[1] Comparing Alternative Approaches to Calculating Long-Run Incremental Cost

Comparing Alternative Approaches to Calculating Long-Run

Incremental Cost

Telecom Service/Policy So-Am, Yoon & Ha-Hyuk, Sung

Incremental Cost

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Contents

IntroductionBasic ConceptsTSLRICTELRIC


TELRICDoes TELRIC differ from TSLRIC?Implementing TSLRIC+ConclusionReferences

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Introduction

Monopoly CompetitionAccess

General term for the way that customer(end users or subscribers) or competing providers gain to networks


subscribers) or competing providers gain to networksAccess Charge

charge made by a local exchange carrier for use of its local exchange facilities for a purpose such as the origination or termination of traffic that is carried to or from a distant exchange by an interexchange carrier

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Introduction

Access ChargeMarginal Cost(MC)Ramsey PricingPrice Cap


Price CapEfficient Component Pricing Rule(ECPR)Fully Distributed Cost(FDC)Long Run Incremental Cost(LRIC)

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IntroductionTelecom Service/Policy So-Am, Yoon & Ha-Hyuk, Sung

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Basic Concepts

Fixed Cost(FC)Variable Cost(VC)Total Cost(TC) = FC + VCMarginal Cost(MC)Average Total Cost(ATC) = TC / Quantity(Q)


Average Total Cost(ATC) = TC / Quantity(Q)

But, no unique quantity of output for multi-product firmCommon Cost(CC)Long Run Incremental Cost(LRIC)

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Basic Concepts

Common CostShort Run vs. Long RunStand-Alone Cost(SAC)LRIC of individual product


LRIC of individual productLRICA=TC-SACB

TC = CC + LRIC (for a multi-product firm)

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TSLRIC

Total Service Long Run Incremental Cost(TSLRIC)Developed for multi-product firmDeveloped in the late 1970s and early 1980s


TSLRIC is technology-dependentFocuses only on the product specific costsEstimates are based on forward looking cost

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TSLRIC

Example of TSLRICTwo relevant telecom Products A, B

A : local call service / B: PSTN interconnection serviceSpecific cost of A , B : C , C


Specific cost of A , B : CA, CBCost of commonly used product elements : FIf only product B were produced , : FBTSLRIC of product A = CA + (F FB)

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TSLRIC

A profit-maximizing firm would not produce a particular product if revenue it earned from that product fall below the TSLRIC

If revenue < TSLRICCease to produce the relevant product


Cease to produce the relevant productIf revenue > SAC

Another firm would come in the marketTSLRIC < revenue < SAC

Profit maximizing for the firm to continue the producing relevant productNo other firm to enter into the industry

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TSLRIC+

TSLRIC is Lower bound for a multi-product frim.A firm that received revenue equal to TSLRIC would

make a loss equal to its common costsBecause TSLRIC only considers product specific costs


Because TSLRIC only considers product specific costsThe Australian Competition and Consumer

Commission(ACCC) proposed TSLRIC+TSLRIC+ = TSLRIC + product specific common costs

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TELRIC

Total Element Long Run Incremental Cost(TELRIC)First used by FCC under the telecommunications Act 1996

In order to Facilitate element-by-element unbundling oflocal network, the FCC modified TSLRIC


local network, the FCC modified TSLRIC

TELRIC is the incremental or additional cost a firm incursin the long run to provide a network element

Assuming all of its other production activities remain unchanged

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TELRIC differs from TSLRIC?

Main differences between TELRIC and TSLRIC relate to the treatment of common cost

Go back to the example Two services A, B


Two services A, BSpecific cost of A , B : CA, CBCost associated with common network element : FThree elements : X, Y and ZX might be a link, Y and Z might be switchesX is needed for both services, Y is common switch and in long run could be reduced 1/3 saving in costs.Z is only used for product B

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Calculate the LRIC of firmAssumption

F = CX + CYCA = 0 , CB = CZ

LRICA = CX + CY +CZ [CX + 2/3CY + CZ ] = 1/3CYLRIC = C + C +C [C + 2/3C ] = 1/3C + C


LRICB = CX + CY +CZ [CX + 2/3CY ] = 1/3CY + CZ

Common cost CC = CX + CY +CZ [LRICA + LRICB] = CX +1/3CY

Suppose that the CC were allocated on the basis of minutes of use, and the share of traffic through both X and Y that relate to service B is given by S

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Now we can calculate the TSLRIC+BTSLRIC+B = LRICB + s.CC = s.CX + (1 + S)1/3CY + CZThe share of traffic through X and Y that relate to A : (1 S)Then, TSLRIC+A = (1 S)CX + (2 S)1/3CY


Then, TSLRIC+A = (1 S)CX + (2 S)1/3CY

TELRICB = s.CX + s.CY +CZTELRICA = (1 S)CX + (1 S)CY

Comparing the two alternative approaches

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Implementing TSLRIC+

TSLRIC modeling is too difficult Need the implementation of TSLRIC+


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Conclusion

TSLRIC is service-by-service approachTELRIC is element-by-element approach

Theoretical foundations of TSLRIC and TELRIC


Theoretical foundations of TSLRIC and TELRICare similar

But the application of these alternative pricing methodologies may lead to very different outcomes

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References

Joshua Gans, Stephen King, Comparing TSLRIC and TELRIC

, , LRIC

Lecture note of telecommunications service and policy


Lecture note of telecommunications service and policy

Wikipedia

Eye News 24, Dec 11, 2008

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[1] Comparing Alternative Approaches to Calculating Long-Run Incremental Cost