Wholesale pricing, NGA take-up and competition

Transcription

1 WIK-Consult Report Study for ECTA Wholesale prcng, NGA take-up and competton Authors: Professor Steffen Hoerng Stephan Jay Dr. Werner Neu Dr. Karl-Henz Neumann Dr. Thomas Plückebaum Professor Ingo Vogelsang WIK-Consult GmbH Rhöndorfer Str Bad Honnef Germany Bad Honnef, 7 Aprl 2011

2 Ths study represents the vews of WIK-Consult, and cannot be assumed to reflect the vews of ECTA or ts ndvdual members.

3 Wholesale prcng, NGA take-up and competton I Contents Content of Fgures Content of Tables IV VI Executve Summary 1 Introducton 11 1 The theoretcal foundaton of FL-LRIC prcng Characterzaton of FL-LRIC prcng FL-LRIC and the compettve standard FL-LRIC and entry FL-LRIC and statc effcency FL-LRIC and ncentves to nvest Concluson 17 2 The ptfalls of applyng FL-LRIC to copper-based ULL at ths tme Decreasng demand Compettve standard Statc effcency Incentves to nvest Entry and ext Cost recovery MEA and fbre technology Conclusons on the defcences of FL-LRIC prcng 22 3 Alternatves to FL-LRIC prcng Prcng accordng to hstorc costs Opportunty cost-based prcng Prcng and margn squeeze Opta's dscounted cash flow approach Practcal mplementaton 29 4 Some mportant case studes Current regulatory practce on ULL prcng n the EU Gudelnes from the NGA Recommendaton 34

4 II Wholesale prcng, NGA take-up and competton 4.3 Country case studes The UK Austra Germany Italy France Span Australa Summary of fndngs 60 5 Modelng the copper and the fbre access network General approach Euroland The copper access network The FTTH network Network cost The unbundlng busness model Proftable coverage and crtcal market shares Brownfeld senstvty WACC senstvty on fbre LLU prce Economc lfetme senstvty Senstvtes on copper network cost WACC Economc lfetme of ducts and trenches Decreasng volumes n the fxed network Reducng the cost of nfrastructure 84 6 Impact of wholesale prces on competton, nvestment and consumer welfare Objectve Modelng approach The theoretcal model The quanttatve model QoS and wllngness to pay n the basc model 95

5 Wholesale prcng, NGA take-up and competton III 6.3 Model runs on the varaton of access charges Varyng the copper access charge (ac) Man assumptons Results on performance varables and the swtch from copper to fbre Effects of changes of consumer valuatons on the ncumbent s profts Varyng the fbre access charge (af) Modelng assumptons Results for the ntegrated ncumbent offerng the most proftable servce(s) Model wth vs. wthout cable Results for an ntegrated ncumbent offerng both servce(s) Results for a parallel varaton of both copper and fbre access charges An ntegrated ncumbent vs. an ndependent fbre nvestor Potental conflcts between the ncumbent and customers on the decson to swtch to fbre Conclusons Regulatory polcy conclusons 135 Appendx: Theoretcal background for the competton model 141 Lst of references 146

6 IV Wholesale prcng, NGA take-up and competton Content of Fgures Fgure 2-1: Welfare loss under excess capacty when access s regulated at FL-LRIC 20 Fgure 3-1: Opta's dscounted cash flow model 27 Fgure 4-1: Cost base unbundled access wholesale (Market 4, prevously Market 11) 31 Fgure 4-2: Accountng methodology unbundled access wholesale (Market 4, prevously Market 11) 32 Fgure 4-3: Fgure 4-4: Prce control method unbundled access wholesale (Market 4, prevously Market 11) 33 France Telecom Investment nto ducts (wthout common cost and OPEX, n mn, constant nvestments from 2006) 52 Fgure 5-1: Overvew of modelng framework 64 Fgure 5-2 European unbundlng prces 68 Fgure 5-3: FTTH/P2P archtecture wth fbre LLU 73 Fgure 5-4: Impact of asset lfetme on fbre P2P LRIC (Euroland Cluster 1-4 average) 82 Fgure 6-1: Preference space 87 Fgure 6-2: Incumbent s total proft under varaton of ac for af = Brownfeld LRIC 99 Fgure 6-3: Incumbent s total proft under varaton of ac for two levels of af 100 Fgure 6-4: End-user prces under varaton of ac for af = Brownfeld LRIC = Fgure 6-5: Welfare and consumer surplus under varaton of ac for af = Brownfeld LRIC = Fgure 6-6: Market shares under varaton of ac for af = Brownfeld LRIC = Fgure 6-7: Retal profts under varaton of ac for af = Brownfeld LRIC = Fgure 6-8: Retal proftablty under varaton of ac for af = Brownfeld LRIC = Fgure 6-9: Senstvty of swtchng ponts and ncumbent s profts to consumer valuatons of copper and fbre (af = ) 110 Fgure 6-10: Effects of a change n consumer valuaton on ncumbent s profts and swtch to fbre for two levels of access charges Brownfeld/SRIC costs 111 Fgure 6-11: Effects of a varaton of af on ncumbent s profts and swtch to fbre for two levels of ac 113 Fgure 6-12: Effects of a varaton of af on ncumbent s end-user prces and swtch to fbre for ac = Fgure 6-13: Effects of a varaton of af on ncumbent s end-user prces and swtch to fbre for two levels of ac 115

7 Wholesale prcng, NGA take-up and competton V Fgure 6-14: Effects of a varaton of af on ncumbent s and cable s end-user prces and swtch to fbre for two levels of ac 116 Fgure 6-15: Effects of a varaton of af on ncumbent s profts and swtch from copper to fbre for model wth and wthout cable cost bass: hgh-hgh 118 Fgure 6-16: Effects of a varaton of ac on ncumbent s profts and swtch from copper to fbre for model wth and wthout cable 119 Fgure 6-17: Incumbent s profts under jont vs. separate offerngs of copper and fbre 120 Fgure 6-18: Effects of a varaton of af on ncumbent s profts for the case of an ntegrated ncumbent offerng both servces hgh valuaton of copper (ac = 8.55 ) 121 Fgure 6-19: Effects of a varaton of af on ncumbent s profts for the case of an ntegrated ncumbent offerng both servces low valuaton of copper (ac = 8.55 ) 122 Fgure 6-20: Effects of a parallel varaton of ac and af on the ncumbent s profts and swtch to fbre Greenfeld/LRIC 123 Fgure 6-21: Effects of a parallel varaton of ac and af on the ncumbent s profts and swtch to fbre Brownfeld/SRIC 124 Fgure 6-22: Access charge combnatons, for whch a swtch from copper to fbre has occurred 126 Fgure 6-23: The swtch to fbre under an ntegrated ncumbent vs. an ndependent fbre nvestor n the case of a varaton of ac (af = = LRIC) 127

8 VI Wholesale prcng, NGA take-up and competton Content of Tables Table 4-1: ULL prce benchmark over 13 countres ( ) 34 Table 4-2: New prce controls for ULL n the UK 38 Table 4-3: ULL costs and prces n Austra 41 Table 4-4: Monthly rental for ULL n Germany 43 Table 4-5: Key cost parameters for ULL n Table 4-6: Margn squeeze calculaton n case of a bundle product 45 Table 4-7: LLU trend n Italy (monthly rental) 48 Table 4-8: OPEX n monthly LLU prces Table 4-9: Monthly LLU prces n France from 2000 to Table 4-10: Products revewed by CMT and proposed changes to ther prces 54 Table 4-11: ULL monthly rentals from 2001 untl present 55 Table 4-12: Table 4-13: Current ndcatve prces compared wth draft ndcatve prces from 1 January 2011 to 31 December 2014 (n AUS $) 59 Prevous ndcatve prces compared wth IAD prces to apply from 1 January 2011 to 31 December 2011 (n AUS $) 60 Table 5-1: Structural parameters of Euroland 66 Table 5-2: Aeral deployment share per cluster 67 Table 5-3: Dervng cluster-specfc copper network costs from the natonal average 69 Table 5-4: Total monthly cost for the copper network (Clusters 1-4) 70 Table 5-5: Comparson of OPEX and CAPEX of average monthly cost for LLU 71 Table 5-6: OpCo downstream cost 74 Table 5-7: Investment assumptons 74 Table 5-8: Cost and other assumptons 75 Table 5-9: Total monthly cost for the fbre network (Clusters 1-4) 75 Table 5-10: Crtcal market shares for FTTH (cluster by cluster) 77 Table 5-11: Assumpton on effectve reducton of nvestments through duct-reuse 79 Table 5-12: Crtcal market shares and fbre LLU prce for Greenfeld and Brownfeld deployment 79 Table 5-13: Crtcal market shares for dfferent WACC values 81 Table 5-14: Fbre LLU prce for dfferent WACC values 81 Table 5-15: Copper LLU cost: WACC senstvty 83

9 Wholesale prcng, NGA take-up and competton VII Table 5-16: Copper LLU cost: economc lfetme senstvty 83 Table 5-17: Copper LLU cost and nvestment: reducton of number of lnes 84 Table 5-18: Copper LLU cost and nvestment reducton of nvestment nto trenches and poles 85 Table 6-1: ARPU assumptons for quanttatve model 95 Table 6-2: Maxmum WtP assumptons for quanttatve model 95 Table 6-3: ARPU constellatons of relatve valuaton of copper aganst fbre 96 Table 6-4: Output varables of the model for fbre at af = Table 6-5: Output varables of the model for copper at ac =

10

11 Wholesale prcng, NGA take-up and competton 1 Executve Summary 1. Europe has formulated far reachng and ambtous targets for Next Generaton Access n ts Dgtal Agenda for Europe. A wdely avalable and compettvely fast and ultra-fast broadband access - as t s best provded over FTTH networks - s consdered as a cornerstone to meet these ta rgets. Gven the low coverage and penetraton of fbre networks n Europe up to now, fosterng fbre deployment requres large-scale nfrastructure nvestments. In order to facltate the deployment of NGA and to encourage market nvestment n open and compettve networks the Commsson has adopted the NGA Recommendaton to provde approprate access remedes for an NGA envronment. 2. Less attenton has been gven to the transton from copper to fbre access networks. What are the regulatory condtons that favour the transton and whch condtons dscourage t? In ths study we wll prmarly focus on the mpact of access charges on the swtch from copper to fbre. We wll show that not only the fbre access charges have an mpact on the ncentve to nvest n fbre. It s also the copper access charge whch has a major nfluence on the transton to fbre. 3. In ths study we wll deal wth cost methodology ssues for determnng access charges. Specal emphass wll be gven to the challenge of regulatory costng and prcng n case of a declnng demand as can be observed for the copper access network. We characterze current regulatory polcy and practce as regards ULL prcng for copper and fbre. In addton to gvng an European overvew we also present several case studes on countres, whch represent a certan unqueness n ther approach so that a comprehensve pcture of regulatory polcy s emergng. We calculate the relevant costs for copper and fbre networks and the cost drvers for a representatve European country whch we call Euroland. The fbre cost model nforms about proftable coverage and crtcal market shares for a vable busness model. Network costs are derved for the nvestor and for compettors whch base ther busness model on the unbundlng approach. In a varety of senstvtes we show the mpact of Brownfeld assumptons for fbre deployment on costs, coverage and competton. Furthermore, we show the mpact on costs and competton of dfferent assumptons regardng the WACC and economc lfetmes of network assets. We present smlar senstvtes for the copper access network. In addton we show the cost mpact of a decreasng demand. In an nnovatve approach we then model the mpact of wholesale prces on competton, nvestment and consumer welfare by means of a strategc competton model that we specfcally developed for ths purpose. It shows the results of the strategc nteracton of market players for varous performance varables. The study ends wth regulatory polcy conclusons.

12 2 Wholesale prcng, NGA take-up and competton Current prcng approaches n Europe 4. Most NRAs n the EU are stll applyng the Forward Lookng Long Run Incremental Cost (FL-LRIC) cost standard to determne the wholesale prce for copper Local Loop Unbundlng (LLU). FL-LRIC prcng has a long tradton as a prcng prncple to provde economc effcency for regulated servces. FL-LRIC prcng has a lot of attractons for regulators: Prces on that bass reflect the compettve standard and consumers get the best deal. Incumbents get correct sgnals regardng nvestment decsons and compettors get the proper sgnals for ther make-or-buy decson. 5. The prces for the monthly rental per fully Unbundled Local Loop (ULL) n the EU vary n the range of 6 to 16 Euro per month wth an average of These prce dfferences are not (only) due to natonal dfferences n costs, e.g. the WACC. They reveal qute dfferent applcatons of cost methodologes lke cost standard, deprecaton method, asset lfetme and averagng of costs as appled by NRAs. 6. Gven that the market and demand s changng over tme, some nsght nto regulatory polcy s provded by the development of ULL prces over tme. Three dfferent patterns of prce paths can be dentfed from a benchmark coverng 13 European countres over the perod from 2005 to 2011: (1) Some NRAs have set a prce path wth relatve stable but slghtly declnng ULL wholesale prces. France, Germany and to some extent Portugal fall nto ths category. They have reduced prces by less than 10% over that perod. (2) A second group of NRAs has set a more aggressve path of a steady prce declne. Austra, The Netherlands, and Belgum belong to ths category. ULL prces have been decreasng by 32% to 46% n these countres. (3) In a thrd group of countres, prces have been (sometmes strongly) decreasng n the frst part of the perod consdered and have been ncreasng or are begnnng to ncrease agan n the last few years. Span, Sweden, the UK and Italy fall nto ths category. 7. Some NRAs control ULL wholesale prces ex ante, others only ex post or set rate celngs. The accountng lfetme of assets vares from 15 to 25 years for copper cables and from 30 to 45 years for ducts. The relevant WACCs for the access networks are n a range of 7% to 13%. The ULL charge usually (wth a few exceptons) represents a natonal average of the loop costs despte the fact that costs vary sgnfcantly accordng to access densty and compettors demand for ULL s focused on the denser part of a country. Asset valuaton s at current cost, hstorc cost or a combnaton of both. Even more mportant are the dfferences n the way n whch current costs are calculated; there seems to be a lot of dscreton for ncumbents and/or NRAs n ths respect. Some NRAs apply the current cost

13 Wholesale prcng, NGA take-up and competton 3 valuaton on all network elements as nstalled n the access network; other NRAs apply effcency consderatons and only take nto account those network elements and assets whch are needed to run the access network effcently. Some NRAs base ther cost calculaton on bottom-up cost models, others on top-down models, a thrd group just reles on accountng nformaton provded by the ncumbent. Also the deprecaton methods vary from straght lne to economc deprecaton where the latter s often made operatonal by a tlted annuty approach. 8. The vast majorty of NRAs s not yet addressng the costng and prcng mplcatons of decreasng demand for copper access lnes properly. Some NRAs ncreased ULL prces n ther latest decsons (lke the UK and Span) even though (and sometmes because) demand s decreasng. In Italy the NRA even swtched from HCA prcng to CCA wth a major prce ncrease n a moment n tme where ths swtch s most questonable. Some NRAs are begnnng to dentfy and to address the ssue that certan costng methodologes may lead to over-recovery of the relevant cost and therefore may dstort competton between the ncumbent and ts compettors. Not all NRAs seem to apply systematc margn squeeze tests to check the approprateness and consstency of wholesale and retal prces. In Austra the systematc applcaton of a margn squeeze test has led to a retal mnus rule as the effectve calculaton method to determne the adequate level of the wholesale prce. Ptfalls of applyng LRIC and alternatves 9. Applyng FL-LRIC to copper-based ULL at ths tme of competton from upgraded cable networks and substtuton of copper by fbre becomes fraught wth at least three potental dffcultes: (1) FL-LRIC s conceptually based on an expandng market, where addtonal capacty s beng nstalled. The market for copper-based access, however, s shrnkng and leads to excess capactes. Compettve markets would lead to prce reductons n that stuaton. FL-LRIC would, nstead, sgnal ncreased costs and prces. (2) Access-related costs are ncreasng over tme (e.g. copper, labour cost). Ths would sgnal c. p. hgher ULL prces. (3) FL-LRIC s based on a replacement by the most modern technology. Ths s no longer copper access. 10. Copper access prces regulated at FL-LRIC wll lead to neffcences and welfare losses n such a market envronment. We would even argue that FL-LRIC s not defned n case of shrnkng demand. Increased copper access charges would foster even further volume declne and would nduce unnecessary over-capactes and allocatve neffcences n copper networks. The compettve poston of the

14 4 Wholesale prcng, NGA take-up and competton copper access network aganst cable and fbre networks would be artfcally weakened and dstorted. 11. The proper prcng prncple and prce level has to be derved from the more general opportunty cost-based prcng prncple. Ths prcng prncple fnds the effcent prcng n a band whch s determned by a lower and an upper lmt. The upper lmt s gven by the conventonal FL-LRIC as accurately determned before demand actually declned. The lower lmt of the prce band would be determned by the short-run ncremental cost of operatng the copper access network n case all the copper access network elements are sunk, network-specfc and cannot be used for other purposes. If the prce fell below that level, the ncumbent would no longer run the network and close t down, because t no longer provdes any contrbuton to proft. The exact pont n the relevant range has to be determned based on demand and compettve condtons n the retal market. One mplementaton approach reles on the retal mnus concept. It s however necessary to clearly defne the upper boundary, snce relance on retal mnus alone wll delver excessve retal and wholesale charges n the absence of effectve competton. If LRIC has been correctly calculated n the past, the celng could be fxed at the level of the last calculated value ths would have the advantage of predctablty and mantanng the status quo. If, however, LRIC for copper has not been correctly calculated such that copper access charges are excessve, the celng should be newly calculated on the bass of an approprate LRIC approach usng parameters relevant at the moment before volumes were declnng. 12. Some NRAs determne the ULL prce on a valuaton of the network assets at hstorc costs. In case of Ofcom n the UK only parts of the access network assets are valued at hstorc cost. Hstorc cost prcng addresses the potental cost overrecovery problem better than FL-LRIC prcng and also takes better care of the actual deprecaton of the assets. Hstorc cost prcng does, however, not meet any effcency standard. It does, however, have the advantage that the resultng prces fall nto the range of effcent opportunty cost-based prces as proposed here. Ths means that wholesale prces determned on the bass of hstorc cost only concdentally wll meet the effcent prce pont n the relevant prce range. 13. In a stuaton of a shrnkng copper access market ncumbents face stronger ncentves to engage n margn-squeeze actvtes: To be compettve n the retal market wth cable, they tend to lower prces wthout changng the level of wholesale charges. NRAs usually mpose a margn-squeeze test. When the margn squeeze condton s breached, wholesale access charges must be ncreased to remove margn squeezng. Ths n turn leads to hgher retal prces and ncreases excess capacty even more. The more effcent approach s to set the wholesale prce such that t s at a gven level of retal prces margn-squeeze free. Dependng on the retal prce level ths may lead to wholesale prces below the level of FL-LRIC. Lower access charges resultng from such a margn-squeeze adjustment would not

15 Wholesale prcng, NGA take-up and competton 5 mpose addtonal regulatory rsk on ncumbents. Rather, they would only reflect the market rsk from declnng demand for copper-based servces. 14. We cannot recommend NRAs to dstngush between bad and good margn squeezes and to allow good margn squeezes. Bad margn squeezes have the ntent of hurtng rvals dependng on wholesale access. Good margn squeezes are a response to outsde competton from alternatve technologes (such as cable). We do not see that the market power n the copper access market wll be vanshng n stuatons of declnng demand whch s n our vew a prerequste for allowng good margn squeezes. LRIC for fbre networks 15. Snce fbre access s a growng market, cost-based prcng on the bass of the FL- LRIC prncple s the correct approach for access to fbre networks. The fbre wholesale prce should approprately reflect the fbre-specfc nvestment rsk. The fbre-specfc rsk premum as part of the captal costs and as a mark-up on the rsk of the copper access busness has to be determned carefully. Even small devatons from the rsk premum as appled for the legacy network today negatvely mpacts on retal prces, competton and consumer welfare. In case the ncumbent's fbre deployment benefts from Brownfeld savngs due to usable assets of the legacy network, these savngs should be properly reflected n the wholesale prce; otherwse competton would be dstorted to the detrment of users and compettors. 16. To determne the relevant cost of the fbre network we have used an engneerng bottom-up modelng approach. We calculate the cost of a FTTH network followng a Greenfeld approach. Ths means that the nvestor wll construct a new, effcent state of the art network from scratch, assumng that currently exstng nfrastructure, f ncluded n the new network, has to be consdered at (full) cost. We also calculate a Brownfeld scenaro where the ncumbent can make use of avalable nfrastructure from legacy networks to deploy the fbre network. 17. The NRA n The Netherlands has appled a dscounted cash flow (DCF) method of determnng the ULL charge for fbre where the wholesale prce s derved from the busness case of the nvestor. We have shown n ths study that ths approach s equvalent to calculatng the FL-LRIC on the bass of a bottom-up cost model f economc deprecaton s beng used. The DCF method has the advantage that t explctly takes care of the ncreased fbre penetraton over tme.

16 6 Wholesale prcng, NGA take-up and competton Our modelng approach 18. For purpose of ths study we dd not want to model a specfc European country but chose settlement structures whch are typcal n European countres. We desgned a hypothetcal country for approxmately 22 mllon households and busness users or a populaton of around 40 mllon nhabtants. Ths country s referred to as Euroland. We have defned 8 clusters (geotypes), each havng typcal structural access network parameters derved from detaled geo-modelng of access networks n several European countres on a natonwde bass. The geotypes characterstcs rely on concrete data from several countres. In that sense, Euroland s a genercally representatve country. Because a fbre network s not vable n all clusters we focused the competton analyss on Cluster 1 to 4 of Euroland. 19. For compettors usng wholesale access we have consdered a fbre unbundlng scenaro for the P2P network archtecture n whch a compettor rents the unbundled fbre loop, places an addtonal Optcal Dstrbuton Frame of hs own at rented collocaton space n the MPoP where he operates hs own Ethernet Swtch. Wholesale prces for the compettor s busness case have been determned as LRIC of the network elements of the ncumbent whch are used for wholesale access,.e. they are drectly based on the cost determned for the ncumbent. 20. For the copper network we have chosen a dfferent approach. To approxmate the relevant LRIC we started from the European average of monthly LLU charges as a proxy for the ncumbent s LRIC n Euroland. Ths value was broken down to clusterspecfc monthly copper network costs by usng relevant cost drvers; ths way we were able to determne the producton cost of the frst four clusters only. However, the ncumbent s decson to swtch from a copper to a fbre network does not depend on the so determned LRIC replacement cost but on the cost of operatng and mantanng the copper network. These short run ncremental costs are approxmated as 20% of the fxed cost defned by the LRIC determnaton above. 21. Our nnovatve approach towards market modelng combnes our cost modelng results wth a model of competton between copper and FTTH wth multple compettors ( entrants who purchase wholesale access) n order to show aspects of the transton from copper to FTTH, n partcular how the transton depends on the regulated copper access charges for copper unbundlng the regulated FTTH access charges for fbre unbundlng whether there s a sngle ntegrated ncumbent potentally offerng both copper and FTTH or two separate network operators for the respectve technology The objectve s to generate and compare the (potental) coexstence and relatve shares of copper and FTTH and to determne market equlbra wth end-user

17 Wholesale prcng, NGA take-up and competton 7 prces, consumer and producer surplus (for both ncumbent(s) and other frms) and ultmately welfare results. 22. Our modelng approach captures essental aspects of competton n FTTH or copper-based markets, both on the wholesale and retal sde. In our man model one frm (the ncumbent ) owns and nvests n a copper and/or FTTH access network, to whch other frms ( entrants ) must obtan access n order to provde copper-based or NGA-based servces. Entrants are assumed to be specalzed n copper or fbre servces and are otherwse symmetrc. They need to make ther own nvestments n order to provde retal servces based on copper or NGA wholesale access products. In a second model the ncumbent s restrcted to a copper access network, whle an ndependent fbre nvestor (whch could be an alternatve telecommuncatons operator or an energy company) may or may not nvest n fbre, thereby potentally drvng out the copper ncumbent. In both models we consder a thrd vertcally ntegrated broadband nfrastructure ( cable ), to whch no other frms have access. Modelng results 23. In the case of an ntegrated ncumbent the decson to swtch to fbre s drven prmarly by the access charge dfferences between copper and fbre relatve to ther respectve costs. Obvously, the ncumbent s profts are nfluenced by many factors (e.g. costs, market share, retal prces), wholesale access charges beng only one of them. Our results, however, suggest that ther nfluence can be substantal. The relatve wholesale charges determne the proftablty of one technology compared wth another. 24. Our modelng results show that a (long-term) coexstence of copper and fbre networks s possble but unlkely and also undesrable. It takes the combnaton of very hgh copper and fbre access charges to make the jont provson more proftable than the most proftable sngle network nvestment alternatve. Access charges have to be hgh enough to generate monopoly profts for both networks and to keep entrants vrtually out. Such a coexstence scenaro would then lead to hgh retal prces, low competton and low consumer surplus. 25. Once fbre s on the market, there s a strong ratonale from the operator s as well as from the overall economc perspectve for a forced mgraton strategy to fbre. Regulatory nterventons and oblgatons whch make mgraton more dffcult or costly can therefore generate negatve ncentves to nvest n fbre. 26. Consderng all our model runs there are three relevant scenaros of wholesale access charge combnatons that stck out when analyzng the ncentve for fbre nvestment:

18 8 Wholesale prcng, NGA take-up and competton At the current European natonal average copper access charge of ac = 8.55 a fbre access charge of (sgnfcantly above the cost-based rate) would be needed to nduce nvestment n fbre. At these wholesale rates, fbre ARPUs would be approx 42 compared wth copper rates of 29. Consumer welfare under copper would be 18% lower than n the consumer surplus maxmsng case. Ths scenaro s unlkely to reach the Commsson s Dgtal Agenda ultra-speed broadband targets. If fbre unbundlng charges are set on a Brownfeld LRIC bass of per month as calculated through the Euroland model, the correspondng copper charge at whch fbre would be more proftable than copper would be In ths scenaro fbre ARPUs would be 36 compared wth copper ARPUs of 21. Consumer welfare would be maxmsed. If Brownfeld adjustments do not apply (for example f exstng ducts cannot be re-used for fbre), then Greenfeld LRIC for fbre would be per month and copper prces would need to be set at 6.06 n order to stmulate fbre nvestment. In ths scenaro copper ARPUs would be 27 and fbre ARPUs 38. The followng fgure demonstrates the swtchng ponts to fbre. Fgure 1: Access charge combnatons, for whch a swtch from copper to fbre has occurred

19 Wholesale prcng, NGA take-up and competton An ntegrated ncumbent wll swtch from copper to fbre, when copper proft s below the expected fbre proft. Snce hgher copper access charges ncrease profts from copper but leave fbre profts unaffected, hgh access charges for copper reduce the ncentves for a swtch. In partcular, at today s natonally averaged copper access charge of 8.55 there would be lttle ncentve for the ncumbent to nvest n fbre. Hgh levels of copper access charges generate negatve ncentves for ncumbents to nvest nto fbre because of proft cannbalzaton. 28. Under a Brownfeld LRIC scenaro n whch fbre access charges are and copper prces are set at or below the swtchng pont of 3.42, the market supports one "cable" operator wth 28% market share, the fbre ncumbent wth 23% and 3 unbundlng-based entrants wth 16% market share each. Wth copper charges at today s average rate of 8.55, no fbre nvestment would occur, and the market would support one cable operator wth a market share of 33%, and ncumbent wth 20% and 3 entrants wth just over 15% market share each. Such a market structure does not exst n many markets today and reflects an assumpton of perfect regulaton wth no possblty of margn squeeze or dscrmnaton. In practce, ncumbents n Europe mantan an average of 45% of retal market. 29. Our model results clearly demonstrate that a swtch to fbre networks has the potental to ncrease welfare sgnfcantly, n partcular f users recognze the potental of fbre and value servces provded over fbre correspondngly relatve to servces provded over copper networks. The hgher the valuaton of fbre n terms of wllngness to pay from users becomes, the lower the necessary dfference of copper and fbre access charges n order to trgger a swtch from copper to fbre. 30. An ndependent fbre nvestor requres specal cost savngs or other advantages n order to outcompete the copper ncumbent (who has such advantages nvestng n fbre). On top of that such an nvestor may face the threat of the ncumbent preemptng ts nvestment thereby renderng t unproftable. Our model shows that only under rather hgh access charges would t be vable for an ndependent nvestor to nstall fbre alongsde the exstng copper network the nvestment would be justfed n ths case on the bass that both the copper ncumbent and fbre entrant would enjoy a monopoly on the respectve technologes. The ncumbent wll only ext, leavng the access market to such an alternatve nvestor, f both contnung copper and nvestng n fbre appear unproftable for hm. Ths appears unlkely n most cases. 31. Our results show that a swtch from copper to fbre may be accompaned by a retal prce ncrease of about per month. Ths gap could be brdged by a dfferentaton of retal prces by product, allowng for vrtual copper products to be delvered at much lower prces than the fbre average. Ths

20 10 Wholesale prcng, NGA take-up and competton could be consstent wth proft maxmzaton and be feasble for the ncumbent. However, unless equvalent wholesale optons are avalable, t could be dffcult for entrants. Such wholesale optons could nclude o two-part access tarffs that would facltate dfferentaton by entrants. However, such tarffs may reduce the number of entrants and favor the compettve poston of the ncumbent. o an offer of a low-prce vrtual copper access product on btstream bass n addton to ULL. Ths requres an ncrease of the fbre ULL charge to compensate the ncumbent and may lead to a delay of the swtch to fbre. Ths opton could be lmted to a transtonal perod. 32. Our modelng favours an approach to avod a rate shock, under whch regulators sgnal that they plan to decrease copper prces through a glde-path to the relevant levels, but would allow rapd swtch-off of copper f fbre s nstalled on far terms and condtons wth LRIC-based unbundlng charges. In ths scenaro nvestment should be trggered and a potental rate shock would be lmted to the gap between current ARPUs of approx 29 to the margnally hgher fbre Brownfeld ARPUs of 36 assocated wth LRIC fbre unbundlng charges. Consumers would mmedately beneft from hgher capactes offered by fbre. 33. We have ncluded cable as a player wthn our base case scenaro. We assume that ths technology offers capabltes whch le between copper and Pont-to-Pont fbre and that consumers wllngness to pay for cable s determned accordngly. Whlst the retal prces for the market as a whole are strongly nfluenced by the underlyng wholesale charges, the presence of cable adds an addtonal constrant n that hgher copper (and/or fbre) charges wll n the presence of cable, cause some customers to mgrate away from the ncumbent towards what s vewed as a superor (or cheaper) technology. Other thngs beng equal, lower profts for copper and fbre wll result from the presence of cable. 34. Competton n any network s advantageous not only for the economy but also for ncumbents. Entrants help the ncumbent of a partcular technology because they take away customers from the other technology and because they buy access at wholesale charges that contrbute to cover fxed network costs.

21 Wholesale prcng, NGA take-up and competton 11 Introducton Europe has formulated far reachng and ambtous targets for Next Generaton Access n ts Dgtal Agenda for Europe. The need for a wdely avalable and compettvely fast and ultra-fast broadband access as t s best provded over FTTH networks s regarded as a key to meet these targets. Gven the low coverage and penetraton of fbre networks n Europe up to now, fosterng fbre deployment needs heavy nvestments to emerge. To foster the deployment of NGA and to encourage market nvestment n open and compettve networks the Commsson has adopted the NGA Recommendaton to provde approprate access remedes for an NGA envronment. Less attenton has been gven to the transton from copper to fbre networks. What are the regulatory condtons whch favour the transton and whch are dscouragng t? In ths study we wll prmarly focus on the mpact of access charges on the swtch from copper to fbre. We wll show that not only the fbre access charges have an mpact on the ncentve to nvest n fbre. It s also the copper access charge whch has a major nfluence on the transton to fbre. It has been a long tradton n regulatory economcs to derve the Forward Lookng Long-Run Incremental Cost prcng prncple as the one whch best fts wth establshed prncples and objectves of regulaton. Forward lookng costs are the on-gong costs of provdng the relevant servce n the future usng the most effcent means possble and commercally avalable. Ths means n practce to base costs on the best n use technology and producton operaton and valung nputs at current prces. Calculatng forward lookng costs also nvolves the cost provdng the relevant servces usng modern equvalent assets (MEA). The LRIC costng and prcng methodology s assumed to provde effcent producton, set the proper ncentves to nvest n new technology, enable the ncumbent to compete aganst a new entrant who would set-up a new Greenfeld network wth the most effcent technology and set the proper ncentves for the make-or-buy decson regardng the entrant s own network. Many (not all) European regulators apply the LRIC prcng prncple based on current cost to calculate the wholesale prce for the Unbundled Local Loop. Gven the mpled theoretcal prerequstes of applyng LRIC we wll show n ths study that none of the prerequstes for applyng LRIC for a copper-based ULL holds anymore gven the mgraton to NGA, to FTTH networks and generally to deployng fbre deeper nto the network and closer to the end-user. There are ndcatons that a further and smple orentaton of ULL wholesale prces on current costs may cause neffcences. The effcent prcng of the copper ULL needs a new platform and new answers n the process of mgratng the access network to a new technology. Ths study s organzed as follows: In Chapter 1 to 3 we wll deal wth cost methodology ssues for determnng access charges. Specal emphass wll be gven to the challenge of regulatory costng and prcng n case of a declnng demand as can be observed for the copper access network. In Chapter 4 we characterze current regulatory polcy and

22 12 Wholesale prcng, NGA take-up and competton practce as regards ULL prcng for copper and fbre. Besdes gvng an European overvew we present several case studes on countres, whch each represent a certan unque approach so that a comprehensve pcture of regulatory polcy s emergng. In Chapter 5 cost modelng approaches for copper and fbre networks are beng developed. We calculate the relevant costs and the cost drvers for a representatve European country whch we call Euroland. The fbre cost model nforms about proftable coverage and crtcal market shares for a vable busness model. Network costs are derved for the nvestor and for compettors whch base ther busness model on the unbundlng approach. In a varety of senstvtes we show the mpact of Brownfeld assumptons for fbre deployment on costs, coverage and competton. Furthermore, we show the mpact of dfferent assumptons on the WACC and economc lfetmes of network assets on costs and competton. We present smlar senstvtes for the copper access network. In addton we show the cost mpact of a decreasng demand. In Chapter 6 we model the mpact of wholesale prces on competton, nvestment and consumer welfare by means of an olgopoly model whch we have developed for ths purpose and whch shows the results of the strategc nteracton of market players. The task s to develop a model of competton between copper and FTTH wth multple compettors ( entrants ) n order to show aspects of the transton from copper to FTTH, n partcular how the transton depends on the regulated copper access charges for copper unbundlng, the regulated FTTH access charges for fbre unbundlng, and whether there s a sngle ntegrated ncumbent potentally offerng both copper and FTTH or two separate network operators for the respectve technology. The objectve s to generate and compare the (potental) coexstence and relatve shares of copper and FTTH and to fnd n a market equlbrum end-user prces, consumer surplus and producer surplus (for both ncumbent(s) and other frms), leadng to welfare results. The study concludes wth some regulatory polcy conclusons n Chapter 7.

23 Wholesale prcng, NGA take-up and competton 13 1 The theoretcal foundaton of FL-LRIC prcng Characterzaton of FL-LRIC prcng The provson that the wholesale bottleneck servces are to be offered at a cost-orented bass has been mplemented under the so-called FL-LRIC (Forward-Lookng Long-Run Average Incremental Costs) 2 standard wthn European Member States. 3 FL-LRIC as a long-run measure ams at the costs of effcent producton of unts where those varable and fxed costs are ncluded whch are essental for a group of servces. 4 Consequently, outdated technologes and neffcently ncurred costs lke redundant manpower are not reflected. Forward-Lookng Long-Run" means that the tme span of new nvestments s ncluded n the cost consderaton. It also means that all nputs are generally consdered as varable. The long-run nature of costs s justfed by the nfrequency of regulatory prce changes (FCC, 2008) and, at least mplctly, by the dffculty regulators face n determnng correct short-run costs, both n cases when these are to reflect short-run bottlenecks (rsk of explotaton) or temporary low demand (rsk of margn squeeze). In the forward-lookng approach only the actual (forecasted) operatng costs are consdered, hence the equpment s assessed at the replacement value and overcapactes are usually not taken nto account. 5 The costs also nclude a reasonable proft dependng on the rsk of the nvestment. In order to calculate the average ncremental costs per mnute (or per loop), the sum of the costs consdered are dvded by the (actual or forecasted) traffc mnutes or loops. From an economc perspectve, FL-LRIC results n wholesale access charges above short-run margnal cost (whch are near zero for varatons occurrng between servces wthn capacty constrants), snce adequate fxed and common costs of producton are also ncluded. Overhead costs at the enterprse level are not consdered as part of the LRIC of a partcular servce but a mark-up for them s usually added on the grounds that operators also need to recover overheads n order to contnue stayng n busness. In assessng FL-LRIC and potental alternatves we use the followng crtera. Frst and second, the use of FL-LRIC for wholesale prcng should lead to competton and lead to effcent market entry. Thrd and closely related s statc effcency wth partcular emphass on low/affordable end-user charges and adequate qualty of servce. Fourth, wholesale prcng should provde effcent nvestment ncentves for ncumbents and 1 Ths and the followng two sectons draw, n part, on Vogelsang (2009), Brglauer and Vogelsang (2011), and Neu and Kulenkampff (2009). 2 The abbrevaton FL-LRAIC would be correct but we use the more famlar FL-LRIC here. 3 See Cullen Internatonal (2007); the methodologes mandated by European regulators dffer somewhat wth respect to cost bases and cost standards. 4 See IRG (2000). 5 See Evans/Guthre (2005) for the ncluson of optmally planned excess capacty under the headng of optmzed deprval value. Mandy/Sharkey (2003) calculate the effect of lumpness on FL-LRIC.

24 14 Wholesale prcng, NGA take-up and competton entrants. Ths aspect ncludes relablty for nvestment plannng. Dynamc effcency s also largely ncluded n the nvestment objectve. Ffth, the concept has to be mplementable n practce at reasonably low transacton costs. Ths crteron we wll not address separately but rather where approprate. Last, however, FL-LRIC as a cost standard breaks down, f demand for the bottleneck servce for whch t s to be appled steadly and structurally decreases so that overcapactes develop. In ths case no new and replacement nvestments take place so that the current prces of the resources used to construct the bottleneck facltes lose ther functon as a normatve yardstck. 1.2 FL-LRIC and the compettve standard It s well-known that, n a perfectly compettve market, prces equal short-run margnal costs and, n the long-run, equal long-run average costs and long-run margnal costs. These condtons are not always feasble n markets wth extensve economes of scale and scope. Nevertheless, achevng the next best to the perfectly compettve standard would be desrable. Markets characterzed by scale and scope economes would yeld long-run compettve prces between long-run ncremental costs and long-run standalone costs (SAC). 6 FL-LRIC always fulfl ths condton and n growng markets are therefore always compatble wth ths compettve standard. FL-LRIC wll therefore allow as many entrants n the market as are warranted by economes of scale downstream n retal markets. At the same tme compettve prcng usually requres the flexblty to adapt prces to changng cost and demand condtons. Compettve market prces follow short-run (margnal) costs, partcularly n captal-ntensve ndustres. Prces at FL-LRIC wll not usually reflect such short-run consderatons. The long-term averagng mpled by regulated wholesale charges lacks ths flexblty. 7 Ths wll lead to some allocatve dstortons by mssng out on market opportuntes (e.g., for hgher capacty utlzaton n tmes of temporarly low demand). It wll then lead to nter-modal dstortons n competton. It may be no consolaton for a compettor (or the ncumbent) that FL-LRIC wholesale charges are correct on average f the current market condtons would warrant much lower (or hgher) prces. Ths, however, s a problem of regulated prces that s thought to be more than compensated by the avodance of strategc prce settng through regulaton. We wll address these ssues n the followng secton. As we wll see, such fluctuatng market condtons are major reasons why wholesale charges at FL- LRIC can be assocated wth margn squeeze, because ncumbents would lke to sell at low prces n weak markets. It can n prncple be addressed through certan types of prce caps. 8 6 Stand-alone costs are the costs ncurred by a frm producng only the sngle servce n queston (therefore not beneftng from economes of scope/synerges f any). 7 A smlar tenson regardng averagng also holds for geographc cost averagng. 8 See, for example, those suggested by Hogan, Rosellon and Vogelsang (2010) for electrcty transmsson.

25 Wholesale prcng, NGA take-up and competton 15 A partcularly relevant aspect of wholesale access prcng s compettve neutralty between alternatve technologes for the same or related (competng) servces. If both servces are expandng, compettve neutralty s usually achevable f both technologes have comparable bottlenecks that are provded at FL-LRIC prces. If one servce has such bottlenecks whle the other does not compettve neutralty may not be assured, due to the superor flexblty of the servce wthout bottlenecks to respond to market opportuntes. Ths nflexblty of FL-LRIC therefore becomes more problematc under a certan degree of nter-modal competton f the other mode (e.g., CATV) s not subject to the same knd of wholesale regulaton. Snce also deregulatng the bottleneck s not the opton, some flexblty n settng access charges mght thus after all appear approprate even when applyng the FL-LRIC cost standard. Overall, purchasng access at FL-LRIC, the other compettors should be able to compete n the downstream markets, especally after any margn squeezes have been elmnated by regulatory nterventon. 1.3 FL-LRIC and entry Snce market entry requres a long-run perspectve and snce entrants have to expect coverng ther costs, FL-LRIC wll provde the lowest prce, under whch an entrant would enter an expandng market. The correspondng upper lmt under competton would be SAC, under whch entry would be possble for sngle-product frms only offerng the bottleneck. SAC nclude all common costs that would be ncurred by a multproduct frm. FL-LRIC, as calculated n practce, nclude some common costs and therefore le n between theoretcally pure FL-LRIC and SAC. In expandng or at least not declnng markets, wholesale charges at FL-LRIC levels therefore gve entrants compettve opportuntes that resemble those of the ncumbent. Ths wll lead to effcent entry and effcent competton for end-users. As a result, nvestments downstream of the bottleneck wll also be correctly ncentvzed for both ncumbents and entrants. The effcency condton that wholesale access charges nduce enough competton downstream cannot always be fulflled because there may exst downstream economes of scale that severely lmt the number of entrants. Ths can hold, for example, n rural markets. In ths case, t s not only the wholesale access charge that matters but also the scope of the access product, whch may have to be adjusted to assure enough downstream competton (lke ULL vs. btstream). 1.4 FL-LRIC and statc effcency FL-LRIC are reasonable average prces, but usually overestmate short-run margnal costs relevant for statc effcency. However, provded FL-LRIC wholesale prces are able to nduce suffcent competton by wholesale access seekers and other entrants

26 16 Wholesale prcng, NGA take-up and competton (such as Cable TV) end-users wll enjoy low prces and desrable qualtes. In that case the level of wholesale charges wll assure that the ncumbent s chargng adequately at the wholesale level and the competton wll assure that downstream mark-ups are compettve. Ideally n ths case consumer surplus wll be close to the maxmum wthout the ncumbent or entrants ncurrng losses. It only comes close to the maxmum because FL-LRIC access charges typcally use mark-ups for fxed and common costs that are not dfferentated by demand elastctes for the servces. Ths s n contrast to Ramsey access prces whch would allow for mark-ups reflectng such demand elastctes. Ramsey prces are, however, hardly used by regulators for a number of dffcultes and wll therefore not be consdered here any further FL-LRIC and ncentves to nvest FL-LRIC wll generally cover all costs that are expected over the lfetme of the assets and add mark-ups for common costs. Wholesale charges at FL-LRIC levels wll therefore provde correct expanson and replacement nvestment ncentves for bottleneck assets of the ncumbent. Hgher than cost-coverng charges would lead to less nvestment because of the reducton n downstream demand assocated wth hgher downstream prces that especally compettors would have to charge. Lower charges would lead to lower nvestments on the part of the bottleneck provder because of nsuffcent cost coverage. Under cost and/or demand uncertanty a buffer may be necessary to cover for estmaton rsks. It s usually assumed that nvestment rsks of the ncumbent are correctly covered n the WACC used for the FL-LRIC calculaton The dea of Ramsey access prcng s to allow the regulated frm to recover fxed and common costs n such a way that overall welfare s maxmzed. In dong ths, regulators would have to determne smultaneously optmal mark-ups for access and retal prces. In ther constructon, Ramsey prces refer to both cost and demand characterstcs by whch nformatonal requrements become very hgh; regulators not only have to be nformed about cost condtons but they are also supposed to estmate nterrelated demand (super-) elastctes. Snce regulators generally fal to calculate Ramsey prces drectly, prce-cap mechansms whch delegate the prcng decson to the typcally much better nformed frm have been ntally developed to solve the Ramsey prcng problem. However, f prce caps are targeted only towards specfc wholesale access products, the regulated frm loses the flexblty to rebalance all ts prces accordng to the requred Ramsey mark-ups. Ths s, n part, why Laffont and Trole (1996) suggest that a sngle ( global ) prce-cap should be appled to both wholesale and retal products, argung that an ncumbent maxmzes profts wth respect to all products. Global prce caps would nduce Ramsey prces f weghts attached n the basket constructon (ex ante) were exactly proportonal to realzed quanttes of the servces nvolved. Here realzed quanttes refer to the ex post proft-maxmzng prces under the prce-cap constrant. But dervng optmal weghts of the global prce-cap basket would become tantamount to solvng the Ramsey problem. Furthermore, global prce caps would combne markets wth hghly dfferent competton ntenstes (e.g. access and calls markets) whch mght gve rse to antcompettve strateges on the part of the regulated frm as well as neffcent entry. It wll also dstort prces away from true Ramsey mark-ups. Snce global prce caps are ncompatble wth the European telecommuncatons framework s selectve deregulaton of telecommuncatons markets and snce Ramsey prces are too hard for regulators to determne, the goal of settng regulated Ramsey prces s an unachevable standard. The dstorton created by not achevng Ramsey prces s small f common costs are only a small fracton of total costs but could become substantal f most costs are common. 10 We are here only assessng the approprate level of a regulated wholesale access charge that s leved on a wholesale access servce on a pay-as-you-go bass. Alternatve access arrangement, such

27 Wholesale prcng, NGA take-up and competton 17 Wth the same rsk provso FL-LRIC also provde the correct ncentves for bottleneck bypass nvestments of those alternatve compettors that depend on bottleneck access. If wholesale charges are too hgh alternatve compettors wll nvest n bypass even f ther costs are hgher than those of the ncumbent. If wholesale charges are too low they wll not nvest n bypass even f ther costs are lower than those of the ncumbent. 11 But those desrable propertes of FL-LRIC hnge on the assumpton that regulated markets are expandng. Alternatve ntermodal compettors (such CATV and FTTH), who are not dependent on bottleneck access, beneft from hgher wholesale access charges mposed on access seekers because of less competton from entrants and/or because the ncumbent must keep end-user charges hgh n order to avod margn-squeeze allegatons. Agan, wholesale charges at FL-LRIC n prncple provde compettve neutralty for ntermodal carrers. The same holds for downstream nvestments of alternatve compettors dependng on bottleneck access. These compettors would nvest too lttle downstream (.e., n concentraton and core networks) f bottleneck access charges were too hgh and would nvest too much downstream f those charges were too low. 1.6 Concluson To conclude, FL-LRIC has proved to be qute valuable n settng regulated prces, n partcular prces for wholesale servces n markets under expanson. Conceptually, t s the cost standard on whch, at least on average, prces are based that would obtan under effectve competton. Prces set ths way provde entrants wth the necessary nformaton n respect of buy-or-make decsons and at the same tme provde ncumbents wth correct sgnals regardng ther nvestment decsons. They assure (f properly appled) entrants the opportunty to take advantage of the busness prospects offered by growng retal markets on essentally an equal footng wth the ncumbent. In the fnal analyss, they are one of the cornerstones assurng that consumers wll get the best deal. as nvestment sharng may or may not provde better nvestment ncentves. See, for example, Ntsche and Wethaus (2010). 11 See, however, Sappngton (2006), who shows that the effcent make-or-buy decson can be qute ndependent of the level of access charges. In contrast, Mandy (2009) lmts the generalty of ths vew and states The necessary condton shows that nput prces are relevant for Make-or-Buy decsons except under restrctve and often unverfable assumptons on the demand structure.

28 18 Wholesale prcng, NGA take-up and competton 2 The ptfalls of applyng FL-LRIC to copper-based ULL at ths tme Applyng FL-LRIC to copper-based ULL at ths tme of declnng volumes due to substtuton of copper by fbre and upgraded cable s made napproprate by at least three developments. The frst one s that the use of FL-LRIC s conceptually based on an expandng market, where addtonal capacty s beng nstalled. The market for copper-based access, however, s shrnkng and appears to contnue to shrnk, due to substtuton from cable TV and, more recently, fbre. Snce a large porton of the copperrelated costs are sunk and therefore overcapactes develop, true forward-lookng costs wll therefore be much lower than FL-LRIC as tradtonally calculated by NRAs. Some cost calculaton approaches appled by NRAs sgnal ncreasng (unt) costs n case of decreasng demand. The second one, relevant f FL-LRIC are then stll beng used, s that ncreasng nput costs (n partcular copper) would lead to ncreasng charges for access. As a result, ncumbents offerng wholesale access under such charges would be over-recoverng ther nvestments, whch have largely been ncurred n the past at lower costs. Thrd, the noton of FL-LRIC s based on a replacement by the most modern technology. Copper access, however, does not appear to be the most modern access technology anymore. One can therefore argue that FL-LRIC should be calculated for a modern equvalent asset (MEA) rather than for copper. Whle one could thnk that fbre mght fulfl ths functon ths would throw up nsurmountable nformaton requrements as to how to establsh the equvalence between a fbre and a copper cable. 2.1 Decreasng demand Compettve standard Decreasng end-user demand leads to excess capactes. In compettve markets ths would lead to prce reductons whch should not only hold at the retal level but also at the wholesale level, because wholesale demand s a derved demand. Also n ths stage of the market an operator n a compettve envronment would wsh to take advantage of wholesale demand to defend ts poston aganst competng technologes. But f FL- LRIC were stll appled ths would, as argued below, lead to prce ncreases because of the smaller quantty base over whch then fxed costs would have to be spread. Thus entrants that for ther offerngs have to rely on regulated wholesale prces would not be able to compete on terms that correspond to market condtons. In contrast, ncumbents can respond to the pressure by reducng ther retal prces so that relatve to FL-LRIC margn squeezes result. If then there s no correctve acton on the part of the regulator, FL-LRIC would prevent compettve results from beng acheved.

29 Wholesale prcng, NGA take-up and competton Statc effcency Gven that FL-LRIC are based on average costs and that economes of scale preval, a long-term or permanent reducton n demand would conceptually lead to an ncrease n wholesale access charges when the regulator takes nto account ths average volume declne. Such access charge ncreases based on declnng volumes have already occurred n Germany and Austra The resultng feed-back mechansm would foster even further future volume declne, not least because the freedom for compettve prce decreases on the retal level s typcally also lmted on the part of the regulated (ncumbent) frm. In order to protect ntra-modal competton, NRAs sometmes apply a margn-squeeze test, accordng to whch prces (P) must satsfy P Retal P FL-LRIC + retal costs and other wholesale costs. When the margn-squeeze condton s bndng and f such a margn-squeeze test was effectvely appled, hgher wholesale access charges would lead to hgher retal prces, ncreasng excess capacty. Otherwse, a margn squeeze would result. Fgure 2-1 shows the extent of allocatve neffcences (area ABCD) when cost-based access charges (P FL-LRIC ) are to be mantaned wth excess capactes (K 0 > X FL-LRIC ). As Fgure 2-1 ndcates, there mght be a postve ratonng prce P r < P FL-LRIC where exstng capacty (K 0 ) s fully employed. But n fxed-networks one mght also end up n a stuaton wth capacty exceedng demand at any postve ratonng prce (K 1 > Demand(P r = 0)). Allocatve neffcences thus ncrease wth the amount of excess capacty. In a stuaton where there was ferce nter-modal competton retal prces would be drven down to short-run margnal costs (SRMC), whch s, as mentoned above, usually prevented by some form of ex ante regulaton / margn-squeeze tests. But even at these prces, as just mentoned, excess capacty may preval. Incumbents can respond to ths downward pressure on retal prces because of the typcally hgh share of sunk nvestments n network ndustres such as communcatons. Gven the long-run market demand declne, sunk costs have then become rrelevant for prcng decsons, both from the pont of vew of fxed-network operators and that of effcency consderatons. 12 Fnal decson of the German regulator s avalable at: _8-ss37/BK3c-_8-ss37_E_56f.html. For the recent decson of the Austran regulator see: 13 In the decson mentoned above RTR ncreased the local termnaton charge by 37%, the sngle tandem termnaton charge by 23% and reduced the double tandem termnaton charge by 4%. These rate changes go together wth a declne of fxed network mnutes by 7% n 2008 and by 35% n 2009 (see RTR Telekom Montor 1/2011).

30 20 Wholesale prcng, NGA take-up and competton Fgure 2-1: Welfare loss under excess capacty when access s regulated at FL-LRIC Prce, Costs Demand SRMC 0 SRMC 1 FL-LRIC P FL-LRIC D P R C SRMC A B X FL-LRIC K 0 K 1 X, K Incentves to nvest Generally, there s lttle need for nvestment under decreasng demand. Whle FL-LRIC wholesale access charges may, under decreasng demand, provde enough contrbutons to enable an ncumbent to make bottleneck nvestments, they would, by drvng up prces, ncrease the problem of excess capacty and therefore would tend to lead to too lttle nvestment n replacement and mantenance. Whle the ncumbent could channel the lqudty generated nto nvestments for alternatve technologes, ths rases the queston whether ths would be n lne wth effcency and competton gven that the ncumbent would effectvely be able to leverage ths advantage nto these technologes undermnng the potental for far competton and foreclose the chances for compettors to nvest n these alternatve technologes. 2.2 Entry and ext If demand for copper-based access lnes s decreasng and NRAs stll apply ther prevous method of calculatng the wholesale prces accordng to FL-LRIC at current costs, wholesale prces wll not declne but probably ncrease due to reduced volumes and ncreasng nput prces. In such a case the margns of compettors wll declne up to the pont where they become negatve. Wthout regulatory nterventon entrants face a loss due to a margn squeeze stuaton. Entry and competton wll be dscouraged. More concretely, n a stuaton of long-term decreasng demand there s lttle ncentve for new frms to enter. Ths would per se be true for new frms that would erect new

31 Wholesale prcng, NGA take-up and competton 21 networks, but t would probably also hold for new frms that use, for example, the copper ULL as an nput. The stuaton should n partcular arse f a new market s emergng that s replacng the shrnkng one. On the other hand, however, t s questonable whether ext of exstng frms should be nduced. Such ext s nevertheless lkely f wholesale access charges contnue to be based on FL-LRIC so that alternatve provders cannot adjust ther retal prces downwards (or even force them to ncrease ther retal prces) n response to declnng demand. In an envronment of shrnkng demand, normal notons regardng the effects of the scale of output on cost become meanngless. Ths s due to the presence of sunk costs whch are no longer decson relevant. For exstng frms, prevously relevant economes of scale for gven outputs lose mportance. Ths rases the queston regardng the approprate prces for the nputs for alternatve provders snce there s no a pror or effcency reason for ther ext. It s unambguous, however, that dseconomes of scale and average costs faced by new frms enterng wth new assets would ncrease so that new entry would make lttle or no sense. Compettors already n the market may face the stuaton of becomng unproftable and havng to leave the market. 2.3 Cost recovery A standard argument by ncumbents has, untl recently, been that FL-LRIC wholesale prces do not allow them full cost recovery because network costs are declnng over tme so that FL-LRIC because of the forward-lookng nature do not allow the ncumbents to recover the hgher costs they ncurred n the past. 14 Today the most relevant bottlenecks are ULLs, for whch t s rather the case that costs are ncreasng due to economes of scale and ncreasng nput prces (e.g. copper) so that forwardlookng costs would be hgher than the costs ncurred by ncumbents n the past. Ths would hold to the extreme f the network s not expanded or replaced at all so that hgh FL-LRIC were appled to nvestments that all were made n the past. In addton to beng an effcency ssue, t s prmarly one of equty between ncumbents and entrants. 15 Gven the long lves of the copper access network and gven that prcng n the past has only relatvely lately started to be determned accordng to approprate cost standards, ths could mean that the ncumbent has already been fully compensated or even been overcompensated for the actually ncurred cost. Ths would come n addton to the fact that entrants would overpay for access to a network that s not beng expanded and was acqured at the lower costs n the past. Equty or farness has always been vewed as a legtmate ssue n regulatory practce. However, from a perspectve of economc analyss one should pursue equty objectves 14 Ths argument actually s based on an applcaton of FL-LRIC where not all forward-lookng nformaton normally avalable s taken nto consderaton. See Neu and Kulenkampff (2009) for a demonstraton of how both expected future prce and growth developments can approprately be rolled nto the FL-LRIC calculatons. 15 See, however, Guthre et al. (2006).

32 22 Wholesale prcng, NGA take-up and competton wth polces that are also assocated wth superor effcency. In case of copper ULL and fbre ULL ths seems to be the case. Copper ULL has the problems dscussed n Secton 2.2 above so that a forward-lookng approach should not nclude sunk costs from an effcency perspectve. From an equty perspectve, ncumbents have untl now beneftted from hgher access charges compared to lower actually ncurred costs n the past. Fbre LLU s largely new so that all costs would be due to new constructon. To the extent that exstng ducts etc. are used an opportunty cost approach may be warranted (see our argument n Secton 3.2). 2.4 MEA and fbre technology The modern equvalent asset (MEA) approach would mply that one determne the cost of that part of an equvalent technology that equvalently replaces copper. Ths approach s conceptually feasble but very hard to make operatonal, because t would requre translatng dfferences n QoS and capacty nto cost equvalents. The dffcultes would already start n dentfyng an approprate bandwdth for a copper lne. Do we start at the MDF locaton and allocate an ADSL 2+ bandwdth equvalent? It s unclear how large ths would be, snce the bandwdth transferable depends on the copper lne length. The bandwdth equvalent of the sub-loop from the street cabnet to the customer premse may be determned by VDSL2, but whch concrete standard shall be taken? VDSL bandwdth also depends on the copper lne length. Is a mxture of ADSL2+ and VDSL2 the proper MEA concept n ths case? Even f such nformaton s avalable and the FL-LRIC for fbre s properly determned, there remans the queston of consumer valuaton of any equvalent capacty f t s provded over copper compared wth the case where t would be provded over fbre. In sum, the MEA value of the copper network s relatvely low gven the potental capacty dfferences between copper and fbre. A calculaton approach n detal, however, can only be materalzed wth arbtrary assumptons. 2.5 Conclusons on the defcences of FL-LRIC prcng Relyng on the FL-LRIC standard alone would nduce unnecessary over-capactes and allocatve neffcences n copper networks. Furthermore, such an approach s lkely to lead ether to margn squeeze and the ext of competton or dstortons between dfferent technologes. To avod such a vcous crcle one has to look for more sutable forms of access regulaton whch allow for a lowerng of wholesale charges and ncreased prcng flexblty at the retal level.

33 Wholesale prcng, NGA take-up and competton 23 3 Alternatves to FL-LRIC prcng 3.1 Prcng accordng to hstorc costs Hstorc costs of assets equal ther orgnal purchase prce mnus accumulated accountng deprecaton. Usng hstorcal costs as the relevant asset base avods overrecovery or under-recovery of actual costs and thereby balances the nterest of access provder and access seeker. It has, however, two drawbacks. The frst s that the relatonshp between hstorc costs and the value relevant for sutable wholesale access prcng s purely concdental and vares from jursdcton to jursdcton and from carrer to carrer, due to dfferent asset age structures and deprecaton methods. The second s that decsons about nvestment, shrnkng and abandonment of copper networks must be forward lookng. Hstorc costs do not nform about the future. As mentoned earler ther man value s n ther equty propertes. Ths comes out clearly n Fronter (2010) who suggest that hstorc costs should be used as the asset base and that the gross hstorc costs should at the relevant pont n tme be adjusted by the compensaton receved by the ncumbent aganst those assets (where t s not clear whether ths compensaton refers to actual and mputed wholesale charges only or also to retal charges) (p.21). Thus, the dea s to generate cost coverage for the access provder largely ndependent of effcency aspects. If one uses a hstorc cost base for equty reasons effcency aspects (among others) are gong to suffer or one needs addtonal nstruments besdes access charges for servng the goals besdes equty Opportunty cost-based prcng Opportunty costs dffer essentally from FL-LRIC n that the yardstck for the cost of the servce s not anymore the cost of the resources wth whch the servce could currently be produced, but exclusvely the valuaton by demanders of the types and volumes of servces that could be produced by the exstng capacty. To make ths pont more precse, consder that a compettor would be wllng to pay for the exstng copper nfrastructure. The hypothetcal scenaro for ths case could be that of a swtched local and long-dstance network that ntends to add an access network, belevng that t can serve the market even wth a copper network. In ths case the ncrement would be the whole access network, and the prce that the compettor s wllng to pay would represent ts opportunty cost. A provso would be that ths prce 16 One way of dong that s the use of two-part access tarffs, n whch the fxed fee reflects the equty aspects and the varable or margnal prce compettve and other aspects. Ths can be a sutable approach to the extent that the fxed fee remans compettvely neutral (does not affect entry or ext of compettors).

34 24 Wholesale prcng, NGA take-up and competton would not reflect prces at the retal level that the compettor expects to be able to charge that nclude monopoly rents from sellng to customers wth hgh swtchng costs. In the absence of addtonal costs for gvng up a servce (such as socal costs of layngoff personnel or of tearng down lnes or buldngs) the floor of opportunty costs s gven by the short-run margnal costs (or short-run avodable costs), because below those costs the servce would be abandoned. These short-run costs nclude the rental value of assets that could be sold n a (second-hand) market, such as real estate. A celng for opportunty costs would be gven by conventonal FL-LRIC because at that prce a compettor would be nduced to buld the nfrastructure herself (although, n the short term or medum term the celng could be hgher). In case of long-term declnng demand we can expect that the opportunty cost floor wll be relevant. When that happens the access provder may end up recevng nothng for the use of her exstng assets. Ths may be vewed as nequtable and may deprve the ncumbent of her ablty to fnance new servces, such as fbre. It may therefore be approprate to consder a wholesale access prce that exceeds opportunty costs n order to provde lqudty for rsky nvestments. The adequate or effcent mark-up on the prce floor s, however, hard to determne. The compettve model developed for ths report serves as a tool for such a determnaton based on performance crtera, such as the effect of alternatve wholesale access charges on consumer surplus and welfare. In competton wth fbre the relevant cost base for copper may well be short-run avodable costs as the lower lmt, whle for fbre, as already ponted out, t would be FL- LRIC. The reason s that copper should only be defntely abandoned f t can no longer earn ts short-run avodable costs whle nvestment n fbre should only defntely occur f t earns ts full nvestment costs. Exceptons from ths rule (hence the defntely ) can occur when part of the copper network can be used to buld fbre access or when the buld-out of fbre leads to ncreased value of fbre (because of learnng and network effects). There s one partcular mplcaton f ducts as an mportant part of the copper network can be used to buld the fbre access network and these are n oversupply due to the fact that fbre needs less than the capacty beng released by the declne n the copper network. If ths oversupply s not of a temporary nature and expected to exst n future, the argument developed above for the whole copper network would also apply to ducts as a component of the fbre network. Also n ths case one could ask n a thought experment what fbre network provders would be wllng to pay for the part of ducts that they could use to roll out ther fbre networks. Practcally, t would be very dffcult to get ths answered non-strategcally. Agan, n competton the relevant cost base for these ducts may well be short-run avodable costs.

35 Wholesale prcng, NGA take-up and competton 25 To conclude the dscusson on opportunty cost-based prcng, the noton s also farly well known from the debate about the effcent component prcng rule (ECPR). 17 Accordng to ths rule the relevant costs of wholesale access nclude the margnal (or ncremental) costs of producng t plus the downstream margn that the access provder foregoes by not sellng the resultng servce herself n the downstream market. The problem wth ths noton of opportunty costs s that the access provder mght set a prce downstream that reflects market power so that the ECPR may nclude monopoly rents. A proper defnton of economc opportunty costs therefore would only allow for the ncluson of a compettve downstream margn and therefore be based on compettve retal prces. Ths would requre somethng lke a hypothetcal competton test. If done correctly the test should lead to opportunty costs that are consstent wth those that one would obtan n the hypothetcal scenaro dscussed earler n whch a compettor bds n an aucton for the whole copper access network. 3.3 Prcng and margn squeeze We have already alluded to the margn squeeze ssue, whch has ganed mportance by decreasng demand for copper-based servces. What relevance has ths test n the context of determnng the cost of the ULL n the presence of declnng demand? The test may actually serve as an alternatve for the relevant cost standard for the ULL, gven that n ths case FL-LRIC s not applcable any more. The provso would be that observed retal prces are reflectve of a compettve stuaton and that the compettve margn for sellng at the retal level s known. What would then perhaps be called a "margn test" would determne what the relevant cost of wholesale access should be. The approach s conceptually smlar to the ECPR dscussed above n the context of the opportunty cost concept. There we argued that the defnton of economc opportunty costs would only allow for the ncluson of a compettve downstream margn and therefore be based on compettve retal prces. There have been some recent contrbutons n the lterature that eventually lead to the same result as just derved. Some authors (Ntsche and Wethaus, 2010 and forthcomng; Brglauer, Götz and Schwarz, 2010) have argued that regulators or competton authortes should dstngush between bad and good (effcent) margn squeezes. The bad margn squeezes have the ntent of hurtng rvals dependng on wholesale access, whle the good margn squeezes are a response to outsde competton from alternatve technologes that do not depend on the wholesale access. Presumably, good margn squeezes would not volate competton polcy prncples. Ths concluson would be easy to follow f market power of the access provder actually had vanshed n ths stuaton. That s, however, rarely the case n stuatons of declnng demand. On the contrary, many customers reman stuck wth the old technology and 17 See, for example, Vogelsang (2003) for an overvew of the debate.

36 26 Wholesale prcng, NGA take-up and competton therefore at the mercy of the copper provder(s). 18 Vogelsang (2009) and Brglauer and Vogelsang (2011) have therefore suggested a regulatory response that would elmnate the good margn squeezes as well. It s that an ncumbent, who wants to lower retal prces n such a way that at rulng wholesale prces a margn squeeze would occur, would have to reduce ts wholesale prce untl the margn squeeze vanshes. Provded prces at the retal level are determned compettvely, the resultng wholesale prce would correspond to the valuaton placed by users on ths nput or, n other words, correspond to ts opportunty cost. At the same tme there s prcng flexblty for the ncumbent at the retal level. 3.4 Opta's dscounted cash flow approach The Netherlands NRA Opta apples a prce-cap approach to regulate the prce of NGA access for whch the startng prce has been determned on the bass of a dscounted cash flow (DCF) model based on the busness case of the nvestor. 19 We wll focus here exclusvely on the DCF approach. Opta's use of ths methodology s best explaned wth the help of Fgure 3-1 taken as t s shown from a presentaton by an Opta representatve. 20 In t, the ntal captal expendture plus operatng expendtures over the economc lfetme of the NGA assets are set aganst expected revenues over the lfetme. Expendtures are shown as negatve cash flows and revenues are shown as postve cash flows. Applyng the condton that the operator must recover ts costs and earn a reasonable proft, the ntal prce that supports ths revenue stream s determned. Ingredents n ths net present cash flow calculaton are the actual capex, a fbre-specfc WACC, a payback perod of 25 years, an expected CPI of 1.5% per year, and so called genune expectatons regardng volumes of sales over the relevant tme perod. Note that the pcture desgnates the red columns as revenues beng equal to quantty tmes prce (p*q). The process of determnng these revenues must, however, have started from projectons of sold volumes for the varous perods, for whch the revenues/prces are then determned gven the constrants that ther net present value equal the net present value of the expendtures and that the prce ncreases from year to year develop accordng to the projected change n CPI of 1.5 % per annum. 18 The retal markets for fxed lne copper-based access servces reman n the nelastc regon of demand, ndcatng that market power could be exercsed by a monopolst (Brglauer, Schwarz and Zulehner, 2011). 19 See Muselaer and Stl (2010) and Stl (2010). 20 See Stl (2010), slde 10.

37 Wholesale prcng, NGA take-up and competton 27 Fgure 3-1: Opta's dscounted cash flow model Quelle: Stl (2010) Ths DCF model s essentally equvalent to the calculaton of FL-LRIC by means of a bottom-up cost modelng approach, as for example appled n the cost models that WIK has developed. In these cost models, the capex for an asset, e.g. a lne n the NGA network, s transformed nto annual costs on the bass of an annuty formula of the followng form: I = A 1 * [1 + q + q q n ] where q = (1+g)*(1+ p)/(1+wacc). In the annuty formula, I stands for captal expendture (the yellow negatve column n Opta's fgure), A 1 for the amount to be amortsed n perod 1 (correspondng to the expected revenue for that perod,.e. the frst red column n Opta's fgure), q for the dscount factor and n for the number of years n the economc lfetme of the asset. The formula for the dscount factor q contans besde the WACC and p, the expected average nput prce change, an addtonal "tlt" n the form of the average growth rate g. Ths factor takes account of the fact that demand for unbundled fbre lnes s growng and wll generate correspondngly more revenues n the followng years. Thus A 2 = (1+g)* A 1, A 3 = (1+g)* A 2 and so on. In other words, A 2 > A 1 corresponds to the sold volume shown n Opta's fgure for year 2 and A 3 > A 2 to the sold volume for year 3. The

38 28 Wholesale prcng, NGA take-up and competton dfference to Opta's DCF model s that an average growth rate g s used whle Opta apparently uses a growth model wth varyng growth rates over tme. Ths could also be ntroduced nto the annuty formula, t would requre that each A gets ts own ndvdual value; WIK has abstaned from ths approach usng nstead the more easly determnable average growth rate g. To recaptulate, both approaches start from a knowledge of ntal expendtures for the asset, a knowledge of what current demand (that n year 1) s n physcal terms, an expectaton of how ths demand wll develop over tme, an expectaton of how nput prces develop over tme (represented n the Opta approach by the consumer prce ndex, CPI), then apply a dscountng procedure on the bass of a gven WACC and determne from that what the revenue/prce n perod 1 should be. (Opta then apples a prce cap formula for the perods 2, 3, etc., applyng an annual change n the CPI of 1.5 %, to determne the prces for the followng perods; here we are prmarly nterested n how the amount for perod 1 s determned.) Whle we focused n the above dscusson on the relatonshp between capex, volumes of demand and requred revenues, the effect of operatng expendtures on revenues/prces would n the bottom-up cost model also essentally be determned n an equvalent way. There s one advantage n Opta's approach n that t focuses explctly on and vsually presents the revenues that are to be generated by the asset over ts economc lfetme. If one s able not only to estmate the current and expected volumes demanded (as s assumed n above dscusson) but also to estmate what the revenue n money terms wll be, t s possble, nstead of determnng the prce (or revenue per lne), to determne the value of the asset. In other words, ths way the queston to be answered s reversed. It s not the queston for the prce of a fbre lne knowng the ntal nvestment, the ntal demand and the development of demand over tme t s the queston for the current value of the asset. The nformatonal requrement s that one can form expectatons over both the demand n terms of physcal unts and n terms of revenues, whch would then contan the answer to the queston for the prce and thus allow to answer the queston for the current value of the asset. As presented n the precedng paragraph, the DCF methodology could thus be an alternatve method for determnng the current value of an unbundled copper loop. Remember that n Chapter 2 we argued that due to declnng demand ths value cannot be determned anymore on the bass of the current prces of the nputs used to construct them. Instead, as shown n the precedng paragraph, ths value could be determned on the bass of expectatons formed over current and future revenues earned wth these assets that are then dscounted to obtan ther net present value. Once one has dentfed ths value whch s analogous to the value obtaned on the bass of the prces of the nputs n case of a growng market one can proceed wth transformng ths value nto costs, as s done n conventonal costng exercses.

39 Wholesale prcng, NGA take-up and competton 29 There s one fnal observaton. Plum Consultng suggests n ther recent report for ETNO 21 that the DCF approach be used for the determnaton of the cost of the fbre unbundled local loop. We have shown that the approach s essentally equvalent to determnng FL-LRIC on the bases of a bottom-up cost modelng. They go on to suggest that for the copper unbundled local loop the bottom-up cost modelng approach based on current replacement prces for nputs be used. We have shown that, on the contrary, that for the copper unbundled local loop the DCF approach could be an alternatve wth, however, the queston to be answered to be reversed. From estmates both of future volumes demanded and revenues obtanable from sellng these loops the value of a lne could be determned and thereby the bass of approprate costng of that asset. 3.5 Practcal mplementaton Above we have argued that when there s decreasng demand the FL-LRIC cost standard s not applcable any more for the settng of the prce for a regulated product. In partcular ths means that NRAs need to adopt a new methodology. Ths holds n partcular for the copper ULL, the demand for whch s n declne throughout the EU. Part of the new methodology has essentally already been presented n the precedng secton. Provded there s effectve competton at the retal level, prces for the copper ULL should reflect users' valuaton of the retal servce that stll depends on ths wholesale product. Gven that the demand for t would be a demand derved from the retal market, the correspondng prce for t would have to be determned from the retal prce mnus the compettve margn requred to sell the product on that market. The procedure wll be lke that for a margn squeeze test wth the dfference, however, that not the compettve compatblty of the retal prce s to be tested but rather the wholesale prce for the copper ULL be determned from the retal prce. Obvously, one need to be assured that there s effectve competton on that market. A costng methodology needs to be n place for determnng the compettve margn. One can expect that NRAs that carry out margn squeeze tests have ths methodology at ther dsposal. It should be further developed and staff be traned to routnely collect the relevant nformaton and apply t for the gven purpose. The provso that the market s n fact effectvely compettve s a precondton. When demand s declnng and overcapactes develop, competton wll have ts effect and drve retal prces down so that also wholesale prces derved from them wll fall. Unfortunately, effectve competton cannot be assumed as a gven. In some markets, ncumbents may stll have SMP to such a degree that they have large degrees of freedom n settng retal prces. Dervng n such stuatons the wholesale prce from the retal prce harbours the rsk that the latter reflect the market power that the provder stll exercses n the retal market. Gvng up the FL-LRIC cost standard n favour of an 21 Plum Consultng (2011).

40 30 Wholesale prcng, NGA take-up and competton approach based on the outcome n the retal market would then lead to wholesale prces that do not reflect the true valuaton of users and would thus fal the objectve. In partcular, t may be the case that the resultng wholesale prce s hgher than before when t was derved on the bass of the FL-LRIC standard. The approprate safeguard for such a stuaton s to set a celng for the wholesale prce, where the natural canddate for ths celng s the prce that would be determned on the bass of an accurate applcaton of the FL-LRIC standard when that was the relevant approach. If correctly calculated n the past, ths could be the prevous LRIC calculaton, or otherwse could be set on the bass of a properly appled LRIC methodology usng parameters relevant to the perod before demand was declnng. Any prce above that value comng out of the margn squeeze-test would have to be rejected. The prce would then have to be set at the level of the celng as determned by the last costng exercse based on FL-LRIC before demand was declnng. Presumably, the frst tme when the new approach s appled, the celng would be the rulng prce as that would lkely stll have been determned on the bass of FL-LRIC. The floor for the wholesale prce should be the short-run ncremental cost (SRIC) of provdng the copper ULL. The SRIC conssts of the out-of-pocket expenses for contnung to offer the product. If retal prces fall to such a level that the derved wholesale prce of the copper ULL falls below the level of SRIC, the ncumbent would lose money even n the short run. When prces reach that level the ratonal busness decson then s to take that network out of busness. In any case, at such prces the ncumbent would actually be motvated to cease offerng the servce altogether, both at the retal and wholesale level, and n general such a shut-down of operatons should not be prevented by regulatory nterventon. It would n any case hold that by ths tme the mgraton from copper access to fbre access would for all ntent and purposes have been complete. Mantanng an offer of copper ULL under these crcumstances would then not be justfed any more. In sum, effcent wholesale prces should reflect a prcng polcy that maxmzes economc welfare. Ths requres an approach to practcally determne ths prcng polcy. Our market modelng approach below n Chapter 6 ams at dong just ths. Prces should le between LRIC as calculated the last tme before declnng demand (upper lmt) and short run ncremental cost (lower lmt). LRIC would appear to be the approprate cost standard for fbre (not copper) ULL. Fbre access fulfls all the prerequstes for applyng a FL-LRIC approach to determnng the regulated wholesale prces. Fbre access s a growng market, ncumbents and access seekers get the proper sgnals for makng ther nvestment decsons f that prcng prncple s beng appled. In practcal terms LRICbased prces can ether be calculated by usng a bottom-up cost model or be usng a DCF approach based on the busness case of the nvestor. Both methods lead to equvalent results f properly appled as we have shown. Brownfeld savngs of the ncumbent, however, have to be properly reflected n determnng ULL cost for fbre.

41 Wholesale prcng, NGA take-up and competton 31 4 Some mportant case studes 4.1 Current regulatory practce on ULL prcng n the EU European NRAs show relatvely clear preferences regardng prce control methods, cost base and accountng methodologes for regulatng the ULL wholesale charge. The degree of harmonzaton of methodologes for key wholesale markets seems hgh as BEREC (2010) ponts out n ts latest Regulatory Accountng report. The analyss shows a clear preference for cost orentaton, a trend towards usng current cost accountng (CCA) and a farly even dstrbuton of LRIC and FDC accountng methods. 26 countres 22 partcpated n the BEREC survey for the year NRAs out of the 26 countres reported CCA to be ther cost base for unbundled access. 6 NRAs reported HCA as ther relevant cost base and 1 NRA reported to use a dfferent cost base. Fgure 4-1 gves an nsght nto how the choce of the relevant cost base has changed over tme, takng nto account only data provded by those 22 NRAs whch consstently reported snce Fgure 4-1 shows a qute stable and sustanable choce of the cost base made by the NRAs. CCA s by far the most commonly used cost base methodology appled. Both, the number of NRAs usng HCA and those usng CCA has been stable snce Fgure 4-1: Cost base unbundled access wholesale (Market 4, prevously Market 11) Number of countres:22 Source: BEREC RA PT The countres contrbutng ncluded the 27 EU Member States plus Iceland, Norway, Swtzerland and Croata. 23 These and the followng references are provded by BEREC. However, one cannot dscern to what extent ths ncludes NRAs usng mxed approaches. In addton, n 2010 Italy swtched from HCA to CCA whch apparently has not been reflected n these numbers.

42 32 Wholesale prcng, NGA take-up and competton As shown n Fgure 4-2, the most commonly used accountng methodology n 2010 and n the prevous years s LRIC. 64% of the NRAs are applyng LRIC for wholesale products n market 4 and 36% are applyng FDC. Fgure 4-2: Accountng methodology unbundled access wholesale (Market 4, prevously Market 11) Number of countres:22 Source: BEREC RA PT 2010 As Fgure 4-3 shows, the most commonly used prce control method n the unbundled access wholesale market s by far cost orentaton. 21 NRAs apply cost orentaton although for 5 NRAs t s combned wth prce cap. From Fgure 4-3 t can be observed that between 2008 and 2009 two NRAs moved from benchmarkng or another type of prce control to cost orentaton.

43 Wholesale prcng, NGA take-up and competton 33 Fgure 4-3: Prce control method unbundled access wholesale (Market 4, prevously Market 11) Number of countres:22 Source: BEREC RA PT 2010 European NRAs so far prefer CCA as a cost base combned wth LRIC as the costng methodology and cost orentaton as the prce control method for unbundled wholesale access. Although the cost and prcng methodology looks rather harmonzed n Europe, the resultng range of actual ULL prces seems to speak a dfferent language. As of October 2009 ULL prces are n a range of 6 to 16 n the Member States wth an average of Ths prce range cannot be explaned by country-specfc cost dfferences but ndcate relevant methodologcal dfferences n usng cost parameters and calculaton approaches. Gven that the market and demand s changng over tme, some nsght nto regulatory polcy s provded by the development of ULL prces over tme. Table 4-1 provdes a benchmark for 13 countres over the perod from 2005 to 2011 recently used by the Spansh NRA CMT. Three dfferent patterns of prce paths can be dentfed from that benchmark: 24 See Fgure 5-2.

44 34 Wholesale prcng, NGA take-up and competton (4) Some NRAs have set a prce path wth relatve stable but slghtly declnng ULL wholesale prces. France, Germany and to some extent Portugal fall nto ths category. They have reduced prces by less than 10% over that perod. (5) A second group of NRAs has set a more aggressve path of a steady prce declne. Austra, The Netherlands, and Belgum belong to ths category. ULL prces have been decreasng by 32% to 46% n these countres. (6) In a thrd group of countres, prces have been (sometmes strongly) decreasng n the frst part of the perod consdered and have been ncreasng or are begnnng to ncrease agan n the last few years. Span, Sweden, the UK and Italy fall nto ths category. The other countres not attrbuted to one of the three groups do not reveal a clear prce path pattern lke Ireland where prces frstly ncrease sharply and then decrease sharply. Table 4-1: ULL prce benchmark over 13 countres ( ) Austra The Netherlands Belgum Span ) Greece Sweden 2) UK 3) Portugal France Italy ) Denmark 5) Germany Ireland ) 2) 3) 4) 5) Proposal of CMT 1 = SEK 1 = for = DKK Source: CMT (2011) from mplementaton report of the EU (for ) and Cullen (for ) 4.2 Gudelnes from the NGA Recommendaton The NGA Recommendaton tres to fnd a balance between optmal ncentves to nvest n NGA and to keep competton n servce provson n the NGA world. The system of

45 Wholesale prcng, NGA take-up and competton 35 remedes to guarantee competton n the area of copper networks are transposed nto fbre-based networks and the transton from copper-based to fbre-based networks. The followng basc prncples of the Recommendaton are of partcular mportance for the subject matters of prcng n ths study: (1) Mandatng access to cvl engneerng s only regarded as effectve, f the SMP operator provdes access under the same condtons to ts own downstream arm and to thrd party access seekers. 25 (2) When nvestments n non-replcable physcal assets such as cvl engneerng nfrastructure are not specfc to the deployment of NGA networks, ther rsk profle should not be consdered to be dfferent from that of exstng copper nfrastructure. 26 (3) Access prces n the NGA context should reflect the costs effectvely borne by the SMP operator, ncludng due consderaton of the level of nvestment rsk. 27 (4) The cost of captal n settng access prces should reflect the hgher rsk of nvestment n NGA relatve to the rsk nvolved n current copper-based networks. 28 (5) Non-lnear access prces whch dversfy the nvestment rsk between the nvestor and the access seeker should not lead to a margn-squeeze preventng effcent market entry. 29 (6) A margn squeeze can ether be demonstrated on the bass of an equally effcent compettor test or on the bass of an reasonable effcent compettor test. In the context of ex ante prce controls the Recommendaton regards the reasonably effcent compettor test as more approprate. 30 More specfcally, the NGA Recommendaton prescrbes the followng prcng rules for NGA wholesale products: (1) The prce of access to the unbundled fbre loop should be cost-orented. The relevant cost of captal should nclude a rsk premum properly reflectng the fbre nvestment rsk. 31 (2) To create a genune level playng feld between the downstream arm of the SMP operator and alternatve network operators, a consstent regulatory 25 See Rec See Rec See Rec See Rec See Rec. 24 and See Rec Se para. 25.

46 36 Wholesale prcng, NGA take-up and competton approach may mply the use of dfferent cost bases for the calculaton of costorented prces for replcable and non-replcable assets. 32 (3) Access to exstng cvl engneerng nfrastructure should be mandated at costorented prces under the same methodology as for prcng access to the unbundled local copper loop. NRAs should n partcular take nto account actual lfetmes of the relevant nfrastructure. Access prces should capture the proper value of the nfrastructure concerned, ncludng ts deprecaton. 33 (4) Access prces to the unbundled fbre loop at the MPoP n the case of FTTH should nclude a hgher rsk premum than prces for access to the unbundled local copper loop. 34 The fbre ULL prce charged to the SMP operator s downstream arm should be the same as the prce charged to thrd partes. (5) Regulated access prces for copper sub-loop unbundlng should not be hgher than the cost ncurred by an effcent operator-based on bottom-up modelng or benchmarks Country case studes The UK In 2005, Ofcom decded upon a major shft n the asset valuaton of BT s copper access network and therefore on the cost standard to determne the LLU wholesale charge or more precsely a rental charge celng. Up to then Ofcom had appled a current cost accountng approach wth fully allocated costs (CCA FAC). The major change was related to the regulatory asset valuaton: In the Valung copper access statement, Ofcom concluded that t was no longer approprate to value BT s pre-1 August 1997 copper access network assets on the bass of CCA FAC (or LRIC+). Ths was because to do so would have allowed BT to over-recover the costs of those assets whch, untl 1 August 1997, had been valued under the HCA conventon. In order to avod the potental for such over-recovery, and gven that t s unlkely that any operator wll buld a new natonwde access network n competton wth BT n the near future, Ofcom decded to create a regulatory asset value, or RAV, to represent the remanng value of the pre-1997 copper access network assets rather than contnung to value those assets at ther current cost. The value of the RAV s set to equal the closng hstorcal cost accountng value for the pre-1 August 1997 assets for the 32 See Annex I, para See Annex I, para See Annex I, para See Annex I, para. 5.

47 Wholesale prcng, NGA take-up and competton /5 fnancal year and ts value wll be ncreased each year by the Retal Prce Index ( RPI ) to ensure t s not eroded by nflaton. Over tme the RAV wll gradually dsappear as the pre-1997 assets are gradually replaced wth new ones. Post-1 August 1997 assets whch have been valued consstently on a CCA FAC bass throughout ther lves wll contnue to be valued usng the CCA conventon. Therefore, the part of the LLU charge whch reflects recovery of the costs of the local loop wll reflect an average of the costs assocated wth pre-1 August 1997 assets, based on the RAV, and the costs assocated wth post-1 August 1997 assets, calculated usng CCA FAC as descrbed above. The other components of the fully unbundled rental charge are based on CCA FAC. 36 Ths combnaton of valuaton prncples effectvely means that the ULL rate celng wll partally reflect hstorc cost and partally current costs. Gven the deprecaton perods of the relevant assets, ths (n theory) would mean that the last remanng assets ncluded n the RAV wll become fully deprecated n 2037/8. 37 From ths pont onwards all assets would be treated agan under a full CCA bass. BT wll be requred to mantan approprate records to dentfy the relevant assets for the RAV to be dstngushed from other access assets whch are subject to a full CCA approach. Ofcom regards the European Court of Justce decson n the Arcor case whch we wll dscuss n more detal n the context of the German case 38, as less clear cut than presented by the stakeholder. 39 Ofcom reads the decson such that t mples a mx of HCA and CCA although t remans unclear how ths should be appled n practce. Ofcom tself has placed greater emphass on forward lookng costs and, hence, CCA whle the RAV approach does acknowledge hstorc costs. As a consequence of ths new polcy approach BT voluntarly reduced the unbundled rental charge on 1 August 2005 from to (whch means by 27%). Ofcom tself has set the unbundled rental charge celng at 81.69, whch took effect from 1 January Ths sequence also ndcates that Ofcom effectvely s not regulatng the ULL charge. It s just settng a rate celng. In addton to revalung (parts of) the access asset base, Ofcom revewed the accountng lves for duct and copper cables and the relevant WACC. Ofcom vewed BT s deprecaton polcy for ducts of a 25 year lfetme as too aggressve and not justfed by actual use. 41 It s dffcult to envsage any large scale technologcal development whch wll render the duct network obsolete. BT stated that duct has a 36 Ofcom (2005b), p See Ofcom (2005a), p See Secton See Ofcom (2009), p See Ofcom (2005a), p See Ofcom (2005a), p. 41f.

48 38 Wholesale prcng, NGA take-up and competton book lfe of 38 years whlst the maxmum book lfe s 45 years. Ofcom therefore adopted to straght lne deprecaton treatment for ducts wthn the regulatory fnancal accounts and to use an accountng lfe of 40 years. Smlarly, Ofcom regarded the lfetme whch BT assumed for copper cables, namely 15 years as napproprate. 42 BT has ndcated that the desgn lfe for the cables s 20 years, the majorty of European access network operators ndcate a book lfe n the range of 16 to 20 years, actual lfetme s somewhere between 15 and 20 years. Ofcom therefore adjusted copper cable lfetme to 18 years. Ofcom also revewed the relevant WACC for the access network. In the 2004/05 accounts BT stll appled a WACC of 13.5%. In ts cost of captal revew 43 Ofcom has concluded that a WACC of 10% s more approprate for the access network assets. Applyng the changes as dscussed above has led to major changes n the cost for the LLU servce. Increasng the asset lfetme and movng to the RAB asset valuaton reduced the annual cost of the copper loop from to representng a reducton of per loop or of 14%. Changng the WACC further reduced the average cost per loop to or by 10% for the 2005/06 fnancal year. For the fscal year 2007/08 Ofcom reports an (unaudted) BT estmate of 65 as the LRIC for the ULL. 44 These costs correspond agan to a rate celng of whch s much above the relevant costs. In 2009 Ofcom (2009) made new decsons regardng the prce celng for the ULL servces. The new prce control kept the system of fxng a prce celng for 2009/10. Ths celng was then ndexed for the servce n 2010/11. The new celng was fxed such that f an equvalent annual ndexaton were to apply untl 2012/13 t would delver a prce that equals Ofcom s assessment of the projected effcent fully allocated cost of ULL n that partcular year. Table 4-2: New prce controls for ULL n the UK Prevous prce (celng) Prce n 2009/10 Indexaton n 2010/11 ULL annual rental charge RPI + 5.5% 42 See Ofcom (2005a), p See Ofcom (2005c). 44 See Ofcom (2009), p. 67.

49 Wholesale prcng, NGA take-up and competton 39 On 22 September 2009, Carphone Warehouse Group PLC brought an appeal aganst Ofcom s LLU Statement mentoned above to the Competton Appeal Trbunal. 45 Brtsh Sky Broadcastng and BT both ntervened. On 27 November 2009, the Trbunal referred to the Competton Commsson the specfed prce control matters. On 31 August 2010 the Competton Commsson notfed the Trbunal of ther determnaton of the prce control matters. On 11 October 2010 the Trbunal has remtted the decson under appeal to Ofcom wth the followng drecton: For the ULL servce the annual rental charge for the unelapsed perod of the prce control s The charge for the frst relevant year was even set at for the perod begnnng on 1 st Aprl 2010 and endng 14 October 2010 and the amount of for the remander of the second relevant year. On 31 March 2011 Ofcom (2011) publshed a consultaton on the revson of the prce control for LLU and WLR servces. Ofcom proposes new ULL annual rental charges whch are expected to come nto effect later ths year and wll run untl 31 March Today s regulated wholesale prce of per year s supposed to decrease n real terms by between RPI -1.2% and RPI -4.2% every year. For ts base case calculaton Ofcom assumes a real decrease of RPI -2.7% whch would result nto a nomnal prce ncrease to To calculate the new charges Ofcom bascally reled upon ts prevous approach to calculate costs on a CCA replacement cost bass wth an RAV valuaton approach for assets deployed before Ducts as a major component to be used to carry copper lnes have been re-evaluated by BT/Openreach n Ths reevaluaton s reflected n Ofcom s new charge proposal. As part of ths re-evaluaton BT updated the cost and natonal buld dscount elements of ts absolute evaluaton calculaton for ther duct assets. As a result the duct valuaton ncreased to 6.5 bllon, an ncrease of 1.8 bllon compared to the 2008/09 equvalent valuaton. The largest sngle reason for ths ncrease s a much lower natonal buld dscount whch decreased from 45% to 14.5% based on data by a new sngle contractor. Ths ncrease n the captal cost asset base was partally compensated by a lower WACC. Ofcom s cost model and the new charge proposals are based on a WACC for Openreach of 8.6%. Ofcom does not gve much regulatory gudelnes regardng the prcng of fbre unbundlng. In ts latest decson on wholesale local access (market 4) Ofcom ncluded fbre-based local access n that market besdes copper-based and cable-based access. It dd, however, effectvely not mpose an unbundlng remedy on BT s GPON network. Instead, Ofcom mposed a wholesale vrtual unbundled local access (VULA) oblgaton. 46 VULA s an actve lne product wth smlar characterstcs as btstream access. Ofcom s concluson s based on the assumpton that non-physcal products have underlyng characterstcs consstent wth physcal products and should therefore be ncluded n the same market. Furthermore, Ofcom defned some functonal characterstcs for VULA lke localness, mnmum functons ncorporated, servce- 45 See Ofcom (2010b). 46 See Ofcom (2010a).

50 40 Wholesale prcng, NGA take-up and competton agnostc and dedcated capacty for VULA whch should make t functonally smlar to physcal unbundlng. Whle copper LLU, sub-loop unbundlng and physcal nfrastructure access (duct and pole access) s n prncple subject to LRIC prcng, Ofcom allows BT prcng flexblty for the VULA servce. Ths ncludes geographc varatons, volume dscounts and tered prcng. However, BT s requred to provde VULA to communcatons provders on an equvalence of nput bass as to ts own downstream dvsons. In ts comments to Ofcom s ntended decson the Commsson 47 accepted VULA to be ncluded n market 4 although t s characterzed as an actve NGA product. The Commsson accepted that VULA has many features whch ndcate that t s equvalent to local loop unbundlng. The Commsson dd not challenge Ofcom s fndng that today fbre unbundlng would not be a justfed and proportonate remedy n case of GPON. Nevertheless, the Commsson assumes Ofcom to re-assess the actve lne remedy as soon as a technology 48 enablng fbre unbundlng (lke WDM) s avalable. The VULA remedy should be replaced by fbre unbundlng as soon as t s techncally and economcally feasble or should possbly contnue to be requred n addton to full fbre unbundlng Austra The Austran NRA RTR s generally followng a FL-LRAIC approach for determnng the wholesale LLU prces. Insofar and as long as retal prces are unregulated and are not necessarly cost-based, a cost-based wholesale prcng approach does not necessarly exclude economc dstortons of competton. Dependng on the retal prcng polcy of the ncumbent cost-based wholesale prces may lead to nconsstences of prcng between the ntegrated and non-ntegrated compettors. If the ncumbent values the copper network dfferently to a FL current cost approach or f he engages n a prce dscrmnaton, the retal prces of the ncumbent may not be replcable by compettors on the bass of FL-LRAIC-based wholesale rates. In such a case a margn squeeze occurs. Compettors are then unable to meet the retal prce of the ncumbent on the bass of FL-LRAIC wholesale prces and effcent downstream costs. Downstream compettors face a stuaton of prce dscrmnaton at the wholesale level. Cost-based wholesale prces therefore are a necessary but not a suffcent condton for prce consstency and undstorted competton between ntegrated and non-ntegrated operators. If retal prces are set below (full) costs a margn squeeze may occur even f wholesale prces are cost-based. 47 European Commsson, SG-Greffe (2010) D/7658 of 1/06/ The Commsson mentons the example WDM as fbre unbundlng technology, whle we understand WDM as a wavelength unbundlng enabler only.

51 Wholesale prcng, NGA take-up and competton 41 To avod such a compettve dstorton and a potental foreclosure of the market, RTR requres that the relevant wholesale prce also has to meet a margn squeeze test such that the wholesale rate s not allowed to exceed a level that would generate a margn squeeze for compettors. The level of retal rates decdes whether ths compettve consstency condton generates a bndng condton for wholesale prcng. Effectvely, the relevant wholesale prce becomes the mnmum of a prce whch s margn squeeze free and a prce set at the level of the relevant FL-LRAIC. RTR appled ths prcng method n 2007 for the frst tme when t dentfed that the LRIC were sgnfcantly above the margn squeeze free prce. Ths stuaton remaned n further rate cases n partcular because FL-LRAIC tended to ncrease over tme. In September RTR estmated the relevant FL-LRAIC n a range of per month whle the margn squeeze free wholesale prce was determned at Table 4-3 descrbes prces and costs for ULL n Austra. Table 4-3: ULL costs and prces n Austra FL-LRAIC Wholesale prce The sgnfcant reducton of the ULL wholesale prce n 2007 effectvely was a decson of the ncumbent Telekom Austra (TA). TA ntended to reduce a low-prced access bundle product ncludng telephony, nternet and moble access for 19.90, orgnally only for a two month acton perod. RTR provded TA wth the opton ether to reduce the ULL wholesale prce or to ncrease the ntended retal prce because the actual wholesale prce dd not provde a suffcent margn between the retal and wholesale product on the bass of RTR s calculaton rules for a margn squeeze. 50 TA decded n favor of reducng the wholesale prce and RTR confrmed the level of the ULL charge. To dentfy the margn squeeze free wholesale prce RTR apples the equally effcent operator (EEO) standard. Accordng to ths standard a wholesale prce s margn squeeze free f the ncumbent can produce retal and other wholesale products n the value chan on the bass of the wholesale prce and ts own downstream costs wthout makng a loss. RTR does not apply ths test for a sngle retal product, because the unbundled local loop s used to produce a varety of dfferent servces and end-user prces are dfferentated. Instead, RTR s applyng the test for all broadband products provded over the copper lne. The relevant revenues are therefore determned as a weghted average of all average revenues per user (ARPU). From the revenues RTR 49 Telekom-Control-Kommsson (2010). 50 See Telekom-Control-Kommsson (2007).

52 42 Wholesale prcng, NGA take-up and competton deducts those downstream costs whch a compettor would rase tself. At the retal level these costs nclude: Marketng and sales Bllng and bad debt Accountng Product development and management Customer servce/call center Backhaul and nternatonal connectons Costs related to addtonal servces lke Web-space, E-Mal Other common costs at the retal level. Furthermore, compettors have to generate certan techncal servces whch are not provded as wholesale servces. Those costs nclude: xdsl equpment lke modem and DSLAM Equpment at the collocaton pont Mantenance of techncal equpment Work force for network servces Captal costs of own nfrastructure Common costs at the nfrastructure level. Avodable costs whch are provded by the access seeker tself can ether be one-off or recurrng. The net revenues determned on the bass of gross revenues mnus avodable costs are then compared wth all (one-off) and recurrng charges for wholesale provson. These costs nclude the wholesale prce for the unbundled loop, all costs related to collocaton and those for backhaul connecton. If the calculaton generates a postve margn, then the correspondng wholesale charges are margn squeeze free. In addton to ths overall margn squeeze test relatng to all retal products provded over the access nfrastructure, RTR apples n addton a test related to each sngle product. Ths test ntends to avod margn squeeze n the sense of predatory prcng. To pass ths test and to avod cross subsdzaton, each retal product has to cover ts ndvdual varable or ncremental costs. Accordng to ths test each product has to provde a postve contrbuton over and above the varable or ncremental cost/prce of the correspondng wholesale product(s). The wholesale prce therefore defnes the mnmum level of each retal prce. Ths test even s appled for temporary prcng polcy actons. The prce for the sub-loop from the street cabnet to the network termnaton pont s determned as a fxed percentage pont (77.3%) of the fully unbundled loop. There s no

53 Wholesale prcng, NGA take-up and competton 43 prce or cost element for nhouse cablng, because t s assumed that these costs have already been covered by the end-user n provdng the lne. The Commsson commented RTR s prcng approach crtcally 51 n ts letter regardng RTR s last measures regardng market 4. The Commsson argued that wholesale prces for the ULL should generally be cost-based. Otherwse negatve ncentves to nvest would occur for the ncumbent to upgrade and expand ts access nfrastructure Germany BNetzA s one of the NRAs whch consstently over the last 12 years appled a FL-LRIC approach to determne the regulated ULL rental charge. Ths cost standard s mandatory under German telecommuncatons law for all ex ante regulated wholesale servces. The BNetzA also consstently appled the same approach to calculate the FL- LRIC over the years. We wll descrbe ths approach for the latest ULL decson n the followng. The approach led to a slghtly decreasng ULL charge as Table 4-4 shows. Related or unrelated to the prcng decsons, ULL s a qute attractve wholesale product n Germany. 9.7 Mo. lnes were unbundled n Germany at the end of About 25% of all copper access lnes are provded on that bass. Table 4-4: Monthly rental for ULL n Germany Delta ) (25.40 DM) (24.80 DM) ) New rates were usually fxed at the 1 Aprl for the followng two years. BNetzA appled a FL-LRIC approach also n ts latest ULL decson from March The network assets of the copper access network were valued at current costs. The relevant network asset elements were calculated on the bass of a bottom-up engneerng cost model. The model uses a scorched node approach nsofar as number and locaton of MDFs are concerned. For the feeder and the drop segment as well as the number and locaton of dstrbuton ponts ( Kabelverzweger, street cabnets) and related elements the model reles upon a scorched earth optmzaton approach. Ths 51 See SG-Greffe (2010) D 8552, Brüssel 17/06/ See BNetzA (2009).

54 44 Wholesale prcng, NGA take-up and competton means that the model endogenously bulds on an optmzed effcent network structure nstead of the real network structure of the exstng access network. The optmzaton starts from a gven demand for copper access lnes dstrbuted n the country at the pont of decson makng. The mnmal nvestment values are calculated for each of the 8,000 access areas 53 and then aggregated to a natonwde average value. Investment values per lne (as well as the ULL prce) s calculated on a natonwde bass of the whole copper access network. The model parameters on current prces of equpment tems are manly based on nformaton provded by DTAG. Ths nformaton was completed wth nformaton from other market players. BNetzA, however, dd not accept requested prce ncreases for deployng cable and ducts of 40%. OPEX were bascally calculated on the bass of cost nformaton provded by DTAG. Ths nformaton was partally corrected by effcency consderatons or error correctons. Many of the relevant nvestment and cost parameters of the BNetzA cost calculaton are treated as confdental. The parameters lsted n Table 4-5 are publshed n the latest TAL decson. 54 Table 4-5: Key cost parameters for ULL n 2009 WACC (real WACC after adjustment for fluctuatons, from 5.51% to 7.19 % Asset lfetme of copper cables Asset lfetme of ducts and manholes Investment savngs due to nfrastructure sharng wth other utltes 7.19% 20 years 35 years Feeder cable segment 11.43% Drop cable segment 27.24% Addtonal nternal nvestment savngs due to VDSL n the feeder segment Investment value of standard ULL % Bascally due to ncreased current prces of network assets (manly cable deployment, cable and labor costs) the nvestment value per ULL ncreased from the prevous decson n 2007 from to (ncrease of 6.8%). Ths ncrease was (more than) compensated by a lower WACC (7.19% nstead of 8.07%) and lower allowed OPEX. The combned effect of all parameter changes lead to a cut of the ULL charge from to (a reducton of 2.9%). 53 In the prevous decsons the modelng was based on a sample of 600 MDF areas. 54 See BNetzA (2009).

55 Wholesale prcng, NGA take-up and competton 45 BNetzA also appled a margn squeeze test to check the consstency of the calculated ULL wholesale prce wth the retal prce level of DTAG. For calculaton purposes BNetzA used a reasonably effcent compettor test. BNetzA dd not apply the test for each ndvdual retal prce but only for a combnaton of retal prces. Compettors shall be able to reproduce a telephony only product as well as a bundle product consstng of telephony and DSL on the bass of unbundlng. In the case of a bundle product BNetzA calculated on the bass of the cost tems n Table 4-6 that revenues exceeded compettors cost by about 10% resultng n a no margn squeeze relatonshp. Smlarly n the case of a telephony only servce, revenues exceeded compettors cost by even 30% accordng to the BNetzA calculaton. Table 4-6: Margn squeeze calculaton n case of a bundle product Monthly cost of TAL access seeker Wholesale prce TAL Provson 1.95 Monthly rental Cost of DSLAM 4.64 Cost of spltter 0.89 Transport n concentraton network 2.10 Collocaton 0.93 Transport IP backbone network 2.31 Usage dependent cost telephony 3.00 Customer acquston, mantenance, common cost, bllng, bad debt 6.99 Monthly revenues of a broadband bundle product Sum Source: BNetzA (2009) p. 68 The debate on the proper level of the ULL rental charge n Germany has receved new fuel from a decson of the European Court of Justce (ECJ) n and subsequent decsons bult on the ECJ s decson of the German Admnstratve Court 56. The ECJ decson was related to the BNetzA decson on the ULL prces n The Court made crtcal comments regardng the applcaton of a current cost approach as well as a hstorc cost approach for ULL. Wthout developng a clear defnton t asked for a stronger consderaton of the actual costs of the operators for determnng the ULL prce. From an economc perspectve, the European Court decson was confusng nsofar, that the Court s costng concept dd nether exclude hstorc or current cost as a 55 European Court of Justce, Decson of , Rs. (55/06, Arcor AG & Co./Bundesrepublk Deutschland). 56 VG Köln, Decson of , AZ.: 1K1749/99; VG Köln Decson of , AZ.: 1K3481/01.

56 46 Wholesale prcng, NGA take-up and competton relevant standard nor gve a meanngful gudelne how eventually to combne both cost standards n a relevant and meanngful way. In any case, on the bass of the ECJ decson the German Admnstratve Court declared the TAL decsons of BNetzA from 1999 and 2001 as nvald. Ths Court case s not yet fnalzed because BNetzA appealed aganst the decson. Besdes the open court cases, there s a dscusson n Germany whether and to what extent the European Court s decson has any relevance to subsequent decsons on ULL prces and n partcular on upcomng decsons. The compettve carrers assocaton VATM argues that the Court s decson has to be taken nto account for all past and upcomng ULL decsons. 57 The BNetzA on the other hand doubts the relevance of the decson because there has been a change n the telecommuncatons legslaton n Germany n the meantme. The second topc whch s hghly debated n Germany s whether or not the European Court has set a bndng new cost standard to be appled by BNetzA. Whle the compettve carrers n Germany argue, that the Court requres some knd of combnaton of hstorc and current cost as a new gudelne for actual costs, the BNetzA does not nterpret the Court s decson such that t requres a (new) combned cost standard. BNetzA nterprets the European Court s decson such that t stll gves the NRA the flexblty to choose between hstorc and current cost to determne the cost of ULL. 58 BNetzA s understandng s that the Court does not prescrbe a combnaton of hstorc and current cost as a new (bndng) cost standard called actual costs to apply. One of the compettve carrer s assocaton n Germany recently has publshed a study 59 to make the economcally unclear actual cost concept of the European Court of Justce more concrete and calculable. The authors of the study defne actual costs as hstorc cost up to the pont of regulatory decson makng and as current costs for the prospectve two year regulatory perod. The regulated prce should then become a weghted average of these costs. The study calculated the hstorc cost on the bass of the nvestment values of BNetzA, deflated these values backwards and assumed sgnfcant hgher deprecaton perods. Wthout gong nto calculaton detals the authors calculated actual costs for the ULL rental for 2011 on ths bass at 6.94 (at the maxmum) compared to a current regulated prce of On 31 March 2011 BNetzA made a new decson on the monthly ULL charges to be appled from 1 Aprl 2011 to 30 June Bascally the BNetzA used the same approach as before and calculated ULL charges on the bass of a current cost approach by usng a cost modelng approach. 60 Monthly charges were reduced (n nomnal terms) from to The sup-loop part was reduced slghtly less (n relatve terms) 57 See for nstance the poston of ts legal advsor, Kühlng (2010). 58 See BNetzA (2009), p. 20ff. 59 See Dalog Consult (2011). 60 See press release of BNetzA from 31 March 2011.

57 Wholesale prcng, NGA take-up and competton 47 from 7.21 to In ts decson the BNetzA ponts out that the nvestment value of the copper loop has been ncreasng due to ncreased nput prces, reduced economes of scope n the deployment of other nfrastructure and a decrease n the number of copper loops. Ths ncrease of the captal cost base was compensated by an effcency ncrease n OPEX cost components. In January 2011 BNetzA publshed ts draft decson regardng access oblgatons for market 4 ncludng unbundled access to DTAG s FTTH network. 61 Unbundled access to the fbre loop of FTTH has to be provded regardless whether the network s deployed n a Pont-to-Pont (P2P) or a Pont-to-Multpont (GPON) archtecture. In case of P2P unbundled access has to be provded at the Optcal Dstrbuton Frame (MPoP). In case of GPON access has to be provded at the spltter (Dstrbuton Pont). In case WDM PON s avalable n addton to access at the Dstrbuton Pont, access to a wavelength has to be provded at the ODF. The decson only ndrectly deals wth the prcng of fbre access. BNetzA dd not set an ex ante prcng rule for ths type of access but decded n favor of ex post regulaton of fbre ULL. Ex post prce regulaton works under German telecommuncatons law such that ntended prces have to be notfed to BNetzA n advance. BNetzA then has to check whether they are abusve e.g. are leadng to a margn squeeze, are dscrmnatory or are abusvely hgh. Ex post regulaton does not requre to apply the FL-LRIC cost standard whch s generally requred under German telecommuncatons law n case of ex ante prce regulaton. In ts comments to the BNetzA notfcaton of market 4 remedes the Commsson 62 made crtcal remarks regardng the access ponts n fbre networks and the lack of costorentaton for access based on FTTH. The Commsson asked for the mposton of the access oblgaton n a technology-neutral and not n a archtecture-specfc way. Otherwse, the domnant operator could be encouraged to make archtectural choces wth a vew of possble regulatory consequences. In that sense access to the fbre loop n case of FTTH should be gven at the most approprate pont n the network, whch s normally the MPoP. In that regard the Commsson asks for clarfcaton of the access oblgaton. Regardng the ex post prce control remedy for fbre access the Commsson expresses ts doubts that ths methodology wll not result n cost-orented prces as requred by Recommendaton 25 and Annex I of the NGA Recommendaton. In the vew of the Commsson the prce control as proposed by BNetzA does not provde the necessary legal and regulatory certanty for access seekers. Therefore the Commsson asks BNetzA to mpose an ex ante prce control based on true cost orentaton for fbre access. 61 See BNetzA (2011). 62 See SG-Greffe (2011) D/2/2850, Brussels 24/02/2011.

58 48 Wholesale prcng, NGA take-up and competton Italy Prce determnaton methods for the unbundled copper loop n Italy changed rather often n the last decade. AGCOM, the Italan NRA, just recently 63 decded to change the cost methodology for determnng the approprate prce for the copper access lnes from HCA to CCA. Ths was due to EU harmonzaton and n order to encourage a shft from copper to fber by gvng a proper make-or-buy sgnal to alternatve operators. Whle the decson was made n 2009, the cost methodology s now for the frst tme appled n the actual market analyss. Also the accountng method changed now from FDC to Bottom-Up LRIC 64 as part of the same decson. Table 4-7: LLU trend n Italy (monthly rental) EU benchmarkng (best tarff) Prce Cap (FDC/HCA Cost orentaton (RoR) on FDC/HCA Prce cap on BU-LRIC model (change from HCA to CCA) The prce control method changed several tmes over the recent years. Whle n the years 2003 to 2005 the prce was set by usng EU-benchmarks, n 2006 and 2007 a prce cap was appled on the cost determned by FDC/ HCA. In the two years to follow (2008 and 2009) prce control was based on cost orentaton (Rate of Return regulaton), whle n the market analyss under dscusson now a prce cap was appled once agan for the years 2010 to Under the BU-LRIC model used by AGCOM asset lfe tmes for trenches wth ducts are 40 years, for trenches hostng drect bured cables 25 years, for aeral cablng poles 20 years. The asset lfe tmes for underground copper cables are assumed to be 25 years (n ducts or drectly bured), aeral cables have the same lfe tme as the poles, 20 years. The WACC decreased over the last decade from 13.5% (before 2006) to 10.20% ( ) and to actually 9.36% (2010 onwards). LLU prces had always been calculated as a natonal average. The BU cost model under use n the actual market analyss dd not calculate the LLU cost on a natonwde geodata analyss, but was based on a sample of 50 MDF areas only of approxmately 10,500 MDFs n total. Accordng to a WIK analyss the choce of the sample taken by AGCOM systematcally overestmate the LLU cost. Ths result s based on a BU-LRIC model whch calculates costs on the bass of all MDF wthout samplng. 63 AGCOM resoluton 731/09/CONS. 64 For Btstream Access the cost methodology already n the past had been CCA, but the accountng method changed from FDC to BU-LRIC n parallel wth LLU.

59 Wholesale prcng, NGA take-up and competton 49 The determnaton of the copper LLU prce ncludes two OPEX components, regular mantenance and fault mantenance (Table 4-8). The fault mantenance costs represent a sgnfcant share of the total LLU monthly cost and are under dscusson n the Italan market. Durng the notfcaton process of the results of the recent market analyss the Commsson stated doubts n the AGCOM approach to assume the cost and case fgures for fault mantenance delvered by Telecom Itala to be effcent. Thus the values have been decreased slghtly n a not really transparent way. Table 4-8: OPEX n monthly LLU prces LLU cost components Network cost (ncl. regular mantenance) LLU 2008 (FDC/ HCA) [ ] LLU 2009 (FDC/ HCA) [ ] LLU 2012 (LRIC/ CCA) [ ] 5.11 (67%) 5.61 (66%) 6.83 (74%) Fault mantenance 1) 1.84 (24%) 2.28 (27%) 1.80 (19%) Wholesale commercal cost 0.69 (9%) 0.60 (7%) 0.65 (7%) Total monthly LLU prce [ ] ) Cost components based on assumptons provded by Fastweb There exsts an opton for a btstream access product nstead of an unbundled local loop n those MPoP areas, where due to techncal reasons a LLU servce cannot be offered. In MPoPs wth lack of collocaton space ths btstream s a temporary remedy untl suffcent space had been provded by the ncumbent. The btstream prce regulaton follows that of the copper ULL. AGCOM publshed ts draft regulaton on access servces to next generaton networks n January The publc consultaton process wll end n the mddle of March 2011, and the decson process wll be fnshed after EU notfcaton and fnal decson by AGCOM not before end of May The draft decson proposes to dffer between areas of nfrastructure competton or potental nfrastructure competton and areas where only the ncumbent Telecom Itala owns fbre access nfrastructure. Remedes proposed are duct access, access to dark fbre and nhouse cablng, and n monopoly areas fbre LLU access at the MPoP, startng n If Pont-to-Multpont fbre topologes (wth GPON network archtecture) are deployed only fbre sub-loop access at a dstrbuton pont closer to the end customer s mandated. Btstream access at the MPoP only s mandatory as long as a LLU (or sub-llu) access s not avalable. A vrtual ULL or VULA servce n case of Pont-to-Multpont fbre topologes s not mandated. Dark fbre and fbre LLU dffer n the network segments covered and the prce structure. Dark fbre can be rented per network segment only (feeder, dstrbuton, 65 AGCOM resoluton 1/11/CONS.

60 50 Wholesale prcng, NGA take-up and competton drop/ nhouse), on an IRU base for 15 years, whle fbre LLU ends at the CPE and has a short term lease contract pad on a monthly bass. All prces for wholesale servces consdered n ths proposal are based on cost orentaton n a BU-LRIC manner, ncludng a rsk premum. But f the ducts already exst a specfc rsk premum cannot be appled. The dfference between the two approaches (exstng ducts wthout rsk premum and new ducts wth rsk premum) s not quantfed yet. The btstream prcng may dffer between areas wth (potental) nfrastructure competton and nfrastructure monopoly areas. In the compettve areas t s proposed to only mandate nondscrmnatory prcng, whle n the latter cost orentaton shall be mandated France Table 4-9 shows the evoluton of LLU prces n France. The most promnent change s the one related to the 2002 decson 66 whch reduced the number of lnes taken nto account for determnng the cost of unbundlng (see below) and reduced the WACC from 12.1% to 10.4%. Snce 2005 ARCEP does no longer determne the LLU prces ex ante but verfes ex post that FT comples to ts oblgaton to set non-excessve tarffs. France Telecom dropped the prce to 9.50 and to 9.29 n France Telecom explaned that productvty gans allowed to decrease the wholesale prce from 9.29 to 9 n January Table 4-9: Monthly LLU prces n France from 2000 to 2011 Date LLU prce Cost base LRAIC LRAIC/ FDC (?) Asset valuaton Successve replacement cost (les Coûts de Remplacement en Flère (CRF)) Current cost wth economc amortsaton (~tlted annuty) Bass of cost calculaton 100% of lnes ~70% of lnes ~95% of lnes WACC >12.1% 12.1% 10.4%?? 10.7%? Source: Bouygues, WIK In France copper access lne costs are not determned on the bass of all lnes whch was the case only up to In 2002 ARCEP took note 67 that alternatve operators 66 ARCEP decson ARCEP decson , p. 15/16.

61 Wholesale prcng, NGA take-up and competton 51 tend to unbundle lnes prmarly n denser populated areas and that the average copper local loop costs depend on the densty of the area. ARCEP decded to dstngush two areas, one densely populated area where t s lkely that other operators wll nvest n unbundlng wthn two years and a lower densty area where t s hghly unlkely that such nvestment wll occur. At that tme ARCEP consdered about 70% of total lnes for determnng the LLU cost. Therefore the cost of the French LLU cost was domnantly derved from the average copper cost n denser areas (about 21mn lnes of 34mn lnes). 68 In 2005 ARCEP noted 69 that the footprnt of unbundlng had enlarged sgnfcantly (also due to actvtes of local governments) brngng the average cost of unbundled lnes closer to the average cost of all lnes. However, ARCEP also noted that the exstence of the compensaton fund for Unversal Servces was lkely to conflct wth a LLU prce based on all lnes. It was decded to exclude the longest lnes from the LLU cost determnaton. These make up 5% of all lnes so that the new regme extended ts copper par average cost base to 95%. Up to 2005 the cost of unbundled local loops n France was determned as Long-Run Average Incremental Cost. 70 The asset valuaton was based on Successve Replacement Cost ("les Coûts de Remplacement en Flère"). Ths approach was orgnally proposed by France Telecom and s supposed to emulate a "make or buy" decson of ether renewng or mantanng an asset. It determnes the asset value as the dfference between 1) the cost of renewng the asset mmedately at ts market value and 2) the cost of mantanng the asset untl the end of ts lfetme. 71 In 2005 ARCEP changed the asset valuaton to current cost wth economc amortzaton. However, under ths approach the asset s not valued at ts "economc" value based on future dscounted revenues. The approach s effectvely a tlted annuty method. Whle mathematcally equvalent to the replacement cost approach appled n prevous decsons, t s not appled to a theoretcal nvestment path but to the hstorcal nvestment path. Accordng to ARCEP ths methodology has three man advantages 72 : non-dscrmnaton (n partcular between the dfferent offers of France Telecom), creaton of an ncentve for FT to nvest effcently n the copper local loop, and an ncentve for alternatve operators to nvest effcently n unbundlng. ComReg summarzes ths approach n a consultaton of cost methodology as follows 73 : "Wth the economc amortzaton method, the ncrease n the deprecaton charge over tme exactly counterbalances the decrease n the captal charge over tme, whch mples that the sum of the deprecaton charge and the cost of captal are constant over 68 In the 2005 decson ARCEP quantfed ths share stll as 70% of all lnes. 69 ARCEP decson , p. 31/ EU Commsson Case FR/2005/ ARCEP decson , p.8, ComReg 08/56, p. 24/ EU Commsson Case FR/2005/ ComReg 08/56, p. 26. The exact method remans unclear to us.

62 52 Wholesale prcng, NGA take-up and competton the years f prces are stable. Therefore, LLU prces that are based on these charges are less nfluenced by the short term nvestments of the ncumbent. Also, the annuty vares wth asset prce changes, whch would gve proper sgnals to nvestors." Current cost wth economc amortzaton (e.g. tlted annuty) shfts deprecaton to later years compared to current costs wth straght lne amortzaton. The mpact of ths effect s shown n Fgure 4-4 whch shows the nvestments n ducts n France gven constant nvestments after The blue graph represents nvestments for ducts n current costs (deprecaton plus cost of captal based on remanng net book value) and the red graph s current cost wth economc amortzaton. The costs do not nclude OPEX. Alternatve operators complan that ths approach s napproprate when consderng assets that wll not be renewed lke ducts and that t overcompensates the ncumbent. Fgure 4-4: France Telecom Investment nto ducts (wthout common cost and OPEX, n mn, constant nvestments from 2006) Source: Bouygues The cost standard appled by ARCEP after 2005 appears to be a Fully Allocated Cost standard. 74 To our understandng ARCEP has manly conducted ex post prce control wth top-down cost models. 75 In the course of the 2005 consultaton hstorc cost accountng and the prevous successve replacement cost method were dscarded. 76 The reasons for decdng 74 ComReg 08/56 calls the approach FAC. Also, the present cost determnaton ncludes drect and ndrect costs wth 6% common cost mark-up whch may be an ndcator for FAC rather than LRAIC. It s however, not entrely clear to us whch approach ARCEP s applyng. 75 To our knowledge Bottom-Up models have not played an mportant role n ARCEP's decson makng, even though some early LLU prces have been set ex ante. In addton, some of the prce changes shown here may have been a result of France Telecom reducng the prce n advance of an ARCEP decson.

63 Wholesale prcng, NGA take-up and competton 53 aganst hstorc cost accountng were prmarly that t does not take the evoluton of prces nto account. In addton ARCEP stated that hstorc cost accountng does not allow to moderate the mpact on prces from changes n the nvestment rate. ARCEP states that successve replacement cost does not encourage effcent nvestments by France Telecom and would lead to hgh LLU prces. 77 In November 2010 ARCEP publshed a decson regardng the economc condtons that would rule access to ducts n France Telecom s access network. 78 The decson n partcular determnes how the relevant cost of duct s to be shared by the copper and fbre loops. The relevant cost s determned from the normal regulatory accounts as t relates to the local loop. (It apparently excludes costs that are explctly ncurred to enable roll-out of fbre FTTX that would not have been necessary f one had used a less volume consumng technology. 79 ) ARCEP consders four ndcators for determnng the shares of the costs of the duct network to be allocated to copper and fbre. These are the relatve lengths of copper and fbre cables, the relatve volumes that copper and fbre cables occupy n the ducts, the relatve volumes of cables effectvely n use, and the relatve number of customers that get access ether over copper or fbre. ARCEP decded to use the last of these approaches. The reason s that allocatng the cost accordng to the numbers of customers usng ether technology would better reflect the needs of long-term transton from copper to fbre. It would allow a progressvely ncreasng share of the relevant costs to be charged to fbre as t would be proportonal to the correspondng revenues. It would also not dsturb the equlbrum of current servces usng copper as technology. ARCEP reports that the majorty of respondents n the publc consultaton expressed themselves n favor of ths approach. ARCEP s approach does not reflect any cost-based prcng rule but represents value of servce prcng. Over tme the cost allocaton approach brngs the allocaton of costs closer to the actual capacty used by each technology. In the frst years when the penetraton of fbre stll s low, fbre uses a (much) larger share of duct capacty than costs are allocated. ARCEP s allocaton approach lghtens fbre from costs t would otherwse have to carry and reduces the rsk of fbre nvestment to a relevant degree. Ths method of allocaton, however, also amounts to a cross-subsdzaton of fbre by copper, as the share of the actual use of duct space by fbre s presumably larger than the share of customers currently gettng access over fbre. 76 Durng the consultaton process stakeholders also proposed a prce-cap approach and the Infrastructure Renewal Accountng method. Both were dscarded by ARCEP for beng a mechansm for tarff control rather than asset valuaton (prce-cap) and too theoretc (Infrastructure Renewal Accountng). 77 ARCEP decson See ARCEP decson of 9 November See p. 8 of the decson.

64 54 Wholesale prcng, NGA take-up and competton Span On 23 February 2011 the Spansh NRA CMT publshed a statement n whch the results of a revew of the regulated prces of four products are reported. The four products revewed and the proposed changes to ther prces are shown n Table Table 4-10: Products revewed by CMT and proposed changes to ther prces Product Current /month Proposed Change n % Copper ULL monthly rental Shared monthly rental Naked btstream monthly rental Wholesale acces to the analogue telephone lne Wholesale acces to the ISDN telephone lne Source: CMT (2011) The most relevant change shown n Table 4-10 s the one for the copper ULL monthly rental, and we wll focus on t n the followng. Before we do ths, some comments on the proposals regardng the other three products are n order. Shared monthly rental CMT proposes no change to the rental. The proposal s not based on any cost apprasal. It s clamed that the market for the product s declnng and does not share n the dynamsm whch s characterstc for the unbundled access market n general. Further t s argued that ths development reflects the preferences of customers as well as the strateges of the operators who do not put great efforts nto promotng ths product. It s mpled that no further decrease n the prce for ths product s justfed gven that t s already at a very low level. Naked btstream monthly rental The reducton n the prce for ths product follows from the fndng of CMT that the component "STB actvaton", heretofore consdered part of the product, actually does not belong to t. Correspondngly the cost of ths component has been taken out of the total cost for the product. Furthermore, the mark-up to account for costs that cannot drectly be accounted for has been reduced from % to 5 %. For detals regardng the cost reducton, the reader s referred to the confdental annex of the CMT document. Wholesale access to analogue and ISDN telephone lnes The reductons n the prces for these two products follow from the evaluaton of Telefónca's cost

65 Wholesale prcng, NGA take-up and competton 55 accountng records for For detals the reader s referred to the confdental annex of the CMT document. As regards the monthly rental for the copper ULL, Table 4-11 below shows ts development snce January Table 4-11: ULL monthly rentals from 2001 untl present Perod /month January December January December January 2003 March March 2004 September September 2006 November Snce November From Table 4-11 follows that ths s the frst tme that an ncrease n monthly copper ULL rental s beng proposed. The CMT goes to some length explanng the procedure that t used to arrve at ths result. The lne of argument can be summarzed as follows: Telefónca's cost accountng system s crtczed on several counts. In partcular, t s observed that the costs that would emerge would tend to overstate the relevant costs. Nevertheless t s ponted out that despte the defcences n the cost accountng records, there are ndcatons that the cost of the unbundled loop would be substantally hgher than the current prce for t. The reason s seen n a structural dsequlbrum between Telefónca's exstng network and the one demanded. The reason for ths s seen n that more and more households reman wthout a fxed connecton so that the number of lnes are decreasng. Ths tendency s expected to contnue nto the future. It follows a dscusson of the lkely market evoluton whch comes to the concluson that n the face of the uncertantes nherent n ths development, a change n the economc parameters on whch regulaton s based should be contemplated. It s further argued that, n order to obtan cost estmates that are ndependent of the cost accountng records of the operator, CMT should have at ts dsposal an nstrument wth whch to determne the cost of the unbundled copper loop ndependently. Such an nstrument should be a bottom-up cost model. The procurement of such a model s under way.

66 56 Wholesale prcng, NGA take-up and competton It s then argued that n the lght of the foregong dscusson one could already undertake a prudent adjustment of the rental whch would avod dsruptve changes n the busness cases of the operators. The noton of a clmb path s ntroduced analogous to the glde path used for declnng rates for other markets. It s mentoned that Ofcom n the UK and Agcom n Italy have already been applyng ths concept. The new proposed copper ULL rental s then derved on the bass of a benchmark analyss. The startng pont conssts of the monthly copper ULL rentals of 13 EU countres (ncludng Span 80 ). It s then found that the rate for Span s below the average of these 13 rates. By an argument, whch need not be recaptulated here n detal, the proposed rental of 8.32 per month s then derved, one of the arguments n ts favor beng that t s below the average of the rates n the set of benchmarks whch equals The concludng statement s that the ncrease from 7.79 to ths level would n all lkelhood not be nconsstent wth the results to be expected from the future cost model as well as wth the approprate regulatory nterventon called for at the present tme. In the dscusson summarzed above there s no menton that the cost of overcapacty n the access network, caused by the decrease n the uptake of lnes, should not be rolled nto the cost of lnes actually n use. It appears that wthout a trace of a doubt t s accepted that declnng numbers of lnes wll nevtably lead to hgher unt costs Australa Australa s on ts way to set up a natonwde fbre network fnanced by the state and operated by a state-owned entty called NBN Co. To manage the transton from the current ndustry and network structure the Australan government has negotated an agreement wth the ncumbent operator of the copper network Telstra n Ths agreement deals wth the decommssonng of the exstng copper and HFC networks, the mgraton of exstng Telstra end-users onto the NBN Co fbre platform and the use of Telstra s exstng passve nfrastructure (e.g. ducts, conduts acqured) for deployng the NGN fbre network. The agreement assumes a progressve dsconnecton of copper servces and decommssonng of Telstra s fxed lne copper and HFC networks as the NBN FTTP network s rolled out. Related or unrelated to ths major restructurng of the ndustry, the Australan Competton and Consumer Commsson (ACCC) ntated a major reform of the access prcng prncples for fxed lne servces n December The new access prcng prncples wll be appled to all legacy network servces delvered over Telstra s copper 80 See Table See NGN Co. (2010). 82 The ACCC publshed a frst dscusson paper n December 2009, a draft report n September 2010, and made ts fnal decson n March 2011.

67 Wholesale prcng, NGA take-up and competton 57 network ncludng ULL 83, wholesale lne rental, PSTN orgnaton and termnaton and other servces. The new approach reles on a revew of the 1997 telecommuncatons access prcng prncples. Accordng to these prncples, the ACCC has consdered that the long term nterests of end-users are best promoted by cost-based access prces based on the total servce long-run ncremental cost of provdng the servce, ncludng a mark-up for overhead costs (TSLRIC+). TSLRIC s based on a forward lookng ncremental cost bass valung nputs usng current prces. Accordng to the ACCC s assessment, applcaton of TSLRIC had the followng (crtcal) mplcatons: The contnual revaluaton of network assets means that there has been ongong uncertanty over the level of access prces. TSLRIC compensates an access provder as f t s contnually upgradng assets even when they contnue beng used beyond ther assumed lfetme, thus generatng lttle ncentve to upgrade the copper network to modern access technologes. Past deprecaton of exstng asset values not beng taken nto account may have resulted n over-recovery by the access provder. Consderable uncertanty regardng what consttutes a modern equvalent asset (MEA). Less proftablty of the copper access network beng bypassed by own nvestment of access seekers gven the current technologcal and market developments. Telstra s copper access network remans an endurng bottleneck nstead of a network to be bypassed. As a consequence of ts concerns over the napproprateness of the access prcng prncples as appled so far, the ACCC released a dscusson paper n December 2009 consderng a dfferent prcng approach for regulated fxed lne servces. The ACCC decded to move to a buldng block approach wth a locked-n ntal regulated asset base (RAB). The so-called buldng block model (BBM) approach s an establshed approach to determne the revenues requred by regulated busnesses whch has been wdely adopted by Australan utlty regulators n other sectors. The new approach determnes an ntal value for the RAB, locks t n and rolls t forward from one year to the next to reflect net capex. 83 Ths servces s called uncondtoned local loop servce (ULLS) n Australa.

68 58 Wholesale prcng, NGA take-up and competton The BBM approach nvolves and requres the followng steps for calculaton: 84 Forecasts of operatng expendture for each year A return of captal of the regulated frm (.e. deprecaton) A return on captal to the regulated frm (.e. compensatng the frm for ts effcently ncurred nvestments) Effcency mechansms and servce qualty ncentves Forecast tax labltes. The revenue requrement for each year s determned usng the followng formula. For example n year one: RR 1 = Expected (OPEX 1 ) + (RAB 0 *WACC) + Expected (DEP 1 ) + Expected (TAX 1 ) Return of captal Return of captal Where RR s the revenue requrement OPEX s operatng expendture WACC s the weghted average cost of captal RAB s the regulatory asset base DEP s deprecaton TAX s tax payable. The ACCC consdered possbltes for the RAB n the range between the scrap value up to the optmzed replacement cost. Whle the scrap value could be justfed by the sunk nature of the copper network, t would be nconsstent wth the access provder s legtmate commercal nterests. The ACCC also decded to take nto account past recovery receved by the access provder for the regulated assets, thus mnmzng the rsk of cost over-recovery or cost under-recovery. No further adjustments for any estmated past over- or under-recovery wll be made after the ntal RAB s set. From the varous possbltes to value the ntal RAB, the ACCC chose the deprecated actual cost (DAC) approach whch adjusts the hstorc cost of an asset by the proporton that the costs have already been recovered. The ACCC assumes that the DAC prcng approach provdes effcent nvestment ncentves because the access provder can recover ts actual captal costs. Sunk assets become recovered, there s no regulatory opportunsm. The roll-forward mechansm wll permt future effcent nvestments n sunk assets. The ACCC argues that the ntal RAB value has no mplcatons for compettve neutralty because bypass of the exstng copper access nfrastructure s unlkely. By lockng-n a value for the 84 See ACCC (2010), p. 30.

69 Wholesale prcng, NGA take-up and competton 59 RAB, relablty and certanty for both the access provder and access seekers s mproved. It s nterestng to note whch changes n the wholesale rates ths fundamental change of the accountng and costng approach would cause. The ACCC calculated draft ndcatve prces as shown n Table Table 4-12: Current ndcatve prces compared wth draft ndcatve prces from 1 January 2011 to 31 December 2014 (n AUS $) Current ndcatve prces ULLS access prces wth geographcally de-averaged prces SIO-weghted natonal average (per lne per month) Draft ndcatve prces based on ntal RAB of $7.5b $28.50 $28.42 Band 1 $6.60 $6.50 Band 2 $16.00 $16.00 Band 3 $31.30 $31.00 Band 4 (nomnal) $100 WLR (per lne per month) $25.57 (Homelne) $26.93 (Busnesslne) $20.00 (natonally averaged) LSS (per lne per month) $2.50 $2.50 PSTN OTA (per mnute) 1c (headlne rate) 1.1c LCS (per call) 17c 7.0c Source: ACCC (2010), p. 55 The nterestng result s that the ULL prces would effectvely not beng changed; resale product prces would be cut by between 25% and 60% and termnaton would ncrease by 10%. Because the ACCC receved a lot of crtcal comments to ts draft report n partcular from the ncumbent Telstra 85, t could not mplement ts approach n tme (1 January 2011). The ACCC made ts fnal decson on 3 March and released ts new nterm access determnatons at that tme. The new rates have been backdated to commence on 1 January 2011 and expre on 31 December 2011 (or on the ntroducton of a fnal access determnaton for that servce). The ACCC totally changed the structure of the ULL prces compared to ts orgnal proposal as represented n Table The ACCC came back to a much more averaged prcng approach wth sgnfcant prce ncreases for the more dense areas. It decded to set a sngle copper access prce of $ 16 for CBD, metropoltan and regonal areas (Bands 1 to 3) the same prce prevously 85 See Telstra (2010). 86 See ACCC (2011).

70 60 Wholesale prcng, NGA take-up and competton set for metropoltan areas (Band 2). The ACCC has also, for the frst tme, set a prce for Band 4. The Band 4 prce s for the most remote areas. In June 2010, there were only about 144 actve ULL lnes n Band 4 compared to over 690,000 actve lnes across Band 1 to 3. Table 4-13 compares the prevous prces wth the prces to apply from 1 January 2011 due to the new costng approach. Table 4-13: Prevous ndcatve prces compared wth IAD prces to apply from 1 January 2011 to 31 December 2011 (n AUS $) ULLs access prces wth averaged prces Prevous ndcatve prces New IAD prces Band 1 $6.60 $16.00 Band 2 $16.00 $16.00 Band 3 $31.30 $16.00 Band 4 $48.00 WLR (per lne per month $25.57 (Homelne) $26.93 (Busnesslne) $22.10 LSS (per lne per month) $2.50 $1.80 PSTN OA and TA (per mnute) 1 c (headlne rate) 1.0c LCS (per call) 17c 9.1c Source: ACCC (2011) Although the ACCC has rejected natonal averagng of ULL prces n the past, t s manly justfyng ts return to averagng wth the changng nature of the telecommuncatons ndustry and n partcular NGN Co s stated ntenton to charge unform natonal wholesale prces for usng the NBN. Averagng of Band 1 to 3 ULL prces at ths tme wll ease ndustry s transton to natonal wholesale prcng for the NBN. Band 4 access areas are not part of the averagng because they are largely outsde the fbre footprnt. Averagng, furthermore smplfes the ULL prce structure and may reduce admnstratve costs. The ACCC assumes that for most access seekers the Band 1 prce ncrease wll be more than offset by the lower Band 3 ULL prces and lower prces for other regulated fxed lne servces. The reducton n prce charged n Band 3 may even promote further nvestment n those areas. 4.4 Summary of fndngs European NRAs reveal relatvely clear preferences regardng prce control methods, cost base and accountng methodologes for regulatng wholesale charges for local loop unbundlng. The preference s for cost orentaton, a trend towards usng current cost accountng and a farly even dstrbuton of usng LRIC and FDC accountng methods. Despte ths hgh degree of harmonzaton n prncple, costng methodologes n detal

71 Wholesale prcng, NGA take-up and competton 61 however, vary sgnfcantly. As a consequence the range of ULL prces s rather large n Europe. Some NRAs control ULL wholesale prces ex ante, others only ex post or set rate celngs. The accountng lfetme of assets vary from 15 to 25 years for copper cables and from 30 to 45 years for ducts. The relevant WACCs for the access networks are n a range of 7% to 13%. The ULL charge usually (wth a few exceptons) represents a natonal average of the loop costs despte the fact that costs vary sgnfcantly accordng to access densty and compettors demand for ULL s focused on the denser part of a country. Asset valuaton s at current costs, hstorc cost or a combnaton of both. Even more mportant are the dfferences n the way n whch current costs are calculated; here seems to be a lot of dscreton for ncumbents and/or NRAs. Some NRAs apply the current cost valuaton on all network elements as nstalled n the access network; other NRAs apply effcency consderatons and only take nto account those network elements and assets whch are needed to run the access network effcently. Some NRAs nform ther cost calculaton through bottom-up cost models, others through topdown models, a thrd group just reles on accountng nformaton provded by the ncumbent. Also the deprecaton methods vary from straght lne to economc deprecaton where the latter often s made operatonal by a tlted annuty approach. There are more dfferences n the costng methodology when certan cost parameters are beng consdered. The dfferences mentoned above are more related to basc methodologcal aspects. They should explan that the dfferences n regulated ULL prces whch can reach a factor of three n Europe are not only explaned by structural natonal cost dfferences but are to a large degree also the result of fundamental dfferences n detal n applyng the same basc costng methodology. The vast majorty of NRAs s not yet addressng the costng and prcng mplcatons of decreasng demand for copper access lnes properly as we have argued n Chapter 2 and 3 of ths study. Some NRAs ncreased ULL prces n ther latest decsons (lke the UK and Span) even though (and sometmes because) demand s decreasng. In Italy the NRA even swtched from HCA prcng to CCA wth a major prce ncrease n a moment n tme where ths swtch s most questonable. Some NRAs are begnnng to dentfy and to address the ssue that certan costng methodologes may lead to over-recovery of the relevant cost and therefore may dstort competton between the ncumbent and ts compettors. Not all NRAs seem to apply systematc margn squeeze tests to check the approprateness and consstency of wholesale and retal prces. In Austra the systematc applcaton of a margn squeeze test has even led to a retal mnus rule as the effectve calculaton method to determne the adequate level of the wholesale prce.

72 62 Wholesale prcng, NGA take-up and competton Our analyss and results on costng methodology ndcate, that ncreasng copper access charges s not the approprate regulatory answer to a shrnkng demand for copper access. Also the transton to fbre networks requres other answers to copper wholesale prces than many NRAs have gven so far as we wll show n the followng chapters of our study.

73 Wholesale prcng, NGA take-up and competton 63 5 Modelng the copper and the fbre access network 5.1 General approach Our basc modelng reles upon an engneerng bottom-up cost modelng approach. Ths means we model the total cost of the servces consdered under effcent condtons, takng nto account the cost of all network elements needed to produce these servces n the specfc archtecture deployed. Ths approach s coherent wth an LRIC approach as appled n regulatory economcs. We calculate the cost of a Fbre-to-the-Home network followng a Greenfeld approach. Ths means that the nvestor wll construct a new, effcent state of the art network from scratch, assumng that currently exstng nfrastructure, f ncluded n the new network, has to be consdered at (full) cost. However, when consderng to deploy fbre networks as next generaton of access networks there could be avalable nfrastructure from legacy networks whch may be reused for NGA to generate nvestment savngs. Ths possbly could have an mpact on the nvestment decson. Therefore we have also run a senstvty wth reduced nvestments for FTTH, whch we call Brownfeld scenaro (Secton 5.4.4). The model and the assumptons are bascally the same as n a recently publshed study whch we have conducted for Vodafone on fbre archtectures and competton. 87 The prmary dfferences are an mproved optmzaton algorthm for cable szes and ncreased asset lfetmes of passve nfrastructure. In addton, we do not model the nhouse fbre cablng and have also adjusted the ARPU accordngly. The fbre network s modeled on the bass of Pont-to-Pont archtecture as that s consdered to represent the most future-proof technology and also enables effcent unbundlng. GPON would result n slghtly lower buld costs around 10% reducton. However, as dscussed n the study for Vodafone, reduced costs would be more than counteracted by the more lmted capactes of ths network desgn and poorer compettve and retal dynamcs. The costs of the copper network are not modeled explctly. We started here from the European average ULL charge as a representatve of the LRIC of the copper network. Usng the same modelng structure we then derved the cost of the copper network n the varous clusters from that startng pont. We also modfed the LRIC as relevant cost platform for the copper network and also consdered SRIC as a decson relevant cost platform for the ncumbent operator. We have developed two partly nterlnked modelng approaches to analyze the mpact of dfferent archtectures and wholesale scenaros on nvestment, cost, proftablty, reach, competton, market shares, prces and welfare. The frst model s a steady state cost 87 See Hoerng et al. (2010).

74 64 Wholesale prcng, NGA take-up and competton model. Ths model feeds cost functons nto the second model envronment whch s a strategc competton model. Fgure 5-1 shows the relatons between the two models and ther prmary outputs (grey). Ths secton explans the cost model and shows our results prmarly related to determnng the nvestment and cost of FTTH and copper networks. Chapter 6 s dedcated to the competton model. Fgure 5-1: Overvew of modelng framework 5.2 Euroland The vablty of access networks strongly depends on the subscrber densty (subscrbers per km²) and on settlement structures. The denser the subscrbers, the sooner the access network wll become vable. Thus the modelng depends on concrete settlement structures of a gven country and the results derved depend on that country. For purpose of ths study we decded not to choose a dedcated European country but chose a settlement structure whch s typcal for European countres. We desgned a hypothetcal country for approxmately 22 mllon households or a populaton of around 40mn nhabtants. Ths country s referred to as Euroland. We have defned 8 clusters, each havng typcal structural access network parameters derved from detaled geomodelng of access networks n several European countres on a natonwde bass. The geotypes characterstcs rely on exact data from several countres. In that sense, Euroland s a genercally representatve country. Each of the 8 clusters s characterzed by specfc subscrber denstes. The vablty of a specfc busness model s calculated for each cluster separately, lke for a separate proft center,.e. the vablty of a busness model n Cluster 1 s ndependent from the vablty n Cluster 2. In each of the clusters we assume the access network to be rolled

75 Wholesale prcng, NGA take-up and competton 65 out to 100% homes connected. For each of the clusters, the pont where the NGA busness may become vable s calculated ndvdually and ndependently from the results of other clusters. The operators (ncumbent and entrants) nvest n all clusters whch are vable. The clusters are composed n a way that they address smlar numbers of potental subscrbers. Table 5-1 provdes an overvew of the resultng cluster classfcaton.

76 66 Wholesale prcng, NGA take-up and competton Table 5-1: Structural parameters of Euroland Geotype Cluster ID Potental customers per km² Total potental customers per cluster Share of total customers Potental customers (cumulated) Number of MDF Potental customers per MDF Average trench length per potental customer (m) Dense urban 1 4,000 1,763,916 8% 1,763, , Urban 2 1,600 2,163,672 10% 3,927, , Less Urban ,646,000 12% 6,573, , Dense Suburban ,062,480 9% 8,636, , Suburban ,460,360 11% 11,096, , Less Suburban ,989,056 14% 14,085, , Dense Rural ,331,208 20% 18,416,692 1,421 3, Rural 8 < 60 3,448,368 16% 21,865,060 2,488 1, ,865, % 5,398

77 Wholesale prcng, NGA take-up and competton 67 The steady state model runs for all 8 clusters descrbed n Table 5-1. Typcally n the dense clusters there are larger MDF locatons concentratng sgnfcantly hgher numbers of potental subscrbers than n the rural areas, thus wth 28% of the MDF one can already cover 64% of the potental subscrbers (Cluster 1 6). Our assumpton s that the number of MDF for copper equals the number of MPoPs for a FTTH roll-out,.e. we have modeled a steady state n whch no MDF locatons are dsmantled. The clusters are manly used to consder the cost dfferences due to the dfferent geographc and settlement nformaton. We use cluster-specfc ndvdual nput data for access network structure nput data, for constructon cost and for deployment methods (e.g. underground ducted, bured or aeral cablng). The man cluster-specfc values are the constructon cost of ducts/cables, manholes, sleeves and aeral cables and the nhouse cablng. Constructon costs are hghest n the densely populated areas, whle aeral cablng s used to a larger degree n the rural areas. Table 5-2: Aeral deployment share per cluster Cluster ID Aeral share 1 0% 2 0% 3 10% 4 20% 5 30% 6 40% 7 60% 8 60% The values for MPoP components lke Ethernet swtches/ ports, OLTs, ODF ports and patch cables and fbre splces and also the prces of fbre cables and CPE are dentcal for all clusters. Our clusterng approach also enables us to determne the vablty of each of the clusters ndependently from other clusters. We have approached the modelng of the passve copper and fbre access network n slghtly dfferent bottom-up calculatons. They are descrbed n the two followng sectons. 5.3 The copper access network The copper access network connects every customer of Euroland n every cluster. We have opted for an approxmaton of copper network costs by basng them on the European average of monthly LLU cost (8.55, see Fgure 5-2). That means we take

78 68 Wholesale prcng, NGA take-up and competton the LLU charge as a proxy for the ncumbent's LRIC n Euroland. Therefore, the monthly fxed cost of operatng the passve copper network that connects all of Euroland's 22mn customers to MDF locatons s (n prncple) 22mn tmes Snce the competton model only consders the frst four clusters we have derved cluster-specfc LLU charges by weghtng the average natonal charge wth loop lengths, nvestment per meter and number of lnes per cluster. We derved the followng cluster-specfc monthly copper network costs per lne (see Table 5-3). These costs represent the passve network from the Network Termnaton Pont at the customer ste (wthout nhouse cablng 89 ) to the MDF n the central offce. Fgure 5-2 European unbundlng prces Source: 14 th EU Implementaton Report 88 We assume that n addton to network cost the wholesale prce also ncludes sales cost (ncludng nter-carrer bllng) of the ncumbent's wholesale dvson. We assume that ths cost s 0.90 per month, whch s a value more at the hgh end of the relevant cost estmates. Ths s part of the varable cost per subscrber n Table 5-4 and Table The costs of the nhouse cablng are not part of the LLU charge n many countres.

79 Wholesale prcng, NGA take-up and competton 69 Table 5-3: Dervng cluster-specfc copper network costs from the natonal average Cluster 1 Averaged LLU charge Deducted LLU-cost per cluster (producton cost of the ncumbent) Number of customers Adjusted monthly fxed cost of ncumbent ,763,916 2,046, ,163,672 7,053, ,646,000 12,542, ,062,480 9,466, ,460,360 13,728, ,989,056 20,654, ,331,208 38,807, ,448,368 63,001,683 Not surprsngly, n denser areas the ncumbent produces at a monthly cost lower than the (natonally averaged) access charge that compettors have to pay for unbundlng. Ths s mportant to note because t mples wholesale profts for the ncumbent n the competton model whch only consders Clusters 1 to 4 under certan assumptons on the wholesale prce. The ncumbent's monthly fxed cost of operatng the passve copper access nfrastructure n Euroland s therefore the sum of the frst four clusters homes multpled wth the respectve deducted cluster-specfc LLU cost. To reman comparable wth our FTTH cost calculaton we need to track sales cost aspects (see footnote 88) separately from network cost and as subscrber-drven (rather than homes passeddrven) cost. We have therefore reduced the cluster-specfc LRIC by 0.90 (last column n Table 5-3; also see Secton 5.4.2). The only varable cost elements of the access network are therefore these "sales cost" and the network sded ODF port that s drven by subscrbers rather than by homes passed (0.02 per month). All other passve access network costs are fxed. For feedng nputs nto the competton model properly we have dvded the ncumbent s operaton nto a NetCo and an OpCo unt. The NetCo provdes the passve access network to entrants (and to ts own downstream organzaton) and the OpCo runs the actve components of the network and markets t to customers. The OpCo bears the cost for actve equpment n the exchange (DSLAMs, Ethernet Swtches) and ther energy consumpton, concentraton and core network, central offce floorspace, CPE and retal cost (customer acquston, sales and marketng, customer care, churn and bllng). These cost tems are domnantly varable costs except for the fxed cost components of the core and concentraton network and the floorspace tself. The wholesale access seeker also bears the OpCo's downstream cost elements whch are largely smlar to those of the ncumbent but not dentcal. The dfference s that we have accounted for a separate small MDF that the access seeker wll nstall n addton to the

80 70 Wholesale prcng, NGA take-up and competton ncumbent. Furthermore we assume that n terms of the sales costs dscussed earler the ncumbent self provdes access at a lower cost than to entrants. 90 Ths explans the dfference n varable downstream cost components between OpCo and entrant. The access seeker only faces varable costs for the NetCo components because he buys unbundled access whch s assumed to be prced solely as varable access charge. The cost of nhouse cablng was not consdered. The aggregate cost functons for ncumbent and entrant for the frst four clusters are shown n Table 5-4. Ths s the nput for the competton model. Varable cost s cost per subscrber per month. Table 5-4: Total monthly cost for the copper network (Clusters 1-4) Copper ncumbent Copper LLU entrant NetCo fxed cost 31mn 0 NetCo var. cost (LLU charge) OpCo fxed cost 7mn 7.6mn OpCo var. cost As we have shown n Secton 2.2 the ncumbent s decson to swtch from a copper to a fbre network does not depend on the LRIC replacement cost of the copper network but on the cost of operatng and mantanng the copper network. These costs are called short run ncremental costs (SRIC). The SRIC are bascally OPEX of the copper access network. To calculate the relevant amount of these costs, we have analyzed three dfferent cost models wth a vew towards the share of monthly OPEX as part of total LRIC and found the results as shown n Table 5-5. Based on the range of these fndngs we chose to base the SRIC n ths model on 20% of the total LRIC cost. 90 Ths s reflected n a dscount of varable cost for the OpCo. It was modelled ths way n order to have a NetCo ncumbent wholesale unt that sells at a unform prce to both access seekers and ncumbent OpCo.

81 Wholesale prcng, NGA take-up and competton 71 Table 5-5: Comparson of OPEX and CAPEX of average monthly cost for LLU CAPEX OPEX Total OPEX as a % of total cost WIK model for Italy % Swedsh model of PTS % Dansh model of NITA % Source: WIK-Consult 5.4 The FTTH network There are several FTTH network archtectures one can deploy. Snce ths study s not ntended to compare these archtectures but to model fbre/copper mgraton n a compettve market envronment, we concentrate on one fbre archtecture whch s most future proof. For a comparson of advanced FTTH archtectures we refer to our recently publshed study that used the same modelng structure and compares the performance of several FTTH archtectures. 91. Thus we assume the FTTH network to be rolled-out n a Pont-to-Pont archtecture. FTTH P2P deploys fbre access lnes from the MPoP to each of the customers homes (apartments, dwellngs). The complete fbre capacty s avalable for each customer n the subscrber access network snce every customer has a dedcated fbre from hs home to the MPoP, thus one fbre per home n both the feeder and the drop cable segment s requred. Because of the uncertantes of the future bandwdth need of resdental and busness customers ths Pont-to-Pont fbre plant appears to be the most future-proof soluton, because the use of the full optcal spectrum per fbre s not restrcted by any ntermedate technology. Not only the CAPEX of the nvestor are calculated n a bottom-up approach, t s also the wholesale costs and prces that are derved from ths archtecture. Another dscusson covers the manageablty of larger fbre network starponts, so that an upper lmt regardng the fbre count at the MPoP mght exst. Today large copper MDFs serve more than 35,000 copper pars. An end-customer connecton n Pont-to- Pont fbre plants needs only a sngle fbre nstead of a copper par and each fbre requres less space (has a much smaller dameter) than a copper wre, whle the fbre connectors are more space consumng and addtonal space to organze the larger bendng radus of fbre cables has to be consdered. The Optcal Dstrbuton Frame may therefore be larger than the copper equvalent, so the ODF may stll be a lttle bt larger 91 See Hoerng et al. (2010).

82 72 Wholesale prcng, NGA take-up and competton per fbre, but due to techncal nnovatons we expect ths to change over tme 92. Overall, a fbre MPoP wll be able to serve more fbre lnks than the largest copper MDFs today. Therefore, we are convnced that wth our model approach of assumng the exstng copper MDF locatons to be the proper scorched nodes of the new NGA network, where all exstng spare ducts may be used, we are conservatve and are not facng fbre management problems. In the P2P archtecture the ncumbent termnates the access fbres on an Optcal Dstrbuton Frame located n each of the MPoPs. Thus an ODF has as many customer sded ports as potental customers are n the feld and as many homes have been passed by the fbre plant. The ODF s used to connect the sngle access fbres to the ports of the traffc concentratng Ethernet equpment by patchng only those subscrber access fbres to the network sded ports of the ODF, whch then are connected to the ports of the Ethernet swtches. Thus patchcables, network sded ODF ports and Ethernet ports are demand drven. Ths arrangement also allows to connect each end-customer ndvdually to ports of a dfferent speed (0.1 to 10 Gbps) or to separate dedcated equpment, thus enablng full end customer servce flexblty Network cost Usng our bottom-up cost model we determne cluster-specfc nvestments and monthly cost for deployng and operatng a FTTH network that connects all customers n Euroland. Fgure 5-3 descrbes the P2P topology n general and t defnes the cost elements whch are consdered n the ncumbent s total cost. It also detals whch cost tems become part of the fbre LLU prce (underscored cost postons) and t defnes whch elements and costs of the access network the compettor has to bear drectly (red). The wholesale entrant's busness model s descrbed n more detal n Secton At the FTTH Councl Europe conference n February 2011 Dättwyler demonstrated an ODF wth more than 6700 fbres on a footprnt of 120 x 80 cm.

83 Wholesale prcng, NGA take-up and competton 73 Fgure 5-3: FTTH/P2P archtecture Scenaro wth fbre 1: Unbundlng LLU of FTTH/P2P Fber 1:1 Handhole/Sleeve ODF * MPoP Ethernet Swtch Ethernet modem /router ODF Ethernet Swtch Access Seeker Incumbent cost (relevant for LLU prce) CPE Access Network ncl. Inhouse cablng ODF + Patch cablng + floorspace Ethernet Swtch + floorspace + energy Network sded Ethernet port (1 per MPoP) * Only actve customers patched through to Ethernet Swtch Compettor cost** CPE LLU charge Compettor s ODF & Patch cablng + floorspace Ethernet Swtch + floorspace + energy Network sded Ethernet port (1 per MPoP) Concentraton Network Core Network Concentraton Network Core Network ** Assumpton: Unbundler operates Ethernet P2P network 3 As ndcated above the cost functons we feed nto the competton model separately show cost functons for the NetCo who provdes the passve access nfrastructure and the OpCo who actvates the network and markets servces to customers. The scope of the NetCo actvtes s equvalent to the scope of the local loop unbundlng wholesale product. The NetCo has a large fxed cost component (derved from our bottom-up cost model) that represents the cost of the access network from the customer to the ODF n the MPoP. The only varable components are a) the network-sded ODF port that we only prce for actual subscrbers (drven by penetraton rather than homes-passed) and b) a "wholesale sales cost" that reflects wholesale marketng, nter-carrer bllng etc. The "downstream costs" of the OpCo consst of the elements defned n Table 5-6.

84 74 Wholesale prcng, NGA take-up and competton Table 5-6: OpCo downstream cost CPE Customer Ethernet Ports at the MPoP Aggregatng Ethernet Ports at the MPoP Floorspace Energy for actve equpment at the MPoP Fxed cost x x Var. cost per subscrber Concentraton network cost X x Core network cost x X Retal cost (customer care, bllng, sales & marketng, churn, customer acquston) x X x x The values of the most relevant nput parameters n addton to the structural data for Euroland are presented here n the followng two tables. Table 5-7: Investment assumptons Element Invest per unt Lfetme (years) Ethernet CPE ODF port / patch cablng 23 / OLT Ethernet Port 1Gbps / 10Gbps 120 / Cvl works for trenches, ducts dependng on cluster 35

85 Wholesale prcng, NGA take-up and competton 75 Table 5-8: Cost and other assumptons Element Natonal concentraton network cost per month Natonal core network cost per month Retal cost (customer care, bllng, sales & marketng, churn, customer acquston) 93 Assumpton 6mn per subscrber 7mn per subscrber 5 per subscrber per month WACC 10% OPEX mark-up on Invest 0.5% passve, 8% actve equpment Common cost mark-up on CAPEX / OPEX 10% The cost of nhouse cablng was not consdered. Ths s a debatable assumpton 94 whch we fxed for havng a symmetrcal approach to the copper network. The aggregate cost functons for ncumbent and entrant for the frst four clusters are shown n Table 5-9. Ths s the nput for the competton model. Table 5-9: Total monthly cost for the fbre network (Clusters 1-4) Fbre nvestor Fbre LLU entrant NetCo fxed cost 76mn 0 NetCo var. cost * (fbre LLU charge) OpCo fxed cost 6.9mn 7.6mn OpCo var. cost * = 76mn (NetCo fxed cost) / 70% of lnes (var. cost per subscrber) The unbundlng busness model For compettors usng wholesale access we have consdered a fbre unbundlng scenaro for the P2P archtecture n whch a compettor rents the unbundled fbre loop, places an addtonal Optcal Dstrbuton Frame of hs own at rented collocaton space n 93 From our experence ths value s a very conservatve assumpton at the low end of the concevable cost range.. 94 Who bears the cost of nhouse cablng s not unform n Europe. There are countres where the cost of nhouse cablng s pad by the house owner (e.g. Germany) and countres were they are pad by the network operator (e.g. France).

86 76 Wholesale prcng, NGA take-up and competton the MPoP where he operates hs own Ethernet Swtch. The compettor s ODF s connected va a dedcated connecton cable to dedcated customer sded ports of the ncumbent s man ODF. The costs of all these elements are part of the compettor s total cost. In addton, the compettor has to bear the cost of the concentraton and core network hmself. The dfferences n OpCo varable downstream cost equvalents between fbre nvestor and LLU entrant (see Table 5-9) are due to a) the compettor's addtonal ODF and b) our assumpton that selfprovsonng nsde the ntegrated ncumbent s less expensve. As explaned above we have appled a dscount on the ncumbent retal cost rather than dscounted the wholesale prce of self-supply. The dfference n fxed cost s due to the fact that part of the MPoP floorspace cost of the nvestor s accounted for n the NetCo unt and that the compettor practcally pays for the floorspace of two ODF. Wholesale prces for the compettor s busness case have been determned as LRIC of the network elements of the ncumbent whch are used for wholesale access,.e. they are drectly based on the cost determned for the ncumbent. Snce a sgnfcant part of costs s fx, the total costs per customer strongly depend on the number of customers on the ncumbent s network. Wholesale prces have been determned under the assumpton that the ncumbent s network operates at a 70% take-up. Ths rate corresponds to the market share of the FTTH network aganst the competton of moble and cable networks. 95 Ths also means that these are the lowest possble wholesale prces under the LRIC assumptons. Intally, our cost and proftablty analyss s cluster-specfc, so the wholesale prce n Cluster 1 s ndependent from the wholesale prce n other clusters. Before provdng nputs to the competton model we create an average wholesale prce for the frst four clusters as an aggregate. Ths prce s per month and ncludes the passve network from the Network Termnaton Pont at the customer sde (excludng the nhouse cablng) to the Optcal Dstrbuton Frame n the MPoP. Wholesale prces used n ths cost model for calculatng the busness model of a compettor are always a fxed monthly access charge per user per month (lnear access charge). On top of the LRIC network cost per customer a wholesale sales cost of the ncumbent s wholesale dvson (wholesale nter-carrer bllng, sales and marketng,) s appled to determne the access charge for wholesale access seekers. Ths wholesale dvson cost was assumed to be 0.90 per user per month (less than 20% of the assumed retal cost that ncumbent and compettors both spend for each subscrber). Ths value presumably s at the upper end of the relevant costs f assessed aganst effcency crtera. 95 The correspondng share n Germany of the fxed network today amounts to about 80% of potental subscrbers.

87 Wholesale prcng, NGA take-up and competton Proftable coverage and crtcal market shares The cost model s prmary result s total cost per subscrber per month whch bascally s fxed cost dvded by number of subscrbers plus varable cost per subscrber. Naturally, these total costs decrease wth ncreasng penetraton. By comparng ths total cost per subscrber and month wth the Average Revenue Per User (ARPU) we can determne the pont where, f at all, revenue equals the cost. Ths s the crtcal market share necessary to make the NGA busness proftable and hence t determnes the vablty range of a network operator. We have used an ARPU of for the fbre nvestor and for a fbre LLU access seeker. The dfference reflects an ncumbency advantage, e.g. a frst mover or brand advantage. The results presented n Table 5-10 are cluster-specfc. Where crtcal market shares exceed 70% we consder the busness model not to be vable because other technologes reman relevant players n the access market. Table 5-10: Crtcal market shares for FTTH (cluster by cluster) Cluster Total potental customers Fbre nvestor Fbre LLU operator 1 1,763,916 20% 7% 2 2,163,672 32% 7% 3 2,646,000 43% 10% 4 2,062,480 42% 11% 5 2,460,360 52% 20% 6 2,989,056 63% Not vable 7 4,331,208 Not vable Not vable 8 3,448,368 Not vable Not vable Under our assumptons on costs and revenues the ncumbent can proftably roll-out ts fbre network up to Cluster 6 or for 64% of the populaton (Table 5-1). The compettors can follow the ncumbent only up to Cluster 5. Here the compettor already needs a 20% market share to run a proftable busness model Brownfeld senstvty In bottom up LRIC modelng we consder the stuaton that an nvestor constructs a new, state of the art forward lookng fbre network, takng nto account future demand (Greenfeld scenaro). In the real world the nvestors often face the stuaton that locatons and nfrastructure already exst whch may be reused by a new network generaton n order to save nvestment. Ths wll be consdered n our modelng approach by takng the exstng

88 78 Wholesale prcng, NGA take-up and competton MDF locatons as scorched nodes of the new network (maybe some of the MDF wll be dsmantled), not lookng for new locatons, thus the remanng are a subset of the exstng ones. Regardless of any dsmantlng scenaros, the cost of the locatons that are n use are fully consdered. The nvestor s decson nevertheless s drven by the level of (addtonal) nvestments he has to make, consderng that there are exstng ducts wth spare capacty whch could satsfy part of the demand of the new network, thus resultng n lower nvestment expendtures. We face that stuaton by defnng a scenaro whch we call Brownfeld n contrast to the above mentoned Greenfeld scenaro, where we reduce the nvestment for the passve network components ducts, trenches and manholes 96 by dedcated percentages due to the NGA archtecture and ther fbre demand and due to the part (segment) of the access network, where ths spare capacty s located. Proceedng lke ths requres that duct nfrastructure exsts whch stll has spare capacty to host all of the new requred fbre cables. If only part of the cables could be hosted, a new trench would have to be dug so no sgnfcant savngs could be acheved. Our basc assumpton s that on average the spare components have exsted for half of the total equpment lfe tme, thus we assume that the new FTTH network can use the duct nfrastructure of an older network for an average remanng lfetme. In the cases where the exstng nfrastructure has been renvested n the shorter term future (e.g. due to poor consttuton of the ducts) an nvestor may decde to renvest now before the new fbre cables wll be plugged n. Otherwse renvestment can hardly be managed wthout broadband customer nterrupton (relatvely soon after they have taken up the servce). In consequence for the components beng reused we only consder half of the nvestment one would need n a Greenfeld envronment. Thus we have to assume, how many of the components (ducts) per network segment may be reused. We assume that n the feeder network segment (between MPoP and Dstrbuton Pont) only n 20% of the cases the exstng duct network may also host the new fbre cables for FTTH/P2P, resultng n an nvestment reducton of 10% of the feeder duct nfrastructure 97. We beleve these assumptons to be optmstc, snce we assume here that n Euroland all feeder cables are already constructed n a ducted manner, whch s not the case n each European country. In the drop network segment (between the Dstrbuton Pont and the customer) sharng of exstng ducts only can take place where ducts are deployed. For our Brownfeld scenaro we assume optmstcally that ducts exst n half of the areas where there s no 96 For ease of expresson n ths secton we call these components duct nfrastructure only, snce the ducts determne ther ablty to be reused. Drect bured lnes cannot be reused. 97 Ths assumpton takes nto account, that wth a FTTH/ P2P fbre topology each end-customer home passed has ts dedcated fbre n the feeder segement. Thus fbre Pont-to-Multpont topologes may have a hgher share of duct reuse due to a lower fbre count, see: Hoerng et al. (2010).

89 Wholesale prcng, NGA take-up and competton 79 aeral constructon 98 and that all of these ducts can be shared wth the new fbre cables. For the ducts to be nstalled these assumptons reduce the requred nvestment for duct nfrastructure by 25% n the drop cable segment. Table 5-11: Assumpton on effectve reducton of nvestments through duct-reuse Drop 25% n non-aeral deployments Feeder 10% The results and mplcatons of ths calculaton are shown n Table 5-12 where we have also shown what the mpact would be f the savngs from reusng ducts by the nvestor are passed onto the fbre LLU compettor through reduced access charges. The vable range of the fbre nvestor does not change but costs and therefore crtcal market shares are reduced notceable. The unbundlng busness case becomes more attractve as the frst fve cluster now only requre a market share of below 10% and entry n the 6 th cluster could become proftable now. Table 5-12: Crtcal market shares and fbre LLU prce for Greenfeld and Brownfeld deployment crtcal market share fbre nvestor crtcal market share fbre LLU Monthly fbre LLU prce Cluster Greenfeld Brownfeld Greenfeld Brownfeld Greenfeld Brownfeld 1 20% 16% 7% 6% % 25% 7% 5% % 33% 10% 7% % 33% 11% 7% % 41% 20% 9% % 49% n.v. 15% % 73% n.v. n.v n.v. n.v. n.v. n.v For aeral deployment shares see Table 5-2.

90 80 Wholesale prcng, NGA take-up and competton WACC senstvty on fbre LLU prce The German NRA BNetzA has recently publshed a study on the calculaton of the approprate WACC for broadband access. 99 Ths study had to quantfy n partcular the specfc rsk related to FTTH/B networks. The study determned the relevant rsk for the (copper-based) fxed network as well as for a fbre network. The study calculates a rsk premum for fbre networks n the amount of 2.59% over and above the baselne of a WACC of 7.11% for the fxed network n The relevant (real) WACC for calculatng a fbre network therefore amounts to 9.7% Ths hgh level delta between the two nterest rates s drven by the followng buldng blocks: (1) Increased fbre beta (1.3 vs. 0.78) (2) Hgher market rsk premum for fbre (5.69% vs. 4.73%) (3) Hgher rsk for fbre debt (6.81% vs. 5.98%) Other factors determnng the WACC lke rsk-free nterest rate, taxes, debt/equty rato are assumed to be the same. The captal cost s a sgnfcant leverage for cost determnaton. In our base case the WACC s assumed to be 10%. We calculated senstvtes on the WACC from 7% to 12% and show the mpact on crtcal market shares and the fbre LLU charge. As n the base case calculatons the fbre LLU charge s presented as a cluster-specfc LLU charge whch s based on the nvestor's cost at 70% penetraton. Devatng from the base case the WACC varatons change the mnmum proftablty level n less dense clusters sgnfcantly. In the frst cluster changes are mnor and hardly notceable 100. As expected the fbre LLU compettor s crtcal market shares change only moderately untl the shape of the cost curve leads to dramatc ncreases n crtcal market share and dependng on WACC - deny proftablty n Clusters 5 to See Stehle (2010). 100 Movng from the 10% WACC base case to a WACC of 7% reduces the fbre LLU player's crtcal market share from 7% to 6% n the frst cluster (14% change).

91 Wholesale prcng, NGA take-up and competton 81 Table 5-13: Crtcal market shares for dfferent WACC values Cluster Crtcal market share Incumbent WACC 7% WACC 10% WACC 12% Crtcal market share Fbre LLU WACC 7% WACC 10% WACC 12% 1 16% 20% 22% 6% 7% 7% 2 26% 32% 37% 5% 7% 8% 3 35% 43% 49% 7% 10% 16% 4 34% 42% 48% 8% 11% 16% 5 43% 52% 59% 10% 20% 57% 6 52% 63% 71% 18% n.v. n.v. 7 77% 91% n.v. n.v. n.v. n.v. 8 n.v. n.v. n.v. n.v. n.v. n.v. Table 5-14: Fbre LLU prce for dfferent WACC values Cluster WACC 7% WACC 10% WACC 12% Generally, a 1%-pont devaton from the base case WACC of 10% nduces a 5 to 6% change n the fbre LLU charge Economc lfetme senstvty We have vared the economc lfetme of passve nfrastructure (sleeves, manholes, trenches ncludng ducts and cables) for fbre deployment n Euroland to show how t mpacts cost. In ths senstvty we chose to report the fbre LLU prce as the LRIC ncurred by the nvestor. Fgure 5-4 clearly shows that movng beyond 30/35 years asset lfetme has a very small effect on the cost.

92 82 Wholesale prcng, NGA take-up and competton Fgure 5-4: Impact of asset lfetme on fbre P2P LRIC (Euroland Cluster 1-4 average) 5.5 Senstvtes on copper network cost To show the mpact of key parameters on the cost of the local loop of the copper access network we have undertaken senstvty calculatons wth a BU-LRIC model that we developed for Italy. Ths s a completely separate bottom-up model whose results do not feed nto the competton model. The dfference between the model for Euroland and the model for Italy s that Euroland was modelled on the bass of 8 clusters n whch all structural data (trench length, MDF sze etc.) for mllons of users s the same. The average values were derved from geo-data but they reman averages for each cluster. For Italy the real coordnates of all streets and households have been taken nto account. There s no averagng untl the fnal step of dvdng the cost for all lnes by the number of lnes. In December 2009 Fastweb mandated WIK-Consult to develop a state of the art Bottom-Up LRIC model to calculate the cost of an effcent operator to produce the copper local access loops n Italy for connectng the customers to a PSTN/ DSL based telecommuncaton network. Assets valuaton s based on the current cost standard. The bottom-up model was fed wth geo-coordnates of all Italan households, buldngs, streets and all ~ MDF locatons to determne an effcent network not on the bass of a representatve sample but all of Italy. We have appled a scorched node approach by takng exstng MDF locatons for granted. Snce nether the borders of the MDF servce areas (access areas) nor the assgnment of buldngs to MDF locatons are publcly avalable, we have derved access areas by allocatng the access lnes per

93 Wholesale prcng, NGA take-up and competton 83 home to the closest MDF locaton, thereby already conductng a frst network optmzaton. Four dfferent senstvtes were conducted regardng: 1. WACC, 2. Economc lfetme of passve access network, 3. A 10% reducton of the number of access lnes, 4. A 20% reducton of the nvestment n trenches and poles WACC We have run the cost model for all of Italy wth three dfferent WACC (8%, 9.38% and 11%). The results are shown n Table Each varaton nduces a 10-11% change n monthly loop cost. Table 5-15: Copper LLU cost: WACC senstvty WACC 8% 9.36% 11% Total cost per month Economc lfetme of ducts and trenches As descrbed n Secton an economc lfetme of 35 years for ducts and trenches was appled for Euroland. In lght of the ongong dscusson about the real and approprate duct lfetme we have extended the asset lfetme to 50 years as senstvty for Italy. Movng from 35 to 50 years only has a very mnor mpact (1%) on the monthly LLU cost as shown n Table Table 5-16: Copper LLU cost: economc lfetme senstvty 35 years 50 years Total cost per month

94 84 Wholesale prcng, NGA take-up and competton Decreasng volumes n the fxed network The demand for copper access networks can be expected to decrease through the mgraton of customers to fbre and cable. 101 Customers focusng manly on voce wth only lmted broadband requrements may also decde to abandon copper n favour of moble-only. We have approxmated the mpact of a 10% demand reducton by removng 10% of access lnes. Ths was done after trenches for connectng all customers were defned because t can be assumed that a major share of removed lnes wll be n (mult-dwellng) buldngs that stll have demand for copper and need to be connected. Ths 10% reducton has been appled undfferentated to all lnes (no dfferentaton between loop lengths or customer densty). After reducng the number of lnes cable szes were optmzed agan to reflect an effcent network. The mpact of ths senstvty s a rather mnor reducton of nvestment (1%) but an ncrease n nvestment per lne by 6%. Ths s drectly reflected n a local loop prce ncrease of 6% (see Table 5-17). Table 5-17: Copper LLU cost and nvestment: reducton of number of lnes Base case 10% less lnes Total cost per month Total nvestment (n mo. ) 21,558 21,391 Total nvestment per lne (n ) Reducng the cost of nfrastructure We have shown arguments for a dfferent valuaton of ducts (see Secton 3.5) that should lead to lower costs. Our senstvty goal was to model a 20% decrease of the nvestment nto ducts to reflect such a lower asset valuaton whle keepng all other assumptons. However, n Italy ducted deployment s practcally non-exstent because almost all copper cables are drectly bured n the ground. We have opted to approxmate the mpact of a duct cost decrease by reducng the nvestment nto nfrastructure (trenches and poles for aeral deployment) n Italy (manhole and sleeve nvest reman unchanged). Accordngly, the senstvty s usng trenches and poles as proxy for the mpact of a duct cost decrease. Table 5-18 shows that the total nvestment, the nvestment per lne and the total cost per month decrease by roughly 10%. Ths also hghlghts the mportance of trenches and poles whch account for about half of total nvestment. 101 In fact cable operators are rrelevant n Italy.

95 Wholesale prcng, NGA take-up and competton 85 Table 5-18: Copper LLU cost and nvestment reducton of nvestment nto trenches and poles Base case 20% nvest reducton Total cost per month Total nvestment (n mo. ) 21,558 19,294 Total nvestment per lne (n )

96 86 Wholesale prcng, NGA take-up and competton 6 Impact of wholesale prces on competton, nvestment and consumer welfare 6.1 Objectve The task s to develop a model of competton between copper and FTTH wth multple compettors ( entrants ) n order to show aspects of the transton from copper to FTTH, n partcular how the transton depends on the regulated copper access charges for copper unbundlng the regulated FTTH access charges for fbre unbundlng whether there s a sngle ntegrated ncumbent potentally offerng both copper and FTTH or two separate network operators for the respectve technology The objectve s to generate and compare the (potental) coexstence and relatve shares of copper and FTTH and to fnd n a market equlbrum end-user prces, consumer surplus and producer surplus (for both ncumbent(s) and other frms), leadng to welfare results. 6.2 Modelng approach The theoretcal model The challenge for buldng a competton model that captures the nteracton of frms offerng dfferent types of servces and dfferentatng brands wthn servce groups s to characterze user preferences for servces and frms and to derve demand. The man approach to ths has been the Hotellng model, whch assumes that the consumers and two competng frms are located along a lne wth fxed length. However, ths model s restrcted to competton between two frms and therefore cannot be used for any larger number of frms or servces. Our modelng approach s therefore based on the pyramd model, whch s closely related to the spokes model and s a generalzaton of the Hotellng model: 103 For each par of servces, there s a set of consumers who choose between these two products and these consumers are (unformly) dstrbuted n ther wllngness to pay for one servce rather than the other. Graphcally ths leads to a pyramd, as llustrated n Fgure 6-1, wth each servce located at one of the tps of the pyramd. In addton, there may 102 The descrptons n ths secton are based on Hoerng et al. (2010). 103 The pyramd model was frst developed by von Ungern-Sternberg (1991), whle the spokes model orgnates from Chen and Rordan (2007).

97 Wholesale prcng, NGA take-up and competton 87 be Hnterland consumers who consder only one of the servces, represented as the thn lnes emanatng from the tps. We do not consder the Hnterland case n ths study n detal. Fgure 6-1: Preference space An alternatve would be the Salop model, whch s wdely used n the ndustral organzaton lterature. 104 A major dsadvantage of the Salop model s that t mposes a very partcular substtuton pattern across products: A servce s a substtute only to ts two neghborng servces mplyng that cross prce elastctes to other servces are equal to zero. Our modelng approach allows for postve cross prce elastctes between any par of servces. Another frequently used model s the logt model. 105 Our approach and the logt model have n common that all cross prce elastctes are strctly postve. Whle our approach s n general very flexble, our chosen mplementaton and the logt model have n common that a gven number of avalable servces are affected symmetrcally by the ntroducton of an addtonal servce. In terms of mplementaton, an advantage of the present framework s that t leads to lnear demand functons and, thus, explct solutons. Ths s not the case for the logt model unless all market partcpants are symmetrc, whch s not true n the context of ths study. Infrastructure. Our approach captures essental aspects of competton n FTTH or copper-based markets, both on the wholesale and retal sde. In our man model one frm, the ncumbent, owns and nvests n a copper and/or FTTH access network, to 104 See Salop (1979). 105 For an extensve treatment, see Anderson, de Palma and Thsse (1992).

98 88 Wholesale prcng, NGA take-up and competton whch other frms ( entrants ) must obtan access n order to provde copper-based or NGA-based servces. Entrants are assumed to be specalzed on one of the servces and are otherwse symmetrc. They need to make own nvestments n order to use copper-based or NGA access. In a second model the ncumbent s restrcted to a copper access network, whle an ndependent fbre nvestor (whch could be an alternatve telecommuncatons operator or an energy company) may or may not nvest n fbre, thereby potentally drvng out the copper ncumbent. We consder both models wth and wthout a thrd vertcally ntegrated broadband nfrastructure ( cable ), to whch no other frms have access. Demand. The servces that frms offer are both horzontally and vertcally dfferentated. The former means that consumers do not react strongly to small prce dfferences because ndvdual preferences for frms brands dffer. In partcular, assumng a unform dstrbuton of ndvdual tastes n ths horzontal dmenson leads to lnear demand functons over the relevant range of prces. As a result of horzontal dfferentaton, the market s mperfectly compettve and frms wll enjoy postve markups. Vertcal dfferentaton expresses dfferences n servce qualty and goodwll or brand recognton as perceved by consumers,.e., at equal prces a frm wth hgher servce qualty would attract more consumers. Servce qualty s assumed to affect all consumers smlarly,.e. we abstract from market segmentaton n the servce qualty dmenson. We call potental subscrbers compettve when they are actvely n the market. In the model each compettve subscrber makes a frst choce between two of the frms, and unless ther offers are very unfavorable, he wll choose one of the two. It s assumed that all pars of preferred frms (before qualty dfferences) are equally lkely n the populaton, so that effectvely each frm wll compete wth any other frm for consumers. Formally speakng, cross prce elastctes are dfferent from zero for all product pars. Due to the assumpton of unform dstrbutons of consumer tastes, the resultng demand functon of each frm s lnear n ts own prce and lnear n the prce of all other frms. Ths makes the analyss tractable and allows for explct solutons. In spte of advances n emprcal demand estmaton that allow for more flexble demand specfcatons, the lnear demand system remans popular n emprcal research. Our underlyng mcro foundaton permts us to compare markets wth dfferent numbers of frms n a meanngful way. If the frms n the market nclude the cable frm, our model has the feature that the sum of copper and/or FTTH subscrpton demands s varable. However, total demand for subscrpton (ncludng cable) s fxed and assumed to be 95% of potental subscrbers n the clusters consdered. In the absence of cable as a non-copper and non-ftthbased compettor, the sum of copper-based and FTTH subscrptons s fxed at 70% of all potental subscrbers n the clusters consdered. In the presence of cable 5% of the populaton are assumed not to sgn up for any fxed network but rather to stay wthout a

99 Wholesale prcng, NGA take-up and competton 89 connecton or resort to moble only. In the absence of cable the remanng 30% are deemed to subscrbe to cable or stay wthout a connecton or resort to moble only. All subscrbers then ether buy one subscrpton or none, where compettve subscrbers wll always buy one subscrpton. Not buyng leads to a surplus normalzed to zero, whle the choce between the two preferred optons s based on the comparson between prces, qualty of servce and the relatve preference for the two brands. Cost structure. We consder market outcomes on a monthly bass, so nvestment cost for provdng or usng copper or fbre NGA have been translated nto a monthly value over the lfetme of the nfrastructure. Each frm also bears downstream costs whch consst of a fxed part and a varable part as a functon of the number of subscrbers. For the latter, the model allows for ether ncreasng or decreasng margnal cost. In the actual model runs we have only used constant margnal costs, though. The wholesale access tarff pad by the entrants to the ncumbent conssts of a prce per subscrpton and potentally also of a fxed fee. In ths study we are consderng only lnear wholesale access tarffs.e. those tarffs that would be set for operators not enterng nto a long-term volume commtment. We treat the ncumbent as f he were under vertcal accountng separaton nto a NetCo that supples copper-based or FTTH nfrastructure access and an OpCo that sells copper-based or FTTH end-user servces. The ncumbent s NetCo sells access to other frms ( entrants ) and to the OpCo. Ths accountng separaton does not affect prcng behavor and overall profts but t provdes for an automatc prce-squeeze test. 106 All cost components consst of fxed costs and constant varable costs, but we could also nclude a quadratc term to model non-constant varable cost. Incumbent(s): - Costs of wholesale products for the whole output - Prce of wholesale products for own end-user sales - Downstream network and retal costs for own end-user sales. In case of an ntegrated ncumbent the downstream network costs (core and concentraton) are Fully allocated to that servce f only one s offered Splt 50:50 f servces over both networks are offered Compettors: - Prce of wholesale products purchased - Downstream network and retal costs for end-user sales. Entrants/compettors are modelled on a scorched node bass, where nodes are determned by the 106 In our model runs prce squeeze generally has not been an ssue.

100 90 Wholesale prcng, NGA take-up and competton ncumbent s network archtecture. Entrants fully penetrate each modelled cluster. Cable TV/DOCSIS3 - Total costs of own end-user sales Whle the costs of copper and fbre for both ncumbents and entrants come from the results of the WIK cost model for clusters 1 through 4, we have made the followng cost assumptons for cable. The fxed costs of cable for clusters 1-4 for both the access network and the core/concentraton network are set at 20 mllon per month. Ths compares to about 13 mllon SRIC for the copper ncumbent or about 38 mllon LRIC for the copper ncumbent for the same set of clusters. It also compares to about 70 mllon Brownfeld LRIC for the fbre ncumbent or about 83 mllon Greenfeld LRIC for the fbre ncumbent. Snce we prmarly rely on the SRIC/Brownfeld costs for the decson about swtchng from copper to fbre or leavng the market altogether, the fxed costs for cable appear reasonable. Snce we assume the presence of cable all the tme, any change n the cable fxed costs would only affect the cable proft, but not prces. We further assume 10 varable cost per cable subscrber for network and retal operaton, whch compare to 9.92 for the copper ncumbent and for the fbre ncumbent. We generally treat the prce of the wholesale product ( access charge ) as a varable n order to determne the effects of changes n ts level on the relevant outcome varables. However, two types of access charges are most relevant for each type of access provder. Frst, for both copper and FTTH the access charge can be based on the tradtonal Greenfeld long-run ncremental costs (LRIC) of the access servce, whch n turn contan the fxed and varable costs ncurred by the ncumbent for the FTTH access product. Here the varable costs of the NetCo nclude wholesale sales costs. These wholesale sales costs are saved when the ncumbent provdes the access product nternally to hmself. A lnear wholesale charge s then the total LRIC dvded by the FTTH access quantty (ncludng access used nternally by the ncumbent). Second, under the assumpton that copper networks are no longer expandng the copper access charge can be based on those costs necessary to keep a copper access network gong. They are the short-run ncremental costs (SRIC). These are bascally the operatng costs to run the copper network. They can be substantally lower than LRIC. For FTTH access networks SRIC are not relevant, because these networks can safely be assumed as expandng. However, when buldng such networks the ncumbent can use exstng nfrastructure from the copper access network. Ths leads to Brownfeld (LRIC) costs as a relevant alternatve to Greenfeld LRIC for the case of FTTH access. SRIC and Brownfeld LRIC are relevant because these costs are the crucal base for the

101 Wholesale prcng, NGA take-up and competton 91 ncumbent s decsons whether to shut down the copper access network and swtch to an FTTH access network or not. Equlbrum. We can thnk of our compettve game as consstng of fve stages, whch determne the order n whch partcpants make ther moves. Stage 0: There exsts a copper ncumbent n an equlbrum wth entrants under a gven copper wholesale access charge. There can also exst an addtonal network wth a dfferent technology (cable). Ths s a natural startng pont that largely elmnates multple equlbra. Stage 1: A planner decdes on the scenaro, consstng of the horzontal ntegraton/separaton of ncumbents and the access prces for copper and fbre access. Stage 2: The ncumbent frm or an ndependent fbre nvestor decde on nvestments n copper and/or FTTH access and n concentraton/core network nfrastructures, based on the restrctons and ncentves provded by stages 0 and 1. Stage 3: Potental entrants n copper or fbre decde whether to enter or not. If they decde to enter they also decde on ther level and type of nvestment. Ther choces and ncentves are based on the decsons made n earler stages. Stage 4: Entrants and the ncumbent(s) compete for end-users n dfferentated copper/ftth markets usng prces as strategc varables. The choce at stage 1 wll be based on the rankng that results from the competton analyss. The choce would be made based on the crtera socal surplus, consumer surplus, ncumbent s profts, entrants profts, end-user prces and market shares. Havng the planner decde about wholesale access charges at stage 1 before the market players decde about ther nvestments at stages 2 and 3 s natural n order to assess the long-term effects of the absolute and relatve levels of wholesale access charges on network nvestments. At the same tme the sequencng means that the planner s commtted to the access charges. The specfcs of stage 2 consst of the followng: Dependng on the scenaro consdered, the ntegrated ncumbent and/or an ndependent fbre nvestor make certan nvestments n networks and access, whch determne ther servce qualty levels and operatng cost. We assume that there can only be at most one operator nvestng n each type of access nfrastructure. In the case of an ntegrated ncumbent there wll be only one concentraton/core network, whose fxed costs we splt f both copper and fbre are offered. The ndependent operator would make a Greenfeld nvestment n the fbre network and has to run ts own concentraton and core network.

102 92 Wholesale prcng, NGA take-up and competton In order to cover the full range of costng optons we alternatvely consder LRIC/Greenfeld and SRIC/Brownfeld as the cost bass for the ncumbent s decson makng. The ncumbent chooses ether to stay only n copper, add fbre or swtch fully to fbre. The ncumbent wll only nvest n fbre f the new equlbrum wth fbre yelds more proft than the orgnal stuaton of copper only. In a further model an alternatve fbre nvestor can decde whether to nvest n fbre, whle the copper ncumbent remans n copper or exts. Each model generates the swtchng pont between fbre and copper, based on the most proftable choces for the ncumbent (and the ndependent fbre nvestor). Regulated wholesale access prcng follows from stage 1. Our consumpton unt s the number of subscrptons. Although the ncumbent s costs depend on the level of output, by settng them exogenously at stage 1 we do not make the access charges depend on wholesale output quanttes. At stage 3 the level of nvestments by compettors s derved from the cost model, assumng full penetraton of each actve entrant. Compettors enter ether usng copper or wth fbre access technology. The numbers m1 and m2 of fbre and copper compettors s adjusted through repeated runs of the model n such a way that a free entry equlbrum results, under whch the current number of entrants generates a proft and any addtonal entrant generates a loss. We do ths for all possbly relevant combnatons of copper and fbre nvestments, startng from the orgnal copper equlbrum (wth entrants) of stage 0. At stage 4 all actve frms compete n subscrpton fees at the retal level. The resultng market outcome s modelled as the Nash equlbrum outcome of the resultng prcng game, from whch subscrber numbers, profts, market shares, consumer surplus and total welfare are derved. 107 Ths s repeated for each of the cases developed n stages 0-3. In the model wth entry and ext, we frst allow for a non-specfed process of entry and ext wth the feature that all actve entrants make profts and that the entry of an addtonal entrant would lead to losses of all actve entrants of an actve access mode. Here we postulate that entrants correctly foresee the effect of entry (and the assocated nvestment decsons) on the prcng decsons and, thus, on market outcome. Formally, and n lne wth the lterature on ndustral organzaton, the stronger noton of subgame perfect Nash equlbrum s used. Ths means that we consder subgame perfect Nash equlbra of the two-stage game n whch entrants frst make ther partcpaton decson and then all actve frms make prcng decsons and 107 The Nash equlbrum s the standard soluton concept used n the lterature. It assures that frm decsons are mutually consstent.

103 Wholesale prcng, NGA take-up and competton 93 of the three-stage game n whch access network nvestors (ncumbent and ndependent fbre nvestor) frst make ther nvestment and partcpaton decsons n vew of the entrants partcpaton decsons n the next stage and then all actve frms make prcng decsons. The competton at stage 4 wll be n prces for dfferentated products as descrbed above. We model horzontally and vertcally dfferentated sngle-product and twoproduct ncumbents. We cannot dstngush between dfferent consumer types, such as households and busness consumers. Consumers only buy subscrptons wth unlmted usage. Under the pyramd model wthout hnterlands total output s kept constant. So, competton s only for market shares. In the model wthout cable copper and fbre together serve an assumed 70% of the populaton as customers wth the other 30% ether gong to other broadband modes, moble only or stay out of telecommuncatons. Ths fully corresponds to the equvalent assumpton of the cost model. In the model wth cable 95% of the populaton are assumed to be customers of one of the three modeled types of networks. Ths approxmates a 70% market take-up for copper and/or fbre, but may devate from the 70% mark, dependng on market condtons The quanttatve model A formal descrpton of the compettve model s provded n the Appendx. In the market for broadband, n frms (the ncumbent or alternatve fbre nvestor, fbre and/or copper entrants and potentally a cable company) compete for N compettve consumers. Each frm provdes a qualty level S. The ntensty of preferences of consumers between servces suppled by frms and j are measured by t j. After nvestments have been made, frms compete n subscrpton prces. Market outcomes are gven by the Nash equlbrum of ths prcng game between frms. Provdng FTTH and copper access nvolves a margnal cost of c 01 and c 02 as well as a fxed cost of K 01 and K 02. Frm s downstream costs of provdng retal servces consst of a margnal cost c and a fxed cost K. Downstream frms pay an access tarff consstng of a per-subscrber prce af for fbre and ac for copper plus (potentally) a fxed fee A. Only the ncumbent or the ndependent fbre nvestor receves wholesale payments (γ 1 = 1 and γ = 0 for the other frms), but all frms apart from the cable company use the ncumbent s FTTH access (δ = 0 for cable, and δ = 1 for all other frms). Model output varables. The followng varables are determned at the equlbrum outcome: p = fnal output subscrpton prce

104 94 Wholesale prcng, NGA take-up and competton n = the equlbrum number of frms. Whle the number of frms s actually an nput nto the quanttatve model, we determne the free-entry equlbrum number by runnng the model wth an ncreasng number of entrants, untl under n frms entrants are proftable whle under (n+1) frms entrants expect to make losses. prof = profts per month per frm. The allowed return on captal (WACC) s part of the costs and not part of the profts. WhProf = wholesale profts of ncumbent. These nclude profts from the sale of the ncumbent s Netco to the ncumbent s Opco. s = market share per frm sum(q) = market output CS = consumer surplus. It has to be noted that n our model total output (ncludng cable) does not vary. W = welfare = CS + sum(prof). The man welfare effects stem from cost and wllngness to pay (WtP) dfferences of the varous technologes and supplers. Among others, welfare s affected by changes n the market shares of the dfferent technologes and by changes n the market shares of the dfferent provders usng the same technology. Wth endogenous entry, also the duplcaton of fxed costs affects the welfare analyss. Not covered n the welfare analyss are spllover effects on ndustres that would beneft from the presence of fbre n developng new products or new busness models. In addton to these varable we use the followng abbrevatons: ac = Copper access charge af = Fbre access charge IncF = Incumbent fbre IncC = Incumbent copper EntrF = Entrant fbre EntrC = Entrant copper.

105 Wholesale prcng, NGA take-up and competton QoS and wllngness to pay n the basc model Whle costs are gven by the WIK cost model, the demand data are generated by assumptons on certan parameter values. The most mportant demand-related parameters are: The gross surplus S generated for consumers wth the hghest wllngness to pay (WtP) for servce or frm. Ths parameter expresses qualty (QoS) and goodwll. The S therefore capture vertcal product dfferentaton. They are derved proportonally from assumed ARPUs. The transport costs tj for consumers located between frms and j. These reflect the declne n wllngness to pay by consumers away from and j. They express both the heterogenety among consumers and the substtutablty between the supplers servces. The tj therefore capture horzontal product dfferentaton. The tj can n prncple dffer from each other and tj can dffer from tj. We have used ths feature to make product dfferentaton wthn the same technology less pronounced than product dfferentaton between dfferent technologes. The vertcal product dfferentaton parameters for Wllngness to Pay here expressed as ARPUs - are provded n Table 6-1. Table 6-1: ARPU assumptons for quanttatve model Incumbent FTTH Entrant FTTH Incumbent Copper Entrant Copper Cable These ARPU fgures translate nto maxmum Wllngness to Pay (the S n the model) n Table 6-2. Ths represents the hghest prce any sngle customer would be wllng to pay and perhaps reflects specfc benefts that a few customers may experence from fbre that cannot be acheved through other means such as home securty through vdeo survellance. Table 6-2: Maxmum WtP assumptons for quanttatve model Incumbent FTTH Entrant FTTH Incumbent Copper Entrant Copper Cable

106 96 Wholesale prcng, NGA take-up and competton The ranges n Table 6-1 and Table 6-2 reflect senstvty analyses around assumed values. In the followng hgh, low and ntermedate refer to endponts and mdponts of the ranges. Ths s shown n Table 6-3. Table 6-3: ARPU constellatons of relatve valuaton of copper aganst fbre Low valuaton of copper Intermedate valuaton of copper Hgh valuaton of copper copper fbre copper fbre copper fbre ncumbent ncumbent ncumbent entrant entrant entrant The value of the QoS dfferences between copper, cable and fbre that s expressed n the full range of ARPUS n the tables above may appear large and ncumbency prema may appear small from today s perspectve. However, t has to be kept n mnd that we are consderng stuatons wth potentally full FTTH penetraton, whch could only happen several years from now. It can be expected that the share of customers wth hgh-bandwdth demands and the prevalence of correspondng applcatons wll then be much hgher than now. Thus, the premum for ultra-hgh bandwdth wll also be much hgher than now. Also, we restrct most of the numbers presented n ths study to mddle ponts of the ARPU range. In contrast, the ncumbency premum, whch ncludes both QoS dfferences and goodwll advantages of the ncumbent, wll lkely become smaller, as tme goes by. Ths justfes the small ncumbency premum of 3% over entrants that we have chosen. If, n practce, consumers are not wllng to pay for some addtonal cost of fbre because they do not see utlty n the servces that t makes possble, then there s nether an economc nor a welfare-maxmzng case for fbre to be nstalled. Model runs. The competton model runs over aggregate WIK cost functons of clusters 1 through 4 and therefore all of ths remanng chapter relates to ths set of clusters. As shown n Chapter 5 above the nvestor as well as compettors can run a proftable busness model n all these clusters. The restrcton to Clusters 1 through 4 means, n partcular, that many suburban and all rural areas are excluded from consderaton. We have run the model for both the ntegrated copper/fbre ncumbent and the case of two separated network provders for fbre and copper. Because of the market dsadvantages of ndependent fbre nvestment we wll here mostly dsplay results for the ntegrated ncumbent. The dscretonary data nputs were calbrated to be compatble wth assumed ARPUs, wth plausble qualty dfferences and wth plausble market shares.

107 Wholesale prcng, NGA take-up and competton 97 The nvestment hurdles for FTTH aganst the preexstng copper access network are substantal. Based on a Greenfeld approach to fbre and LRIC for both fbre and copper, copper over all stages of producton s cheaper to produce per subscrber than fbre. The dfference ncreases to f one uses a Brownfeld approach to fbre and short-run average ncremental costs (SRIC) for copper. On top of havng to pay the access charge entrants have a downstream varable cost dsadvantage aganst ncumbents of 1.74 under fbre and 0.68 under copper (due to ODF/MDF equpment duplcaton and sales cost). They also have about an 8-10% fxed cost dsadvantage downstream due to the mssng opportunty of economes of scope of an ntegrated busness model. Gven the above cost consderatons fbre nvestment faces a hgh hurdle. Thus, the market advantage of fbre n terms of consumer apprecaton has to be large n order to succeed. Also, because of larger downstream cost dfferences relatve to ncumbents, fbre entrants face hgher hurdles than copper entrants. 108 Realstcally, both an ntegrated ncumbent and an ndependent fbre nvestor wll make use of already exstng facltes when nvestng n fbre. Hence, the Brownfeld approach s most approprate for ther decson makng. Also, the copper ncumbent wll only consder the costs of mantanng a copper network (SRIC), when decdng on gvng up copper. 6.3 Model runs on the varaton of access charges Varyng the copper access charge (ac) Man assumptons In ths secton we provde the results of a number of model runs. They are a subset of a much larger number of runs we performed. We chose the ones provded as examples and because we beleve them to be the most realstc and the most relevant ones for polcy assessments. In the current secton we consder varatons of the copper access charge ac for gven levels of the fbre access charge af. In the followng secton varatons of af for gven levels of ac are taken up. Fnally, we present results of parallel varatons of both ac and af. 108 Because of the hgher overall level of margnal costs for fbre compared to copper t may be that these dsadvantages do not play out fully n practce.

108 98 Wholesale prcng, NGA take-up and competton Frst, the copper access charge s vared n eght stages from 1.71 to (reference charge: 8.55 ). 109 All other modelng parameters reman constant. We mostly concentrate on the ncumbent s profts under varous scenaros, because they determne, whch technology he chooses. In contrast, we provde prces, entrants profts, market shares and consumer surplus/welfare only for selected cases. We currently only consder an ntegrated ncumbent as the fbre nvestor. Snce t almost never pays for an ntegrated ncumbent to operate copper and fbre sde-by-sde, n ths secton the ncumbent s assumed only to operate the more proftable of the two networks. Jont supply of copper and fbre s addressed below n Secton Unless stated dfferently SRIC and Brownfeld costs are appled to determnng the decson, whether to nvest n fbre or not. The SRIC/Brownfeld cost assumpton s referred to as the low-low case as opposed to the hgh-hgh case for LRIC/Greenfeld costs. We use ntermedate valuaton of copper relatve to fbre as our reference case Results on performance varables and the swtch from copper to fbre The ntegrated ncumbent always nvests n the type of network that s most proftable for hm, gven the regulated access charges. Thus, a swtch from copper to fbre occurs, when fbre profts exceed copper profts for the same combnaton of access charges (ac, af). Obvously, the ncumbent s profts are nfluenced by many factors (e.g. costs, market share, retal prces), wholesale access charges beng only one of them. Our results, however, suggest that ther nfluence can be substantal. The swtchng ponts from copper to fbre are marked by a crcle n the followng fgures 6-2 and 6-3. They show a strong ncrease n the ncumbent s copper profts from an ncrease n ac. As a result, copper s preferred by the ncumbent f ac s suffcently hgh. To the left of the vertcal lne markng the swtchng pont n Fgure 6-2 fbre profts are hgher than copper profts, whle to the rght of the lne copper profts are hgher than fbre profts. 110 In contrast, ac does not nfluence profts from fbre. Instead, fbre profts depend on af. An ncrease n af ncreases the range, where fbre s preferred. Consequently, under af = = Brownfeld LRIC the swtch from copper to fbre occurs below ac = 3.42 (> SRIC = 1.95 ), whle under af = the swtch from 109 The stages are generally defned by 20% ncrements or decrements startng from the 8.55 level. Smlarly, we mostly used 20% ncrements or decrements for fbre access charges startng from fbre LRIC of Thus, the second decmals are not shown for hgher precson but only because they reflect 20% changes. The only exceptons from the 20% changes are made to nclude copper LRIC (6.06 ), copper SRIC (1.95 ) and fbre Brownfeld (11.65 ), each for Clusters 1 through Ths s strctly true only f at the swtchng pont both profts are equal. Because we have changed ac n dscrete steps ths s generally not assured, but t holds almost precsely n ths partcular case.

109 Wholesale prcng, NGA take-up and competton 99 copper to fbre occurs below ac = The latter scenaro generates substantally lower consumer surplus than the former scenaro, wth CS = 405 mllon under ac = 3.42 and CS = 334 mllon under ac = Ths also means that at today s copper access charges n Europe t would take fbre access charges above 19 n order to nduce ncumbents to buld fbre access networks. The resultng end-user prces for fbre would be above 42 per month. In contrast, the ncrease n profts (for the ncumbent) from a 10 ncrease n ac s about 50 mllon per month. Ths s spread over about 6 mllon subscrbers (countng the subscrbers of entrants, who are relevant for the wholesale profts), whch corresponds to an over 80 cents proft ncrease for every one access charge ncrease. The proft ncrease shown n Fgure 6-3 for fbre ndcates a smlar order of magntude of proft ncrease for fbre from a one access charge ncrease. Fgure 6-2: Incumbent s total proft under varaton of ac for af = Brownfeld LRIC Swtch

110 100 Wholesale prcng, NGA take-up and competton Fgure 6-3: Incumbent s total proft under varaton of ac for two levels of af In the followng Table 6-4 and Table 6-5 we provde the outcome varables of the model for two of the runs descrbed so far. They concern the behavor of these varables at the swtchng pont from copper to fbre at the low fbre access charge of af = Table 6-4 gves the outcomes for fbre alone, whle Table 6-5 gves the outcomes for copper alone at ac = A comparson of the two tables shows how close the ncumbent s total profts for copper and fbre are at ths swtchng pont. Although af s set equal to Brownfeld LRIC costs, fbre s makng a wholesale loss because total fbre output s less than 70% of the market (t s 72% of 95%!). In contrast, copper s makng a handsome wholesale proft at ac = 3.42, whch s dstnctly above SRIC, even at less than 70% share of the market. Due to the smaller number of entrants for fbre (m1 = 3) than copper (m2 = 4) entrants under fbre make a handsome proft, whle entrants under copper barely make any proft. Ths ndcates that at any further ncrease n ac copper entrants wll ext. Total welfare and consumer surplus do not dffer much between both scenaros.

111 Wholesale prcng, NGA take-up and competton 101 Table 6-4: Output varables of the model for fbre at af = General Incumbent- Fbre Incumbent- Copper Cable Each Fbre Entrant Each Copper Entrant subscrbers 1,871,141 2,308,392 1,341,576 retal prce RtProf 14,434,240 17,004,698 6,047,840 WhProf -1,517,709 market share aggregate market share fbre entrants copper entrants 3 0 W 453,891,468 CS 405,826,718 Table 6-5: Output varables of the model for copper at ac = 3.42 General Incumbent- Fbre Incumbent- Copper Cable Each Fbre Entrant Each Copper Entrant subscrbers 1,401,007 2,339,927 1,115,832 retal prce RtProf 4,881,215 18,022, ,645 WhProf 8,440,193 market share aggregate market share fbre entrants copper entrants W 442,074,235 CS 409,479, Fgure 6-4 shows the effects of ncreases n ac on end-user prces of all types of frms and technologes. af s gven at Brownfeld LRIC = Ths s the same case as the one depcted n Fgure 6-2. So, the swtch between fbre and copper occurs at ac =

112 102 Wholesale prcng, NGA take-up and competton Ths case s, among others, characterzed by the fact that fbre attracts three entrants, whle copper attracts four entrants at ac below Only at ac 5.13 does the number of copper entrants drop to three. The most strkng observaton s that at the swtch pont from copper to fbre the retal prce for fbre s about 15 hgher than the retal prce for copper. How can ths gap be sustanable? In our model we do not assume that customers smply swtch and pay 15 more for fbre. Rather, we compare equlbrum stuatons before and after a fbre buldout. The dfferent customer valuatons therefore reflect dfferences after consumers have been gettng used to the value fbre provdes. It also ncludes a change n the composton of servces demanded, n partcular away from sngle play towards trple play. In Secton we wll address some of the adjustment ssues and the mplcatons of provdng a vrtual copper product on the fbre network at an equvalent cost to copper. The copper retal prces ncrease n ac. The ncrease s steeper f, as at ac = 5.13, the number of entrants decreases. In that case the prce ncrease s actually larger than the ncrease n ac. The fbre prce s not affected by ac and s always hgher than the copper prce. Entrants always set prce close to that of the ncumbent. Because of hgher costs the prce of fbre entrants can, n spte of lower valuaton, be hgher than that of the ncumbent. The end-user prce of cable ncreases n ac and s always below fbre prces and above copper prces. However, as ac ncreases the gap between copper and cable prces narrows.

113 Euro Wholesale prcng, NGA take-up and competton 103 Fgure 6-4: End-user prces under varaton of ac for af = Brownfeld LRIC = End-user Prces and Copper Access Charge Swtch ac = Copper Access Charge n IncF IncC Cable EntrF EntrC Fgure 6-5 shows the effects of ncreases n ac on consumer surplus (CS) and welfare (W) for the same scenaro as before. What stcks out s that an ncrease n the copper access charge reduces CS but leaves W almost unchanged. The loss n consumer surplus s almost compensated by an ncrease n profts. CS decreases because of the prce ncreases for both copper and cable. Welfare changes lttle because almost all of the prce ncreases lead to hgher profts (gven that total output of copper plus cable s constant). At the current ac = 8.55 n Europe consumer benefts appear as farly low. A reducton n ac from 8.55 to 5.13 would ncrease CS by almost 20%. Because of further copper entry at ac = 3.42 the further reducton from 5.13 to 3.42 would ncrease CS by a smlar amount. All ths s n lne wth Fgure 6-4 on the correspondng prce developments. However, that assessment does not hold for the swtch to fbre, whch leads to no reducton n CS n spte of a more than 15 prce ncrease. The reason s that over the long run n a scenaro n whch fbre speeds fbre s valued more hghly than copper, even at a substantally hgher prce as would have replaced copper speeds, be the case today comparng broadband and IPTV capabltes and the capabltes of narrowband dal-up Internet connectons. W and CS are hgher under

114 104 Wholesale prcng, NGA take-up and competton fbre, except at ac = 3.42, where there s ferce entry competton n copper and therefore CS ncreases, whle W decreases. As mentoned above the ncrease n welfare and consumer surplus arsng from the swtch to fbre probably underestmates the total effect of the swtch because households and frms wll beneft n ways not captured n ther demand for fbre servces n ths model. Estmatng ths extra effect s dffcult because the end-user demand for fbre access s a derved demand from the demand for the servces that can be accessed va the fbre connecton. Thus, the ncreased Wllngness to Pay for fbre over copper s a real welfare effect that ncludes the consumer valuaton of new servces developed for fbre. However, t does not capture the proft opportuntes realzed by the sellers of such servces, for example, for exports. Our model also shows welfare ncreases from a swtch from an LRIC/Greenfeld approach to an SRIC/Brownfeld approach. Ths, however, s generally not a real welfare effect f t only relates to the way one counts the costs. In other words, the real costs do not change f one swtches from an LRIC to an SRIC approach. The swtch from LRIC to SRIC only represents a real effect f, for example, we use SRIC f copper does not requre expanson nvestments, whle we use LRIC f t does; or, f n one case an ncumbent can use copper ducts for nvestng n fbre, whle n the other he cannot. Further real changes can occur f regulators use dfferent access charges correspondng to dfferent cost concepts or f ncumbents make ther nvestment decsons depend on the cost concept used.

115 Wholesale prcng, NGA take-up and competton 105 Fgure 6-5: Welfare and consumer surplus under varaton of ac for af = Brownfeld LRIC = Swtch As Fgure 6-6 shows for the same scenaro as before, an ncrease n the copper access charge generally reduces the market share of copper entrants and ncreases the market share of cable, but changes the market share of the copper ncumbent very lttle. 111 The market share of (ndvdual) copper entrants falls n ac, whle the market share of the copper ncumbent remans almost constant. Where fbre s optmal t has a hgher market share relatve to cable than copper where t s optmal. Not surprsngly, the market share of cable ncreases n ac. Cable benefts from the hgher costs mposed on ts compettors. The market share of cable s hgher than that of any other frm but less than half of that of all frms of another technology. 111 It s worth notng that the market share of the ncumbent s substantally lower and the market share of entrants substantally hgher than the crtcal market shares provded by the cost model. The reason for the ncumbent s that here t s the wholesale market share that counts and that s close to 70% of the populaton. The reason for the hgher market shares of entrants s that competton drves down prces well below the ARPU values assumed n the cost model. Under those prces fewer entrants can survve.

116 106 Wholesale prcng, NGA take-up and competton Fgure 6-6: Market shares under varaton of ac for af = Brownfeld LRIC = As Fgure 6-7 demonstrates, an ncrease n the copper access charge can have ambvalent effects on retal profts. The effects are ambvalent because of the effect of ac on the number of copper entrants. At ac = 5.13 the number of copper entrants s reduced from 4 to 3, leadng to much ncreased entrants profts as well as ncumbent s retal profts. Otherwse, wthout further ext, entrants profts and ncumbent s retal profts decrease sharply n ac. 112 Snce we have seen n Fgure 6-2 that the copper ncumbent s overall profts ncrease sharply n ac, the wholesale profts must have ncreased by substantally more n order to make up for the reducton n retal profts. The ncumbent s retal proft must decrease n ac snce under accountng separaton and non-dscrmnaton the accountng upstream cost to the ncumbent s retal dvson s ac. But at the same tme the wholesale profts ncrease correspondngly. Profts of fbre entrants are unaffected by ac. They only depend on af (as long as copper and fbre do not exst sde by sde) and at af = Brownfeld LRIC = fbre retal profts exceed copper retal profts. 112 Ths effect s absent n the model wthout cable, whch s one of the reasons for developng the model wth cable n the frst place.

117 Wholesale prcng, NGA take-up and competton 107 Incumbents always make much larger retal profts than entrants. Ths occurs because of ther QoS and goodwll advantages on the one hand and ther lower downstream costs on the other. In our model retal profts can be very hgh. Ths hgh level s explaned mostly by the free-entry feature, whch means that there s no entry unless a further entrant can at least earn the WACC. There are two factors that can prevent entry. Frst, an entrant has large fxed costs that have to be covered n addton to the fxed costs of all other frms. Thus, f entry had no effect on prces and on total output the extra fxed costs would have to be covered from the profts of the already establshed frms. Second and no less mportant, entry leads to lower prces and somewhat ncreased overall outputs, where each establshed frm wll produce less than before entry. Because of overall nelastc demands n the model, total revenues after entry wll be less, further reducng overall profts avalable for coverng the entrant s fxed costs. Fgure 6-7: Retal profts under varaton of ac for af = Brownfeld LRIC = Fgure 6-8 provdes the same nformaton as Fgure 6-7, ths tme only expressed as retal profts (based on low-low costs) as a percentage of retal revenues and wth the addton of wholesale proftablty. The man change here s that, due to the hgher retal

118 108 Wholesale prcng, NGA take-up and competton prces for fbre, the retal proftablty of fbre s lower relatve to the absolute proft levels. Also, part of the hgher absolute level of retal profts of ncumbents s explaned by ther larger market share. The wholesale proftablty of fbre s negatve at af = Brownfeld LRIC 113, whle wholesale proftablty of copper ncreases steadly n ac, reachng 30% at ac = Fgure 6-8: Retal proftablty under varaton of ac for af = Brownfeld LRIC = Retal Proftablty and Copper Access Charge 35,00% 30,00% 25,00% 20,00% 15,00% 10,00% 5,00% IncF IncC EntrC EntrF WhProf1 WhProf2 0,00% -5,00% Copper Access Charge Summng up, what trggers the ncumbent s decson to swtch from copper to fbre s that fbre becomes more proftable for the ncumbent than copper. Snce hgher copper access charges ncrease profts from copper but leave fbre profts unaffected (as long as the two servces are not offered sde by sde), an ncrease n ac reduces the ncentves for a swtch. In partcular, at today s natonally averaged ac of 8.55 there 113 It has to be stated here that profts are defned as recevng a return on captal over and above the assumed WACC. Furthermore, the resultng negatve profts are wthn the margn of error of estmatng Brownfeld access charges, because quantty predctons by the regulator wll never be precse.

119 Wholesale prcng, NGA take-up and competton 109 would be lttle ncentve for the ncumbent to nvest n fbre. Wthn the range analyzed wholesale profts strongly ncrease n ac, whle retal profts and entrants profts suffer, unless an ncrease n ac forces the ext of entrants. An ncrease n ac also leads to a reducton n the aggregate market share of copper relatve to cable. Furthermore, t clearly leads to a reducton n consumer surplus, whle the welfare level s affected qute lttle. However, snce the swtch to fbre most lkely ncreases both consumer surplus and welfare, an ncrease n ac that prevents the swtch would have negatve effects on both. Under a Brownfeld LRIC scenaro n whch fbre access charges are and copper prces are set at or below the swtchng pont of 3.42, the market supports one cable operator wth 28% market share, the fbre ncumbent wth 23% and 3 unbundlng-based entrants wth 16% market share each. Wth copper charges at today s average rate of 8.55, no fbre nvestment would occur, and the market would support one cable operator wth a market share of 33%, and the copper ncumbent wth 20% and 3 entrants wth just over 15% market share each. Ths market structure does not exst n many markets today. Rather, ncumbents n Europe mantan an average of 45% of retal market Effects of changes of consumer valuatons on the ncumbent s profts The hgher consumer valuaton of fbre s the most mportant reason for the ncumbent to swtch from copper to fbre. So, how do varatons n consumer valuatons affect the ncentves for such a swtch? Fgure 6-9 shows that a change n the consumer valuaton of copper relatve to fbre changes the range for whch fbre s more proftable than copper. Ths fgure dffers from the prevous ones n that t shows a varaton of ac for a gven level of af = = Greenfeld LRIC. Whle the hgher dark lne and lower lght lne represent hgh valuaton of copper relatve to fbre, the lower dark lne and hgher lght lne represent low valuaton of copper relatve to fbre. The swtch from copper to fbre occurs at ac = 8.55 at low copper valuaton compared to ac = 6.06 for ntermedate valuaton and ac = 5.13 at hgh valuaton. Thus, by nference, at ntermedate valuaton the swtch occurs, where both ac and af are set at LRIC, whle at hgh copper valuaton copper s preferred at a lower ac and at low copper valuaton t s preferred at a hgher ac. At hgh valuaton of copper fbre has lttle chance at the currently prevalng ac = 8.55 n Europe even f af s set at Greenfeld LRIC. The hgher the valuaton of fbre over copper the lower the necessary dfference between ac and af n order to trgger a swtch from copper to fbre, because at hgh valuaton by customers fbre generates more profts for a gven level of af.

120 110 Wholesale prcng, NGA take-up and competton Fgure 6-9: Senstvty of swtchng ponts and ncumbent s profts to consumer valuatons of copper and fbre (af = ) We have further lnked the consumer valuatons of fbre relatve to copper to the ncumbent s profts from copper and fbre, each consdered n solaton. Ths s done for two sets of access charges. Note that, contrary to the sectons above, we here measure valuaton n the other drecton. Fgure 6-10 shows the effect of the valuaton of fbre relatve to copper on the development of the ncumbent s copper or fbre profts under two levels of access charges but only for SRIC/Brownfeld costs. Fbre s valued on the scale wth 1 = lowest fbre valuaton and 10 = hghest fbre valuaton, where 1 corresponds to the prevous hgh valuaton of copper and 10 corresponds to the prevous low valuaton of copper. The upper two lnes of Fgure 6-9 present the case of tradtonal LRIC charges (ac = 6.06 and af = 13.92) and the lower two lnes the case for copper SRIC and fbre Brownfeld charges (ac = 1.95 and af = 11.65). For all consdered sets of wholesale access charges n Fgure 6-10 we assume that the ncumbent produces at copper SRIC and fbre Brownfeld cost (cost bass: low-low).

121 Wholesale prcng, NGA take-up and competton 111 The level of access charges has a large effect on the level of profts, as shown by the dstance between the two sets of curves. At LRIC access charges copper profts are always hgher than fbre profts but the gap generally narrows wth hgher valuaton of fbre. At SRIC/Brownfeld charges fbre profts are mostly hgher than copper profts and the gap generally wdens. Exceptons to these trends occur only because of entry and ext of entrants, the effects of whch can be substantal. In partcular, lower valuaton of copper leads to the ext of a copper entrant n the upper part of the graph at 4 on the scale and n the lower part of the graph at 9 on the scale, whle ncreased valuaton of fbre leads to a new fbre entrant at 8 on the scale. Fgure 6-10: Effects of a change n consumer valuaton on ncumbent s profts and swtch to fbre for two levels of access charges Brownfeld/SRIC costs Summng up, as expected, at hgh valuaton copper s more proftable than fbre for a larger range of ac than at low valuaton of copper. What may, however, be surprsng s that entry and ext of entrants can have such a large effect on the ncumbent s profts that they compensate the effect of even qute large dfferences n consumer valuatons. Thus, wthn the range of valuatons analyzed the effect of consumer valuaton changes on the ncumbent s profts and hs ncentves to swtch from copper to fbre s dstnct but not overwhelmng. Ths justfes our focus on ntermedate valuatons.

122 112 Wholesale prcng, NGA take-up and competton Varyng the fbre access charge (af) Modelng assumptons Ths secton addresses the queston, what the effects of a change n af would be for gven levels of ac. To answer t the fbre access charge s vared n nne steps from 5.57 to All other modelng parameters reman constant. As before, f not stated otherwse we assume SRIC/Brownfeld costs (low-low), an ntegrated ncumbent and ntermedate valuaton of copper relatve to fbre. We consder two cases. Frst, the ntegrated ncumbent offers only the proftable servce(s). Second, n Secton the ntegrated ncumbent for any copper access charge always offers both servces Results for the ntegrated ncumbent offerng the most proftable servce(s) As Fgure 6-11 shows, an ncrease n af substantally ncreases the ncumbent s fbre profts. At hgher ac the swtch to fbre occurs at a hgher level of af. In partcular, wth ac = 1.71 the swtch from copper to fbre occurs at af = (< Brownfeld LRIC), where fbre profts substantally exceed those of copper. 114 In contrast, wth ac = 8.55 (= average EU copper access charge) the swtch only occurs at af = 19.49, or at af = f we only consder dscrete steps of varaton. 114 The fgure shows that the match for the swtch s mperfect, due to dscrete model runs. Under contnuous varaton the swtch would occur at about af = 9.80.

123 Euro Mllonen Wholesale prcng, NGA take-up and competton 113 Fgure 6-11: Effects of a varaton of af on ncumbent s profts and swtch to fbre for two levels of ac 70 Incumbent's Profts and Fbre Access Charge Copper: ac = 8.55 FTTH Copper: ac = Fbre Access Charge In Fgure 6-12 to Fgure 6-14 we turn to the effects on end-user prces of varatons n af for gven ac levels. Fgure 6-12 shows the effects of varatons n af on the ncumbent s prces for ac = Because of very low ac the end-user prces for copper are also very low. Snce the swtch to fbre occurs at a low level of af, the prces of fbre start low and then ncrease sharply n af.

124 Euro 114 Wholesale prcng, NGA take-up and competton Fgure 6-12: Effects of a varaton of af on ncumbent s end-user prces and swtch to fbre for ac = End-user Prces and Fbre Access Charge 0 0,00 5,00 10,00 15,00 20,00 25,00 30,00 Fbre Access Charge IncF IncC As Fgure 6-13 shows, an ncrease of ac from ac = 1.71 to ac = 8.55 ncreases the end-user prces for copper sharply (from about 20 to 29 ), n fact by substantally more than the 6.84 ncrease n access charge. Ths s the result of a reducton n the number of copper entrants that s assocated wth ths ncrease n ac. Ths large ncrease s also what moves the swtch from copper to fbre from af = to af = 19.49, where the end-user prce for fbre s already at close to 45. After that an ncrease n af further ncreases ths prce.

125 Euro Wholesale prcng, NGA take-up and competton 115 Fgure 6-13: Effects of a varaton of af on ncumbent s end-user prces and swtch to fbre for two levels of ac 50 End-user Prces and Fbre Access Charge IncF ac = 1.71 IncC ac = 1.71 IncF ac = 8.55 IncC ac = ,00 5,00 10,00 15,00 20,00 25,00 30,00 Fbre Access Charge Fgure 6-14 provdes the same nformaton as Fgure 6-13 but adds the end-user prces for cable for the two levels of ac. In both cases the prce for cable s clearly above the end-user prce for copper and below the end-user prce for fbre. As expected t ncreases n af, but wth a slghtly lower slope than the end-user prce for fbre. The only surprse s that through the swtch from copper to fbre at af = the end-user prce for cable s reduced. Ths s lkely the combned effect of the hgher valuaton of cable relatve to copper and the lower valuaton of cable relatve to fbre.

126 Euro 116 Wholesale prcng, NGA take-up and competton Fgure 6-14: Effects of a varaton of af on ncumbent s and cable s end-user prces and swtch to fbre for two levels of ac Prces and Fbre Access Charge cable at ac = 8.55 cable at ac = Fbre Access Charge IncF ac = 1.71 IncC ac = 1.71 IncF ac = 8.55 IncC ac = 8.55 Cable ac = 8.55 Cable ac = 1.71 Summng up, the effects of a change n the fbre access charge on the swtch from copper to fbre are a mrror mage of the effects of changes of the copper access charge. Thus, an ncrease n af relatve to the fxed ac ncentvzes the swtch from copper to fbre n the same way as a decrease n ac relatve to a fxed af had n the prevous assessment. Increases n af have smlar negatve performance effects as ncreases n ac on consumer surplus and welfare Model wth vs. wthout cable We have ntroduced cable n the model, because n the model wthout cable the choce of the ncumbent for ether fbre or copper elmnates any ntermodal competton and makes the total demand for that servce completely nelastc. As a result, retal profts and market shares are unaffected by access charge ncreases. Thus, there needs to be another communcaton mode to brng elastcty nto the demand and at the same tme provde a credble compettor. Gven that we restrct the analyss to clusters 1 through 4 wth ther farly hgh populaton densty, cable s best suted to fulfll ths functon. What then s the mportance of the ntroducton of cable for the modelng results? We only answer ths queston wth two examples that are restrcted to the effects on the

127 Wholesale prcng, NGA take-up and competton 117 ncumbent s profts. The answers have to be nterpreted wth cauton, because they are derved from two dfferent models wth somewhat dfferent parameters. In Fgure 6-15 we show that the ntroducton of cable can have qute asymmetrc effects on copper and fbre profts. In ths example the profts for copper at an assumed ac = 8.55 are vrtually dentcal wth and wthout cable. In contrast, profts for fbre are dstnctly lower n the presence of cable and ncrease less sharply n af. However, the swtch from copper to fbre both wth and wthout cable occurs at af = Interestngly, cable profts at af = equal fbre profts. They are reduced by the swtch to fbre but at hgher af fbre profts ncrease by more than cable profts. Nevertheless, cable benefts from hgher fbre access charges, although not as much as fbre. Fbre profts are reduced by the presence of cable and the ncrease n fbre profts from ncreases n af s mtgated by the presence of cable. Thus, n ths example cable only seems to dscplne fbre. The reason s that at ac = 8.55 copper s market share n the model wth cable s almost exactly equal to the 70% penetraton assumed n the model wthout cable. As a result wholesale profts have to be dentcal. The model wth cable shows three entrants, whle the model wthout cable has four. Thus, wth fve market partcpants n each case the level of competton s qute smlar, leadng to smlar retal profts as well.

128 Mllonen 118 Wholesale prcng, NGA take-up and competton Fgure 6-15: Effects of a varaton of af on ncumbent s profts and swtch from copper to fbre for model wth and wthout cable cost bass: hgh-hgh 90 Incumbent's Profts and Fbre Access Charge E u r o FTTH Copper FTTH- Cable Copper- Cable Cable 0 5,57 8,35 11,14 13,92 16,7 19,49 22,27 25,06 Fbre Access Charge Fgure 6-16 shows the symmetrcal case of a varaton n ac for fxed af = Here fbre profts are equal both wth and wthout cable for the same reason as copper profts were smlar n the prevous case. Copper profts n Fgure 6-16 also dverge lttle from each other but t s clear that, as wth the case of fbre n Fgure 6-15, cable reduces the rate of ncrease n copper profts as a result of access charge ncreases. Ths dampenng of the ncrease n profts through the presence of cable s the general result from ths exercse. Because fbre profts wthout cable start lower than fbre profts wth cable the swtch to fbre occurs at a lower ac level wth cable than wthout cable.

129 Mllonen Wholesale prcng, NGA take-up and competton 119 Fgure 6-16: Effects of a varaton of ac on ncumbent s profts and swtch from copper to fbre for model wth and wthout cable 60 Incumbent's Profts and Copper Access Charge 50 E u r o FTTH Copper FTTH- Cable Copper- Cable 0 0,92 1,71 3,42 5,13 6,06 6,84 8,55 10,26 11,97 Copper Access Charge Results for an ntegrated ncumbent offerng both servce(s) Our assumpton n the last few sectons has been that the ncumbent only offers ether copper or abandons copper and fully swtches to fbre. In the course of our model runs ths has actually been a result of optmal choce rather than an assumpton, because for all the relevant runs keepng both the copper and fbre networks turned out not to be the most proftable soluton for the ncumbent. Ths result, however, s not trval, snce a combnaton of both copper and fbre would generate substantal downstream savngs by avodng duplcaton of the core and dstrbuton network. These savngs correspond to the full fxed costs of a rval entrant. Thus, an ntegrated ncumbent, who only needs to ncur SRIC for the copper access network could actually offer copper very cheaply alongsde provdng fbre access. It may therefore be surprsng that the restrcton to a sngle access network appears to domnate two parallel networks. We exemplfy the resultng ssues frst for a parallel ncrease or decrease of both ac and af from ther SRIC/Brownfeld levels and then for hgh and low consumer valuaton of copper relatve to fbre and for a varaton of the fbre access charge. Fgure 6-17 s based on ntermedate valuaton of copper relatve to fbre and on low-low costs. It shows that under a parallel varaton of both ac and af the profts for fbre and

130 Mllonen 120 Wholesale prcng, NGA take-up and competton copper alone clearly exceed the profts for copper and fbre offered jontly. Jont offerng of copper and fbre also reduces the number of entrants. There are no fbre entrants and only 2-3 copper entrants. The only pont, at whch the proft level of the jont offerng moves closer to the proft levels of copper and fbre alone, s where copper loses one of three entrants due to the ncrease n access charges. Because of the resultng overall reducton n competton ths knk affects both copper and fbre profts. Otherwse, an extrapolaton of the numbers suggests that the proft seres do not approach each other at realstc access charge levels. The result s partcularly negatve for the fbre porton of jont profts, because under jont offerng the fbre market share s too small to recover the hgh fxed costs. It would take very hgh access charges for jont profts of copper and fbre offered together to reach the profts of the most proftable one offered separately. Such hgh access charges would probably exclude all entrants. Fgure 6-17: Incumbent s profts under jont vs. separate offerngs of copper and fbre 30 Incumbent's Profts under a parallel change of ac and af E ( 10) u r( 20) o ( 30) ( 40) ( 50) ( 60) Parallel change of ac and af FTTH alone Copper alone FTTH Copper Sum Fgure 6-18 and Fgure 6-19 llustrate the effects of a varaton of af on ncumbent s profts and on the swtch to fbre for the case of an ntegrated ncumbent offerng both servces. Both fgures are based on ac = 8.55 = current ac average n EU, but they dffer on the valuaton of copper relatve to fbre. Fgure 6-18 assumes hgh valuaton of copper relatve to fbre. In ths scenaro, because of copper s hgh market share fbre entrants are never proftable. Thus, for lack of fbre entrants, an ncrease n the fbre

131 Wholesale prcng, NGA take-up and competton 121 access charge has almost no effect. 115 Fbre s the bg loser, whle copper turns out to be very proftable. However, the ncumbent s total profts are sgnfcantly negatve. Fgure 6-18: Effects of a varaton of af on ncumbent s profts for the case of an ntegrated ncumbent offerng both servces hgh valuaton of copper (ac = 8.55 ) Fgure 6-19 wth low valuaton of copper provdes an entrely dfferent pcture. In ths case copper s scramblng to make any proft and only turns out a postve proft at af = In contrast, fbre, whle makng a loss at af = 5.57, turns out to be very proftable at hgh fbre access charges. As before, cable profts ncrease steadly n af. Ths case turns out to be the most favorable for a parallel offerng of copper and fbre smultaneously. The man queston here s f the sum of the large fbre proft and a small copper proft s smaller or larger than the hghest of copper or fbre profts alone. Our model runs show that, because of the relatvely hgh ac of 8.55, at low levels of af copper alone easly beats the sum of copper and fbre together. At hgher levels of af and after the swtch to fbre ths dfference shrnks, but fbre alone keeps an advantage of close to 5 mllon per month. Therefore, wthn the range of af analyzed t s never preferable for the ncumbent to operate both networks smultaneously. 115 In fact, because n ths case the ncumbent prces the end-user servce of fbre ndependently of the level of af a prce squeeze ssue may arse at hgh levels of af. It would be a purely academc ssue because no entrants would appear even at low levels of af.

132 122 Wholesale prcng, NGA take-up and competton Fgure 6-19: Effects of a varaton of af on ncumbent s profts for the case of an ntegrated ncumbent offerng both servces low valuaton of copper (ac = 8.55 ) Summng up, t takes very specal crcumstances and very hgh access charges to make jont offerngs more proftable than the most proftable sngle network Results for a parallel varaton of both copper and fbre access charges The results on ndvdual varatons of ether ac or af for gven access charge levels of the other mode suggested certan patterns of developments. In partcular, whle ncumbent s profts always ncrease n the relevant access charge, the swtch to fbre depends as much on the level of the other access charge. Ths has lead us to enqure the effects of smultaneous changes of both access charges. We frst tred proportonal ncreases of both, but those dd not lead to nterestng patterns. Ths changed, however, when we tred ncreasng or decreasng both access charges by the same absolute amounts. The natural startng ponts were access charges at LRIC copper/greenfeld fbre LRIC and at SRIC copper /Brownfeld fbre LRIC levels.