REVISED TAL MODEL GUATEMALA NOV 4-8 , 2002

1. REVISED TAL MODEL GUATEMALA NOV 4-8 , 2002

2. Bridging The ICT Divide • Istanbul Action Plan: • Access to ICT facilities is an imperative to Socio-econ growth, particularly in developing countries. • Access to ICT services is highly contingent on telecommunication networks that deliver services at prices that are equitable, affordable and cost oriented. • These are fundamental pricing principles.

3. Interconnection & The Digital Divide • A range of physical, logical and commercial interface required to complete a call on a network on which the call did not originate. • Indeed interconnection is essential to facilitate seamless communication between end users subscribing to different service providers. • It is,Therefore, a critical node to ensure that end users are exposed to a matrix of choices in accessing ICT services.

4. Interconnection Triangle • Regulator Consumers Service Providers

5. Conceptual Battleground. • FDC vs IC • Historical vs Current Cost

6. FDC vs IC • Developed countries favoured IC while developing countries favoured FDC • Developing countries operators claim that FDC permit cost recovery while IC does not necessarily guarantee such. • Developed countries operators complain that FDC is inefficient pricing and would consider FDC only if certain efficiency criteria are met including: • Cost allocation based on causality, ABC; • Valuation of assets at current prices;

7. The Triangle &ITU/WTO Interconnect Imperatives? legislation • Applicability: Network technical standards. (legislation/Regulation) • Compulsory Interconnection: access to ROAs at any technical feasible point on incumbent’s network to duly authorized competitor.(Legislation/Regulation) • Network Unbundling: Separation of network elements according to usage/demand. (Legislation/Regulation) • Non-Discrimination: No most-favoured interconnect pricing between an ROA and its subsidiary. (Legislation). legislation

8. Continued Transparency: An overarching clause. (Legislation/Regulation) Cost-Oriented Prices: interconnect rates should be based on the cost of the components used to deliver the service. (Legislation/Regulation supported by appropriate costing methodology/model to estimate cost) Cost estimates are necessary to determine cost oriented pricing for providing service. cost model

9. Fundamental Costing Principles • Transparency: “Open availability of information used in cost derivation in order to allow comprehension of the final from the vintage point of an external analyst” • This principle is critical for verification of cost and advancement of the process of competition.

10. Continued • Practicability: “the ability to implement a costing methodology with reasonable demands being placed on data availability and data processing in order to keep the costing exercise economical, yet still useful.” • The complexity of cost models must take into account the trade off between limitations in available human resource, timeliness of information, cost of implementation of methodology and and in-house resources to monitor and revise methodology.

11. Continued • Efficiency: “The provision of forecasts of cost reduction that results from a more efficient combination of resources.” • This is the most nebulous principle since there is no common barometer for stipulating efficiency. Even within the ITU models different models have different benchmarks for measuring/extrapolating efficiency.

12. Network Pricing Revolution • Unbundled Costs: • Access Network • Conveyance Network Unbundled Conveyance Network to provide interconnection at: • Local switch • Single tandem • Double tandem.

13. PSTN

14. Simplified Component Usage RE: Call Path • Number dialed on originating network to subscriber on another network. • Signal sent from equipment to originating switch. • Originating switch examines called digits, recognizing that digits are in another local exchange activates and routes a query trigger to the STP.

15. Continued • The STP performs the translation and routes the query to an appropriate SCP. • SCP matches the location of routing number associated with dialed number. • SCP response containing location routing number is sent back to the originating switch by the STP. • Originating switch receives message and routes call to recipient switch based on location routing number. • Recipient switch continues the switching (including signaling and transmission until call reaches destination.

16. Invariably Call Path Utilizes Components Of: • Switching network (including signaling network), • Transmission Network and • Access network (if included) Since the first two are used invariably whenever interconnection is required, the objective is to find an estimator which derives the most efficient component Costs, subject to market peculiarities. This is the objective of the TAL model for Caribbean and Latin American countries.

17. Objectives Cluster Consumers: Need affordable Prices Regulator : Ensure market price Encourage consumer Demand and network Investment cost oriented pricing Competitors: Need the most cost Incumbent: Needs the Best rate for use of Network facilities. Efficient Rates to encourage Investment.

18. Economics of TAL Model • Long Run Efficiency Costing

19. Formula • General LREC formula: • C = A(1-ß)/Mo • Where: • C= per minute cost of traffic • A= total cost (direct, indirect and common) • ß = Efficiency factor • Mo = traffic throughput.

20. Diseconomies of scale Relatively high financial costs Geographical impediments Procurement disadvantages Etc Long Run Economic- Efficiency Costing (LEC) Incremental Economic-Efficiency Costing (IEC) Note that they are both long run concepts. Efficiency Constraints

21. EEC = Aå/M1 Aå = total cost adjusted for unavoidable dis- economies of scale (inefficiency). M1= total traffic (current + expected) IEC= A@/M-1 A@ = cost of additional components to deliver interconnect traffic, subject to adjustment for inefficiency M-1= interconnect traffic LEC & IEC

22. Accounting Modalities Direct Costs : Annualized equipment costs (depreciation) + annualized cost of capital (interest on loans and reasonable return to equity) + acquisition and installation costs + proportion equipment which cannot as yet be depreciated + annualized operational, repair and maintenance costs (OPEX) where appropriate R&D costs; plus

23. Accounting Modalities Indirect Costs: Shared expenses attributed to more than but not all activities i.e. site, trenches, ducts, electricity, network management systems etc. Plus Common Cost: General administration, Other R&D, bad debt expenses, taxes not included in direct or indirect expenses.

24. Continued Generally incurred in the provision of All services that do not have specific And therefore traceable causal relationship to any one i.e. general administration,(including: over heads, head office expenses, training), accounting systems, taxes, bad debts, etc.

25. Modeling Equipment Cost • Equipment Cost: estimated on the basis of current cost. • Historical costs tend to favour the incumbent at the expense of the competitor and consumers welfare. • However, there may be need for adjustment to account for diseconomies of scale.

26. TAF/BDT Model • Objective : Assess the cost of resources used in the delivery of telephone service. • Cost concept: ITU –T Recommendation D 600R Enhanced Fully Distributed Cost (EDFC) • Adopting the principles of ABC unit cost of service = total cost/traffic volume • Adjusted historical cost: use the accounts of the network operator, amortization is adjusted to correspond with current replacement cost. • Demand side of the equation is modified to deduct non-voice traffic and the cost side is modified accordingly.

27. TAF Adjustment to Current Cost • Example: Purchase price of equipment in year 0 = $10 Million • Manufacturer’s amortization schedule 10yrs • Market price of equipment falls by 8% per annum • Depreciation allowance in year 2 = 10 000000x (1-0.08)2/10 = 846, 400 instead of 1 000 000.

28. Depreciation A very sore bone of contention Methods: • Straight line • Adjusted straight line • Front loaded or back loaded sum of digits • Annuity • Applicability • Likely movement of real price of asset over its life span taking into consideration productivity, revenue earning capability over asset life and obsolescence

29. Modeling Other Costs • Cost of capital: Should reflect opportunity cost of investment. Rate of return should be determined by the capital market. Note that the rate should cover investment costs, including equity and debt costs. • OPEX: Proxy mid-range/best practice values should be used given that the Latin America & Caribbean region has relatively high OPEX costs. • Ancillary costs: May be estimated by allowing a mark up based on best practice bench marks.

30. Technology Modalities Re: Efficiency • Core network is circuit switched; • Complete digital switching; • A two tier switching system: tandem switching, local switching supported by remote switching; • Extensive usage of fibre in urban areas; and • Application of relatively modern transmission technology.

31. Estimating Unbundled Switching Costs • Objective is to estimate the LEC and IEC of switching traffic over different switching elements on the network including: • Tandem Switch • Local Switch • Remote Switch

32. Partial Core Network

33. Switching Network Continued Local Switching: Line side facilities: (including but not limited to) connection to local loop at MDF and Line cards; Trunk side facilities: Connections between trunk-side termination at trunk-side cross connect panel and trunk cards Other facilities that connect lines to lines, lines to trunk, trunk to trunk and features such as telephone numbers, dial tone, local area signaling, customer calling, Routing functions etc

34. Continued Tandem Switching: Facilities that afford connection between trunk termination at cross connect panel and trunk cards; Facilities that provide trunk to trunk switching; Facilities that provide other functions including: call recording, call routing to operator services and signaling conversion features. Signaling Network: includes signaling links and signaling control and transfer points.

35. Cost Estimation • 1. Component Identification • 2. Data collection (See table 1.p13) • 3. Undertake cost estimates : unit & total investment costs (appendix I), Depreciation, annualized (OPEX, indirect costs and common costs that are traffic sensitive). • Calculate total cost per switching component sum: annualized direct, indirect and common costs.(appendix I) • Calculate interconnect component costs

36. Estimating Demand • Definition: number of calls or number of minutes switched. • Current demand, calls = number of successful & unsuccessful call attempts that engage the switch • Current demand, minutes= minutes of switched traffic plus holding time. • Expected demand Calls /minutes) = current demand + growth factor. • Traffic per switching component is determined by traffic routing. Routing factors have to be accessed or computed.

37. Primary LEC &IEC • LEC = total cost /total demand. • IEC = Incremental cost/incremental demand. • Crude calculations that do not take into account market distortions and such do not address issues of efficiency.

38. Network Dimension & Efficiency • Network is normally dimensioned to facilitate peak loads as denominated in busy hour call attempts and busy hour erlangs. • Efficient dimensioning of the switching network to equate required capacity to handle busy hour traffic (call attempts and erlangs, including growth factor) with installed switching capacity. • If not the network is inefficient either in terms of excess or under capacity. • The key concern for the regulator is excess capacity.

39. Efficiency Adjustment Key efficiency adjustment questions: • Is excess switching capacity avoidable? If so what is the economic cost of the excess? E.g. If computed consistent busy hour traffic demand for a particular switch is Q but closest manufacturing specification for that switch is of capacity Q1where Q1 > Q, the excess capacity Q1- Q is unavoidable. 2. If the operator elects to install a switch with capacity Q2, where Q2 > Q1, there is a gap Q2 - Q1. If pQ2 > pQ1 the efficiency gap is negative and avoidable and requires an efficiency adjustment factor.

40. Evaluating Economic Cost • Negative efficiency gap in terms of excess capacity is Q1/Q2 = ß • Then ß is the adjustment factor that should be applied to reduce LEC or IEC switching cost estimated earlier.

41. Modeling Transmission PSTN transmission involves narrow band and leased line services. Objective is to derive the unbundled cost of narrow band services. Such services do not include Fax and voice via ISDN lines. Linkages modeled: RAU-LS LS-LS LS-TS TS-TS

42. Transmission Network Transmission electronics Multiplexers, digital cross connectors,regenerators etc Infrastructure: ducts, trenches, poles, cable & fibre etc. Network Unbundling Interconnection at: (See relevant diagram above) • Local switch: purchase restricted to transmission linkage between remote and local switches. ii) Single tandem : purchase restricted to those at (i) plus linkage between local and tandem switches. iii) Double tandem: purchase of transmission link between tandem switches plus purchases indicated at (ii) above.

43. Costing Procedure • Similar to that employed for switching: • Data collection on transmission equipment and infrastructure (pp 22- 24) • Critical to make appropriate assumptions as to the minimum levels of transmission technology. (pp 24-26) • Access and study blue print of transmission network. • Estimate the cost of the transmission links on actual network (Appendix V) • OPEX and Ancillary cost may be estimated using benchmarks. (optional)

44. Accounting for Leased lines • Collect data re: number of 2 Mbits links dedicated to: • Retail carriers • Mobile carriers • Other services • Estimate the proportion of the PSTN dedicated to leased line traffic. • Based on dedicated capacity calculate leased line traffic in Mbits (Eq 23. P.32) and subtract from total traffic. • Subtract that from total transmission cost leased line cost

45. Estimate Re: LEC & IEC • Subject to routing profile: • LEC per transmission link = Tci/Vi • IEC per transmission link = Ici/Vni • Where Tci = total cost of transmission facilities used for voice traffic including interconnect traffic. • Vi = total mbits of voice traffic. • Ici = additional cost of facilities for interconnect traffic. • Vni = Mbits of interconnect traffic.

46. Actually Incurred Cost vs Cost of Efficient Service Provision • General agreement that every service provider should strive for provision of “optimal”cost efficient services. • This concept should form the basis for cost derivation and therefore cost oriented pricing. • This concept proposes costing based on up-to-date technology supported by efficient operation. • Developing countries argued that: because of difference in economies of scale efficiency criteria are different on relatively smaller networks given that network dimensioning do not favour even the largest operators in developing countries.

47. Critical Efficiency Indicators • Capacity reserves built into installation to accommodate future traffic since cost based on this capacity would not truly reflect the cost of current operation. • Depreciation rates based on economic life of assets. • Cost of capital • The relationship between OPEX and equipment costs. • Cost of universal service.

48. Efficiency • Maxim: “Operators must verify that idle capacity is not the result of inefficient use of resources. They must ensure that all available capacity is used within a period compatible with good replenishment practices “ • K1 = Max {0,∆K-K0 *[(1+λ)n – 1]} Where: λ is the compounded growth rate;

49. Continued • K0 is current capacity; • N is appropriate replenishment period; • K is spare capacity; and • K1 is inefficient capacity. • If K1 is positive, investment cost should be reduced by K1/(K0 + ∆K). • Example: • Assume K0 = 200

50. Continued • Current Demand = 150, is forecast to increase by 15% per annum; • Period for capacity maturity i.e long run period is 3 yrs • Them K1 = {0; 50- 150* [(1+0.15)3 – 1]}=0 • If actual growth in demand is 5% then: • K1 = 26.36 in which case cost would have to be reduced by 26.36/200 = 13.8%.