Post &Telestyrelsen. Bottom-Up LRIC Model Documentation March 2003

Transcription

1 Post &Telestyrelsen Bottom-Up LRIC Model Documentation March 2003

2 Post &Telestyrelsen Bottom-Up LRIC Model Documentation March 2003 PA Knowledge Limited 2002 Prepared for: Prepared by: Viveca Norman BU Modelling Team PA Consulting Group 123 Buckingham Palace Road London SW1W 9SR Tel: Fax: Version: Model documentation

3 FOREWORD This document has been prepared by the Bottom-up Modelling Team consisting of: Roger Steele (PA Consulting), Karl Wermig (PA Consulting), David Ramsbottom (PA Consulting) and Jasper Boe Mikkelsen (Andersen Management International). The purpose of this document is to help users of the bottom-up LRIC models to understand how they work and how they relate to the criteria set out in the Model Reference Papers (MRP). This document is complemented by a User Guide that provides additional guidance on how to operate the models. The User Guide also describes the models Excel in more detail. The views expressed in this document do not necessarily reflect those of PTS. i

4 TABLE OF CONTENTS Foreword i 1. Introduction Structure of this document The BU LRIC modelling process Structure of the models overview of each Definitions and priciples common to all models Consolidation model Definitions and assumptions Structure of Consolidation model The main functions of the Consolidation model Annualisation assumptions Working capital Functional area costs Other common costs Treatment of other services incl. retail Allocation of costs to services Core model Definitions and assumptions Structure of Core model Technical and volume inputs Cost inputs Network Design Rules Switching Transmission and infrastructure Routing factors Shared costs in the Core model Core model calculations Access model Definitions and assumptions Structure of Access model Modelling the Access network Modelling the access network: equipment at the scorched node and links to island sites Shared costs in the Access network Network elements for the Access network Co-location model Definitions and assumptions Structure of Co-location model Modelling Co-location services Direct costs in the co-location model 5-63 ii

5 5.5 Shared costs in the Co-location model Common costs in the Co-location model Other service costs included in the co-location model Sensitivity analyses Introduction Consolidation model Core model Access model Co-location model 6-71 Appendices AP iii Post &Telestyrelsen.28/3/03

6 1. INTRODUCTION 1.1 STRUCTURE OF THIS DOCUMENT This document describes the structure and principles used behind the Bottom Up Long Run Incremental Cost models (BU LRIC) that have been developed for PTS by the BU modelling team. The modelling team consist of members from PA Consulting Group and Andersen Management International. The BU LRIC model consists of several individual models that are inter-related and work together. Together, they form one LRIC model. This document uses the word model to mean both one of the individual models as well as the overall LRIC model that is formed by the combined individual models. This document does not describe in detail the Excel that is used to make each of the models this is described in more detail in the User Guide. In this document we do describe each of the four main models: Consolidation. This combines results from each of the models below and calculates the resulting service costs. Core. This calculates the cost of core network services and systems. It also includes some access costs. Access. This calculates the costs of access services such as raw copper. Co-location. This calculates the cost of services areas that may be used by other operators to co-locate equipment at TeliaSonera sites. Each model is described in overview in the sub section 1.3. Subsequent main sections describe each model is greater detail. A section that describes the model results and sensitivities is included (Section 6). The numerical values shown here are subject to change as inputs to the model are altered. Appendixes to this document describe how the model criteria have been met. Due confidentiality reasons a description of the source data used in the models has not been attached to this document. 1.2 THE BU LRIC MODELLING PROCESS The BU LRIC models have been created as part of a wider process that has been managed by PTS. This wider process includes: Defining and agreeing Model Reference Papers (MRPs) that specify purpose of the BU model and the criteria that the model must follow. The MRP also defines a top-down (TD) LRIC model that TeliaSonera will create. The BU and TD models will be compared and differences of each identified. This leads into a hybrid model process that will use the BU model as its basis. 1-1

7 The hybrid model will be developed using data from the TD and BU models. The overall process is therefore much more embracing than simply the BU model creation. This paper is not directly concerned with the other phases of work but clearly they have had an impact on the BU model development. A general feature of the wider process has been consultation. Consultations with the Swedish telecoms industry have been conducted at all stages of the process and opportunities have been given to influence the model structures and features. Within the BU LRIC project, the BU modelling team have communicated with industry members using a Bottom Up Working Group (BUWG) as the forum. The BUWG has given opportunities for its members to comment on the model structures. The progress of the model creation and planning have been reported on to the BUWG members. The resulting model is therefore the product of inputs not only of the modelling team itself but also the BUWG members that include PTS. The consultations with BUWG members have used discussion papers and open forum discussions at BUWG meetings. Additional one to one meetings or discussions with BUWG members have been conducted where required. The modelling team created a Model Specification. This document described the model functions and features, prior to model creation. It was agreed by PTS and the BUWG. Parts of the specification are re-used in this model description. Critical to the model are input data. This data has been supplied by BUWG members and other parties who have been invited to supply information. The results of the model depends on the quality of the input data. The modelling process has allowed each member to submit data for the model via the modelling team. This process has been used to help with the following: The BU modelling team examine the data and select the best values or to adjust the values when needed. The BU modelling team enables confidentiality to be maintained. Data that is used in the final model is given to PTS, but the source and actual values can be hidden, if required, in any released version of the model. The BU modelling process is completed after the BU models have been refined and reviewed. Following this stage, the model may be developed further as part of the comparison with the TD model and the development of the Hybrid model. This work is beyond the scope of this paper. 1.3 STRUCTURE OF THE MODELS OVERVIEW OF EACH In the following we give a general guide to each of the main models that together form the overall LRIC model. As mentioned previously the LRIC model consists of 4 components that are linked together: consolidation; core; access; and co-location models. These are shown in the diagram below. 1-2

8 Input data Input data Input data CoLo model Core model Access model Consolidation model: - transfer of costs - annualisation - common costs -consistency - costing services Overall structure of the models The models have some shared data - common data that is used by each model. This shared data is not extensive and so it is entered into more that one model. The consolidation model has a verification that enables checks to see that the different models are using the same data. This also allows one model to be adjusted so that cost data for one is different from the other a feature that might be useful under some scenarios. Each model is self-contained it carries out almost all of the calculations associated with its services. This enables each model to be developed independently. The structure shown reduces the number of inter-file links and this simplifies model management. The final results are calculated in the consolidation model. It is here that data from each model is collected and processed into the final service costs. As well as the models themselves some additional analytical work was required for some areas. These are referred to as off-line calculations as they do not form a part of the models. They are, however, no less important to the model since the off line calculations create input values for the models. The main off-line analysis concerns map and road analysis. This analysis has been made using of Graphical Information Systems (MapInfo) and paper maps. This work produced information about the road lengths and hence provides the basis for trench and cabling calculations. Cost inputs are often confidential. Some versions of the models will have disguised values. The user must trace to the source and check that the correct value is used. Version control is therefore important (this is up to the model users). The source data is identified by comments fields. The source name is identified by a code. The code can be traced back to the name of a source using a code sheet (this is confidential and is not normally available to all model users). The code sheet identifies which supplier delivered which input item value Consolidation model This model brings together the outputs of each of the main models. 1-3

9 Input data Mix of interconnect sites Input data CoLo Core No data feeds between models except Core to Access and Core to Colo CoC calc Working capital Common business Consolidated results - element or service Costs are sent to Consolidation model for results calculations. Other services incl. Retail business Cable TV Data & Other Common trench NB Line cards moved to Access in Consolidation model Annualisation Mark-up or allocations Input data Access Product costs Overview of the consolidation model The consolidation model collects the cost data from each model. Additional numerical data about the number of services, and other technical values are also collected. The data is linked into the consolidation model. The cost data is annualised. This annualisation converts the capital costs of equipment into average annual costs, based on the equipment lifetimes and price trends. Each cost items is given an allocation this defines what network element or service the cost relates to. The cost is then allocated and network elements are transformed into service costs using a routing / allocation table technique. The allocation allows cost items that were calculated in one model to be transferred to other services (thus access line cards or main distribution frame costs are calculated in core model but are used as part of access service calculations in the consolidation model). The routing tables are constructed using data supplied from the main models. The routing tables define how each product uses the network elements, and along with products volume data, it enables the services to the costed from the network element cost information. Additional inputs and calculations in the consolidation model allow mark-ups of common costs and the addition of working capital cost. The cost of capital (CoC) is a user-defined input that is used to calculate the annual cost of equipment based on the purchase price Core model The core model calculates the network systems and associated costs that are needed for a network operation of the scale of TeliaSonera. It calculates the cost of switching and transmission systems. The costs of building and overhead systems are also calculated. The core model therefore deals with the element costs that are 1-4

10 driven by traffic (call volumes and numbers of calls) in contrast to the access model, where costs are driven by number of customers. Staff or operation costs based on mark-ups are also calculated and included. The allocation of the staff cost to network elements is carried out in the consolidation model. The core model should be understood to have a different boundary to the core network. The core model also calculates costs of line card and the main distribution frame (MDF). These costs are part of the access network, but are included within the core model calculations. These access-related costs are allocated to access service costs in the consolidation model. The core model starting point is the volume data for each service. The PSTN/ISDN call services define the overall network size. This dimensioning of the network is done through a routing table that defines how each service uses the network. Additional inputs are required to define how non-ptsn services such as leased lines use the network. This gives an overall dimension for the network. The equipment needed to create the overall network is calculated next technical design rules are used to calculate the numbers and sizes of each element. Network costs that relate to other services (not PSTN services) are then excluded. The final costs of the many network elements needed for the PSTN services are finally exported to the consolidation model along with routing table data and volumes data. Off-line calculations are used to estimate inter-site distances and building costs per square metre. Key features of the core model are: A three layer switching hierarchy is assumed. There are Remote Subscriber Switching units (RSSs), Local Exchanges (LEs) and Transit Switches (TSs). The numbers of each may be altered and more than one may exist at any site. Additional international gateway and IN platforms are required. Circuit-switched voice technology is assumed. Voice over IP is not considered. Transmission is based on SDH (Synchronous Digital hierarchy). Transmission technology and layout is not constrained by the MRPs, however the transmission network must supply the level of service required. Rings are used to provide resilience. Optical systems are usually used, but microwave is also used. Some sites may be connected via spurs, due to local geographical features. 1-5

11 1.3.3 Access model The access model calculates the equipment and costs needed to create an access network for Sweden with the scope of services and demand as seen by an operator with SMP such as TeliaSonera. The access model calculates the amount of cables and equipment needed to connect from the Scorched Node site to the customer premises. The main items in the access network are copper cables ducts and trenching. Distribution nodes and splitting points are also required. Fibre is also used in the loop and fibre distribution links are also included. The access services are calculated in the consolidation model. This stage allows for additional costs that are calculated in the core model to be added to the cost calculated in the access model. LE LE Demux Lowest level Scorched Node(s) Line cards RSS RSM Line cards RSM Access Access Network Network Model Model FAM SDP SDP SDP Customer Site SDP SDP SDP NTP Fibre Copper Overall scope of the access network model The diagram shows that access model calculated costs from the scorched node via a tree- and branch style network to customer premises. Primary distribution points () may be used to split the cables. Secondary distribution points (SDP) can also be used to split the cables to the final drop-off points. These final drop of points or final splits are not shown and link the customer site to the cables in the street over the final drop. Not all links will have the need for primary and secondary splits as well as the final split the majority need only one distribution point. Fibre Access Multiplexers (FAMs) are used in the street (where needed) to provide optical systems links to copper final delivery to customers. 1-6

12 The costs of the cables and equipment are calculated using data about the populations and node sizes. Much of this analysis is carried by geotype and is done as an off-line analysis Co-location model This model calculates the systems and costs required to equip space in TeliaSonera buildings that is suitable for co-location space services. The main components of the co-location services modelled at different sites in the SMP operators network are: Location of equipment Installation and mounting of equipment Station wiring Placing Power, cooling and ventilation. Co-location is relevant in relation to switched interconnection, access to unbundled local loop, and for other potential purposes. However, the model only explicitly considers the co-location costs of the unbundled loop. However, the model takes account of sharing of costs between other co-location services and other increments. Unlike services in the core and access network, co-location services consist of relatively few cost categories. They are mostly standalone sub-products that may be combined by the operator who demands co-location. Therefore, although the colocation model is simpler in structure compared to both the core and access models, costs inputs are more detailed in order to capture costs at a sufficiently granular level. The main co-location cost is the cost of space. We assume that space in buildings is, in the long run, an incremental cost hence the building size is variable in the long run. Without this assumption the building costs would be fixed. 1.4 DEFINITIONS AND PRICIPLES COMMON TO ALL MODELS Some concepts and definition are used throughout this document and it is useful to understand the main ones. Scorched Node. This is a TeliaSonera site that has a voice switch or multiplexing equipment (Remote Subscriber Multiplexer - RSM) that has been used to replace a voice switch in recent times. The location and number of these nodes cannot be altered. The equipment within each may be altered (or scorched out ). A scorched node may contain several different types of equipment and it is typically a building varying from small hut to large exchange site in a city. A scorched node does not include small multiplexers that are used as part of the access network, typically in street cabinets or in basements of larger buildings. These are part of the access network. NB it is not permitted to scorch out one type of node completely (thus there must always be some RSSs, LEs and TSs the number of each cannot be set to zero). Geotype. Each site can be classified to be in one of several geotypes. A geotype depends on the density of subscribers per square km. Costs of services may 1-7

13 therefore vary by geotype. Geotypes enable the model to represent the diversity of areas in Sweden, whilst avoiding the need for detailed analysis and estimation for every one of the 10,000 or so switch zones. The geotypes used in the model are: 1. City: over 1,000 lines per km2 2. Urban: 100 to 1,000 lines per km2 3. Rural A: 10 to 100 lines per km2 4. Rural B: 1 to 10 lines per km2 5. Sparse: up to 1 lines per km2; at least one access network subscriber line. 6. Empty: no Access subscriber lines. Zone. Each scorched node is assumed to have an access zone around it. The subscribers in the zone connect to the node via the local access network for the zone. Subscribers are generally connected to the scorched node that they are closest to (with a few exceptions where local geography makes it more cost effective to connect subscribers to another nearby zone due to an obstacle such as a lake or due to local clustering of households). A zone is typically a few km (city) up to about 50 km in area (rural). The overall area covered by a node depends on the access technology used the limits of copper cables means that customers cannot be located very long distances from the node. The scorched node assumption means that the zones are effectively fixed. Note that there are many parts of Sweden that require no access zone at all, as there are no customers in the zone the zone has only lakes, forests and mountains with no population to service. These are allocated to the last of the geotypes listed above, and play no further part in the analysis of costs in the Access network. Fibre Access multiplexer (FAM). This is an item of electronics that multiplexes copper subscribers with fibre-accessed customers. The combined data is linked back to a scorched node via fibre optic link where the data is de-multiplexed. A FAM is typically in a street cabinet or larger customer-building basement. Remote subscriber multiplexer (RSM). This is a scorched node site that has multiplexing equipment. The RSM combines data and voice service from customers and transmits them over a fibre link to another scorched node site where they are demultiplexed and linked to other systems such as voice switched and data systems. Any voice-switch site may be converted to an RSM and vice versa under the Scorched node rules. The RSM will have copper line termination cards. Core-access demarcation. For ease of modelling the demarcation of the models and the services are different. The access service includes all equipment from the customer premises up the scorched node, including the line cards in the scorched node. Thus, access includes copper terminating line cards in the RSM and in a voice switch. The MDF is also included in the access network costs. The model demarcation, however, is at the scorched node, where the access model includes costs all the costs from the Network Termination Point (NTP) up to (and excluding) the scorched node site. The differences of core and access models and networks are illustrated in the diagram below. 1-8

14 Core Network Model Transit Switch (TS) TS Core Network Local Exchange (LE) LE LE Demux Line cards RSS RSM Line cards RSM Access Network Access Network Model SDP SDP SDP FAM Customer Site NTP SDP SDP SDP Fibre Copper Core and access network versus model demarcation The core model includes the line card and MDF calculations, even though these are access network cost items. Main distribution frame (MDF). The main termination point for copper access cables in a scorched node site. The copper pairs from the customer are linked from the MDF to the equipment in the scorched node. Spur. A path to one or more sites that has only one physical route. Ring. A logical or physical connection that has two paths that therefore can (optionally) provide alternative routes should one path round the ring fail. Logical versus physical link. The logical link (or links) is the path between two items of equipment. The physical path is the actual route taken by the data between the equipment. There may be two logical paths, but it is possible for these to be on the same physical path or on diverse paths. Capital versus operational costs. A fundamental feature of the BU model is the different determination of capital related costs and operational costs. Capital costs (or capex) are a result of the purchase and installation costs of the equipment. The total capital cost of a particular type of item is the cost of one item times the number of items required. The lifetime of the equipment and the price trends are also capital related data. They are used, along with the purchase costs to determine the average cost per annum the annualisation calculation is carried out in consolidation. The depreciation is calculated in the consolidation model (and is related to the capital cost). Operational costs are a result of the maintaining, operating and repairing the equipment once bought. This is an on going or annual cost. Operational costs are derived separately from the capital cost and the two items are not directly related. Functional areas and operational cost calculations. Operational costs are based on a definition of functional areas. These are areas of the business that are needed to carry out a set of related functions such as operational work on (say) switches. Functional areas are defined to have a set number of staff. The costs of this functional area are therefore independent of the capital cost. The models allocate the cost of the functional area to the capital items in proportion to a cost factor. The cost 1-9

15 factor is defined as a percentage of the capital cost the percentage is an initial estimate of the equipment capital cost as a fraction of the purchase cost. Costs are allocated pro-rata. Therefore if the capital cost of equipment varies, then the total operational cost is still fixed (it is defined by the functional area size). The allocation of the total operational cost will vary slightly. However, if every item s capital cost increases similarly, the allocation will remain the same. Base year. This is the starting year for cost and volume calculations. All primary data should be for this year. Future year data may be needed in some parts of the model, but these are by definition predicted values. Market forecasts of volumes for future years are typical examples that are required to enable the base year data to be extrapolated to ensure the network is dimensioned to cope with future demand. 1-10

16 2. CONSOLIDATION MODEL 2.1 DEFINITIONS AND ASSUMPTIONS The consolidation model uses the costs relating to core, access and co-location that are produced by each of the separate models. The costs are brought together in the consolidation model. This grand consolidated list of all cost categories is shown in the I_Cost Categories Sheet. The consolidation model produces the final cost of each service. It also undertakes some checks for consistency between the other three models. As well as annualised costs, any cost may be expensed, hence the cost is recovered as a one-off payment. Some cost items that are relevant to access or co-location services are typically treated in this way. Core PSTN costs would not normally be expensed. The model therefore calculates service costs as a mixture of one-off and annualised costs. The choice of annualisation or expensing is user-defined and it is essentially a pricing decision. 2.2 STRUCTURE OF CONSOLIDATION MODEL The consolidation model structure is captured in the navigation map. This is reproduced in the diagram below. Consolidation model - navigation map The consolidation model has three main stages input, calculations and output. The main functions of the consolidation model is the calculation of service costs from the cost category inputs of the core, access and co-location models, and the integration of functional area costs, including common business costs. 2-11

17 2.3 THE MAIN FUNCTIONS OF THE CONSOLIDATION MODEL The consolidation model carries out several key functions. They include: Annualisation of capital costs to give an annual cost. Optionally the cost item may instead be expensed (treated as a one-of cost) Calculation and recovery of costs relating to working capital Calculation of service costs. These functions are discussed in more detail in the sections that follow. The consolidation model contains come central data values and calculations, but its prime purpose is to consolidate all of the calculated costs from each model and calculate the service costs from these cost inputs. The design is based on disaggregated cost data. This approach based on a collation of cost data enables all costs that contribute to each service to be identified individually. The collated input costs from each model are annualised (or expensed). This involves adding together different cost types such as equipment costs, installation costs and operation costs to derive a single cost (annual or one-off) that represents the long-run cost that must be recovered. The assumed cost of capital, price trends, lifetimes and scrap values are combined in this calculation. The disaggregated approach also allows the user to use alternative annualisation formulae for any cost category. A number of different annualisation options have been provided. These are discussed in more detail in the next section. The annual cost of each cost category is allocated to network elements or services. The user is allowed the flexibility to define the allocation to use. The resulting element costs are then processed into service costs. Routing tables and other allocation/combinatorial techniques are used as required. The final cost of services is then subject to an uplift to give an equal mark-up approach to common business costs and costs related to working capital. A feature of the approach taken is that the costs, when input to the consolidation model, can be altered (or overwritten) to give another value and the results directly evaluated. This is approach to sensitivity analysis is not a normal action (it invalidates the true results), but it is easy to carry out. Another approach for sensitivity analysis is to alter the allocation of the cost category. If a cost category is not given an allocation (remove or delete the network element allocated to the particular cost category) then the cost is taken out of the service cost. It is easy to compare the new value with the normal value and hence see the sensitivity of any service to a particular cost category. This type of analysis is also referred to as the delta method the user can quickly see the difference or delta caused by any one cost. This means that the contribution of any one cost to a service can be easily seen. 2-12

18 2.4 ANNUALISATION ASSUMPTIONS Cost of Capital The cost of capital measures the opportunity costs of the sources of capital (debt and equity) invested in the company (the SMP operator). In March 2001, a study was conducted by BDO Consulting Group for PTS in order to establish the cost of capital for interconnection services in TeliaSonera s fixed network. Although the various parameters used in this study may have changed, PTS believes the methodology used is appropriate and should be used for estimating the cost of capital in the top-down and bottom-up models. This estimated value of 13.5% (nominal pre tax) is an input in the model, cf. CG 1 in the MRP Annualisation options The consolidation model offers a number annualisation options. These are: Straight-line depreciation Tilted Straight-line depreciation Sum of digits depreciation (front loaded) Standard annuity function Tilted annuity function Straight-line depreciation divides the asset s price by the asset s life to produce an annual depreciation charge. To calculate the annualisation charge, a capital charge is added. The straight-line annualisation factor used in the model is: SV CV (1 CoC) AL 1 + CoC, AL where CV is the capital value of asset, SV the scrap value of the asset, AL the asset life and CoC the cost of capital. Tilted straight-line depreciation takes account of expected price changes for assets. It will result in a steeper depreciation profile when prices are falling than unadjusted straight-line depreciation. The tilted straight-line annualisation factor used in the model is: where PT is the price trend. SV CV (1 CoC) AL 1 + CoC PT, AL The sum of year digits (SOYD) is a simple method for generating a front-loaded depreciation schedule. It may be a useful approximation if the asset s operating costs 2-13

19 are expected to rise or its price or the revenue it generates is expected to fall. The sum of years digits annualisation factor used in the model is 1,2 : SV CV (1 CoC) 2 AL + AL 1 + CoC The annuity approach calculates both the depreciation charge and the capital charge. A standard annuity calculates the charge that, after discounting, recovers the asset s purchase price and financing costs in equal annual sums. In the beginning of an assets lifetime the annualisation payment will consist more of capital charges and less of depreciation charges; this reverses over time resulting in an upward sloping depreciation schedule. The increase in the depreciation charge over time exactly counterbalances the decrease in the capital charge with the result that the annualisation charge is constant over time. The standard annuity function used in the model is: SV CV (1 CoC) AL CoC CoC A tilted annuity calculates an annuity charge that changes between years at the same rate as the price of the asset is expected to change. This results in declining annualisation charges if prices are expected to fall over time; for a large enough tilt the slope of the depreciation profile will also be negative. As with a standard annuity, the tilted annuity should still result in charges that, after discounting, recover the assets purchase price and financing costs. The tilted annuity function used in the model is: AL CV SV (1 CoC) AL CoC PT 1+ PT 1 1+ CoC AL As stated in the MRP the starting point for the bottom-up model, should be to use (tilted) annuities. The annuity approach has the advantages that the annualisation charge is independent of the age of the asset. The fact that the bottom-up model is (artificially) modelling new assets therefore becomes less of an issue 3. 1 Note the formula used is a simplified version of the sum of digits (front loaded) annualisation formula. This simplification is possible since the costs we are modelling are those for the first year in an asset s life. 2 Note that sum of years digits depreciation may also be back-loaded. This is the reverse of the depreciation under sum of years digits front-loaded. 3 Otherwise, it could be argued that the bottom-up model should not model the costs in year 1 but rather in year 3 or 5 for example. 2-14

20 However, the MRP also states (in CG 18) that choice of depreciation methodology may be justified by reference to a formal comparison between the different depreciation profiles and economic depreciation. International experience may also be used as justification to the extent that the annualisation methodology has been selected on a similar criterion (proxy to economic depreciation). We have not carried out a justification based on economic depreciation profiles. This is due to the significant practical and informational difficulties in estimating economic depreciation correctly. However, we note that the tilted annuity function is in line with the FCM methodology 4 recommended by the European Commission 5. The default annualisation formula used in the model is therefore tilted annuities 6. Note that the majority of equipment costs and installation costs are passed on to the consolidation model where they are annualised. However, there are a few exceptions. These are building costs and common site costs that are annualised in the core model Annualisation parameters Price trends, residual (scrap) values and equipment lifetimes are specified for all cost categories and are used in the calculations. These inputs are made in the separate core, access and co-location models. The consolidation model merely imports these values and then uses them in the annualisation process. The MRP does not provide specific guidance for the BU model on these parameters. However, the specific guidelines for the TD model indicate that the economic life of equipment is the appropriate measure for asset lives. Estimating the expected economic life of the asset will involve a degree of subjectivity. Although the engineering life or the physical life can be used as a starting point, the difficulty is to determine how much the asset life should be shortened to reflect the stranding of assets as a result of technological change or through changes in demand. The BU modelling team have asked for the BUWG to provide estimates of asset lives in the data requests submitted. With regard to price trends the BU modelling team have used evidence supplied by the BUWG of the likely changes in prices and international benchmarks where account also was taken of changes in the price in the recent past. 4 The tilted annuity meets the requirement of financial capital maintenance (FCM) in that it returns to the investor, in present value terms (using the cost of capital as the discount factor), the full cost of the asset. 5 Commission Recommendation on Interconnection in a Liberalised Telecommunications Market Part 1 Interconnection Pricing, 15 October Note that tilted annuities do not work well when asset prices are declining rapidly (understating costs) or where asset prices are rising over time (overstating costs but less than a lot of the other methodologies). Hence, using tilted annuities may result in understatement of core costs and overstatement of access. 2-15

21 2.5 WORKING CAPITAL The cost of the working capital is a percentage of the total working capital. For the purpose of bottom-up modelling the MRP states that the required level of working capital may be calculated as: (Debtor days sales) (creditor days total trade creditor related costs) + cash, where stock is assumed to be negligible and debtor days and creditor days refer to the weighted average. Only working capital, which is related to the operator's network (wholesale), may be included. Hence, working capital related to retail debtors and creditors cannot be included. Since there is likely to be a significant difference in working capital between the wholesale core and access business, the model calculates working capital for each of these businesses separately Debtors and cash The sales will be the sales revenue of co-location, core PSTN and access network services. These should be calculated assuming a cost-oriented price. Because the BU model does not calculate sales revenue, total annualised costs may be used as proxy, since they will equal the level of sales revenue if LRIC charges are set correctly. Determining the prudent level of cash to be held as working capital will depend on attitudes to risk and the perceived cost to an operator of suffering a cashflow crisis. The MRP indicates that a percentage increase in the debtor days may be used instead of a figure for the amount of cash a prudent operator requires. This is the method used. Applying these simplifications debtors and cash may be rewritten: n i = 1 DDi DWi 365 TC ( 1+ %increase in DD) where DD i = debtor days of debtor i=1,..,n DW i = is the weight assigned to the debtor i (a percentage of total annualised costs). TC = total annualised costs. We note that some services are paid for in advance hence some services will have negative debtor days and others will be a positive number of days (paid for in arrears). Since there a likely to be large differences in debtor days for access and 7 Note that the cost of working capital for the core business is used as a proxy for co-location services. 2-16

22 core services the model makes a distinction between the two. Data suggests that access debtor days will be negative while core debtor days will be positive Creditors The total trade creditor related costs should include costs of wages, electricity and other payments to suppliers, such as support contracts and equipment suppliers. The creditor costs can be determined from the total costs, excluding cost of capital. This is because equipment suppliers costs (annual capital expenditure) are approximately equal to depreciation and the remaining creditor costs as e.g. electricity, wages and other supplier costs may be regarded as related to operational cost. Sum of depreciation, electricity, wages and other supplier costs is the total cost produced by the LRIC model when the cost of capital is set to zero. Thus, the total cost when cost of capital is set to zero can be assumed equal to the creditor costs. Applying these simplifications, creditor related costs may be written as: j m CD j CW = j TC ex CoC, where CD j = creditor days of creditor j=1,..,m CW j = is the weight assigned to creditor j's. TC excoc = Total costs excluding the cost of capital Working capital formula The formula for the required level of working capital used in the model can therefore be summarised as follows: n m DD DW CD i j CW i j TC ( 1+ %increase in DD) - = i j = TC excoc The required level of working capital is determined using the above formula and using international benchmarks as input values. To calculate the working capital surcharge the total working capital value is multiplied by the cost of capital to get the cost of working capital. The cost of working capital is then calculated as a fraction of the total costs (sum of costs of core, access and colocation) and used to used to uplift the cost of services. We note that working capital could have a lower return than the return used for capital investment. This is possible since some of the working capital could be used to obtain a return from (say) short term bank deposits. We have chosen to apply the same return value for working and investment capital, because even an efficient operator may not realistically be able to obtain such a return. Also, agreeing on the expected fair return on working capital is not easy. As a result our estimate of the cost of working capital is potentially a slight over-estimate. 2-17

23 2.6 FUNCTIONAL AREA COSTS The MRP gives considerable freedom in the modelling of operating costs and other indirect non-network costs. The BU modelling team have considered a variety of options. Ideally, all operating costs and other non-network costs should be modelled from first principles. This involves: 1) identify the drivers of these costs, 2) identify the relationships between the cost drivers and classes of costs and 3) incorporate these relationships into the model. In practice however, such a modelling process is likely to be extremely complex, costly and time-consuming. Further, as the MRP notes this may result in activities being missed without a very detailed understanding of the SMP operator s operations. As a result, typically in LRIC models, operating costs and other non-network costs are estimated as a percentage of network capital investment. There are however, a number of potential problems with this approach. First, it assumes strict relationships between capital investment and operating and maintenance costs and that this is stable over time. Second, as operating costs are based on network investment, this approach tends to amplify any errors made in the determination of the appropriate level of network investment. Another approach would be to derive mark-up s using the actual operating costs of the SMP operator based on existing accounts. Although not forward-looking or necessary reflecting efficient costs, this approach would ensure the costs do reflect the situation of SMP operator. However, even if the SMP operator were fully efficient, any percentages derived would be inappropriate as capital investments would not be valued on the basis of their current replacement costs. The BU modelling team have therefore chosen a novel functional area approach, recognising that a pure mark-up based approach may not be satisfactory. The approach taken is a quasi top-down approach, encompassing estimates for the operational costs for the wholesale business, plus other relevant operational overheads. The approach used is to identify each operational (or functional area) that is needed. Each of these areas is dimensioned (e.g. X number of staff in department Y needed for every N local exchanges or for the entire company) in order to define the total operational costs expected for an efficient operator (using average cost per staff member). These results define the expected total staff costs required to run the domestic PSTN network of an operator with SMP in Sweden. This approach consists of several stages: 1. Define the operational areas to consider. 2. Define the size of each area. 3. Define the cost of each area. 4. Allocate the cost of each area to (say) switches or other network items, such that the total is equal to the sum of the functional areas. 2-18

24 Stage 1 resulted in the identification of 21 functional areas for costing. Stages 2 and 3 where completed following input from BUWG members and TeliaSonera. Stage 4 has been implemented in the model Operational areas to consider The functional areas considered in the model retained as full-time staff are: Corporate Overheads Core transmission Human resources maintenance Finance Core transmission planning Billing Access transmission management Support systems Access transmission Admin maintenance Switched Network Access transmission planning Management Site management Switched network maintenance Field Engineering access Switched network planning Field Engineering core Core transmission management Functional areas in the model related to one-off, non-recurring events considered in relation to a single piece of equipment are: Switch implementation Transmission implementation Access implementation Size of each area For each of the identified functional area above, the model includes input for the staffing requirements i.e. the number of staff required for each area. The total staffing requirements determine the size of each area. Note that staffing requirements input do not distinguish between different staff types. Distribution to different staff types is done at a later stage in the calculation, cf. below. The inputs are based on an evaluation of the requirements for an optimised network with the scope and size of the SMP operator. However, due to the lack of sufficiently detailed data some of staffing requirements may be set to zero and grouped into other areas Cost of each area The cost of each area is calculated using staffing profile assumptions (%-manager, %- support and %-technical) and the average annual cost of the different staff types. The staff costs include social costs, benefits (car, healthcare etc.). Further, a mark-up has been added to take account of non-pay costs. In order to derive the total annual cost of each area the model simply multiplies the average salary costs with the calculated number of staff and sum over all staff types. 2-19

25 2.6.4 Allocation of the cost of each area In order to use the costs calculated using the functional area approach, the model utilises an allocation table and the operating costs already allocated to different network elements by using the mark-ups in the core and access model. The allocation table consists of zero (do not allocate costs) and one (allocate costs). Using this allocation table and the operating costs allocated to each network element the model calculates the functional area costs to each network element. The formula used to allocate costs is: where FA NE j α ij FA j =, opex NE α i i FA j = the FA cost of network element j FA i = the FA cost of area i j NE j = operating cost allocated to network element j using mark-ups in the core and access model j opex α ij = allocation key for network element j and area i Common business cost The functional area costs also provide an estimate of common business costs. In the model common business costs are defined as: Costs that are required by an efficient operator with SMP in Sweden, with the scope of services similar to TeliaSonera. These costs are common to the businesses of core, access, co-location and other retail services. They are indirect non-network costs that are required to make the business function and hence not directly related to the services or the network. Examples are the chairman s office, legal department, audit fees etc. Clearly these are required in any business, are common to the entire business and do not vary directly with service or network costs. Common business costs, in contrast to common or shared network costs, are not directly related to services or the network Expensed vs. annualised costs The model calculates the mark-up for common business based on the annualisation of all costs. Therefore expensed costs are allocated a share of the common business costs by calculating the common business costs mark-up as if all costs where annualised and applying this mark-up directly on the expensed unit costs. This may be regarded as a pragmatic solution to ensuring that expensed costs receive a proportion of common business costs. The underlying assumption is that the total pot of annualised costs, for those cost that are expensed, may be taken as a proxy for the proportion of annual one-off costs. ij 2-20

26 2.7 OTHER COMMON COSTS Common business costs were described above. This section concerns other common costs such as building related costs and shared costs such as ducts and cables. These are the network costs of shared network equipment that are necessarily incurred if access and interconnection services are provided and are not avoided if interconnection and access services are no longer provided. These costs are not specific to the consolidation model, but are described here because they relate to all models Building costs Building space and common building-related costs are an input in the core model. Common building-related costs (or site costs) include site security, power supply units and air conditioning. The model attributes each site type (RSS/RSM, LE and TS) a common site cost. This cost is then divided by the average size of these sites to obtain a per square metre value. The average site size is assumed to consist of area used for PSTN equipment, non-pstn equipment and co-location. The average site size for co-location is an input value from the co-location model (manually entered). The raw annual building space costs per square metre for each genotype is an input to the model. This value has been derived from publicly available sources. Common site costs are annualised and added to the annual building costs to achieve a cost per square metre for each geo-type. These values are then converted to a per square metre value for each site type. This value is also used in the co-location model (manually entered). Each cost category has a defined accommodation area of occupancy. Thus local exchanges will obtain some building costs, and transmission equipment will also occupy some space. The areas occupied by each piece of equipment are user inputs. The total common site costs (equipment, operational costs and any allocated building costs) are next allocated to the equipment within the sites. This is done in proportion to the area occupied. Thus the area occupied in a local exchange building by a local exchange switch determines the amount of common shared building costs that are allocated to the network element or service. Accommodation costs remain disaggregated through the individual models into the consolidation model. It is therefore possible for the user to modify the consolidation model to re-allocate these common costs in any manner desired Shared facility costs A number of shared facilities exist (excluding buildings). While it is relatively straightforward to identify the network elements used by services other than PSTN, the potential difficulty is determining the usage of the network elements by other services. The BU Modeling Team have therefore allowed in a fairly large degree of flexibility in the treatment of these costs in the models. The two major categories of shared facility costs discussed in this section are: Duct facilities (and of trench diggings) and core network systems. Duct and trench facilities 2-21