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 themes

1. 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 Switch

C4

Local Switch

C5MUX

Local Switch

C5MUX

AAccess

NNode

DDigital

SSubscriber

LLocal

AAccess

MModule

IP Router

IP

Router

IP

Router

Gateway Gateway

DDigital

SSubscriber

LLocal

AAccess

MModule

AAccess

NNode

Circuit

Switched

PSTN

Next

Generation

Network

Simplified Architectures of TDM and Next Generation Network

and their ‘Type 1” interconnection

Source: Cisco4

Customer

Premises

Equipment

Outside

Cables

Customer

Building

Core

Networks

Local

Telephone

Exchange

Internet

Service

Providers

Internet

& Intranets

M56K

M ADSL

S

DSLAM

S

DSLAM

PSTN

ATM 1

ATM 2

M

56K

M

56K

M

56K

INTRANET

INTERNET

ISP 1

ISP 3(Private)

ISP 2

FW

To

ISPs

SLU

M ADSL

‘’Type 2’ interconnection between PSTN and broadband networks

5

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 multipliers

Fixed 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 GDP

1.3% increase in GDP

1.0% 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 multipliers

Fixed TDM Teledensity Impact of 10% investment

Broadband

Qiang, et al World Bank, 2009 10% 1.21% increase for DME

1.38% 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 broadband

2. 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 591

4. 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 overview

Parameters 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 approaches

Accounting practices Accounting data

Historic 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 data

TDM 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

Incremental

Cost

Incremental

Cost

Incremental

Cost

Incremental

Cost

Incremental

Cost

Incremental

Cost

Incremental

Cost

Service-specific

Fixed CostAllocation of Part

of Joint &

Common Cost

Allocation of Part

of Joint &

Common Cost

Allocation of all

Joint & Common Cost

Allocation of

Residual of Joint

& Common Cost

FAC-based allocation of

all Joint & Common Cost

All Joint and Common Cost

+

+

+

+

+

+

+

+

+

+

+

+

Service-specific

Fixed Cost

Service-specific

Fixed Cost

Service-specific

Fixed Cost

Service-specific

Fixed Cost

Service-specific

Fixed 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 Average

Capital +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

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: ITU Tariff Policies Survey, www.itu.int/icteye20

Based on 40/44

Countries

Based on 16/21

Countries

Based on 28/40

Countries

Based on 32/43

Countries

Based on 31/35

Countries

Based on 154/195

Countries

Based on 7/12

Countries

Perc

enta

ge o

f

responses

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

Source: ITU Tariff Policies Survey, www.itu.int/icteye

21

Perc

enta

ge o

f

responses

Based on 32/44

Countries

Based on 10/21

Countries

Based on 14/40

Countries

Based on 31/43

Countries

Based on 23/35

Countries

Based on 112/195

Countries

Based on 2/12

Countries

Advanced wholesale cost-based servicesCurrent costs more used

Source: ITU Tariff Policies Survey, www.itu.int/icteye

22

Perc

enta

ge o

f re

sponses

Based on 19/44

Countries

Based on 6/21

Countries

Based on 11/40

Countries

Based on 1/12

Countries

Based on 24/43

Countries

Based on 15/35

Countries

Based on 76/195

Countries

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

Source: ITU Tariff Policies Survey, www.itu.int/icteye

23

Perc

enta

ge o

f

responses

Based on 18/44

Countries

Based on 7/21

Countries

Based on 14/40

Countries

Based on 16/43

Countries

Based on 21/35

Countries

Based on 79/195

Countries

Based on 3/12

Countries

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

Source: ITU Tariff Policies Survey, www.itu.int/icteye24

Perc

enta

ge o

f re

sponses

Based on 16/44

Countries

Based on 6/21

Countries

Based on 13/40

Countries

Based on 2/12

Countries

Based on 12/43

Countries

Based on 11/35

Countries

Based on 60/195

Countries

Traditional wholesale regulated services31C:27B in Asia-Pacific

Source: ITU Tariff Policies Survey, www.itu.int/icteye

25

Perc

enta

ge o

f

responses

Based on 38/44

Countries

Based on 15/21

Countries

Based on 18/40

Countries

Based on 32/43

Countries

Based on 24/35

Countries

Based on 132/195

Countries

Based on 5/12

Countries

Advanced wholesale regulated services29C:24B in Asia-Pacific

Source: ITU Tariff Policies Survey, www.itu.int/icteye

26

Perc

enta

ge o

f

responses

Based on 23/44

Countries

Based on 10/21

Countries

Based on 14/40

Countries

Based on 26/43

Countries

Based on 17/35

Countries

Based on 92/195

Countries

Based on 2/12

Countries

Traditional retail regulated services26C:22B in Asia-Pacific

Source: ITU Tariff Policies Survey, www.itu.int/icteye

27

Perc

enta

ge o

f

responses

Based on 26/44

Countries

Based on 10/21

Countries

Based on 22/40

Countries

Based on 21/43

Countries

Based on 28/35

Countries

Based on 112/195

Countries

Based on 5/12

Countries

Advanced retail regulated services28C:28B in Asia-Pacific

Source: ITU Tariff Policies Survey, www.itu.int/icteye

28

Perc

enta

ge o

f

responses

Based on 22/44

Countries

Based on 7/21

Countries

Based on 17/40

Countries

Based on 10/43

Countries

Based on 15/35

Countries

Based on 75/195

Countries

Based on 4/12

Countries

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