LRIC model for access in the fixed network

Transcription

1 LRIC model for access in the fixed network Annex 3 8. november 2013

2 Innholdsfortegnelse 1 Introduction The LRIC method LRIC model for Market 4 in brief

3 1 Introduction From 2009 to 2012, the Norwegian Post and Telecommunications Authority has developed a model for calculating costs in the fixed network based on the LRIC method (Long Run Incremental Cost). The model is used to calculate the costs that an efficient operator will have in relation to offering copper-based LLU (efficient cost level). The calculations form part of the basis for the price controls in this decision. The aim of this annex is to give a brief introduction to the LRIC method and to the model that has been developed for market 4. 2 The LRIC method It is generally accepted that the LRIC method gives the regulating authority an in-depth tool for identifying the effective costs linked to electronic communication networks. The method is based on economic theory and is considered today as best practice within cost determination in the interconnection and access markets. An overview from BEREC 1 shows that most of the European regulators use a LRIC model as a starting point for determining cost oriented access prices in market 4. LRIC is an abbreviation for long run incremental cost. It is these costs that the service providers must base their pricing on in a market with effective competition. A regulated price should mimic the prices that would have arisen in a market with effective competition, since this gives the providers incentives to produce the demanded service at the lowest possible cost and because the operators that demand the service are given incentives to optimize their own investment decisions. Thus, the price controls may contribute to effective utilization of public resources. There may also be other considerations that the Authority finds relevant to emphasize when deciding the regulated price. A fundamental principle of economic efficiency is that the price should be equal to the short-term marginal cost of offering the service, i.e. the extra short-term cost that the provider is faced with when producing an extra unit of a service (e.g. copper accesses). However, the costs related to electronic communication networks largely consist of fixed costs (and overheads), and the economies of scale are substantial. This implies that the cost of offering a marginal increase for a specific service (e.g. copper accesses) is very small. A regulated price that is equal to the short-term marginal cost would therefore result in the provider not being able to cover his fixed costs (and overheads). The provider will not therefore achieve a sufficient return on invested capital and will lack incentives to invest. 1 BEREC Report Regulatory Accounting in Practice 2013, BoR (13) 110. (BEREC is an abbreviation for Body of European Regulators for Electronic Communications.) 3

4 The LRIC method therefore uses a time frame that is long enough for several costs in the production to be variable. If the time frame is long enough, all types of input factors in the production may be regarded as an increase in the capacity level that can be adapted to the demand over time. The long-run incremental costs also include production capital as a variable factor in the production. Price controls that are based on prevailing efficient production costs will help to give the right signals to operators that aim to optimize their own investment decisions. A key element of the LRIC method is to define the increment to be calculated. An increment may be defined as the cost of producing an extra unit of a service (e.g. a concrete copper access line), as the sum of the total production of a service (e.g. access to the copper access network), as the sum of the production of a group of services (e.g. telephony services) or as the sum of the production of all services (e.g. telephony and broadband services in the fixed network). The difficulty in defining a large increment is that the costs get so aggregated that it becomes difficult to demonstrate that the price for the regulated service(s) is cost-oriented. On the other hand, an increment that is too small may lead to both practical and method-related challenges, since it will generally be the case that the smaller the increment, the less robust the cost modeling. A replacement cost (current cost) is used in the LRIC method to calculate the value of the individual network elements. This is the current cost of investing in new equipment that has equivalent functionality as the original equipment, and it is this cost that a new operator aiming to develop a new equivalent network will be faced with. Depending on how equivalent functionality is defined and for which network elements replacement costs are used, the use of replacement cost could recreate the conditions as they would have been under effective competition. Furthermore, economic depreciation is the most common method of depreciation. 2 Expensing the investment in line with the equipment s contribution to production of the service over time is the easiest way to highlight the effective cost of offering the service at a particular point in time. The calculation of the depreciation for the network elements over time also takes into account the capital cost of the investment and operation of the equipment. In order to estimate the hurdle rate on invested capital, the WACC method is normally applied. WACC stands for Weighted Average Cost of Capital and is the most recognized method for calculating a fair expected return. With regard to the breakdown of overheads, Ramsey pricing is considered to be the theoretical most optimum method. However, when EPMU (Equal Proportion Mark Up) is the most commonly used method, this is because the calculation of elasticity, which is needed in Ramsey pricing, requires substantial amounts of information and is often impossible to calculate accurately using the limited data that is available. Accurate Ramsey pricing also requires all services to be priced in accordance with this method, but in practice only a few individual services are subject to price controls. For this reason also the method is not applicable for regulatory authorities. There are two principal ways to approach the modeling of LRIC costs; top-down or bottom-up. The top-down approach is based on the actual costs of the regulated operator as stated in the financial accounts, and is allocating these to product groups. With the bottom-up approach, a network is constructed with an optimal effective network structure and with the most effective technology available. In order to create the most robust model possible, these two approaches are often combined in a so-called hybrid model. 2 In some cases tilted annuities or modified tilted annuities are used as depreciation method instead of economic depreciation. 4

5 3 LRIC model for Market 4 in brief In 2008, NPT initiated a project to develop LRIC models for the fixed network, i.e. call origination and termination on the fixed network (the core network, Markets 2 and 3) and the LLU market (access, Market 4). After the tender process was completed, Analysys Mason won the contract in May 2009 to develop the LRIC models for the fixed network. The original plan was to develop an LRIC model for these markets in parallel, with completion in spring After feedback from Telenor that the collecting of data was a major undertaking, NPT decided to postpone the model for Market 4 and complete the model for Markets 2-3 first. Draft model for the access network was submitted for national consultation 15 September NPT received comments from four operators. A summary of the responses and explanation of changes made to the model after the national consultation is presented in the document Response to operator consultation from Analysys Mason. 3 The access model (Market 4) reflects Telenor s existing copper access network. However, the model can be configured to calculate the costs for an operator with less geographical coverage and / or another service provision. It can also be adapted to calculate the costs of access via other technologies (FTTH/PON and FTTH/PTP). The LRIC model for the access network consists of three active modules in terms of three different Excel files: Market module (consisting of the same market data that are used in the model for the core network) Network Design - Access module Service Costing - Access module These three modules do not contain confidential information, and the Excel files are available on NPTs homepage ( However, some calculations that form the basis for the modules, among other related to Telenor s node structure and ducts, are confidential and cannot be shared with the other operators. The same applies for the Excel file that calibrates the model results with actual cost data from Telenor. The depreciation method that is used is economic depreciations, and the imputed rate of interest is 7.52% real before tax. 4 3 Report for the Norwegian Post and Telecommunications Authority (NPT), Fixed long.-run incremental cost (LRIC) model for Market 4, Response to operator consultation 4 Source: Kapitalkostnad for norsk telekom fastlinjevirksomhet, report from professor Thore Johnsen June

6 For more details regarding the principles of the model, model documentation and the actual models, as well as other relevant information about the LRIC models for the fixed network, reference is made to NPT s homepage. The LRIC model for the access network is used as part of the basis for the price controls in Market 4. 6