EACO DIGITAL TERRESTRIAL TELEVISION (DTT) COSTING AND PRICING PRINCIPLES FOR TRANSMISSION SERVICES

Transcription

1 EACO DIGITAL TERRESTRIAL TELEVISION (DTT) COSTING AND PRICING PRINCIPLES FOR TRANSMISSION SERVICES 1.0 Scope 1.1 The EACO member states have recognized there is no effective competition in the signal distribution market segment which calls for regulatory intervention to promote competition and its associated benefits. 1.2 The purpose of this document is to develop harmonized regional costing and pricing principles in the DTT transmission market to enhance effective competition and related consumer benefits. 2.0 Background 2.1 EACO member states being signatories to GE-06 agreement are committed to implementing analogue to digital migration and meet the deadline of June In recognition of the benefits associated with digital broadcasting, EACO member states have set a deadline to switch off analogue broadcasting by 31 st December In respect of that, digital migration roadmaps have been adopted in each member state to facilitate the migration. 2.3 The EACO member states are at different stages of implementation of DTT. Annex A provides for the status of each member state on implementation of analogue to digital migration as of September Rationale for Determining Cost & Pricing Principles 3.1 In recognition of the need for effective competition in DTT transmission services and the need for fair return on network investment, the regulators should establish costing and pricing framework to achieve the dual objective of promoting DTT networks and fair charges by MUX to CSPs. This will promote fair end user tariffs for DTT services. 3.2 In the absence of a reference base for transmission rates for DTT transmission services, the regulatory agencies considered as an important step, to develop costing and pricing principles for DTT services. This intervention will 4.0 General Objectives The objectives of this document include the following i. To be used as a regulatory benchmark to guide the smooth migration from analogue to digital broadcasting ii. To promote fair competition in the DTT service market iii. To promote efficient delivery of DTT services. iv. Ensure fair return to DTT providers v. Ensure fair and non discriminatory charges by MUX to CSPs vi. Promote fair consumer prices and its associated benefits

2 vii. Encourage rollout of the DTT platform 5.0 Legal & Regulatory Framework 5.1 Policies EACO member states have developed policies governing migration from analogue to digital broadcasting. The policies broadly provide for i) The establishment of signal distributor and CSPs as two distinct markets ii) Establishment of DTT licensing framework iii) Financing digital migration 5.2 Legislation EACO member states are at different stages of enacting new legislations or amending existing legislations to implement policy objectives in analogue to digital migration. Tanzania & Rwanda have new laws governing digital migration. 5.3 Regulations EACO member states are in preliminary stages of developing regulatory instruments specific to digital migration. The regulations will set framework for costing, pricing, competition, technical specifications and QOS guidelines of DTT services To date Tanzania had developed regulations on digital terrestrial network and other broadcasting networks. 5.4 Licensing framework EACO member states are at different stages of developing the licensing frameworks for digital terrestrial broadcasting. The common practice in licensing DTT services is the separation of signal distribution/mux services and content service provision The signal distributor/mux shall be responsible for multiplexing, transfer service, remultiplexing, and transmitter network service The content service provider shall be responsible for content production, content aggregation and delivery of content to the signal distributor/mux for delivery to the consumer. In the two player licensing framework, the content service provider is also responsible for the retail services Tanzania developed a third license category called Support Service Provider responsible for handling subscription services and retail service including packaging, distribution, marketing, sales, maintaining the subscriber management system. 6.0 DTT Transmission Network Topology 6.1 The transmission network topology consists of Multiplexer, Transmission link, and transmission systems. Figure 1 below illustrates the transmission network topology and its elements of which costing are detailed against each. The content provider feeds into the multiplexer system, and the transmission system transmits the programs to the consumer.

3 Figure 1. DTT Transmission Network Content Multiplexer Transmission Link Network Transmission System Reception Multiplexing System Encoders Multiplexing switch Management & Monitoring system Software Licenses Conditional access system IT Network (Servers, Routers, switches, cabling, security) Cooling system Power system Modulator equipment Initial installation of multiplexer equipment, cooling system, power system Spectrum Transmission Link Facilities Microwave links Optic fiber Satellite links Transmission Site System Transmitter equipment Mast/Tower Antenna & feeder System TVRO VSAT Terrestrial antennas Power system Power supply Diesel Generators UPS Cooling system Initial installations for transmitter, antennas, cooling system, tower, generator 6.2 Network Capacity Digital broadcasting has the capacity to provide multiple channels and also improve functionality of broadcasting services. This means that digital television broadcasters are able to broadcast data, which enhance the programs that can meet the requirements of the consumers. This requires that the network operator should have enough and appropriate capacity in their networks. When defining pricing for transmission services, consideration should be made on the capacity to be provided by the parties in the digital broadcasting chain. 6.3 Network operations Besides the network elements identified in 6.1 above, there are other overhead costs. These should be included in the costing of DTT services. i. Personnel/staff ii. Maintenance iii. Security iv. Utilities v. Communication vi. Fuel

4 vii. Stationery viii. Transport ix. Rent x. License fee 7.0 DTT Business Model (DTT value chain) 7.1 Content service provider Free to Air revenue flow As shown in Figure 2 below, the primary revenues of the content service provider in the free to air digital broadcasting value chain is drawn from: i. Advertisement ii. Sponsorships iii. Airtime sales Subscription broadcasting/pay TV revenue flow As shown in Figure 2 below, the primary revenue of the pay TV services is drawn from i. Subscription fees ii. Limited advertisement Operational Expenses for the CSP The major operational expenses of the CSP are: i. CSP carriage fees to MUX ii. Production of in-house content (staff, studio, maintenance, transport etc) iii. commissioning fees for independent content providers iv. Acquisition cost for content v. Broadcasting rights fees vi. Licensing and regulatory fees vii. Transmission link fees viii. Conditional Access System fees ix. Retail cost (for the case of a two player model e.g. sales, marketing of STBs) Capital Expenses The major capital expenses for the CSP are:- i. Studio equipments ii. Outside Broadcasting Van & equipment iii. Broadcasting software license 7.2 Signal distributer/mux The primary sources of revenues for the signal distributer are: i. Transmission fees from content service providers, ii. Site rental from other service providers and iii. Conditional Access Management fees from the CSP.

5 7.2.2 The major expenses of the MUX are: i. Network roll out (site acquisition, civil works, right of way, etc) ii. Installation of equipment iii. Network maintenance iv. Spectrum fees v. Conditional Access System management cost vi. Software license vii. Annual Regulatory and license fees viii. Other operating expenses(staff salaries, maintenance, advertisement etc) Figure 2. Digital Broadcasting Business Model Royalty/production Cost Content Producers/Ow ners Content Service Provider Free to Air Channels Signal Distributor (MUX) Pay TV Channels $ $ Programming Fee Support Service Provider/Conte nt Service Provider Subscription Transmission Fee Transmission Fee $ $ $ Customer 8.0 Costing methodologies Bottom up/top down/hybrid approach In a bottom up approach the costing is premised on the roll out of a hypothetical/generic and efficient network free from the historical network shortfalls and its related constraints. This has a benefit of encouraging efficiency but may sometimes lead to ambitious projections hence service under costing In a top down approach, the costing is based on an existing network. This has a disadvantage of carrying forward incumbent network limitations and inefficiencies. On the plus side, operators with an existing network argue that this is a more realistic approach The hybrid approach is an intersection of the two approaches above. Here a fairly efficient generic network is modeled based on the hypothetically efficient network and the existing network. This has the benefit of taking cognizance of incumbent/legacy network while at the same time encouraging efficiency Annex 2 gives a detailed brief of the three approaches.

6 8.2 FAC vs LRIC costing Though majority of operators worldwide are using an incremental costing models for network costing, regulators have to make choice between Full Cost allocation and Long Run Incremental Costing depending on respective market circumstances. The fundamental differences between the two costing approaches are as follows: i. The Full Cost allocation costing (FAC) is a system of full cost absorption where all costs are attributed to services. It takes as a starting point the accounts of an operator and drills down into the accounts (FAR, cost centres). It allows full recovery of costs and it is generally transparent. However, it may sometimes embed economically inefficient allocation of resources ii. The Long Run Incremental Costing(LRIC) is defined as The additional cost of providing for an additional increment of output (or cost avoided if the product is removed). It encourage efficient resource allocation as the Economic theory suggest that marginal cost should be the basis for optimal prices. It might however create cost recovery issues, due to high fixed common and joint cost Therefore the choice between the two costing approaches the regulator. is dependent on the primary objective of If the primary objective is to encourage DTT roll out, Full Cost Allocation should be preferred while incremental costing may be most preferred if the primary objective is encouraging competition in the provisioning of MUX services. 8.3 Recommended pricing approach FDC In our considered opinion based on limited penetration of DTT services, wholesale DTT service prices may be based on a Fully Distributed Costing approach. In addition, regulators may choose to add a mark up on the FDC cost at least for a period of 3-5years. This would offer a good enough incentive for the necessary investment to boost DTT service coverage in our markets. The disadvantage of this is that it may not be as efficient as the incremental costing approach and may encourage legacy inefficiencies. A bench mark with other markets has shown that FDC cost oriented transmission prices have been used in countries like Sweden, Finland With the aim of encouraging DTT roll out. Annex B provides a detailed description of the FDC costing approach and the treatment of key parameters Rate of return/payback

7 Alternatively in light of the rigors of the FDC costing approaches, regulators may choose to adopt a rate of return pricing framework for DTT services. Here the regulators would establish the capital employed by the signal distributor and a specific rate of return is applied. The rate of return is based on the weighted cost of debt and equity. This approach has the advantage of guarding against excessive rate increases as well as guarantee minimum grade of service. The downside to this approach is that it offers no incentive for efficiency by the MUX operators as they enjoy a guaranteed return. Further like the FDC approach, the determination of operator risk premiums and the WACC can only be estimated in markets like ours in which such companies are not listed and no equivalents can be used for comparison Price cap An improvement of the rate of return pricing framework may be the use of a price cap regime. Here, the price increases would be linked to an appropriate measure of inflation, the CPI. An x factor may also be applied to the CPI to encourage the MUX operator to seek cost efficiencies Revenue Share The last alternative would be for member states to establish a revenue share framework for members in the DTT value chain. Here revenue allotments may be shared across the players in the value chain ie, content producers, Content aggregators, MUX operators and the retail agents without setting wholesale rates. The disadvantage to this would be the imbalance in bargaining power which would most likely be in favour of MUX operators based on the licensing and capital barriers to entry that they enjoy. Further, a revenue share based approach makes little effort in protecting downstream consumers. 9 Conclusion The individual EACO countries are recommended to undertake specific studies of the establishment of the costing model for DTT services consistent with the recommended costing and pricing principles

8 Annex A Costing Approaches Different types of cost models can be built around the following key choices: 1. Average cost (FAC) versus Incremental cost (LRIC) 2. Top-down versus Bottom-up, or Hybrid 3. Historical versus Forward-looking There are many other choices to be made, for example the level of service and network components granularity, the number of years to be modelled, what depreciation method to be selected, type of markup etc. However the 3 choices above are key for the overall outcome and the costing model selection starts with them. Below the description and benefits of each of these alternatives are presented 1 Average versus incremental cost Average cost, also known as Fully Allocated Costs or Fully Distributed Costs, when prepared under the Historical Cost Accounting ( HCA ) and top-down conventions, is the most straight-forward type of model, where the costs are taken directly from the operator s accounting records and are allocated to services using service demand and allocation rules. In this type of model, there is no distinction between incremental costs and fixed and common costs hence the average cost approach. The cost allocation follows the next steps: Identify costs Identify services which are provided Identify network elements which provide the services Group costs into cost pools based on the network elements Identify relationships between the services and the cost pools Divide cost pools into unit costs based on volume information Allocate appropriate unit costs to services The main advantages and disadvantages of the average costing approach are presented in the table below: Average costing approach (FAC) Advantages Reconciliation with the published accounts Disadvantages Backward looking Aims to recover all costs Captures the incurred cost of doing business Embeds economic inefficient allocation of resources Cost allocation may be arbitrary in the case of fixed common costs, Due to the complexity, it requires implementation of a specialized costing system, with high costs of implementation and maintenance According to economic theory, in competitive markets the price of a service or product will equal the marginal cost of providing that product or service. The solution that the regulators have adopted is incremental costing and more specifically long-run incremental costing (LRIC). LRIC modelling distinguishes between the costs that are incremental and the costs that are fixed common and joint. Incremental costs are typically lower than average costs in the presence of economies of scale and/or scope because the sum of all the incremental costs will not equal the total cost in the event that there are fixed common and joint costs. In order to ensure full recovery of cost, a methodology for recovering the fixed, common and joint costs needs to be implemented, in the

9 form of a mark-up. The mark-up methodology is discussed further in the chapter dedicated to the LRIC model. The main advantages and disadvantages of the incremental costing approach are presented in the table below: Incremental costing approach(lric) Advantages Uses current assets costs, hence provides a reasonable reflection of the costs of a new operator entering the market Provides incentives to the operators to be more efficient / promotes efficient investment A long-run forward-looking approach provides stability in the sector from known future prices Disadvantages Does not reconcile to published accounts Fixed and joints costs may be significant in some specific sectors especially in the broadcasting industry, which puts a lot of emphasis on the mark-up methodology and may raise issues of cost recoverability More complex modelling approach and revaluation requirements, which may bear the risk of inaccuracies or reconcilability 2 Top-down versus bottom-up A top-down approach takes as a primary data source the company's accounting information, and calculates the costs of the relevant increments (normally at component or product group level) and applying appropriate cost/volume relationships usually incorporating several layers or hierarchy of processing. Top-down approach Advantages Transparent and reconcilable Disadvantages May embed economically inefficient allocation of resources A bottom-up approach can be described as an economic-engineering model, which starts with the demand for the service/product included in the increment and initially uses dimensioning algorithms to engineer an efficient network that can address this demand and then to assess the use of each network element to the different services of the increment. Bottom-up approach Advantages Allows for construction of an efficient network, supporting economically efficient decisions Benchmarks, common network design rules and averages of operator data can be used Can run multiple demand and market evolution scenarios Disadvantages Sensitive to efficiency input parameters, risk of setting an efficiency standard that is unachievable in the real world Less good at modelling opex and indirect investments, risk that relevant costs could be omitted from the model The model requires extensive data, not all of which is easily available and as such assumptions are often required Establishes target costs The two methods may be used as complementary tools, the top-down model to determine the incurred costs of the operator and the bottom up model to check its efficiency. This method is referred to as the hybrid approach.

10 Annex B 9.0 Costing parameters 9.1 In the application of the costing methodologies, the regulator has to make choice on the treatment of a number of key inputs and assumptions in the costing model. These include but not limited to: i. Depreciation ii. WACC iii. Asset lives iv. Inflation rate v. Interest rate vi. Demand projection This is the recommended treatment of the parameters identified above: Table 1: Recommended treatment of parameters Parameter Inflation forecast(inf X ) Depreciation T X Recommendation To be obtained from the central bank Lined or titled annuity depending on each member state decision Corporate tax rate Risk free rate(r F ) Unleveraged beta Leveraged beta Cost of equity(k E ) WACC Mark up for OPEX Rfx K L U 1 1 E 1 Rf 1 CR1 inf US Real L U 1 1 R T X f E D ( Equity risk premium) L x 1 1 RfUS Nomin al1 CR1 inf x 1 inf D E T X D E WACC pre tax KD(1 TX ) KE D E D E Based on the realised accounting information, consider setting specific mark up for OPEX US References 11.0 Glossary

11 WACC 10.0 This is the weighted average cost of capital ie the weighted average return on equity (return required by shareholders in the company) and the cost of debt (cost of long term borrowing) 11.0 Equity Risk Premium (Beta) 12.0 Return over and above the risk free rate to reflect the inherent risk in investing in a particular company. This is based on historical performance of the company share price in comparison with the overall market 13.0 Asset Valuation 14.0 This is the value attached to assets used in the determination of relevant costs. This may be the current replacement cost or the net book value (actual asset purchase price less accumulated depreciation) 14.1 Comparative DTT transmission rates in the region