Model Reference Paper (rev B) Guidelines for the LRIC bottom-up and top-down models

Transcription

1 DATE 12 September 2007 Dnr /23 Model Reference Paper (rev B) Guidelines for the LRIC bottom-up and top-down models

2 1 Introduction and background Policy and objectives Policy Objectives Methodology Process Document structure... 4 Part A: Common guidelines Long Run Incremental Cost Definition of LRIC Long Run Incremental Forward-looking costs Definition of increment Size of increment Access and core increment Other increments Cost Causality Treatment of common costs Allocation of common costs Services modelled Core and access services PSTN (PSTN/ISDN) and Broadband services Leased lines Other services Co-location services The nature of co-location services List of co-location services covered by LRIC Demand and growth Demand Margins for growth Model outputs Cost types Level of detail Cost categories Cost of co-location Costs of shared access to unbundled local loop Cost of Bitstream access General costing issues Annualisation methodologies Post- och telestyrelsen i

3 5.1.1 Annualisation criteria Capital charge Depreciation charge Annuities Guidelines Cost of capital Geographical differentiation Geographical differentiation Geo-types Other costing issues Base year Working capital Set-up and duration related charges Routing factors Part B: Specific guidelines for top-down model Overview of top-down modelling Determine homogenous cost categories (Step 1) Group cost category by activity and network elements (Step 2) Re-value assets, calculate GRC, NRC and CCA depreciation (Step 3) Developing cost-volume relationships (Step 4) Cost access and interconnection services (Step 5) Top-down asset valuation and capital costs Gross asset valuation Current cost accounting Revaluation methods Asset prices New technology Land and buildings Utilisation rates Valuation of major asset categories Access network Core network Trenching costs, incl. poles Poles Indirect network costs (buildings, IT, motor vehicles, etc.) Co-location Annualisation Asset lives Annualisation of relatively new assets Fully depreciated assets Capital maintenance Net asset valuation NBV/GBV methodology Rolling forward methodology Assets under construction Post- och telestyrelsen ii

4 8 Operating costs Operating costs Cost categories Efficiency Activity based allocation of operating costs Documentation Costing services Homogeneous cost categories Service usage Trenching and duct Copper and fibre cable Local Exchanges Tandem exchanges Transmission equipment Indirect network costs and overhead costs Outsourced costs Assigning costs to services Calculating incremental costs Calculating costs of services within an increment Treatment of common costs Model functionality and documentation Model requirements Sensitivity analysis Model documentation Justification Audit of model Part C: Specific guidelines for bottom-up model Overview of bottom-up modelling Measuring demand and establishing unit costs (Step 1&2) Building hypothetical network (Step 3) Determining the cost of network elements (Step 4) Costing services (Step 5) Optimisation Scorched node assumption Technology Switching technology Transmission technology Access technology Requirements of the optimised network Quality of service Service equivalence Correct dimensioning of the network Post- och telestyrelsen iii

5 13 Demand Demand in the access network Demand in the core network Estimation of end-user demand Estimation of dimensioned demand Bottom-up modelling Equipment prices and cost data Modelling exchanges The hierarchy of the exchanges Choosing between different nodes Modelling transmission Transmission hierarchy Network configuration Dimensioning the network Modelling access Collecting information by geo-types Estimation of equipment requirements Modelling infrastructure Trench in the core network Costing of trench Duct Poles Cable requirements in the core network Cable modularity and length Modelling co-location Bottom-up costing issues Indirect network costs Overheads Operating costs Cost allocation Model functionality and documentation Model requirements Sensitivity analysis Model documentation Appendices Appendix 1 Summary of criteria Appendix 2 Abbreviations used Appendix 3 Glossary of terms Post- och telestyrelsen iv

6 Appendix 4 Detailed list of services modelled or covered by LRIC A.4.1 Interconnection services A.4.2 (Wholesale) copper access services A.4.3 Bitstream Access A.4.4 Co-location services Post- och telestyrelsen v

7 1 Introduction and background This Model Reference Paper (MRP) outlines the features and key principles applying to the bottom-up and top-down models to be developed with the purpose of producing a hybrid model and determining LRIC based cost for certain (wholesale) access and interconnection services in Sweden. The 'LRIC method' refers to a method for the calculation of cost-orientated pricing that is - based on the long run incremental costs for an efficient operator who makes use of modern technology, and - includes a mark-up for common costs for an efficient operator under competitive conditions. 1 The hybrid model shall be used, together with a pricing methodology approved by PTS, when PTS assesses whether the prices that TeliaSonera applies for interconnection and LLU, including co-location products, satisfy the requirement regarding cost orientation. During the years , PTS, together with operators, has produced an LRIC model, a 'hybrid model', for calculating the costs of interconnection in the fixed network and local loop unbundling (LLU). The first version of the hybrid model was approved on 19 December PTS has thereafter updated the hybrid model on an annual basis, resulting in the current version (v4.1) released in December According to the PTS Regulations on the LRIC method for the calculation of cost-oriented pricing, PTS shall, at least every three years, review the need to revise the respective hybrid model. PTS shall then take into account, among other things, economic life, required return and the application of new technology. A review of the need to revise the hybrid model for the fixed network means that PTS needs to consult operators regarding a multitude of technical and financial issues. The consultation with the operators confirms that there is a need for revising the hybrid model. PTS has decided to revise the Model Reference Paper as a prelude to preparing a revised bottom-up model and requiring the SMP operator to prepare a revised top-down model. The revision of the hybrid model for the fixed network comprises: - products and services in the access network that are covered by PTS's obligation decision on local loop unbundling: shared access, full access and co-location, - interconnection services in the fixed networks that are covered by PTS's obligation decision on interconnection. 1 PTSFS 2005:5 PTS Regulation on the LRIC method for the calculation of cost-orientated pricing. 2 LRIC, The final hybrid model, 19 December Post- och telestyrelsen 1

8 The revision also includes the development of the hybrid model to produce cost calculations under the LRIC method for: - products and services covered by PTS's obligation decision on bitstream access. 1.1 Policy and objectives Policy One of the main principles in PTS policy for the access regulation of last mile networks is that infrastructure-based competition should be promoted when replication of infrastructure is feasible. 3 To give the right investment signals and promote effective competition, the prices for interconnection and LLU should be based on the long-run incremental cost (LRIC) for an efficient operator. When the prices are determined on the basis of the LRIC-methodology infrastructurebased competition is promoted in those areas where it is efficient to have replication of infrastructures, while service-based competition is promoted in areas where replication of infrastructures is not efficient. The hybrid model puts the policy into practice by creating neutrality in the choice between building your own infrastructure and paying for access to the SMPoperator s infrastructure. Conditions for neutral incentives are created since the assumptions underpinning the hybrid model represent a balanced view on what it would cost for an efficient operator of TeliaSonera s size to build and run a network today. Thus the assumptions take account both of those within the bottom up model, which are by necessity somewhat theoretical, and those in the top down model, that encompass some of the realities of TeliaSonera s actual network Objectives The objective of using LRIC are to: Encourage the use of existing facilities of the SMP operator where this is economically desirable, avoiding inefficient duplication of infrastructure costs by new entrants (incentive to buy); Encourage investment in new facilities where this is economically justified by 1. new entrants investing in competing infrastructure 2. the SMP operator upgrading and expanding its networks (incentive to build); Increase the transparency of the cost calculations underlying the access and interconnection charges; and 3 Policy för tillträdesreglering i accessnät - PTS-ER-2006:26, 10 July Post- och telestyrelsen 2

9 Increase predictability for both the SMP operator and the other operators with regards to future determination of access and interconnection charges. When access and interconnection charges are based on LRIC they do not distort the build/buy decision of new entrants they will be encouraged to use existing facilities if, and only if, it is economically desirable to do so. Just as important, LRIC-based access and interconnection charges also mean retaining investment incentive for incumbents to upgrade or extend the existing network when new technology is available. When charges are set on the basis of LRIC, infrastructure competition is encouraged in those areas where it is efficient to have competing infrastructure, whereas service competition is encouraged in those areas where the investment in competing infrastructure is not efficient. 1.2 Methodology To send the right investment signals and promote efficient competition, prices should reflect the LRIC of an efficient operator facing the demand of the existing SMP operator (currently this means TeliaSonera) 4. The efficient operator is defined as the theoretical operator that would exist if it were in a fully competitive market in Sweden, but with the same scope and demand of the existing SMP operator. This approach ensures that the economies of scale, scope and density are divided equally between the SMP operator and the interconnecting operators allowing the interconnecting operators to compete with the SMP operator on equal terms. Ultimately, the cost results derived from the hybrid model will be based upon a fair comparison of the costs calculated in a top-down and a bottom-up model respectively. The purpose of the top-down model is to calculate the LRIC on the basis of the existing network and cost structure of the SMP operator, eliminating inefficiencies and replacing outdated equipment with new, more cost-effective technology. The purpose of the bottom-up model is to calculate the LRIC on the basis of an efficient network using the newest technology actually employed in large-scale networks. In principle, the bottom-up model should model the network that an efficient operator would build today to meet the forward-looking demand of the SMP operator. The costs (if any) for migrating to the efficient operator from today s operations are not included. 1.3 Process The review of the hybrid model will observe the principles prescribed by PTS's Regulations. This revised model reference paper sets out the guidelines and criteria for the modelling work. All guidelines set out as criteria as well as other guidelines should 4 These costs are likely to be different from the costs of an actual new entrant, entering the current market, as the new entrant will not be able to achieve the same economies of scale, scope and density as the SMP operator when the SMP operator is already in the market. Post- och telestyrelsen 3

10 be followed during the modelling work unless it explicitly appears that the text is of a guiding nature that the responsible modellers may choose to depart from. Other deviations require prior clarification with PTS. Upon finalisation of the revised models, PTS will undertake a thorough review of the two models to ensure that they meet the guidelines set out in this MRP. TeliaSonera is responsible for developing a revised top-down model while PTS is in charge of developing a revised bottom-up model in co-operation with interested parties from the industry, including TeliaSonera. A reconciliation of the two models will again be undertaken by PTS and used as the basis for PTS's development of a revised hybrid model on which the final price setting will be based. A reconciliation report will be submitted to public consultation in order to seek opinions from the industry. The report will identify, quantify and where possible explain the differences between the two revised models. Also the revised hybrid model and PTS s final proposed pricing methodology will be subjected to public consultations. 1.4 Document structure The guidelines provided in the MRP are structured in three parts plus appendices: Part A includes common guidelines for the two models. Part B includes specific guidelines for the top-down model. Part C includes specific guidelines for the bottom-up model. In part A: Chapter 2 discusses concepts involved in the definition of long run incremental costs. Chapter 3 describes the services that need to be modelled and the services that should be priced according to LRIC. Chapter 4 discusses the outputs of the two models including the level of detail. Chapter 5 discusses a number of general costing issues such as depreciation methodologies, cost of capital, working capital, and the use of routing factors. In part B: Chapter 6 provides an overview of the main steps involved in building a topdown model. Chapter 7 discusses the gross and net asset valuation of assets in the top-down model. Chapter 8 describes the calculation of working capital and allocation of operating costs in the top-down model. Chapter 9 discusses a number of the issues involved in the costing the access and interconnection services including the allocation of costs from cost categories to network elements (using cost volume relationships) and on to services (using routing factors). Post- och telestyrelsen 4

11 Chapter 10 sets out the requirements for the functionality, documentation and audit of the model. In part C: Chapter 11 provides an overview of the main steps involved in building a bottom-up model. Chapter 12 discusses the level of optimisation in the bottom-up model including constraints such as the scorched node assumption. Chapter 13 describes how demand in the core and access network should be estimated and applied in the bottom-up model. Chapter 14 covers issues related to the estimation of equipment prices and specific guidelines for the modelling of exchanges, transmission and access network and infrastructure. Chapter 15 discusses a number of other costing issues such as the calculation of indirect costs, overheads, operating costs and working capital, and allocation of costs to network elements and on to services. Chapter 16 sets out the requirements for the functionality and documentation of the bottom-up model. In the appendices: Appendix 1 includes a summary of criteria. Appendix 2 lists the abbreviations used in the MRP. Appendix 3 presents a glossary of terms. Appendix 4 details the list of services included within the various Reference Interconnect Offers that should where practical be modelled. Post- och telestyrelsen 5

12 PART A: COMMON GUIDELINES Post- och telestyrelsen 6

13 2 Long Run Incremental Cost 2.1 Definition of LRIC In this section, the concepts involved in the definition of (forward-looking) Long Run Incremental Costs (LRIC) are discussed Long Run Using a long-run measure of costs, such as LRIC, implies a time horizon where all inputs, including capital equipment, may vary in response to a change in demand. This means that the cost models should adapt all input factors to the forecasted demand for services respecting practicalities like minimum size of input and quality of service Incremental Incremental costs are the costs caused by the provision of a defined increment of output given that some level of output (which may be zero) is already being produced. Equivalently, incremental costs can be defined as the costs avoided (i.e. saved) by not providing the increment of output. For the purpose of interconnection charges, the increments have usually been defined as the entire group of services using the core (or access) network. These services (PSTN, 5 Broadband, leased lines, etc.) include those provided by the SMP operator as well as those provided by interconnecting operators using the SMP operator s network. The costs of the network providing this wider group of services are then divided by the total volume of demand (for example, number of subscribers, calls or traffic minutes, Gigabytes) in the increment to produce the average incremental cost or per unit LRIC 6,7. Figure 1 illustrates the concepts of incremental and average incremental costs: 5 For the purpose of this Model Reference Paper, PSTN should be considered to include both PSTN and ISDN. 6 The terms LRIC and LRAIC (long run average incremental costs) are often used interchangeably. 7 This averaging does not imply that all the services included in the increment will be attributed the same costs. It simply means that the costs of using a given network element will be the same for the included services. Services will use the network differently. As discussed in section 5.4.4, this will be taken into account through the use of so-called routing factors. Services may also have different cost drivers, such as subscribers, calls and minutes, or packets. Nor does the averaging imply that prices will need to be the same throughout the day. When setting interconnection charges, costs may also be "de-averaged" to a peak and an off-peak charge. Post- och telestyrelsen 7

14 Figure 1: Long Run (Average) Incremental costs Costs Incremental costs 1 Average incremental costs Fixed common costs Increment Volume Forward-looking costs Costing systems can be backward-looking, forward-looking, or a mixture of the two. Backward-looking systems are based on the historic cost basis. They may contain outdated technologies and inefficiently incurred costs reflecting, for example, the costs of manpower required to maintain outdated technologies. Forward-looking costs are not the costs in the future but reflect the costs that a network operator, building a network today, looking forward, would incur. Costing measures should be forward-looking to reflect the true economic costs of producing an increment of output. In practice, however, there is likely to be considerable debate about the precise definition of forward-looking. Networks evolve over time with the result that the network of even an efficient SMP operator may look very different from the network design that would be used if starting from scratch (often referred to as a scorched earth assumption). To make no allowance for the starting position of the operator could result in cost estimates, and therefore interconnection charges, that are too low. Such an outcome would not provide the right incentives for SMP operators to invest in, and maintain, their networks. Moreover, other operators would have no incentive to invest in their own infrastructure, since they could immediately purchase the interconnection services from the SMP operator when an investment is successful, while not paying for unsuccessful investments. Therefore, the scorched node assumption discussed in section 12.1 should be applied. How forward-looking the models should be in their choice of technology is described in more detail in sections 7 and As mentioned, the forward-looking costs are the costs of building a network today, looking forward. "Looking forward" implies that the expected development in prices, first of all asset prices, and expected development in demand will need to be taken into account. Finally, it should be noted that the models should model this optimised network as if it were already in place. No migration costs (additional costs associated with moving from the existing network to the optimised network) should be included. Post- och telestyrelsen 8

15 Criterion CG 1 The models should be based on forward-looking long run incremental costs. No migration costs should be included. 2.2 Definition of increment Size of increment In principle, there are an infinite number of different sized increments that could be measured. However, these increments can effectively be grouped into three different categories: 1. a small change in the volume of a particular service; 2. the addition of a whole service; or 3. the addition of an entire group of services. The first definition of the increment is equivalent to a measurable version of marginal cost, that is the cost associated with a one-unit change in output. The second definition may apply to services of very different sizes, such as interconnection, local calls and national calls. In telecommunications regulation, the third definition of the increment is generally used to set interconnection charges. The use of large increments minimises the amount of common costs and ensures an equal treatment of the SMP operator's internal (on-net) and external (interconnection) traffic Access and core increment Two main increments are defined 9 : The access increment defined as all (regulated as well as unregulated) services using the access network The core increment defined as all (regulated as well as unregulated) services using the core network. The incremental costs of the core are those costs incurred when adding a core network when an access network is already in place. Similarly, the incremental cost of the access network is the cost incurred when adding an access network when a core network is already in place. The LRIC of co-location is the cost incurred when providing co-location services. 8 When both the internal and external traffic is included, the cost of using a given network element will be the same for internal and external traffic. This may not be the case if a separate increment is defined for interconnection services. 9 These definitions are consistent with the original definitions offered by the Commission in Commission Recommendation on Interconnection in a Liberalised Telecommunications Market Part 1 Interconnection Pricing, 15 October Post- och telestyrelsen 9

16 Criterion CG 2 For the core network, the increment should include all services using the core network. For the access network, the increment should include all services using the access network. The LRIC of co-location is the cost incurred in providing co-location services. These definitions should include the services provided by the SMP operator s network division to its own retail division as well as the services provided to other operators. Costs in the core increment are driven by, for example, the volume of traffic, packets or calls, whereas costs in the access network are mainly driven by the number of subscribers. Costs are also driven by the quality of service (QoS), particularly in the core network. Until QoS is specifically charged for separately, it will need to be treated as a minimum requirement. The access network is typically defined from the first connection point at the customer s premises up to and including the line card (hereafter referred to as the access-core line card). Having said this, current developments in technology are now blurring the borderline between the access and core networks. For PSTN services, the access-core line card can either be placed as part of the local exchange (often referred to as Host Subscriber Stage - HSS) or away from the local exchange (often referred to as Remote Subscriber Stage - RSS). For leased line services, the access-core line card will be placed as part of the transmission equipment at the first node (ie the serving node), and for broadband services, the access-core line card placed as part of the DSLAM, which might even be placed in a street cabinet. For Remote Multiplexers (RSMs) locations the situation is not so clear cut. In some cases, the RSM was installed to replace an old analogue exchange and in others has been used merely as a work-around for a lack of copper in the access network. In either case, there will also be a line card at the RSS/HSS and so there is an option for the access/core demarcation to be deemed to occur at either the line card of the RSM (in which case the RSM would have the access-core line card) or the line card of the RSS/HSS (in which case the RSS/HSS would have the access-core line card). Potentially, therefore, each RSM location needs to be treated on its own merits, with factors taken into consideration including: the historical reason for the RSM deployment the number of connected customers the existence (or not) of other equipment at that location (particularly DSLAMs) the physical distance from the RSM to the next equipment location The access-core line card should be included in the access network, as the number (and thus costs) of such line cards are related to the number of lines rather than the amount of traffic (whether minutes, calls, or packets). The cost of the line card should therefore be included in the cost of access services. However, the Post- och telestyrelsen 10

17 access-core line card(s) should be excluded from the costs of unbundled local loops, as the line card is not used in the provision of this service. Criterion CG 3 The access-core line card (typically, though not necessarily, for the PSTN located in the concentrator) should be included in the access network, whereas other equipment related costs should be included in the core network, except where costs are common between the two networks. The access-core line card(s) should be excluded from the costs of unbundled local loops but included in the costs of the access service it relates to (such as telephone line rental for a PSTN line card, broadband access for a DSLAM line card etc.) Other increments Other potential increments include a retail increment for the access and core networks; an international increment; an increment for premium rate services; an increment for the mobile network; and an increment for other services: Retail Increment. The costs referred to for the access network and core network are wholesale costs. They exclude any costs incurred in packaging and selling services delivered over these networks to final customers, as opposed to wholesale customers. Such costs include marketing and customer billing costs, customer service costs and retail elements of the finance and human resources departments, land and buildings. These costs belong in the retail increment. International Increment. This increment covers the costs of the transmission links between tandem and international exchanges as well as the cost of international exchanges and assets at these exchanges. International calls will typically use both the core increment and the international increment. Premium Rate Services Increment. Premium rate services include toll free (0800) phone calls and various information services which can be accessed at premium rate charges. These services may require a separate network of switches (in which additional transmission assets will be required) or may be delivered over existing switches. Mobile Increment. Assets included in this increment include the base stations, basestation controllers, mobile-switching centres and transmission links required by the mobile network. Other Increment. The SMP operator may provide a range of other services, such as the provision of customer premises equipment, and may have investments in other companies either at home or abroad. These increments will not need to be modelled separately. However, the associated traffic, using the core and access network, needs to be included in the core and access increment. Also the core and access increment may share costs with these other increments. For example, the international switches and mobile switches will often be co-located with the PSTN switches. Where this is the case, a fair proportion of the building costs (and other common costs) should be allocated to the mobile and international increment respectively. Similarly, the cost Post- och telestyrelsen 11

18 of the head office function should have a portion allocated to overseeing any investments in other companies. 2.3 Cost Causality The definition of the access and core increments set out in section implies that fixed costs 10 that are specific to either the core or access networks are included in LRIC. To the extent practical, costs (both capital costs and operating costs) should be allocated to services on the basis of cost causality. This might be on either a direct or indirect basis. A good example of how this might apply in practice is to consider the issue of trench, duct, cable and fibre where, as a starting point: Trench should be allocated on the basis of duct Duct should be allocated on the basis of cables Cables should be allocated on the basis of system lines (fibre pairs connecting distant items of transmission equipment) System lines should be allocated on the basis of usage, where necessary taking account of usage translation techniques (for example, translating voice minutes into Mbps) The above example assumes that the network is constructed in an efficient manner and does not, without good, justifiable reasons, separate services such that not all services attract a fair proportion of cost. We distinguish here between three types of costs: Directly attributable costs, shared costs and common costs. Directly Attributable Costs are the costs incurred as a direct result of the provision of a particular service in a particular increment. These costs fall into two types. Firstly, the costs of some inputs vary with the level of output, so that even if the output of more than one service requires this input, the extent to which a single service causes the costs can be calculated. Secondly, there are assets and operating costs which are fixed with respect to the level of output but which are service specific. Shared Costs are the costs of those inputs necessary to produce two or more services within the same increment, where it is not possible to identify the extent to which a specific service causes the cost. Examples of shared costs in the core network include optical fibre, transmission equipment and related overheads, all used by PSTN, leased line and other services Common Costs are the costs of those inputs necessary to produce one or more services in two or more increments, where it is not possible to identify the extent to which a specific increment causes the cost. Trenching costs provide a good example of the difference between shared and common costs. The costs of trenching specific to the access network (or the core network) will generally be shared costs since the trenching is likely to be used by two or more services. 10 Fixed costs are defined here as costs which do not change with the level of output Post- och telestyrelsen 12

19 However, some trenching will be used by both the access and the core network. In these instances, the costs will be common costs. Another example of common costs is corporate overheads. Figure 2: Cost concepts Access Network Costs Core Network Costs Attributable costs in the access network (e.g. line card) Shared costs in the access network (e.g. trench in the access network) Attributable costs in the core network (e.g. tandem exchange) Shared costs in the core network (e.g. trench in the core network, ADMs etc.) Common costs (e.g. trench shared by access and core) Figure 2 illustrates the relationship between directly attributable, shared and common costs. The first definition of the increment discussed in section would only include some of the directly attributable costs in the core and access networks. The second definition would include all directly attributable costs. But the variant of the third definition taken to be the increment for LRIC purposes would include all directly attributable and shared costs in the core and access networks. Only common costs would be excluded. Criterion CG 4 To the extent practical, costs (both capital costs and operating costs) should be allocated to services on the basis of cost causality. This assumes that the network is constructed in an efficient manner and does not, without good, justifiable reasons, separate services such that not all services attract a fair proportion of cost. 2.4 Treatment of common costs The large proportion of fixed common costs in telecommunications means that setting interconnection charges equal to incremental costs does not allow the SMP operator to recover the costs that span increments, even when those costs are efficiently incurred. However, setting interconnection charges based on (but not set at ) LRIC permits recovery of efficiently incurred common costs. This can be achieved via the use of mark-ups, where, for example, the LRIC of each increment is marked Post- och telestyrelsen 13

20 up by an equal proportion so as to recover (but not over-recover) the common costs. Criterion CG 5 The models should allow recovery of common costs. These costs should be shown separately. Criterion CG 6 The models should identify the costs that are common between the other increments and the core and access networks Allocation of common costs As defined above, common costs are the costs of those inputs necessary to produce one or more services in two or more increments, where it is not possible to identify the extent to which a specific increment causes the cost. The allocation of such common costs will therefore always be somewhat arbitrary. Otherwise the common costs would not really be common and should instead be allocated directly to the increment. Common costs are therefore typically allocated using some sort of mark-up 11. Before turning to the description of mark-ups, it should, however, be underlined that broad mark-ups should only be used where it is not possible to establish a clear causal relationship between costs and services/increments. In many instances it will be possible to establish such a relationship by carefully examining the direct and indirect costs drivers 12. Exchange buildings, for example, might at first sight be considered a common cost, as they are used to provide both access and core services. It would however, be inappropriate to allocate the total costs of exchange buildings on the basis of simple mark-ups. The costs of exchange buildings are to a large degree driven by the number of square meters required by the equipment installed in the buildings. Most of the equipment in the exchange building is core related. Only the distribution frame and part of the subscriber stage are access related. It will therefore be possible to allocate most of the building costs to the core network, e.g. on the basis of the occupied square meters. Mark-ups can be either additive or multiplicative and similarly be either differentiated or uniform. A (uniform) additive mark-up implies that common costs are divided by the number of increments and the resulting total is added to each increment (thus, if common costs were 2,000, 1,000 would be added to both 11 It may be noted that a price based on LRIC + mark-up for common costs will lie between LRIC and the so-called stand-alone costs (SAC), which are the costs of producing the increment, assuming no other increments were produced. A price set at SAC would correspond to allocating all the relevant common costs to the increment, whereas a price set at LRIC would correspond to not allocating any of the common costs to the increment. 12 Some underline this point by using the term residual common costs instead of common costs (the common costs that can not be satisfactorily allocated using direct or indirect cost drivers). Post- och telestyrelsen 14

21 the core and access increments). An additive mark-up implies that the allocation of common costs is independent of the costs of the various increments. A multiplicative mark-up implies that common costs are split in relation to the relative level of incremental costs of each of the increments. For example, if the incremental cost of access is 75% of total incremental costs and the incremental cost of core is 25% of these costs, then the access increment would be allocated 75% of common costs and the core increment 25% of these common costs. This means that if LRIC for the access network is 15,000 and LRIC for the core network is 5,000 and commons costs are 2,000, the mark-up will be 10% (2,000/ (15, )). Thereby 1,500 (=0.1x15,000) of the common costs are allocated to the access network and 500 to the core increment. Multiplicative mark-ups are sometimes referred to as equi-proportionate mark-ups. An alternative approach would be to calculate differentiated mark-ups. That is to say the mark-up as a proportion of incremental cost would vary between services. There are at least two potential rationales for using differentiated mark-ups. Firstly, differentiated mark-ups could be used to encourage entry or to ensure that common costs are not assigned to increments that are not prone to competition. 13 Having said this, differentiated mark-ups could well be not allowed under established regulatory practice. Secondly, differentiated mark-ups may be used to reflect the fact that services have different demand elasticities. So-called Ramsey mark-ups are determined on the basis of demand elasticities. Where a service has a high elasticity, the markup should be low, because changes in price have a significant impact on purchasing patterns thereby distorting market signals. The converse is the case where elasticities are low. From an economic point of view, a Ramsey mark-up is the theoretically correct way to efficiently recover the common costs, ensuring that resources are put to their best possible use. Indeed, it can be shown that a profit maximising company operating in a competitive market would also set its prices in this way. Ramsey pricing, however, has a number of weaknesses when implemented in practice. First of all, price elasticities are very difficult to estimate and verify. This is of special concern since an operator operating in both competitive and regulated markets will have a strong incentive to attribute a disproportionate amount of the common costs to the regulated products. Price elasticities would also be likely to vary over time, with price, and be dependent on the level of competition in various segments of the market. Also multiple price elasticities could occur depending on the intended use of the product. The method therefore faces a number of operational difficulties See footnote 11 in the Commission's recommendation on interconnection in a liberalised telecommunications market (98/C84/03) and point 696 in FCC's "First Report & Order in the Matter of Implementation of the Local Competition Provisions in the Telecommunications Act of 1996". 14 Proper Ramsey mark-ups would also take into account the impact of cross-elasticities and externalities. This could significantly improve the allocative properties of the resulting prices, but would also add to the complexity of the analysis and the associated data requirements Post- och telestyrelsen 15

22 Secondly, it may seem unfair that consumers should bear a larger burden of the costs just because they are so dependent on provision of the services or have so few alternatives that their demand is not very sensitive to the price. Finally, it is not always clear how to estimate demand elasticities for access and interconnection services, since these services are sold to other operators reselling and re-packaging the services to end-users with very different demand elasticities. Criterion CG 7 As far as possible, common costs should be allocated to increments and services using appropriate (direct or indirect) cost drivers. Only common costs, for which it is not possible to identify the extent to which a specific increment or service causes the costs, should be allocated via mark-ups. The starting point should be equi-proportionate mark-ups. The models should allow for equi-proportionate mark-ups to be used for all cost categories. It is possible that there could be instances where there might be good reasons for departing from equi-proportionate mark-ups. However, if this is the case, it must be properly justified in the model documentation. Post- och telestyrelsen 16

23 3 Services modelled Telecommunications operators typically carry a wide range of services across their networks. In addition to the traditional voice services, operators provide leased lines, broadband and other data services, and other services such as cable TV. The models need to account for all of these services. To exclude some would result in an under-dimensioned network and increased costs for the remaining services as costs, such as ducts, would be allocated to fewer services. Therefore more services need to be modelled than the actual number of services that should be priced on the basis of LRIC. Appendix 4 includes a detailed list of the RIO (Reference Interconnect Offer) services. The models should include and categorise services under the following headings: Core and access services PSTN/ISDN services Broadband services (including Bitstream access) Leased lines; and Other services Co-location services 3.1 Core and access services PSTN (PSTN/ISDN) and Broadband services PSTN services include standard call services that originate and terminate on exchange lines, whereas broadband services include both retail and wholesale (Bitstream) services. The services comprise a broad variety; below is listed the most important of these. Post- och telestyrelsen 17

24 Table 1: List of standard PSTN/ISDN and Broadband services Core Access National calls PSTN Line Rental - FO 15 -internal calls ISDN 2 Line Rental - FO-external calls ISDN 30 Line Rental International calls Inbound Wholesale Line Rental** International calls Outbound Shared Access** International calls Transit Full Access** Fixed to mobile calls Other Access (including fibre and wireless technologies)** Mobile to fixed calls IN services Broadband Mass call services Internet dial-up (network product) Retail broadband Interconnection - double segment (double Bitstream access tandem) Interconnection - region segment (single tandem) Interconnection - metro segment Interconnection - local segment Interconnection - single transit Interconnection - double transit Interconnection - international call Operator Services Other calls ** Where the demand for these services has not been included in other categories, such as PSTN or ISDN line rentals. The purpose is to estimate demand for all access lines, avoiding double counting. Criterion CG 8 The models should include all standard PSTN/ISDN and Broadband services Leased lines To ensure that the volume information in the top-down and bottom-up models is consistent, the leased lines should be defined in a uniform way ensuring compatibility between the models. Leased lines may thus be classified in the three following groups: 15 Förmedlingsområde, or transit area. An FO internal call covers calls up to and including those using a single transit switch, whereas an FO external call covers calls using more than one transit switch. Post- och telestyrelsen 18

25 retail customers, usually requiring leased lines to provide a permanent connection between customer premises; other operators, usually requiring leased lines to provide a permanent connection between networks; network operators, requiring leased lines for internal use. In addition to this, SMP operators may carry data or other services over leased lines. Such services should be modelled and shown separately. Criterion CG 9 When dimensioning the network, the leased lines traffic volume should include leased lines provided to retail customers, to other operators and to the network operator itself. The models will not need to calculate the costs of leased lines explicitly. Leased lines should only be included for dimensioning the network and for ensuring that a fair amount of the costs shared with PSTN and Bitstream services are allocated to leased lines services Other services Demand for other services using the core and access networks should also be included to ensure that the core and access increments are dimensioned properly. Inclusion of this demand will allow a fair distribution of shared and common costs. Cable television, Virtual Private Networks (VPN) and packet-switching technologies such as frame relay are examples of these services. Criterion CG 10 Where possible, the models should categorise the other services into two major groups: one category comprising for example cable TV services, IP TV services and other services using their own nontelecommunications electronic equipment. one category comprising non broadband data services (by type) using the core network. It is not the purpose of the models to calculate the LRIC of these services, but only to ensure that a fair proportion of costs is attributed to these services. 3.2 Co-location services The nature of co-location services Co-location enables the placement and operation of telecom equipment in buildings housing technical plant. Co-location services provide access to the infrastructure of these buildings such as power supply, cooling, ventilation, security, and common amenities. Post- och telestyrelsen 19

26 From a modelling point of view, no network modelling is required in order to model co-location services. What has to be modelled is the cost incurred by producing the co-location services. Co-location may be relevant in relation to switched interconnection, access to unbundled local loop, or for other purposes. However, only the co-location services related to access to the unbundled local loop are to be priced on the basis of LRIC. Despite this, the co-location services to be modelled in the top-down and bottomup models may include more services than only the services which are to be costed according to LRIC principles. The reason behind the inclusion of more services is that some of the costs that make up the LRIC-specific co-location services are shared with other co-location services (i.e. co-location in relation to switched interconnection or "tele hotels"), services in the access network, and services in the core network. Examples of such shared costs may be the cost of accommodation, power supply, cooling/ventilation, and also the cost of administrative and technical staff. On the other hand, some co-location services include only co-location specific cost categories, such as racks and cables. In this case, only the services related to access to the local loop (that are to be costed according to LRIC principles) have to be modelled. Last, the costs of power consumption used by electronic equipment and cooling/ventilation can be attributed directly to relevant co-location services on the basis of the unit price paid to the power supplier List of co-location services covered by LRIC According to Skanova s co-location agreement, co-location includes the following services: Fee for tenders Location of equipment Transportation of equipment Installation and mounting of equipment Station wiring Placing Power, cooling and ventilation Demonstration of co-location node In Skanova s co-location agreement, a number of service variations are listed for each of these services. The variations are associated with different prices. The reason may be that different costs are incurred for the different service variations. The models should model the cost of all service variations set out in Appendix 4. Post- och telestyrelsen 20