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UK: Spectrum costs November 29, 2006

Posted by Jasper in Costing, Mobile, Regulation.

In a letter sent to Ofcom the European Commission expresses concerns as to how wholesale tariffs, charged by the five UK mobile operators for terminating calls to their customers, have been assessed. In the Commission’s view, Ofcom’s proposed tariffs keep termination values higher than necessary due to 3G spectrum cost valuations which risk overestimating the costs. The Commission therefore asks the UK watchdog to reconsider the valuations. OFCOM’s approach would be detrimental to fair competition in the UK’s mobile market and lead to higher consumer prices for consumers. Commissioner Viviane Reding said:

I am concerned that Ofcom’s approach to calculate 3G spectrum costs could hinder the movement towards lower mobile interconnection prices.

The Commission believes that such costs should not be calculated on the basis of prices paid during the spectrum auctions, which are in today’s context inflated. Otherwise, distortions of competition and higher prices for mobile customers could be the result. I therefore ask OFCOM to reassess their method of calculating mobile termination rates in the UK.

I am generally of the belief that mobile termination prices in most jurisdictions are excessive, but I am surprised that the Commission has decided to attack Ofcom on this issue – Ofcom who were the first to create a mobile LRIC model and have been very aggressive on excessive termination rates. There are many assumptions in the UK mobile LRIC model that could be questioned. To pick one, as the Commission has done, tastes of regulatory cherry picking.

The target mobile termination prices are € 0.078 (5.3 pence) per minute for 2G/3G and € 0.089 (6 pence) per minute for 3G operators. According to the Commission, Ofcom has indicated the inclusion of 3G spectrum costs adds, on average, € 0.016 (1.2 pence) per minute to the mobile termination rates for the 2G/3G operators and € 0.028 (1.9 pence) per minute for the 3G-only operator. Even a small reduction in spectrum costs could therefore have an effect on prices.

However, valuation of spectrum on a current cost basis is no easy task. While a re-valuation of spectrum costs is likely to lead to a reduction, it is far from clear that any reduction in cost will be significant. Europe Economics considered how spectrum could valued in a report to the Commission in 2001. In it they noted:

One interesting case of particular importance in mobile telephony is the appropriate valuation of spectrum. Since the spectrum for 2G licenses cannot be traded, the NRV [Net Realisable Value] is zero. It could also be argued that the replacement cost is infinite (since it is impossible to purchase a similar asset), except on the rare occasion when further spectrum licences are offered for sale (e.g. 3G auctions). Even in these instances, spectrum is typically sold in large blocks that may be inappropriate for the replacement of 2G spectrum alone (MEA adjustments would be necessary). Furthermore, such sales are infrequent and therefore not helpful for calculating current costs on an ongoing basis.

The basis for Europe Economics analysis is the value to the owner convention. This defines current cost as the lower of replacement cost (RC) or deprival value (the greater of either selling the asset or using the asset). This can be written as Min [ RC, max [ NRV, NPV] ]. The replacement cost measures the cost of replacing the existing asset with another asset of similar performance characteristics; NRV is the net realisable value, the amount that would be obtained by selling an asset; and NPV is the net present value, the sum of discounted cash flows that an asset is expected to generate during its lifetime.

According to Europe Economics the substantial barriers to replacing 2G spectrum mean that it is not appropriate to use replacement cost for defining the current cost of spectrum. Hence, using the formula above, the current cost of spectrum is the greater of either zero (which is the NRV) or the NPV of the spectrum.

Basing the cost of spectrum on NPV requires the evaluation of the the expected future profits available to the mobile operator in question (after allowing for return on capital), over the life of the spectrum rights. If the future expected profit stream is greater than zero, the current cost of spectrum is the expected future profit stream (allowing for return on capital).

An easier methodology (but also subject to critique) may simply be benchmarking of spectrum value across Europe. This is likely to give the lower value desired by the Commission.

The Commission’s letter is available here.

Japan: The need for speed October 2, 2006

Posted by Jasper in broadband, Costing, NGN, Regulation.
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Japanese incumbent NTT Group plans to build a 10-Tbit/s optical backbone network to cope with the capacity demands of a growing FTTH and high-speed DSL customer base. The carrier’s growth in high-speed broadband connections is putting its current 1-Tbit/s backbone under strain. NTT says it needs to step up from its current DWDM backbone, which multiplexes 10-Gbit/s signals, to a 10-Tbit/s network that can support multiple 100-Gbit/s channels because “data traffic has been doubling every year due to the rapid spread of broadband access.” Most of NTT’s broadband customers have at least 50-Mbit/s connections. See article in Lightreading for more information.

With greater and greater bandwidth and increasingly more greedy data applications the core network backbone must adapt. From a cost modelling perspective this can only mean one thing: the relative cost of a voice interconnect must be declining. This is particularly the case when considering the cost of a forward-looking network, where voice and data services are fully integrated.

The ongoing saga of mobile termination August 7, 2006

Posted by Jasper in Costing, Mobile.
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In a recent report Jerry Hausman and Julian Wright revisit the issue of mobile termination costing. The authors develop a framework where mobile subscribers can substitute cheaper mobile-to-mobile calls for expensive fixed-to-mobile calls. They purport to show how this substitution (which they claim has been ignored in the existing literature and regulatory proceedings) can undermine the normal argument of a competitive bottleneck in mobile termination. Termination charges, in equilibrium, are constrained by the ability of consumers to substitute.

The authors calibrate a model of the Australian market which shows that:

  • Penetration is maximized at (a =) $0.30 per minute since high FTM prices (above profit maxing level) encourage more subscription; and
  • Welfare is maximized at (aw =) $0.18, which is lower than equilibrium but much higher than cost of $0.05 (their estimate).

I must admit I find these results incredible and in need of a review. I will post commentary on the model when I have had a closer look.