economic regulation, cost methodologies and tariff regulation in the asia pacific region

John Ure Associate Professor and Director

TPR, Social Science Research Centre, University of Hong Kong

Director, TRPC Pte Ltd (Singapore)http://www.trpc.biz

Economic regulation, cost methodologies and tariff regulation in the Asia Pacific region

ITU/BDT Regional Economic and Financial Forum of Telecoms/ICTs for Asia Pacific

Kuala Lumpur, 28 September 2015

1

The Message The Agenda

Four broad themes1.The transition from PSTN to broadband and the need for economic regulation

2.Economic multipliers of network Investment

3.The driving role of competition

4.How economic regulation works

Economic regulation is essential for making the transition from narrowband TDM networks to broadband all-IP Next Generation Networks (NGN)

Network access issues (costs and access points) are key to non-discrimination

2

ASEAN Internet Penetration 2009-2013: key role of BWA

• Source: ITU World Telecommunication/ICT Indicators database

3

Country SwitchC4

Local SwitchC5 MUXLocal Switch

C5MUX

AAccess

NNode

DDigital

SSubscriber

LLocal

AAccess

MModule

IP Router

IP Router

IP

Router

Gateway Gateway

DDigital

SSubscriber

LLocal

AAccess

MModule

AAccess

NNode

CircuitSwitchedPSTN

NextGenerationNetwork

Simplified Architectures of TDM and Next Generation Network and their ‘Type 1” interconnection

Source: Cisco4

CustomerPremises

Equipment

Outside Cables

CustomerBuilding

Core Networks

Local Telephone Exchange

Internet Service

Providers

Internet & Intranets

M56K

M ADSL

SDSLAM

SDSLAM

PSTN

ATM 1

ATM 2

M56K

M56K

M56K

INTRANET

INTERNET

ISP 1

ISP 3(Private)

ISP 2

FW

ToISPs

SLU

M ADSL

‘’Type 2’ interconnection between PSTN and broadband networks5

Why economic regulation?

• Fulfil policy objectives for economic growth, employment, trade, foreign investment, etc. Incentivize investment in network extensions, upgrades and

new networks (NGNs, BWA, etc.) => network innovations Competitive pricing and service innovation

• Open markets drive competition, investment and innovation = “contestability” Remove barriers-to-entry (hidden subsidies, discrimination,

review licensing conditions, including inter-modal entry, etc.)

• Constraints can be historical or political Incumbent power sustained by partial state-ownership?

6

Quick overview of multipliersFixed TDM Teledensity Impact of 10% investment

PSTNs

OECD average (2004) 30% 2.8% increase in GDP

USA (Roller & Waverman, 2001) 40% 7.8% increase in GDP

Hong Kong (Ure, 1997) 33% 1.15% increase in GDP

Mobile Networks

Torero et al. (2002) 5-15% 0.3% increase in GDP

Waverman et al (2005) 10% 5.9% increase in GDP

Sridhar & Sridar (2004) < 20% 7.0% increase in GDP

Kathuria et al (2009) – All – Low – High

10%< 25%> 25%

1.2% increase in GDP1.3% increase in GDP1.0% increase in GDP

Note 1: Research involves different methodologies, data sets, etc. Note 2: Is there evidence that multipliers grow as economies grow? Roller & Waverman suggest so.

7

Quick overview of multipliersFixed TDM Teledensity Impact of 10% investment

Broadband

Qiang, et al World Bank, 2009 10% 1.21% increase for DME1.38% increase for an EME

Crandall, W, W Lehr & E Litian, 2007 10% 2% increase in US non-farm employment

Arab emerging economies (Mona Badran, 2011)

10% 0.05% increase in GDP in Egypt and some emerging Arab economies

25 OECD countries (Czernich et al. 2009) 10% 2.7% - 3.9%

References: 1. Christine Zhen-Wei Qiang and Carlo M. Rossotto with Kaoru Kimura (World Bank ,2009) Economic impacts of broadband2. Crandall, W, W Lehr & E Litian, 2007. ‘The Effects of Broadband Deployment on Output and Employment’, Issues in Economic Policy, 6, July 2007. 3. Mona Badran (2011) The impact of broadband infrastructure on economic growth in Egypt and some Arab and emerging countries’ Economic Research Forum, WP 5914. Czernick et al (2009) ‘Broadband infrastructure and economic growth’ CESIFO WP No.2861 - see (3) for reference.

Note: Research involves different methodologies, data sets, etc. 8

Regulatory overviewParameters Examples

Policy objectives Investment and/or competition?

Market structure SMP vs. competitive

Economic regulation Implicit subsidies: FDC vs. LRIC

Accounting approach Historic vs. Current Cost

Techno/Engineering Legacy vs. NGN

9

Policy objectivesInvestment in broadband coverage

Across ASEAN < 5% using fixed broadband access; but around 30% using BWA (See slide 3 above)

Intra-modal competition

Wholesale/retail separations, equal access and LLUB models in different economies

Inter-modal competition

Around 30% using BWA in ASEAN; TV cable Internet access widespread

Broadband speeds Fixed/Mobile averages: Global = 23.4 Mbps fixed and 12.4 Mbps mobile Asia = 28.1 Mbps fixed and 10.9 Mbps mobileSee: https://www.techinasia.com/asia-internet-speeds-mobile-broadband/

Broadband affordability

10 ASEAN economies = 2 ‘affordable’, 5 ‘moderate’, 2 ‘expensive’, 1 ‘unaffordable’ISOC Report Unleashing the Power of the Internet http://trpc.biz/unleashing-the-potential-of-the-internet-for-asean-economies/

10

Market structure

Possible market condition Economic condition

11

Economic regulation & markets

Define markets Close substitutes and cross-elasticities of D/S; geographical scope, etc.

Standalone nets and services/ ‘intrusive networks’ (e.g. OTT)

Measures of ‘contestability’ and of barriers to entry

SMP End internal subsidies; cost-oriented pricing = caps, incentive-regulation, separations, etc.

Non-discrimination Reduce barriers-to-entry; Internal value-chain cost accounting to avoid profits squeeze, etc.

Inter-modal competition Liberalise licensing: unified and unlicensed

12

Accounting approachesAccounting practices Accounting dataHistoric cost accounts (HCA) Available from company accounts, but subject

to changed circumstances, depreciated assets, subsidised assets,‘etc.

Current cost accounts (CCA) ‘To market’ values can fluctuate; makes sense to use replacement costs, but depends on the cost item

Forward-looking costs Appropriate when new technologies with lower costs replace old

Accounting assumptions Length of depreciation periods, write-downs and write-offs, local accounting practices, etc… including ‘creative accounting’ and ‘bad’ practices such as capitalizing current costs!

13

Technologies/engineering‘Vintage’ Accounting dataTDM networks Core networks TDM in many developing

economies; customer access networks mostly copper + extensive mobile connections

Multi-modal competing network services

Copper POTS, ISDN, xDSL, FTTx, coaxial cable, Wimax, GSM, WiFi, satellite, etc. = different cost structures for different levels of competition for regulated services

Hybrid networks in transition From PSTN to end-to-end IP NGNs to HS-NGN and BWA

Transitional regulation How to design and manage? Sunset periods phasing out one set of economic regulations and phasing in another to create incentives? Parallel sets of regulations for TDM and IP? Just fade out TDM regulations? 14

Economic cost vs. implicit subsidies

Incremental Proportion of total costs attributable to the output of single service or network element

Standalone All costs attributable to single firm’s product; i.e. all costs incremental

FDC/FAC Total costs directly and indirectly (allocated common and joint) attributed to a sub-set of selected outputs

TSLRIC/ TELRIC

Incremental costs directly and indirectly (allocated components of common and joint) attributed to a sub-set of selected service or network element outputs

LRIC/LRAIC Incremental costs directly attributed to a sub-set of selected service

Allocation Ramsey Pricing (inverted ED) vs. MoU15

IncrementalCost

IncrementalCost

IncrementalCost

IncrementalCost

IncrementalCost

IncrementalCost

IncrementalCost

Service-specificFixed Cost

Allocation of Partof Joint &

Common Cost

Allocation of Partof Joint &

Common Cost

Allocation of allJoint & Common Cost

Allocation ofResidual of Joint& Common Cost

FAC-based allocation ofall Joint & Common Cost

All Joint and Common Cost

+

+

+

+

+

+

+

+

+

+

+

+






LRIC

TSLRIC/LRAIC

TELRIC

TELRIC+ uniform mark-up*

TSLRIC/LRAIC+Uniform Mark-up*

FDC/FAC *

Stand-alone Costs

Notes: 1. For TSLRIC/LRAIC the increment is defined as the total service. Hence, indirect cost elements are shaded while direct cost elements are not shaded. 2. In this example, FDC/FAC is assumed to be calculated based on forward-looking economic cost methodology. 3. The total costs of the 3 cost concepts identified by an asterisk (*), do not necessarily have to be equal as shown in this example. 4. Note the relative sizes of the costing concepts are indicative only and should not be taken as an approximation of an actual costs Source: Hank Intven (2000) ed. Telecommunications Regulation Handbook The World Bank

The Relationship Between Costs, Costing Methods and Allocations

16

Competitive network access pricing

• FDC or other methods (benchmarking, retail minus, etc.) used where no other data available to regulator

• Economic (incremental cost) principles used to eliminate implicit subsidies Core network services (upstream) such as routing, directory

services, bit-streams, etc. Interconnection pricing (Reference Interconnection Offer – RIO) Line leasing and unbundling (LLU)

• Non-discrimination (lower barriers-to-entry) Quality, location and timeliness as well as service and network

element pricing Margin squeezing (a form of own cross-subsidy)

17

Example of why price cap regulation requires separate identification of costs

• Telco offers Voice + DSL services…. but if Total Factor Productivity (TFP) is estimated to include both services then overall TFP will underestimate TFP in the sector where costs have fallen faster… assume RPI rose by 5%

Price cap = Retail price index – TFP = (5% - 4.6%) = + 0.4%Source: Testimony of Dr David Gabel on Behalf of the Maryland Office of People’s Counsel

Voice + DSL Growth rate Expense Share Weighted AverageCapital +2.0% 0.40 +0.8%

Labour +1.0% 0.40 +0.4%

Materials +1.0% 0.20 +0.2%

Total Input +1.4%

Total Output assume +6.0%

TFP +4.6%

18

Price cap regulation if costs are assigned to separate services

• By separating out the costs of DSL, the price cap for voice services indicates voice tariffs should fall by 2% rather than rise by no more than 0.4%

Price cap = Retail price index – TFP = (5% - 7.0%) = - 2.0%

Source: Testimony of Dr David Gabel on Behalf of the Maryland Office of People’s Counsel

• Telco 2: Total Factor Productivity for voice + DSL service

Voice-only Growth rate Expense Share Weighted Average

Capital +1.0% 0.40 +0.4%

Labour -3.0% 0.40 -1.2%

Materials -1.0% 0.20 -0.2%

Total Input -1.0%

Total Output assume +6.0%

TFP +7.0%

19

Cost-based prices for regulated services50:50 in Asia-Pacific – lowest ratio

• Source: www.itu.int/icteye

20

Based on 40/44Countries







Perc

enta

ge o

f re

spon

ses

Traditional wholesale cost-based services47H:40C Asia-Pacific


21

Perc

enta

ge o

f re

spon

ses








Advanced wholesale cost-based servicesCurrent costs more used


22

Traditional retail cost-based services47C:40H in Asia-Pacific


23

Perc

enta

ge o

f re

spon

ses








Advanced retail cost-based services57C:27H in Asia-Pacific


24

Traditional wholesale regulated services31C:27B in Asia-Pacific


25

Perc

enta

ge o

f re

spon

ses








Advanced wholesale regulated services29C:24B in Asia-Pacific


26

Perc

enta

ge o

f re

spon

ses








Traditional retail regulated services26C:22B in Asia-Pacific


27

Perc

enta

ge o

f re

spon

ses








Advanced retail regulated services28C:28B in Asia-Pacific


28

Perc

enta

ge o

f re

spon

ses








Conclusions• Economic regulation often seems like having to square a

circle: Encourage investment in networks (supply)Keep markets competitive (options)Keep prices affordable (demand)

• Cost-oriented wholesale prices simulate competitive forces – have the highest modal use (see charts)

• Retail tariff regulation in the absence of effective market choice – regulation methods more mixed (see charts)

• Non-discrimination essential to keep markets open

29

Thank You

30

economic regulation, cost methodologies and tariff regulation in the asia pacific region

Technology