Access and Termination Charges in Telecoms

1. Access and Termination Charges in Telecoms Jonathan Sandbach Head of Regulatory Economics Vodafone Group + 44 7795 300653 jonathan.sandbach@vodafone.com 30 June 2006

2. Net Neutrality in context of 2SM

3. Net Neutrality Debate Net Neutruality debate started in US... ...appying to “incumbent“ network platforms: • Access networks (DSL, fibre, CATV) • Next generation networks (NGN) Opposing View Net Neutrality Non-discriminatory access to all content providers Networks make judgements on how different types of content are to be handled and priced

4. 2SM Model 2SM model incorporates two special cases: • Content providers (e.g. Google, Yahoo) want to push content onto networks with lots of subscribers  • Networks want to pull content (e.g.UEFA champion league) onto their networks to get subscribers Opposing View Net Neutrality Assumes first case only applies - and so is special case of 2SM Networks have flexibility to arrange and price content to maximise value to subscribers

5. When can net-neutrality be applied? Opposing View Net Neutrality Non-discriminatory access to all content providers Networks make judgements on how different types of content are to be handled and priced • Mature/incumbent monoply platforms ? Developing/competing platforms ?

6. Mobile networks in developing markets2SM and investment incentives

7. Mobile networks as 2SM 2SM: Call origination and termination • Developed markets ...where platform coverage is complete  interest: • price structures • Developing markets ...where platform coverage is incomplete (and function of investment)  interest: • price structures • endogenously determined investment levels

8. Numerical example (1) Assumptions Annualised cost of a mobile network rural base station $1,200 Expected incremental traffic (both originating and terminating) 10,000 minutes/year Simplistic assumption: orig. & term. calls incur equivalent capacity cost on the base station • Average cost of a call minutes 12 cents. Ratio of inbound to outbound call minutes for this rural base station 2:1 Ratio of incremental/average cost of minute on whole network 50% Retail price of a call minute 20 cents. Overall impact of investment in new rural base station Total incremental revenue $2,000 (10,000 minutes x 20 cents/minute). Incremental cost of base station $1,200 Other Incremental capacity investment $600 (10,000 minutes x 50% x 12 cents) Total cost $1,800 Incremental profit $200  Worthwhile investment.

9. Numerical example (2) Impact on individual network operator …with a market share of 25% when termination rate is set at cost of 12 cents. Incremental minutes 10,000 …Outbound 3,333 …Inbound 6,667 …On-net outbound 833 (25% x 3,333) …On-net inbound 1,667 (25% x 6,667) …Other operator outbound 5,000 (6,667 less 1,667) …Other operator inbound 2,500 (3,333 less 833) Outbound revenue on new base station $667 (3,333 minutes x 20 cents) Outbound revenue in rest of network $333 (6,667 minutes x 25% x 20 cents) Inbound revenue $600 (5,000 minutes x 12 cents), Total incremental revenue $1,600 Incremental cost of the base station $1,200 Other incremental capacity investment $150 (2,500 minutes x 50% x 12 cents) Terminating outpayments $300 (2,500 minutes x 12 cents) Total incremental cost $1,650 Incremental profit -$50  Investment will not be made In fact, if the investment were made, the other operators would gain $250, arriving back at the net industry gain of $200. The point is that no operator will be incentivised to make the investment that is profitable for the industry as a whole.

10. Numerical example (3) Impact on individual network operator …with a market share of 25% when termination rate is set at cost of 15 cents. Incremental minutes 10,000 …Outbound 3,333 …Inbound 6,667 …On-net outbound 833 (25% x 3,333) …On-net inbound 1,667 (25% x 6,667) …Other operator outbound 5,000 (6,667 less 1,667) …Other operator inbound 2,500 (3,333 less 833) Outbound revenue on new base station $667 (3,333 minutes x 20 cents) Outbound revenue in rest of network $333 (6,667 minutes x 25% x 20 cents) Inbound revenue $750 (5,000 minutes x 15 cents), Total incremental revenue $1,750 Incremental cost of the base station $1,200 Other incremental capacity investment $150 (2,500 minutes x 50% x 12 cents) Terminating outpayments $375 (2,500 minutes x 15 cents) Total incremental cost $1,725 Incremental profit $25  Worthwhile investment Higher termination incentivises investment

11. Numerical example (4) • In this simple example incentives to invest in new base stations will be positively related to the termination charge… …when inbound/outbound traffic ratio is skewed towards incoming calls (which will be the normal case for marginal base stations in developing markets). …when inbound/outbound traffic ratio is skewed towards outbound calls incentives would be reversed. • Numerical example of what may effect optimal level of investment (profit maximising & welfare maximising): • regulated price structure • demand and network externality characteristics of incremental users on each side of market (e.g. incoming/outgoing call asymmetries) • High market share, or more on-net traffic, will internalise the effect (profit maximising investment converges on welfare maximising) Application to roll-out of mobile platforms in developing markets