Chapter-23. Tariff Fixation

Transcription

1 Chapter-23 Tariff Fixation BSNL, India For Internal Circulation Only 1

2 Tariff Fixation Regulatory authorities have considered a number of criteria for telecom tariffs, incorporating several objectives. Prices are based either on costs or on demand, and could be determined at a fixed level or be allowed to be flexible (within or without a specified range). Often the cost concepts considered for cost-based pricing include a rate of return (or mark-up) together with costs, i.e., they focus on economic costs, which include a normal commercial return. Some basic concepts Relevant cost-concepts include: total costs, which are equal to the sum of all fixed costs and variable costs; Fixed costs are costs which do not vary with changes in output levels (or in the case of telecom, with changes in the number of calls or the volume of traffic on the network); Variable costs are costs which change (or vary) with a change in the level of output. These costs can be further categorized as: direct costs, i.e. costs associated specifically and only with a particular service and can be assigned directly to the production of that service; when the accounting procedures do not record all the direct cost arising due to the service under consideration, then this total has to calculated by considering all the costs which can be attributed to it directly, i.e. the directly attributable costs. Indirect costs are costs whose relationship with the production of a service is indirect, e.g. maintenance cost; overhead costs are normally the fixed costs for running the operating facility; Common costs are costs shared among various activities; And joint costs are costs which arise in a situation where production of more than one service takes place simultaneously and jointly. The different types of costs for certain telecom services, such as local calls, long-distance calls, and international calls. BSNL, India For Internal Circulation Only 2

3 When the output level of a services changes, variable costs specific to that service are incurred. Similarly, direct fixed costs specific to any particular service can be identified. a. The other costs are either joint costs or common costs, which are costs shared between two or more services. Some important considerations As mentioned earlier, there is an increasing emphasis on basing telecom prices on costs, particularly due to a focus on enhancing efficiency. The determination of a cost-based price is, however, not a straightforward exercise. For example, there is no universal agreement on which concept of cost --- average variable cost, average total cost, long-run incremental cost, short run marginal cost, fully distributed cost, actual book cost --should be applied in specifying cost-based prices. Furthermore, cost-based pricing methods require monitoring in order to check any tendency of the operators to report higher costs than those actually incurred. Both the estimation and monitoring of costs is a data- and skill-intensive exercise. A noteworthy point is that operational costs are higher during the peak load period. Therefore, not only demand but costs also provide a basis for charging higher prices for the peak period and lower prices for the non-peak period. Concepts of costs used for determining prices Three concepts of costs that have received much attention in the context of cost-based pricing are short-run marginal costs, long-run incremental (or marginal) costs, and fully-allocated costs. (I) Short-run marginal costs 10. Marginal costs are those costs which arise due to an increase in the output level: BSNL, India For Internal Circulation Only 3

4 Alternatively, these costs are the increment to total costs when an additional unit of the output is produced. These costs correspond to costs commonly referred to as "variable costs",. In contrast to fixed costs, which remain unchanged after production capacity is installed, marginal costs show the resource costs required if production has to be carried out once capacity is in place. A price equal to marginal costs is considered efficient because at that price the value given to the product is the same as the resource cost that would be required for increasing the output level. There are, however, certain shortcomings of a system of telecom tariffs based on short-run marginal costs. With fixed costs being a large portion of the total costs of telecom (see Annex 1), a price equal to marginal costs will not cover total costs. This is even more likely if the technology exhibits declining costs, such as for telecom. Moreover, there are measurement problems and conceptual difficulties in calculating marginal costs. A basic information needed for ascertaining marginal costs is the link between a change in the output level and in total costs. ii. Long-run (marginal or) incremental costs More comprehensive information can be considered for long run marginal costs, also referred to as long run incremental costs. The long-run is defined as the time period within which additional production capacity can be installed/used. Conceptually, the increase in capacity does not involve fixed costs before the capacity is installed. Thus, long run incremental (or marginal) costs cover not just the normal variable costs but also the potential fixed costs.. BSNL, India For Internal Circulation Only 4

5 Long run incremental costs (LRIC) are based on forward-looking costs, and would thus incorporate the effects of economies of scale and technical change. Normally, estimation of long run incremental costs relies on historical data for the past year or two and on the prospective costs arising in the future as a result of increasing the capacity of operation. Recent emphasis is to focus mainly on the forward-looking costs to determine long run incremental costs. Fully-allocated costs (or fully-distributed costs) 25. Fully-allocated costs methodology covers all cost components, i.e. in addition to a consideration of the cost components covered by the long-run incremental costs, this methodology requires a full allocation of common or joint costs to the individual services on the basis of some specified formula. In the various allocation methods used, the emphasis is on simplicity rather than theoretical correctness. Methods to allocate common or joint costs include, for example, allocating these costs proportional to the revenue earned by each service or to the ratio between individual output levels and the total output ("output method"); or proportional to the directly attributable costs for different services or based on the ratio between direct costs and shared costs for services ("input method"). These costs could also be allocated according to the Ramsey method, i.e. in a proportion inverse to the elasticity of demand; elasticity of demand is the proportionate change in demand for a product (or demand by a particular user group for a product) as a result of a one percent change in the price of the product The allocation methods are based on accounting principles rather than on economic ones. The following factors are also pertinent to determine the pricing methodology. 1. Maximizing efficiency 2. Assuring a specific rate of return 3. Two-part pricing ( A fixed charge and flexible charging on usage) BSNL, India For Internal Circulation Only 5

6 4. Subsidized prices (or a negative mark-up) 5. Demand-Based Prices 6. Flexibility 7. Price caps 8. Price floor and ceiling to check abuse of market power Need to choose which services should be subject to price regulation To begin with, a regulator needs to determine which services should be subject to price control and which should be left outside the purview of such control. Furthermore, the nature of the regulation or control might differ among different services which are subject to price regulation. For instance, certain services (such as essential services) could be subject to closer price scrutiny and control, including a specification of the price level. Others might be subject to price control, but only in terms of price floors and ceilings. Thus, important questions in this regard include, (i) What should be the basis for categorizing services into those subject to price regulation, and others? (ii) Should it be, for example, basic/non-basic telecom services, or voice/non-voice telecom services? (iii) If basic/non-basic services, then what should be the coverage of basic services for this purpose? (iv) Should the services not subject to price regulation be those services which are considered not essential? (v) Or, should non-essential services be categorized into those subject to weaker price regulation and others not subject to such regulation? (vi) If yes for the latter query, then on what criteria should such a categorization take place? (vii) What should be the definition of essential services in this context? (viii) Should a specific price level be determined for certain services. If yes, which services should be subject to this type of price regulation? (ix) Which services should be subject to floor and ceiling prices? (x) Should the type of price regulation depend on the extent of competition in the market? BSNL, India For Internal Circulation Only 6

7 (xi) (xii) (xiii) If yes, then what is the link between the type of price regulation and the extent of competition? What is adequate competition? Should one use a thumb-rule that three or more operators in the market result in adequate competition for reconsidering the pricing methodology to be applied to the service provided by these operators? Conclusions The discussion above shows that the methodologies used by regulators emphasize efficiency, flexibility, fair competition and social objectives. BSNL, India For Internal Circulation Only 7

8 Questions on Tariff Fixation 1. What are the basic concepts in Tariff Fixation? 2. Write short notes on short run marginal costs 3. What is long run (marginal or ) incremental costs? 4. Explain briefly about Fully allocated costs (or fully distributed costs )? 5. What are the factors pertinent to determine the pricing methodology? 6. Give a brief on fixed cost and Variable cost 7. What are the important considerations for determination of cost based price? 8. Name the three concepts of cost based price? 9. What is meant by tariff fixation? 10. What is direct cost? BSNL, India For Internal Circulation Only 8