisition & Customer Loyalty • Customer Service • invoice cost of the end user • Cost of subsidized equipment • Cost of SIM cards

15. the relevant costs (3/3) Special case:The Self-consuming cost of the License

16. valuation Methods of assets

17. valuation Methods of assets • The cost of capital is, economically, bring back to one year base a series of costs over time • The valuation method is the rule to move from investment to the annuity • By definition, the update of balance sheet on the base of annuities is equal to investment • The annuity can be decomposed into two parts: • Depreciation represents the lost value of the assets (repayment of the investment) • The return on capital (interest) • Valuation methods differ mainly by the profile of depreciation (speed at which the lost value is noticed) • Some depreciation methods uses Technical progress: • Changes in asset prices in current value of one year to another (Depends on both inflation and price movements of specific assets)

18. Historicalcostaccountingdepreciation Generally based on straight-line depreciation methodology the most commonly used in accounting Insensitivity to changes in price since the date of purchase

19. Currentcostdepreciation OCM • Accumulated amortization should allow the replacement of assets • Taking into account price changes • Accumulated amortization may be: • Lower initial investment if the price of the asset declines • Higher initial investment if the asset price increases

20. Currentcostdepreciation FCM Accumulated amortization must allow reimbursement of the investment Taking into account price changes The accumulated depreciation is equal to the initial investment Annuity: COM + correction factor method for covering investment

21. EconomicDepreciation Annuity : With (1+h)=(1+a)*(1+g) The asset value is defined as the difference between the replacement cost of assets and the cost of its conservation Independence property of the annuity with respect to the age of the asset The theoretical application of the method uses this property and is to calculate the first installment of the current cost of rebuilding the network This application is called the “file replacements cost”

22. Modern equivalentasset Source: IRG

23. Cost of capital

24. Cost of capital • The operators considered as having significant market power are allowed to charge their interconnection charges a reasonable cost of capital. • using the formula of weighted average cost of capital (WACC) is widely accepted.

25. Cost of capital The cost of capital reflects traditionally the following: • the average cost (weighted) of debt for different funding held by each operator; • the cost of capital, measured by the returns that shareholders require to invest in the network, given the risks associated with such investment; • the value of debt and equity.

26. Expected risk premium R – Rf = B ( Rm – Rf ) Or, the expected return on a stock is R = Rf + B ( Rm – Rf ) Market Risk Premium CAPM Capital Asset Pricing Model Expected return Market Portfolio Market Return Rm Risk Free Rate Rf 0.5 1.0 1.5 2.0 Beta

27. WACC formula • Cost of equity : rf+β*(rm-rf)  • Cost of debt : rf+sp • E : is the total value of equity and • D : is the total value of interest bearing debt. • rf : is the risk free rate (risk free return) • Rm : is the average rate expected on the market (eg the rate represented by a market benchmark like Dow Jones, S & P, etc. ACC.) (level of market return). •  :is a weighting factor of the differential market (equity beta) • sp : risk premium of the operator • T : Tax Rate

28. Respect of causality The cost must be allocated on the basis of causal relations and on key relevant division.

29. Cost components 1/4 The cost of general network include costs relating to: • Technical assets : These include: • investment costs (depreciation and return on capital) in relation to radio equipment, equipment for switching and routing equipment for the provision of additional services as well as technical buildings; • rental costs of radio sites. • Means of transmission in own or rented; • operating network Costs; • Cost of frequencies; • Research and development related to network activities.

30. Mobile network

31. Cost components 2/4 The specific costs for interconnection services are the costs related to : • A billing related to interconnect ( information systems and staff); • the administration and overall coordination of the interconnection (Personnel Expenses); • the audit of interconnection.

32. Cost Components 3/4 The specific costs for services of operators other than the interconnection costs are excluded from the base cost of interconnection services.

33. Cost components 4/4 Common costs are costs relating to joint activities, structure and support, including: • Head office costs; • Tax expenses; • Administrative buildings; • Mixed Buildings; • Transport staff; • Training; • IT management; • Logistics non network routing equipment.

34. Types of decisions from the regulator • Relevant Markets • Power on the relevant markets • Accounting separation • The method and rate of the WACC • Classification costs • Method for setting interconnection tariffs • Fixation tariffs following an interconnection dispute. • Decision Approval of the RIO.

35. Thankyou for your attention M. Mohammed SAYAH M. Abdelmounaim EL HAFFAF sayah@anrt.maelhaffaf@anrt.ma