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New Zealand: Separation April 16, 2007

Posted by Jasper in Regulation.
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Telecom New Zealand announced Friday last week an outline of its response to an operational separation consultation document released by the Ministry of Economic Development last week. The interesting thing about the outline is that Telecom proposes ownership separation of its access network. This is more far reaching than the consultation document which envisages a complex form of operational separation. According to Telecom:

The complicated separation requirements add unnecessary cost, and propose governance arrangements that are unworkable within a single entity.

Watch out for the Telecom submission due on the 27 April.
You can view the media release here.
You can view the Telecom high level proposal here.
You can view the Initial Impact Assessment here.
The consultation document on the proposed operational separation of Telecom can be accessed here.
Access assorted background documents here.

UPDATE: Access the Telecom Submission here. The Minister of Communications has invited comment on the proposal.

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Ireland: Mobile termination H3GI January 12, 2007

Posted by Jasper in Mobile, Regulation.
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The Irish regulator ComReg is consulting on wholesale voice call termination on Hutchison 3G Ireland’s mobile network, releasing a consultation paper yesterday.

The interesting thing about this consultation is that reference is made to a bargaining model by Binmore and Harbord (BH).  This model emphasises the bargaining dynamic when operators set termination rates. While considerations of countervailing buying power and the like have been considered in mobile termination consultations before this would appear to be the first time that bargaining has been considered more formally by a regualtor.

ComReg has a number of reservations about the model, their principal being that its predicted outcomes do not fit the empirical evidence. The BH model predicts that H3GI would achieve termination rates equal to the average of the lowest termination rates in the market, this has not happened, as H3GI’s rates are above the levels in the overall mobile market. The BH model also predicts that in a situation of regulatory intervention stemming from the interconnectivity obligation and dispute resolution that H3GI’s bargaining power would be increased but that termination rates would remain around the average of the 2G operator rates. Again, this has not happened, H3GI’s rates are above the level in the overall mobile market.

I haven’t read the whole consultation document yet, but it certainly has a very different flavour than many other model termination consultations that nowadays more or less revolve around the same issues.

The consultation paper is available here.

UK: Spectrum costs November 29, 2006

Posted by Jasper in Costing, Mobile, Regulation.
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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.

Body of Knowledge November 14, 2006

Posted by Jasper in General, Regulation.
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I recently became aware of a website developed by the Public Utility Research Center (PURC) at the University of Florida, in collaboration with the University of Toulouse, the Pontificia Universidad Catolica, the World Bank and a panel of international experts. It is called the Body of Knowledge (BoK) on Utility Regulation. In the about section they state:

The site provides summaries of and links to the more than 300 references, an 80+ page glossary and self-testing features to facilitate learning. The references include publications and decisions by regulatory agencies and other governmental bodies; policy advisories by think tanks, consultants, donor agencies, and others; and research by academics, consultants, and other experts.

I have only looked at a few selected pages so I can’t say if the site is any good, but what I have seen certainly looks interesting.

Network Neutrality papers November 8, 2006

Posted by Jasper in Regulation.
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Recently a number of prominent economists have commented on network neutrality.

In a lengthy paper entitled “A Consumer-Welfare Approach to Network Neutrality Regulation of the Internet,” Professor J. Gregory Sidak, maintains that network neutrality regulation would prevent broadband service providers from offering a guaranteed, expedited delivery speed in return for the payment of a fee. In his analysis, Professor Sidak concludes that,

economic welfare would be maximized by allowing access providers to differentiate services vis-a-vis providers of content and applications in value-enhancing ways and by relying on existing legal regimes to protect consumers against the exercise of market power, should it exist.

Professor Alfred Kahn has published a paper titled “A Democratic Voice of Caution on Network Neutrality.” The piece originated as a comment Kahn posted to a PFF blog entry commenting on the opposition to network neutrality regulations by Bill Kennard. Kahn suggests we put our trust in competition, reinforced by the antitrust laws and direct regulation only when institutions prove inadequate to protect the public.

In essence it is Kahn’s hope that existing regulatory mechanisms – from the FCC and in particular to the Anti-trust Division at the Department of Justice – will prevent abuses. While I am skeptical of the ability to prevent anti-trust abuse in the US, I am nevertheless sympathetic to Kahn’s argument. At least in Europe where the network neutrality debate has had little air-time I think Kahn’s starting point is probably reasonable. Here powers related to Significant Market Power assessment will likely assist in combating any abuse of network neutrality.

The Netherlands: Cable unbundling November 2, 2006

Posted by Jasper in broadband, Regulation.
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This is slightly old news, but nonetheless important. On 24 October Dutch parliamentarians voted to approve a proposal that forces domestic cable TV companies (CATV) to share their networks with rivals. The new proposal is effectively a cable network unbundling (CNU) initiative and replicates the local loop unbundling (LLU) scenario in traditional telecoms networks. It also sets a precedent as this is the first time that authorities have succeeded in bringing forth legislation that would harmonise regulations for cablecos and their telco counterparts. Hence after years of insisting on a privileged classification, the cable industry may come under the same regulations as the telecoms industry.

Presently, the EC is silent on CNU, focusing instead on LLU in traditional telephone networks and the new fibre access networks incumbent telecoms companies plan to roll-out in future. Prima facie, the arguments for intervention in the CATV may not hold for the CATV industry, so it will interesting to see how this develops.

Germany: VDSL – nothing new October 31, 2006

Posted by Jasper in broadband, Regulation.
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According to the Associated Press the European Union reiterated Monday that it would take Germany to court if its parliament passes a law that allows Deutsche Telekom AG to shut out rivals from its high-speed broadband network.

It has been a while since I have seen any action on the German access holiday issue, so I was starting to wonder what might have happened. As it turns out – nothing.

EU spokesman Martin Selmayr warned that legal action would be ”unavoidable” if Berlin ignored the European Commission’s view that the law unfairly discriminates against other investors and would ultimately hurt funding for the telecoms sector. ”The Commission does not take the view that competition is the enemy of investment,” Selmayr said. ”We have indicated a number of times that we will exercise our duty … to challenge any law that is incompatible with the (EU) treaty.”

Selmayr was responding to media reports that quoted German official Bernd Pfaffenbach as saying the government had no plans to change the law.

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.

Europe: International roaming – ATKearney CRAI report September 30, 2006

Posted by Jasper in Mobile, Regulation.
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On 21 September 2006 the GSM Association (GSMA), the global trade association for mobile operators, filed a complaint with the European Ombudsman setting out its concerns about the European Commission’s proposal for regulation of the international roaming market. The GSMA’s complaint relates to three aspects of the regulation and the associated adoption process (see press release):

1) The GSMA believes the European Commission failed to conduct a proper consultation process. While the Commission conducted two public consultations on regulation of the international roaming market, they both failed to follow the Commission’s own procedures for providing clear content and adequate time for responses. Moreover, following these ‘public consultations’, the Commission drastically changed its proposal for regulation without submitting the new proposal to additional public consultation.

2) The GSMA believes the European Commission failed to conduct a proper impact assessment. The published impact assessment, which didn’t follow the Commission’s internal guidelines, is incomplete, contains important methodological flaws and is based on unrealistic assumptions. For example, the Commission concluded that consumers would see a net gain of 3.78 billion euros from the proposed regulation. But a review of the Commission’s impact assessment, prepared for the GSMA by AT Kearney and CRA International (CRAI), found that the impact on consumer welfare would be marginal at best, and could even be negative.

3) The GSMA believes the European Commission’s proposed regulation violates the principles of proportionality, subsidiarity, legitimate expectations and non-discrimination. The holistic nature of the existing regulatory framework restricts the Commission’s ability to adopt an ad hoc regulation on roaming services.

What interests me is the report undertaken for the GSM Association by AT Kearney and CRAI. The report discusses the impact of the European Commission’s plans for international roaming and maintains that the Commission has used the wrong figure for the size of the retail roaming market. According to the report’s authors:

…their corrected welfare modelling indicates that the case for the Commission’s proposed regulation is only marginal at best and could even be negative, rather than significant, as the Commission has estimated.

Let me offer a few comments.

The ATKearney CRAI recommendation centres on a Cost Benefit Analysis (CBA) and on the their own evaluation of that CBA. The CBA is an assessment of a counterfactual scenario (“the future without regulation”) with a factual scenario (“the future with regulation”) – in fact there are two factual scenarios.

In principle, the approach adopted is more complete compared to that of the Commission. It attempts to model detriments to regulation which the Commission appear to have neglected (I have not read the Commission assessment). In this sense it provides a more complete analysis of the market for international roaming and the (net) consequences of regulation. Whether or not there are measurable detriments of the magnitude suggested by the authors is an issue I explore briefly below.

One crucial correction is the Commission’s estimate of the benefits which is based on the GSMA’s estimate of the aggregate EU roaming revenues of about €8.5 billion. However, according the authors the GSMA’s €8.5 billion figure includes revenues from both the retail and wholesale markets and is not an appropriate basis on which to calculate the ultimate saving for consumers. I do not have the data to evaluate the figure, but expect that ATKearney and CRAI are correct as the number has been sourced from their client.

I agree with ATKearney and CRAI that the Commission should take account of announcements by individual operators and any announced industry agreements in the factual scenario. Also I agree that the Commission has adopted some rather suspect elasticity assumptions in some of their scenarios.

The authors introduce two concepts: cost pass-through and the waterbed effect or a rebalancing effect.

Cost pass-through is degree to which reductions in wholesale prices are passed-through to retail prices, while the waterbed effect is the degree to which operators seek to recoup lost profits in the market for international roaming from other services or markets. The waterbed effect might also be called a pass-through rate, i.e. it is the extent to which any given loss in international roaming profits resulting from regulation is translated through into increases in other retail mobile prices. A decrease (increase) in this rate produces a smaller (greater) waterbed effect, and hence a smaller (larger) detriment. Setting the pass-through rate to zero is equivalent to assuming that there is no waterbed effect.

Both assumptions are critical to the author’s analysis, unfortunately very little documentation is provided to substantiate the values used. In particular I would have liked to have seen an analysis of historical cost pass-through. In their Medium case, the authors assume that rebalancing would operate so that 80 per cent of the loss in profits on retail roaming calls would be recovered in mobile subscription charges and mobile outgoing call prices. No evidence is provided to support this value – a value I believe is exaggerated.

The authors criticize the Commission for using an aggregate measure for total welfare for consumers and industry and not considering how the proposal will impact different Member States. However, the authors themselves do not attempt a disaggregated approach. I think it would desirable to disaggregate into at least three or four category of Member State.

Any offsetting effects of their new assumptions are disregarded. For example, as a result their assumed reductions in mobile subscribers there would a corresponding outward shift of the demand for fixed calls.

In addition, makes no attempt to discuss a number of issues that could have major impact the results (although to their defense I assume they adopt the same values as the Commission). For example:

  • Study Period: what is period over which the welfare gains/losses are calculated?
  • Discount rate: The choice of discount rate in a CBA is potentially a very contentious issue. What is the level of the discount rate used to calculated the net present value of net benefits?
  • VAT: VAT should be excluded for estimates of productive surpluses since the VAT is a transfer payment; however, it is not correct in the calculation of allocative surpluses. How is it treated here?
  • Shape of demand curve. Two alternatives are typically used: a linear curve and the constant elasticity of demand curve. Which one is used?

ATKearney CRAI assume that the impact of lower wholesale roaming charges on the profitability of operators maintaining cell sites in areas in which roaming revenues are significant leading to loss of coverage. I disagree. It seems highly implausible that an operator will remove (sunk) cell sites already deployed.

A CBA should be applied rigorously and transparently. The ATKearney CRAI report appears to be an improvement on the Commission’s analysis, but it is overly critical and hence biased towards a non-regulation scenario and does not provide the detail needed for a third party to do a proper evaluation.

Access the AT Kearney CRAI report “Review of the Commission’s Impact Assessment” here and the Executive Summary of the Review here.

Australia: Coonan on FTTN investment September 8, 2006

Posted by Jasper in broadband, Regulation.
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News.com.au brought an article earlier today on Senator Coonan’s expectations for Telstra’s fibre investment. I have previously commented on this issue here and here. Here are some of her rather convoluted statements:

I expect that their decision about fibre may be revisited in different circumstances but Telstra is clearly important to the (fast broadband) picture.

I’m not going to speculate about when they might [rethink their decision] but clearly Telstra is interested in its … transformation plan

One of the reasons Telstra withdrew from the plan was its view that price proposals put up by the ACCC were not what it was seeking. Senator Coonan said there had been nothing to suggest Telstra had insurmountable problems with the ACCC.

[For around six months] Telstra was engaged … in discussing that particular proposal with the regulator and the impediments didn’t appear to be apparent until right at the end of the process. In fact there’d been a number of statements made that the majority of the issues had been dealt with. So I think that there may be in those circumstances an opportunity to revisit if Telstra wishes.

World: Momentum in international roaming September 8, 2006

Posted by Jasper in Mobile, Regulation.
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Recently, there is been a lot of focus on international roaming. Much of this interest seems to derive from the heated debate in the EU, initiated back in February when commissioner Viviane Reding warned of imminent and binding European laws to force a cut in international roaming charges.

In the period leading up to the final decision in July, a number European operators agreed to cut international wholesale roaming charges in a bid to avert EC. The EC ways not swayed by any of these initiatives and published pretty tough regulations.

Subsequently there have been several developments in international roaming on a more global scale that draw inspiration from the European experience.

In Africa, MTN (the regions largest mobile operator) is looking at reducing costs for subscribers who roam on its sister networks across Africa, according to CEO Phuthuma Nhleko. He said MTN would first look at existing international agreements before implementing any roaming tariff changes, and possibly enter into reciprocal wholesale arrangements with other operators on the continent to cap roaming costs. The MTN initiative mirrors deals between European operators.

In August, Taiwan Mobile announced it would lower its prices for cross-strait roaming services between Taiwan and China by 11.8-50.0%, through cooperation with China Mobile Communications, a leading mobile-communication services company in China, with the new charge rates to be effective on September 1 of this year.

Also in August Telecom regulators in Southeast Asia formed a task force to look into the varying international call charges among operators in the region. In an interview with BusinessWorld, National Telecommunications Commission (Philippines ) deputy commissioner Jorge Sarmiento said the creation of the task force is seen as an initial step in a bid to follow a similar move in Europe.

In Japan, NTT DoCoMo said on Tuesday (5 September) it aimed to cut tariffs for international roaming to undercut rivals and encourage more Japanese to use their phones abroad. The seven operators of the Asia-Pacific Mobile Alliance (APMA), including DoCoMo, were seeking to cut the fees they charge each other when serving each other’s customers, Toshinari Kunieda, director of DoCoMo’s global business unit, said in an interview. (APMA was set up this year by DoCoMo, Taiwan’s Far EasTone Telecommunications Co., India’s Hutchison Essar, Hutchison Telecommunications International Ltd. in Hong Kong, South Korea’s KTF Co., Indosat TBK PT, and Singapore’s StarHub Ltd). Such efforts by APMA may put pressure on other Asian alliances such as Bridge, which includes Singapore Telecommunications Ltd. and India’s Bharati AirTel.

It is very encouraging to see global flow-on effects of this kind.

OECD on separation September 5, 2006

Posted by Jasper in Regulation.
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In 2001, the OECD Council issued a Recommendation Concerning Structural Separation in Regulated Industries. The other day I came accross a recent 2006 OECD review of country experiences in this area: Report on Experiences on the Implementation of the Recommendation Concerning Structural Separation in Regulated Industries

The report finds that, in many jurisdictions, requirements for separation have grown stronger since the 2001 Recommendation. Moreover, innovative approaches are being adopted in some sectors that are functionally equivalent to structural separation.

The report discusses different types of separation that have been used, from ‘weak’ forms, such as accounting, functional or corporate separation, to ‘strong’ forms, such as ownership separation, club ownership, and separation of ownership from control.

The OECD also has numerous papers on separation:

Structural Reform in the Rail Industry 21-Dec-2005

2001 – Recommendation of the Council concerning Structural Separation in Regulated Industries [link updated]

The Benefits and Costs of Structural Separation of the Local Loop 03-Nov-2003

Structural Separation and Access Pricing: A New Synthesis, November 21, 2003, Amsterdam 08-Oct-2003

Policy Brief: Restructuring Public Utilities for Competition 22-Feb-2002

Australia: Core network upgrade September 1, 2006

Posted by Jasper in broadband, Regulation, Technology.
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Just as I had finished writing the previous post on investment in Australia I came across a Telstra and Alcatel announcement setting out Telstra’s fixed network transformation in 2006/07, with an expected value of AUD 460 million (EUR270m). The programme is part of Alcatel and Telstra’s strategic supplier relationship announced in November 2005. In 2006/07, Alcatel will establish an IP network footprint in Melbourne, Sydney, Brisbane, Perth and Adelaide. The technologies deployed will include IP-DSLAM, Ethernet aggregation and optical networking solutions.

Of course the press release also makes very clear that this upgrade is unrelated to Telstra’s previous FTTN proposal. It is interesting, however, that access to both Telstra’s core and access network in principle is regulated in the same way, but Telstra are happy to invest in the core technologies, but reluctant to invest in access.

See the press release here

Australia: Encouraging investment August 31, 2006

Posted by Jasper in broadband, Regulation.
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With the recent announcement of the sale of the Governments remaining shares in Telstra, there is been little focus on the prospects for investment in FTTN. This is understandable given the importance of the sales issue, however, with it now a done deal (it would seem) attention should once again shift to ensuring the Australian broadband future.

One of the major critiques raised by commentators is that current regulations are stifling investment and are in need of a major overhaul. While regulation is never perfect, I personally, do not find the regulations governing the telco sector in Australia to be in a particular bad shape or hostile towards investment. None of the evidence that has been presented to me, other than perhaps the current investment morass with Telstra, indicates that there might be a problem.

There is no doubt that investments in fibre will be made – also within the current regulations. If Telstra fails we must put our faith in the ‘Gang of Nine’ (G9). However, Sol Trujillo does not appear to have turned his back completely on fibre investements. So, is there any way Telstra can be encouraged to invest?

One option, could be to give Telstra an access holiday on their FTTN investment. An access holiday would give Telstra the opportunity to recoup their investment over a pre-defined period of time where competitors would have no right to access to the new infrastructure. In a sense this option acts like a patent – it creates an incentive to invest by allowing the investor a period where it faces no access regulation. Note that it would still open for the access provider to negotiate access terms with potential seekers. However, this approach effectively forecloses competition and promotes monopoly pricing in the holiday period.

Another option could be to allow Telstra to recover an additional premium on top of the Total Service Long Rund Incremental Cost (TSLRIC) of access. Conventional wisdom dictates that TSLRIC sends the “correct” signal to the market about building or buying. When a price is set at TSLRIC entrants will be encouraged to use existing incumbent facilities if, and only if, it is economically desirable to do so. And for the incumbent investment incentives are preserved to upgrade or extend the existing network when new technology is available. However, one of the insights of real option theory is that a regulated price equal to TSLRIC might not be enough to provide firms with efficient investment incentives in case the investment is irreversible, uncertainty is present and the firm has managerial flexibility to postpone the investment. As long as these three assumptions are partly correct a firm will require some premium to cover the lost option value associated with investing today instead of postponing the investment decision. [see Holm (2000) for an excellent introduction to access pricing under uncertainty and from whom I have sourced many of the arguments in the following]

As noted by Ofcom:

If the riskiness of a firm’s investment is modelled using the CAPM and Net Present Value (NPV) analysis, then …. the systematic risk faced by investors is taken into account via an estimate of the firm’s Weighted Average Cost of Capital (WACC). Cash flows should be calculated in such a way as to ensure that the rewards from successful investments within the portfolio are expected to be sufficient to pay for the losses associated with unsuccessful investments. This analysis does not, however, explicitly take into account the extent to which risk can be mitigated by the adoption of certain investment strategies (e.g. investing later in order to “wait and see” how a market develops, or investing early in order to gain a first mover advantage). It may not, therefore effectively mimic the signals given by a competitive market with regard to risky, non reversible investments.

However, regarding existing unconditioned local copper loops, already in place, the investment has already been undertaken. An option premium is therefore unnecessary. In option terms one could say that the value of the option to “wait and see” is zero.

Of course, if we accept the option argument, the entrants’ incentives to invest in alternative infrastructure is reduced compared to a situation where the local copper loop is priced above TSLRIC. However, this bias is appropriate because society does not face any opportunity cost when renting the copper already in place. To add a premium to TSLRIC for existing loops and biasing the decision in favour of investing in alternative infrastructure would imply that society incurred otherwise avoidable opportunity costs, duplicating the existing infrastructure. Therefore a price based on TSLRIC alone is appropriate for existing local copper loops.

With regard to new investments and upgrades along the line that Telstra are proposing, however, the option value argument seems to have merit. If the ACCC is not offering Telstra a premium on top of TSLRIC, real option theory would predict (in line with current behavior) that Telstra would postpone the FTTN investment in fibre until uncertainty about demand, investment costs, technology and regulation has been reduced. To the extent that consumers are willing to pay a price for new services that would be result of a FTTN network that exceeds TSLRIC, a welfare loss would be incurred.

So is the answer to allow Telstra to recover a real option premium?

If the FTTN investment is 1) irreversible, 2) involves uncertainty over future net revenues and 3) can be postponed; then the answer is yes: the regulated access price would need to include a premium on top of TSLRIC to compensate Telstra for the lost “wait and see” option.

If the FTTN investment is 1) reversible, 2) involve no uncertainty over future net revenues and 3) can not be postponed; then the answer is no: the regulated access price should not include a premium on top of TSLRIC.

For the FTTN investment the real option argument would appear to be strong. There is certainly uncertainty of demand, the investment will be sunk and it can be postponed as we have seen. Case closed – compensate Telstra for the the lost option value. Unfortunately, it is not that easy. There are a number of potential objections could be made to weaken Telstra’s case. For example:

  • In many cases it will not be possible for a firm to enter or compete effectively within a market unless it already has a presence in the market. Investing therefore, confers real options on a firm, rather than (or possibly in addition to) using them up.
  • By undertaking the FTTN investment Telstra may reduce uncertainty, providing it with valuable information about costs as well as demand for its product. So, while uncertainty will increase the value of waiting until further information has arrived, the opposite is true if investment by Telstra provides it with information that reduces uncertainty.
  • Waiting is associated with costs. Cash flows are foregone and other firms like the G9 may enter. These costs of waiting must be balanced against the benefits of waiting for new information, making it less clear that there is a net cost of extinguishing an option to wait.

All in all, the case for an option compensation is not an easy one to make. And not having a robust methodology to derive its value in a regulatory setting certainly doesn’t make matters easier. In this respect the holiday approach may be the preferred option.

Further reading:

For the Australian perspective on real options see the following submission by AAPT here.

Robert Pindyck (2005), Pricing Capital Under Mandatory Unbundling and Facilities Sharing, NBER Working Paper No. 11225. This paper resulted in part from a study commissioned by Verizon. The paper shows how pricing formulas used to set lease rates can be adjusted to account for the transfer of option value from incumbents to entrants, and estimates the average size of the adjustment for fixed local voice telecommunications in the U.S

US: Background on FTTx regulation August 23, 2006

Posted by Jasper in Regulation.
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In a recent post I commented only briefly on the regulatory shift that has occured in the US wrt. the unbundling and mandating access. Below is some background information on that shift.

Regulation in the US is based on the 1996 Telecommunications Act (hereafter ‘the Act’). The aim of the Act is to open up all aspects of telecommunications in the US to competition and to enhance the deployment of advanced telecommunications services. The Act is designed with the long-term aim of gradually replacing industry regulation with market competition.

In August 1996, the Federal Communications Commission (FCC) published the first of three orders to give precise meaning to the Act. The first order – the Interconnect Order – requires the Incumbent Local Exchange Carriers (ILECs) to open their networks to enable competition in local services.

The Order takes as its starting point the philosophy that Competitive Local Exchange Carriers (CLECs) might want to enter the local services market in a variety of ways. For example, they may want to:

  • build their own facilities;
  • rent network elements (such as local loops) from the ILECs; and
  • resell the ILECs’ local services in combination with their own facilities based long-distance services.

The Order does not attempt to favour any one approach; the FCC argues that it is best for the market to decide. At this early stage, the FCC stressed the need for “stepping stones” to competition, i.e. a concept similar to that used in Europe called the “ladder of investment”.

The Order identifies a minimum set of five technically feasible points at which ILECs must offer interconnect. These points are:

  • the line side of a local exchange (for example, the MDF);
  • the network side of a local exchange;
  • the trunk interconnect points of a tandem switch;
  • local exchange cross-connect points; and
  • out-of-band signalling facilities such as signal transfer points.

Given these points of interconnect, it defines six sets of unbundled network elements (UNEs) that the ILECs must offer on a non-discriminatory basis at reasonable prices to CLEC.

However, more recently the US has taken a 180 degree turn. spurred in part by ILECs successfully arguing that they should be treated in a manner similar to cable TV providers (the leading providers of broadband services in the residential sector) who have no obligation to provide UNE from their networks.

As a result of two recent decisions – the Triennial Review Order of 2003 and the review of Section 251 unbundling obligations of 2004 – and findings from a court case on the Triennial Review Order, the FCC now rules that:

  • there is no requirement for an ILEC to supply unbundled elements from its FTTH or fibre to the curb (FTTC) facilities, in particular:
  • New builds. An ILEC is not required to provide non-discriminatory access to a FTTH loop or FTTC loop on an unbundled basis when the ILEC deploys such a loop to an end user’s customer premises that previously has not been served by any loop facility.
  • Overbuilds. An ILEC is not required to provide non-discriminatory access to a FTTH loop or a FTTC loop on an unbundled basis when the incumbent LEC has deployed such a loop parallel to, or in replacement of, an existing copper loop facility.
  • ILECs are no longer obliged to supply UNE platform offerings;
  • ILECS are not required to preserve existing rented local loops or offer rivals substitute products when they replace their copper loop access with fibre; and
  • there is a requirement for ILECs to supply rivals with access to all except the largest office blocks using DS1 or DS3 circuits. However, there is no requirement to offer dark fibre.

These rules are subject to 12-18 months transition periods to give the CLECs time to negotiate commercial terms or make alternative arrangements for supply. During this period, an ILEC is not obliged to supply new UNEs.

In the Triennial Review Order, the FCC emphasises that marketplace realities of robust broadband competition and increasing competition from intermodal sources eliminating unbundling requirements for broadband architectures serving the mass market. The outcome of the Triennial Review Order was therefore the limiting of unbundled access.

More generally, the Commission has endorsed facilities-based competition and only required unbundling where carriers genuinely are impaired without access to particular network elements. According to the FCC, its approach provides the right incentives for both incumbent and competitive LECs to invest rationally in the telecommunications market in the way that best allows for innovation and sustainable competition.

As noted by Commissioner Michael Powell:[8]

Deep fibre networks offer consumers a ‘triple play’ of voice, video and data services and an alternative to cable. By limiting the unbundling obligations of incumbents when they roll out deep fibre networks to residential consumers, we restore the marketplace incentives of carriers to invest in new networks.

However, the move has not been without controversy and there are clear opposing views. For example, Commissioner Michael Copps takes the opposite view:

I don’t believe competitive telecommunications have been faring very well under our watch and this particular proceeding strikes me as yet another in a series of prescriptions this Commission is willing to write to end competitive access to last mile facilities…

The loop represents the prized last mile of communications. Putting it beyond the reach of competitors can only entrench incumbents who already hold sway. Monopoly control of the last mile created all kinds of problems for basic telephone service in the last century, and now we seem bent on replicating that sad story for advanced services in the digital age….

It doesn’t take a compass to see what direction this is heading. With fewer and fewer loops available to competitors, more and more control will be wrestled away from consumers and placed with the entrenched owner of the last mile facility. By shutting off the last mile to competitors, the Commission is not ushering in a new era of broadband. It is returning to the failed and non-competitive policies of the past.