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19862-64 | Commercial in confidence
Implementation of a margin-squeeze test in
Macedonia
Presentation for the Izmir Cullen Conference
21 February 2013 • Paulina Pastor Alfonso
19862-64 | Commercial in confidence
Copyright disclaimer
Copyright © 2012. The information contained herein is the property of
Analysys Mason Limited and is provided on condition that it will not be
reproduced, copied, lent or disclosed, directly or indirectly, nor used for
any purpose other than that for which it was specifically furnished
2
19862-64 | Commercial in confidence
Introduction: About Analysys Mason
Methodology for a margin-squeeze test
The Macedonian case versus the Italian case
Q&A
Contents
3
19862-64 | Commercial in confidence
Analysys Mason is uniquely positioned to provide consulting and research to the TMT industry
4 Introduction: About Analysys Mason
Our focus is exclusively on telecoms, media and
technology (TMT)
We support multi-billion dollar investments, advise
clients on regulatory matters, provide spectrum valuation
and auction support, and advise on operational
performance, business planning and strategy
We have developed rigorous methodologies that deliver
tangible results for clients around the world
We analyse, track and forecast the different services
accessed by consumers and enterprises, as well as the
software, infrastructure and technology delivering those
services
Research clients benefit from regular and timely
intelligence in addition to direct access to our team of
expert analysts
Our dedicated Custom Research team undertakes
specialised and bespoke projects for clients
Research
Consulting
Transaction
support
Strategy
and planning Operational
consulting
Procurement Regulation
and policy
Consumer services
Enterprise services
Telecoms software
Regional markets
Network technologies
19862-64 | Commercial in confidence
Contents
5
Introduction: About Analysys Mason
Methodology for a margin-squeeze test
The Macedonian case versus the Italian case
Q&A
19862-64 | Commercial in confidence
A margin-squeeze test checks whether a product has positive margins
6
Example of a profitable product
Methodology for a margin-squeeze test • The formula
Source: Analysys Mason
SMP: Significant market power
W/s
inputs
(r)
Net.
costs
(w)
Retail
costs
(d)
Margin > 0
Retail
price
(P)
19862-64 | Commercial in confidence
A number of conditions are necessary to establish a situation of margin squeeze
7 Methodology for a margin-squeeze test • Minimum conditions
Vertical
integration
Dominance on
the upstream
market
Upstream
input must be
essential
Downstream
market not
effectively
competitive
Sufficient
duration
The firm willing to implement a margin-squeeze strategy must be
vertically integrated and/or have control over the key upstream
inputs, while being active on the downstream market
The vertically integrated operator must hold SMP in the upstream
input market
The provided upstream inputs must be ‘essential or key’ for the
provision of the tested downstream service
The downstream market is not effectively competitive: however, this
does not imply that the SMP operator should be dominant in the
retail market
The margin squeeze must be of sufficiently long duration, taking into
account the lifetime of the product
19862-64 | Commercial in confidence
8 Methodology for a margin-squeeze test • Methodological choices
Five methodological choices are to be considered when performing a margin-squeeze test
Item Question to be answered
Level of
efficiency of
the operator
From which perspective will the situation be analysed: from the
dominant operator’s or from an alternative operator’s point of view?
Downstream
cost standard
Which methodology will be used for the downstream costs analysis:
an accounting or an economic approach?
Evaluation of
profitability
over time
Which approach should be used to measure an operator’s
profitability: a period-by-period (PdP) or a discounted cash flow
(DCF) method?
Level of
aggregation
of products
What is the aggregation level of the considered retail products:
product-by-product or aggregated level?
Upstream
input
How must the wholesale inputs be considered:
in aggregate or in a separate way?
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19862-64 | Commercial in confidence
W/s
inputs
(r)
Net.
costs
(w)
Retail
costs
(d)
Margin > 0
Retail
price
(P)
The test can be performed following an EEO and/or a REO approach Two imputation tests may be
considered to perform the test:
the equally efficient operator
(EEO) test considers an operator
whose efficiency level is similar to
that of the SMP operator
the reasonably efficient operator
(REO) test considers a reasonably
efficient downstream operator (i.e.
an operator efficient but not able to
leverage the scale and scope
economies of the incumbent)
The formula items affected by the
approach are w and d
9 Methodology for a margin-squeeze test
EEO SMP operator’s
REO alternative operator’s
Example of a profitable product
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19862-64 | Commercial in confidence
For retail costs, the cost measure is usually chosen according to the information available
10 Methodology for a margin-squeeze test
*CCA: Current cost accounting
Main features of the most relevant cost measures
Fully allocated cost (FAC) Long-run incremental cost (LRIC)
Usually historical assets (can also be
converted to current assets, in this case
being CCA* FAC)
Modern equivalent assets (MEA)
Usually straight-line depreciation
(annuities can also be used)
Economic depreciation
Actual installed capacities Efficient levels of capacity
Actual costs of operation (with CCA, the
costs of operation can be adjusted)
Efficient costs of operation
All costs included Relevant costs only
In summary: ‘Observed fact’ In summary: ‘Modelling assumptions’
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19862-64 | Commercial in confidence
In the evaluation of an investment, four variables must be considered: time, risk, costs and revenues
11
Variables to be considered in an investment evaluation
Methodology for a margin-squeeze test
Investment
evaluation
Revenues
What are the total revenues that
will be generated over the
investment lifetime?
Must they be considered as
recognised revenues or as cash
inflows?
Costs
What are the total costs that will
be incurred over the lifetime of
the investment?
Which costs are capex and which
ones opex?
Time
How long must the time horizon
be?
Does it have to be considered as
a whole or split in sub-periods?
Risk
What is the associated risk to the
investment?
How can it be measured?
Will it change over time?
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19862-64 | Commercial in confidence
12
Comparison between the main features of DCF and PbP methods
Methodology for a margin-squeeze test
DCF and PbP are the two methods most commonly used for the evaluation of investments
DCF Item PbP
▪ Financial Perspective ▪ Accounting
▪ One single value (net present
value or NPV)
Model output ▪ One value for every considered period
(periodification)
▪ Yes (discount of expected future
cash flows)
Time
consideration
▪ No (no actualisation)
▪ Overall timeframe within a
single calculation
Considered period ▪ A single period in the overall timeframe
▪ As a cash flow Investment
consideration
▪ Depreciation along the underlying lifetime
of the asset
▪ Need for estimates (cash flows,
cost of capital and terminal
value)
Potential issues ▪ Misleading about economic value
creation (short-sighted approach)
▪ Constant cost recovery over time for
capitalised costs
▪ Growing/dynamic markets Best for ▪ Stable markets
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19862-64 | Commercial in confidence
13
Service Product-by-product Aggregated
Access
PSTN access
ISDN PRA access
ISDN BRA access
PSTN access
ISDN PRA access
ISDN BRA access
Voice
Local/national calls
(on-net, off-net)
ISDN PRA access
ISDN BRA access
Local/national calls
(on-net, off-net)
ISDN PRA access
ISDN BRA access
Possible levels of aggregation of retail services
Methodology for a margin-squeeze test
The test can be performed either on a single retail service or on the whole retail portfolio
Best for
Test a new retail offer (e.g. to avoid
cross-subsidisation by other
products at early stages)
Assess the overall replicability
of the SMP operator’s retail
portfolio
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19862-64 | Commercial in confidence
14
Service Subset of wholesale inputs Mix of wholesale inputs
Access
Local loop unbundling (LLU)
Wholesale line rental (WLR)
LLU
WLR
Voice
Call termination
Origination:
– carrier selection
– carrier pre-selection
Call termination
Origination:
– carrier selection
– carrier pre-selection
Possible levels of consideration of the upstream inputs
Methodology for a margin-squeeze test
The upstream inputs can be considered either separately or as a mix of inputs
Best for
Easiness of implementation
(though several combinations could
be considered)
One-go implementation
(but need to estimate the
weight of each input)
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19862-64 | Commercial in confidence
Contents
15
Introduction: About Analysys Mason
Methodology for a margin-squeeze test
The Macedonian case versus the Italian case
Q&A
19862-64 | Commercial in confidence
We were commissioned to implement a retail price regulation methodology for Macedonia
The Agency for Electronic Communications of the Republic of
Macedonia (AEC) commissioned Analysys Mason to develop and
implement a methodology for price regulation of the retail services
offered by the operator with SMP in the relevant retail markets
The AEC’s Decision published in March 2010 imposed a price control
obligation on Makedonski Telekom at the retail level
16 The Macedonian case versus the Italian case • Market context
Makedonski Telekom is required to submit its proposed retail tariffs
for all the relevant products and services to the AEC at least 30 days
before varying the tariffs for its existing retail offers
19862-64 | Commercial in confidence
Before carrying out a margin-squeeze test, we reviewed the market conditions in Macedonia
17
Comparison of the fixed voice markets in Macedonia and Italy
The Macedonian case versus the Italian case • Market context
Source: AGCOM (Dec 2011), AEC (Dec 2010)
Item Unit Italy Macedonia
Incumbent
Fixed voice
subscribers # 14 686 673 322 160
Market % 66.7% 77.7%
First altnet
Fixed voice
subscribers # 2 774 394 50 687
Market % 12.6% 12.2%
Market
Number of
competitors # 4 6
Monthly
ARPU
EUR
/subs 13.5 11.4
19862-64 | Commercial in confidence
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Items for which different choices were made
The Macedonian case versus the Italian case • Implementation of a margin-squeeze text
The different market conditions led to different choices of operator type and upstream input
Item Macedonia Italy Rationale
Level of efficiency of the operator
Both EEO and REO
r: REO
w: EEO with OLO network architecture
d: EEO
Difficulty of definition of the REO (e.g. market share)
The OLO network with the EEO scale is assumed as the ‘efficient’ one
Upstream inputs
Subset Mix Market development stage:
– Italy: mature market, no need to look for a specific ‘supply chain’
– Macedonia: developing market, need to look to the different ‘supply chains’ separately (ladder of investment)
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19862-64 | Commercial in confidence
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Items for which the same approach was taken
The Macedonian case versus the Italian case • Implementation of a margin-squeeze text
For the non market-related items, the same approach was taken in both cases
Source: Analysys Mason
Item Choice (both countries) Rationale
Downstream
cost standard
LRIC (application of a
mark-up on the
network costs,
in turn LRIC)
Easiness of implementation, widely
accepted in the industry (by both
operators players and regulators)
Evaluation of
profitability
over time
Both DCF and PbP Margin-squeeze assessment in
different time horizons (DCF: whole
lifetime; PbP: single period)
Level of
aggregation of
products
Product-by-product Assessment of the replicability of a
single retail offer still to be launched
(ex ante) and not of the overall portfolio
of the incumbent operator
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19862-64 | Commercial in confidence
Contents
20
Introduction: About Analysys Mason
Methodology for a margin-squeeze test
The Macedonian case versus the Italian case
Q&A
19862-64 | Commercial in confidence
21
19862-64 | Commercial in confidence
Contact details
22
Paulina Pastor Alfonso
Senior Manager
paulina.pastor@analysysmason.com
Analysys Mason Limited España
José Abascal 44 4°
28003 Madrid, Spain
Tel: +34 91 399 5016
Fax: +34 91 451 8071
www.analysysmason.com
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