ITU/BDT Regional Economic and Financial Forum of Telecoms/ICTs for Asia Pacific Kuala Lumpur, 28 September 2015

1. 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

2. 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

3. ASEAN Internet Penetration 2009-2013: key role of BWA
• Source: ITU World Telecommunication/ICT Indicators database
3

4. Country Switch
C4
Local Switch
C5
MUX
Local Switch
C5
MUX
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: Cisco
4

5. 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

6. 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

7. 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

8. 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

9. 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

10. Policy objectives
Investment 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 mobile
See: 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

11. Market structure
Possible market condition Economic condition
11

12. 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

13. 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

14. 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

15. 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. MoU
15

16. Incremental
Cost
Incremental
Cost
Incremental
Cost
Incremental
Cost
Incremental
Cost
Incremental
Cost
Incremental
Cost
Service-specific
Fixed Cost
Allocation 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

17. 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

18. 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

19. 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

20. Cost-based prices for regulated services
50:50 in Asia-Pacific – lowest ratio
• Source: www.itu.int/icteye 20
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
Percentageof
responses

21. Traditional wholesale cost-based services
47H:40C Asia-Pacific
• Source: www.itu.int/icteye 21
Percentageof
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

22. Advanced wholesale cost-based services
Current costs more used
• Source: www.itu.int/icteye 22

23. Traditional retail cost-based services
47C:40H in Asia-Pacific
• Source: www.itu.int/icteye 23
Percentageof
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

24. Advanced retail cost-based services
57C:27H in Asia-Pacific
• Source: www.itu.int/icteye 24

25. Traditional wholesale regulated services
31C:27B in Asia-Pacific
• Source: www.itu.int/icteye 25
Percentageof
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

26. Advanced wholesale regulated services
29C:24B in Asia-Pacific
• Source: www.itu.int/icteye 26
Percentageof
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

27. Traditional retail regulated services
26C:22B in Asia-Pacific
• Source: www.itu.int/icteye 27
Percentageof
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

28. Advanced retail regulated services
28C:28B in Asia-Pacific
• Source: www.itu.int/icteye 28
Percentageof
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

29. 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

30. Thank You
30