24742 November 2000 Telecommunications Regulation Handbook Edited by Hank (ntven McCarthy Tetrault infoDev Telecommunications Regulation Handbook Funding for the preparation of this Handbook was provided by the infoDev Program of The World Bank infoDev Additional funding was provided by McCarthyTetrault Telecommunications Lawyers and Consultants The authors gratefully acknowledge the support and assistance provided in the preparation of this Handbook by the International Telecommunication Union (ITU) The rmodules of this Handbook are available electronically at www.lnfodev.org/projects/3 1 4regulationhandbook © 2000 The World Bank 1818 H Street Washington, DC 20433 USA Rrst printing November 2000 The Vvorld Bank enjoys copyright under protocol 2 of the Universal Copyright Convention. This material may nonetheless be copied for research, educatlonal. or scholarly purposes only In the member countries of the Wobrld Bank. The findings, Interpretations, and conclusions expressed in this document are entirely those of the authors and should not be attributed to the World Bank, to its affiliated organizations, or the members of its Board of Executive Directors or the countrles they represent. This book is distributed on the understanding that if legal or other expert assistance is required in any particular case, readers should not rely on statements made in this book. but should seek the services of a competent professional. Neither McCarthy Tetrault nor The World Bank accepts responsibility for the consequences of actions taken by readers who do not seek necessary advice from competent professionals, on legal or other matters that require expert advice. ISBN 0-9697178-7-3 Principal authors: Hanik Intven Jeremy Oliver Edgardo Sepuilveda of McCarthyTetrault Telecommunications Lawyers and Consultants www.mccarthy.ca Summary of Contents Note: Detailed Tables of Contents appear at the beginning of each Module Module I Overview of Telecommunications Regulation l-1 Module 2 Licensing Telecommunications Services 2-i Module 3 Interconnection 3-I Module 4 Price Regulation 4-I Module 5 Competition Policy 5-1 Module 6 Universal Service 6-1 Appendices A wTO Regulation Reference Paper A-I B The Economics of Telecommunications Prices and Costs B- I C Glossary C-I D Selected Sources D-1 Foreword It is a pleasure for us to present this Telecommunications We are pleased to provide this foreword for the Regulation Handbook. Telecommunications Regulation Handbook. The preparation of this book was partially funded by a Staff of the Intemational Telecommunication Union have grantfromthe infoDev Program ofThe World Bank Group. collaborated in the preparation of this handbook, and In funding the book, we recognized the fundamental we recommend its reading for regulators and others importance of an approprate regulatory environment to involved in the telecommunications sector around the accelerate connectvity and access to informaton services. world. The objective of infoDev in supporting this project was to provide regulators and others involved in the regulatory The book provides a useful compilation, in a single process with a practical reference source on the methods volume, of descriptions and analyses of regulatory used to regulate the telecommunications sector around practices and approaches applied in a wide range of the world, focussing on best practices. countries. The authors have succeeded in providing a clear and This type of information will be particularly important to straighfforward description of major regulatory practices members and staff of the new separate regulatory used in the telecommunications sector around the authorities that have been established in more than 90 world. The focus is on practices that promote the countriesaroundtheworldinthelastdecade. However, efficient supply of telecommunications services in a it will also be of interest to the policymaking community competitive marketplace. and to those in the private sector involved with the regulatory and policy aspects of the telecommunications The practice of telecommunications regulation is sector. constantly evolving and there will undoubtedly be different views on which approach to use in a given market at any The book was prepared with input and assistance from point in time. While the advice and opinions expressed in the ITU Telecommunication Development Bureau and this book do not necessarily reflect the views of infoDev the ITU Strategies and Policy Unit. However, the views or The World Bank Group, we believe that the book will expressed in the book are those of the authors and do make a valuable contribution to the understanding of not necessarily reflect the opinions of ITU or its telecommunications regulation around the globe. members. Mohsen A. Khalil Ben A. Petrazzini Director, Global Information and Communication Policy Advisor, Office of the Secretary General Technologies Department International Telecommunication Union The World Bank Group Doreen Bogdan-Martin Carlos A. Primo Braga Regulatory Officer, Policies, Strategies, and Financing Program Manager, infoDev Program Department The World Bank Group Telecommunication Development Bureau Intemational Telecommunication Union Peter L. Smith infoDev Task Manager Principal Telecommunications Specialist The World Bank Group Editorial Committee Members Telecommunications Regulation Handbook Professor Dr. Jens C. Arnbak Mr. Diego E. Molano Vega* Mr. Peter L. Smith Chairman of the Commission Coordinator, Telecommunications Principal Telecommunications OPTA Regulatory Commission, Specialist The Hague, Netherlands Bogota, Colombia The World Bank Washington, DC, USA Ms. Doreen Bogdan-Martin Ms. Elizabeth M. Nzagi Ms. Susan Schorr Regulatory Officer Legal Counsel Regulatory Officer, Sector Reform ITU Tanzania Communications Unit Geneva, Switzerland Commission ITU Dar Es Salaam, Tanzania Geneva, Switzerland Mr. David Colville Mr. Ben Petrazzini Ms. Meni Styliadou Vice Chairman Policy Advisor Counsel Telecommunications Office of the Secretary General European Bank for Reconstruction, CRTC ITU and Development Ottawa, Canada Buenos Aires, Argentina London, UK Mr. Sonwabo Eddie Funde Professor Gyula SalIai Mrs. Lee Tuthill Deputy Chairperson, SATRA Executive Vice President Senior Counsellor Chair of TRASA Communication Authority World Trade Organization Marlboro, South Africa Budapest, Hungary Geneva, Switzerland Mr. Leong Keng Thai* Prof. Rohan Samarajiva* Dr. Herbert Ungerer* Director General Director General Head of Unit IDA Telecommunications Regulatory DG IV Singapore Commission of Sri Lanka European Commission, Colombo, Sri Lanka Brussels, Belgium Mr. Jorge Kunigami Mr. Winston Ragbir Mr. Bjom Wellenius* Chairman Acting Chair TelecommunicationsAdviser OSIPTEL Caribbean Telecommunications Union The World Bank Lima, Peru RO.S. Trinidad Washington, DC, USA Dr. Yusuf Mansur* Mr. David E. Satola Mr. Dimitri Ypsilanti Director General, Telecommunications Senior Counsel Head of Telecommunications Section Regulatory Commission of Jordan The World Bank OECD Amman, Jordan Washington, DC, USA Paris, France Mr. William H. Melody Dr. Harsha Singh Mr. B.K. Zutshi* Professor, Economics of A/ Secretary Vice Chairperson Infrastructure Telecommunications Regulatory Telecommunications Regulatory Delft University of Technology Commission of India (TRAI) Commission of India (TRAI) Delft, Netherlands New Delhi, India New Delhi, India Dr. Enrique Melrose Comisionado de Ingeniera Technologia COFETEL Mexico D.F., Mexico Note: * position at time of appointment to editorial committee Preface and Acknowledgements It is not an easy task for busy professionals to write a We gratefully acknowledge the support of the infoDev book on their area of practice. The task has both Program of The World Bank which provided funding challenges and rewards. While this book was being for the production of the book. Special thanks to Peter written, our practice group advised on the privatization L. Smith, who acted as project task manager and Carlos of a major telecommunications company in one country, Braga, who leads the infoDev Program. the resolution of interconnection disputes in three countries, the licensing, establishment or financing of We also wish to acknowledge the support and assistance new telecommunications operators in half a dozen from representatives of the ITU's Telecommunication countries, and other telecommunications projects on Development Bureau and Strategies and Planning Unit, five continents. particularly Doreen Bogdan-Martin, Don Maclean, Ben Petrazzini and Susan Schorr. Their comments, as well The challenge was finding the time to write the book. as access to ITU reports, data and contacts, greatly The reward was the constant cross-fertilization of ideas facilitated the task of writing the book. and experience between our telecommunications practice and our work on the book. We frequently Our thanks to all of the members of the handbook incorporated ideas from our practice in the book, and editorial committee. They included some of the leading vice versa. Therefore, our first acknowledgement must players in telecommunications regulation and sector go to our clients: telecommunications companies, reform around the world. We are grateful to the investors, regulators, governments and international committee members who sent us missives through financial institutions, among others. We leamed from cyberspace, with constructively critical comments, them all. information and text revisions that significantly improved the quality of the book. Members of the editorial The principal authors of this book were Jeremy Oliver, committee are listed on the previous page. Edgardo Sepulveda and myself. However, we received a lot of help from other members of the McCarthy Finally, I must acknowledge some of the book's Tetrault telecommunications practice group across shortcomings. Given our time and budget, we did not Canada and in Europe. Some wrote sections of the set out to produce a comprehensive text on all aspects book, others provided invaluable comments, of telecommunications regulation. Some significant information and advice. Grant Buchanan, Julio areas of regulation, particularly spectrum regulation and Montero and Steve Rawson made major contributions. numbering, have been largely omitted. We could not Other members of our group who provided comments cover approaches to regulation in all countries and and support include Tim Ellam, Peter Grant, Tony regions. Instead, we attempted to focus on "best Keenleyside, Monique Lafontaine, Charles Morgan, practices". We undoubtedly got it wrong in some cases. Michel Racicot, Georges Racine, Lorne Salzman, and In addition, factual and other errors and dated Elspeth Williams. Finally, the book would not have references will have crept into the text. For this I been completed without the extraordinary efforts of apologize, and, as editor, accept personal responsibility. Mary Riccobene. Any corrections or comments would be appreciated. Hank Intven Toronto, Canada November 2000 hintven@mccarthy.ca MODULE 1 Overview of Telecommunications Regulation Table of Contents Module I - Overview of Telecommunications Regulation 1.1 Regulatory Objectives I 1.1.1 Why Regulate Telecommunications? 1 1.1.2 Expansion of Telecommunications Regulation 3 1.1.3 Implementing Telecommunications Sector Reform 4 1.2 Regulatory Organizations 5 1.2.1 The Role of National Government Authorities 5 1.2.2 The National Regulatory Authority 6 1.2.2.1 Independence of the Regulator 6 1.2.2.2 Funding the Regulatory Process 7 1.2.2.3 Single Regulators and Collegial Commissions 7 1.2.2.4 Multi-Sector Regulators 8 1.2.2.5 Organization of Regulatory Staff 10 1.2.3 International Agencies 11 1.2.3.1 International Telecommunications Union (ITU) 11 1.2.3.2 Other International Organizations 13 1.3 The Regulatory Process 19 1.4 Principles for Effective Regulation 21 1.4.1 Minimize Regulatory Intervention After Competition is Established 21 1.4.2 Harmonize with Regional and Global Regulatory Standards 22 1.4.3 Introduce Competition 23 1.4.4 Regulate by Principle 24 1.4.5 Establish Operational Efficiencies 24 1.4.6 Strategies for Effective Regulation in Developing Economies 25 McCarthyTetrault infoDev Boxes, Figures and Tables Boxes Box 1-1: Widely Accepted Regulatory Objectives 2 Box 1-2: Advantages and Disadvantages of Multi-Sector Regulators 9 Box 1-3: Principles of Proper Decision Making 20 Box 1-4: Highlights of 1999 Plan to Overhaul the FCC 24 Figures Figure 1-1: Growth in Number of Regulators 3 Tables Table 1-1: Major Global Telecommunications Sector Reforms and Associated Objectives 4 Table 1-2: Standard Institutional Structure in Developed Market Economies 5 Table 1-3: Selected International Organizations Interested in Telecommunications Regulation 14 Table 1-4: Regulatory Strategy Checklist 25 1 - ii infoDev McCarthyTetrault OVERVIEW OF TELECOMMUNICATIONS REGULATION 1.1 Regulatory Objectives and introduced new service providers to tele- communications markets 1.1.1 Why Regulate Telecommunications? W Development of intemational trade in telecom- The last decade of the 20th Century saw munications services, which are increasingly unprecedented changes in the global telecommuni- provided by transnational and global service cations industry. Numerous state-owned providers telecommunications operators were privatized, and a wave of pro-competitive and deregulatory tele- As market-based approaches were adopted during communications policies swept the world. New the 1990s, the number of national telecommunica- market-based approaches to the supply of tions regulatory authorities increased from 12 to over telecommunications services were introduced in 90 around the world. To some this appears ironic. scores of countries. Shouldn't the market-based supply of telecommuni- cations be accompanied by less regulatory This liberalization of telecommunications markets intervention, rather than more? was motivated by various factors, including: The consensus answer around the world is yes - in > Increasing evidence that more liberalized tele- the long run, but no in the short run. The successful communications markets were growing and transformation of monopolistic telecommunications innovating faster and serving customers better markets into competitive ones requires regulatory intervention. Without it, viable competition is not > The need to attract private sector capital to likely to emerge. In fact, the times when privatization expand and upgrade telecommunications and the introduction of significant competition occur networks, and to introduce new services can be the busiest periods in the lIfe cycle of a regulatory organization. - Growth of the Intemet, which caused data traffic to overtake voice traffic in many countries, and Regulatory intervention is required for a variety of led to the introduction of many new service reasons. Typically, regulators must authorize or providers license new operators. They must often remove barriers to market entry by new operators. They > Growth of mobile and other wireless services, must oversee interconnection of new entrants with which provided altematives to fixed networks incumbent operators. Regulatory intervention may McCarthyTe'trault infoDev 11 Telecommunications Regulation Handbook also be required to ensure competitive markets do telecommunications services to the public. The not fail to serve high cost areas or low income service suppliers will generally be private sector subscribers. operators. The objectives of telecommunications regulation The trend today is toward deregulation. Some vary from country to country. Govemments in most traditional forms of telecommunications regulation countries continue to see telecommunications as an are now viewed as having been more damaging essential public service. Even after telecommunica- than beneficial to the development of national tele- tions networks are no longer run by them, communications infrastructure and services. Today, governments normally retain a regulatory role to when regulatory measures are proposed or ensure that telecommunications services are reviewed, govemments and regulators must supplied in a manner consistent with national generally ensure that (1) there is a demonstrated perceptions of the public interest. need to regulate, and (2) the most efficient measure is selected to meet the specific regulatory objective. With the widespread adoption of market-based approaches to the supply of telecommunications While regulatory measures vary from country to services, there is a growing consensus that regula- country, the main objectives of telecommunications tors should not be involved in detailed regulation are often similar. Box 1-1 lists some "management" of the sector. Instead, the regulators' regulatory objectives that are widely accepted role is seen to involve maintenance of a regulatory around the world today. environment conducive to the efficient supply of Box 1-1: Widely Accepted Regulatory Objectives > Promote universal access to basic telecommunications services > Foster competitive markets to promote: - efficient supply of telecommunications services 9 good quality of service > advanced services, and " efficient prices > Where competitive markets do not exist or fail, prevent abuses of market power such as excessive pricing and anti-competitive behaviour by dominant firms > Create a favourable climate to promote investment to expand telecommunications networks > Promote public confidence in telecommunications markets through transparent regulatory and licensing processes - Protect consumer rights, including privacy rights Promote increased telecommunications connectivity for all users through efficient interconnection arrangements > Optimize use of scarce resources, such as the radio spectrum, numbers and rights of way 1- 2 iinfoDev McCarthyTetrault Module I - Overview of Telecommunications Regulation 1.1.2 Expansion of Telecommunications administrations were privatized. The overall Regulation objective of these new regulators was to ensure that public policy objectives for the sector continued to be Government regulation of private sector telecommu- met. While government monopolies are not nications operators began in the US and Canada in perceived to require regulation, private monopolies the late 19th Century. However, in most of the world, generally are. Introduction of competitors in many telecommunications networks were operated by newly privatized markets also increased the need for government administrations for most of the 20th new regulators, to act as referees between the new Century. In most countries, governments ran tele- entrants and incumbent operators. communications operations in the same way as government postal, rail or highway transportation ITU data indicate that in 1990, 12 countries had services. This situation changed dramatically over telecommunications regulatory agencies that the past ten years, as dozens of countries privatized functioned separately from telecommunications their telecommunications operations. operators. The term "separate regulators" generally refers to agencies that operate separately from The number of telecommunications regulators has government ministries or PTTs that are also increased rapidly over the past few years. Several responsible for the provision of telecommunications factors precipitated this growth in regulation. The services. By August 1999, that number had major factor is the implementation of telecommuni- increased to 84. Nine new regulators were estab- cations reforms that led to the separation of the lished between mid-1998 and mid-1999. In late policy, regulatory and operational functions of 2000, the number was around 96 and increasing. telecommunications. The growth in the establishment of separate regulators is illustrated graphically in Figure 1-1. Regulatory agencies were established at the same time that many government telecommunications Separate regulators, by region, 1999 Establishment of separate regulators 96 E~op 24% A.iP.dfC M . _.__._ _ 1990 1992 1994 19s9 1999 2000 M_Carthy _&rault infoDev 1-3 McCarthyTetrault infoDev1-3 Telecommunications Regulation Handbook While the growth of regulatory authorities is remark- 1.1.3 Implementing Telecommunications able, it should be kept in perspective. In many Sector Reform cases, new regulators replace existing PTT or Ministry functions. Therefore, in some countries, the While govemment policy officials usually introduce establishment of separate regulators may not result telecommunications sector reforms, regulators must in an increase in the number of government officials implement many of these reforms. Good regulation with regulatory functions. Also, while there is likely to is required to ensure the success of sectoral be an increase in regulatory activity around the time reforms. Table 1-1 summarizes major reforms that of privatization and the introduction of competition, have been introduced, and are continuing to be the level of regulatory intervention can be expected introduced around the world. The table also lists to drop significantly once competitive markets are major objectives for the introduction of these established. refomms. Thble 1-1: Major Global Telecommunications Sector Reforms and Associated Objectives Reforms Major Objectives Privatization of PTTs 9 Attract financing to expand telecommunications infrastructure l Increase sector efficiency, introduce new services > Generate government revenues from privatization proceeds Licensing of Competitive - Expand range of services; serve unserved markets Operators 9 Increase sector efficiency through competition l 9- Decrease prices, improve range and supply of services X Stimulate innovation and introduce advanced services 9- Generate government licensing revenues Introduction of - Increase success of licensing processes & govemment credibility Transparent Regulatory , i Processes Ru9 Increase government revenues from licensing new services , Increase market confidence, attract more investment Mandatory > Remove barriers to competition Interconnection and Unbundling of PSTN : > Promote competition in advanced services (e.g. broadband lntemet) Price Cap Regulation > Better incentives for efficient service supply by dominant firms 9 Simpler method that ROR regulation to prevent excessive pricing > Reduce regulatory lag; ensure timely price adjustments Targeted Universal Access 9 Increase efficiency and effectiveness of universality policies Funds 1- 9 Replace less transparent and potentially anti-competitive cross-subsidies Removal of Barriers to 9 Increase investment in telecommunications sector International Trade in Telecommunications Improve competition in telecommunications markets Improve global communications 1 - 4 infoDev McCarthyTetrault Module 1 - Overview of Telecommunications Regulation While a number of-these reforms were perceived as also facilitates compliance with the WTO Regulation radical when they were first proposed 10 or 20 years Reference Paper, in that it provides for a regulator ago, many have become the generally accepted that is separate from the telecommunications standards today. As these reforms were introduced operator, and that can resolve interconnection in an increasing number of countries, some have disputes. This structure has the following features: become incorporated into trade agreements and intemational trade policies. Most significantly, the > Govemment officials can set policies in the WTO Agreement on Basic Telecommunications national interest, without conflicting concems (ABT) and its Regulation Reference Paper incorpo- based on their role as owners, managers or rate a number of these reforms. The ABT is employees of telecommunications operators. In discussed in several Modules of this Handbook and particular, governments are more inclined to the Reference Paper is reproduced in Appendix A. introduce significant competition in telecommu- nications markets if they do not also run the 1.2 Regulatory Organizations main operator. 1.2.1 The Role of National Government > Separate regulatory authorities can implement Authorities government policy in an objective and impartial manner. Separation from state-owned telecom- Until recently, in many countries, a single Ministry or munications operators increases the ability of other government administrative unit performed the regulators to act impartially toward all market roles of telecommunications policy maker as well as participants, for example in matters involving owner and operator of the national telecommunica- competition policy or interconnection. tions network. No need was perceived for a regulator in this environment. The same government - Market confidence in the impartiality of regula- officials were often involved in policy decisions, tory decisions generally increases with the policy implementation and operation of the degree of independence of regulators from both telephone service., operators and governments. Such market confidence promotes increased foreign and Privatization and market liberalization has led to a domestic investment in both incumbent re-organization of the govemment institutions operators and new entrants in the sector. involved in the telecommunications sector. The most common institutional model used in developed - Privately owned operators can make rational market economies around the world today, is economic decisions about the supply of tele- illustrated in Table 1-2. communications services, without conflicting concerns arising from government ownership. The structure set out in Table 1-2 is compatible with the market-based supply of telecommunications services, rather than govemment-based supply. It glT511eiti -2:.aSt n-dar.-duns7titu-tion-alzStr.uc-t-u-raIei-niBe3veI1o7pe-dLMrketj nMIe Policy ~~~evelopmen1 Gover07 ~nment iityo tievtlve Branch BR, ~~~~~~~~~ega e eglaoy utort NetorkOprations/SRieF Provi6.s ion111111 I~rPdLIvqate"lyorcomm,erclalIyopraed McCarthy Tetraukt infoDev I1-5 Telecommunications Regulation Handbook - For example, some PTTs traditionally main- - Independence of the Regulator tained excessively large work forces for political or other non-economic reasons. This resulted in ' Funding of the Regulatory Process inefficiency and added costs for consumers. In most cases, privatization of telecommunications :" Single Regulators and Collegial Commissions operations has increased the supply of tele- communications services and reduced costs. > Multi-Sector Regulators "Commercialization" of state-owned operators can also increase immunity from government - Organization of Regulatory Staff interference, relative to traditional PTTs. However, the degree of immunity depends on 1.2.2.1 Independence of the Regulator the degree of independence granted to the "commercialized" state operators. As illustrated in Table 1-2, the standard institutional structure for the telecommunications sector around While there continue to be different views about the the world today includes a separate regulator. What best institutional structure for the telecommunica- is most important in this regard is separation of the tions sector in different countries, the model regulator from the telecommunications operator(s) in described above has clearly become the standard the market. Such separation inspires market one. Other models are often seen as transitional, confidence and promotes compliance with intema- with recognition that the "standard" model will tional trade obligations. ultimately be adopted. Of equal importance in the eyes of many In some countries, other govemment ministries or experienced telecommunications experts is agencies may play key roles in the telecommunica- independence of the regulator from governments. In tions sector. For instance, a competition authority practice the degree of such independence varies may be an important component of the institutional considerably from country to country. It depends on structure (the respective roles of a general competi- the legal, political and institutional structure of each tion authority and a sector-specific telecommunica- country. Regulators in few, if any, countries enjoy tions regulator are discussed in detail in Module 5). complete independence from governments. At a Other organizations that may play a significant role minimum, most regulators are appointed and paid in determining the overall economic environment of by governments, and have budgets established or the telecommunications sector include ministries of controlled by them. finance and ministries of planning, as well as privatization and tax authorities. All of these There are good reasons for increasing the degree of institutions can play particularly important roles at independence of regulators from govemments. Such the time of privatization. However, once privatization independence increases perceived neutrality and is completed, they often take on a more secondary insulation from political or operational pressures. role to the three entities described in the "standard This perception of independence is particularly mode". important where a government retains ownership of the PTO. 1.2.2 The National Regulatory Authority Telecommunications operators and investors will An increasing number of govemments have generally have greater confidence that an developed an institutional structure of the type illus- independent organization will regulate a market trated in Table 1-2, which includes a separate objectively and transparently. This can lead to national regulatory authority. A variety of increased investment in the sector and to related approaches have been developed to establish and benefits for the economy. Such confidence will, operate such regulatory authorities. In the following however, depend on the credibility of the regulator. It sections we consider five major issues that must have a demonstrated capability to regulate in a frequently arise: professional and impartial manner. 1-6 infoDev McCarthyTetrault Module I - Overview of Telecommunications Regulation In some countries, separation of regulators from the telecommunications revenues in the sector. Over general government administration also provides an time, however, the licence fees payable by the opportunity to pay higher salaries to regulatory incumbent will decrease, as other operators gain officials. This can be important in developing and market share. transitional economies where extremely low gov- emment pay scales can make it difficult to attract There are advantages to funding a regulator through and retain highly qualified and non-corruptible staff. licence and spectrum fees rather than government The best staff of regulators in such countries can appropriation. Licence fees provide a way of recov- easily be lost to the private sector if the regulators' ering the costs of government services on a "user pay scale is not competitive. pay' basis. Telecommunications sector licence fees can generate a sufficiently large source of revenues Finally, it must be clear that "independence" of the to ensure the regulatory function is carried out in a regulator does not mean independence from the professional manner, something that cannot always laws and policies of a country. The mandate of an be assured by cash-strapped governments in independent regulator should be clearly spelled out developing economies. Other segments of society in national laws. Regulators should be accountable and the economy are not burdened with the regula- to legislatures or other govemment bodies. Such tory costs. There is some accountability and greater accountability should include mechanisms, such as transparency to determine when regulatory budgets annual reports or legislative hearings, in which the are being spent well, and when they are not. The regulator must demonstrate in a transparent manner issue of licence fees is discussed further in Module that it has properly exercised its mandate. 2. 1.2.2.2 Funding the Regulatory Process 1.2.2.3 Single Regulators and Collegial Commissions It is essential to provide adequate funding for the regulatory process. Funding is required to hire good- Telecommunications regulators first emerged in the calibre professional staff and consultants that can US and Canada at the end of the 19th Century. implement regulatory objectives. Without adequate These regulators were structured as quasi-judicial funding, regulation will not usually be effective. boards or commissions. While these regulators were Regulatory objectives related to the opening of led by a chairperson, they were essentially collegial competitive markets and the establishment of a level organizations. Decisions were typically made by playing field are not likely to be achieved. consensus or, in case of controversy, by a majority vote. As the complexity of regulation increased, Separate regulators can be funded in a number of these regulators eliminated some of their judicial ways. Traditionally, regulatory functions were funded trappings, and hired an increasing number of out of general government budget appropriations, technical, professional and support staff. particularly when the functions were carried out within Ministries of Communications or PTT When new telecommunications regulators were Administrations. Budget appropriations are also established around the world in the 1990s, many used for many separate regulators. However, were headed by a single director general, or other licence fees and spectrum fees paid by operators official. This structure was similar to other govern- provide an increasingly common means to fund the ment organizational models used in some of the regulatory function. countries where the new regulators were estab- lished. An early example was Oftel, the UK A typical approach to levying licence fees is to regulator, which was established in 1984, when distribute the costs of running the regulatory British Telecommunications was privatized. As with functions among all licensed telecommunications the commission model, regulators headed by a operators in proportion to their gross telecommuni- single official are usually assisted by various cations revenues. Thus, in the early years, the technical, professional and support staff, as well as incumbent operator (e.g. the former PTT) may pay outside consultants. 90% of the regulator's costs because it earns 90% of McCarthyTetrault infoDev 1 - 7 Telecommunications Regulation Handbook In the latter part of the 1990s, the commission Bureau Chiefs of the FCC in the US. Thus, while the approach became more popular again. The 1999 final decision on important regulatory matters and ITU Trends Report indicates that six of the nine new directions will rest with the single regulator or regulators established between July 1998 and commission, depending on the model, much of the August 1999 were collegial bodies, composed of staff work and more routine decision-making can be between five and eleven members. New regulators very similar under both models. established in Albania, Bulgaria, Egypt, Greece, Kenya, Malawi and Malaysia are all collegial bodies. 1.2.2.4 Multi-Sector Regulators There are advantages and disadvantages to both Telecommunications regulators usually have sector- the hierarchical and collegial approaches. Neither specific regulatory functions. In most cases, they are can be said to be superior in all cases. However, responsible for regulating only telecommunications several observations can be made: markets. In some cases, they also have regulatory functions in adjacent markets. Examples include > Single regulators can act more quickly and broadcasting (e.g. Canada and the US) and decisively than collegial bodies. information services generally (e.g. Singapore and Malaysia). South Africa has established a merged - Collegial bodies provide checks, balances and telecommunications and broadcasting regulator collegial support for the decision-makers. (ICASA) on 1 July 2000. Decisions can therefore be more thoroughly debated and considered. A different approach that is well worth considering involves the establishment of a multi-sector regula- - Large collegial bodies can lead to less cohesion tor. Such an agency typically regulates and consistency than small ones or single telecommunications as well as other industry sectors regulators. with similar economic and legal characteristics. Examples of such sectors include electrical power > Some countries with large collegial bodies have generation and distribution, oil and gas pipelines, reduced them in size to increase decision- postal services, transportation and water utilities. making efficiency (e.g. the US). Multi-sector regulators, often referred to as public ' Some collegial bodies, especially large ones, service commissions, existed for many years in have part-time members. Such members Canadian provinces and states of the US. They usually find it more difficult to keep abreast of have also been established in some developing developments in rapidly changing telecommuni- economies, such as Bolivia, El Salvador, Jamaica cations markets. and Panama. The multi-sector approach was also seriously considered, but recently rejected in the UK. > Collegial bodies are somewhat less susceptible Box 1-2 sets out some of the advantages and to "capture" by regulated companies. However, disadvantages of the multi-sector regulatory financially insecure regulators of both types may approach. be motivated by future career prospects in the industry. Government tenure or other forms of Other considerations are relevant in deciding security can mitigate this concem. whether a multi-sector regulatory approach works in any particular country. In most countries, reform In practice, both single regulators and collegial occurs at different times in different industry sectors, commissions often rely heavily on professional staff such as telecommunications, energy, and water. It and consultants for fact gathering, analysis, and may be impractical to establish multi-sector recommendations. In some cases, regulatory staff regulatory agencies , for example, where the tele- are empowered to make some types of regulatory communications industry has been privatized, but decisions. This is the case, for example, for staff energy and water services continue to be supplied by government administrations. 1 - 8 infoDev McCarthyTetraukt Module 1 - Overview of Telecommunications Regulation Box 1-2: Advantages and Disadvantages of Multi-Sector Regulators Key Advantages Key Disadvantages l Reduce risk of "industry capture' because s" Increase risk of 'industry capture" by a the creation of a regulator with responsibility dominant industry player not only of the single for more than one sector can help avoid the sector regulator but of the entire MSR body rule-making process being captured by Increase risk of 'political capture' by a industry-specific interest groups dominant ministry of not only the single sector ) Reduce risk of 'political capture" because a regulator but of the entire MSR body regulator with responsibility for more than I one sector will necessarily be more s Increase risk that a precedent set in relation independent of the relevant line Ministries, to one sector could be applied inappropriately The broader range of entities regulated by in another sector (although this can also be such a regulator will be more likely to resist mitigated by creating strong sector-specific political interference in a decision on, say, departments undermeath a central cross- price regulation in one sector since that sectoraldecision-making body) could set a precedent for other sectors - Dilution of sector-specific technical expertise Create more precedents, and therefore less required where, for example, the skills of a uncertainty, for investors because a decision tariff expert for one sector are not transferable by an MSR in relation to one sector on a to similar tariffing issues in another sector, or, regulatory issue common to other sectors for example, of a frequency engineer (e.g. the application of price cap regulation or cost accounting rules) will set a precedent that is valuable to potential investors in those other sectors Economies of scale in the use of one set of high-calibre professionals (e.g. economists, lawyers, financial analysts). Such economies are particularly important during the early stages of liberalization and privatization in a TDC when there is likely to be a scarcity of regulatory experience Other Advantages Other Disadvantages Economies of scale in administrative and s- Failure by the regulator cascades to other support services (e.g. computers, office sectors space, support staff), particularly important . . where the costs of regulation can have a real Difficulty ri achieving acceptance by relevant impact on the affordability of basic services line Ministries of the concept of having an Flexibility in dealing with "peak load" periods, Subsequent difficulty in achieving consensus such as periodic price reviews, where from the relevant line Ministries on the type of intensive regulatory expertise is needed fr the establined which may be spread across sectors if a MSRto beestablished .multi-sectoral approach is adopted ' Greater complexity in establishing the legal Economies of scale in the development and framework for the MSR, including the level of implementation of the regulatory agency independence and allocation of functions as whereby, for example, uniform rules on between the Minister and the regulator licence award or dispute settlement - Potential delays in the reform process due to procedures can extend to more than one the disadvantages mentioned above sector and, therefore, avoid the need to 're- invent the wheel" for each sector McCarthy Tetrault infoDev 1-9 Telecommunications Regulation Handbook Box 1-2: Advantages and Disadvantages of Multi-Sector Regulators (cont'd) - Transfer of regulatory know-how between - Merging existing agencies may be regulators responsible for different sectors; problematic again, this is particularly important when a country has limited experience in regulation l Effective means of dealing with converging sectors (e.g. telecommunications and broad- casting where it is increasingly difficult to decide what is a telecommunications and what is a broadcasting service, for example video-on-demand, or telecommunications and posts, for example email and fax re- mailing) > Effective means of dealing with the bundled provision of services (e.g. provision of both telecommunications and electricity by the same company) and with co-ordination requirements between sectors (e.g. where companies from a number of different sectors all need to dig up the same roads to construct their networks) > Avoidance of market distortions due to the application of different rules to competing sectors (e.g. electricity and gas, or road and rail) Source: Schwartz, T. and Satola, D. (2000) Finally, many variations are possible on the theme of workplace culture of a country. The structure of the multi-sector regulation. The choice is not simply regulator will also play a role. For example, the staff between one single multi-sector regulator and a of collegial commissions may be, but is not always, series of single-sector ones. As indicated above, structured dfferently from that of an organization Canada's CRTC regulates two similar and reporting to a single director general. Multi-sector converging sectors, telecommunications and broad- regulators will have different structures from single- casting, but no others. The CRTC's predecessor, sector regulators, since professional staff such as the Canadian Transportation Commission, regulated economists, lawyers and accountants will deal with a variety of industries, including telecommunications telecommunications issues one day, and electrical (but not broadcasting), air and rail transportation. power regulation the next. However, at that time, gas pipelines, electrical power and other infrastructure industries fell under the The main factors determining organizational differ- authority of different regulators. Other combinations ences are the functions and objectives of dfferent are possible. regulatory agencies. Some telecommunications regulators are responsible for spectrum manage- 1.2.2.5 Organization of Regulatory Staff ment, licensing of new operators and regulation of broadcasting and other content services. Others are There are many ways to organize the decision- not. Some must actively regulate prices. Others are makers, management, staff and other advisors of a merely responsible for verifying compliance with a regulatory agency. No one approach is ideal. Much price cap regime prescribed in a long term licence, will depend on the institutional structure and the or adjusting the X-factor in a price cap regime every 1 -10 infoDev McCarthyTetrault Module 1 - Overview of Telecommunications Regulation few years. Different functions and objectives require 1.2.3 International Agencies different types and levels of professional assistance. The following sections describe the organization and For these reasons, it would not be useful to functions of various international organizations that prescribe an ideal model for a regulatory organiza- play an important role in telecommunications tion. However, some general observations can be regulation. made: 1.2.3.1 International Telecommunications > Regulatory decision-making requires multidisci- Union (ITU) plinary skills. Specific types of regulatory decisions require qualified economists, Overview of the ITU engineers, lawyers, accountants and financial analysts. However, many other decisions benefit The ITU was founded in Paris in 1865 as the from having a range of different professional International Telegraph Union. It changed its name skills and perspectives brought to bear. Where to the International Telecommunication Union in high-calibre professional skills are not 1934, and became a specialized agency of the immediately available within the public service, United Nations in 1947. outside experts should be brought in. Experts with hands-on experience with established The ITU is a global organization which includes regulators can be particularly valuable. Outside public and private sector participation on telecom- experts can be replaced as good permanent munications matters. The ITU's mission covers the staff are hired and trained. following areas or "domains": > The telecommunications environment is chang- > technical domain: to promote the development ing rapidly. Accordingly, regulatory organizations and efficient operation of telecommunications should not establish rigid hierarchies; they facilities, in order to improve the efficiency of should be flexible and adaptable. Many effective telecommunications services, their usefulness, regulatory organizations employ a "task force" or and their general availability to the public; "working group" approach to staffing teams to advise on important regulatory decisions. These > development domain: to promote and offer task forces are often selected from different technical assistance to developing countries in branches of the regulatory organization. They the field of telecommunications; to promote the are frequently brought together solely for a mobilization of the human and financial specific project. resources needed to develop telecommunica- tions; and to promote the extension of the > Consideration should be made to contracting benefits of new telecommunications technolo- out specific regulatory functions, rather than gies to people everywhere; building large permanent staff organizations. This approach is recommended by the authors > policy domain: to promote, at the intemational of the regulatory strategies checklist for level, the adoption of a broader approach to the developing economies (Table 1-4). They provide issues of telecommunications in the global the following examples. Audit firms can monitor information economy and society. compliance with operating licence conditions. In Argentina, a private contractor monitors compli- As of 1 July 2000, the ITU comprised 189 Member ance with radio spectrum rules. External experts States and over 600 Sector Members. The latter can also resolve operator disputes, leaving final include scientific and industrial companies, public decisions to the regulators. Many other exam- and private operators, broadcasters and ples exist. regional/international organizations. McCarthyTetrault infoDev 1-11 Telecommunications Regulation Handbook Structure of the ITU that govern the use of the radio spectrum by some 40 different radiocommunications services Under its constitution, the ITU's organizational around the world. The Sector also acts, through structure comprises the following elements: its Bureau, as a central registrar of international frequency use. It records and maintains the - The Plenipotentiary Conference, which is the Master Intemational Frequency Register which supreme authority of the Union. It meets every currently includes around 1,265,000 terrestrial four years to: frequency assignments, 325,000 assignments servicing 1,400 satellite networks, and another (a) adopt the strategic plan and fundamental 4,265 assignments related to satellite earth policies of the organization; stations. (b) amend the Constitution and Convention as In addition, the ITU-R is responsible for co- required; and ordinating efforts to ensure that communica- tions, broadcasting and meteorological satellites (c) adopt a financial plan for the next four-year can co-exist without causing harmful period. interference to one another's services. In this role, the ITU facilitates agreements between > The Council, which is composed of 46 ITU operators and govemments, and provides Member States (representing 25% of the practical tools and services to help frequency Union's membership). The Council acts on spectrum managers carry out their day-to-day behalf of the Plenipotentiary Conference and work. meets annually to consider broad telecommuni- cations policy issues in order to ensure that the The legislative and policy functions of the Union's policies and strategies respond to the Radiocommunication Sector are performed by constantly changing telecommunications world radiocommunications conferences, which environment. The Council is also responsible for adopt and revise the Radio Regulations, by ensuring the efficient co-ordination of the work regional radiocommunications conferences, and of the Union and the approval of its budgets. by radiocommunications assemblies supported by study groups. > World Conferences on International Telecom- munications, which are convened periodically to > The Telecommunication Standardization review and revise the International Telecommu- Sector (ITU-T) co-ordinates the intemational nication Regulations. The Regulations are an telecommunications standards-setting activities intemational treaty governing the provision and which result in the ITU-T Recommendations. operation of public telecommunications The Standardization Sector carries on the stan- services, as well as the underlying transport dardization efforts of the ITU which span more mechanisms used to provide them. The Regu- than 130 years. Today, these efforts include lations provide a broad, basic framework for development of standards for Intemet Protocol telecommunications administrations and (IP) networks, and IP-based systems. operators in the provision of international tele- communications services. The majority of the membership of the ITU-T comes from the private sector. Given the rapid > The Radiocommunication Sector (ITU-R) is pace of technical and market developments, the charged with establishing technical characteris- Telecommunication Standardization Sector's tics and operational procedures for wireless main challenge is in speeding up time-to-market services. The Sector also plays a key role in the progress of its Recommendations. The legisla- management of the radio frequency spectrum. tive and policy functions of the Standardization In its role as global spectrum co-ordinator, the Sector are carried out through World Telecom- Radiocommunication Sector develops the Radio munication Standardization Assemblies, Regulations, a binding set of intemational rules supported by study groups. 1-12 infoDev McCarthyTetrault Module 1 - Overview of Telecommunications Regulation - The Telecommunication Development Sector The policy functions of the Development Sector are (ITU-D) discharges the ITU's responsibilities as fulfilled by World and Regional Telecommunication a United Nations specialized agency and as an Development Conferences supported by study executing agency for implementing projects groups. under the United Nations development system or other funding arrangements. - The General Secretariat: Manages the administrative and financial aspects of the ITU's The ITU calculates that a lack of reliable access to activities, including the provision of conference basic telecommunications services affects around services, the management of the IT two-thirds of its 189 member countries. It is the task infrastructure and applications, long range of the ITU-D to help redress this imbalance by strategic planning, and corporate functions promoting investment and the implementation of (communications, legal advice, finance, telecommunications infrastructure in developing personnel and common services). nations throughout the world. The General Secretariat is also responsible for The ITU-D maintains a regional presence via 11 organization of the world and regional offices located in Africa, the Arab States, Asia, the TELECOM Exhibitions and Forums. Caribbean and Latin America. The Telecommunica- tion Development Sector's two Study Groups 1.2.3.2 Other International Organizations discuss key telecommunications development issues and policies. They also establish best Organizations Interested in Telecommunications business practices for the deployment, management Regulation and maintenance of networks and services. Special attention is paid to the needs and concerns of the A large number of international organizations play a UN-designated Least Developed Countries. role in telecommunications regulation and regulatory reform. For some, telecommunications regulation is Sector activities range from policy and regulatory a major part of their mandate. Others deal with it as advice, advice on the financing of telecommunica- an ancillary matter. An example of the latter is the tions and on low-cost technology options, assistance WTO, which has dealt with telecommunications in human resource management, as well as well as regulation as a means of promoting its core the development of initiatives targeting rural objective of facilitating international trade. development and universal access. The ITU-D emphasizes partnerships with the private sector. The focus of the organizations listed below varies considerably. Some have regional or global ITU-D also produces a range of information mandates to improve regulation, or to carry out resources which provide analysis of trends in the specific regulatory functions. Some promote global telecommunications sector backed by official regulatory reform. Others provide technical statistics from the world's leading source of tele- assistance and fund consulting resources, studies, communications information. Examples include the workshops and other activities to increase regulatory Wotld Telecommunication Development Report know-how. Still others act as focal points for the (WTDR), which provides a comprehensive overview exchange of information between regulators and of transition in the telecommunications industry and other stakeholders in the telecommunications regu- the annual Trends in Telecommunication Reform latory process. (Trends). Trends is based largely upon the annual Telecommunication Regulatory Survey conducted International organizations with a major role in tele- by the Telecommunicaton Development Bureau. communications regulation are listed in Table 1-3. The Bureau monitors world telecommunications reform and maintains a regulatory database for governments reforming their telecommunications sectors. McCarthyTetrault infoDev 1 - 13 Telecommunications Regulation Handbook Table 1-3: Selected International Organizations Interested in Telecommunications Regulation Organization I Activities African Development Bank Like its Asian and Inter-American counterparts, the Asian Development (AFDB ) Bank provides financial and technical assistance for the establishment, hftpl//www.afdb.org expansion, improvement and integration of public telecommunications l http://www.afdb.org systems in Africa. Its programs are aimed at infrastructure development, increasing access to telecommunications services and improving the contribution of the telecommunications sector to its members' economic growth. It also aims to improve the competitiveness of Africa's telecommunications industry, and provide the conditions for its participation in the information economy. Among the main activities of the bank is the provision of support for privatization and strengthening of institutional Iframeworks. African Telecommunications | ATU co-ordinates the development of an African telecommunications Union (ATU) networks. It promotes telecommunications development in Africa by serving as a regional discussion forum. (Formerly known as Pan-African Telecommunications Union.) Caribbean U CTU promotes telecommunications development and regulatory reform by Telecommunication Union serving as a regional discussion forum. It also promotes co-ordination of the (CTU) intemational policies of its 13 English-speaking Caribbean member states. http://www.ctu.org Common Market for Eastern COMESA serves the English-speaking sub-regions of Eastern and Southem and Southem Africa Africa. In collaboration with the ITU, COMESA's Transport and (COMESA) Communications Division provides technical assistance in several areas, http://www.comesa.org including network connectivity and tariffs. European Bank for The EBRD is an international financial institution established along Reconstruction and somewhat similar lines as The World Bank Group, and particularly one of its Development (EBRD) members, the International Finance Corporation (see description of The World Bank below this table). The EBRD supports telecommunications http://www.ebrd.org privatization in Central and Eastem Europe and in the former Soviet Union (FSU) through the provision of equity or long-term debt financing to newly privatized companies and by providing pre-privatization finance. The EBRD provides support for new network operators in local, domestic and international long distance, and mobile telephone services. It also supports regulatory reform through its Technical Co-operation Programme, which has provided assistance to national authorities in establishing and improving the telecommunications legal and regulatory framework. European Conference of CEPT's Telecommunications Committee (ECTRA) promotes co-operation Post and between member administrations and bodies responsible for Telecommunications telecommunications policy and regulation. Its activities include Administrations (CEPT) harmonization of licensing conditions, spectrum management and http://www.cept.org numbering. 1-14 infoDev McCarthyTetrault Module 1 - Overview of Telecommunications Regulation Table 1-3: Selected International Organizations Interested in Telecommunications Regulation (cont'd) European Commission - The EU shapes telecommunications law and policy in Europe through l DGIS legally binding instruments. Its directives on' different aspects of h,tp://www.europaeu.int Itelecommunications liberalization aim at developing a common market for telecommunications service and equipment throughout Europe. The Directorate-General for the Information Society (DGIS) implements the European Commission's policies in the area and elaborates the economic, political and social analyses on which such policies are based. The DGIS supports telecommunications sector reform through programs and initiatives, which include monitoring activities and assistance in the establishment of regulatory frameworks consistent with the Commission's policies. The European Union provides additional support for economic reform in Central and Eastern Europe through development programs such Las PHARE and TACIS. European ETO supports the establishment of new regulatory regimes for liberalized Telecommunications Office telecommunication markets and promotes the harmonization of existing l(ETO) regulations. It promotes the establishment of common procedures for licensing and numbering. ETO also provides a forum for discussion and http://www.eto.dk analysis of national situations and undertakes studies on issues of topical concern. Recent ETO studies cover the areas of licensing, pricing, numbering and mobile number portability. Gulf Co-operation Council The Telecommunications Department of the GCC has assisted Persian Gulf (GCC) member states to co-ordinate telecommunications services tariffs, adopt the GSM mobile telephony standard and harmonize the curriculum taught at academic institutions and training centres in GCC member states. It also works with the ITU to promote harmonization and standardization ;processes. Inter-American Development The IADB provides financial assistance for the establishment, expansion, Bank (IADB) improvement and integration of public telecommunications systems. It also provides technical assistance at all stages of the projects it finances and http://www.iadb.org | supports its member countries in the rationalization of telecommunications activities, with special emphasis on institutional reform and strengthening of regulatory capabilities. Its areas of involvement indude local networks and rural telephony. Inter-American As the principal advisory body to the Organization of American States (OAS) Telecommunications on matters related to telecommunications, CITEL's main objectives are to Commission (CITEL) ifacilitate and promote the development of telecommunications in the http:/Iww.citel.oa. Americas, in order to contribute to the overall development of the region. hftp://www.citel .oas.org l International Finance A member of The World Bank Group (see separate description below this Corporation (IFC) table). Together with the World Bank, IFC works through the new Global hftp:llwww.ifc.org Information and Communications Technology Group (GICT) to promote the httP-//www.ifc.org development of the telecommunication sector in emerging economies, particularly through private participation. The IFC has financed a large number of telecommunications projects throughout the developing world in areas such as basic wireline services, cellular telephony, equity funds for telecommunications service providers and equipment manufacturers, as well as satellite, wireless local loop and cable television operations. McCarthyTetrault infoDev 1-15 Telecommunications Regulation Handbook Table 1-3: Selected International Organizations Interested in Telecommunications Regulation (cont'd) International Institute of I The IIC is a multidisciplinary organization that brings together policy makers, Communications (IIC) regulators, academics and industry players. It provides a forum for the I ttp /Iwww.iicom.org exchange of ideas on topics related to telecommunications and their [ http://wwwilicom.org i commercial, cultural, political and social implications. It maintains an active | publication program, hosts an annual conference and organizes international fora on a regular basis. International See separate description of ITU above this table. Telecommunication Union (ITU) http:/lwww.itu.int Latin American Forum of REGULATEL encourages co-operation and co-ordination of efforts among Telecommunications 16 Latin American telecommunications regulatory agencies and promotes Regulators (REGULATEL) the development of telecommunications in the region. It provides a forum for discussion and for the exchange of information and experience in, |; http://www.regulatel.org EI telecommunications policy and regulation. Mercosur (Southern I Mercosur supports telecommunications liberalization among its members Common Market) (Argentina, Brazil, Paraguay and Uruguay). Through its Public Telecommunications Services Commission, Mercosur promotes regional ihttp://www.mercosur.org.uy telecommunications development, harmonization of spectrum management and equipment certification and homologation as well as the exchange of I information on telecommunications topics. Organization for Economic I The OECD publishes data and studies on telecommunications markets. It Co-operation and promotes telecommunications reform as a means to achieve sustainable Development (eOECD) growth and employment that contributes to economic and social welfare, as; h well as to the expansion of world trade. Pacific Telecommunications PTC membership includes individuals, businesses and non-profit entities. It I Council (PTC) provides a forum for discussion and exchange of information on http://www.ptc.org telecommunications in the Pacific area. It promotes regulatory reform and general awareness of the telecommunications sector in the area. PTC organizes conferences and seminars and interacts with national, regional and international organizations responsible for telecommunications policy and regulation. Regional African Satellite Among RASCOM's main objectives is the improvement of inter-urban . Communications communications in its member states through the establishment of direct Organization (RASCOM) satellite links between African countries. It also promotes the provision of http://www.rascomorg .telecommunications service to rural and remote areas. http://www.rascorn.org 0 Regional Commonwealth in RCC co-ordinates network development, technical standards and spectrum, the Field of Communications management activities in CIS countries. It also co-operates with its (RCC) members in the development of principles goveming tariff policy as well as network interconnection and interoperability. In addition, the RCC is involved' ,J in joint research and development programs, and the training of, communications specialists. 1 -16 infoDev McCarthyTetrault Module 1 - Overview of Telecommunications Regulatior Table 1-3: Selected International Organizations Interested in Telecommunications Regulation (cont'd) Telecommunication TRASAs main goal is to increase communications and co-ordination, Regulators Association of between regulatory authorities in the Southem Africa region. TRASA seeks Southem Africa (TRASA) to encourage investment in the telecommunications sector by supporting the creation of a common enabling environment. The member states of .the http://www.trasa.org Southem African Development Community (SADC) are committed to undertaking initiatives to improve the economic and social well-being of their populations through telecommunications sector reform. West African WATRA was formed in September 2000 by, West African Telecommunications telecommunications regulators, as a regional organization similar to TRASA Regulators Association (see above). (WATRA) The World Bank Group See separate description below this table. Members of The World Bank Group provide loans, equity and guarantees to developing countries. They http:www.worldbank.org also provide information, advice and assistance on telecommunications sector reform and national information infrastructure strategies. World Trade Organization The WTO is the intemational body responsible for the administration of the (WTO) General Agreement on Trade in Services (GATS), which includes an Annex. on Telecommunications and a Protocol regarding basic telecommunications http://www.wto.org services. This Protocol, officially known as the Fourth Protocol to the GATS Agreement, is referred to throughout this Handbook as the WTO Agreement, on Basic Telecommunications (see Appendix A and Appendix C: Glossary). The WTO provides a global forum for trade negotiations and dispute resolution. The WTO also monitors national trade policies and provides' technical assistance and training for developing countries conceming the; implementation of their WTO commitments, including required regulatory' reforms. Multilateral and Bilateral Development and other consultants), training programs, seminars, Organizations workshops and staff exchanges. A number of multilateral and bilateral development Some major multilateral development organizations organizations have an interest in telecommunica- active in promoting telecommunications sector tions regulation. These organizations focus on restructuring and regulatory reform are listed in countries with developing and transitional Table 1-3. These organizations include: economies. The goal of such development organizations is generally to assist in establishing a s The World Bank Group, including: regulatory framework that will promote telecommu- nications sector development - and with it, general > International Bank for Reconstruction and economic development. Development (IBRD); These organizations generally provide technical as- > Intemational Development Association (IDA); sistance to govemments and regulators to promote the development of a sound regulatory structure. > Intemational Finance Corporation (IFC); and Such technical assistance may include advice from expert staff resources, payment for independent telecommunications advisors (economists, lawyers McCarthyTetrault infoDev 1 17 Telecommunications Regulation Handbook - Multilateral Investment Guarantee Associa- tating entry into the sector and making the sector tion (MIGA). more efficient. > European Bank for Reconstruction and The Bank has been a catalyst in promoting Development (EBRD); privatization and market-based solutions to the development of the telecommunications sector. The > Asian Development Bank; Bank's goal has been to create a sustainable environment to attract private investment required to ' African Development Bank; accelerate and sustain telecommunications sector development. Accordingly, Bank policy advocates > Inter-American Development Bank; and using scarce official funds mainly to support sector reforms, including regulatory reform, that are likely to - Andean Development Corporation. mobilize private capital and management to develop the sector. Many bilateral development organizations also play a role in promoting regulatory development. These In terms of a regulatory framework, the Bank include national development organizations such as advocates separating the government's policy and US AID, Denmark's DANIDA, and Canada's CIDA. regulatory functions from telecommunications They also include regional programs aimed at operations. It supports (a) strengthening the promoting telecommunications development, such government's capacity to formulate and oversee as the European Commission's PHARE program. policy, and (b) creating a regulatory regime and institutions that emphasize competition while A comprehensive review of the role of multilateral keeping regulatory intervention to a minimum. and bilateral development organizations in tele- communications sector regulation is outside the Consistent with its poverty-reduction goals, the Bank scope of this Handbook. We will describe one key encourages governments to develop strategies to institution, The World Bank, in greater detail. The extend telecommunications services throughout the World Bank has been active in the telecommunica- population, including the least privileged groups. tions field for many years, and a description of its changing role illustrates a trend common to some Today, the Bank is leading the way in supporting other major development organizations. solutions to alleviate the effects of the digital divide. The Bank's aim is to encourage investments as well The World Bank as policy and regulatory reforms to create a liberalized environment which will foster the The World Bank Group has played an important role development of communications infrastructure. Such in telecommunications sector reform, including an environment should also promote access to and regulatory reform, in developing and transitional use of the emerging knowledge-based global economies. economy in the fight against poverty. In the past, the Bank provided a significant source of The Bank is also active in the development and direct financing for the expansion of telecommunica- dissemination of information resources to promote tions infrastructure by PTTs. Since the mid-1990s, regulatory reform and to strengthen regulatory Bank lending to state-owned enterprises has been capabilities. For example, infoDev, a multi-donor contingent on a firm commitment from its client grant facility administered by the Bank, provides governments to sector reform. Such commitments funding for innovative projects that use information have included a clear exit strategy for govemment's and communications technologies to facilitate involvement in the ownership and management of economic and social development at the local, telecommunications operators. Alternatively, national, regional and global levels. commitments have included specific progress in reform aimed at commercializing, privatizing, facili- infoDev, through its networking with governments, multilateral and bilateral donors, the private sector 1 -18 infoDev McCarthyTetrault Module I - Overview of Telecommunications Regulation and not-for-profit organizations, provides links to The laws and jurisprudence of most countries technical, informational and communications provide guidance and constraints on the regulatory expertise available throughout the world. The decision-making process. Procedural rules vary from program has provided funding to support the ITU country to country and legal system to legal system. Regulatory Colloquia and other initiatives to expand However, there are common trends. regulatory knowledge and experience, including the preparation of this Telecommunications Regulation Two "fundamental rules" of procedural fairness in Handbook. common law countries are worth noting. While they are not legally binding on regulators in many other 1.3 The Regulatory Process countries, they are widely respected. Adherence to them will often alleviate political and public relations Regulators employ a variety of regulatory problems as well as legal challenges. These rules procedures. Depending on the legal framework, they are: may issue different types of "regulatory instruments", such as regulations, decisions, orders, decrees, (1) Provide all interested parties with an rules, policies, notices, resolutions. In general, the opportunity to comment or otherwise make their effect of these instruments is to make "decisions" case, before making a decision that affects that implement regulatory policies, resolve disputes, them. This rule is sometimes expressed by or deal with other matters within the regulators' means of the Latin maxim audi alteram partem mandate. In this section, we focus on the general or "hear the other side". Breach of this process used in making regulatory decisions. The procedural rule will lead the courts to quash discussion in this section disregards the country- regulatory decisions in some common law specific legal form that such decisions may take. jurisdictions. In other jurisdictions, this rule is part of the unwritten code of basic procedural Regulatory decision-making can be difficult. fairness applied by regulators. The rule has a Interested parties may vigorously promote and lobby pragmatic basis, as well as a legal one. Unless in support of different outcomes for many regulatory perspectives of all interested parties are taken decisions. In most cases, some parties will be happy into account, regulators risk making decisions with a regulatory decision, and others will not. that ignore important factors. Taking those Decisive regulators necessarly create winners and factors into account can lead to different and losers in some situations. Indecisive regulators may better decisions. Application of this rule try to avoid offending anyone by delaying decisions, promotes transparent decision-making. or creating unworkable compromises. Such indecision and compromises can damage (2) "Don't be a judge in your own cause". This development of the sector and ultimately help no rule is based on another Latin legal maxim: one. nemo judex in sua causa debet esse. The rule has been interpreted to mean that regulators The principles of good regulatory decision-making should avoid bias as well as the perception of are well known. They include: bias. They should not make decisions on matters in which they have a personal interest. ) Transparency; Nor should they make decisions on matters where a reasonable person, knowledgeable of > Objectivity; all the facts, would perceive a real likelihood of bias. In the words of the jurisprudence: "justice > Professionalism~ must not only be done, it must be seen to be Professionalism; done". Perceptions of regulatory bias can stem Efficiency; and from any number of factors, from a relative's financial interest in a matter, to a former position ' Independence as part of the management of a PTO that is the beneficiary of a regulatory decision. Application McCarthyTetrault infoDev 1-19 Telecommunications Regulation Handbook of this rule promotes objectivity and credibility of sF Design public processes that will improve the the regulatory process. quality of public input. Provide background information and options for the decision to be While these common law rules are not mandatory made, in notices or consultation documents. and do not cover all the bases of good decision This approach helps to focus industry comments making, they will promote credible and impartial and to provide more useful input on the issues good decision-making. Various other rules and to be determined by the regulator. This principles for good regulatory decision-making have approach has been used successfully in a wide been promulgated. by different regulators. A good range of countries, such as Jordan, South example of such principles was developed by the Africa, the US, the UK and Colombia. Australian regulator. These principles are summarized in Box 1-3. - Publish all significant regulatory developments on a regulatory web site. The web site can also A variety of procedures are available to assist be used to invite the industry and other regulators to make better regulatory decisions. The members of the public to comment on pending choice of procedures will vary with the objectives of regulatory decisions. Publish decisions, rules, the decision-making process. Depending on the procedures, notices, and consultation papers on circumstances, the following approaches should web sites. Provide links to other useful sites for help regulators achieve the hallmarks of good parties wishing to participate in the regulatory decision-making, namely: transparency, objectivity, process. Require major operators to provide professionalism, efficiency and independence: useful public information, such as rates, service options and complaint procedures, on their web > Use public processes, wherever time permits. sites. Issue public notices inviting comments on proposed rules or approaches to regulating the > Provide written information requests to major industry and other major decisions. Publish ads operators on complex matters. Have them in newspapers or other media to let the public provide the regulator with technical, financial know about such opportunities. Box 1-3: Principles of Proper Decision Making 1. Decisions must be within legal authority of regulator 2. The regulator must consider all relevant matters and disregard irrelevant ones 3. Decisions must be made in good faith and for proper purposes 4. Factual underpinnings of decisions must be based on evidence 5. Decisions must be reasonable 6. Those affected by a decision must be accorded procedural faimess (including the right to respond to prejudicial arguments and evidence that may be taken into account) 7. Government policy must be properly applied 8. Independent regulators must not act on the direction of other persons Note: These principles were adapted from those developed by the Australian Communications Authority 1 - 20 infoDev McCarthyTetrault Module I - Overview of Telecommunications Regulation and economic information necessary to make In the following sections, we review basic principles informed decisions; Ask them to provide for effective regulation that can be applied in detailed arguments and evidence on actions different circumstances. that the regulator is considering. 1.4.1 Minimize Regulatory Intervention After : Encourage electronic filing of applications, Competition is Established comments and all other material filed by interested parties. If necessary to protect Regulation should be kept to a minimum, particularly sensitive confidential information, provide for in competitive markets. The evidence from around secure electronic filing. In other cases, the world indicates that freely competitive markets encourage public filings that are accessible and are better able to meet the demands of consumers transparent to the industry and other interested than government controlled ones. The advantages parties. of privatization and liberalization can be lost, or severely limited by burdensome regulatory > Use alternative dispute resolution techniques to measures. resolve complex issues. These include mediation and arbitration. Consider hiring The extent of regulation should be geared to the independent experts as mediators and state of development in a market, and particularly 'arbitrators. They can report to the regulator for the level of competition. As competition increases, guidance or a final decision, where necessary. regulation should decrease. - Follow the basic steps to informed decision- However, there must often be decisive regulatory making. Decide what type of information would intervention in the early stages of market liberaliza- be relevant in making a decision. Determine the tion, in order to ensure effective competition has a best means to gather appropriate information chance to emerge. Clear decisions to remove (e.g. staff research, consultants studies, barriers to competition early in the process will information requests to operators, etc.). Provide stimulate competition and permit greater an opportunity for comment on the evidence by deregulation down the line. While markets are being interested parties and the public; and make a opened to competition, regulation should normally decision based on the public record, wherever be focussed on the incumbent operators, whose possible. networks must be open to interconnection and unbundled to permit new entrants to be viable. - Streamline decision-making where possible. Establish and publish schedules for decision- There is a tendency among new regulators to try to making processes - and stick to them. be "even-handed" and to treat incumbent operators and new entrants the same. This approach can 1.4 Principles for Effective actually increase regulatory intervention over the Regulation longer term. It can impose unnecessary burdens on new entrants, and prevent implementation of "asymmetrical" regulatory initiatives that will open Although telecommunications markets around the the PSTN to'competition. world are in transition, the basic direction of change is similar in most countries. It is therefore not This lesson has taken some time to learn. Initially, surprising that the principles of effective regulation for example, many regulators have declined to around the world are converging. However, applica- intervene decisively in interconnection disputes, tion of these principles will vary considerably, s t copeitv e depending on the structure and state of evolution of operators should "freely negotiate' the terms of inter- a particular telecommunications market, the opecton sh the ters-f inte resources of the country, its legal framework and connection with the PSTN. It took years -for some regulatory capabilities. regulators to realize that most incumbent PSTN operators had few incentives to negotiate favourable interconnection agreements with their would-be McCarthyTerault infoDev 1 - 21 Telecommunications Regulation Handbook competitors. Rather than minimizing regulation, this 1.4.2 Harmonize with Regional and Global hands-off approach can lead to repeated regulatory Regulatory Standards intervention on interconnection issues over a protracted period of time. The basic technologies and economics of the tele- communications industry are the same around the Over the years, more and more regulators have world. Today, a small group of manufacturers is realized that decisive regulatory intervention is responsible for producing the majority of switching, required to implement interconnection arrangements transmission, terminal, software and related network that will substantially increase competition. Such facilities used almost everywhere. Even where there intervention includes proactive regulation, that is are variations in technology or local applications, the advance, guidelines, as well as dispute resolution. same basic network architectures are employed. Regulatory thinking is evolving on this subject. The trend to harmonization of telecommunications technology is increasing. Regulation of interconnection represents one of a small number of exceptions to the general rule. In The basic economics of telecommunications service most cases, regulation can and should be markets is also the same in most countries. minimized. Interventionist measures should always Businesses and consumers all demand telecommu- be assessed against their objectives. Are the nications services, with increasingly advanced objectives valid? If so, are the measures the least features, at the lowest possible price. Other things intrusive means of achieving the objectives? being equal, suppliers that meet that demand best will succeed. Those that fail to compete successfully A recent European case provides an example where will be bypassed by consumers and their competi- these questions were asked, and a less interven- tors. While the ability of businesses and consumers tionist regulatory approach was adopted. For many to pay for services varies greatly, this variation does years governments in various countries have not account for the large differences in approaches administered testing and certification programs for to regulation around the world. Equally rich countries terminal equipment attached to telecommunications have often taken very different regulatory networks. This approach was reviewed by the EU in approaches, as have equally poor ones. an effort to reduce unnecessary regulation. As a result, the EU recently decided to abandon its Regulatory differences are often ascribed to previous approach to regulation of terminal differences in the legal, institutional, political or equipment in favour of industry self-reporting. The cultural framework of different countries. These 1999 EU Directive on Radio and Telecommunication differences are important, but generally do not justify Terminal Equipment, requires only manufacturers' substantial differences in technical or economic declarations of conformity with essential require- aspects of regulation. ments. This type of regime should permit new technologies to be introduced more quickly, with Telecommunications markets are increasingly fewer regulatory delays or other barriers. becoming regional and global markets. While successful telecommunications service providers will This European example may not be applicable in always be close to their customers, they must think some developing countries, where, for example globally in terms of their business and competitive there is no effective frequency spectrum monitoring. strategies. Regulators should do the same. However, in all countries, new regulatory measures should be assessed carefully to ensure they provide Regulators that impose uniquely local regulatory the most efficient means of achieving valid burdens, or more costly requirements than other objectives. countries, can handicap players in their national markets. Similarly, regulators that protect national operators from regulatory disciplines that apply in other countries are doing them no favours. Such regulators will retard competition, service innovation and possibly economic growth by failing to 1 - 22 infoDev McCarthyTetrault Module I - Overview of Telecommunications Regulation implement the same pro-competitive regimes as organizations to harmonize regulatory approaches neighbouring countries. can certainly improve regulation. Over time, global regulatory standards or "best 1.4.3 Introduce Competition practices" are emerging. Some of those are evident from the list of major global telecommunications It is widely recognized that the benefits of competi- sector reforms in Table 1-1. Others are discussed tion in the supply of telecommunications services throughout this Handbook. Examples of such and facilities far outweigh any disadvantages. standards are price cap regulation and targeted uni- Today, telecommunications markets have been versal service funds (as opposed to inter-service opened to varying degrees of competition in most cross-subsidy by incumbent PSTN operators). Other countries around the world. regulatory practices are newer, such as the various approaches to requiring unbundling of the local loop. Over the last decade, the most dramatic progress in liberalizing telecommunications markets occurred in Some regulatory standards or practices are being Europe and other OECD countries. Most telecom- adopted in trade agreements and other intemational munications services in Europe were provided on a accords. Prime examples are the regulatory monopoly basis at the beginning of the decade. By disciplines included in the WTO Regulation the end of the decade, over 96 per cent of the Reference Paper (see Appendix A). OECD market, measured by total telecommunications revenues, was open to In this context, it is interesting to note that in late July competition. 2000, the US announced that it would request WTO consultations with Mexico regarding that country's Significant liberalization has also occurred in tele- alleged failure to implement its commitments under communications markets in other economies the Agreement on Basic Telecommunications. This throughout the Americas, Eastem Europe and the is the first time a country has taken a dispute on FSU, Africa and the Asia-Pacific region. Based on barriers to competition in a telecommunications ITU data for 1999, the most open telecommunica- market to the WTO. The three issues put forward by tions markets globally were in cellular services (67 the US for the consultations are: 1) lack of effective per cent) and Internet services (72 per cent). Basic disciplines over the former monopoly, Telmex, which telecommunications services markets remained is able to use its dominant position in the market to fairly closed. About 73 per cent of global basic thwart competition; 2) failure to ensure timely, cost- telecommunications markets continued to have oriented interconnection that would permit monopolies at the beginning of 1999. However, competing carriers to connect to Telmex customers there is no doubt about the trend. Basic telecommu- in order to provide local, long-distance, and nications markets are being opened to competition intemational service; 3) failure to permit alternatives in all regions. It is in this area that regulators will face to an outmoded system of charging U.S. carriers the greatest challenges. above-cost rates for completing international calls into Mexico. Regulatory involvement is generally required to ensure the establishment of viable competition. This Regulators that are concemed about maintaining the is not the case in all industries. However, the competitiveness of their domestic telecommunica- structure of the telecommunications industry and the tions markets should monitor international regulatory nature of telecommunications networks are such trends and become early adopters of trends that will that regulation is required. Regulatory intervention is increase efficiency and competition in their markets. required to meet a number of objectives related to Telecommunications regulation can be complex the introduction of competition. Key objectives without re-inventing the wheel in each market. In discussed in detail later in the Handbook are: most cases, economic and technical regulatory techniques that have proven themselves in some - To license new competitors and existing opera- markets will work in other similar markets. Increased tors on terms and conditions that will provide a communication between regulators and regulatory McCarthyTetrault infoDev 1-23 Telecommunications Regulation Handbook clear and certain basis for both to attract Good international practices are emerging on the investment (see Module 2). principles for dealing with many types of regulatory issues. An example is the pricing of unbundled inter- > To ensure interconnection of networks and connection facilities. The calculation of telecommu- services, and to resolve interconnection nications costs can be very complex and time disputes (see Module 3). consuming for a regulator. However, making a decision in principle that interconnection facilities > To prevent incumbent operators from abusing should be priced at a level equal to estimated LRIC their dominant position to drive new competitors (Long Run Incremental Costs) plus a mark-up for out of telecommunications markets (see Module forward looking common costs, is not that difficult. 5). General principles and practices for such costing and pricing decisions have been adopted in many r To prevent dominant operators from charging countries. Best practices are often clearly excessive prices for services over which they established and it is not that risky to adopt them. have market power, and using the proceeds to cross-subsidize their services in competitive 'Regulatory decisions, even ones to adopt general markets (see Module 4). principles, should always be made in a transparent manner. Providing opportunities for public comment > To ensure universality objectives are achieved in on whether a regulatory principle should be adopted a competitive environment (see Module 6). will generally improve the quality of the decision as well as the credibility of the regulatory process. Without regulatory intervention to achieve such objectives, there is a good prospect that competition 1.4.5 Establish Operational Efficiencies will fail to produce the benefits that have been achieved in the world's more competitive markets. Sharing experiences with other regulators can often lead to operating efficiencies. Regulatory operations 1.4.4 Regulate by Principle can clearly be more efficient today than ever before. The Internet, electronic filing of regulatory applica- Regulators are prone to regulate "after the fact". tions and electronic publication of regulatory Sometimes, they wish to avoid regulatory decisions have vastly improved the efficiency and intervention. In other cases, they are unsure of the transparency of regulation. The costs of establishing right approach to take on a disputed regulatory a regulatory web site and arranging for electronic issue. In some cases they do not have the resources and professional advice necessary to rule . K ., . confidently on complex issues. Box.-11_4: Highligh ofs1999 Man to Overhu "the C-C Delays in deciding major regulatory issues can retard development in the sector. Interconnection ereive170-6 issues provide prime examples. If regulators do not wi,in ye n 10 wti provide clear advance guidance on interconnection .fiv,.years principles, parties may negotiate for months or 'Re uce b k years, and service introduction will be delayed. J inn 6 i Regulators will understandably want to be careful to Reduce. siaffl-by ag avoid decisions on complex issues without careful sa - consideration. However, in many cases they can _ o 1 r establish principles to be applied by the industry, , A riese o ge without spending an undue amount of time on the details of implementation. Those details can often be left to the industry. Announcement of the principles in advance can often expedite industry discussions. 1 - 24 infoDev McCarthyTetrault Module I - Overview of Telecommunications Regulation filing of reports, applications and other regulatory 1.4.6 Strategies for Effective Regulation in communications has declined to a level where every Developing Economies regulator can use such approaches to increase regulatory efficiency. While the principles of effective regulation are similar in most countries, some may be applied differently in Regulators have adopted many different approaches developing economies. There are significant to improve operational efficiency. An example of one differences in resource and other constraints in regulator's approach is set out in Box 1-4, which developing economies from those of OECD includes highlights of the FCC's plan to expedite its economies. This obviously has implications for intemal processes in the US. regulation. Regulators in developing and transitional economies have a greater need for practical and straighfforward approaches. Table 1-4: Regulatory Strategy Checklist: Primary (.) and Secondary (/) Benefits Measure Reduce Need for Enhance Regulatory Use Resources Agency Decisions Credibility Effectively Accelerate competition / / Prepackage regulatory rules / / Establish rules for / interconnection Keep operators' obligations / reasonable Focus licensing on the main / operators Rebalance prices early / Reduce regulation as competition develops l Adopt transparent process Hamess public support Lock in principles through intemational commitments Outsource regulatory functions Adopt altemative dispute / . resolution Put the operators to work / Consider mulftsectoral agencies Create regional capacity Source: Smith, P. and Wellenius, B (1999) McCarthyTe'trault infoDev Telecommunications Regulation Handbook The principles listed above can generally be adapted strategies, which have proven to be effective there. to the needs of developing and transitional A good paper on such strategies was published by economies. However, telecommunications experts the senior telecommunications experts of The World with experience in telecommunications regulation in Bank in 1999. The regulatory strategies checklist such economies have developed additional from this paper is reproduced in Table 1-4. 1 - 26 infbDev McCarthy T~trau 1 - 26 ~~~~~~infoDev McCarthyTetrault MODULE 2 Licensing Telecommunications Services Table of Contents Module 2- Licensing Telecommunications Services 2.1 Introduction 1 2.1.1 Telecommunications Licences 1 2.1.2 Licensing Objectives 2 2.1.3 Licences and Other Regulatory Instruments 4 2.1.4 Multilateral Trade Rules 5 2.1.5 The EU Licensing Directive 6 2.2 Types of Licensing Regimes 7 2.3 The Licensing Process 9 2.3.1 Licensing Incumbent Operators 9 2.3.2 Licensing New Entrants - Individual Licences 12 2.3.3 General Authorizations 12 2.3.4 Spectrum Licences 12 2.3.5 Spectrum Auctions, Lotteries and Comparative Evaluation Processes 12 2.4 Licensing Practices 15 2.4.1 Transparency 15 2.4.2 Public Consultation 17 2.4.3 Licence Fees 17 2.4.4 Balancing Certainty and Flexibility 18 2.4.5 Distinguishing Licensing from Procurement 19 2.4.6 Concessions, BOTs and Similar Arrangements 20 2.4.7 Service Areas 21 2.4.8 Qualification Criteria 21 2.4.9 Selection Criteria 23 2.5 Contents of Licences 23 McCarthyTerault infoDev 2i Boxes, Figures and Tables List of Boxes Box 2-1: Licensing Rules in WTO Regulation Reference Paper 6 Box 2-2: EU Licensing Objectives 7 Box 2-3: EU Rules on Conditions for General Authorizations 8 Box 2-4: EU Rules on Conditions for Individual Licences 9 Box 2-5: Features of Multiple Round Auctions: The Canadian Example 15 Box 2-6: Auctions and Comparative Evaluations - UMTS Case Studies 16 List of Figures Figure 2-1: Licensing Competitive Operators 3 List of Tables Table 2-1: Types of Licensing Regimes 10 Table 2-2: EU Licensing Directive: Types of Regulation of Competitive PSTN Operator 1 1 Table 2-3: Possible Qualification Criteria 24 Table 2-4: Possible Selection Criteria 25 Table 2-5: Contents of a PSTN Operator's Licence (Example for Emerging Economy) 26 2 - ii infoDev McCarthyTetraukt LICENSING TELECOMMUNICATIONS SERVICES 2.1 Introduction In many cases, licences for incumbent operators were prepared as part of their privatization process. 2.1.1 Telecommunications Licences By specifying the rights and obligations of such operators, investors were provided with some cer- A telecommunications licence authorizes an entity to tainty as to the business in which they are investing. provide telecommunications services or operate The licence provides all stakeholders, including telecommunications facilities. Licences also consumers, competitors and the government with a generally define the terms and conditions of such clear understanding of what the operator is and is authorization, and describe the major rights and not permitted or required to do. obligations of a telecommunications operator. Licences are particularly significant in the context of Licences for new entrants in telecommunications emerging and transitional economies. Licences markets are frequently granted by means of a com- provide certainty for investors and lenders, and with petitive licensing process, which involves the selec- it the confidence that is required to invest the millions tion of one or more operators from a group of or billions of dollars required to install or upgrade applicants. In other cases, general authorizations telecommunications infrastructure in such econo- are issued. These authorize any entity that complies mies. with the basic terms and conditions of the authoriza- tion to provide a telecommunications service, Licences do not have the same importance in all without the need for an individual licence. countries. In a few countries where monopoly tele- communications operators have long been privately Licensing is a relatively recent development in many owned, notably the US and Canada, there have telecommunications markets. Historically, state- traditionally not been telecommunications licences. owned incumbent operators provided telecommuni- Instead, regulatory terms and conditions were cations services on a monopoly basis in most imposed through decisions, orders or tariff-approval markets. Telecommunications operations were processes of a government regulatory authority. In treated as a branch of the public administration, some other countries, including Latin American along with postal services, road transportation and countries, privately-operated telecommunications other government services, and licences were not carriers were traditionally granted concessions or considered necessary. franchises. McCarthy .~trau1t infrDev 21 McCarthyTetrault infoDev2- Telecommunications Regulation Handbook While the terms "licence", "concession" and are an important tool for exercising such "franchise" may be defined differently in the laws of control in most countries. dfferent countries, these terms generally refer to the same basic concept. In the context of telecommuni- (ii) Expansion of Networks and Services cations regulation, they all refer to a legal document and Other Universal Service Objectives - granted or approved by a regulator or other govem- This is a major reason for licensing new ment authority that defines the rights and obligations telecommunications operators in most of a telecommunications service provider. For the countries. Network roll-out and service sake of simplicity, we will use the term "licence" only coverage obligations are often included in in this Module. In most cases, however, what is said licences. This is particularly the case where about licences applies equally to concessions and a state-owned incumbent operator (a PTT) franchises. is privatized, or some degree of exclusivity is granted (e.g. a duopoly cellular licence, The process of licensing incumbents and new with a right to use scarce spectrum). entrants is sometimes handled by independent tele- Licences are an important tool for expand- communications regulators and sometimes directly ing infrastructure investment and promoting by governments or Ministers. In this Module, for universal service and universal access ease of reference, we will generally refer to the objectives in developing countries. licensing authority as the "regulator". This term is (Universal service objectives are discussed intended to include other licensing authorities, such in detail in Module 6). as Ministers. (iii) Privatization or Commercialization - A No matter which government authority is responsi- licence is necessary where a state-owned ble, the licensing process is generally one of the incumbent (a PTT) is privatized. The licence most important "regulatory" processes undertaken in specifies the rights and obligations of the the course of reforming the telecommunications operator. It is a key document in the privati- sector. The licensing process is integrally tied to the zation process. It specifies what the investor structure of telecommunications markets, the num- is buying and what the govemment expects ber and types of operators, the degree of competi- from the operator and the investor. tion between them, the revenues earned by governments in opening markets, and, ultimately, (iv) Regulating Market Structure - A key the efficiency of the supply of telecommunications aspect of regulation is the determination of services to the public. the market structure of the telecommunica- tions sector, and in particular, the number of 2.1.2 Licensing Objectives operators licensed to provide telecommuni- cations services. In many countries a prime Governments and regulators normally have several reason for licensing new telecommunica- different objectives for licensing telecommunications tions operators is to increase competition. operators. Common licensing objectives are set out Licensing of new operators has made below: competition the dominant mode of supply in some telecommunications markets (e.g. (i) Regulating Provision of an Essential cellular, ISP), but not yet in others, including Public Service - Basic telecommunications basic services. Figure 2-1 illustrates the is viewed as an essential public service in different levels of competition in various most countries. While there has been an telecommunications markets around the irreversible trend toward privatization and world. A major objective of the licensing reliance on market forces, most govern- process in many markets is to ensure the ments continue to impose some controls to viability and benefits of new competitive ensure basic telecommunications services entry. On the other hand, while licensing are provided in the public interest. Licences initiatives can increase competition, licensing requirements can also provide a 2 - 2 infoDev McCarthyTetrault Module 2 - Licensing Telecommunications Services means to limit market access. This is the tion, and to limit the prospects that objective of licensing authorities in some incumbent operators will abuse their countries, where licences have granted or dominant position in telecommunications retained monopoly, duopoly or other exclu- markets. Such conditions are generally sive rights. Such rights are often retained for referred to in licences as "anti-competitive political or financial reasons. For example, safeguards" or 'lair trading conditions". govemments in many countries have (Examples of such conditions are discussed increased privatization proceeds to gov- in greater detail in Modules 3, 4 and 5). emment coffers by granting monopoly rights to the newly privatized operator for a fixed (vi) Allocation of Scarce Resources - Finite term. While maintenance of monopolies resources required in the operation of a generally reduces efficiency in telecommu- telecommunications service (such as radio nications markets, many govemments have spectrum, numbers and rights of way) accepted this as a "transitional" problem, in should be allocated between operators order to generate cash for purposes like fairly, efficiently and in the public interest. debt reduction. In these cases, liberalization This allocation often requires a balancing of generally proceeds in stages. competing interests and priorities. Spec- trum, for instance, may be auctioned to the (v) Establishing a Competition Framework - highest bidder or allocated at low cost to Licences frequently include conditions to reduce prices or to encourage the rollout of establish a "level playing field" for competi- new services. Access to rights of way can Level of Competition in Basic Services: Level of Competition: Various WrO Signatories Services * Monopoly *Compellon l noi.EGompi.on 60l 1001 _____ ~50 I- 80- 40- MC0 3 2- Li K' ~~~~~ 40. 20 ' 10. ~'=='~20- 0. 0-~~~~~~~~~~~~~~~~0 Local Long International Basic Cellular Cable TVi ISss Distance ~~~~~~~~Serv ces ~~~~ ~~~-3 McCarthyTe'trault infoDev2- Telecommunications Regulation Handbook be a source of revenue to government Whether an operator's rights and obligations are set authorities or public utilities, but economic or out in a licence or by some other means is generally other restrictions on access can delay the determined by two factors: rollout of services and lead to higher consumer prices. > requirements of local law, and (vii) Generating Government Revenues - - the level of development of the local regulatory Licensing of telecommunications operators framework. and of radio spectrum can provide signifi- cant revenues to governments. An auction Matters that are dealt with in licences in some for new licences can generate one-time countries are dealt with in other regulatory instru- revenues. In addition, annual licence fees ments in different countries. For example, in Mexico, often provide a continuing source of the quality of service standards and targets for revenue to fund the operations of the regu- Telmex were included in the licence (concession) lator, or for other purposes. In addition, prepared for Telmex prior to its privatization. In licensing of new operators can increase the Canada, quality of service standards and targets are overall size of telecommunications markets set out in decisions and orders of the regulator, the and thus generate higher tax revenues for CRTC. governments. Privatization and liberalization first occurred in (viii) Consumer Protection - Conditions relat- Europe in the United Kingdom in the early 1980s. At ing to consumer protection are often that time, the concept of telecommunications regula- included in telecommunications licences. tion was new to the UK. There was no existing Such conditions may relate to matters such regulatory framework. Therefore, the licence issued as price regulation, billing practices, to British Telecom was prepared as a largely self- consumer complaint mechanisms, dispute contained regulatory code. It governed most aspects resolution, limitations of liability for service of the operations of BT and granted a variety of ex- defaults, and mandatory services to con- clusivity rights, such as a limited monopoly for basic sumers (e.g. directory services, operator voice services and limitations on simple resale. assistance and emergency services). Similarly, the licence for Mercury, the first fixed-link competitor in the UK, contained a fairly comprehen- (ix) Regulatory Certainty - By clearly defining sive regulatory code for that operator. the rights and obligations of the operator and the regulator, a licence can significantly A similar model was adopted in a number of other increase confidence in the regulatory re- countries in Europe and elsewhere as incumbent gime. Regulatory certainty is a critical operators were privatized and new operators were element of the licensing processes where licensed. the aim is to attract new operators and investment. This is particularly true in the As indicated above, some countries, particularly in case when foreign investment is sought in North America, have no tradition of issuing compre- riskier developing or transitional economies. hensive licences that spell out detailed regulatory regimes. In the United States and Canada, detailed 2.1.3 Licences and Other Regulatory regulatory rules are typically contained in regula- Instruments tions, decisions, orders or tariffs made or approved by the regulator. Accordingly, when Canada In most countries, licences comprise only one ele- implemented a licensing regime for certain tele- ment of the regulatory framework. Other rules that communications operators for the first time in 1998, govern operators are included in telecommunica- the regulator issued very short (2 page) licences for tions laws, sector policies, regulations, decrees, international service operators. The balance of the orders, decisions, guidelines, directions and other rules governing these operators is set out in other documents of general application. regulatory instruments. 2 - 4 infoDev McCarthyTetrault Module 2 - Licensing Telecommunications Services Countries that do not have a clear regulatory frame- proceeds to governments from privatization work and that intend to license new operators, or sales or licensing fees. attract investment in incumbents, will need to develop fairly comprehensive licences. Some z Defining Exclusivity Rights - Sector policy countries that have initiated privatization and may call for the licensing of multiple operators, liberalization without clear and detailed licences or or it may grant exclusive monopoly (or duopoly) other regulatory instruments have experienced rights for specified periods of time. The granting serious problems due to regulatory uncertainty. of exclusivity rights generally increases govern- ment revenues from privatization and licensing In other countries, without a clear regulatory frame- transactions. However, as noted in Modules 1, 4 work, certainty has been achieved at an early stage and 6, maintaining monopolies can limit sector through the use of comprehensive licences. growth and reduce operator efficiency to the Examples include Hungary, Uganda, Morocco and detriment of consumers. Whatever policy is Jordan. The more detailed licences have contributed adopted on exclusivity, it should be clearly to the success of privatization and new competitive reflected in the licences of new operators in entry. Table 2-5 provides an example of the fairly order to provide certainty to them, their investors comprehensive contents of a PSTN licence in a and lenders. developing country without a clear regulatory framework. 2.1.4 Multilateral Trade Rules With increasing competition in telecommunications The General Agreement on Trade in Services markets, it should be possible to reduce the detail of (GATS) and the 1997 WTO Agreement on Basic the regulatory framework included either in licences Telecommunications (ABT) of the World Trade or in other regulatory documents. This trend is Organization (WTO) include trade rules applicable to recognized in the 1997 European Union Directive on telecommunications regulation and licensing. Sig- Licensing, and the subsequent July 2000 licensing natories to the ABT, as well as countries wishing to proposals, which favour minimal licence conditions join the WTO, must bring their regulatory and and the eventual elimination of the licensing licensing practices into compliance with WTO trade requirement. rules. However, the situation remains different in less The trade rules relevant to the licensing process are developed telecommunications markets, and espe- summarized below. Further detail is provided in cially in those with perceived high country risk, other Modules (e.g. trade rules affecting intercon- economic and governance problems. Most of these nection, fair competition and universal service). The markets do not have clear or consistent regulatory central themes of all of these rules are evolution policies or frameworks. In such markets, it will be towards open competitive markets and transparent important to develop clear and detailed licences as licensing processes. part of privatization and liberalization initiatives. There should be two key goals in preparing such (i) General GATS Requirements licences: All WTO member states are bound by the "general > Regulatory Certainty - Where privatization and obligations and disciplines" of the GATS. Three of licensing transactions are implemented before a these are directly relevant to the licensing process: clear regulatory framework has been developed, the rights and obligations of operators should be (a) Most Favoured Nation (MFN) Treatment (GATS clearly defined in licences. Regulatory certainty Article II)- A licensing regime must grant market on key issues (such as interconnection, price access to operators from a WTO member regulation and competitive safeguards) will pro- country on terms "no less favourable" than the mote success of privatization and initiatives to terms applicable to operators from "any other promote new market entry. Uncertainty will country". reduce investor interest. It will also reduce McCarthyTetrault infoDev 2-5 Telecommunications Regulation Handbook (b) Transparency (GATS Article ll) - All laws and The wTO Regulation Reference Paper, which was rules affecting trade in services must be annexed to many countries' ABT commitments, published. The Telecommunications Annex to binds them to adopt certain regulatory practices the GATS specifically requires publication of, applicable to basic telecommunications services. among other things, all notification, registration Two of these commitments, which are set out in Box or licensing requirements, if any as well as any 2-1, are directly relevant to licensing. other forms of recognition and approval (e.g. type approval of terminal equipment) needed The complete text of the WTO Regulation Reference before foreign service suppliers can do business Paper is set out in Appendix A. lawfully in a member country. 2.1.5 The EU Licensing Directive (c) Barriers to Trade (GATS Article VI) - Licensing -requirements must not "constitute unnecessary The 1997 EU Licensing Directive provides a detailed barriers to trade". framework for telecommunications licensing in Europe. This framework is consistent with the WTO (ii) Specific ABT Commitments commitments of the EU. While it is only binding within the EU, the Directive provides a good The schedules to the GATS contain additional trade approach for other countries to consider in develop- commitments by individual member countries ing their own licensing regimes. concerning specific services, including basic tele- communications services. Further, national The EU has recently published a proposal for new commitments made as part of the WO Agreement licensing Directive (Proposal for a Directive on the on Basic Telecommunications require many coun- authorization of electronic communications networks tries to provide greater telecommunications market and services, 12 July 2000). However, as discussed access. In many cases, implementation of these below, this new proposal largely represents a commitments is phased in over a period of several renewed effort to implement the harmonized and years. Box 2-1: Licensing Rules in WTO Regulaton Reference Paper WTO Regulation Reference Paper- Commitments on Licensing Process 4 Public Availability of Licensing Criteria Where a licence is required, the following shall be made publicly available: (a) All the licensing criteria and the period of time normally required to reach a decision conceming an application for a licence, and (b) the terms and conditions of individual licences. The reasons for the denial of a licence will be made known to the applicant upon request. 6. Allocation and Use of Scarce Resources Any procedures for the allocation and use of scarce resources, including frequencies, numbers and rights of way, will be carried out in an objective, timely, transparent and non-discriminatory manner. The current state of allocated frequency bands will be made publicly available, but detailed identification of frequencies allocated for specific govemment uses is not required. 2 - 6 infoDev McCarthyTetrault Module 2 - Licensing Telecommunications Services deregulatory approach set out in the 1997 Directive. Therefore, we will focus on the 1997 Directive Box 2-2: EU Licensing Objectives below. Objectives of the 1997 EU Licensing The objectives of the EU in adopting the Directive Directive are set out in Box 2-2. To extend competition in telecommunications The Directive encourages the use of general markets by means of a licensing regime which: authorizations, which the British refer to as class - Eliminates all barriers to entry except for licences. The proposed use for individual licences is objective, transparent, non- restricted to public voice telephony and services discriminatory and proportionate using scarce resources. Conditions of general restrictions relating to the availability of authorizations should be limited to those relating to scarce resources, such as numbers, l "essential requirements". The contents of this type of spectrum and rights of way, condition are described in Box 2-3. The licence con- - Simplifies and harmonizes licensing ditions and eligibility criteria for general processes across the EU, and authorizations are to be published by the licensing >_ Establishes licence conditions that are authority. Any person who meets the criteria will be transparent and constitute 'the lightest authorized to provide service without any further possible regulation, compatible with the selection process, regulatory decision or individual fulfillment of applicable requirements". licensing requirement. Under the 1997 Licensing Directive, restrictions are also placed on the types of conditions that may be applied to individual licences. These conditions are The EC's July 2000 proposal aims to ensure that no described in Box 2-4. Specific provisions of the information is required as a prior condition for market Directive relating to the form and content of licences entry. It also places limits on subsequent verification are discussed in more detail later in this Module. of compliance with conditions. In addition, the proposed Directive would reduce administration In its July 2000 proposal for a new Licensing charges considerably, and would require regulators Directive, the European Commission renewed its to publish annual overviews of costs and charges. If efforts to harmonize and reduce European licensing charges collected by regulators exceeded their requirements. Although the 1997 Licensing Directive administrative costs, the regulators would be re- gives priority to general authorizations, the. EC quired to adjust the level of charges the following determined that it still leaves too wide a margin for year. Member States to use individual licences. In fact, the EC found that individual licences have become the 2.2 Types of Licensing Regimes rule rather than the exception in most European national licensing regimes. In order to further In general, there are three approaches to authorizing promote market entry, the EC's July 2000 proposal telecommunications operators and services: would cover all services and networks under a general authorization scheme, and would limit the 1. individual operator, licences; use of individual licences to the assignment of radio frequencies and numbers only. The proposed direc- 2. general authorizations; and tive would also further limit the number of conditions that may be imposed on service providers. It 3. no licensing requirements (i.e. open entry). requires strict separation between conditions established under general law (applicable to all These j categories are reflected in the regulatory operators), conditions under the general authoriza- framework of a number of countries. The categories tion and conditions attached to individual licences. are used in the EU's 1997 Licensing Directive. While the existing legal framework in all countries does not McCarthyTetrault infoDev 2 - 7 Telecommunications Regulation Handbook Box 2-3: EU Rules on Conditions for General Authorizations 1. Any conditions which are attached to authorizations must be subject to the principle of proportionality and consistent with the EU's competition rules. 2. Conditions which may be attached to all authorizations: 2.1 Conditions aimed at ensuring compliance with relevant essential requirements, 2.2 The provision of information reasonably required for the verification of compliance with applicable conditions and for statistical purposes, 2.3 Conditions intended to prevent anti-competitive behaviour in telecommunications markets, including measures to ensure that tariffs are non-discriminatory and do not distort competition, 2.4 Conditions relating to the effective and efficient use of numbering capacity. 3. Specific conditions which may be attached to general authorizations for the provision of publicly available. Telecommunications services and networks: 3.1 Conditions related to the protection of users and consumers, in particular, in relation to: - The prior approval by the national regulatory authority of the standard subscriber contract, s- The provision of detailed and accurate billing, - The provision of a procedure for the settlement of disputes, 9- Publication and adequate notice of any change in access conditions, including tariffs, quality and the availability of services. 3.2 Financial contributions to the provision of universal service, in accordance with Community law. 3.3 Communication of customer database information necessary for the provision of universal directory information. 3.4 Provision of emergency services. 3.5 Special arrangements for disabled people. 3.6 Conditions relating to the interconnection of networks and the interoperability of services, in accordance with the EU's Interconnection Directive and obligations under Community law. Source: CEC (1997) reflect this categorization, it is a useful approach for The form of a licence depends on the legal regime of considering licensing requirement. (Once again, the each country. Matters of form are largely irrelevant North American situation is different. There have to good licensing practice. What is more important is generally been no licensing requirements for tele- that the licence conditions are clear, proportionate communications operators or services, except for and enforceable. spectrum licences, FCC Section 214 facilities certifications, CRTC international service licences, In many countries the grant of a telecommunications and, historically, public convenience and necessity licence is a unilateral act of the regulatory authority. certificates in some states and provinces.) The licence is granted to one or more licensees subject to the terms and conditions specified in the The main features of each of the three approaches licence. The grant of the licence is a purely adminis- to licensing are outlined in Table 2-1. trative act. 2 - 8 infoDev McCarthyTetrault Module 2 - Licensing Telecommunications Services Box 2-4: EU Rules on Conditions for Individual Licences Specific conditions which may be attached to individual licences, include: - Specific conditions linked to the allocation of numbering rights (compliance with national numbering schemes). > Specific conditions linked to the effective use and efficient management of radio frequencies. > Specific environmental and specific town and country planning requirements, including conditions linked to the granting of access to public or private land and conditions linked to collocation and facility sharing. > Maximum duration, which shall not be unreasonably short, in particular in order to ensure the efficient use of radio frequencies or numbers or to grant access to public or private land, without prejudice to other provisions concerning the withdrawal or the suspension of licences. p > Universal service obligations. > Conditions applied to operators having significant market power, intended to guarantee interconnection or the control of such significant market power. ' Conditions concerning ownership which comply with European Community law and the Community's commitment vis-a-vis third countries. - Requirements relating to the quality, availability and permanence of a service or network. > Specific conditions relating to the provision of leased lines. Source: CEC (1997) In other countries, a licence is a contract between 2.3 The Licensing Process the regulator and the operator. This approach is used where licences are granted by way of tradi- The last section considered different types of tional "concessions". Licences in this form generally licensing regimes. In this section, we consider the set out rights and obligations of both the regulator different processes by which licences are issued. and the operator in some detail and are signed by The process will depend on the sector policies, laws both parties. This "contractual" form of licence is and market structure in a particular country. Five most common and useful in countries where the common types of licensing process are discussed legal and regulatory framework is less developed. below. Over time the need for individual licences will dimin- 2.3.1 Licensing Incumbent Operators ish in many liberalized markets. In a highly competitive market the main justification for The telecommunications reform process in most individual licences will be the need to fairly allocate countries includes privatization of PTTs and the scarce resources such as spectrum. This is one granting of competitive licences in various market reason to separate the licensing of spectrum from segments. Many countries have completed this pro- the other aspects of licensing. cess; others are in the midst of implementing it, and a few have not started. Whatever the legal form and process of licensing, good licensing regimes have common features. A major step in the privatization and liberalization These include clarity, transparency and the avoid- process in many countries is the issuance of a ance of unnecessarily burdensome conditions. icence to incumbent operators. This step generally These features are discussed further in Section 2.4 of this Module. McCarthyTetrault infoDev 29 Telecommunications Regulation Handbook Table 2-1: Types of Licensing Regimes Type of Licensing Main Features Examples Requirement Individual ' usually a customized and detailed licence - basic PSTN services in Licences document a monopoly market (Operator Specific frequently granted through some form of com- - mobile and fixed Licences) petitive selection process wireless services useful where: ' any service requiring (i) a scarce resource or right is to be licensed (e.g. spectrum spectrum) and/or (ii) the regulator has a significant interest in ensuring that the service is provided in particular manner (e.g. where the operator has significant market power) General - useful where individual licences are not jusb- > data transmission Authorizations fled, but where there are significant regulatory services (Class Licences) objectives which can be achieved by 9 resale services establishing general conditions > normally contain provisions relating to con- > private networks sumer protection and other essential requirements > generally issued without competitive selection process; all qualified entities are authorized to provide service or operate facilities Services which no licensing process or qualification require- - Intemet service may be provided ments providers (ISPs) (fully liberaized >. useful where an activity is technically caught > Value-added services (fullysliberavice) within the definition of activities subject to services) regulation (e.g. offerng a telecommunications service to the public) but where there is no jus- tification for imposing licence requirements > general requirements (e.g. registration with the regulator) can be imposed through a general regulation or order does not involve competitive selection or other authorizations. Others, including the PTT, generally formal public process. New telecommunications receive individual licences. While the EC licensing laws or amendments often authorize the licensing of proposals advocate a move away from individual the incumbent operator. The licensing process licences in mature competitive markets, there are involves the detailed identification of existing and still good reasons for individual licences for new rights and obligations of the operator. In some incumbents in less competitive markets with less cases, incumbent operators may be granted general well-defined regulatory frameworks. 2-10 ... infoDev McCarthyTetrault Module 2- Licensing Telecommunications Services loan of sssued through essenti!a1l&L?ui"r genera operaing authiorization or class _ailetoalluos appiicabletoall* l a v.a ia u- orI The rights and obligations incorporated in new Parallel Licences for PTO and New Entrants licences for incumbents must generally be adapted to a new sector policy and regulatory regime. In In some countries, established PTOs are granted particular, they must often be adapted to the realities licences for new services (e.g. cellular, data com- of a market based economy, especially where the munications, ISP, value added services) while operator is to be privatized and to face competition licences for those services are also granted to new for the first time in some markets. It is generally ad- entrants. The PTOs generally receive the licence visable to obtain good market input before, settling outside the competitive selection process that may the terms of such licences. This can be achieved be used to select new entrants, such as new mobile through a public process, although it is more com- operators. This has been the case for cellular mobile mon to do so by retaining good professional licences in both developed and less developed advisors with experience in privatization and countries. liberalization in other markets. Issues of competitive faimess arise in this process. In practce, the licensing of incumbents often Often the new entrant pays a significant amount for involves a process of negotiation between the Public the licence under a competitive selection process Telecommunications Operator (PTO) and the regu- but the incumbent does not. This issue has some- lator. Additional input generally comes from profes- times been addressed by requiring incumbent sional advisors, including investment bankers and operators to pay a fee equal to the amount of the lawyers hired by the PTO, govemment or regulator. winning bid or a fixed percentage of that amount. It is important for the regulator (or other licensing This occurred recently when Jordan licensed a authority) to obtain a good balance of views on the second GSM operator. When Colombia licensed contents of the licence. In this regard there are often second cellular operators in each of three regional competing agendas between the PTO, which may markets, the,existirng operators were required to pay want to retain as much exclusivity and market power 95% of the amount of the winning bid in the as possible, and those promoting a competitive tele- applicable region. communications policy. Ministries of Finance and investment bankers for PTOs often focus on In other countries the incumbent operator has not granting exclusivity and market advantages as been required to pay licence fees, even though new means of increasing privatization proceeds. entrants do pay. Some argue that the incumbent Ministries of Communications and regulators are was awarded a licence in accordance with past often more focussed on promoting competition as a practice and law, and that it would be unfair to retro- means of increasing efficiency of telecommunica- actively tax it. Others have pointed out that the tons niarkets and delivering better services to the incumbent may have taken risks and incurred public. expense in developing the market. From this McCarthyTe6trault infoDev 2-11 Telecommunications Regulation Handbook perspective the retroactive imposition of a substan- the same service are subject to the same licence tial licence fee may be considered inappropriate. conditions. While there is not always a right answer in these situations, care must be taken to provide a level 2.3.4 Spectrum Licences playing field. If preferential treatment is granted to an incumbent, there should be clear benefits to the Many telecommunications services require an public for doing so. These may include maintenance authorization to use radio frequencies. Spectrum of network rollout obligations or other specific licences that are required to provide a service are universal service objectives. often granted as part of an individual licensing process. It is necessary, for instance, to authorize 2.3.2 Licensing New Entrants - Individual cellular operators to use the required spectrum as Licences well as authorizing them to operate the cellular net- works. The issuance of individual licences to new operators requires some form of selection process. Where no Authorizations to operate a telecommunications existing operator holds a licence, it is best to imple- service and to use the required radio spectrum ment a competitive and transparent licensing should be granted at the same time. There should process in accordance with the practices discussed be no delays or risks of inconsistent regulatory re- in detail later in this Module (especially in Section quirements as between the two types of authoriza- 2.4). tions. If two separate licences are issued, they should be issued simultaneously. A good approach 2.3.3 General Authorizations is to attach a draft spectrum licence as well as a draft operator's licence to a call for applications for Issuance of general authorizations (class licences) licences. This approach is discussed later in this involves the definition of licence eligibility criteria and Module. licence conditions. Ideally, both processes should involve prior public consultation. This improves the One reason for retaining two separate licences is transparency of the licensing process and ensures administrative convenience in management of the all relevant information is taken into account. No spectrum. In most countries spectrum management selection process is required for general authoriza- is delegated to a different administrative group from tions, since all eligible operators or service providers the group that regulates other aspects of telecom- will be licensed. munications operations, such as price regulation or anti-competitive conduct. By having a separate, Implementation of a general authorization regime consistent form of spectrum licence, technical, can be more complicated where existing individual reporting and compliance requirements can be licences authorize the same services as those standardized across all users of the radio spectrum. covered by the general authorization. For example, general authorizations are frequently used to 2.3.5 Spectrum Auctions, Lotteries and establish conditions for the provision of value added Comparative Evaluation Processes services. However, many PTO operators are also authorized to offer value added services under their The radio spectrum is universally acknowledged to individual licences. be a valuable, limited public resource and thus subject to government regulation. Technological To ensure fair competition, regulators should ensure developments have expanded the usable portions of that any differences between general authorizations the spectrum and enabled the transmission of more and individual licence conditions are competitively and more information in the same amount of band- neutral. A good solution is to indicate that individual width. Despite these developments, an increasing licences do not authorize the offering of any service number of telecommunications services and that can be offered under a general authorization. In applications rely on spectrum, and thus demand for this way, regulators can ensure that all providers of spectrum often exceeds availability. Hence there is a need to develop policies and approaches to assign 2-12 infoDev McCarthyTetrault Module 2 - Licensing Telecommunications Services spectrum. These approaches have similarities with winners proved to be financially incapable of starting other licensing processes, but there are also up service. differences. Comparative Evaluation Processes In the era of public telecommunications monopolies, PTTs were often responsible for spectrum assign- Under a comparative evaluation approach, the ment, and they assigned spectrum for their own use regulator (or another government agency) decides as the need arose. Many countries have since de- to whom the relevant spectrum is to be assigned. veloped new approaches to spectrum assignment to Comparative evaluation provides an approach for replace those used in the era of public monopolies. choosing among multiple applications that are sub- The development of new approaches was spurred stantially equal. It also allows regulators to match on by the WTO Regulation Reference Paper. specific sectoral objectives with the operators in Section 6 of the paper requires that procedures for charge of achieving them. the allocation and use of scarce resources, including frequencies, be carried out in an objective, timely, There are many forms of comparative evaluation transparent and non-discriminatory manner. schemes. In some cases, spectrum licences are awarded to applicants expected to make the best Different approaches have been adopted to assign use of spectrum to serve the public. Comparative spectrum where demand exceeds availability. No evaluation processes may involve the application of consensus exists as to which approach is best in a variety of qualification and selection criteria. In which cases. most cases, these criteria will be published in advance, and applicants will strive to demonstrate Traditionally, govemments often allocated spectrum how their applications meet the criteria better than to particular applications and then assigned parts of other applications. the spectrum to entities to use for specific purposes on a "first come, first served" basis. This approach is Minimum qualification requirements generally fast, practical and inexpensive, but not appropriate in include evidence of financial resources, technical today's competitive environment. The increase in the capability and commercial feasibility of the relevant number of competitors and demands for spectrum spectrum application. Selection criteria may include have led to the development of competitive proposed tariffs, coverage (geographical and in approaches for its assignment. These approaches terms of users), network rollout targets, quality and include lotteries, comparative evaluation approaches range of service commitments, and efficient use of and auctions. Various combinations of these frequencies. Some of the above criteria are applied approaches have also been used. For example, in some cases as qualification criteria and in others applicants may be short-listed using a "comparative as selection criteria, depending on the country and evaluation" approach and then participate in an even on categories of services within a country. auction or lottery for the final assignment of spectrum. There have been many criticisms of the comparative evaluation approach. Criticism generally focuses on Lotteries lack of transparency. No matter how stringent the evaluation criteria, there is a subjective element to Lotteries provide a fast, inexpensive and transparent most comparative evaluation processes. Hence they approach for selecting from substantially similar or are sometimes referred to as "beauty contests". equally qualified applicants. Lotteries should gener- Because of the subjective element, it is often ally be preceded by a formal qualification process to suspected that regulators or other decision-makers select lottery participants. Otherwise, their use may may not exercise their judgement impartially. In hinder sector development. In the US, for example, some cases these suspicions have led to litigation. experience demonstrates that some past lottery In others, the suspicions are not acted upon, but participants had no intention of operating telecom- they nevertheless undermine the credibility of the munications services, but simply planned to resell licensing process and the government or regulator. their spectrum licences for a profit. Other lottery McCarthyTetrault infoDev 2-13 Telecommunications Regulation Handbook Other criticisms of the comparative evaluation proc- rounds until a high bidder is determined for each ess focus on its speed. The process is often slow. licence; Careful evaluations of financial capability, technical plans, etc. can take time. Finally, comparative At 'the beginning of each round, every bidder evaluation processes are sometimes crticized as receives information about its eligibility.to bid and involving inappropriate or questionable regulatory about the standing high bid on.each licence. New intervention in the selection of winners and losers. It bids must normally be higher than the standing high is often said that auctions provide a better altemative bid by 'at least a minimum pre-set amount. In some to comparative evaluations, in that they rely on mar- cases, bidders may have the opportunity to withdraw ket forces rather than regulatory fiat to determine bids made in earlier rounds, although this action is competitive outcomes. usually subject to penalties. Sometimes an "activity rule" penalizes bidders who are inactive by reducing Auctions their "bidder eligibility points". The rounds continue until there are no new bids on any licence. - Auctions are increasingly used by regulators to grant spectrum licences to the highest bidders. In the case The bidding process in simultaneous multiple round of auctions, the market ultimately determines who auctions is usually computerized, so that bids and will hold the spectrum licences. However, in many other auction information can be posted and calcu- auction schemes, bidders are pre-qualified using lations made quickly. Bids are typically encrypted for criteria similar to those used in comparative evalua- security and submitted electronically. tion processes. -As a result, participation in some auctions is limited to bidders with proven financial Some key features of simultaneous multiple round and technical capabilities. auctions are illustrated in Box 2-5, which describes the Canadian auction process. Experience with spectrum auctions in the US illus- trates the importance of using rigourous technical, There are many arguments in favour of spectrum financial and commercial criteria to pre-qualify auctions. Auctions provide an efficient, transparent bidders. In that country, some successful bidders and objective means of awarding spectrum licences later proved to be incapable of financing their to the bidders who value them most highly. A proper aggressive bids. It appeared that others had neither pre-qualification process can ensure that successful the technical capability nor the intention of operating bidders have the technical and financial capabilities telecommunications services utilizing the frequen- to implement services quickly and efficiently. The cies they had successfully bid on. high investments required to win an auction can be viewed as incentives for rapid roll-out of infrastruc- There are different types of spectrum auctions. The ture and services, since that is the only way the most common are: successful bidder can recoup its investment in the licence fee. Another argument in favour of spectrum > One round or simple auctions (open or closed); auctions is that they provide the means to provide and the public with the highest "rents" for the use of a public resource. Govemments can use the proceeds > Multiple-round auctions (sequential or simulta- of. auctions for deficit reduction and other public neous). priorities. Initially developed in the US in the mid 1990s, the There are also arguments against spectrum auc- simultaneous, multiple-round auction has become tions. First, it is argued that the high costs paid by the most widely used auction approach. While there successful bidders are usually passed on to are variations from country to country, the approach customers. The result can be excessive rates for generally involves a simultaneous auction for consumers of wireless services, and reduced pene- different spectrum licences. There are "rounds" of tration, particularly among lower income consumers. bidding, that is series of consecutive bids, for each Some argue that capital used to pay high auction licence. The bids continue to increase during these fees will not be available to invest in network 2-14 iinfoDev McCarthyTetrault Module 2 - Licensing Telecommunications Services Box 2-5: Features of Multiple Round Auctions: The Canadian EBxample 1. Bidder Eligibility Points: Each licence in an auction is assigned a number of points proportionate to the bandwidth and population covered by that licence. Each bidder must indicate which licences, and the number of-'points-worth" of licences, it may wish to bid on. 2. Activity Rule: A bidder is considered active on a particular licence if it has the current high bid from the previous round or if it submits an acceptable bid in that current round. In each stage of bidding, a bidder must be active on licences whose corresponding points add up to a certain percentage of the bidder's eligibility point level. 3. Bid Withdrawals/Penalties: If a bidder makes a bid and later wishes to change it, it may do so subject to paying a penalty which corresponds to the potential loss of revenue caused by the withdrawn bid. I 4. Bid Increments: Bid increments are used to expedite the auction. They are set in percentage and/or absolute dollar terms and are changed during the course of the auction. 5. Walvers: Waivers protect bidders against mistakes they may make or in the case of technical or commu- nication problems. They prevent a bidder from losing bidder eligibility points when it does not satisfy the activity requirements in a given stage. 6. Stopping rule: The auction generally stops when a round finishes with no acceptable bids or waivers having been submitted on any licences. 7. Forfeiture: A bidder who submits the high bid on a licence but fails to pay will forfeit its right to the licence and must pay a penalty Source: Department of Industry Canada (I 998) infrastructure. While it is arguable that a well- 2.4 Licensing Practices financed applicant should be able to pay for both, it is not possible to prevent strategic bidding to obtain While telecommunications licensing approaches spectrum. Banks, rating agencies and financial vary considerably from country to country, there are advisors have been critical of recent record-high common features, particularly among better licens- auction fees paid for UMTS mobile spectrum in ing practices. The following sections review good several European countries. Share prces and debt practices that will help ensure the success of a ratings of some successful bidders have dropped licensing process. due to widely-held perceptions that too much was paid by them in the auctions. Finally, high auction 24. 1 Transparency fees may discourage smaller participants from entering a telecommunications market. The result Procedural transparency is one of the fundamental may be increased market concentration, and ulti- requirements of a successful licensing process. The mately also higher consumer prices. importance of transparency in the licensing process is evidenced by its inclusion in the WTO Regulation Simultaneous multiple round auctions have recently Reference Paper (see Box 2-1). been used to license wireless service providers in Australia, Canada, Spain, the Netherlands, the Transparency requires that a licensing process be United Kingdom and Germany. The recent UMTS conducted openly and that licensing decisions be (3G Cellular) licensing process provides some inter- made based on criteria published in advance. These esting case studies in different spectrum licensing requirements apply to all licensing decisions, approaches. Box 2-6 describes the quite different including ones to award or revoke a licence. The UMTS licensing processes utilized in a variety of licensing processes described later in this Module European countries. McCarthyTetrault infoDev 2-15 Telecommunications Regulation Handbook Box 2-6: Auctions and Comparative Evaluations - UMTS Case Studies Germany - In August 2000, Germany auctioned off 12 blocks of UMTS spectrum. The German regulator (RegTP) published the rules applicable to the award of the UMTS licences on 18 February 2000. The rules provided that eligibility to take part in the auction would be governed by the basic eligibility requirements of the Telecommunications Act. Bidders were required to bid successfully for at least two blocks of spectrum to qualify for a licence. Minimum bid increments were set at 10 percent. Additional rules were established to prevent bidders from influencing the outcome or controlling the pace of the auction. While the auction took place, for example, small groups of representatives of each bidder were isolated from 8 a.m. to 6 p.m. each day, with two observers from RegTP present with each group at all times. Bidders were not able to see what rivals were bidding. Only the highest bids for each block were made known to bidders. Germany's UMTS spectrum auction lasted for 14 days and 173 rounds of bids. At the end, six operators each obtained two blocks of spectrum and 20-year licences. The licences require operators to provide coverage of at least 50 percent of the German population by the end of 2002. This auction concluded with record bids for UMTS licences: a combined total of over USD 46 billion. As a result of the enormous amounts paid, concerns were expressed that some operators may well end up spending more on acquiring the licences than on building their networks. United Kingdom, Spain and Netherlands - The UMTS spectrum auction held in the United Kingdom in April 2000 raised USD 32.58 billion. That process continued for more than 100 rounds over a period of more than four weeks. The Netherlands auctioned off five licenses for USD 2.3 billion in July 2000. Spain, on the other hand, raised only USD 425 million from its sale of four UMTS licences in March 2000. Norway - In Norway, a comparative evaluation process was used instead of an auction to grant UMTS spectrum licences. Applicants were required to meet minimum eligibility requirements, such as a commitment to meet specific coverage and roll out obligations, and proof of financial strength/capability. The two main selection criteria were coverage (geographical and in terms of population) and roll out. Financial aspects, quality of service, environmental impact and previous experience were secondary criteria. Norway's emphasis was not on raising as much money as possible from the licensing of spectrum for 3G mobile systems. Rather the goal was to encourage rapid network development and to increase the country's overall competitiveness. In Norway, wireless operators are required to pay moderate administrative and fre- quency management fees. Operators awarded 3G spectrum licences were required to pay a special annual fee of approximately USD 2 million. In addition, subject to parliamentary approval, 3G licensees were required to pay a one-time lump sum of approximately USD 11 million. These sums are very small compared with the results of the spectrum auctions in the United Kingdom and Germany. Sweden - In Sweden, spectrum licences for 3G mobile communications systems will also be awarded using a comparative evaluation process. Swedish law provides that spectrum licences must be awarded based on specific criteria. As in Norway, the main selection criteria for the award of 3G spectrum licences in Sweden are coverage and roll out. Modest fees will be charged for the spectrum licences. This approach is considered beneficial in that it will enable operators to invest in network development. High spectrum fees paid by operators will not be passed on to customers. reflects the principles of transparency. Key features - separation of qualification and selection of such processes include: processes; > advance publication of a call for applications, ) return of unopened financial offers (bids) to with application process (tender) rules, quali- applicants who do not meet the published fication and selection criteria; qualification criteria; and 2- 16 infoDev McCarthyTerault Module 2- Licensing Telecommunications Services > public opening of sealed financial offers from public comment. By contrast, in a competitive li- qualified applicants. censing process there are usually other ways for stakeholders to make their views known, such as A transparent process can be different in the case of pre-bid conferences and written exchanges of electronic applications or auctions. These are questions and answers. discussed above under the heading Auctions. Consultation can be formal or informal. In the Transparency is best measured from the point of context of any major licensing initiative, it is generally view of the participants in the licensing process. It is advisable for the regulator to establish a formal and good practice for a regulator to take all reasonable transparent consultation process. A good approach steps to ensure that participants in the licensing pro- is for the regulator to publish a notice stating its cesses, including applicants, existing licensees, and intention to launch a licensing process, and inviting competitors as well as the general public, perceive comments on the proposed approach. The notice the process to be fair. should set forth in some detail the proposed approach and any specific issues on which com- Conducting a transparent licensing process is ments are sought. Where the regulator is unsure of sometimes perceived to be more time consuming the best approach, comments can be invited on and difficult than less transparent altematives. The different options. process, for instance, of publishing procedural rules and selection criteria in advance can be difficult for a Notices of this kind should be sent to all interested newly formed regulator in a country where proce- parties, including prospective applicants, existing dural transparency is not entrenched in government licensees, consumer and industry interest groups. In practice. some cases, a public meeting is held to allow a public exchange of views by interested parties. However, the absence of transparency undermines Copies of written comments can also be published. investor confidence in the fairness of the entire regulatory process and in the telecommunications A pre-licensing consultation process increases the market itself. Lack of transparency can significantly likelihood that the regulator's approach to licensing slow the process of liberalization and reduce the will be based on a good understanding of all relevant benefits of privatization. considerations. Consultation also helps to ensure that even those who may disagree with the regula- 2.4.2 Public Consultation tor's approach will believe that their views have been considered. It is good practice to engage in public consultation before and during a licensing process. To start, it is 2.4.3 Licence Fees often useful for a regulator to invite public comment on the approach to be taken in a proposed licensing In the telecommunications industry, the term "licence process before it starts. Consultation with fee" is used to describe different things. It may stakeholders reinforces the perception of a trans- include one or more of the following: parent process. Consultation allows the regulator to receive directly the views of consumers, existing ' a fee paid as a premium or "rent" to a operators and prospective applicants on a proposed government or licensing authority for the licensing initiative. This allows licence terms and right to operate a network, provide a service conditions and licensing procedures to be fine-tuned or use a limited resource, such as radio to maximize the prospects for a successful licensing spectrum or numbers; process. > administrative charges to compensate a Consultation is particularly important where a regulator for its costs in managing and su- general authorization is to be issued. Advance pervising use of the radio spectrum; and publication of proposed conditions of general authorizations provides the main opportunity for McCarthyTetrault infoDev 2-17 Telecommunications Regulation Handbook - administrative charges to compensate a administrative costs incurred. This will allow regulator for costs incurred in performing undertakings to verify that administrative costs other regulatory functions, such as licensing and charges are in balance. Administrative operators, ensuring compliance with licence charges should not act as a barrier to market terms, resolving interconnection disputes, entry. Such charges should therefore be distrib- establishment and supervision of other uted in proportion to the turnover on the relevant aspects of the regulatory framework, etc. services of the undertaking concerned as calculated over the accounting year preceding It is good practice to differentiate the above-noted the year of the administrative charge. Small and types of fees. This improves transparency and medium sized undertakings should not be makes it easier to determine that the administrative required to pay administrative charges. charges related to cost recovery are indeed cost- based. Separating administrative licence fees (16) In addition to administrative charges, usage related to spectrum management from other fees may be levied for the use of radio frequen- administrative fees improves transparency and cies and numbers as an instrument to ensure the accountability. Spectrum management is usually optimal use of such resources: Such fees should handled by a separate branch, and sometimes a not hinder the development of innovative wholly separate ministry or agency from the tele- services and competition in the market." communications regulator. 2.4.4 Balancing Certainty and Flexibility It is generally accepted that administrative fees should not impose unnecessary costs on the tele- Telecommunications licences should balance regu- communications sector. The most transparent latory certainty with the flexibility necessary to manner by which to achieve this objective is an address future changes in technology, market explicit cost-recovery scheme. Cost recovery structure and government policy. schemes involve establishment of licence fees based on the projected or actual costs of the In many countries, a balance between regulatory regulator. Once that overall level of cost-recovery certainty and flexibility is achieved by using regula- has been set, it is necessary to allocate the costs tory instruments other than licences as main among licensees or market participants. This alloca- elements of the regulatory framework. However, tion can be based on different factors, including tele- where a country's regulatory regime is not well communications revenues, licensed coverage areas developed, it is often necessary to include a or types of services. The most common allocation reasonably comprehensive codification of the basic factor is revenues. regulatory regime in a licence. This is necessary to provide the certainty required to attract new entrants The July 2000 EC proposal to replace the 1997 and substantial investment to the sector. Licensing Directive criticized the "lack of transpar- ency and high fees" of its European Member States. Licence conditions should be sufficiently flexible to It provides the following proposal: allow their integration into the general regulatory framework for the sector as it develops. Licensing an "(15) Administrative charges may be imposed on operator should not preclude future regulatory providers of electronic communications services reform. in order to finance the activities of the national regulatory authority in managing the authoriza- There are several approaches to providing such tion system and for the granting of rights of use. flexibility, including: Such charges should be limited to cover the actual administrative costs for those activities. > permitting unilateral licence amendment by For this purpose transparency should be created the regulator; in the income and expenditure of national regu- latory authorities by means of annual reporting ) establishing short licence terms; about the total sum of charges collected and the 2-18 infoDev McCarthyTetrault Module 2 - Licensing Telecommunications Services > permitting licence amendments with the In licensing a telecommunications operator, a regu- mutual consent of the licensee and regulator; lator is not buying goods or services using public and money. In essence, licensing involves offering a business opportunity to qualified investors who > permitting unilateral amendments by the agree to comply with the licence conditions. The regulator only of specific licence conditions regulator is more a seller than a buyer. that should constitute part of the country's general regulatory regime, provided such This observation leads to two important recommen- amendments are made in a procedurally fair dations for licensing processes: and competitively neutral manner. > The regulator must offer to licence applicants an The first two approaches are not consistent with opportunity that is financially attractive to experi- regulatory certainty. They will generally make it diffi- enced and competent telecommunications cult, if not impossible, to attract the investment and operators. While some licensing opportunities financing required for a major licence, such as a sell themselves, others, particularly those in fixed line or cellular licence. emerging and transitional markets, must be carefully structured and marketed to attract The fourth approach is more attractive in this regard. qualified applicants. Experience shows that To implement it, a distinction can be made between almost any call for applications for telecommu- licence conditions that are of a regulatory nature and nications licences will attract some bidders. those which can only be amended with the agree- However, many are not financially or technically ment of the licensee. For example, licence capable of meeting the regulator's objectives to conditions on industry-wide universal service expand and improve services. mechanisms or general terms of interconnection may be subject to amendment by the regulator. - Govemment procurement procedures are Other conditions of a purely contractual nature or generally not suitable for a telecommunications which are fundamental to the economic value of the licensing process. Many countries have bureau- licence may be subject to modification only on cratic centralized procurement administrations. consent of the operator. These would normally Detailed government procurement procedures include conditions such as the term of the licence are often developed for good reason - to reduce and the licence acquisition fee payable. corruption. However application of these proce- dures can cause legal and administrative Where the regulator has the right to amend the headaches, and delay and confusion about the general regulatory conditions of a licence, such real goals of the licensing process. For example, amendments should be made in a transparent and government procurement officials generally competitively neutral manner. Any amendments want to see detailed specifications for every should be preceded by consultation with the licen- aspect of the goods and services being see and other affected parties. In some cases, a purchased and a careful inspection and right of appeal or review may be warranted. monitoring of installation and performance after selection and delivery. This kind of micro- 2.4.5 Distinguishing Licensing from management is inappropriate in a telecommuni- Procurement cations licensing process. As discussed below, clear qualification requirements should be The process of licensing a telecommunications established. However, the regulator is generally operator should be distinguished from the govem- concerned only with results. What matters is ment procurement process. In many countries there whether - not how - licence conditions are has been confusion between the two types of complied with. From this perspective, such processes, sometimes with adverse consequences issues as technology choices, management for the licensing process. structures and marketing strategies should not be the subject of licence conditions or selection criteria. McCarthyTetrault infoDev 2-19 Telecommunications Regulation Handbook Other problems are experienced in trying to apply It should be noted that the term concession has standard govemment procurement procedures to a different meanings in different countries. For telecommunications licensing process. It is generally example, in some Latin American countries, such as best to avoid such procedures, and to use a simple Mexico, the term concession is used to refer to a and transparent competitive licensing process, document (e.g. the Telmex Concession) that is es- based on internationally accepted telecommunica- sentially a licence, not a commercial agreement, tions licensing procedures. although it is signed by the government and the concession holder. 2.4.6 Concessions, BOTs and Similar Arrangements Some countries, particularly in Asia, have granted concessions that are in the nature of joint venture A licence is a grant by a public authority of a right to agreements rather than granting full licences to operate a service, subject to the terms and condi- operate telecommunications networks independent tions specified in the licence or in other regulatory of the government. instruments. The issuance and enforcement of a licence is therefore always, to some extent, a matter Many variations are possible on the theme of "joint of public or administrative law. As indicated above, ventures" between private sector investors on the licences, concessions and other types of one hand and governments or PTTs on the other. government permits to operate telecommunications These include Build-Operate-Transfer (BOT), Build- facilities and services have more in common than Transfer-Operate (BTO), Build-Operate-Own (BOO), not. and an alphabet soup full of altematives limited only by the imagination of project finance lawyers and However, in some cases, private sector investors bankers. Some examples of countries where such have entered into business arrangements with arrangements have been implemented are listed governments or state-owned operators that are below: more in the nature of joint ventures with govemment entities than independent rights to operate telecom- > BTO: Thailand, Philippines munications facilities or provide services. > BOT: Lebanon, India, Indonesia (Joint Before describing these arrangements, the term Operating Schemes or KSOs) "concession" should be discussed. In most countries, this term is used to refer to a document > BOO: Malaysia, Solomon Islands that establishes a commercial agreement between a government and the private builder, owner or op- In general, these are all project finance structures erator of an element of public infrastructure (such as aimed at attracting investment and management a toll road, power plant or telecommunications expertise required to develop telecommunications network) or a business located on public property. infrastructure. A variation on such structures Contractual remedies, such as money damages, are involves contracts where an investor does not build available for breach of a concession through civil or own any facilities, but shares in revenues from a courts or arbitration. Governments can fine tune state-owned operator in return for providing financ- concession terms to establish the protections and ing, management or both. Financing contracts of this incentives necessary to attract investors and to type have been entered into in China and Indonesia. guarantee performance by the concession holder. An example of a management contract with revenue sharing is the Vietnamese "Business Cooperation Some licences have both regulatory and concession Contract". features. It is important to distinguish between the two. A good approach is to deal with the concession Most of the types of structures discussed in this features in a concession contract between the host Section have experienced initial success in promot- government (not the regulator) and the investor. In ing network expansion. In part this was because project finance terms, such an agreement would be they were not characterized as licences to private called a govemment support agreement. operators but rather as contracts under which 2 - 20 infoDev McCarthyTetrault Module 2 - Licensing Telecommunications Services private contractors would build and operate 1 Financial viability must be a key factor. If finan- telecommunications services "owned" by the cially non-viable rural or high cost areas are government or by a state-owned operator. This licensed, a universality fund, or similar arrangement allowed for private sector participation mechanism should be established. A preferred in telecommunications operators without breaching approach in such cases is to select a licensee laws or policies that prevented private sector owner- from among competing applicants, based on the ship of operators. lowest requested subsidy. Universality funding mechanisms and approaches for measuring However, experience in Lebanon, Indonesia and financial viability are discussed in Module 6. elsewhere suggests that these models are not viable in the long term. Investors in BOT projects lack the > Experience shows that regional licensees often long-term security and equity interests of a licensee. merge with, or are acquired by, other regional They are therefore motivated to maximize short-term licensees to serve larger regions or form profitability at the expense of long term network or national operators. Examples range from the service development. A BOT must either terminate, Colombian cellular operators to the U.S. with the resulting withdrawal of the private investor, Regional Bell Operating Companies. These or it must be converted into a true licence. If the moves are often driven by economies of scale. investor withdraws, the operator may or may not be Regulators may want to keep this trend in mind, able to continue to expand and manage the service and license several competing national opera- on its own. If the concession is converted to a tors at the outset, rather than numerous finan- licence, serious questions may arise regarding the cially weaker regional operators. The result will fairness and transparency of the licensing process. be lower transaction costs for the sector, and less disruption due to integration of different 2.4.7 Service Areas operating systems. The definition of geographic service areas to be > Licensing operators to serve larger areas will covered by a new licence presents unique chal- permit them to cross subsidize from more profit- lenges. Different approaches have been taken in able areas to less profitable ones. This different countries. In some cases, national licences approach can be used to extend service to less are issued, while in others, a distinction is made profitable areas. However, it can lead to anti- between regions or between rural and urban areas. competitive conduct where an incumbent In some cases, national licences are offered in operator retains the right to serve profitable parallel with competing regional licences for the urban markets as well as less profitable rural same service. ones, while new entrants can serve only the rural markets. Problems of anti-competitive There is no one right approach to designating cross-subsidy are discussed in detail in Module service areas. However, some approaches are likely 5. to be less successful than others. One approach that has experienced limited success in a number of ' National licences and large service areas are countries is to preserve the profitable urban markets consistent with the consumer interests in ob- for a state-owned PTT, and to invite private sector taining seamless "one stop shopping" service operators to serve only financially less viable rural from a single service provider. This is particularly areas. In some cases, the failure of the private sec- true where technical or other barriers to efficient tor operators to perform well in such areas has been interconnection or roaming are present. used as evidence to argue against further sector liberalization. 2.4.8 Qualification Criteria The following points are relevant in selecting It is important to distinguish between criteria relating licensed service areas: to the qualification of an applicant to participate in a licensing process and criteria for the selection of a McCarthyTetrault infoDev 2-21 Telecommunications Regulation Handbook successful licensee from among the qualified appli- another operator that does provide it. A qualification cants. process is therefore less important. In the case of a general authorization, only the quali- Recent experience in spectrum auctions demon- fication criteria are relevant because there is no strates, however, that even in relatively competitive selection to be made. In the case of a selection markets, such as mobile services in Brazil and the process for an individual licence, both qualification US, it is important to establish some minimum and selection criteria are normally developed. It is qualification requirements. These requirements will generally advisable to conduct a licensing process in ensure that valuable spectrum and other scarce at least two phases. The qualification phase is resources are awarded to applicants who are finan- completed first. Only qualified applicants participate cially and technically capable of providing the public in the second phase - the licensee selection with service using such resources. process. Some licensing processes involve more than one Qualification criteria are minimum requirements for qualification phase. In issuing a large individual the right to participate in the selection process. licence, a pre-qualification requirement is often Generally, qualification criteria are limited to ensur- established. This limits the eligibility of applicants ing applicants have the financial and technical who can participate in the final qualification process. resources and experience to successfully operate It is justified, for example, where there are high costs the licensed service. incurred by the regulator (and applicants) in con- ducting a detailed qualification process or where Some countries impose foreign ownership restric- confidential access to information or facilities is bions that establish minimum levels of local granted to applicants. ownership for licensed operators. Foreign ownership restrictions are generally contrary to the spirit, if not In those circumstances it makes sense to discour- the letter of foreign trade agreements, including the age participation in the process by applicants who GATS. However, various WTO. signatory countries are unlikely to meet the qualification criteria or to have registered exceptions permitting them to submit a competitive application. Various pre- continue to apply foreign ownership restrictions. qualification options exist. These include: Over time, such restrictions are likely to be phased out in most countries. > payment of a substantial registration fee; The importance of establishing clear and rigourous > a substantial document purchase fee; and qualification criteria is related to the level of competi- tion in the applicable service. In the case of > use of a proxy indicator of experience and individual licensees that will enjoy monopoly or other resources (e.g. minimum number of custom- exclusive rights, it is of critical importance to ensure ers or lines in service for similar services in that the licensed operator is financially and techni- other markets). cally able to meet its licence obligations. Otherwise, the licensee may fail to meet important licence It is important to specify whether qualification criteria conditions, such as those related to network rollout, are in any way relevant to selection. Transparency service coverage and quality. The process of requires that applicants be told whether minimum enforcing licence compliance or revoking and re- compliance with qualification criteria is sufficient. tendering a licence in the case of default is time There has been litigation against regulators in some consuming, costly and disruptive for consumers. countries where certain qualification criteria were specified, and then some qualified applicants were In the case of competitive services, competition will rejected on the basis that they were less qualified generally discipline the market. If a market is than others. sufficiently competitive, consumers will switch from an operator that fails to provide adequate service to Table 2-3 sets out possible qualification criteria for a variety of different services. 2 - 22 infoDev McCarthyTetrault Module 2 - Licensing Telecommunications Services 2.4.9 Selection Criteria proposed service. Resources which are allo- cated to one aspect of an application on which There are two basic types of selection processes: selection is based (i.e. the financial offer or accelerated roll-out commitments) are not > Competitive selection based on a single available to fund other aspects of the operation quantitative criterion. Examples include: which are not related to selection criteria (i.e. universal service, lower prices, introduction of - an auction where the highest bidder wins; enhanced services). and > Transparency is increased by use of simple > a subsidized rural service competition, where quantitative selection criteria. A competitive the operator that bids the lowest subsidy selection process that is based on subjective or wins. qualitative criteria will be less transparent. The same is true of multiple criteria that cannot > Comparative evaluation where based on a more easily be compared. A lack of transparency subjective evaluation of one or more quantitative undermines the credibility of the process and of or qualitative criteria. the regulator. It also opens the door for com- plaints of bias, corruption or incompetence. To Advantages and disadvantages of both approaches maximize transparency, a single financial or are discussed above under the heading Spectrum other quantitative selection criterion should be Auctions, Lotteries and Comparative Evaluation used. This can be derived by use of a formula Processes. The single criterion approach is clearly which combines a number of selection criteria the most transparent and simplest to use. It is the into a single numeric factor if desired. most consistent with international trade agreements, and the most frequently recommended approach of Use of a single financial criterion does not mean international financial institutions and intemational other service factors or licensing objectives are development organizations that promote telecom- irrelevant. Important factors and objectives not used munications sector reform. However, it may not as selection criteria can be indirectly included in the always result in the selection of the best qualified qualification process. For example, coverage, rollout applicant, and, in the case of an auction, it may and universal service commitments can be specifi- result in the imposition of excessive costs on the cally incorporated as licence conditions that any sector. successful applicant will have to comply with. All applicants will then incorporate these minimum There are many variations on these two basic requirements into the calculation of their financial approaches. For example, in some cases, there is bid. more than one quantitative criterion, with a weighting scheme for the various criteria that will result in a Table 2-4 describes possible types of selection single "score". In other cases, numerical scores are criteria and summarizes their advantages and given for essentially subjective measures, such as disadvantages. the experience record of an applicant, or the quality of its management 2.5 Contents of Licences Several observations can be made about the choice The contents of licence documents vary considera- of selection criteria: bly depending on the country, the service and the operator. As indicated above, much depends on the - Qualified applicants are motivated to devote state of development of the regulatory regime in a financial and other resources to those aspects of country. Where it is well developed, licences tend to their applications that will form the basis of the be shorter. Where it is not well developed, licences selection decision. Licensing selection is a zero- must often include considerably more detail, in order sum game. Each applicant has a finite amount to provide a comprehensive regulatory framework of cash and other resources to devote to the for the operator or service being licensed. For McCarthyTetrault infoDev 2-23 Telecommunications Regulation Handbook Table 2-3: Possible Qualification Criteria Ucence Type Possible Qualification Criteria Rationale First new 9 Applicant not currently licensed to - Effective competition will not develop competitive offer a competitive service; not between related entities fixed network associated with the incumbent (l ocal Or D- Only experienced operators can linteational > Applicant has a minimum number of meet the significant challenges fac- service) fixed lines in service in other coun- ing a start up fixed line competitor service) tries/markets (an international PTO as partner) > Experience and contacts in local market increases prospects of > Relevant experience in similar mar- successful start-up kets (direct or by contract) > Evidence of access to required > Financial comfort letter from recog- financing nized bank > Evidence of financial viability and l Business plan, including pro forma likelihood of success of the project; financial statements and a marketing disadvantage in that it is costly to plan prepare plan - Technical plan, including details of > Business plan and technical plan network planning and roll out and can demonstrate detailed and viable technology selections service plans and knowledge of local economic and other conditions Competitive 9 Similar to, but less onerous than, - Presence of competition reduces cellular above (but does not eliminate) public costs service (first of failure an emergnt in Significant economic and sector de- aemarket) velopment objectives will be achieved by successful launch l Valuable and scarce spectrum will be allocated to the selected operator on an exclusive basis Data > None - General authorization is best transmission approach service in No scarce resources involved highly competitive : Existing competition makes success market or failure of this operator relatively I ____________ ._______________________________________ unim portant Broadband > Financial comfort letter > Spectrum is a scarce and valuable wireless . . . resource. Regulator has a important services in > Evidence of experence in successful role to play in ensuring efficient use highly operation of similar businesses in any and avoiding warehousing competitive market market 2 - 24 infoDev McCarthyTetrault Module 2 - Licensing Telecommunications Services example, if a price regulation regime already exists the licence document (even to say that prices will be in a country, it will not be necessary to spell it out in unregulated). Certainty is the key theme in good a licence. However, where no rules on price regula- licensing practice. tion exist, it is essential that they be spelled out in Table 2-4: Possible Selection Criteria Selection Criteria Advantages Disadvantages Comparative Evaluation - > Maximum flexibility and dis- > Non-transparent based on subjective assess- cretion to select the most l ment and comparison by the attractive application bias or corruption from regulator of applications based Allows applicants to focus losing bidders which are onuantistativcriteria on factors they believe are hard to refute and damage quantitative criteriaimportant and to convince regulatory credibility regulator accordingly ~ > Risk of confusion among bidders who may not clearly understand regulatory pri- orities Pure Auction - selection from > Maximum transparency > Payment of fee can divert among qualified bidders based . . financial resources from on the highest financial bid w Market efciency - licence service provision to auction awarded to the bidder fees (government revenue) l which values it most I High bidder will have strong > Encourages applicants to incentiv t bieroll have servie minimize resources devoted incentive to roll out service to other important priorities quickly to recover its bid (i.e. rollout, coverage etc.) > Suited to licensing in competitive markets Pure Auction - selection based > As above - Encourages applicants to on quantitative criteria, other ReIlto f bidd minimize resources devoted than cash, relating to the r egulatr can ocus bid er to priorities which are not service (i.e. time required to resources on service tdeves selection criteria, unless meet roll-out target, opmen or o ter pnoest they make business sense commitments on maximum opposed to government t prices for consumers) revenues Combined auction/comparative - A compromise which has > Difficult to develop a sound selection via weighted formula many of the benefits of both formula that compares auction and comparative "apples to apples' selection ;9. Compromise has disadvan- > Applicants are awarded tages of both comparative points based on selection selection and auctions criterial c> Less transparent than pure auctions McCarthyTetrault infoDev 2-25 Telecommunications Regulation Handbook Table 2-5 provides an example of the contents of a Not all of the matters included in Table 2-5 will be fairly comprehensive licence. It is based on the necessary in all licernces for PSTN services. In many contents of a PSTN operator's licence in an emerg- countries some of the matters included in the table ing economy without a well-developed regulatory will already be covered in general laws, regulations framework. This type of licence has been chosen as or policies. Examples include general regulations on an example since it is fairly comprehensive. It also universal service or licence fees, a competition law covers many of the areas often dealt with in licences or general rules of practice and procedure governing for other services, such as mobile services - except licensee information reporting or licence termination that licences for such other services can usually be and renewal. It generally does not matter which type much less comprehensive. Some additional and of legal document is used to deal with these issues, different conditions will be required in licences for provided the provisions are stated clearly and are particular services. enforceable under local law. Table 2-5: Contents of a PSTN Operator's Licence (Example for Emerging Economy) Contents Notes Part 1 - Background and Identification of Parties Recitals > Provides background, governing law, licensing circumstances, etc. - Important for posterity, and for courts and governments interpreting the licence Naming of parties > Ensure licensed entity has legal and financial substance Definitions 9 Key to clarity of licence conditions > Should repeat relevant definitions from laws, regulations, etc., since these may change Part 2 - Grant of Licence Describe scope of licence: > Approaches may differ (e.g. licensing of facilities or services) services, facilities and Spectrum often licensed separately - refer to separate licence > Sometimes useful to define exceptions - i.e. what licensee is not entitled to do > Specify services licensee may not offer (e.g. to implement competition policy) Exclusivity rights : Define precisely, including time limits, possible extensions and any pre-conditions for extensions Term of licence > Duration of licence and renewal terms, if applicable - Include effective date of licence Part 3 - Licence Fees Licence acquisition fee > Usually based on competitive bid or fixed in advance > One time fee = May be payable in installments, with revocation penalty 2 - 26 infoDev McCarthyTetrault Module 2 - Licensing Telecommunications Services Table 2-5: Contents of a PSTN Operator's Licence (Example for Emerging Economy) (cont'd) Operating licence fees > Periodic fee (usually annual) > Often intended to recover administrative costs of regulation > Fees should not exceed demonstrable administrative costs - Should be impartial assessment of fees across industry Spectrum fees > Usually provided for in spectrum licence > Cost recovery for spectrum management l Sometimes higher fees (if no licence acquisition fee) l Part 4 - General Conditions of Licence l Application Include essential requirements and public interest mafters applica- l l ~~~~~~~~~~~ble to all or most licences for telecommunications servicesl Eligibility > Cite requirements to retain eligibility to hold licence (if any) Ownership and control rules > Cite any restrictions on ownership and control of licensee (e.g. cross-ownership with major competitors, foreign ownership restric- tions) Facilities and equipment > Rules on equipment that may be used (e.g. type approval rules) Books, records and reports > Any applicable rules (e.g. to verify price or revenue cap regulation) l Specify reporting requirements and rules on provision of information to the regulator Co-operation with regulator > Specific obligations to provide access by regulator to information or premises, and to co-operate with regulator for specific regulatory purposes Co-operation with other > Specify obligations to co-operate with other authorities (e.g. police governmental authorities and national security forces regarding interception of communica- tions, environmental protection, health and safety rules if not covered by law of general application) Access to rights of way and > Rights of operator to access streets, sidewalks, road allowances other public property and other public property and rights of way for the purpose of con- structing, operating and maintaining facilities > Cite legal authority for any such rights > Include rules for access, if not stated elsewhere (e.g. payment, if any, public safety and convenience, aesthetics, compliance with applicable law) Access to private property > Any rights of operator to access private property (e.g. rights of way for cable or microwave routes) including expropriation rights, if applicable = Cite legal authority for any such rights McCarthyTetrault infoDev 227 Telecommunications Regulation Handbook Table 2-5: Contents of a PSTN Operators Licence (Example for Emerging Economy) (cont'd) Part 5 - Specific Conditions of Licence Use of radio spectrum : Often dealt with in separate spectrum licence l Include rules on efficient spectrum use Numbering ' Assignment of numbers, if applicable l Refer to national numbering plan, if applicable l Rights and obligations regarding implementation of number portability arrangements Directory and Emergency > Obligations to provide such services, and co-operate with other Services operators in providing them jointly Universal Access and/or - See Module 6 - Universal Service Universal Service Obligations Network roll-out and service > Specific obligations (usually set out in Appendix, including maps, coverage obligations number of access lines, etc.) l See Module 6 Quality of service >" Specific obligations (usually set out in Appendix, including specific indicators, standards to be met by specified dates, reporting procedures, etc.) l May be covered or supplemented in other regulatory documents Security for Performance of : Reference details of performance bond or other method used to Licence Obligations secure performance of licence obligations l Bond or security document(s) may be annexed to licence Part 6 - Relations with Customers Terms and conditions of " Terms and conditions usually set out in regulatory documents Iservice serve > May include mandatory contents of customer contracts l May include consumer "code of rights" Customer complaints ' Rules on handling and recording complaints l May be set out in regulatory documents Consumer protection' " Provisions may be in regulatory documents or approved customer contracts (to provide notice to customers) l Include protection of privacy > Rules often published in telephone directories Price regulation > Price regulation (tariff) regime usually specified (e.g. price caps) s Specify services to which price regulation regime applies - Review period and rules for review often specified > Key to financial viability of licence L Details in appendices or referenced regulatory documents 2 - 28 infoDev McCarthyTetrault Module 2 - Licensing Telecommunications Services Table 2-5: Contents of a PSTN Operator's Licence (Example for Emerging Economy) (cont'd) - See Moduie 44- Price Regulation Dispute resolution ) Method to resolve disputes over application of licence Part 7 - Relations with Other Operators Interconnection - See Module 3 - Include rights and obligations to interconnect Anti-competitive practices > See Module 5 - Include remedies and sanctions, if not specified elsewhere Access to shared facilities )- Rights and obligations regarding collocation and access to poles, (poles and conduits) towers, conduit, etc. > See Module 3 Resale s Rights and obligations regarding resale by licensee and by other service providers (e.g. for payphones, Internet services, value added and simple resale) Dispute resolution > Method to resolve disputes with other licensees, e.g. regarding interconnection (see Module 3) Part 8 - Amendment, Renewal and Termination Amendment by regulator > See Section 2.4.4 > Unilateral modifications should only apply to certain regulatory matters, not key commercial terms of licence - Procedural safeguards s Competitive neutrality should be maintained Amendment by mutual > Provides certainty, where needed agreement > Key commercial terms usually only subject to amendment by agreement between licensee and regulator _ Competitive neutrality should be maintained Compliance >- Specify sanctions and penalties for failure to comply with various terms of licence (e.g. fines, forfeiture of performance bonds, revocation) Renewal > Include renewal rights (e.g. if certain performance targets met) Termination for cause > Termination, revocation and/or suspension may be included Grounds (usually certain major, unresolved breaches only) > Procedure (include due process) - Include lesser penalties (e.g. fines) which will not disrupt service Termination if no renewal - Clarify surviving rights of licensee, property rights, treatment of as- sets, and other effects of non-renewal McCarthyTetrault infoDev 2 - 29 Telecommunications Regulation Handbook Ta,6l5 -Z ne (Emple forerin Icnomy(*l Part9Gen-rii _n=r E ;cie; 6erfrmce in aeo pcfe ye feet'eod ForcejaJe'-l Iontrol of licen see -Assig,ment' - eonsent.: § ~ ~ - Rules and restrictionson assgnen oflicence .~~~~- i S~peTra i ntorf l, I I i s il Transitional'poiios gRue n imtbefr oigitofl 4pliancerwith, -ience'-j - im,po rtn-inlsingiof I=orother 2 - 30 infoDev McCarthyTetrault MODULE 3 Interconnection Table of Contents Module 3 - Interconnection 3.1 Interconnection Principles 1 3.1.1 The Importance of Interconnection 1 3.1.2 Scope of Interconnection Issues 2 3.1.3 Interconnection Issues 3 3.1.4 Regional Interconnection Rules 3 3.1.5 Multilateral Interconnection Rules 5 3.1.6 Interconnection Principles 6 3.1.7 Contents of Interconnection Agreements 10 3.2 Interconnection Procedures 17 3.2.1 Establishing Interconnection Arrangements 17 3.2.2 Negotiation of Interconnection Arrangements 17 3.2.3 The Regulator's Role in Interconnection Negotiations 18 3.2.4 Dispute Resolution 21 3.2.5 Ex Ante Regulatory Guidance 22 3.3 Financial Terms of Interconnection 23 3.3.1 Interconnection Charges 23 3.3.2 Approaches to Setting Interconnection Charges 23 3.3.3 Comments on Different Approaches 25 3.3.4 Specific Interconnection Costs 27 3.3.5 Structure of Interconnection Charges 29 3.3.6 Internet Interconnection Charges 31 3.3.7 Interconnection with Mobile Networks 33 3.4 Technical and Operational Conditions 35 3.4.1 Provision of Information by Incumbents 35 3.4.2 Treatment of Competitor Information 36 3.4.3 Treatment of Customer Information 37 3.4.4 Points of Interconnection 37 3.4.5 Access to Unbundled Network Components 38 3.4.6 Local Loop Unbundling 42 3.4.7 Sharing of Infrastructure and Collocation 48 3.4.8 Equal Access 49 3.4.9 Quality of Service to Interconnecting Operators 52 3.4.10 Quality of Interconnected Services 53 McCarthyTetrault infoDev 3-i Boxes, Figures and Tables Boxes Box 3-1: Some Key Interconnection Issues 4 Box 3-2: Interconnection Rules of WTO Regulation Reference Paper 5 Box 3-3: Summary of Widely Accepted Interconnection Principles 9 Box 3-4: Principles for Efficient Interconnection Price Structures 29 Box 3-5: Examples of Technically Feasible Interconnection Points 38 Box 3-6: Compulsory National Roaming in the UK 39 Box 3-7: Some Possible Unbundled Network Components and Services 40 Figures Figure 3-1: Full Unbundling - Local Loop 43 Figure 3-2: Full Unbundling - Two Local Loops 44 Figure 3-3: Shared Use of Copper Loop Using Splitter 45 Figure 3-4: Provision of High-Speed Bit Stream Access 46 Tables Table 3-1: Contents of a Typical Interconnection Agreement 10 Table 3-2: Approaches to Resolving Interconnection Disputes 22 Table 3-3: Main Approaches to Interconnection Charges 23 Table 3-4: Advantages and Disadvantages of Unbundling 41 Table 3-5: Arguments For and Against Local Loop Unbundling 47 Table 3-6: Steps to Promote Infrastructure Sharing and Collocation 50 Table 3-7: Some Key Interconnection Quality of Service Measures 53 3 -I iiinfoDev McCarthyTT&rault ii i ii I INTERCONNECTION 3.1 Interconnection Principles competition. For most of the history of telecommunications, operators and government 3.1.1 The Importance of Interconnection administrations negotiated with each other to set the terms of interconnection without regulatory interven- Interconnection of telecommunications networks has tion. The emergence of competition has changed been important for a century, but never more so than this. Incumbent operators have little incentive to today. Originally, operators, such as PTTs and the make things easy for their new competitors, and North American Bell companies, interconnected with most of the bargaining power in negotiations lies neighbouring operators. However, these operators with the incumbents. retained monopolies over all networks and equipment in their geographic serving areas. For Strategic anti-competitive behaviour on interconnec- decades, few other types of interconnection tion matters by incumbents has retarded or occurred. prevented competition in many telecommunications markets around the world. Incumbents can engage Beginning in the 1970s, customers began to in a wide range of behaviour to frustrate effective interconnect a growing range of terminal equipment competition. For example, they can charge exces- and private network facilities to the incumbent sive rates for interconnection, refuse to build or operator's facilities. With the liberalization of make available adequate interconnection capacity, telecommunications markets over the last few and refuse to unbundle network elements or decades, effective interconnection arrangements services necessary for efficient interconnection. New have become key to the operations of an entrants in telecommunications markets have little to increasingly wide range of services. These services offer in negotiations to remove these barriers to include local, long distance and international fixed, competition. Today, there is a consensus among mobile and satellite services, providing everything telecommunications experts and policy makers that from basic voice telephony to high speed Internet decisive and informed guidance by regulators is re- connectivity to Internet multimedia services. quired to pave the way for effective interconnection arrangements. Competition is the key to the growth and innovation of today's telecommunications markets. Intercon- Interconnection is an important consumer issue. nection is a critical factor for the viability of Telecommunications users cannot communicate McCarthyTT&rault infoDev 3-1 Telecommunications Regulation Handbook with each other or connect with services they "interconnection" means the physical and logical demand unless necessary interconnection arrange- linking of public electronic communications ments are in place. Interconnection of a multitude of networks used by the same or a different different types of networks has brought tremendous undertaking in order to allow the users of one benefits to consumers and businesses around the undertaking to communicate with the users of the world in the last decade. Without efficient intercon- same or another undertaking, or to access nection arrangements, services such as direct services provided by another undertaking. international dialing, all Internet-delivered services, Services may be provided by the parties involved automated teller machines and e-commerce would or other parties who have access to the network. not be possible. (Article 2 - CEC(2000d)) Increasing network interconnection will continue to This definition differs from others in that it includes improve the convenience and utility of telecommuni- interconnection of networks used by the same cations service for users around the world in the undertaking and not just networks of different next decade. Inadequate interconnection arrange- operators. The proposed Directive also differs from ments not only impose unnecessary costs and some other regulatory interconnection regimes in technical problems on operators - they also result in that it includes a separate concept of "access", delays, inconvenience and additional costs for defined differently from interconnection: businesses, consumers and, ultimately, for national economies. "access" means the making available of facilHties and/or services, to another undertaking, under According to ITU' surveys, Interconnection-related defined conditions, on either an exclusive or non- issues are ranked by many countries as the single exclusive basis, for the purpose of providing most important problem in the development of a electronic communications services. It covers competitive marketplace for telecommunications inter alia: services, interconnection has been a highly contentious issue in Europe. Almost half of all > access to network elements and associated countries in the Asia-Pacific region indicated that facilities and services, which may involve the interconnection issues were a top regulatory priority. connection of equipment by wire or wireless While fewer countries in the Arab states (20%) and means; the Americas (30%) pointed to interconnection as a regulatory priority, the general level of network i- access to physical infrastructure including competition was still low in those regions. That is buildings, ducts and masts; changing. The importance of interconnection issues will increase in all regions as network competition > access to software systems, including opera- develops. tional support systems; This Module examines the arrangements that must )'- access to number translation or systems be put in place between operators, and the steps offering equivalent functionality; that can be taken by regulators, to facilitate effective interconnection. ' access to mobile networks, in particular for roaming; and 3.1.2 Scope of Interconnection Issues > access to conditional access systems for Interconnection is defined in different ways in the digital television services. dfferent regulatory and policy regimes that deal with i. A good recent definition is included in the 12 July Interconnection is a specific type of access 2000 proposed European Commission Directive on implemented between public network operators. access and interconnection: Access in this Directive does not refer to access by end-users. 3 - 2 infoDev McCarthylTetrault Module 3 - Interconnection The last sentence of the definition is important. It Interconnection costs are certainly not the only distinguishes the Commission's use of the term major issue. Various technical and operational 'access" from its normal meaning, which relates to issues are also critical to both incumbent and new end-user access, for example in the terms "access operators. Box 3-1 lists some of the most important lines" or "network access service". Despite this po- interconnection issues encountered in many tential confusion, the types of inter-operator "access" countries. listed in the Commission's definition are very impor- tant in the context of interconnection. 3.1.4 Regional Interconnection Rules The types of "inter-operator access" listed in the In recent years, the development of regional trading Commission's definition are treated as an integral areas and the implementation of multilateral trade part of "full" or "efficient" interconnection in other agreements has accelerated the liberalization of jurisdictions. They may also be considered as interconnection policies. "supplemental" or "ancillary" forms of interconnec- tion. These types of access arrangements are A leading example is the 1997 European Intercon- typically addressed in interconnection agreements nection Directive (97/33/EC). It contains rules entered into between experienced operators. specifically aimed at liberalizing national interconnection regimes. The Directive requires Whatever the regional or local definition of intercon- interconnection arrangements to be public and non- nection, the matters included in the Commission's discriminatory. It also requires interconnection proposed definition of "access" must be dealt with as charges to be cost-based. Related EU Directives part of a comprehensive approach to interconnec- supplement and amend the European interconnec- tion. In this Handbook, therefore, we will deal with tion regulatory framework. These Directives include this type of "inter-operator access" in detail, as an obligations on special access (98/10/EC) and integral part of full interconnection. provision of leased transmission capacity (92/44/EC). 3.1.3 Interconnection Issues The provisions of the European Directives related to Commercial, technical and operational arrange- interconnection are fairly general in nature. This ments must be made to facilitate interconnection approach permits adaptation to the EU's different between network operators. A number of issues national legal regimes and regulatory frameworks. must be agreed upon by the operators, or deter- The European Commission has taken additional mined by the regulator, in order to finalize these steps, beyond the Directives, to improve intercon- arrangements. nection arrangements. One such step is the publication of "best current practice" interconnection The major commercial issues of concern to new rates. These interconnection rates are significantly entrants are generally related to the cost of intercon- lower than those of some member countries, sug- nection. In North America and Europe, for example, gesting that these countries should take action to up to 50% or more of the total costs of some long- meet international cost benchmarks. Another major distance operators have been paid out in intercon- step was the recent adoption of rules and a nection charges to local operators. Such proposed regulation to require unbundling of the interconnection charges are particularly significant local loop. These rules are discussed later in this for operators that rely heavily on resale or that must Module. pay a subsidy or contribution component as part of interconnection charges. The practice of combining The European Commission has also reviewed its subsidies and cost-based charges is widely interconnection-related Directives. As previously discouraged, for the reasons set out in Section. indicated, on 12 July 2000, the Commission 3.3.5.4. Even without a subsidy component, the level published a proposed new Directive on access to, of interconnection charges is often an important and interconnection of, electronic communications factor in determining the financial viability of a new networks and associated facilities (COM(2000) 384). telecommunications service provider. The proposed new Directive seeks to respond to the McCarthyTe6trault infoDev 3-3 Telecommunications Regulation Handbook convergence phenomenon by covering a broader Other multilateral organizations have also developed range of electronic communications networks and interconnection guidelines. For example, the Asia- services. It also contains some new and different Pacific Economic Co-ordination (APEC) Telecom- principles. However, under the proposed new munications Working Group has developed a Directive, the key provisions of the three previous Framework for Interconnection. Unlike the EU (above-noted) Directives will continue to be legally binding on European Union Member States, pending further reviews. Box 3-1: Some Key Interconnection Issues Framework and Procedural Issues - Adequacy of regulatory guidance for interconnection negotiations > Availability of interconnection with incumbent operators for various types of services - Access to standard interconnection terms with incumbent operator - Independent and timely dispute resolution > Non-discriminatory access to interconnection facilities and services - Access to PSTN network specifications (including planned network changes) > Treatment of Universal Service, Universal Access or Access Deficit Charges Commercial Issues - Level and structure of interconnection charges; basis for calculation (i.e. type of costs used to calculate charges, revenue sharing, bill and keep, etc.) > Unbundling of interconnection charges for different network components and related services > Resale of network facilities and services > Payment for network modifications to facilitate interconnection ' Confidential treatment of competitive and customer information Technical and Operational Issues > Open network standards and technical compatibility > Location of Points of Interconnection (POI) > Access to signaling systems, advanced digital features, billing system, operations support systems (OSS), call-related databases and other software to provide advanced services > Access to unbundled network components, including local loops - Equal ease of customer access to competitive networks (e.g. customer dialing parity) > Access to numbers and implementation of number portability > Collocation and sharing of infrastructure (e.g. buildings, poles, conduits, ducts, towers) > Quality of interconnection, including availability of sufficient interconnection capacity to avoid congestion, and to ensure the timely provisioning of interconnection services and facilities 3 - 4 infoDev McCarthyTetrault Module 3 - Interconnection approach, this framework is not binding on APEC summarized in Box 3-2. The full text of the members. The APEC framework is intended to Reference Paper provides more detail than the box. provide principles, examples of interconnection approaches in APEC economies, and other useful The paper's central principles are non-discrimina- information to assist in the development of national tion, transparency, and the availability of reasonable interconnection policies. Similarly non-binding interconnection terms, including cost-oriented rates approaches have been taken in interconnection and unbundled access, from "major suppliers". The principles published by other regional organizations, concept of "major suppliers" in the Reference Paper such as CITEL in Latin America. can generally be assumed to refer to operators with a dominant position vis-a-vis essential infrastructure 3.1.5 Multilateral Interconnection Rules or market share. Thus, at present, the Paper's interconnection disciplines would most commonly The 1997 WTO Agreement on Basic apply to monopoly or former monopoly fixed-line Telecommunications (formally known as the Fourth operators. Protocol of the General Agreement on Trade in Services or GATS) was the first widely accepted The Reference Paper was designed as a set of multilateral trade agreement to include binding general rules or principles to be observed, rather interconnection rules. These rules were included in than as detailed prescriptive guidelines on how the the so-called Reference Paper, an informal text principles are to be implemented. This approach containing regulatory principles negotiated among makes the paper adaptable as telecommunications WTO Members. The Reference Paper became markets evolve, and provides flexibility for applica- legally binding on WTO Members that attached it as tion to different legal systems and regulatory inter- part of their "additional commitments" in their GATS connection frameworks. Schedule of Commitments on telecommunications market access. The Reference Paper was attached in whole or with minor modifications by 57 of the 69 x -3-::,-titerconnection Rules of WTO signatories to the Fourth Protocol. Six additional "Regulation -Referi6d Paper signatories elected to list some of the principles in - their Schedules, but not the entire document. Major Suppiers must be I-:assured..- All WTO Members have the option of undertaking A a t e the obligations of the Reference Paper in their -Af GATS Schedules on interconnection or other matters, whether or not they participated in the .n tinelyjashion Fourth Protocol. As of late 1999, a total of 64 WTO --.=,.i o- .n tasre Member governments had committed to the l - q.aity and ratesi interconnection obligations of the Reference Paper. This increase from 57 was due to the submission of | Suffisentl ai charges for commitments by seven more countries since the Fourth Protocol. Of these, four WTO Members l At nontaiil i ection points if attached the Reference Paper to telecommunica- u -- charges - tions commitments they made after the Protocol -- negotiations ended and three countries attached it to the GATS Schedules they filed upon accession to n -P-d3 e f lo malor the WTO. Most of the nearly 30 additional countries IC-splers ms b de pubic seeking accession to WTO are expected to also L rency commit to the Reference Paper and its interconnec- A r l ir of tion obligations. io mao ie s becmd on offer The most important interconnection-related rules set out in the WTO Regulation Reference Paper are McCarthyTetrauk infoDev Telecommunications Regulation Handbook As a practical matter, therefore, more detailed For these reasons, a large number of regulators and guidance is essential to turn the general Reference telecommunications experts promoted industry Paper principles into workable interconnection negotiation as the main approach for developing arrangements, agreements, national regulations or interconnection arrangements. Ex ante regulatory regulatory directives. The experience of other coun- intervention was discouraged. The focus of regula- tries can provide valuable precedents in this regard. tory attention was on dispute resolution, in the event industry negotiations broke down. When the GATS Agreement on Basic Telecommunications came into effect on 15 In recent years, there have been increasing doubts February 1998, many signatory countries did not yet about the effectiveness of the ex post approach. have detailed interconnection rules in place. Some There appears to be a growing consensus that still do not. Given the general nature of the advance regulatory guidelines, or even specific inter- Reference Paper principles, it will be a challenge for connection rules, are necessary to facilitate many countries to develop sufficiently detailed successful negotiations. This view has been interconnection regimes to put "flesh on the bones" expressed recently by the European Commission, in of their GATS obligations. its 12 July 2000 proposed Directive on access and interconnection. The Commission stated: Before examining the details of interconnection arrangements, the following sections of this Module "...there is a consensus that ex-ante sector will review the basic principles underlying most inter- specific rules will continue to be needed connection rules. alongside competition rules to regulate access and interconnection, until such time as there is 3.1.6 Interconnection Principles full and effective competition in all segments of the market." (CEC (2000c)) 3.1.6.1 Providing Advance Regulatory Guidelines This view has long been held by regulators and policy-makers on the other side of the Atlantic. There continues to be a regulatory debate about the During the 1980s and 1990s, US and Canadian relative advantages of providing ex ante or advance regulators issued a series of detailed guidelines and interconnection guidelines versus ex post regulation. decisions on most aspects of interconnection with Proponents of the ex post approach generally favour dominant operators, including interconnection rates negotiation of interconnection agreements between and technical terms and conditions. The more inter- operators, with recourse to regulatory dispute reso- ventionist approach of the North American lution or competition law remedies, if negotiations regulators appears to have led to more unbundling fail. of network services, more competition, and arguably more service innovation and growth. Several years ago, there were more advocates of the ex post approach, particularly outside of North The issues of negotiating interconnection arrange- America, than there are today. This approach was ments and approaches to regulatory intervention are based on the belief that regulation should be mini- discussed in detail in Section 3.2.2 of this Module. mized in competitive markets. Many regulators recognized that the financial, technical and 3.1.6.2 Focus Interconnection Obligations operational details of interconnection arrangements on the Incumbent Operator could be complex. They considered that incumbent operators and new entrants would generally have a One generally accepted means of minimizing regu- much better understanding of these arrangements latory intervention is to limit imposition of than regulators. They were also concemed that interconnection obligations to dominant incumbents. inappropriate regulatory intervention in interconnec- In practice, this is the most effective and efficient tion matters could impose high costs on the sector. means of utilizing limited regulatory resources. 3 - 6 infoDev McCarthyTetrault Module 3 - Interconnection This approach is sometimes subject to criticism by 3.1.6.3 Transparency incumbent operators. They argue that this approach amounts to regulatory "handicapping" and construc- Transparency is a major policy objective of multilat- tion of "non-level playing fields". Others suggest that eral trade agreements as well as the national universal imposition of interconnection obligations telecommunications policies of many countries. would provide more interconnection opportunities for While there is a lot to be said for protecting the all operators. confidentiality of business agreements in a competi- tive marketplace, interconnection with dominant However, this is a minority view. The consensus incumbents is generally considered an exception. view is that universal imposition of interconnection obligations on all operators, large and small, Confidential treatment of interconnection arrange- generally amounts to over-regulation. In principle, ments would provide incumbents with an opportunity only firms with a dominant market position have the to act strategically to thwart competitors. For ability to establish interconnection terms example, such operators could enter into confiden- independently of competition. Non-dominant com- tial interconnection agreements that provide petitors would find it difficult to independently unfavourable interconnection arrangements with maintain excessive interconnection rates, or competitors, and more favourable ones with discriminatory conditions. Other service providers affiliates. Dominant operators could also limit the wishing to interconnect could avoid such unfavour- functionality of the types of interconnection offered, able interconnection arrangements by interconnect- levy excessively high charges, and otherwise act - ing with a competitor, including the dominant strategically to limit competition. supplier. Over time, as markets become increasingly - competitive, it may be possible to deregulate more Transparency of interconnection arrangements is an interconnection arrangements, including those of effective means of discouraging anti-competitive once-dominant operators. However, in the transition strategic behaviour by dominant operators. It is period to full competition, a degree of asymmetric easier for regulators to detect and remedy such regulation is required in order to level a playing field behaviour if interconnection arrangements are made that is tilted in favour of incumbents. public. Publication of agreements also makes it easier for regulators and all industry participants to For these reasons, the regulatory approach to inter- compare interconnection rates, terms and condi- connection in this Module focuses on interconnec- tions. Transparency also assists in developing tion arrangements with dominant incumbent industry standards and benchmarks, as well as best operators. practices on operational and administrative issues. This approach is consistent with the Reference Many countries require publication of reference Paper of the WTO Agreement on Basic interconnection offers or model interconnection Telecommunications, which only imposes agreements. To further promote transparency, some interconnection obligations on dominant operators regulators maintain public registries of interconnec- (i.e. "major suppliers"). It is also consistent with the tion agreements, or require publication of agree- European Commission's 12 July 2000 proposed ments by operators. In some cases, interconnection Directive on access and interconnection. The agreements are available over the Internet. proposed Directive aims to expand the scope of its interconnection framework to a wider range of Where interconnection agreements are made public, electronic communications networks. However, only various mechanisms can be used to protect dominant operators will be subject to the ex ante confidential commercial information. For example, regulatory obligations proposed by the Commission, Indian legislation requires the regulator to maintain a such as mandatory interconnection, resale, registry of interconnection agreements. However, at collocation, etc. the request of parties, the regulator may direct that parts of an agreement be placed in a confidential portion of the registry. In such cases, a summary of McCarthy T-trauk infoDev McCarthyTetrault infoDev3 7 Telecommunications Regulation Handbook the confidential parts must be made publicly avail- or "co-carriers". This approach often leads to higher able. prices and inferior interconnection arrangements. Regulators should generally insist that intercon- 3.1.6.4 Non-Discrimination necting carriers should be treated on an equal and reciprocal basis, as peers and not customers. Avoidance of discrimination is a central objective of most interconnection policies. Discrimination in One type of discrimination can be fatal to the interconnection arrangements can take several prospects of competition. It involves providing forms. One form involves discrimination by a domi- insufficient network capacity to interconnecting nant operator in interconnection arrangements operators, as compared to an incumbent's own entered into with several dfferent new competitors. services. Network congestion can be a deadly anti- For example, new entrant B may obtain better competitive barrier. Regulators must sometimes arrangements than new entrant C. Such discrimina- intervene to ensure non-discriminatory rationing of tion is relatively easy to detect if interconnection network access and transport facilities. They must agreements are public. often also ensure that established PSTN operators construct sufficient capacity to handle growing It should be noted that interconnection arrange- demand that can be expected in a competitive tele- ments may vary from one competitor to another communications market. without being "unduly' or "unjustly" discriminatory. The two competitors may have voluntarily agreed to One regulatory approach to reduce, or at least assist dfferent arrangements, for example, to suit their in the identification of, discrimination between a different operating conditions. The real test, there- dominant firm and its competitors involves the es- fore, should not be "discrimination" in the sense of tablishment of structural or accounting separations "differences" in interconnection arrangements. The or divestiture. Under structural separation test should be "unjust", "undue" or "unfair" discrimi- approaches, a dominant firm is required to move its nation, in the sense that an interconnecting competitive operations into a separate affiliated competitor is placed at a significant disadvantage as company, with separate management, accounting a result of less favourable interconnection arrange- records, etc. Divestiture involves selling all or part of ments. the separate affiliate to other persons. Accounting separations involve setting up separate accounting The other major form of discrimination is often records only, and not actually requiring the estab- harder to identify. It involves the provision of more lishment of a separate legal entity for the competitive favourable interconnection arrangements by a business. These approaches are discussed in dominant firm to its own operations or its affiliates Section 5.3.3 of Module 5 - Competition Policy. than to competitors. Disputes or complaints about this form of discrimination are often difficult for Another less interventionist approach that is regulators to resolve. For example, it is sometimes commonly used by regulators and competition impossible to grant a competitor exactly the same authorities to prevent undue price discrimination by type of interconnection arrangements as it is possi- a dominant firm is an "imputation approach". Such ble to provide to an internal operation. an approach is applied to vertically integrated suppliers. Such suppliers include operators that pro- Various approaches have been developed to identify vide a retail service, like local telephone access and resolve cases of discrimination of the second service, on a competitive basis, and also provide a type. Since interconnection arrangements need not wholesale service, like international telephone be identical, the objective of preventing undue dis- service, on a monopoly basis to itself and other crimination has been described as one of competitors. developing "comparably efficient" interconnection arrangements. Under an imputation test, a vertically integrated supplier would be required to include the same Some incumbents discriminate against competitors amount it charges to its competitors for international by treating them as "customers" rather than "peers" service in its own retail rates, and to add an amount 3 - 8 infoDev McCarthyUTerault Module 3 - Interconnection sufficient to cover its additional costs of providing originating on the dominant operator's network. In local services. Imputation tests are discussed under the absence of regulatory intervention, some new the heading Vertical Price Squeezing in Section competitors might have little choice but to accept 5.3.4. of Module 5. such a deal or remain unable to interconnect. 3.1.6.5 Cost Orientation Serious problems can result from a dominant firm charging competitors interconnection prices that are Interconnection principles, such as those set out in significantly above cost. First, it deters market entry the Reference Paper for the WTO's Agreement on and the development of competition. Second, Basic Telecommunications and the European customers of the competitors will ultimately have to Union's Interconnection Directive, require intercon- pay for these excessive charges. Third, the exces- nection charges to be "cost-oriented". sive prices can provide a pool of revenues that the dominant firm can use to subsidize losses, for There are various reasons for specifying that inter- example losses incurred as a result of predatory connection charges. should approximate costs. pricing action taken by the dominant firm to drive Without a cost-based standard for setting intercon- competitors out of a market. nection charges, an established monopolist or dominant operator would have an incentive to The approaches used by telecommunications demand a high price for terminating calls that economists and regulators to calculate interconnec- originate on a new competitor's network. Similarly, a tion costs, 'and telecommunications costs generally, dominant operator would have an incentive to pay are discussed in Section 3.3 of this Module, in little or nothing to the competitor to terminate calls Module 4 and in Appendix B of the Handbook. Box 3-3: Summary of Widely Accepted Interconnection Principles l Terms of interconnection should not discriminate unduly between operators or between a dominant firm's own operations and those of interconnecting competitors - Interconnection should be permitted at any technically feasible point, but the requesting operator should pay any additional costs of non-standard interconnection :- Interconnection charges should generally be cost-based (i.e. the evolving best practice specifies that the cost standard should be forward-looking long-run incremental costs; there is normally a mark-up to cover forward-looking joint and common costs) >- Cost inefficiencies of incumbent operators should not be passed on through charges to interconnecting operators | > Where reciprocal interconnection and costs can be expected to be reasonably balanced, bill and keep arrangements are an efficient alternative to cost-based interconnection > Regulatory guidelines and procedures should be prescribed in advance, to facilitate interconnection negotiations between operators - Standard terms and procedures should be published for interconnection to dominant operators > Interconnection procedures and arrangements should be transparent - Interconnection arrangements should encourage efficient and sustainable competition | Network elements should be unbundled, and charged separately | Charges related to universal service obligations should be identified separately, and not bundled with interconnection charges > An independent regulator (or other third party) should resolve interconnection disputes quickly and fairly McCarthyTetrault infoDev 3 - 9 Telecommunications Regulation Handbook 3.1.6.6 Other Interconnection Principles framework. If the existing regulatory framework provides sufficient detail on the terms and conditions A number of other interconnection principles have of interconnection, then interconnection agreements been proposed and adopted by regulators, policy can be shorter. The same is true if an incumbent makers and trade organizations. In many cases, operator, or an industry group, has published these are variations on the same themes. Box 3-3 detailed interconnection tarffs, technical standards, summarizes widely accepted interconnection princi- procedures, etc. which can be incorporated into an ples. agreement. In other cases, interconnection agree- ments must be more comprehensive. 3.1.7 Contents of Interconnection Agreements Bearing these variations in mind, Table 3-1 provides a list of the possible contents of a "typical" intercon- The contents of interconnection agreements vary nection agreement. considerably. Much depends on the regulatory Table 3-1: Contents of a Typical Interconnection Agreement Contents Detail and Commentsl Interpretation Recitals ' "Whereas" clauses add historical and legal context to assist understanding by future readers of agreements Definition of Key Terms > Terminology varies significantly among different countries and operators :> It is important to ensure compatibility of terminology to the local environment when adapting interconnection agreements from other countries - Definitions in other documents may be referenced, e.g. definitions in laws or regulations, regulatory guidelines, ITU definitions Scope of Interconnection Description of Scope and - Different types of interconnection agreements have different Purpose of Interconnection purposes (e.g. two local networks, local to long distance/international, fixed-to-mobile, mobile-to-mobile, local ISP to ISP backbone) - The purpose of some interconnection agreements is to provide termination services or transit services; others involve provision of unbundled facilities, etc. :- Interconnection architecture (annotated diagrams) Points of Interconnection and Interconnection Facilities Points of Interconnection > POI locations (e.g. exchanges, meet points) usually listed in an (POI) and Related Facility appendix; may be modified from time to time. Typically includes Specifications exchange types and street addresses > Specific POI facility locations (e.g. digital distribution frame; manhole L ________________________ splice box) 3-10 infoDev McCarthyTetrault Module 3 - Interconnection Table 3-1: Contents of a Typical Interconnection Agreement (cont'd) - Description of network facilities to be interconnected (e.g. OC-3 fibre optic terminals with interconnecting single-mode optical fibres) - Specify capacity and/or traffic volume requirements Indicate which party is to provide which facilities (include diagram of POIs and interconnected facilities) :> Technical specifications, for example: - Calling Line Identification (CLI) specs . Other advanced digital feature specs, e.g. call forwarding, caller name ID, etc. > Basic and ISDN call control interface specs :i Local Number Portability (LNP) query-response network specs Signaling Interconnection > Specify type of signaling networks/standards (e.g. CCS7) > Signaling POls locations to be specified (i.e. Signal Transfer Points or STPs) - Point Codes to be specified - Technical interface specifications (e.g. signaling links to be dedicated E-1 or DS-1 transmission facilities; operating at 56 kbps) > Diagram of signaling interconnection architecture Network and Facility Changes Planning and Forecasts > Requirement for mutual notification of network changes and capacity forecasts, for example: > traffic forecasts for each POI 9 local number and portability requirements > area code saturation and changes to increased digit phone numbers > default and redundant routing arrangements 9 Periodic network planning reports may be specified Facility Ordering Procedures > Specify rights and obligations of each party with respect to ordering and provisioning of interconnection facilities (including unbundled network elements - see below). > Confidentiality requirements and procedures to ensure same > Ensure no anti-competitive use of order information (e.g. no contacts with end users; competitive service divisions of operator receiving orders) - Specify points of contact (e.g. Interconnection Service Groups; E- mail addresses, etc.) >. Specify order format and procedures (e.g. standard order forms may be utilized in paper or electronic (EDI) format) McCarthyTetrault infoDev 3 -11 Telecommunications Regulation Handbook Table 3-1: Contents of a Typical Interconnection Agreement (cont'd) > Procedures to expedite specific orders > Co-ordination process for migration of customers between operators (e.g. coordination of cut-overs to prevent or minimize service interruptions to end users) > Procedures for ordering operator to arrange for all equipment installations and changes at end-user premises > Order confirmation and order rejection procedures, timely notification, notification of additional charges, etc. - Order completion notification and reporting requirements Traffic Measurement and Routing Traffic Measurement >_ Describe party responsible; measurement and reporting procedures Responsibilities and (see billing procedures below): Procedures * Rules for routing of different types of traffic, if any (e.g. Bill and Keep local traffic that is to be terminated reciprocally without charge may be carried on "Bill and Keep" trunks; traffic to which termination charges apply may be carried on other trunks, e.g. transit trunks, national traffic trunks, etc.) Infrastructure Sharing and Collocation Sharing of Infrastructure, > Availability of poles, conduits, towers, rights of way, etc. Procedures and Costs P Procedures, if any, for determining available capacity; procedures for allocating capacity among requesting operators (e.g. first come/first served) > Prices and/or costing method ' Provision and pricing of supplementary services (electrical power, security systems, maintenance and repairs, etc.) ; Sub-licences on property of third parties (e.g. right of way owners, municipal and other public and private property owners, where infrastructure is located), insurance and indemnification for damages Collocation > Availability of actual or virtual collocation (e.g. for transmission facilities on exchange premises); list of addresses where collocation is available; procedures for determining available space; reservation of expansion space - Prices and/or costing method for collocated space > Provision and pricing of supplementary services (e.g. electrical power and emergency backup power, lighting, heating and air conditioning, security and alarm systems, maintenance and janitorial services, etc.) ' > Procedures for ensuring access to and security of collocated facilities (notification; supervised repair and provisioning work and/or separated premises, etc.) 3-12 infoDev McCarthyTetrault Module 3 - Interconnection Table 3-1: Contents of a Typical Interconnection Agreement (cont d) . Negotiation of other lease and/or licence arrangements, including issues of sub-licences on property of third parties (e.g. building owners, right of way owners, municipal and other public property owners), insurance and indemnification for damages Billing l Scope of Billing May include'different arrangements, for example: Arrangements and > Operators billing each other for interconnection services (e.g. Responsibilities termination) and facilities (e.g. unbundled loops and other network elements) > Performance of billing functions by some operators for others (e.g. local operators billing end-users for long distance or international operators, ISPs, etc.) Billing Procedures i Interconnection billing media - discs, tapes, paper and/or electronic (EDI) transfers; format and software specifications - Guidelines for production of interconnection billing outputs, including: Applicable industry standards (e.g. CABS, BOS, SECABS, used - with or withoUt modifications) I Billing data format and data elements . Standardized codes and phrases - Billing schedule >- Customer Service Record (CSR) provision, including: details to be supplied by provisioning local operator (e.g. record of interconnection elements used, including circuit and other (e.g. DSLAM) equipment identification numbers) - media (e.g. tape, paper, etc.) and schedule for delivery - other requirements to facilitate efficient verification and billing of end-user by non-provisioning operator - Retention periods for billing data Payment Terms and > Billing fees and related charges. Conditions >- Payment terms and conditions, including late payment penalties; service disruption credits, etc. Billing Disputes and > Contact details for reconciliation and billing queries IReconciliation Procedures...I R i Responsibilities to provide back-up records Notification of billing disputes > Initial resolution procedures (e.g. escalation to more senior management) >- Final resolution (referral to arbitration, regulator or courts) McCarthyTerauk infoDev 3-13 Telecommunications Regulation Handbook Table 3-1: Contents of a Typical Interconnection Agreement (cont'd) Quality of Service/Performiance and Trouble Reports Quality of Service > Service performance standards may be specified in appendix, for example: l Average time for provisioning interconnection circuits l Percentage of interconnection cut-overs made on scheduled dates l Comparative provisioning performance for competitors and self (or affiliates) l Switching and transmission quality measures on interconnected circuits (e.g. probability of blockage at peak hours, transmission delay and loss - consider referencing ITU-T recommendations Testing and Maintenance - Right to make reasonable tests, and to schedule service interruptions; procedures to minimize disruption Trouble Reports > Procedure for trouble reports; notice periods; response time standards ' Duty to investigate own network before reporting faults to interconnecting operator - Responsibility for costs incurred to second operator in investigating faults subsequently found to exist in first operator's network. Calculation of charges (labour, etc.) for investigating trouble reports System Protection and > Responsibilities of parties to take necessary precautions to prevent Safety Measures interference with, or interruptions of, other parties' networks or customers Interchange and Treatment Information Data Interchange Format - Method and format of data interchange between carriers, including data interfaces, software, forms, etc. Data to be Exchanged > Specify all data types and systems for which data is to be interchanged, for example: l New facilities and service orders, network changes and forecasts, billing, etc. (see above) l Number allocations and other data required for call routing and local number portability (where applicable, e.g. where LNP system is operated by incumbent operator rather than an independent party) l Customer listings in directories and databases = Access to network databases, for provision of advanced services 3-14 infoDev McCarthyTerault Module 3 - Interconnection Table 3-1: Contents of a Typical Interconnection Agreement (cont'd) Access to and use of > Confidentiality procedures for customer information, including: l Customer Information . Establishment of separate interconnection services group with secure data (password protection for electronic files; locks for data rooms and filing cabinets, etc.) - Confidentiality forms to be completed by all relevant employees (penalties and bonding optional) l Procedures to ensure protection of customer privacy Access to and use of > Confidentiality procedures (see customer information procedures - Operator Information above) _ Intellectual property rights Equal Access and Customer Transfer Equal Access Procedures > Procedures depend on equal access approach, e.g. carrier pre- selection; casual selection. Detailed procedures normally incumbent for carrier pre-selection, including: l Customer authorization requirements (signature on prescribed form, clear choice requirements) I Authentication and measures to prevent unauthorized customer transfers (slamming) l Penalties for unauthorized customer transfers l Methods of reporting customer transfers (contact points and data to be provided) l Order confirmation procedure (format, medium, etc.) > Schedule to implement transfers l Procedures to implement transfers > Dispute resolution process (e.g. escalation through senior management, arbitrator and regulator); information to be provided in dispute resolution process l Procedures for dealing with disputed customers (which operator may contact customer, information to be provided to and/or obtained from disputed customers) Ancillary Services Operator Assistance > Types of operator assistance services to be provided, including directory assistance, translation services, fault report routing, etc. l Call handling and operations procedures > Fees and billing procedures McCarthyT6trault infoDev 3-15 Telecommunications Regulation Handbook Table 3-1: Contents of a Typical Interconnection Agreement (cont'd) Other Ancillary Services - Subscriber listings in telephone directories > Information and billing inserts l Repair and maintenance services > Other services provided by one or other operators to increase mutual operating efficiencies Termination Grounds for Termination and > Termination may only be permitted subject to certain restrictions (e.g. Restrictions regulatory approval for termination of interconnection by incumbent operator) l Grounds for termination by incumbent may include: l Regulatory or court orders l Bankruptcy, insolvency, receivership, etc. l Cessation of business > Fewer, if any, termination restrictions in competitive markets, and by non-dominant operators Termination Procedures > Advanced notice requirements > Payment of non-recoverable interconnection costs incurred by disconnected operator > Computation and payment schedule for disconnection costs :- Dealings with end-users, communications restrictions, etc. 9 Disconnection cutover procedures. Other Provisions Force Majeure > List of conditions for which non-performance of interconnection agreement obligations will be excused Assignment > Rights of assignment and restrictions on same (e.g. consent or regulatory approval requirements) Applicable Laws > Agreement to be governed by, and interpreted in accordance with, the laws of relevant jurisdiction Regulatory Approvals - Specify regulatory approvals required for effectiveness and/or renewal, amendment, termination, etc. of agreement Breach of Agreement > Remedies and penalties > Liabilities, indemnification and limitation of liabilities Legal Interpretation > Standard provisions for legal interpretation and enforcement of agreement (e.g. entire agreement clause, effect of unenforceable I terms, cumulative rights and remedies, etc.) 3 16 infoDev McCarthyTerault Module 3 - Interconnection Table 3-1: Contents of a Typical Interconnection Agreement (cont'd) Dispute Resolution >- Procedures for resolution of disputes under agreement that are not specifically dealt with elsewhere. For example: l Good faith negotiations, time schedule for same, escalation through management levels l Referral to regulator, arbitrator or court (e.g. of different types of issues) > Selection of, and procedures for, arbitration Term > Duration of term l Renewal rights and procedures Amendment > Review and re-negotiation procedures l> Impact of regulatory changes 3.2 Interconnection Procedures > Independent arbitration or mediation of inter- connection disputes. 3.2.1 Establishing Interconnection Arrangements > Regulatory review, variation and approval of negotiated arrangements. A variety of different approaches have been used to establish interconnection arrangements. The main Active industry participation is necessary to develop approaches are listed below. Combinations of these practical interconnection arrangements However, approaches have been used in different countries at there has also been a growing consensus that it is different times. necessary to have regulatory involvement to provide advance guidelines for operator negotiations and to > Regulatory prescription (ex ante) of intercon- resolve disputes. Different approaches to balancing nection arrangements. industry participation and regulatory intervention are discussed in the followving sections. :>Negotiation between operators. 3.2.2 Negotiation of Interconnection > Establishment of general regulatory guidelines Arrangements for operators to negotiate. In many countries, industry negotiation has been the - Regulatory mediation to facilitate operator- main approach to establishing interconnection negotiated agreements. arrangements. As previously discussed, there are good reasons for this. Operators understand their Regulatory prescription (ex ante) of default networks and operational requirements better than interconnection arrangements, for example, regulators, and they have the technical information based on other jurisdictions, that will apply jf required to implement effective interconnection negotiations fail. arrangements. > Regulatory decisions to resolve interconnection However, without regulatory intervention and direc- disputes. tion, interconnection negotiations do not usually proceed successfully. Incumbent operators are McCarthyTetrault infoDev 3-17 Telecommunications Regulation Handbook generally suspicious that interconnecting operators entrants, without adequate regulatory guidance. Ex will seek subsidized access to their extensive ante regulatory direction and ongoing supervision or existing networks. Indeed, interconnection at almost mediation are generally required for operators to any price is less expensive for a new entrant than negotiate reasonable interconnection agreements duplicating major parts of the PSTN. However, the on a timely basis. purposes of interconnection include minimization of total network costs, and speedy introduction of com- 3.2.3 The Regulator's Role in petition and rollout of new services, such as Interconnection Negotiations broadband access services. Interconnection obligations must often be imposed on incumbents, Once it is decided that regulators should play a role whether or not they agree with them, in order to in promoting the successful conclusion of intercon- promote sector development. nection negotiations, the next question is: how can the regulator intervene most effectively? Regulators Some incumbents may also act strategically during have a variety of tools available to expedite negotia- the course of negotiations to implement arrange- tions and to assist in the successful completion of ments that can effectively prevent or hinder interconnection agreements. Some proven competitive entry. Consequently, regulators must regulatory approaches are described below. find ways to overcome incumbents' reluctance to Variations and combinations of these approaches interconnect their network to new competitors' can be used in some cases: networks on efficient, cost-based terms and conditions. > Establishing guidelines in advance of negotiations - As indicated in Section Despite encouragement from govemments and 3.1.6.1, there is a consensus that ex ante regulators, the reality is that dominant incumbents interconnection guidelines are a necessary have little incentive to enter into agreements that and effective means to promoting good in- expedite competitive entry by interconnecting terconnection agreements. The task of operators. Incumbent operators hold all the developing such guidelines has been made bargaining power in negotiations. New entrants have easier for newer regulators due to the little to offer in exchange for favourable interconnec- growing number of published interconnection tion terms. They can promise market expansion, principles and guidelines established by which should benefit all operators. However, most other regulators. The increasing availability incumbents see this benefit as being outweighed by of precedent interconnection agreements the loss of existing markets to new entrants. and the development of "best practices" and benchmark interconnection charges in other Delays and failure have characterized many inter- countries also make it easier for regulators to connection negotiations. In some of these situations, establish such guidelines. The remaining regulators subsequently realized that delays and sections of this Handbook also discuss disputes could have been resolved by appropriate approaches that can be used in establishing regulatory intervention. For example, regulators ex ante guidelines. could have applied benchmarks or best practices from other countries. In other cases, while negotia- > Setting default interconnection arrange- tions did produce interconnection agreements, these ments in advance of negotiations - were sometimes one-sided, costly and inefficient. Regulatory interconnection guidelines are Sometimes, new entrants accepted one-sided usually fairly general. As a result, there are agreements as the only means available to start up often disputes among operators about how business and avoid bankruptcy. best to apply guidelines. This can cause delays and impasses, and the need for As a result of this experience, many regulators and further regulatory intervention. One approach interconnection experts have concluded that it is to deal with this issue, is for the regulator to generally impractical to direct dominant incumbents publish default interconnection arrangements to negotiate interconnection agreements with new together with guidelines. If the negotiations 3-18 infoDev McCarthyTetrault Module 3 - Interconnection fail, the default arrangements will apply. Another option that is sometimes proposed Such an approach was adopted for some is final offer arbitration. In final offer arbitra- interconnection issues by the US regulator in tion, an independent arbitrator must select its landmark 1996 interconnection order. one of the final offers put forward by two disputing parties. In theory, this provides an In the case of a first interconnection agree- incentive for the parties to make reasonable ment with an incumbent, it may be difficult for offers. In practice, this approach is generally a regulator to establish appropriate default inappropriate for interconnection negotia- arrangements. The regulator may need to tions, due to the number of issues involved, review the issues in depth, obtain informa- their complexity, and to the regulatory goal of tion and submissions from the operators, etc. developing efficient and non-discriminatory before it is in a position to establish default arrangements. The regulatory goal is not arrangements. However, default simply to establish an interconnection arrangements will usually be easier to arrangement, but to establish a good one. establish for subsequent agreements. > Establish Industry Technical Committees As with guidelines, published interconnection - Bilateral or multilateral industry committees agreements and the development of "best are often the best forum for establishing the practices" and "benchmark" interconnection details of interconnection arrangements. If charges in other countries is making it easier negotiations are proceeding smoothly, for regulators to establish default incumbents and new entrants may take the arrangements. Benchmarking has been initiative to delegate the details of technical used extensively by the European interconnection arrangements to working Commission, and at the intemational level, groups or committees. However, in some such as in the US-Japan bilateral telecom- cases, it may be necessary for the regulator munications negotiations. to take the initiative to ensure appropriate technical committees are established. In Finally, if there is a concem about the appro- either case, it is usually good practice to set priateness of the default arrangements, the deadlines for reports by such committees. regulator can provide a "sunset' clause for their applicability. In other words, the Depending on the degree of co-operation regulator can indicate that the default between operators, representatives of the arrangements will cease to have effect after, regulator may also be able to play a useful for example, one year. That will provide time role on the committees. They can often fa- for a more detailed review between the time cilitate agreement on interconnection negotiations fail and the sunset of the default arrangements, suggest altemative arrangements. approaches when there is an impasse, and otherwise mediate the discussions. In some Establish deadlines for various stages of cases, it will be necessary or useful for the the negotiations - Deadlines should be set regulator to retain expert consultants to at the outset of negotiations for completion of assist in this role, and particularly in various steps or deliverables. For example, assessing the merits of conflicting positions the incumbent might be asked to produce a of operators. proposed interconnection agreement in 30 days. Alternatively, deadlines can be Sometimes industry technical committee proposed as soon as it appears delays will work can drag on for months or years. In occur. Consequences of the failure to meet such cases, the committees actually slow the deadlines can include regulatory inter- down the process of reaching interconnec- vention to impose an agreement and tion agreements. Delays can result from the independent mediation or arbitration. establishment of committees with rigid work schedules, lack of familiarity with intercon- McCarthyTetrault infoDev 3-19 Telecommunications Regulation Handbook nection technologies on the part of the with the new entrant. The arrangements that regulatory participants, unnecessary process applied to the new entrant would also apply concems, and other factors. The regulator to the incumbents' own cellular operations. should be flexible and willing to adopt This "no head start" rule proved to be altemative approaches to ensure that the effective. Mutually acceptable agreements industry technical committee process were quickly concluded. The incumbent op- produces results on a timely basis. erators did not want to delay the introduction Alternatively, in some cases, the process of their own cellular services. should be abandoned, and other approaches adopted. In developing positive incentives for incum- bents to complete interconnection The industry technical committees estab- agreements, regulators must take care to lished under regulatory supervision in ensure that they do not create incentives for Canada have generally been considered new entrants to stall or frustrate the negotia- very successful. The Canadian tions. In the Canadian example discussed Interconnection Steering Committee (CISC) above, for instance, if the new entrants had and its sub-committees included participation not been ready to start up service, they from interested industry firms, as well as rep- might have delayed start up by the resentatives of the regulator. CISC was incumbents by stalling completion of established after a regulatory decision that agreements. Regulators must provide provided ex ante guidance on the terms and incentives for both sides to complete conditions of interconnection. However much negotiations. detail remained to be determined by CISC. It took about 2 years to reach agreement on Finally, the prospect of receiving compen- major issues, and regulatory intervention satory interconnection charges can provide was required from time to time. However, an incentive for incumbents to conclude CISC managed to achieve consensus on interconnection agreements. Most many important interconnection issues. The incumbents focus on short-term loss of CISC committees continue to deal with market share to competitors. However, those ongoing issues that arise, for example, in that take the longer view, and build appropri- connection with new types of ate network facilities, can eam significant interconnection. interconnection revenues as a result of the new traffic stimulated by their competitors. s- Incentives to complete interconnection arrangements - A carrot can be more - Appoint mediators or arbitrators - Where effective than a stick. Various incentives can negotiations fail, or where they are likely to often be provided to conclude interconnec- fail, success can often be achieved by tion agreements. Incumbents depend on appointment of a mediator or arbitrator. The regulators for approvals or actions that can two are dierent in that arbitrators are sometimes be linked to the successful con- empowered to make binding decisions clusion of interconnection arrangements. where an agreement cannot be reached. Mediators can provide additional information, An example of this approach can be found in develop compromises, propose altematives, Canada. In 1984, the incumbent operators and persuade. However, they cannot impose (the "wireline operators") were licensed to their own decision on the negotiations. provide new cellular telephone services. At the same time, licences were issued to a It is possible for regulators or regulatory staff new entrant cellular operator. As an incen- to act as mediators and arbitrators. However, tive, the incumbents were prohibited from this in not always the best approach, starting up their cellular services until they particularly in the case of inexperienced had completed interconnection agreements regulators and staff. Interconnection is a 3 - 20 infoDev McCarthyTerault Module 3 - Interconnection complex area, and the costs of delays and marks can be applied. Other practices applied in improper regulatory intervention can be high. foreign jurisdictions can provide useful precedents. There is a growing body of intemational Discussions with other regulators and assistance interconnection "know-how". Experienced from expert advisors can facilitate the regulators' independent interconnection experts can task. often add valuable experience. They can recognize issues from other countries, If interconnection negotiations fail, an operator, suggest options for unresolved issues, and usually the new entrant, may apply to the regulator otherwise save time. In addition, the use of to resolve the interconnection dispute. There is no outside experts maintains the independence single best approach to resolving a complex inter- and credibility of the regulators. The regula- connection dispute, but some approaches are better tors can act as a final decision-maker in the than others. Table 3-2 suggests some approaches event the mediation process fails. They can regulators may use in resolving interconnection also review the final decision of an arbitrator, disputes. if necessary. The WTO Regulation Reference Paper defines an One or more of the foregoing regulatory approaches independent regulator as follows: is usually required to promote the successful con- clusion of interconnection negotiations. Whatever "Independent Regulator" - The regulatory body is the approach, it is important for regulators to be separate from, and not accountable to, any proactive in establishing interconnection procedures supplier of basic telecommunications services. and guidelines that will promote the negotiation of The decisions of and the procedures used by effective interconnection agreements. Further, regulators shall be impartial with respect to all where negotiations fail, regulators must be prepared market participants. to take steps to bring them to a successful conclu- sion. As discussed in Module 1, the degree of independ- ence of regulators varies in different countries. In 3.2.4 Dispute Resolution some countries, the regulator is a government ministry, or a government agency that also has In most countries, it is the regulator's role to resolve responsibility for the operations of a state-owned interconnection disputes. The WTO Regulation incumbent. Many observers would not consider such Reference Paper requires signatories to the a regulator independent for the purpose of resolving Agreement on Basic Telecommunications to interconnection disputes. While such a regulator establish an independent dispute resolution may technically be in a separate organization from mechanism. The Paper requires recourse to an the incumbent, it has similar interests. Both are part independent domestic body to resolve of the government telecommunications bureaucracy. interconnection disputes within a reasonable time. Both may consider the financial and operating This may be the regulator or another independent interests of the incumbent as their prime concern. body. In such cases, other independent dispute resolution In practice, regulatory dispute resolution can be a bodies should be considered, possibly using some difficult task. Most regulators will normally be less of the approaches set out in Table 3-3. These might informed than the operators on the details of inter- include an independent arbitrator or mediator connection. The risk of making an unsatisfactory acceptable to both parties. One option is to have an decision deters many regulators from wading into independent dispute resolution body established by interconnection disputes. a senior branch of government (the executive or legislature). This body need not be set up as a However, regulators must resolve disputes in a costly, permanent bureaucracy. It can be staffed on decisive and timely manner, or competition and a temporary basis with independent domestic and sector development will be retarded. If information international telecommunications experts. Another on local costs is insufficient, international bench- option is to request an international agency with re- McCarthyTetrault infoDev 3-21 Telecommunications Regulation Handbook sponsibility in the telecommunications sector, such countries, lengthy regulatory interconnection as the ITU or The World Bank, to appoint or proceedings were held before the rulings were recommend an independent dispute resolution made. Input was obtained from incumbents, new expert or panel to assist in the domestic dispute entrants and other interested members of the public. resolution process. In the end, detailed decisions were issued, specifying many of the approaches and specific 3.2.5 Ex Ante Regulatory Guidance rates, terms and conditions on which interconnection should occur. In some countries, regulators have prescribed detailed interconnection conditions before intercon- This experience produced a wealth of information, nection arrangements are made. Examples are the analyses and insights into interconnection issues. 1996 US and the 1997 Canadian interconnection However, the work effort required to produce a de- orders for competitive local operators. In these tailed set of interconnection rules should not be Table 3-2: Approaches to Resolving Interconnection Disputes Improving the information > Require parties to clearly define areas of agreement and dispute base for decision-making >- Send written information requests to operators to clarify disputed issues and provide information for interconnection decisions - Require written argument (with supporting facts and research, if necessary) to assist in clarifying the issues in dispute - To increase transparency, consider making the arguments (but not confidential business data) available for comment by other interested parties and the public > Consider inviting other interested parties (e.g. other interconnecting operators, service providers, or user groups) to comment on the issues Obtaining expert assistance > Hire an experienced interconnection expert to assist in clarifying the issues, formulating information requests, and providing general advice to the decision-makers > Consider appointing a mediator (or, if the parties agree, an arbitrator) - Use outside parties for informal mediation, arbitration, information gathering or other participation in the negotiations. This approach is particularly useful in countries where direct regulatory involvement would 'taint" the legality or politically prevent it from making an unbiased final decision. Improving accuracy and - Consult with other regulators on their experience in similar cases credibility - Review decisions and interconnection agreements approved by other regulators > Consider circulating a draft of the decision to resolve the dispute to the disputing operators and other interested parties. Their comments should be made public. Comments and corrections can improve the accuracy of the final decision. 3 - 22 infoDev McCarthyTetrault Module 3 - Interconnection underestimated. Moreover, these lengthy are, therefore, major determinants of the viability of interconnection proceedings did not produce the operators in a competitive telecommunications "final word" on interconnection arrangements. In market. both Canada and the US, there have been lengthy follow-up proceedings before the regulators and in Over the years, a variety of approaches have been the courts. In Canada, much of the detail of used to calculate interconnection charges and interconnection arrangements was left to a number generally to determine the financial terms of inter- of industry technical committees led by regulatory connection. In this Section, we first consider the staff. This CISC process (which is referred to above) general approaches that have been used to produced very useful results, but it took about 2 determine interconnection charges. Later in the years to resolve most of the issues. Section, we review specific types of interconnection- related costs that are often treated in specific ways. It should be recognized that interconnection is a Examples are start-up costs, costs of interconnec- dynamic issue. The types of telecommunications tion links and collocation and infrastructure sharing infrastructure and services are constantly changing. costs. As a result, interconnection requirements continue to change as well. Where regulators prescribe inter- 3.3.2 Approaches to Setting Interconnection connection arrangements, they should be viewed as Charges flexible rules that should evolve with telecommuni- cations networks and markets. This Section reviews the general approaches that have been used to determine interconnection 3.3 Financial Terms of charges. While there is no single correct approach, Interconnection there is a consensus among telecommunications and trade experts that the best approaches are cost- 3.3.1 Interconnection Charges based. However, other approaches have their merits in some circumstances. Table 3-3 provides an overview of the main approaches used to determine Interconnection charges often account for a very interconnection charges. Readers interested in more significant part of the costs of new telecommuni- detail on the costing concepts and economic cations operators. This is particularly the case with theories underlying them should refer to Appendix B new entrants that do not own end-to-end networks. the undbook. The level and structure of interconnection charges of the Handbook. ___D_,ip-_________ __ -i ~ o11 mments lC ehar.ges based o rwd-loi -G ra llyi,cepted as best practice * lgUeia z ll operator ausually S -lil App 5 inds _most efficient price Incremeptal U ~~~~~~~~~~~sigal rDse o6i current technology era l lis book assets -- - 1i~f1~ ~i~tiTf.I1~j, @~~1a.the >~losst ~pxirration of costs in a fl competitii- ve .market _ __ - Wuk Itql311 (O1(31Th >,f Requirls. ;and some cost and - .= ;¢ ;1ThLitc.XnS ,n LlC U . inud LICdmar ;leiraesl F----- 4,>{1, TunEl rilMLl. trCu .iThese - UsuaIyFleids"t6 lower- interconnection -=_ approaches I diff t ele ments compelition but i _ ¶~~ed and common costs (e g provides lower revenues to incumbent McCarthyTT&rault infoDev 3-23 Telecommunications Regulation Handbook Table 3-3: Main Approaches to Interconnection Charges (cont'd) overheads, and fixed-service operator otraditional LRIC aexcnluded from - May be substantially out of line with tradionalLRIC analyes. hese actual book costs of inefficient variations are growing in acceptance incumbents as "best practices". They are described in Appendix B of the Handbook Can be inappropriate if end-user prices are seriously unbalanced (e.g. set well below costs and below interconnection charges Historical > Charges based on the accounting > Common practice; less favoured by Accounting records of the operator supplying the regulators and experts today Costs interconnection facilities or services X >~~~~~~~~~~~~~~~ Less efficient since historical costs - Generally includes an assignment of were often incurred less efficiently than direct costs and an allocation of those based on current technology and common costs booked in the operational circumstances (e.g. accounting records privatization) l Examples: UK, 1995 Japanese " Accounting records often misstate real system, and Sweden value of assets: based on subjective accounting policies and political decisions regarding investments > Usually requires study to as- sign/allocate booked cost to interconnection facilities and services Sender - No charges payable between > Works best where the two operators Keep All interconnecting operators for are similarly situated and exchange (SKA) termination of each other's traffic approximately the same amount of (Bill and > Typically, each operator pays for its traffic (e.g. for interconnecting local Keep) own facilities up to the point of operators) interconnection, plus charges for any > Charges can apply to compensate for unusual costs incurred by the other traffic imbalances operators to accommodate its traffic >. Without such charges, SKA can retard > Examples: Indian, US and Canadian financing and development of rural or local operators, and Indonesian other services, where there is an regional operators imbalance of traffic (i.e. more incoming) - Was the main model for interconnec- tion of ISPs in many markets. However, this is changing as larger ISPs, with substantial backbone facilities and reach, increasingly treat smaller ISPs as customers rather than peers Revenue > Typically, new entrants pay the >- This approach is simple - no need for Sharing incumbent operator a share of their cost studies to determine revenues from interconnected services interconnection charges (or all services) - Generally considered non-transparent : In some revenue-sharing arrange- Potentially inefficient and anti- ments, no additional charges are 3 - 24 infoDev McCarthyTetrault Module 3 - Interconnection Table 3-3: Main Approaches to Interconnection Charges (cont'd) payable between interconnecting competitive (i.e. when excessive operators for termination of each revenue shares are paid) other's traffic; in others, additional charges do apply for direct intercon- > Sometimes prescribed by goverments nection costs (e.g. transmission links, or PlUs as the only basis on which l interconnection interfaces) interconnection will be permitted in an otherwise closed market; sometimes . Examples: Thailand, Indonesia, and treated as a "tax" for doing business in China a country. May be a transitional step to a more efficient approach Interconnect > Interconnection charges based on > Difficult to estimate appropriate Charges prices to end users discount - may lead to inefficiency (i.e. based P s A discount is sometimes applied for high discount discourages construction Retail Prices Adinter-operator charges. This can be of competitive facilities; low discount estimated based on the avoided costs undermines financial viability of of the supplying operator (e.g. retail competition) billing and marketing costs). : Specifically rejected in some jurisdic- Examples: US loc-al resale prices, pre- tions (e.g. Hong Kong, China which 1995 Japanese approach ~~differentiate "carrier-to-carrier", charges _ 1 995 Japanesei aCpapiroesachl prices, pre- , from retail rates) Other - Interconnection charges have been 0 Efficiency of charges depends on how Negotiated negotiated between operators based closely they approximate efficient Interconnect on a wide range of other approaches; costs; many negotiated charges Charges some principled, many arbitrary include implicit subsidies between > Example: International accounting operators and customers rates, and some reseller agreements >" Level of negotiated charges often depends on the bargaining power of the operators 3.3.3 Comments on Different Approaches interconnection costs in different circumstances. However, today most regulators and experts Internationally accepted interconnection principles generally agree that the ideal approach for calculat- generally require interconnection charges to be cost- ing the level of interconnection charges would be based or "cost-oriented". This is the case with the one based on forward-looking costs of supplying the interconnection principles of the WTO's Agreement relevant facilities and services. This ideal is usually on Basic Telecommunications and the European implemented by means of some variant on the long- Union's Interconnection Directive. Cost-based run incremental cost (LRIC) approach. This pricing of interconnection services is consistent with approach has been entrenched in the regulations of best practices adopted by regulators in most some countries (e.g. India) and the laws of others countries. This issue is discussed further in Section (e.g. the US). 3.1.6.5. The major variations of the LRIC approach that have Forward-Looking Costing Approaches been most widely accepted by regulators and experts are: There remains a fair amount of debate in regulatory circles about the best approaches to use to calculate McCarthyTe6trault infoDev 3 - 25 Telecommunications Regulation Handbook Long Run Average Incremental Costs (LRAIC) - As can be seen from the preceding descriptions, the A long-run costing approach that defines the most widely accepted LRIC-type approaches increment as the total service. It dffers from generally include a reasonable allocation of joint and traditional marginal and incremental cost common costs. Such costs can also be calculated measures by including allowance for the fixed on a forward-looking basis, to approximate the costs costs specific to the service concemed: "service- of an efficient operator. Joint and common costs are, specific fixed costs". The European Commission by definition, not directly caused by the interconnec- has adopted this approach. tion services, but are nevertheless incurred by an operator in connection with its interconnection Total Service Long Run Incremental Costs facilities and services. Common examples of such (TSLRIC) - This approach, developed by the costs are the salaries of the president, managing Federal Communications Commission (FCC) in director or legal counsel of the operator. By including the USA, measures the difference in cost capital, joint and common costs, a LRIC approach between producing a service and not producing can approximate costs in a competitive market, it. TSLRIC is LRIC in which the increment is the while providing reasonably full compensation to the total service. operator supplying the interconnection - assuming it operates efficiently. Total Element Long Run Incremental Costs (TELRIC) -This approach, also developed by the Further descriptions of the methods used to FCC, includes the incremental cost resulting from calculate long-run incremental costs, including adding or subtracting a specific network element LRAIC, TELRIC and TSLRIC are included in in the long run, plus an allocated portion of joint Appendix B and in Module 4. and common costs. While variations on the LRIC approach are Other variations - There are other variations on considered the best practices by most experts, there the LRIC approach. In Canada, for example, the are practical limitations on their applicability. Some regulator uses an incremental cost approach of these are listed in Table 3-3. Some of these limi- (Phase 11 Costing) and adds a mark-up to tations are particularly significant in countries with approximate forward-looking fixed and common less developed telecommunications sectors. For costs. Other regulators have developed different example, if local retail telecommunications rates are ,pproaches. set well below costs, setting interconnection prices at LRIC may not permit a new, local services entrant A well-designed LRIC-type approach provides an to run a viable business. The new entrant's inter- estimate of the costs of an operator to provide inter- connection costs may exceed its retail prices. While connection in a fully competitive market. An LRIC- rate rebalancing is the long-term solution to this type calculation generally starts by estimating the problem, in the short term interconnection rates may direct costs incurred by an operator in providing the need to be discounted in order to permit competition interconnection services in question. These costs to emerge. There are other practical problems with are calculated over the "long run", usually at least the application of LRIC-type approaches in some ten years, in order to average out the inherently environments. "lumpy' nature of the investment costs of intercon- nection facilities in the year they are introduced. OtherApproaches In addition to the directly attributable costs, LRIC- The applicability of the non-LRIC-type approaches type calculations generally include a capital cost listed in Table 3-3 depends on the circumstances of component. This component is intended to dfferent countries. The comments in the Table reimburse the operators for the costs of financing describe strengths, weaknesses and other consid- the interconnection facilities, since these costs are erations. Several other comments follow. necessarily incurred by the operator providing the facilities. Modifications are often made to the various approaches to attempt to compensate each operator 3 - 26 infoDev McCarthyTetrault Module 3 - Interconnection more closely for costs resulting from its interconnec- should be dealt with by means of a separate charge, tion. An example is the Sender Keep All (Bill and not a revenue-sharng formula. Issues related to Keep) approach. As indicated in Table 3-3, this universal service and universal access charges are approach is appropriate where the two operators are discussed in detail in Module 6. similarly situated and exchange approximately the same amount of traffic. Thus, it is often used for in- Table 3-3 does not provide an exhaustive list of the terconnection of local operators in the same city or approaches to calculating interconnection charges. neighbouring regional operators. Other approaches exist. One example is the Efficient Component Pricing Rule (ECPR), which bases The Sender Keep All approach may be modified to interconnection charges on the net incremental add charges to compensate for traffic imbalances. costs of interconnection, plus the "opportunity costs" For example, operator no. 1 may receive and termi- or margin lost by the incumbent as a result of traffic nate more traffic from operator no. 2 than it sends to "taken" by the new entrant. This approach has been that operator. Operator no. 1 will then usually incur discussed among academics and consultants, but higher costs as a result of the interconnection than has generally not been accepted by regulators as a operator no. 2. To compensate for this imbalance, reasonable option. operator no. 2 may pay a cost-based interconnec- tion charge to operator no. 1 for every minute of Finally, interconnection charges are sometimes traffic it sends that exceeds the traffic it receives. indexed or "price capped" to determine future increases (e.g. for a five or ten year period). Such A word or two about revenue sharing approaches. approaches provide certainty to interconnecting An element of revenue sharing may be appropriate parties regarding their level of future costs or in some cases to distribute surplus revenues after revenues. payment of cost-based interconnection charges. However, in some cases, revenue shares paid to 3.3.4 Specific Interconnection Costs incumbents have included a wide range of compo- nents, ranging from interconnection costs to a 3.3.4.1 Start-up Costs "licence fee" for operating in a jurisdiction or "compensation" to an incumbent for loss of business The network infrastructure of most incumbent to new entrants, or fulfilment of universal service operators was designed to function on a monopoly obligations. basis. In the transition to a competitive telecommu- nications market, some modifications are usually The latter three components are typically not cost required to the operator's switching and transmis- based. They are usually not transparent and are not sion facilities and related software to permit efficient recommended in any jurisdiction where the regulator interconnection among multiple operators. For wishes to improve efficiency in the telecommunica- example, switches must be programmed to tions sector. These approaches can be subject to recognize and route traffic to telephone numbers on abuse. For example, excessively high revenue- the network of interconnection operators. Additional sharing arrangements have been imposed in some numbers must often be allocated and equipment jurisdictions in a short-sighted attempt to eam addi- modified to deal with them. These modifications are tional operator or govemment revenues. The effect often referred to as "start-up costs", since they are is to prevent efficient competition. required at the outset to permit interconnection. If revenue-sharing schemes must be used, then Regulators in different countries have treated start- regulators should consider identifying each compo- up costs in different ways. Some take the view that nent of the revenue share separately. This includes, new operators are the beneficiaries of interconnec- for example, shares to pay for cost-based intercon- tion, so they should pay all start-up costs. In the nection charges, for concession or licence fees, etc. extreme, this approach is applied not only to This approach adds transparency and allows for the interconnecting transmission circuits, but to all gradual elimination of revenue-sharing components modifications and upgrades to an incumbent's that are not cost-based. Universal service charges network required to facilitate interconnection. Some M h af3 -27 McCarthyTetrault infoDev 3-2 Telecommunications Regulation Handbook new operators accept this approach as the only one and distribution frames) in order to accommodate that will provide them with interconnection, the interconnected circuits. particularly in countries with state-owned PTTs. However, this approach has disadvantages. It can One approach is to require the new operator to pay impose a heavy financial burden on a new entrant, the entire cost of the transmission links and related shft costs of network upgrades from incumbents to facilities. This approach is based on the theory that competitors, and ultimately lessen the chances of transmission facilities are being added and the viable competitive entry. modifications made solely for the benefit of the new operator and its customers. If this approach is A different approach that is more pro-competitive in adopted, incumbents should not be able to recover nature has been adopted by a number of countries any more than the actual costs of the transmission such as Canada. The approach is based on the links and related facilities. Sophisticated costing assumption that competition is introduced to benefit approaches are not required. Normally, these costs all telecommunications users and the economy in are easily tracked through expense invoices, related general. Interconnection start-up costs are seen as a labour costs and overhead. As a general principle, direct result of the policy decision to open a market the costs should not exceed fair market costs for to competition. It is also recognized that the costs installing the links. Incumbents may have an incurred by all operators will, market conditions incentive to inflate charges for such links, and regu- permitting, generally be borne by telecommunica- latory oversight may be required to ensure charges tions users. are based on market costs. Therefore, some basis is developed to apportion One method of ensuring charges for interconnection costs among established and new operators on the links are not inflated is to give the new operator the assumption that they will generally pass these on option of installing the links itself, including work on through user rates. A specific surcharge may be the premises of the incumbent. Specifications for considered, but may not be adopted for political such work can be subject to discussion at a joint reasons. One method of apportioning costs is on the technical committee with a dispute resolution basis of the projected use of telecommunications mechanism. Work on its premises can be monitored services (including interconnected services) in the by the incumbent to avoid arguments about future. A formula can be established to adjust improper work or sabotage. compensation between operators in case actual use dfffers from projected use of telecommunications or As with start-up costs (see discussion in previous interconnected services. Section), interconnection links, are a necessary prerequisite for the development of a competitive Under this approach, the incumbent will generally market. Taking this view, regulators may consider it bear a large share of start-up costs. Some appropriate to apportion the costs of such links regulators regard this approach as necessary or between incumbents and new entrants, based on appropriate to facilitate competition. Understandably, the assumption that end users of all operators will this approach is generally opposed by incumbents. ultimately benefit. 3.3.4.2 Interconnection Links The simplest, and probably most common method of apportioning costs of interconnection links is to Different approaches have been adopted to have each operator pay the costs of its interconnec- apportion the costs of the physical links between tion links up to the Point of Interconnection (POI). interconnecting operators. Such links include Since POls are often located in or near the transmission lines or radio links that carry the inter- exchange of the incumbent, this method can impose connecting circuits. They also include the ducts, significant costs on a new operator. However, under towers, manholes and other support infrastructure, this approach, the new operator can decide how to as well as the modifications that are required to the configure its network to limit its costs. transmission-related facilities (e.g. cross-connects 3 - 28 infoDev McCarthyTetrault Module 3 - Interconnection 3.3.5 Structure of Interconnection Charges ture of interconnection charges. Several examples are given below. The structure of charges for interconnection often varies from country to country. These variations 3.3.5.1 Fixed and Variable Charges reflect a number of factors, including differences in the telecommunications infrastructure, policy As a general principle, interconnection charges differences and varying levels of effort on developing should reflect the difference between fixed and cost and price structures. Price structures need not variable costs of interconnection. For example, the be complex to be efficient and fair. In many cases, fixed costs of providing a dedicated network access simplicity is best. However, with some effort, a price line (loop) are best recovered through a fixed structure can be developed that levels the playing charge. On the other hand, where the costs of field for all operators and facilitates more efficient network components, such as telecommunications interconnection. switches, are traffic sensitive, they are best recovered through usage charges. Usage charges Box 3-4 sets out some basic principles for an effi- are usually based on time (minutes). In the case of cient interconnection price structure. interconnection of Internet backbone operators and Internet Service Providers, charges are often based Operators, regulators and telecommunications on capacity (bits of traffic). experts have long discussed how best to refine tele- communications pricing structures to improve While it is not always practical to implement this efficiency. Many of the principles applicable to other principle, doing so is consistent with efficient pricing telecommunications prices also apply to the struc- theory. Distinguishing between fixed and variable costs in the charges for interconnection components Box 3-4: Principles for Efficient Interconnection Price Structures - Interconnection charges should be cost-based (ideally based on long-run average incremental costs, including cost of capital, plus a reasonable markup to cover forward-looking joint and common costs) > Where information is available, costs should be based on the current replacement costs of assets (discounted to their remaining service life); in the absence of such costs, depreciated book value of assets is sometimes used >; Interconnection charges should be sufficiently unbundled so that an operator seeking interconnection need only pay for the components or services it actually requests - Where the costs of a particular component vary significantly in different locations, the interconnection charges should be disaggregated (e.g. costs of access lines may be higher in rural areas (where they are typically longer) than in cities) - Charges should not include hidden cross-subsidies, particularly of an anti-competitive nature (e.g. charges for monopoly-supplied network components should not be inflated to a level well above costs in order to fund below-cost provision of competitive components). This principle is adopted in the WTO Regulation Reference Paper. > The structure of interconnection charges should reflect underlying costs. Thus, fixed costs should be covered by fixed charges, variable costs by variable charges. Peak and off-peak charges should be set where there is a significant difference in costs. McCarthyTetrault infoDev 3-29 Telecommunications Regulation Handbook will send the right price signals. For example, there that major suppliers must provide interconnection on will be less incentive to overuse usage-sensitive a basis that is sufficiently unbundled so that a network components if they are priced based on supplier need not pay for network components or usage, rather than on a flat monthly charge. facilities that it does not require for the service to be Establishing a price structure that reflects underlying provided. fixed and variable costs should lead to a more efficient use of those components. In keeping with their WTO commitments, or gener- ally because it is good policy, many regulators have 3.3.5.2 Peak and Off-Peak Charges issued directives requiring unbundled charges. For example, in India, a regulation was issued in 1999 Peak and off-peak pricing differentials have been by the Telecommunications Regulatory Authority of used for retail pricing of telecommunications India (TRAI) that states that "No service provider services for many decades. Charging higher rates shall be charged for any interconnection facility it for usage in peak hours provides users with an does not seek or require". (TRAI (1998a)) incentive to call in off-peak hours. Advantages of a peak/off peak pricing structure include: 3.3.5.4 Universal Service and ADC Charges > reduced peak-hour congestion; In many countries, incumbent operators incur deficits in carrying out uneconomic universal service ' reduced demand to build new infrastructure to obligations (USO) or universal access obligations. meet peak traffic loads; Beneficiaries of these social obligations generally include high-cost service areas, such as remote - increased overall network utilization; and villages or low-income customers. In some countries, however, deficits are not incurred by the improved quality of service. incumbents to perform specific universality. Rather, the deficits are incurred as part of a policy of The same principles of peak and off-peak pricing are maintaining low access charges for all customers. often incorporated in interconnection charges. If they These are usually referred to as Access Deficit are not, then interconnecting operators will have no Contributions (ADCs) to distinguish them from incentive to charge higher rates to their end-users Universal Services Obligation (USO) payments that during peak hours. The result can be a migration of generate revenues for more targeted social peak-hour traffic to new entrants, who will then purposes. impose higher costs on incumbent's that must build the infrastructure to support the higher peak-hour In a monopoly environment, ADCs are often paid loads. from services priced above costs (e.g. international rates or business services) to access costs that are Good regulatory policies, such as those adopted in priced below cost. In the case of the incumbent, Hong Kong, China specifically provide that the ADCs may be explicit, or implicit in unbalanced structure of interconnection charges must reflect the rates. Traditional telecommunications policies often behaviour of underlying costs. Thus, the "carrier-to- prevent "rebalancing" of the prices to more closely carrier" charging principles in Hong Kong encourage reflect their costs. New interconnecting operators interconnection charges to reflect both fixed/variable often do not have similar universal service obliga- and peak/off peak cost differences. tions or access deficits. Accordingly, they are often asked to contribute to USO payments or ADCs of 3.3.5.3 Unbundled Charges the incumbent. In an increasing number of countries, telecommuni- There are a number of ways of dealing with this cations policies require incumbent operators to issue. These are discussed in detail in Module 6. As provide competitors with access to unbundled indicated in that Module, the best practice for regu- network components. This approach is supported by lators is to levy any USO or ADC charges separately the WTO Regulation Reference Paper, which states from interconnection charges. As demonstrated in 3-~ 30 infoDev McCarthyTetrault Module 3 - Interconnection this Module, the underlying concepts and calcula- services may or may not provide any Internet tions for interconnection charges are very different content or access services themselves. Some ISPs from those underlying USO and ADC charges. with larger networks also provide transit services, in addition to standard Internet interconnection If USO or ADC charges are established, it is cleary arrangements. a good practice to identify them as separate from interconnection charges. Blending the two charges ISPs generally interconnect with each other and with removes transparency from the interconnection Internet backbone providers at Intemet Exchange process. Separate charges permit regulators to Points (IXPs). These are sometimes referred to as comply with the requirement of the WTO Regulation Network Access Points (NAPs), although that term Reference Paper that USO charges be is becoming less common. IXPs have switching administered in a transparent, non-discriminatory equipment and routers that permit interconnection of and competitively neutral manner. Please see the various Internet networks using the IXP. As with Module 6 for a more comprehensive discussion of the Internet generally, IXPs are evolving into USO and ADC issues. increasingly multifunctional, and commercial opera- tions, that charge fees for an increasingly wide 3.3.6 Internet Interconnection Charges range of services, rather than just facilitating 'free' interconnection of ISPs. Many IXPs now provide Over the past decade, the Internet has changed collocation services, providing space as well as from a co-operative to a commercial communica- equipment for Internet routing, transmission, web- tions medium. It has also changed from a relatively hosting and other services. Separate, market-based small education and research-based data network to charges are usually levied for such services. As with a network that accounts for more traffic than voice most Internet-related services, these charges are telephony in several countries today. This generally unregulated, except where they are transformation of the Internet has changed the basis provided by a dominant incumbent operator. for interconnection charges among ISPs and be- tween ISPs and the operators of the large capacity The transition of the Intemet to a more commercial backbone telecommunications networks that carry medium, with large disparities between the sizes Internet traffic. and functions of Internet networks, has changed the structure of Intemet interconnection charges. In Originally, many ISPs regarded themselves as some cases, interconnecting ISPs still exchange equals or "peers". They generally entered into Bill traffic with each other as 'peers' on a Bill and Keep and Keep interconnection arrangements. Under basis. Under this arrangement, each ISP typically these 'peering' arrangements Internet networks pays its own costs of transmission, routing and other exchanged traffic without levying charges or paying equipment, or shares the costs on a negotiated fees to each other. The underlying premise for basis. peering arrangements was that Internet networks of substantially similar size and traffic volumes However, such peering arrangements are becoming benefited more-or-less equally from interconnection, less common, particularly where different types or and incurred generally similar costs. sizes of Internet operators interconnect. There, asymmetrical charges have become the norm. The Over time, some Internet Protocol (IP) networks backbone network operator, or the larger ISP, expanded their coverage to national and global lev- usually charges the smaller ISP or local access els. Some network operators developed into provider for interconnection and transit services. The specialized IP backbone operators, carrying large basis for such interconnection charges is often volumes of Internet traffic for long distances similar to those found in other parts of the telecom- between ISPs and Internet hosting services. These munications industry. Charges are typically based backbone network operators generally provide 'tran- on one or more of the following variables: sit' services. Transit services involve the transmission of Intemet traffic between two or more ISPs and Intemet hosts. Providers of Intemet transit McCarthyTetrault infoDev 3 - 31 Telecommunications Regulation Handbook - traffic flow or usage, based on the increasing carrying traffic that is generated by the other capacity of Intemet routers and other equipment administration." to measure traffic; The US and Canada have opposed this recommen- > imbalance of traffic flows between ISPs; dation. They argue that the North American bias of Internet routing will decrease over time, as > distance or geographical coverage; competition and market developments reduce costs and increase Internet facilities in other regions. The > number of points of interconnection; and US, in particular, has long argued that the Internet should remain unregulated in most respects. The > other cost-based interconnection charges. proposed resolution was considered at the ITU's World Telecommunications Standardization All of these charging variables are related to costs Assembly in Montreal in October 2000. After much incurred by the ISP providing the service, or at least discussion, the Assembly adopted a proxies for such costs. This trend toward cost-based recommendation that calls for arrangements to be interconnection charges is consistent with develop- negotiated and agreed upon on a commercial basis ments in other telecommunications services. when direct Internet links are established intemationally. The new recommendation does not One anomaly in the trend toward cost-based Inter- prescribe any particular costing approach; thus net charges has been related to the traditionally operators are free to determine the approach to be heavy reliance on US-based ISPs and Internet used in implementing it. This recommendation has backbone providers by ISPs in other countries. Due been referred to as a framework for future to the early lead of the US-based Internet industry, discussions. The US and Greece stated that they and the heavy concentration of attractive Intemet would not apply this recommendation in their web sites in the US, many ISPs in other countries international charging arrangements. have paid US ISPs for transportation to and from the US to their home country. There have often been no Local interconnection charges are also important to reciprocal charges paid by US ISPs for traffic to the the viability of ISPs. Local Internet access providers interconnecting ISPs in other countries. This will be principal beneficiaries of the move to unbun- imbalance has become a hot policy issue within the dling of local loops, which is discussed in Section ITU and other international organizations. Within 3.4.6 of this Module. Unbundled local loops can be APEC, for example, Australia and various Asian used by ISPs to provide DSL-based high speed countries have complained that current costs of Internet services on more favourable terms than interconnecting with North America are too high and those currently available in most markets. that it is inequitable that Asian networks are not compensated for their costs in carrying traffic In a number of countries, cable television networks generated by North Americans. provide an efficient and highly successful form of high-speed local Internet access. These 'cable In April 2000, ITU Study Group 3 adopted Recom- modem' services have generally been provided only mendation D.iii on International Intemet by the serving cable TV operator. This has given the Interconnections: cable operator a strong position in ISP markets compared to other ISPs without high-speed capabili- "Noting the rapid growth of Internet and Internet ties. Several countries have considered whether to protocol-based international services: It is rec- require cable operators to interconnect with other ommended that administrations involved in the ISPs to provide them access to high-speed cable provision of international Internet connection networks. negotiate and agree bilateral commercial ar- rangements applying to direct intemational In Canada, the CRTC has ordered major cable Internet connections where each administration operators to grant other ISPs access to their high will be compensated for the cost that it incurs in speed networks at a discount from retail ISP rates. In the US, the FCC has not, to date, taken similar 3 - 32 infoDev McCarthyTT&rault Module 3 - Interconnection action. Some US cable operators have entered into implementing mobile infrastructure can be agreements with ISPs to access their high-speed quicker and less capital intensive than building networks on an exclusive basis, thus making access the type of ubiquitous wireline networks that are unavailable to competitors. This appropriateness of found in most developed countries. such exclusive arrangements is under consideration by the FCC. > All countries have come to appreciate the revenues that can be realized by auctioning 3.3.7 Interconnection with Mobile Networks mobile wireless spectrum. Bidders will take the design of the regulatory environment into As indicated in various places in this Module, mobile account as they assess how much to bid. operators must obtain interconnection with incum- bent operators of the PSTN in order to ensure the When mobile service was first introduced, most viability of their services. In general the interconnec- countries adopted Calling Party Pays (CPP) tion principles and practices described in this arrangements. Under CPP, the person that origi- Module apply to interconnection by mobile operators nates a call is the one that pays for it, whether it to the PSTN. However, certain differences apply to originates on a mobile or fixed-line telephone. A interconnection with mobile operators. person who makes a mobile-to-fixed call pays the mobile operator at the retail rate. The mobile Historically, regulators devoted much less attention operator, in turn, pays the fixed operator an to mobile services than fixed services. Mobile interconnection charge that is relatively small when service was priced at a substantial premium to wire- compared to the retail rate. Usually, the line service. As a result, mobile service was viewed interconnection charge is invisible to the mobile as a discretionary or even a luxury service where caller. However, the situation is quite different for a consumers did not need much in the way of regula- fixed-to-mobile call. Because the interconnection tory protection. As well, mobile service was offered charge paid by the fixed operator to the mobile competitively in many countries, with the expectation operator is relatively large, the fixed operator will that market forces rather than regulators would be want to recover it from the caller who makes the call. the prime force in setting prices. Mobile operators Accordingly, the fixed operator will charge a were not perceived as possessing market power in substantial surcharge for fixed-to-mobile calls, with the same way as fixed operators. the surcharge (less an administrative charge) being passed on to the mobile operator. The mobile However, the role of mobile services has changed in operator does not charge its customers for calls recent years, leading to increased regulatory interest received from the PSTN. and attention: CPP has not been adopted in countries such as the - The consumer rates for mobile service have US and Canada, where most local calls on the declined in both developed and developing PSTN are not metered, but charged at a flat monthly countries. The combination of rate decreases, rate. These are referred to as Receiving Party Pays the fact that consumers like the flexibility of mo- (RPP) or Mobile Party Pays (MPP) environments. In bile service, and improvements in mobile a RPP country, the mobile customer pays both for technology (such as longer battery life) have mobile-to-fixed calls and for fixed-to-mobile calls. contributed to an enormous increase in the However, the customer on the fixed network pays number of mobile users. Indeed, in some coun- the same amount to call someone whether on the tries, the number of mobile users now exceeds fixed network or on a mobile network. Interconnec- the number of fixed users. Thus, for many, tion between the fixed and mobile operators is mobile service is no longer a luxury - it is the generally on a reciprocal basis, either bill-and-keep prime way in which they access the PSTN. (also referred to as sender-keep-all) or mutual com- pensation at the same interconnection rates that are : Some less developed countries have begun to found in fixed-fixed interconnection arrangements. devote much more attention to fostering the growth of mobile service, as they realize that McCarthyTe'trault infoDev Telecommunications Regulation Handbook A number of countries that do not have CPP are sometimes arise, for example in Finland, where considering a switch to it, or have done so. For mobile operators have reduced fixed-to-mobile example, Mexico introduced CPP in April 1999. This rates in line with mobile-to-fixed rates. In move is partly motivated by evidence of higher countries where there is a monopoly fixed mobile subscriber growth rates in CPP countries. Sri operator, the fixed operator has little incentive to Lanka has announced its intention to change to reduce fixed-to-mobile rates. Even in countries CPP. The transition to CPP affects subscribers of all with competing fixed operators, there seems to networks in a market, including PSTN subscribers. be little evidence of competition to reduce fixed- Their bills will be increased since they will be to-mobile rates. charged for calls to mobile subscribers. Accordingly, the transition normally involves regulatory supervi- : The regulatory inattention arises because, as sion to ensure, among other things, that PSTN explained earlier, mobile service was historically subscribers are adequately notified of increased viewed as a discretionary or even a luxury charges that will appear on their bills. service that appealed to a narrow segment of users. In many countries, mobile service was Because fixed-to-mobile calls are so much more offered competitively, and rates were set by expensive than fixed-to-fixed calls in a CPP country, market forces. Unlike the fixed networks, regu- many countries have distinct dialling prefixes for lators did not have good cost data for mobile fixed-to-mobile calls. In that way, consumers under- networks. Without cost data, the regulators were stand that they will be charged a premium for fixed- not in a position to determine if fixed-to-mobile to-mobile calls, and it is obvious when such charging rates might be higher than necessary. takes place. The result of these two factors is that fixed-to-mobile In recent years, some observers have expressed rates in some countries have remained at high levels concem about the level of CPP charges for fixed-to- even as mobile-to-fixed rates have declined sub- mobile calls. The ITU's Trends 2000 Report, which stantially due to reduced costs and vigourous focuses on interconnection, points out that in competition. Europe, where CPP arrangements prevail, the aver- age fixed-to-mobile interconnection rate was USD An examination of the fixed-to-mobile rates that are 0.21 per minute for a three minute call. This charged to the customers of a fixed operator leads contrasts with mobile-to-fixed interconnection rates to an examination of the interconnection charges of USD 0.01 per minute for local interconnection, levied by the mobile operator to the fixed operator 0.014 for single transit interconnection and 0.02 for for the termination of a call on the mobile network. double transit interconnection. The ratios of fixed-to- Few countries have examined the costs of mobile mobile and local mobile-to-fixed rates range from a termination and applied these costs in setting inter- low of 8.7 in Norway to a high of 34 in France. The connection charges. One country that has recently report suggests that asymmetrical regulation of made such an attempt is the United Kingdom. In a fixed-line and mobile operators may have resulted in 1998 report, 'the Competition Commission inflated mobile termination charges under CPP. determined that fixed-to-mobile termination rates were substantially above cost. In 1999, OFTEL Some observers believe that the high level of CPP ordered that rates be substantially reduced to a charges for fixed-to-mobile calls is due to a combi- ceiling of 11.7 pence per minute, and that the ceiling nation of two factors, market failure and regulatory be further reduced by 9% per year (after inflation) for inattention: two years thereafter. OFTEL will be considering if further pricing action is needed following this period. : The market failure arises because there is little competition in fixed-to-mobile rates. Mobile High mobile interconnection rates may be reduced operators often compete vigourously on by competition over time. However, as mobile serv- subscription and mobile-to-fixed rates, service ices catch up with and overtake fixed networks, levels and coverage, but they rarely compete on there is likely to be more regulatory scrutiny of high fixed-to-mobile rates. Such competition does mobile termination rates, particularly where they are infoDev McCarthyTetrault Module 3 - Interconnection thought to be set at levels that are significantly > It facilitates comparisons of interconnection above cost. rates, terms and conditions among major op- erators; and 3.4 Technical and Operational Conditions a It assists in developing industry standards, benchmarks and best practices. While financial arrangements are important to the The disadvantage of mandatory publication of inter- development of interconnection arrangements, the connection agreements is that it breaches the technical and operational conditions determine how normal confidentiality of commercial agreements. efficient and "seamless" interconnection is from the However, this disadvantage can be mitigated in users' perspective. These conditions can also several ways. One is to permit deletion of determine whether competition in a particular market commercially sensitive information from filed agree- will succeed or fail. cmecal estv nomto rmfldare ments. This can include proprietary network or service information and related costs. In such cases, The most important technical and operational acnieta iigwt h euao snral conditions are neither complex nor difficult to under- a confidenbal filing with the regulator IS normally stand. At a minimum, regulators should develop an required. Another approach is to require only the overview of the key technical and operational filing gard ag reements conditions in order to resolve disputes that may arise offers"), rather than all executed agreements. in interconnection negotiations. For the reasons discussed in Section 3.1.5.2, the filing of interconnection agreements between non- Incumbents dominant operators is not generally required. The WTO Regulation Reference Paper requires 3.4.1.1~ ~ Aviaiiyfgemnsr.fr publication of agreements with major suppliers, or a 3.4.1.1 Availability of Agreements or Offers reference interconnection offer with them. A number of countries with well-developed regulatory regimes, The advantages of transparent interconnection for example Denmark and the UK, only require the arrangements are discussed in Section 3.1.5.4. The publication of interconnection agreements of simplest way to encourage transparency is to incumbents. require publication of interconnection agreements or offers of incumbents. In this regard, the W4/TO There is often no telecommunications regulatory Regulation Reference Paper requires signatories to requirement for publication of interconnection ensure that a major supplier will make publicly agreements between smaller operators. However, available either its interconnection agreements or a these are increasingly being made public to comply reference interconnection offer. with the securities laws of some countries. In these countries, securities regulators require companies The advantages of publication of interconnection that issue shares to the public to disclose their mate- agreements or standard offers include: rial contracts. Examples of such agreements can be found on the EDGAR Web Site in the US. > Publicationfacilitates interconnection byexisting Agreements between new entrants can provide and potential new entrants. It allows them to insight into interconnection arrangements in less obtain basic interconnection terms and regulated markets. conditions without lengthy negotiations or regulatory orders; 3.4.1.2 Network Specifications ' It discourages undue discrimination by a Interconnected networks must be technically dominant operator (or by both parties to an compatible. A new entrant must, therefore, have 'agreement) that may not be readily detectable access to technical specifications of the network of by regulators if filed in confidence; the incumbent with which it will interconnect. Simi- larly, the incumbent requires information on the McCarthyTetrault infoDev Telecommunications Regulation Handbook technical characteristics of an interconnecting regularly in response to technological development, operator's network. For example, it will be important market and budget considerations. for both operators to know the types of switching, routing and transmission equipment used by the Over time, as the networks are modified, it is good other, signalling protocols, number of circuits and the practice for regulators to require that networks of projected volume of traffic to be exchanged. dominant incumbents evolve into more open networks. Sufficient information is required to permit the inter- connecting operators to design their own networks 3.4.2 Treatment of Competitor Information to provide efficient connectivity between each other's customers. Regulators should ensure that Monopoly or dominant providers of local telephone incumbents and new entrants do not withhold infor- services, and certain other monopoly services, are in mation necessary to ensure efficient interconnection a position to collect competitively valuable informa- arrangements for both sides. tion on their interconnecting competitors. A typical situation might involve a local monopoly operator Operators should not be permitted, for example, to that receives orders from a long distance competitor withhold necessary information on the grounds that to install leased local lines to interconnect with the their standards and specifications are proprietary. If competitor's POP. The monopolist would know that necessary, some technical information could be the competitor had located a relatively heavy long exchanged under non-disclosure agreements. In distance user (probably a business or govemment practice, however, this is impractical and can user) that had sufficient traffic to require a leased frustrate interconnection of future networks. The local line. In the absence of competitive restrictions, telecommunications sector is evolving towards more the monopoly could send a salesperson from its own open standards, and this is a trend that regulators long distance division to offer a discount or other should encourage. Open standards are often incentive to the customer to persuade it not to use its developed through industry committees with regu- competitor's services. latory observers or mediators. In keeping with this practice, regulators should encourage interconnec- Abuse of such competitive information is subject to tion operators to establish technical committees to regulatory restrictions in many countries. The Refer- develop specifications, protocols, and procedures for ence Paper on Regulation that forms part of the the interconnection of their networks. WTO's Agreement on Basic Telecommunications attempts to prohibit such activities. The Reference In many cases, incumbent operator networks have Paper requires signatories to maintain "appropriate not been designed to anticipate interconnection with measures" for the purpose of preventing major sup- other operators. Accordingly, some network modifi- pliers from engaging in anti-competitive practices. cations are often required to permit interconnection. One of the practices identified is using information Treatment of such network modifications or "start-up obtained from competitors with anti-competitive costs" is discussed in Section 3.3.4.1. results. 3.4.1.3 Network Changes A national example of a prohibition against competi- tive misuse of information can be found in the Telecommunications networks are dynamic. In most General Licence issued by the Irish regulator. countries, networks are constantly changing as new Condition 20 of that licence deals with misuse of switching and transmission facilities are added, new data in the following terms: software and features are installed, and new protocols adopted. The most obvious example is the "The Licensee shall not make use of network or current transition from circuit-switched to packet- traffic data, traffic profiles or any other data of switched networks, such as Internet Protocol any nature, and which are not otherwise publicly networks, to carry both data and voice traffic. available and which become available to the However, the network plans of operators change Licensee directly or indirectly either as a result of entering into interconnection arrangements or 3 - 36 infoDev McCarthyTetrault Module 3 - Interconnection otherwise as a result of carrying telecommunica- in long-term contracts if a competitive international tions messages, in such a way which, in the service operator is about to be licensed. reasonable opinion of the Director, would unduly prefer the interests of any business carried on by In some countries, including the US and Canada, the Licensee or an Affiliate or place persons regulatory restrictions are imposed on the use of competing with that business at an unfair customer information. Some of these rules are disadvantage." (OTDR (1998)) aimed at protecting the privacy of customers. For example, customers typically do not want the world A good approach to preventing abuse of competitive to know what phone numbers they call. information is the establishment of an Interconnec- tion Services Group (ISG). This is sometimes called Another example of a regulatory restriction is found a Carrier Services Group. The idea is to establish a in the European Union data protection directives and separate organization within the incumbent operator, in related laws of EU Member States. These laws whose role it is to handle interconnection-related impose specific obligations on telecommunications dealings between that operator and interconnecting service providers regarding the use that can be operators. For example, all orders by interconnect- made of billing and other customer data, including a ing carriers for interconnection links, additional prohibition against using such information to market capacity and customer access lines would be telecommunications services to customers unless submitted to the ISG. The ISG will process the the customer has consented to that use of its data. orders. Other countries have implemented, or are consider- ing similar consumer protection rules. Safeguards will be put in place to ensure that infor- mation obtained by the ISG is not used for improper Other restrictions are aimed at preventing anti- purposes. For example, where a new entrant orders competitive use of customer information gathered by an access line from the incumbent operator to serve monopoly operators that have competitive opera- a new customer, the ISG should not pass that tions or affiliates. Such rules may require a information on to the marketing department of the monopoly local operator, for example, to share any operator to try to "snare" or "win-back" the customer customer information that it provides to its before the access line is installed. Confidentiality competitive operations or affiliates with intercon- safeguards should include codes of conduct with necting operators or other direct competitors in the mandatory suspension or termination of employees same business line. For example, if a local monop- who "leak information". Separate office space, oly operator's long distance services division collects locked filing cabinets, audits and other measures information to identify heavy Internet users to help its can help ensure confidentiality of ISG information. Internet division sell services, it would be required to provide the same information to competitive Internet 3,4.3 Treatment of Customer Information Service Providers. Monopoly providers of local telephone services are These restrictions are based on the assumption that in a position to collect information on their custom- the local monopoly service provider is in a position to ers. Such information may include names, collect the information solely due to its monopoly addresses and telephone numbers, as well as position. Distribution of this type of information can information on monthly billing levels, calling patterns, be handled through an Interconnection Service percentage of calls unanswered, etc. Customer Group (see Section 3.4.2). information of this type can be very valuable in mar- keting new services. For example, customers with 3.4.4 Points of Interconnection very long calls may be heavy Internet users to whom Internet services can be successfully marketed. The interconnection policies of many countries Users with many missed calls make good customers require incumbent operators to permit interconnec- for voice-messaging services. Customers with high tion with their networks at any technically feasible international calling would be good targets to tie up point. This policy is reinforced by the WTO Regulation Reference Paper, which requires McCarthyTetrault infoDev Telecommunications Regulation Handbook signatory countries to ensure interconnection at any interconnection offers" major suppliers are required technically feasible point with their major suppliers. to make available pursuant to the wTO Regulation Reference Paper. Interconnection agreements and regulatory orders have established different interconnection points in In some cases, new entrants may wish to intercon- different countries. Box 3-5 provides examples of nect at points other than the standard points. In such technically feasible interconnection points that have cases, the Reference Paper provides that such been prescribed by regulators or established in in- interconnection should be made available upon terconnection agreements. request. However, the requesting party may be required to pay charges that reflect the cost of con- The definition of technically feasible interconnection struction of necessary additional facilities. points is not static. Telecommunications networks continue to evolve. As new technologies, such as A variation on the theme of interconnection at non- those based on the Internet Protocol and digital standard points can be found in a recent regulatory subscriber loops, are rolled out, it is becoming tech- decision in the United Kingdom on Third Generation nically feasible to interconnect networks at different cellular services. The UK regulators have recently points. Therefore, interconnection agreements and ruled that new Third Generation cellular networks regulatory directives should not prescribe limitations should have access to earlier generation cellular on the points of interconnection that will be permit- networks at points around the country, by means of ted. It should be open to interconnecting operators a compulsory roaming arrangement. This example is to propose interconnection at different points as set out at Box 3-6. networks evolve. 3.4.5 Access to Unbundled Network The costs of interconnection incurred by both Components operators will vary depending on the points of inter- connection. Incumbents will sometimes propose In an increasing number of countries, telecommu- standard points of interconnection of their networks nications policies require incumbent operators to with other operators. These standard points of inter- provide competitors with access to unbundled connection may be set out in the "reference Box 3-5: Examples of Technically Feasible Interconnection Points l >; The trunk interconnection points of local and national tandem exchanges (most common point of interconnection or POI) ; The national or international circuit interconnection points of international gateway exchanges - The trunk side of local exchanges > The line side of local exchanges (e.g. at the main distribution frame (MDF) or Digital Distribution Frame (DDF) - Cross-connect points of any exchange ' "Meet points" at which operators agree to interconnect )- Signaling transfer points (STF) and other points outside of the communications channel or band, where interconnection is required for CCS7 or other signaling to exchange traffic efficiently and to access call- related databases (e.g. a Local Number Portability (LNP) database). > Access points for unbundled network components - Cable landing stations 3 - 38 infoDev McCarthy TUtrault Module 3 - Interconnection network components. Unbundling generally refers to support the efficient provision of telecommunications the provision of network components on a stand- services. Examples include access to directory alone basis. Unbundling permits interconnecting information databases, operator services and operators to access a single unbundled component subscriber listings in telephone directories. without an obligation to buy other components as part of an "interconnection service". In this Module, we will use the term "network components" to refer to both physical network There are many possible types of unbundled facilities and these "non-physical" features, functions network components. The policies of some countries and services. Box 3-7 lists examples of unbundled require provision of certain features, functions and network components. services on an unbundled basis - as well as certain physical facilities. These features, functions and Unbundling of the local loop is a special case of services may be associated with transmission or unbundling that is currently being addressed by switching facilities. They may also be associated regulators in many countries. It is dealt with in more with software facilities, such as databases that detail in the next Section. Box 3-6: Compulsory National Roaming in the UK Background: As part of the process leading to the licensing of 'Third Generation" cellular wireless networks in the UK, I Oftel and the Department of Trade and Industry ("DTI") dealt with the issue of compulsory roaming. The regulators determined that any existing wireless network operator which participated in the auction to obtain spectrum for Third Generation network services would be required to accept a licence modification obligating the operator to negotiate an interconnection agreement to provide national roaming access to new entrants. The aim was to prevent incumbent operators from using their existing wireless networks to an unfair competitive advantage while new entrants built up their networks and territorial coverage. In effect, DTI and Oftel determined that access to earlier generation networks was an essential facility to be made available to new entrant competitors. (The concept of essential facilities is discussed in the next Section.) The Nature of Roaming: Roaming is typically an arrangement between wireless network operators or services providers to allow access by one service provider's customers to the network or services of another service provider located outside the service area of the first service provider. Roaming arrangements require the implementation of subscriber authorization and billing systems. They also require appropriate technical and spectrum capacity arrangements to be at all points of access by customers of roaming operators. The Requirements of National Roaming: DTI and Oftel intend to make what was previously a system of negotiated interconnection among non- competing wireless operators a compulsory arrangement between incumbents and a new entrant. National roaming is to be made available on a non-discriminatory basis. Oftel will deem the incumbent to have costs of roaming services equal to the rates for roaming services charged to competitors. Oftel will then include such deemed costs in determining whether the service charges of incumbents are sufficient to cover costs and make an adequate return. National roaming services will not be available to a competitor before the competitor has achieved network roll-out covering at least 20% of the UK population, and may expire any time after 31 December 2009. Roaming charges are to be determined on a "retail minus" rather than 'cost plus" basis (meaning that roaming charges will be derived from end user charges, less a discount reflecting elements of cost not incurred in providing the roaming service rather than an end user service). McCarthyTetrault infoDev 3-39 Telecommunications Regulation Handbook Decisions as to what components to unbundle and framework permits, competitors can then obtain how to unbundle them are sometimes left to nego- other network components, such as switching tiations between operators. According to the capability and access lines in other locations, from Japanese interconnection policy, for example, the incumbent. This permits new entrants to mix unbundling should be promoted as much as their self-built network components with those of the possible through a process which takes into incumbent in an efficient manner. consideration the opinions of carriers other than the incumbent. However, the Japanese policy also The ability to mix self-built network components and indicates that the regulator should be involved if those of the incumbent will increase the viability of negotiations fail. In practice, for the reasons the business case for competitive entry in many discussed below, negotiated unbundling arrange- countries. Thus, competition will emerge where it ments are generally unsatisfactory in the long run. otherwise would not. The use of the incumbent The incumbent has little incentive to unbundle its operator's network components by competitors will network sufficiently to permit competitors to operate often be transitional. Over time, the competitor will very effectively. build more of its own facilities and become a full- fledged facilities-based operator. Rationale for Unbundling Many incumbents are unwilling to provide competi- The purpose of unbundling policies is to lower tors with access to unbundled network components economic and technical barriers to competitive entry. unless they are required to do so by regulation. The large capital costs of building duplicate While the issue is still controversial in some networks raise a significant barrier to entry. countries, and among some experts, mandatory Competitors may not be willing or able to finance the network unbundling is becoming more common. construction of complete networks. However, they may be willing to build parts of such networks. For Unbundling Policies example, they may build certain switches, inter- exchange transmission facilities, and access lines in The trend to unbundling was given a strong impetus a limited number of locations. If the regulatory in the WTO Regulation Reference Paper. The Box 3-7: Some Possible Unbundled Network Components and Services > Network access lines (local loops and related functions) - Local switching functions > Tandem switching functions - Inter-exchange transmission (e.g. between local and tandem switches) - Access to signaling links and signal transfer points (STPs) > Access to call-related databases (e.g. line information, toll-free calling and number portability databases) - Central office codes (NNXs) > Subscriber listings (in telephone directories and directory databases) - Operator services - Directory assistance functions > Operations support systems (OSS) functions 3-~ 40 infoDev McCarthyTetrault Module 3 - Interconnection Reference Paper states that major suppliers must pay for anything that is not strictly related to the provide interconnection on a basis that is sufficiently service requested. Similarly, Article 7(4) of the unbundled so that a supplier need not pay for Revised Voice Telephony Directive (Directive network components or facilities that it does not 98/1 0/EC) states that: require for the service to be provided. While this statement is supportive of unbundling policies, it is "Tariffs for facilities additional to the provision of quite general. It provides little guidance for the connection to the fixed public telephone network development of national unbundling policies. and fixed public telephone services shall, in Unbundling policies are still in the early stages of accordance with Community law, be sufficiently development in many countries. unbundled so that the user is not required to pay for facilities which are not necessary for the Unbundling policies have developed in the US, service requested." Canada, Australia, Singapore, Hong Kong and other countries, including, more recently, the EU. The new Advantages and Disadvantages of Unbundling regulatory framework for electronic communications services proposed by the European Commission on There are some disadvantages to a full-scale man- 12 July 2000 provides a strong new impetus for datory unbundling policy. In particular, it can act as a implementation of national unbundling policies. disincentive to the construction of competitive Particularly significant in this regard, is the EU's new network components, and the development of true regulation on local loop unbundling, which will come facilities-based competition. However, the into force on 31 December 2000. disadvantages appear to be outweighed by the advantages. Moreover, the potential disadvantages Unbundling has also been required in other EU can generally be avoided if the pricing and other regulatory documents. Article 7(4) of the EU terms of the unbundling guidelines are properly set. Interconnection Directive provides that interconnec- The main advantages and disadvantages of a tion charges must be sufficiently unbundled so that mandatory unbundling policy are summarized in an applicant for interconnection is not required to Table 3-4. Table 3-4: Advantages and Disadvantages of Unbundling Advantages Disadvantages Reduces economic barriers to entry, by > Reduces incentive for construction of allowing new entrants to construct some competitive network facilities (depending on components of their networks and obtain other the availability and price of unbundled components from the incumbent operator components) Encourages innovation, since new entrants can > Can enrich the new entrant at the expense of combine new technologies (e.g. ADSL and IP the incumbent operator (if unbundled data/voice switches) with components of component pnces are set below costs) existing networks (e.g. access lines) - Requires detailed regulatory intervention and Avoids unnecessary duplication of components technical co-ordination (e.g. access lines in remote areas, transmission tower space) Facilitates access to rights of way, towers, etc. by new entrants (in many countries it can be very time consuming and expensive to obtain such rights) McCarthyTetrault infoDev 3-41 Telecommunications Regulation Handbook Regulatory Approaches to Unbundling Many countries are still developing policies on network unbundling. Unbundling policies vary from Given the potential disadvantages of a mandatory country to country, depending on the conditions of unbundling policy, some regulators have adopted local telecommunications markets. It is arguable that modified approaches to such a policy. These mandatory unbundling is less desirable in countries approaches are intended to achieve some with very limited telecommunications network advantages and avoid some disadvantages of poli- infrastructure and large pent-up demand. In such cies that require unbundling of all network less developed countries, mandatory unbundling components. Some of these approaches may be may reduce the incentive to build much-needed new summarized as follows. infrastructure. On the other hand, in some less developed countries, the business case for new Transitional Unbundling Requirements - entry may not be viable without mandatory Access to certain types of unbundled unbundling. Each telecommunications market components may be required for a limited period should be carefully assessed to determine the role of time. This approach can apply, for example, unbundling policies should play in sector develop- to access lines (loops) in urban areas. ment. Unbundling of access lines might be required for the first five years after a market opening. Thus, 3.4.6 Local Loop Unbundling competitors can use the incumbent's access lines to "jumpstart' competition. However, they Mandatory unbundling of local loops is increasingly will have to construct their own access lines by being used as a regulatory tool to accelerate com- year five, in order to maintain network petition in local access markets. Around the world, connections with their customers. In theory, this telecommunications network competition has approach will encourage the development of developed most rapidly in the long-distance and competition in the short term. At the same time it international markets. Local access markets are should promote development of complete generally less competitive. Wireless services cur- facilities-based competition over the mid to rently provide an alternative means of local longer term. Local loop unbundling is described narrowband access in many markets, and further in the following Section of this Module. broadband competition is starting. However, wireline services still provide the main means of local access - Selective Unbundling Requirements - Some around the world. There, high entry costs and low unbundling policies distinguish between network margins have discouraged competition. components. They require unbundling of some and not others. Unbundled access may be Competition in local access is increasingly seen as required only for certain types of components. an important policy objective. One reason is the For example, unbundled access may be perceived need to provide more competition in high- required for network components in cases speed access markets in order to accelerate the roll where construction of duplicate components out of Internet, e-commerce and video services. would cause environmental damage or public Many regulators and policy makers see such com- inconvenience. Thus, incumbents might be petition as necessary to maintain or increase the required to provide access to towers, poles, competitiveness of their national economies. conduits, ducts, aerial access lines and inside wiring, where a proliferation of such facilities Regulators have now mandated unbundled access would degrade the environment, disrupt public to local loops in a range of different economies. At roads, and/or otherwise inconvenience the one end of the income spectrum, these countries public. The same may be true of access lines or include the US, Australia, Canada, Singapore and switching facilities in architecturally or culturally the EU members. Unbundled loop access has also important areas. Such access might be required been mandated in a number of middle income over the long term as well as the short term. countries, such as Mexico and the Slovak Republic, as well as in lower income countries, such as Albania, Guatemala, Kyrgistan and Pakistan. 3-42 3 - 42 ~~~~~~~infoDev McCarthyTetrault Module 3 - Interconnection Types of Local Loop Unbundling local loop for the competitive provision of Digital Subscriber Loop (DSL) systems and services by Local loop unbundling regimes typically require third parties); and incumbent operators to provide access to their local loops to competitors. Other third parties, such as > High speed bit stream access (provision of customers, may sometimes also obtain unbundled xDSL services by the incumbent). access. Access to local loops is provided at a point of interconnection somewhere between the network Although different approaches are possible, these termination point on the customer premises and the three are the main ones in use today. Each of them line-side of the access network operator's local is described in greater detail below. switch. From this point of interconnection, the com- petitor will obtain dedicated or shared access to the Full Unbundling (Copper Loop Rental) local loop. The competitor will thus be able to use the loop as a direct transmission medium between Full unbundling can provide new entrants with its network and the customer's premises. access to raw copper local loops (copper terminating at the local switch) and sub-loops (copper terminat- Various technical options are available for local loop ing at the remote concentrator or equivalent facility). unbundling. In its proceedings on unbundled access In the case of unbundling at the local switch, the link to the local loop in early 2000, the European between the main distribution frame (MDF) and the Commission's DGIS focussed on three main options local switching equipment on the incumbent's for access to local loops: premises is re-routed and connected to the new entrant's switch. The new entrant takes over the Full unbundling of the local loop (unbundled operation of the local loop. access to the copper pair for competitive provision of advanced services by third parties); Figure 3-1 illustrates this type of full unbundling of a local loop. The illustrated case assumes that the > Shared use of the copper line (unbundled access to the high frequency spectrum of the Link re-routed from incumbent's switch to new entrant'sl 3 | U / I I Fncumnbe nt s| . Local loop McCarthyTe'trault infoDev 3 - 43 Telecommunications Regulation Handbook customer has decided to change telecommunica- Full unbundling of the type illustrated in Figure 3-1 tions service suppliers. The local loop that previously and Figure 3-2 essentially involves rental of a connected the customer to the incumbent's switch dedicated copper loop by the incumbent to a new has been re-routed to connect it to the new entrant's entrant. Such copper loop rental provides the new switch. The new entrant will then use the unbundled entrant with direct access to and use of the copper local loop to provide an altemative local access loop. This allows new entrants to operate their own service to that previously provided by the incumbent. end-to-end transmission systems. Such operational control can be important to ensure the integrity and Figure 3-2 illustrates full unbundling in a case where quality of high-speed services. there are two local loops to a customers premises. One loop is unbundled by the incumbent and re- Although Figure 3-1 and Figure 3-2 indicate that the configured to connect the customer to the new point of interconnection is at the distribution frame entrant's network. The other loop continues to where the copper loop terminates, it is also possible connect the customer to the incumbent's network. A to locate the point of interconnection at a remote similar approach would apply where there are three concentrator unit (remote line unit). or more loops to a customers premises. In each case, the customer could decide how many loops it Shared Use of the Copper Loop wanted connected to different operators. The approach illustrated in Figure 3-2 would be used An altemative means of providing access to the local where a customer wants to retain its basic telephone loop involves shared access rather than exclusive service with the incumbent. It can do so and, for access by a new entrant. In this form of unbundling, example, at the same time have a dedicated con- the incumbent and the new entrant provide services nection to a new entrant's xDSL services to access over the same loop. high-speed data services (e.g. Intemet or video services). Figure 3-3 illustrates one form of sharing the local loop. In this case, the customer will continue to -2Figur&3v-2: FuIllthPn@iridl - Two Local Loops _ . ; ~~~~~F .f r o a I .; l oo p ____ --.. l F '~~~i IC,cel lOOP 8, .IC D l XDSL SEC o n a m.clem Loc31nloocp F New enrian: s PC or oiner DSL aiccess cusnome,i eq..pmenIe, P~l,IeMe: e n131 I I~~~~~~~~~~DSLAM) oiurce:';Adaptedrfrbm CEb. '(2000b) 3-44 ~~~~~~~~infoDev McCarthyTetrault Module 3 - Interconnection igur 3 Shaed se o GoperdoopUsing Splitter - <-i~~~~~~~~~~~~~~~~~~C -------fr- I_ C _ I La _ _3 Iu :r. 3. receive basic PSTN services from the incumbent, speed bit stream to new entrants. To do this, the and at the same time, receive DSL access services incumbent would install a high-speed access link to from a new entrant. As illustrated, a splitter is located the customers' premises and then make it available between the MDF and the incumbent's local switch. to other operators to enable them to provide high- The splitter is connected to both the incumbent's speed services. Provision of bit stream access switch and to a DSL access multiplexer (DSLAM) services requires provision of both the transmission connected to the new entrant's high-speed network. medium (e.g. copper cables, coaxial cables and optical fibre cables) and the transmission system As indicated, the splitter separates telephone and (e.g. synchronous digital hierarchy transmission on data traffic. Thus, the voice frequencies of the loop optical fibres and xDSL transmission on copper continue to be used by the incumbent. The non- cables). voice frequencies are made available to the new entrant to provide high-speed services. In effect, this In the case of high-speed bit stream access, the arrangement provides unbundled access to the high point of interconnection will usually be at the incum- frequency spectrum of the local loop for the com- bent's local switch, but circuits could be back-hauled petitive provision of Digital Subscriber Loop (DSL) to points of interconnection further up the switching services by new entrants. hierarchy. Technically, bit stream access can be provided to any transmission system, since it only Shared use of copper line can provide a cost- requires reservation of a specffied bandwidth, rather effective solution for some customers. For example, than dedicated use of a physical loop. This access it permits a customer to retain the incumbent as its arrangement does not entail any unbundling of a telephone service provider, and at the same time, copper pair. Rather it uses the higher frequencies of select a new entrant to provide high-speed Internet the copper local loop, as in the case of shared use service over the same loop. of the copper line. High-speed Bit Stream Access Providing high-speed bit stream service can be attractive for incumbent operators as it does not A third approach to providing access to the local involve physical access to copper pairs. As a result, loop involves provision by an incumbent of a high- for example, it would not hinder the progressive McCarthyTetrault infoDev f c am Telecommunications Regulation Handbook modernization of the local access network by Implementation of Local Loop Unbundling replacing copper with fibre. Different approaches may be used in mandating and Figure 3-4 illustrates the provision of high-speed bit regulating local loop unbundling. The appropriate stream access by an incumbent. In this example, approach will often depend on the state of competi- two customers obtain high-speed data services from tion in the relevant market for local access. Possible two different service providers, the incumbent and a approaches include: new entrant. At the same time, the incumbent continues to provide basic PSTN services to both > Mandatory loop access without specification of customers. the type of access arrangement. In this case, it is likely many incumbents will choose to offer bit The three means of access to the local loop referred stream access, which enables them to retain to above are not necessarily mutually exclusive. greater management control and possibly obtain Where regulators mandate local loop access, they higher access charges from competitors. The may require or permit incumbent operators to disadvantage of this approach is that provide one or more alternative forms of access. competition may be delayed. Incumbent operators will have little incentive to accelerate Advantages and Disadvantages of Unbundling implementation of bit stream access the Local Loop arrangements, at least until they are positioned to provide competitive services. The main reason regulators have required incum- bents to unbundle their local loops is to promote > Requiring bit stream access only (see previous competition and innovation in access and advanced point - same considerations apply). high-speed services. However, there continues to be an active debate on the merits of mandatory loop - Requiring all three forms of access described unbundling. There remain arguments against it, as above, except where the incumbent can well as for it. Table 3-5 summarizes the pros and cons of mandatory loop unbundling. Figure 3-4: Provision of;High-Speed Bit StreamiAc=c ' - s| Customeroft uincumbent's data 5ar,ices spitl,ers .. L oc al loo P M- D - PSTN . | C IJ - IGm e F ol |F _I :__ _ _._ Cusrc,me, ol new entrant data serfices D LArI H.qn speEa Ctl _ oeaved - strea3m se'.-ce by p -a eda Io c-ne 6 Mcumbeni o,r more neA eniranis . | Source: Adapted from CEC (2000b) p ,-. I 3 - 46 infoDev McCarthyTetrault Module 3 - Interconnection demonstrate significant problems with dedicated States. In the US, the 1996 Telecommunications loop rentals. Act requires incumbents to offer access to unbun- dled network elements and to making retail services - Requiring all three forms of access in some or available at wholesale prices. The US regulator has all national markets. stated that "[p]reventing access to unbundled local loops would either discourage a potential competitor Various other regulatory approaches to unbundling from entering the market in that area, thereby may be developed. denying -those consumers the benefits of competi- tion, or cause the competitor to construct Local loop unbundling may be a transitional unnecessarily duplicative facilities, thereby phenomenon in some areas. Unbundling of loops misallocating societal resources" (FCC, First Report may be required, for example, to facilitate competi- and Order in the Matter of the Implementation of tion in the short term. This will enable new entrants the Local Competition Provisions in the to roll out service rapidly, while they are constructing Telecommunications Act of 1996). The FCC and altemative access networks in the areas where there US state regulators have subsequently taken further is sufficient demand. steps to facilitate loop unbundling. Implementation of local loop unbundling continues to As of June 1999, approximately 685,000 loops had be a novel issue for regulators in many countries. A been provided to competitors in the US as unbun- major source of experience to date is the United dled network elements. This represented an Table 3-5: Arguments For and Against Local Loop Unbundling Pros Cons > Accelerates introduction of local access >- Reduces incentive to build alternative access competition, including xDSL access networks and more sustainable facilities-based competition s Accelerates competition, service innovation - May undermine investment in alternative and roll out for high speed services, including: access networks (wireline and wireless) > Internet services >- May complicate modernization of incumbent > Video services (including interactive ones) operators' networks (e.g. if some access loops are dedicated to competitors use) > E-commerce - Requires prolonged and detailed regulatory . ' other data services intervention compared to facilities-based access competition >- Avoids duplication of access networks, and > Requires more technical co-ordination between increases network operating efficiencies operators compared to facilities-based access competition > Provides new revenue streams to incumbent (which may or may not exceed existing revenues from loops, depending on tariffs) > Reduces disruption of streets and environment due to construction of new access networks McCarthyTetrault infoDev Telecommunications Regulation Handbook increase of 180 percent over the previous year. In Operator negotiations, or unilateral price setting by addition, competitors had collocation arrangements incumbents can result in anti-competitive pricing. in exchanges covering 60 percent of all lines in the Where advance regulatory guidelines are not US (compared with 32 percent of all lines the established, ex post regulatory intervention will often previous year). By the end of 1999, competitors had be required. A recent Australian case illustrates the provided 117,000 xDSL lines, up from 1,500 lines in point. In early August 2000, the Australian regulator, 1997, while incumbents provided 386,000 DSL lines, the ACCC, found that prices imposed by the up from 32,000 at the end of 1998. Competitors had dominant operator (Telstra) on competitors for local installed over 1,400 data switches, a fivefold loop access were too high. increase over 1997. Recent estimates suggest that about 60% of the US population had access to DSL 3.4.7 Sharing of Infrastructure and at the beginning of 2000, with 25% located in cities Collocation with four or more DSL providers. Extensive infrastructure is required to build tele- In July 2000, the European Union adopted a communications networks. Key supporting Regulation on Unbundled Access to the Local infrastructure includes poles, ducts, conduits, Loop. The regulation will be binding on dominant trenches, manholes, street pedestals, and towers. operators in EU Member States, as of 31 December Sharing of such infrastructure can significantly 2000. Issuance of the regulation is based on the increase the efficiency of telecommunications supply assumption that providing access to the local loop to in an economy. The same is true in the case of all new entrants will increase the level of competition sharing building space in exchanges to permit two or and technological innovation in the local access more operators to "co-locate" their cable and radio network, and in turn stimulate the competitive provi- transmission facilities and related equipment. sion of a full range of telecommunications services Collocation permits direct (or near-direct) access to from simple voice telephony to broadband services. exchange switches and local access lines. The regulation is aimed, in part, at ensuring that the EU does not fall further behind the US in the Availability of infrastructure sharing and collocation deployment of high speed access and the advanced can significantly decrease barriers to competitive services it enables. entry. The acquisition of rights of way and other permits required to build pole lines or towers, dig The European regulation requires dominant trenches or install ducts and conduits can be very operators to provide physical access to third parties time consuming and expensive. In some countries, at any technically feasible point of the copper local only government entities, such as the incumbent loop or sub-loop. The third party can locate and operator, have clear legal authority to obtain rights of connect its own network equipment and facilities at way, occupy public property or expropriate private such points (i.e. at the local switch, concentrator or property. Sharing of infrastructure and collocation equivalent facility) in order to deliver services to its can reduce costs for the new entrant, and at the customers. Dominant operators are required to same, time provide additional revenues to incum- make unbundled loop access available to third bents. parties under transparent, fair and non- discriminatory conditions. In addition, the regulation An added benefit is reduced environmental impact provides that the dominant operators must provide and public inconvenience. Competitive entry into competitors with the same facilities as they provide telecommunications markets has led to a prolifera- to themselves or their associated companies, and tion of cellular and microwave towers, aerial pole with the same conditions and times. Regulators are lines and road trenches in many countries. This given authority to intervene in pricing issues and result has become an increasing concern for many resolve disputes in connection with the regulation. municipalities and other local administrations. Experience in other jurisdictions suggests that Some regulators require incumbents to permit infra- regulatory guidance is required in determining the structure sharing and collocation of a new operator's pricing (and costing) of unbundled local loops. transmission facilities in their exchanges. Other 3 - 48 infoDev McCarthyTT&rault Module 3 - Interconnection operators, including new entrants, are frequently : Appointment and supervision process for mutual required to cooperate as well, at least in the sharing cut-overs and work affecting more than one of infrastructure that is seen to be environmentally operator's facilities. Payment and rates for the degrading, such as towers. In some countries, third same. parties that own support infrastructure, such as electrical power utilities, are also encouraged to > Provision and pricing of ancillary services such participate in sharing arrangements. as electrical power and back-up power, lighting, heating and air conditioning, security and alarm In some jurisdictions, sharing of infrastructure occurs systems, maintenance and janitorial services, without regulatory intervention. Both sharing parties etc. can benefit from the arrangements. In these jurisdic- tions, sharing of infrastructure is often seen as a > Negotiation of other lease and/or licence matter to be freely negotiated between operators. arrangements, including issues of sub-licences However, as with other interconnection issues, there on property of third parties (e.g. building owners, is often an asymmetrical market situation. In some right of way owners, municipal and other public cases, incumbents resist sharing their infrastructure. property owners), insurance and indemnification In these markets, regulatory intervention will be for damages. required to implement efficient sharing and colloca- tion arrangements. 3.4.8 Equal Access Table 3-6 lists steps regulators can take to promote On a level competitive playing field, telecommunica- sharing of infrastructure and collocation. tions users should be able to access the services of new entrants as easily as those of incumbent Once there is clear regulatory direction that infra- operators. Without equal ease of access, new structure sharing and collocation must be permitted, entrants will find it difficult to attract customers. While operators are sometimes able to negotiate mutually access need not be exactly equal, accessing a acceptable sharing arrangements. In many other competitor should not be significantly more difficult. cases, however, regulatory direction or dispute resolution has been required to finalize sharing In the early days of long-distance competition in arrangements. Regulators seeking to expedite Canada and the US, for example, customers were sharing arrangements may want to provide advance often required to dial up to 20 or more extra digits to guidelines on such arrangements, after taking into route calls to new entrants' networks. This significant account the views of incumbents and new entrants. difference in access was due to the historical design Some of the main issues that have arisen in relation of the PSTN. The operators' switches had been to infrastructure sharing and collocation are: programmed for a monopoly environment. The addi- tional digits were required to permit the operators' > Rationing of space between incumbents' future switching software to identify the new entrant to requirements and current and future which the call should be routed as well as to provide requirements of various new entrants billing details for the customer. It is not surprising reservation of future expansion space for each that the new entrants initially found it difficult to en- operator. courage customers to switch services from the incumbents. > Pricing of facilities, and costing basis for the Over time, many incumbents and telecommunica- same. tions equipment manufacturers redesigned their > Access and security arrangements for various switches and related software. These facilities are operators' equipment. Collocation premises of now far more adaptable to the requirements of a different operators are usually separated multi-operator environment. Dialling parity is easy to dyiffer y(ent . operato re uesu)ally sockepa achieve with the rght software package. This has physically (e.g. by wire mesh) and locked, made it much easier to implement equal access. McCarthyTe'trault infoDev 3 49 Telecommunications Regulation Handbook However, changes in incumbent procedures and the equal access in a previously monopoly environment. regulatory environment are also required to facilitate Table 3-6: Steps to Promote Infrastructure Sharing and Collocation Develop | Publish a regulatory policy encouraging infrastructure sharing and collocation Regulatory Policy ,> Encourage local authorities, such as municipal governments to support and facilitate infrastructure sharing ,> Encourage reciprocity of infrastructure sharing (i.e. new entrants should be required to size and build their facilities to permit sharing with incumbents and other operators) > Require incumbent operator to publish a standard offer and price list for access to key infrastructure components: poles, ducts, conduits, tower space, etc. > Incumbents should be required to provide information on the location of infrastructure, and capacity available for sharing (e.g. excess capacity in ducts, towers, etc.) > A joint committee of operators should be established to plan infrastructure capacity, co-ordinate permits from local authorities and improve the mutual efficiency of the infrastructure provisioning process _ Operators should be able to reserve capacity in advance on reasonable terms Price of Shared Regulators should encourage development of clear pricing guidelines (the following and Infrastructure guidelines are illustrative only) Collocation Normally, incumbents and other operators should be able to recover at least their direct incremental costs of sharing, plus reasonable overheads l Additional price components may be subject to negotiation and regulatory dispute resolution l Prices for collocation and infrastructure sharing should generally be unbundled so that the operator requesting access is only required to pay for the services it uses l Cost of new infrastructure should be shared among 2 or more operators in proportion to their use of the infrastructure (e.g. number of antennae located on a microwave tower) l Costs of increased capacity and re-location of infrastructure should be shared among those that benefit from such works. Where an incumbent operator receives no benefit from works required to accommodate a new entrant, it should normally not pay, unless and until it benefits from such works. An alternative approach is to allocate the costs among sharing operators based on use, with a surcharge for the operator that requests the work. 9 Future sharers of infrastructure should reimburse early entrants for expenditures that benefit them Regulatory 9 Shared infrastructures should be made available to all operators on a non- | Safeguards discriminatory basis. This includes the owner of the infrastructure. Capacity should normally be provided on a first come, first served basis. The regulator should approve rationing schemes for scarce capacity. 3 - 50 infoDev McCarthyTetrault Module 3 - Interconnection Table_3-6: Steps toPm-ote InfrtteharI andolIction (cont'd) V New entrants (or other -operators.5~thal~ , not use ordered infrastructure capacit e u irequired to return it A penally for 'exRces9siveloresmyasbeapoit- -rat-rsthat p E infrastructure should record and have available for their own operations and -=_._Physical separation of~irifraslructure (e gby walls or fences) may be warrant where nees etvent botage. but operators should be -= ~ ~~~~ en-rae to_ shlE carein temos afitmnner There are basically two approaches to providing > Operator pre-selection - Under this approach, equal access: customers select a operator for some or all of their calling. For example, an operator other > Call-by-call customer selection - Customers than the incumbent might be selected for all select the operator of their choice for each call. long distance and international calling. After the They usually do this by dialing a short code or selection is made, all calls from these customers prefix for their selected operator. For example, in will be routed to the operator of choice until their Colombia, customers dial 09 to route national selection is changed. The main requirements for calls through TELCOM's network, 05 to route this type of equal access are: them through Orbitel's network, and 07 for ETB's network. The main requirements to > Trunk-side interconnection by new entrants provide this type of equal access on an efficient to incumbent switches. basis are: - Switch software features to identify customer - Trunk-side interconnection by new entrants selections and to route and bill calls to incumbent switches. appropriately to the selected operator. - A numbering plan that allocates equivalent > Appropriate billing and audit arrangements to numbers to the incumbent operators and permit direct billing by each operator or bill- new entrants (For example similar access ing by one and remission to the others. As codes for long distance and international with the call-by-call approach, the local competitors; and equivalent blocks of access operator might do all billing and remit long numbers for local and mobile operators). distance charges to the other operators. - Provision of basic signalling services by in- The implementation of equal access has been cumbents to new entrants including Calling uneven around the world to date. It is available, for Line Identification (CLI); answer and example in Argentina, Australia, Canada, Chile, disconnect supervision. Hong Kong, and the US, but unavailable to date in many other countries. Equal access is more ) Appropriate billing and audit arrangements to common for intemational and local services but less permit direct billing by each operator or bill- so for long distance services. In some countries, ing by one and remission to the others. For equal access is unavailable due to limitations in example, the local operator might do all installed switching and software facilities. In others, it billing and remit long distance charges to the is due to delays in implementing a numbering plan other operators. that allocates equivalent numbers to competitors. In McCarthyTetrault infoDev 3-51 Telecommunications Regulation Handbook some, regulators have simply not seen equal access > Monitoring complaints seriously, and estab- as a priority. lishing significant penalties for clearly unequal service quality; and Market experience in more open markets has dem- onstrated that there is considerable inertia among - Establishing an independent Interconnection telecommunications customers. Regulators that Services Group within the incumbent's wish to expedite the development of fully competitive organization. markets will, therefore, want to consider equal access as a useful approach. Quality of interconnection services can be monitored by an Interconnection Services Group (ISG) (see 3.4.9 Quality of Service to Interconnecting Section 3.4.2). The ISG should measure quality of Operators service to interconnecting operators, and compare it to the incumbent's self-provisioning. For example, it It is good regulatory policy to require incumbent should ensure that new circuits ordered by operators to provide a reasonable quality of inter- interconnecting operators are provisioned, on connection services and facilities. Without such a average, within the same number of days as intemal policy, it would be possible for an incumbent to orders. frustrate a competitor's ability to provide competi- tively attractive services. For example, if an Table 3-7 provides examples of interconnection incumbent connected its own new customers' quality of service measures. Where interconnection circuits within days, but delayed connection of a service problems are serious enough to warrant competitor's customers' circuits for months, regulatory supervision, regulators can monitor these customers in a hurry would likely choose the measures. Regulators may also establish a incumbent's services. monitoring regime in advance, to prevent problems. A monitoring regime may require reports from The WTO Regulation Reference Paper deals with incumbents on two types of quality of service quality of interconnection with major suppliers in performance: signatory countries. It requires interconnection to be ensured under terms and conditions that are no less 1. Absolute performance based on established favourable than those provided for their own similar standards or intemational benchmarks, and services. Interconnection must also be no less favourable than that provided to a major supplier's 2. Relative performance by the incumbent in pro- subsidiaries, its other affiliates or to non-affiliated viding interconnection facilities to itself and to service suppliers. interconnecting operators. Similar types of policies in many countries require Interconnection policy in some countries may require "non-discriminatory" interconnection by an an incumbent to provide superior interconnection incumbent. In practice, it is very difficult to ensure services to interconnecting operators under some the implementation of such policies. Many intercon- circumstances. For example, it may be useful to nection complaints of new entrants deal with require an incumbent to provide interconnecting unequal quality of interconnection as between the operators with higher quality service than it normally incumbent's services and their own. provides for its own services - if the interconnecting operator is willing to pay for the difference. Such an The practical tools available to a regulator to approach has applications in industrialized countries promote high quality interconnection are: seeking to promote the provision of advanced telecommunications services. - Establishing interconnection quality of service -monitoring requirements; 3 - 52 infoDev McCarthyTetrault Module 3 - Interconnection Table 3-7: Some Key Interconnection Quality of Service Measures Provisioning Measures > Average time for provisioning interconnection circuits and other interconnection facilities and services (including unbundled components) - Percentage of installation appointments met for competitors' service installations > Average time for processing changes in customers from incumbent operator to competitor (in an equal access regime) > Percentage of repair appointments met for competitors - Comparative provisioning performance for (1) competitors, (2) affiliates, and (3) self-provisioning (including measures such as those set out in the previous points) Switching and Transmission > Probability of blockage in peak hour on interconnecting circuits Quality Measures >- Transmission delay (ref: ITU-T recommendation G114) > Transmission loss (loudness - ref: ITU-T recommendation P76) > Noise and distortion (ref: ITU-T recommendations, including Q551- 554, G123, G232, G712, P11) Other transmission quality standards (e.g. for digital services ref: ITU- T recommendations G821 re: bit errors and timing, and G113 re voice coding problems, and for both analogue and digital services ref: ITU- T recommendations G122 re: echo and loss of stability; and P16 et. al re crosstalk). This type of policy can also be useful in less incumbent does not require payments from new developed countries. In many less developed entrants to construct facilities to improve the countries, the quality of service provided by an incumbent's competitive advantage, as a condition incumbent is below international standards. This low of providing an adequate quality of service. quality of service is often due to financial constraints on the incumbent. In such cases, regulators should 3.4.10 QualityofinterconnectedServices be willing to promote improvement of the quality of service provided to a new entrant, provided the new The previous Section discussed the provision of entrants pays for it. For example, a new entrant may services by incumbents to interconnecting operators. be willing to pay for new trunk circuits between the Regulators in most countries are also concemed point of interconnection at a congested customer with the broader issue of the quality of service to the service exchange and a tandem exchange. public. Many regulators established quality of service reporting systems during the time services Such payments can be a win-win situation for the were provided in their countries on a monopoly incumbent and new entrants. Arrangements of this basis. type are best negotiated between incumbents and interconnecting operators. However, some To deal with the emergence of competition, some regulatory supervision may be required to ensure countries have apportioned responsibility for new entrants do not have to pay excessive charges. providing a prescribed quality of service among Similarly, the regulator may need to ensure that the interconnecting operators. For example, in the UK, McCarthyTe6trault infoDev Telecommunications Regulation Handbook the regulator prescrbed maximum delays for approach is based on the assumption that new interconnecting operators. The purpose of these entrants will not be able to attract and retain maximum delay standards was to ensure calls customers if their quality of service does not match between operators met national transmission speed or exceed that of the incumbent operator. Based on standards. Customer PBX equipment at each end of the same approach, it should be possible to remove a call was allocated 5 milliseconds (ms); originating regulatory quality of service requirements from and terminating local network operators 3 ms each; incumbents once competition is well established and and the long distance network operator 7 ms, for a they lose their market power. total maximum delay of 23 ms. As competition develops, it should be possible for Other countries have taken a more deregulatory more and more regulators to take the latter approach. They have not imposed quality of service approach. Regulation of service quality can then be reporting requirements on new entrants. This left to the market, rather than to regulators. infoDev McCarthyTetrault MODULE 4 Price Regulation Table of Contents Module 4- Price Regulation 4.1 Introduction 1 4.1.1 Objectives of Price Regulation 1 4.1.2 Rate Rebalancing 3 4.2 Approaches to Price Regulation 5 4.2.1 Introduction 5 4.2.2 Discretionary Price Setting 5 4.2.3 Rate-of-Return Regulation 6 4.2.4 ROR-Incentive Regulation 9 4.2.5 Types of ROR-Incentive Regulation 9 4.3 Price Cap Regulation 9 4.3.1 Overview 9 4.3.2 The Basic Price Cap Formula 10 4.3.3 Calculating Price Cap Variables: Looking Ahead or Back 13 4.3.4 The Inflation Factor 14 4.3.5 The Productivity Factor 17 4.3.6 Capped and Non-Capped Services 25 4.3.7 Service Baskets 25 4.3.8 Individual Service Pricing Restrictions 26 4.3.9 Duration and Review of Price Cap Plans 27 4.4 Price Cap Variations 29 4.4.1 Introduction 29 4.4.2 The Exogenous Factor 29 4.4.3 Quality of Service 30 4.4.4 New Services 32 4.4.5 Rate Rebalancing and Price Caps 32 4.4.6 International Accounting Rates 33 Appendix 4-1: OECD Rate Rebalancing 35 Appendix 4-2: Welfare Benefits of Rate Rebalancing 38 McCarthyTetrault infoDev Boxes, Figures and Tables List of Boxes Box 4-1: Weaknesses of Rate of Return Regulation 8 Box 4-2: Simplified Basic Price Cap Formula 10 Box 4-3: Using Price Indices - Simplified Calculation of API 12 Box 4-4: Basic Price Cap Formula Using Indices 13 Box 4-5: Selection Criteria for an Inflation Factor 15 Box 4-6: Alternative Inflation Factors 17 Box 4-7: Inflation Factor for Foreign Exchange Rate Changes 18 Box 4-8: Total Factor Productivity 19 Box 4-9: How Service Baskets Constrain Price Flexibility - Example 27 Box 4-10: Examples of Unexpected Input Price Change Outside Control of Regulated Operator 29 Box 4-11: What are Exogenous Cost Changes? 30 Box 4-12: OECD Tariff Comparison Methodology 35 List of Figures Figure 4-1: Index of OECD Tariff Rebalancing by Distance, including Local Calling 4 Figure 4-2: Index of OECD Business Charges and Teledensity 4 Figure 4-3: Price Cap Plan for Telecom Australia from 1989 to 1992 28 Figure 4-4: Price Cap Plan for Telecom Australia from 1992 to 1995 28 Figure 4-5: OECD Business Tariff Basket 36 Figure 4-6: OECD Residential Tariff Basket 36 Figure 4-7: Index of OECD Tariff Rebalancing, by year- The "Death of Distance" 37 Figure 4-8: Index of OECD Residential Charges and Teledensity 37 Figure 4-9: Rate Rebalancing - Base Scenario 39 List of Tables Table 4-1: Typical Result of Discretionary Price Setting 7 Table 4-2: Selected Estimates of TFP for the US. 21 Table 4-3: A Summary of British Telecom' s Price Cap Plans 23 Table 4-4: X-Factors of Selected National Price Cap Regulation Plans 24 Table 4-5: X-Factors of Selected State Price Cap Regulation Plans in US 24 Table 4-6: Summary of Benchmark Estimates for Setting X-Factor (%) 25 Table 4-7: Service Coverage of Selected National Price Cap Regulation Plans 26 Table 4-8: Service Coverage of Selected Price Cap Regulation Schemes in US 26 Table 4-9: Q-Factor Example -Rhode Island Scheme 31 Table 4-10: Estimates Used in the Telstra Rate Rebalancing Model - Base Scenario 38 Table 4-11: Results of Rate Rebalancing Scenarios 40 4- ii infoDev McCarthyTetrault PRICE REGULATION 4.1 Introduction 4.1.1 Objectives of Price Regulation This Module discusses price regulation in the tele- Good price regulation mimics the results of efficient communications sector. Before reading the Module, competition. However, price regulation may have readers may want to review the section on the additional objectives. The objectives of price regula- economic rationale for price regulation in the tele- tion may be grouped into three broad categories: communications sector that is found in Appendix B of the Handbook. As indicated in Section 1.1 of > Financing objectives; Appendix B, price regulation is normally justified when telecommunications markets fail to produce > Efficiency objectives; and competitive prices. ) Equity objectives. In this Module, we look more closely at the specific objectives of price regulation and at the regulatory Financing Objectives approaches used to achieve those objectives. The basic approaches to price regulation have evolved An important objective of price regulation is to with the transformation of the telecommunications ensure that regulated operators are permitted to sector from monopoly to competition. As regulators eam sufficient revenue to finance on-going have increasingly recognized the benefits of compe- operations and future investments. The minimum tition, they have adapted price regulation to take amount of revenue associated with the financial advantage of those benefts. objective is often referred to as the operator's "revenue requirement". To mimic the effect of a Today, price cap regulation is the most widely competitive market, the revenue requirement should accepted form of price regulation in the sector. ideally match the amount required by an efficient Because of its pre-eminence, a substantial part of operator to finance its operations and investments. this Module is devoted to price cap regulation. This aspect of the financial objective may be Before dealing with it, however, we discuss the ob- considered as sefting a revenue "floor" for efficient jectives of price regulation and review other operators. approaches to price regulation, particularly Rate of Return (ROR) regulation and its variations. McCarthyTetrault infoDev 4-1 Telecommunications Regulation Handbook Some traditional forms of price regulation, including minimized because the actual output from the Rate of Return regulation, do not allow operators to given inputs is less than what could be achieved. eam revenues in excess of their revenue require- ments. This aspect of the financial objective is Dynamic efficiency is achieved when resources associated with. preventing excessive revenues move over time to their highest value uses. Such associated with monopoly or dominant market uses include efficient investment, improved positions. It is discussed in greater detail in Sections productivity, research and development, and the 1.1 and 1.2 of Appendix B of the Handbook. This diffusion of new ideas and technologies. aspect of the financing objective, which may be con- Dynamic efficiency involves the movement from sidered a revenue "ceiling", has been relaxed under one type of efficient use of resources to another some specific conditions in other forms of price type of efficient use of resources. regulation, particularly price cap regulation. Equity Objectives Efficiency Objectves Equity objectives motivate many regulatory deci- It is generally accepted that price regulation should sions on telecommunications prices. Equity promote efficiency in the supply of telecommunica- objectives generally relate to the fair distribution of tions services. However, efficiency can be measured welfare benefits among members of society. Tele- in different ways. Three main aspects of efficiency communications regulators are primarily concemed are discussed below. with two different aspects of equity in the regulation of prices: Allocative efficiency is achieved when the prices of services reflect their relative scarcity. In Operator-consumer equity relates to the an efficient market, prices will equal the marginal distribution of benefits between consumers and cost of producing each service. In the telecom- the regulated operator. For instance, many munications sector, prices of international and people would not consider it equitable that long-distance services have traditionally been set monopoly operators be allowed to earn high significantly above their costs while local calls are profits for an extended period of time without im- priced below theirs. This is viewed as an proving or extending service. In this regard, the example of allocative inefficiency. The above- aim of many regulators is to ensure that the cost pricing of international services discourages savings that result from improved technological consumption of such services. On the other innovations are shared equitably between the hand, pricing local calls below cost encourages operator and consumers. Price cap regulation consumption beyond the level at which local calls includes a mechanism for consumers to share in can be economically provided. A more detailed these productivity gains. discussion of allocative efficiency is presented in Section 1.2 of Appendix B of the Handbook. Consumer-consumer equity relates to the distribution of benefits between different classes Productive efficiency has two related aspects. of telecommunications consumers. For example, One aspect relates to the most efficient mix of in Colombia, consumers in lower socio-economic inputs (capital, labour, etc.) for a given level of brackets pay less for the same local telephone output. Some forms of price regulation can subscription services than consumers in higher reduce productive efficiency. Rate of Return brackets. This approach implements a govern- (ROR) regulation, for example, is generally ment policy aimed at improving consumer- viewed as encouraging operators to use an inef- consumer equity. ficiently high level of capital for its level of output. A second aspect of productive efficiency requires Balancing the Objectives of Price Regulation that the services be produced as efficiently as possible, that is by minimizing all inputs. The The main challenges of price regulation involve the related concept of x-efficiency describes a situa- design and implementation of low-cost and effective tion in which an operator's costs are not regulatory approaches that induce the regulated 4 - 2 infoDev McCarthyTetrault Module 4- Price Regulation operator to achieve the socially desirable objectives therefore be under pressure to reduce subsidies or discussed above. Regulation imposes a burden on risk losing customers in the more profitable market the economy in the form of direct costs to segments. Traditional unbalanced price structures telecommunications operators for enforcement and are also inefficient in that higher-than-cost prices compliance. It may also place indirect burdens on encourage uneconomic entry by high-cost opera- consumers in the form of loss of choice of operators tors. Lower-than-cost prices discourage economic and/or services. A practical objective in the design of entry, even by low-cost operators. price regulation approaches should be to impose the least burden necessary to achieve their purposes. At Costs of dfferent telecommunications services have a minimum, benefits of price regulation should justify been decreasing at different rates as a result of its costs. technological developments. This has further unbalanced telecommunications prices. Where tele- In practice, there is often disagreement over tele- communication markets are open to competition, communications price regulation because the three prices of dfferent services will tend to move towards broad regulatory objectives, financial, efficiency and their costs. However, in monopoly or non- equity, can conflict with one another. Some people competitive environments they may not, and the will place more importance on one objective than regulator may be required to take steps to ensure others. This means that the regulator will often have that prices are more closely aligned with costs. to make trade-offs between these objectives in the Efficient monopoly pricing, and related matters, such course of implementing price regulation. as Ramsey Pricing, are discussed in Sections 1.1 and 1.2 of Appendix B of the Handbook. 4.1.2 Rate Rebalancing A significant amount of rate rebalancing has This Section contains a brief discussion of price occurred in many industrialized countries in recent rebalancing, or rate rebalancing, as it is more years. Comprehensive price comparisons have frequently called. This important topic is dealt with in been conducted by the OECD for its 29 member greater detail in Appendix 4-1 of this Module. countries since 1990. The effects of rebalancing calls in member countries is presented in Figure 4-1. The term "rebalancing" refers to moving the prices As this figure illustrates, since 1990, the average for dfferent telecommunications services more price of local calls in OECD countries has risen by closely in line with the costs of providing each more than 30%. In contrast, the average price of service. Currently, telecommunications price struc- long distance calls (110 km and 490 km calls) has tures in many countries are highly unbalanced, with decreased by about 30% over the same period. some services priced well above costs and others below costs. Telecommunications costing is Figure 4-2 shows the effect of rebalancing on prices discussed in detail in Section 1.4 of Appendix B of for business services. Over the 1990-1998 period, the Handbook fixed charges (connection and subscription) increased by over 20% and usage charges Prices of telephone connections, monthly subscrip- decreased by over 20%, for an overall weighted tions, and local calls have traditionally been set reduction of about 12%. Note that overall teledensity below costs in many countries. Resulting deficits in the OECD countries has increased steadily, have been subsidized by higher-than-cost long despite rebalancing. The relationship between distance and international calling prices. Some of rebalancing and consumer welfare is discussed the historical reasons for these traditional pricing further in Module 6. structures are discussed in Section 4.2.2. These two figures and those contained in Appendix Unbalanced price structures are not sustainable in a 4-1 indicate that rate rebalancing has produced competitive environment. New competitors will lower overall prices for most consumers in a majority generally enter those market segments where profit of the countries surveyed. However, this is not the margins are highest, such as long distance and in- only benefit of rebalancing. Rate rebalancing will ternational calling. Incumbent operators will also increase social welfare by moving prices closer McCarthyTT&rault infoDev Telecommunications Regulation Handbook Figure 4-1: Index of OECD Tariff Rebalancing by Distance, Including Local Calling 1-27km- -110km - - - 490 km -Local Cainkig 150 150 140 140 130 130 120 120 110 110 100 1 - 00 90 ~~~~~~~~~~~~~~~~~~~~~~~90 80 8 70 7 60 60 50 150 1990 1991 1992 1993 1994 1995 1996 1997 1996 N.I Alhk-t.101n 199Ci A_..p .d by n n.* d 0- Caloabon b_d o FFPWs _pds In USO SGOECD(lu) Figure 4-2: Index of OECD Business Charges and Teledensity I ToaI CIN Ul- -U.g. Chargq.. -Fi Chaig.. --TOIOd.lSIly 1 30 1 20 110 10 - 4infoDe McCarthyTetrault Module 4- Price Regulation to costs. This is illustrated in more detail in Appendix principle assumes that a prospective buyer will pay a 4-1, and in other studies that have examined rebal- price that is related to the value derived from the ancing in different countries. Rate rebalancing will service and that telephone services are more provide benefits to the economy in addition to valuable to some classes of customers than to producing lower overall prices. Therefore, there is a others. Accordingly, businesses are often charged strong case to be made for rate rebalancing, with more than residential customers for the same our without the introduction of competition. connection and subscription services. It is assumed that businesses are major users of international and 4.2 Approaches to Price Regulation long-distance services, and that they value such services highly. Accordingly, higher rates are 4.2.1 Introduction charged for such services. Different approaches have been developed over the Discretionary price regulation approaches in many years to regulate telecommunications prices. Some, countries were interventionist. Often the govemment involving rules-based approaches, are designed to or the Minister in charge would micro-manage the provide stability and certainty, as well as achieving PTT's pricing structure, severely reducing its ability regulatory objectives. Others have been more ad to function as a normal business enterprise. In some hoc and discretionary. cases, telephone prices were increased to make up government budget deficits, without extensive con- This Section begins with a discussion of two sideration of the economic or social impacts of such common pricing approaches: traditional discretion- increases. ary price setting and Rate of Return regulation. This . . Section is followed by a discussion on incentive In some countries, traditonal discretionary price regulation. In our analysis we consider how well the regulation failed to generate enough revenue to pay three approaches achieve the broad objectives of the operating costs of the incumbent operator or to price regulation: namely the financing, efciency support network upgrades and expansion. As a and equity objectives ' result, the operator's revenue requirement and the and equity objectives. financial objective of regulation were sometimes not 4.2.2 Discretionary Price Seffing met. Traditionally, in many countries, price regulation was In some jurisdictions, telephone revenues of state- focussed heavily on social objectives as well as owned operators were treated as part of general financial or economic ones. This was particularly govemment revenues. Expenditures of the state- true where the government operated the telecom- owned operator, including those for investments, are munications network. Under such circumstances, included in the general govemment budget. Poor prices were usually set to promote consumer-to- government fiscal management made it impossible consumer equity objectives. In many countries, there to meet a PTT's revenue requirement. Such an was little or no analysis of the economic impacts of arrangement deprives the operator of the capital such policies. required to upgrade its network. It can also reduce the incentive for the operator to innovate and reduce Where discretionary price regulation existed, or costs, which hurts the dynamic efficiency objective. continues to exist, it is usually characterized by In practice, such operators often have poor perform- below-cost prices for connection, subscription and ance and over-stafng, which means that the local calls. The shortfall is made up by higher-than- productive efficiency objective is not met either. cost international call prices, and sometimes also Long-term capital investments should make up a high Iong-distance prices. Ln-emcptlivsmnssol aeu large part of the costs of a telecommunications The frequently-stated objective of this type of pricing operator. However, cash-strapped governments is to promote affordability of basic telephone serv- sometimes extract cash from state-owned operators ices. This type of pricing may also incorporate the to finance other government priorities. This has been value of service principle. Simply stated, this more common where there was no explicit rules- McCarthyTerault infoDev Telecommunications Regulation Handbook based regulatory regime that requires prices to be 4.2.3 Rate-of-Return Regulation set to meet a revenue requirement calculated to in- clude long-term capital investments. Enough cash Rate of Return (ROR) regulation is a rules-based may be left for the operator to meet its day-to-day form of price regulation. Unlike discretionary price operating requirements, but not enough to upgrade setting, ROR regulation provides an operator with or expand the network. relative certainty that it can meet its revenue requirement on an ongoing basis. The essence of Where this has happened, the result has been an ROR regulation is simple. First, the regulated undersupply of telecommunications services and operator's revenue requirement is calculated. Then waiting lists for service. In some countries, telecom- the operator's individual service prices are adjusted munications prices have been increased solely to so that its aggregate service revenues cover its meet general government revenue requirements, revenue requirement. without regard to the specific revenue requirement of the telecommunications operator. Instead of In calculating the revenue requirement, the regulator improving telecommunications service, the proceeds first reviews the operating costs and financing (e.g. of telephone rate increases have sometimes been debt service) costs. Typically there is some regula- used to meet a wide range of other government tory scrutiny to ensure that the costs were priorities, from subsidizing postal services to paying necessarily and prudently incurred in order to the armed forces. provide the regulated services. If not, they may be disallowed from the "rate base". The operator will not In some cases, it is said that local telephone rates be entitled to increase its prices or rates to recover are kept at low levels to maintain affordability of such disallowed costs. services for low-income subscribers (i.e. to meet consumer-consumer equity objectives). In reality, The next step in calculating an operator!s revenue however, the initial telephone users in most emerg- requirement is to determine its rate of return. In ing economies are not the poor. With low prices, the order to allow the operator to remain financially relatively privileged group of telephone users end up viable, and to attract new capital for its operations, paying much less than it can afford. At the same ROR regulation permits the operator to recover not time, the operator cannot expand the network to only its direct operation and financing costs, but also provide service to other users. This undermines the a fair return on its rate base. The regulator deter- operator-consumer equity and consumer-consumer mines an appropriate rate of return on capital for a equity objectives. As a result, most of the poor given time period (typically one to three years). This households, especially in rural areas, receive no return is generally based on a review of financial subsidy at all because they have no access. In market conditions, plus any additional operator or summary, experience has shown that discretionary industry-specific issues (industry or operator risk, price setting approaches have seldom achieved operator specific taxation issues, etc.). their social or economic goals, at least on a long- term basis. Based on the approved rate of return, a revenue requirement is calculated (i.e. total revenues that Traditional discretionary price setting approaches may be generated in a given period). The revenue have usually resulted in inefficient price structures. requirement is to be recovered from the sum of all Table 4-1 summarizes the main differences between services provided. If an operator earns more than its prices that typically result from discretionary price allowable rate of return, the regulator will require setting and the types of cost-oriented prices that price reductions to bring the operator's rate of return would result from competition. down to the allowable level. Conversely, if the operator does not meet its allowable rate of retum, it A detailed discussion of telecommunications costs is will request price increases to raise its revenues. provided in Section 1.4 of Appendix B. 4 - 6 infoDev McCarthyTetrault Module 4- Price Regulation Table 4-1: Typical t ry Price Setting -' Service Discretionati PhceStling Efficient Cost-oriented Pricing Corfnection ---Vy low p riceyica t belcw $50 Related to the incremental costs of providing the line -Wa-itg list4dsed to rati6;n*1d--C`mand. Subscription Rea e lw 9 y below Related -to t incremental costs of local service. $3/m pn' congestion including.the local exchange switch and the "local used to rationsdemand loop" poioin6 of the network Local service costs vary signifi6ghtly across different service areas. based on -; YTi - density rand other factors Higher charges levied on businesses due to their higher demands for main- tetiance and service qualIt6. Local Calling Verylw umetered'- or non- Calls charged per minute and in some cases with -.existent l caihages. additional .call set-up surcharge. Discounts for off- peak calling and special promotions. Domestic High ars ultiple call Calls charged per minute with possible reductions for I Long- -. zones - gestdistce',typically duration of-call. Discounting during off-peak periods. distance - chargIeda tipte;62O or more Ratio between longest-distance call and local call in Calling times lo l a& F -range of -five. to one or less. Tendency to distance- insensitive or postalized' prices International -Geerallyer i ally to Calls charged per minute wilh possible reductions for Calling . distant ou esr ting rates duration of call. Discounting during off-peak periods. kehi anutg oing Ratio between international and national calls -cir.cuits kept low~to generate net typically in excess of 3 to 1, but coming down due to slttiemept . ~ ~ ent. .- . accounting rate reform. I ~~"-'~~' , , -. . , Source: Adapted from lTUI'998a) ROR regulation is designed to equate an operator's the efficiency objectives of price regulation as well total revenues with its total costs. It is generally not as other forms of regulation. designed to equate revenue for any particular service to the cost of that service. As a result, it does The perceived inefficiencies of ROR regulation must not specifically address the structure of prices. In be put into perspective. The reality is that operators practice, where ROR regulation is applied, the in some industrialized countries performed relatively structure of prices generally tends to fall somewhere well under ROR regulation for nearly a century, tak- between cost-oriented prices and the prices that ing advantage of gains in technology and sharing result from discretionary price setting. the benefits with their customers in the form of lower prices. Nevertheless, because of the identified Weaknesses of ROR Regulation weaknesses, many regulators in industrialized countries have been introducing forms of incentive The weaknesses of ROR regulation are summarized regulation instead of ROR regulation. in Box 4-1. The main weakness is that it does not provide operators with a strong incentive to operate Concems about the inefficiencies of ROR regulation efficiently by reducing their operating costs. They arose in industrialized countries after extensive can usually recover most if not all of their costs networks had been constructed. The most important through rate increases, and they are not permitted to objective in many developing countries is to build retain additional profits eamed by reducing their network infrastructure to meet unsatisfied demand. costs.- As a result, ROR regulation does not promote McCarthyTetrault infoDev 4-7 Telecommunications Regulation Handbook Box 4-1: Weaknesses of Rate of Return Regulation Lack of Incentive to Minimize Costs r In ROR regulation, the operator's prices are set at a level sufficient to cover its costs. This is why ROR regulation is often referred to as 'cost plus regulation". From a dynamic perspective, therefore, the operator has little incentive to reduce its rate base or its operating costs. In competitive markets, where the market determines price levels, an increase in costs will reduce profits. Therefore cost containment is a major objective of operators in a competitive market. Lack of InnovationlProductivity Improvement > Over time, ROR regulation of a monopoly operator will lead to a lower rate of productivity improve- ment than would occur under effective competition. ROR regulation does not provide the operator with a strong incentive to increase its productivity. Capital Bias - The Aversch-Johnson Effect >- ROR regulation provides incentives to increase the amount of capital that the operator invests. The higher the capital expenditure, the higher the rate base, and the greater the total return the operator can earn. It therefore encourages the operator to use an inefficient input mix. The operator will have an incentive to use an inefficiently high capital/labour ratio for its level of output. This result is often referred to as the Aversch-Johnson effect, named after two economists who described it. The effect is an indication that productive efficiency is not being maximized. Cost of Regulation > ROR regulation requires the operator and the regulator to spend significant amounts of time and money. The rate base must be repeatedly calculated by the operator and reviewed by the regulator, the cost of capital must be recalculated, and so on. Rate reviews or hearings must be held on a regular basis, incurring costs to the regulator, the operator, and other participants in the process. Interventionist Nature of ROR Regulation > The regulator is required to review many aspects of the operation and management of the firm in a detailed manner. This includes scrutiny to prevent rate base 'padding". Over time, this type of detailed regulation may place a regulatory burden on the firm that impedes its ability to function as a normal business enterprise. Inadequacy for Transition to Competition :> ROR regulation operates relatively slowly, and generally does not allow operators the pricing flexibility they need to respond to competitors' actions. >- The introduction of competition in some parts of the telecommunications sector, combined with continuing ROR regulation in monopoly segments, means that vertically-integrated operators have an incentive to engage in anti-competitive practices (e.g. anti-competitive cross-subsidization). This will typically require a very large capital invest- minimizes the differences between ROR and incen- ment. As a result, the concern about ROR regulation tive regulation. In fact, any economically sustainable emphasizing capital investment is not as significant form of rules-based price regulation would be a concern in developing countries. The political and preferable to the ad hoc forms of discretionary price economic environment in many developing countries 4 - 8 infoDev McCarthyTetrault Module 4- Price Regulation setting currently practised in some developing similar to those created by traditional ROR regula- countries. tion. A broad band of eamings can create stronger incentives for the operator to reduce operating costs 4.2.4 ROR-Incentive Regulation and improve operations. For instance, rather than set the rate of return at 12%, the operator might be The term ROR-incentive regulation is generally used allowed a return of between 10% and 14%. to describe variations on ROR regulation that were developed in different US states to respond to Rate Case Moratoria perceived weaknesses in traditional ROR regulation. ROR-incentive regulation has enjoyed limited Rate case moratoria can be implemented by popularity in other parts of the world. agreements between a regulator and an operator to suspend regulatory scrutiny of the operator's Incentive regulation provides inducements and pen- earnings for a fixed period. This form of incentive alties that encourage an operator to meet regulatory regulation is often used at the beginning of a transi- goals. tion to price cap regulation. It gives the regulated operator an incentive to lower operating costs, since The different types of incentive regulation generally it may retain higher earnings during the transition share the following elements: period. > The operator often participates in setting goals Earnings-Sharing or performance targets. Under an earnings-sharing plan, the operator may - The operator is given more flexibility than under retain higher eamings. However, earnings in a traditional ROR regulation. The regulator specified range are shared with consumers. typically does not prescribe specific manage- Typically, these plans are set up with different ment actions. For example, the operator may be sharing ranges based on a prescribed ROR. These rewarded for reducing its operating costs but not sharing ranges can differ substantially from plan to told exactly how to reduce these costs. plan. In one example of this type of plan, the regulated operator keeps 100% of the earnings up - The regulator restricts some activities of the to 10%, the operator and consumers split eamings operator. between 10% and 14%. The operator's earnings are capped at 14%. > Rewards and penalties established by the regulator motivate the operator to perform 4.3 Price Cap Regulation efficiently. 4.3.1 Overview 4.2.5 Types of ROR-Incentive Regulation This Section provides an overview of price cap In this Section, we summarize some of the incentive- regulation, which is the preferred form of rules- based regulatory schemes that have been based price regulation around the world today. implemented in the US telecommunications industry. These forms of regulation typically replace traditional Price cap regulation uses a formula to determine the ROR regulation. maximum allowable price increases for a regulated operator's services for a specified number of years. Banded Rate-of-Retum The formula is designed to permit an operator to recover its unavoidable cost increases (e.g. inflation, Under this form of incentive regulation, regulators tax increases, etc.) through price increases. establish a range (or band) of authorized eamings. However, unlike ROR regulation, the formula does Prices are set to generate earnings that fall within not permit the operator to increase rates to recover the authorized range. When only a narrow band of all costs. The formula also requires the operator to earnings is permitted, the operator's incentives are lower its prices regularly to reflect productivity McCarthyTe'trault infoDev Telecommunications Regulation Handbook increases that an efficient operator would be 4.3.2 The Basic Price Cap Formula expected to experience. There are a number of ways to express the price Price cap regulation has several advantages over cap formula. In its simplest form, a price cap formula ROR regulation: allows an operator to increase its rates annually by an amount equal to an inflation measure, less an > It provides incentives for greater efficiency; amount equal to the assumed rate of productivity increase. A simplified very basic price cap formula is - It streamlines the regulatory process; set out in Box 4-2. > It provides greater pricing flexibility; It can be seen from this simple example that opera- tors may increase their prices to include the effects It reduces the possibility of regulatory interven- of inflation, but no more. Inflationary cost increases tion and micro-management; of 5% may be passed on because it is assumed that the operator cannot control them. However, the ) It allows consumers and operators to share in example also assumes that telecommunications expected productivity gains; industry productivity will increase by 3%. Such pro- ductivity increases result from technological > It protects consumers and competitors by limit- improvements, lower switching and transmission ing price increases; and costs, and many other factors. Therefore, in the above example, the operator must pass on a - It limits the opportunity for cross-subsidization. productivity benefit to its customers by lowering its year 2001 prices by 3%. For these advantages to materialize, price cap regulation must be implemented in an effective and In this example, the operator may reap the benefits intemally consistent manner. We discuss some of of any measures it takes to reduce its costs below these implementation challenges in the Sections 3%. If the operator has been very efficient, it may below. Price cap regulation is meant to provide incentives t93 1 3 1 9 4 r13a that are similar to competitive market forces. Com- petitive forces require operators to improve productivity and, after accounting for unavoidable prieirease for increases in their input costs, pass these gains on to their customers in the form of lower prices. The price MtM cap formula has a similar effect. ~ fJg 8 f~~f~ItI? .. Price cap regulation is a means to regulate prices E8 over time. The price cap formula determines the rate of change in prices from an initial level. The initial level of prices may be set by the regulator (see Sec- __ _ tion 4.1.2). Altematively, the regulator may establish re. a transition period at the end of which the regulated _ operator must reach target pnce levels or ranges 0 ] (see Section 4.4.5). Future financial performance for 0 8G a price cap regulated operator formulae is highly dependent on the initial price levels. Therefore, it is critical for the regulator to ensure that the initial level li i Mf01iMr0ase fr of prices are consistent with the operator's revenue '' Prices for services with heavier weightings in an index will affect the index more. Therefore, The sample price cap formula in Box 4-2 is highly prices for major services (measured by simplified. In practice, telecommunications operators revenues) may not be increased as much as do not offer a single service at a single price. They prices for less significant services. offer a range of different services at different prices. A typical price cap formula will, therefore, generally 4.3.2.2 Basic Indexed Price Cap Formula use an index of the prices charged by an operator and not a single price. In such cases, the operator Box 4-4 restates the basic price cap formula using will be required to keep its actual prices below a the concept of price indices described above. The Price Cap Index (PCI). formula assumes that prices will be calculated for each year. The symbol "t" is used in the formula to In developing indices for a price cap formula, prices represent the appropriate time period (e.g. a year). of different services are weighted so that the prices In practice, different time periods can be used in- for major services receive a proportionately greater stead of years. weight. Consider a simple example, where an operator provides only two services, local service The factors I and X which are used in the formula and international service. An index of the operator's set out in Box 4-4 are discussed in greater detail in actual prices (Actual Price Index or API) can be later Sections of this Module. developed for this operator using service revenues as weights. For example, assume that local service 4.3.2.3 Service Baskets accounts for 75% of the operator's revenues, and international service accounts for 25%. The same Under price cap regulation, services are usually proportions ("weights") will be used to determine grouped into one or more service baskets. Different whether the operator's API exceeded the price cap, service baskets may be subject to different price cap or PCI. indices. Let us use the same price increase assumptions as For example, a residential service basket might be described in Box 4-2. In the year 2001, prices will be developed to limit price increases affecting residen- allowed to increase from 100 to 102. Therefore, let tial consumers. This basket might include local us assume that 102 is the PCI. To determine residential connection charges, monthly subscription whether the operator's actual prices in 2001 exceed fees, and local and international usage charges. A the PCI of 102, we must compare that PCI to the separate basket might include services used by typi- API. Box 4-3 contains examples comparing the cal business customers. operator's API for 2001 to its PCI of 102. McCarthyTe6trault infoDev 4- 1 Telecommunications Regulation Handbook Box 4-3: Using Price Indices - Simplified Calculation of API Basic Price Cap Rule: API < PCI i.e. the Actual Price Index (API) for the year 2001 must be equal to or less than the Price Cap Index (PCI) for 2001. The objective of this example is to calculate the API for year 2001 and determine whether the proposed price changes comply with the Basic Price Cap Rule. The API for year 2001 is the product of the API for year 2000 and the weighted average of the change in prices from 2000 to 2001. Notes: (1) Set the API, the PCI and all prices equal to 100 in year 2000 (2) Year 2001 PCI = 102 (i.e. a 2% increase over year 2000) (3) Indices are weighted by revenues (4) The operator provides only 2 services: (a) Local Services = 75% of revenues (b) Intemational Services = 25% of revenues (5) The weighted average of the change in prices is the sum of the following calculation for each service: the change in prices (expressed as the division of year 2001 price by year 2000 price) multiplied by the respective revenue weight (expressed as the division of service revenue by total revenue). Example A: Proposed price changes: Local price increases by 1 % from year 2000 to 2001 (100 to 101) International price increases by 4% from year 2000 to 2001 (100 to 104) Weighted average of the Local service: 1.01 x 0.75 = 0.7575 change in prices: International service: 1.04 x 0.25 = 0.2600 Total: = 1.0175 Since the API for 2000 was 100, the API for 2001 is the product of 100 and the weighted average of the change in prices, i.e. 100 x 1.0175 = 101.75. Therefore API < PCI (i.e. 101.75 is less than 102). Since the proposed year 2001 prices are less than the PCI, no additional price reductions would be required by the regulator. Example B: Proposed price changes: Local price increases by 4% from year 2000 to 2001 (100 to 104) International price increases by 1% from year 2000 to 2001 (100 to 101) Weighted average of the Local service: 1.04 x 0.75 = 0.7800 change in prices: International service: 1.01 x 0.25 = 0.2525 Total: = 1.0325 Since the API for 2000 was 100, the API for 2001 is the product of 100 and the weighted average of the change in prices, i.e. 100 x 1.0325 = 103.25. Therefore API > PCI (i.e. 103.25 is greater than 102). Since the proposed year 2001 prices are higher than the PCI, the proposed prices would not be approved by the regulator. The regulator would require that prices must be reduced further. 4 - 12 infoDev McCarthyTetrault Module 4- Price Regulation Box 4-4: Basic Price Cap Formula Using Indices Price cap regulation requires: APIt s PCIt for all t That is, the API for a particular time period must always be less than or equal to the PCI for that period. From year to year, the PCI is adjusted according to the following formula: PCI' = PCI'-1 x (I + It - X)l i.e. the PCI for a given year (t) will be equal to the PCI for the previous year (t-1) multiplied by 1 plus the Infla- tion Factor for year t (i ) minus the Productivity Factor (X). Notes: (1) APlt means the Actual Price Index at year t. The API is a weighted average of the change in prices actually charged by the operator. (2) PClt means the price cap index at year t. The PCI is a weighted average of the change in the maximum allowable prices of the operator. (3) It is the inflation factor at time t. (4) X is the productivity factor. (5) It is common to express It and X in percentage terms especially when referring to them outside the context of actual price cap calculations. Note, however, that in the price cap formulae these variables are expressed in decimal, not percentage terms. Example Using the same PCI assumptions as described in Box 4-2 and Box 4-3, in a period where the inflation factor is 5% and the productivity factor is 3%, the maximum amount that the weighted average of the change in prices would be permitted to increase would be by 2%. i.e. The formula PCIt = PCIt" x (1 + It - X) produces the following result: 102 = 100 x (1+.05 -.03) I~~~~~~~~~ There may also be restrictions on the absolute or of service open to competition (e.g. domestic and relative movement of prices for services subject to international long distance) by monopoly services price cap regulation. Operators may change prices (e.g. access and local calling). for individual services within the baskets as long as the API for the services in the basket complies with 4.3.3 Calculating Price Cap Variables: the price cap formula, and as long as no individual Looking Ahead or Back service pricing restrictions are breached. The basic price cap formula contains a number of An example of an individual service pricing restric- variables that must be calculated. To mimic the tion is a rule that no price for an individual service workings of competitive markets, the price cap may increase by more than 10% per year. Such formula should ideally be forward-looking. Variables restrictions may be applied, for example, to limit the such as the inflation (I) and productivity (X) factors, impact on residential consumers of rate rebalancing. and the weights used to calculate the indices should The concepts of service baskets and individual ideally be determined based on expected future restrictions are discussed further in Sections 4.3.7 values. and 4.3.8 of this Module. Service baskets may also be used to restrict or prevent the cross-subsidization McCarthyTetrault infoDev 4-13 Telecommunications Regulation Handbook In practice, however, the majority of regulators only Another approach is to set fixed weights that do not set the productivity factor based on future values. vary from period to period. This approach is The inflation factor and index weights are administratively simpler and limits any possibility for determined based on the most recent available the operator to manipulate the price cap formula by historical data. setting prices strategically. Setting weights based on forward-looking cost benchmarks is one possible There are a number of practical reasons for setting altemative under this approach. the inflation factor and index weights based on historical data: 4.3.4 The Inflation Factor > In many economies, past inflation performance The price cap formula includes an inflation factor to is a good predictor of future inflation. account for changes in input costs of the operator. For example, holding all the other variables > The process of forecasfing inflation and the de- constant, a 5% inflation factor would allow a mand and revenue variables needed to forecast regulated operator to increase its average prices by weights is complex, time consuming, and 5%. subject to controversy and possibly manipulation. 4.3.4.1 Selection Criteria > A forecasting approach may necessitate In most economies, a number of different indices are corrections to offset the effect of forecasting used to measure inflation. For example, a consumer errors, thus adding complexity and regulatory price index or retail price index (CPI or RPI) meas- uncertainty. ures changes in the prices of goods and services purchased by typical consumers (e.g. food, Basing the inflation factor and weights on historical passenger transportation, residential electrical data also has disadvantages. For instance, future power, etc.). A Producer Price Index (PPI) measures inflation may vary significantly from past inflation. changes in the prices of goods and services This disadvantage may be mitigated by increasing purchased by different types of production industries the frequency of adjustments to the inflation factor, (e.g. prices for labour, freight transport, industrial or by establishing trigger mechanisms as discussed electrical power, etc.). below. In developing a price cap formula, regulators must In principle, index weights may be based on costs or select an appropriate inflation factor (I). A choice revenues. Cost weights are generally considered to may be made from among existing inflation indices, be the more theoretically correct choice, but reliable or a new inflation factor may be calculated. forward-looking costing data is often not available. In Regulators that have implemented price cap regula- practice, therefore, most regulators have chosen tion have identified a number of criteria for selecting revenue weights to calculate the aggregate indices an inflation index to be used as the inflation factor. in the price cap formula. Regulators should be espe- Frequently used criteria are set out in Box 4-5. cially vigilant in the choice of weights when prices are not balanced and heavy cross-subsidization Particular national circumstances may dictate that exists. In this type of scenario there may be other criteria should be considered. It is unlikely that significant differences in the cost and revenue any one potential inflation measure will rank highest weights and use of the latter may bias the in all of the selection criteria. Ultimately, the selection calculation of the API. must be based on the informed judgment of the regulator. 4- 14 infoDev McCarthyTetrault Module 4 - Price Regulation Box 4-5: Selection Criteria for an Inflation Factor Reflective of changes in the operator's costs 3i For the inflation factor to be a useful variable, it must reflect changes in the operator's input costs. This is particularly critical in situations of economic instability, when the inflation factor will have to capture sudden and large changes in the country's exchange rate. This is particularly important for operators that typically purchase a large proportion of their equipment in foreign currency. Availability from a credible, published, independent source 3 This is important if price cap regulation is to have credibility with all parties involved. Private sector participants as well as international investors in the sector must be able to trust the source of the data. Availability on a timely basis >' In order for the price cap formula to respond quickly to any changes in input costs, the inflation factor should ideally be available with a lag of less than 6 months and preferably 2 to 4 months. Understandability :> There is significant benefit in including an inflation factor that is easily understood not only by all the players in the telecommunications sector, but by the public at large. Stability > The values of some statistical indices are subject to revision after their initial release. For example, in March 2001, the January 2001 CPI may be announced at 123.47; however, that value may be revised to 123.58 in June 2001. If possible, an inflation factor should be chosen that is not subject to large frequent revisions. Consistency with total factor productivity of the economy The choice of price index will have a direct impact on the manner of calculating the productivity factor (X) because efficiency gains in the rest of the economy affect the operator through this I index. As we discuss below, the inclusion of specific variables in the price cap formula will depend on whether an economy-wide price index or a price index for the operator's principal inputs is used. This aspect is discussed in greater detail in Section 4.3.5. 4.3.4.2 Potentially Useful Inflation Indices Potentially useful inflation measures may be classi- fied as either economy-wide indices or non- With these selection criteria in mind, the next step is economy wide price indices. Some inflation to examine existing inflation measures available in measures are designed to reflect national or the country. A number of indices are normally pub- domestic output price changes. For example, the lished by or available from the government statistical Gross Domestic Product (GDP) price index office (if one exists), and/or the country's central measures the cost of a fixed basket of goods and bank. In some countries, these statistics are services that make up the GDP in a particular base produced by government ministries, such as the year. This is updated at periodic intervals. Similarly, Ministries of Finance, Statistics, Planning or the price index for the Gross National Product (GNP) Economic Development. gives economy-wide coverage. McCarthyTetrault infoDev 4- 15 Telecommunications Regulation Handbook A related index is the GDP or GNP deflator. Tradi- sider the advantages and disadvantages of each tionally, the deflator is determined by dividing the available index as a potential inflation factor. It is cost of the basket of goods and services that make possible that the regulator will decide that none of up the GDP (or GNP) at current prices by the cost of the existing national indices is appropriate. Box 4-6 the same basket at constant prices. Hence, the presents some possible alternative inflation factors. deflator reflects not only pure price changes, but also changes, if any, in the weights attached to the 4.3.4.4 Period of Adjustment GDP (or GNP) components. The regulator must decide how often changes in the The GDP (and GNP) indices and deflators are chosen inflation index will be used to adjust the price broadly based. They reflect changes in the prices cap formula, and how often the operator will be affecting a large basket of goods and services. Many allowed to adjust its rates. This is referred to as the regulators in the U.S. and Canada have chosen one perodicity of adjustment to the price cap formula. In of these economy-wide indices as the inflation factor industrialized countries, the period of adjustment is to be included in their price cap formula. usually once a year. This is a feasible option be- cause inflation rates tend to be relatively low and Other indices are narrower in scope. For example, stable in such countries. the Consumer Price Index (CPI) or the Retail Price Index (RPI) measures the changes in prices paid by Many developing countries, however, are subject to consumers. They typically measure the cost of a greater economic instability. Hence, the ideal perio- fixed basket of goods and services that are bought dicity may be less than a year, say 3 or 6 months. A by consumers in a particular base year, and update relatively short period between updates lessens the it at periodic intervals. This narrow scope is their impact that an acceleration or deceleration of greatest disadvantage because telecommunications inflation can have on the operator's expenses. The operators incur only a portion of their costs in retail regulator should weigh the benefits of frequent consumer markets. Hence, the CPI or RPI may be adjustment against the administrative costs of relatively poor indicators of inflation affecting the changing and publishing new prices on a regular, operator's cost structure. short-term basis. Another set of inflation measures that is narrower in 4.3.4.5 I-Factor Adjustment Mechanism scope are the producer, industrial or wholesale price indices. Generally, they measure changes in prices One approach developed to deal with economic paid by companies economy-wide, or in particular instability is to include a trigger mechanism in the sectors of the economy. adjustment of the price cap formula. Under this approach, the regulator may select a standard A number of regulators in the United Kingdom and national inflation index as its inflation factor with a Europe have selected retail price indices as the relatively long period of adjustment. However, as a inflation factor to be included in their price cap "fall back", an immediate adjustment may be made formula. In fact, price cap regulation is sometimes to the inflation factor in the event of certain large and referred to as "RPI-X" regulation, referring to the unexpected economic developments. initiative of the United Kingdom in first implementing this type of regulation in the early 1980s, when As an example, an adjustment might take place British Telecom was privatized. when the selected national inflation index increases or decreases by a significant amount. In countries 4.3.4.3 Other Inflation Factors with a history of relatively low and stable inflation, this amount could be in the order of 10% to 20%. Based on the general criteria set out above and on a survey of existing indices, the regulator should con- 4 -16 infoDev McCarthyTetrault Module 4- Price Regulation Box 4-6: Alternative Inflation Factors > One option is to use an inflation index from another country (or inflation measures produced by United Nations organizations and/or international financial institutions, regional development banks, The World Bank, the IMF, etc.). > In Argentina, for instance, some regulated utilities use the producer price index for the United States. This is then converted into the national currency. This choice was designed to reassure foreign investors by relating their revenues to a hard currency. > Another option is to construct a new measure of inflation that more accurately reflects the cost structure of the operators. This new "composite' index may be a weighted combination of several existing indices. > In Colombia, for instance, the interconnection access rates paid by wireless and long distance op- erators to local telephone operators is indexed on a monthly basis to a composite index made up of the following: > An index of the US/Colombia exchange rate and the average customs duty; weight: 0.38 > An index of the minimum industrial wage in Colombia; weight: 0.29 > The Producer Price Index of Colombia; weight: 0.33 > Similarly, in Chile, the access rates paid by mobile operators to terminate calls on the networks of PSTN operators is indexed on a monthly basis to a weighted aggregate index made up of the following: >' An index of the imported goods and services component of the Chilean wholesale price index; weight 0.263 > The Chilean wholesale price index; weight: 0.542 > The Chilean consumer price index; weight: 0.195 Source for Argentina example: Green and Pardina (1999) An I-Factor adjustment mechanism can also be tied consumers receive partly or fully the benefits of the to other key changes that would seriously impact on operator's expected productivity gains in the form of the cost of operating a telecommunications system. lower prices. For example, if all other variables are In many countries, the most serious potential held constant, a 3% X-factor will result in annual change is a devaluation of the national currency. reductions of 3% in average consumer prices. While this may reduce labour costs, it can signifi- cantly increase the costs of equipment, foreign The proper choice of an X-factor is critical for the consulting services, financing charges, etc. An long-term viability of any price cap plan. Selecting adjustment mechanism to deal with this type of the X-factor is often the most contentious aspect of change is presented in Box 4-7. implementing price cap regulation. The X-factor should be set so that it poses a challenge to the 4.3.5 The Productivity Factor operator. It should promise consumers higher gains relative to alternative regulatory regimes. If the X- The price cap formula includes a productivity factor, factor is set too low, the operator will earn excessive which is based on an estimate of the operator's ex- profits and the regulatory regime could fall into pected productivity increases over the relevant disrepute. If too large an X-factor is selected, the period. This variable, commonly referred to as the operator may not be permitted to meet its revenue "X-factor" or the "productivity offset', ensures that requirement. McCarthyTetrault infoDev 4-17 Telecommunications Regulation Handbook Box 4-7: Inflation Factor for Foreign Exchange Rate Changes A mechanism to adjust the inflation factor in a price cap formula can be triggered by large foreign exchange (FX) rate changes. It is possible that national inflation measures will not adjust rapidly enough to reflect the real impact of large FX changes. For example, this occurred in Indonesia in 1997, when the Asian economic crises caused the Indonesian rupiah to drop rapidly from approximately 2400 rupiah per US dollar to 14,000 per dollar. In comparison, the Indonesian inflation indices remained relatively stable. Since telecommunications operators paid for equipment purchase, financing charges, etc. in foreign currencies, the drop in the rupiah translated into a massive increase in operating costs, which was not reflected in the national inflation indices. To account for such large FX changes, a pre-established mechanism could provide for an adjustment to the inflation factor - for example, if the percentage change in the average monthly exchange rate is higher than the corresponding percentage change in the inflation factor by a specified amount (perhaps 20 to 30%) within any specified period. By way of illustration, let us assume a 25% threshold. If the Indonesian rupiah depreciated by 35% during the relevant period (hence, increasing by 35% the number of rupiah required to purchase a US dollar), but the national inflation measure increased by 30%, the trigger mechanism would not apply. However, if the inflation measure only increased by 5%, an adjustment would be triggered. 4.3.5.1 X-Factor Determination ity. The implementation of this approach is subject to the availability of specific data. The calculation may The X-factor may be divided into the "basic offset' be very data-intensive and requires reliable and and adjustment factors. The basic offset should consistent data of a very specific nature at an reflect the regulated operators historical achieve- adequate level of detail for an adequate period of ment of productivity growth. If the operator has had time. a history of lower input price inflation than other firms in the economy, that should be reflected in the basic The other approach, which we will refer to as the offset. Adjustment factors are included to take into regulatory benchmarking method, recognizes that in account changes in the operating environment of the some instances, past productivity performance may regulated operator. For example, an adjustment not be a good indicator of future expected perform- factor might reflect the introduction of price cap ance. This may be the case where the sector was regulation, the introduction of competition or the pri- previously regulated by discretionary price setting (or vatization of the operator. not regulated at all). It may also be the case where the sector has been inefficiently operated under There are two major approaches to determination of public ownership or is subject to very significant the X-factor. One approach, which we will refer to as structural change, for instance, divestiture. In these the historical productivity method, relies on historic cases, the adjustment factors may be much more information about the productivity performance of significant than the calculated basic offset. A the regulated firm to set the basic offset. Once the benchmarked productivity factor is likely the only basic offset is calculated, certain adjustment factors practical altemative in many developing countries. may be added or subtracted to take into account There the regulator is not likely have access to changes in the operating environment of the reliable and consistent historical productivity data to operator. These adjustment factors are based on determine the historical productivity factor. regulatory benchmarking or other predictive methodologies. This approach is based on the understanding that past productivity, with adjustments, is a good indicator of future productiv- 4-18 infoDev McCarthyTetrault Module 4 - Price Regulation 4.3.5.2 Historical Productivity Method provides an overview of TFP and how it may be applied to the telecommunications sector. A number of empirical methods can be used to help the regulator set the X-factor. Most of these methods Historical Productivity - Basic Offset were developed in the countries that first imple- mented price cap regulation (United Kingdom, Price cap regulation is intended to replicate the United States, Canada, etc.). The preferred method discipline of competitive market forces. These forces to determine an X-factor is to carry out a total factor require operators to improve productivity and pass productivity (TFP) study using historical data on the their gains on to their customers in the form of lower regulated operator and/or on the sector. Box 4-8 prices, after accounting for increases in input prices. If all sectors in the economy were fully competitive, Box 4-8: Total Factor Productivity Productivity is the measure of how effectively an entity employs inputs to produce outputs. It is a measure of operational efficiency. A typical, although partial, measure of productivity in the telecommunications industry is lines (one output) per employee (one input). Lines per employee is obviously only a partial measure, given that one could increase the number of lines by increasing capital investment or materials. Simultaneously, a telecommunications operator produces many more outputs than just the number of lines. TFP (also known as multi-factor productivity) measures how effectively an operator, an industry or an economy employs all inputs to produce all outputs. TFP can be said to have increased if the operator produces more outputs with the same amount of inputs, or if it produces the same outputs with fewer inputs. TFP is equal to the ratio of output volume to input volume. Algebraically the TFP index may be expressed as: TFP = Q/Z Where Q is an index of aggregate output volume and Z is an index of aggregate input volume. Note that for price cap regulation we are primarily interested in the changes in the TFP index, rather than its level. If we refer to changes by the symbol A, the change in the TFP index may be expressed in the following manner: A TFP = AQ/AZ Example: If the output volume index has increased by 5% (i.e. A Q=1.05) and the input volume index has increased by 2% (i.e. A Z= 1.02), the change in the TFP index is 2.94%: A TFP = 1.05/1.02 = 1.0294 Note that for the sake of simplification regulators and analysts often approximate the multiplicative relationship between TFP, Q and Z by an additive relationship. In this instance, if output has increased by 5% and inputs by 2%, it can be said that TFP has approximately increased by 3%: Approximation: A TFP AQ -AZ 5% - 2% 3% It should be stressed that while this type of approximation is fairly common, it is not always accurate. While in the example above the approximation (2.94%) was quite close to the actual number (3.00%), this will not always be the case. Generally, the larger the change in TFP the larger the inaccuracy of the approximation. McCarthyTerault infoDev 4-19 Telecommunications Regulation Handbook output prices in the economy would grow at a rate industry are expected to increase 0.5% annually, equal to the difference between the growth rate of and the corresponding growth rate of input prices input prices and the rate of productivity growth. elsewhere in the economy is 2.5%. In this setting, the X-factor should be set at approximately 4% (= [3 As described in Bernstein and Sappington (1998), if - 1] + [2.5 - 0.5]). Note that for simplicity we have regulated telecommunications operators were like a approximated the X-factor by adding and subtracting typical company, the telecommunications regulator the different variables. As pointed out in Box 4-8, for could replicate market discipline by restricting in- small numbers this is generally a fair approximation creases in the operator's prices to the economy- to the mathematically-correct multiplicative wide rate of price inflation. This restriction would calculation. require the regulated operator to achieve the same productivity gains as that of the typical company, Table 4-2 presents the results of some studies of and to pass these gains on to its customers, after TFP for the US communications industry and adjusting for the typical input price inflation rate. If corresponding TFP performance of the US economy the regulated operator faces the same input price as a whole. Based on Table 4-2 and other studies inflation rate as other companies in the economy, (including those of the Canadian telecommunica- the X-factor should be set at zero. tions industry), it appears that in the long-term productivity growth of the communications industry Generally, therefore, the X-factor should reflect the in North America has been about 2% to 2.5% higher extent to which: than productivity growth of the respective economies. Some of these studies are dated and > the regulated operator is capable of increasing the productivity differential may have changed its productivity more rapidly than other recently. companies in the economy; and The choice of the inflation factor will have an impact - the prices of inputs used by the regulated on the choice of variables to calculate the basic operator grow more slowly than the input prices offset. If a general inflation index is selected for the 1- faced by other companies in the economy (this factor (e.g. GDP-PI or CPI or RPI, etc.), the basic is often referred to as the input price differential productivity offset should be calculated as in the or IPD). example presented two paragraphs above. This is referred to as the differential approach. Based on Telecommunications operators should normally this approach, the figures in Table 4-2 suggest a enjoy faster productvity growth than other basic offset between 2.0% and 2.5%. If a sector or companies due to the more rapid rate of operator-specific index is constructed, however, the technological change in the telecommunications appropriate basic offset is simply the industry. Telecommunications operators may also telecommunications TFP estimate. This is referred have lower input price inflation due to the decreasing to as the direct approach. Based on his approach, unit costs of processing, switching and transmission. the figures in Table 4-2 suggest a basic offset between 3.0% and 3.5%. If the regulated operator can achieve faster produc- tivity growth or enjoy lower input price inflation than Historical Productivity Adjustments other companies in the economy, then the regulated operator should be required to pass the associated Many regulators have adjusted the basic offset by benefits on to customers in the form of lower prices. other factors to take into account significant changes in the operating environment of the regulated For example, assume the expected annual rate of operator. We review some of the key adjustment productivity growth of the regulated operator is 3%. factors below. These adjustment factors are often The corresponding growth rate elsewhere in the determined based on benchmarking or predictive economy is 1%. Input prices in the regulated methods, such as time-series, cross-sectional econometric studies. 4 - 20 infoDev McCarthyTetrault Module 4 - Price Regulation Table 4-2: Selected Estimates of TFP for the US. Study Period COM US DIFF Nadiri- 1947-76 4.1 2.0 2.1 Schankerman Jorgenson 1948-79 2.9 0.8 2.1 Christensen 1947-79 3.2 1.9 1.4 AT&T 1948-79 3.8 1.8 2.0 A.P.C. 1948-87 4.0 1.7 2.3 Christensen 1951-87 3.2 1.2 1.9 Crandall 1960-87 3.4 1.3 2.1 DRI 1963-91 3.0 0.2 2.8 Christensen 1984-93 2.4 0.3 2.1 Note: US Communications Industry (COM); US Economy and Differential (DIFF %) Source: Taylor (1997) Incentive Regulation Factor Competition Adjustment After price cap regulation replaces ROR regulation The rise of strong competition is another structural or, more likely, when it becomes the first form of change that can affect the value of the X-factor rules-based price regulation adopted, operators in under price cap regulation. The effect of increased the industry can be expected to achieve a higher competition, however, is unclear. productivity growth rate than they have in the past. On the one hand, increased competition, like a In such circumstances, some regulators have sup- change in regulatory regime, can force the regulated plemented the basic offset with what is sometimes operator to operate more efficiently, and thereby called a customer productivity dividend (CPD). A achieve a higher productivity growth rate. This would number of econometric studies have examined the seem to favour a higher X-factor, particularly if a impact of incentive regulation plans on productivity CPD has not been imposed. of telecommunications operators. On the whole, these studies have concluded that incentive regula- On the other hand, increased competitive forces can tion has a positive impact on productivity growth. shift market share from incumbent operators to new entrants. The result can be an unavoidable reduction In principle, the CPD should reflect the best estimate in the growth rate of the incumbent's outputs. Par- of the increase in the productivity growth rate in the ticularly in the short run, this lowering of the growth regulated sector that will be brought about by the rate of the incumbent's outputs can be higher than improved incentives inherent in the new regulatory any associated lowering of the growth rate of its regime. This variable, also referred to as the stretch inputs. This leads to a lower productivity growth rate factor, could be allowed to vary over the life of the for the incumbent, arguing for a lower X-factor. The price cap plan. For example, the variable may be empirical evidence on the effect of competition on higher at the beginning of the plan and reduced near productivity growth is mixed. A number of recent its end. CPDs adopted in the US and Canada have time-series, cross-sectional econometric studies generally been below 1 % per year. have found no relationship between competition and McCarthyTetrault infoDev 4-21 Telecommunications Regulation Handbook productivity growth, after taking into account other that the X-factor should be set at relatively high factors. levels. On the other hand, there are some very efficient telecommunications sectors in the Privatization Factor developing world that may not be subject to such "catch-up" phenomenon. The theoretical literature suggests that privatization should increase productivity growth. The theory is Countries that have had a number of price cap plans substantiated by recent econometric studies that have generally increased the X-factor over time. have found privatization to increase productivity by One example is that of British Telecom (BT) in the at least 0.5% to 1.0% per year. United Kingdom (UK), where the X-factor has been increased from 3% in the 1984-1989 period to much 4.3.5.3 Regulatory Benchmarking Method higher factors in recent years (see Table 4-3). This regulatory "tightening" has been a result of better- In some instances, past productivity performance than-expected performance by the regulated may not be a good indicator of future expected operator. The major increases in the X-factor from a performance. This may be the case where the modest initial figure also reflects a degree of sector was not price regulated, was not operated regulatory caution, with an initial bias towards efficiently or is the subject to very significant struc- ensuring the regulated operator's revenue tural change. requirement is met. In these circumstances, or when the operator and/or No price cap plan, no matter how carefully designed, its operating environment are undergoing drastic will be perfect or permanent. It is in the nature of change, the X-factor may have to be developed good regulation to evolve with market and policy based on the informed judgement of the regulator developments. The evolving nature of price cap and its advisors. Intemational experience with price regulation is perhaps best illustrated by the changes cap regulation can provide a useful benchmark in in the various price cap plans that have been applied such cases. This is why we refer to this method as to British Telecom. BT was the first telecommunica- regulatory benchmarking. tions operator subject to price cap regulation. It remains subject to this form of regulation, but as Furthermore, this approach may be the only practi- illustrated in Table 4-3, there have been significant cal alternative in many developing countries changes over the years. Regulators that are because of lack of the very specific detailed considering introducing price cap regulation should historical data over an adequate period of time to take comfort from the British experience. The most calculate TFP. More generally, the historical method significant decision at the time of the privatization of may be less applicable to developing economies for BT was to adopt price cap regulation - not to specify the following reasons: its particular X-factor, and other details. The actual form of regulation was not cast in stone. As in other > Low teledensity levels, and privatization of countries where price cap regulation has since been former government telecommunications opera- adopted, adjustments continue to be made as the tors, can be expected to lead to significant regulator's experience with this form of regulation productivity improvements; increases, particularly with respect to the determina- tion of the X-factor. ' Significant political and economic instability, and the lack of a clear legal and regulatory Table 4-4 and Table 4-5 provide examples of current framework may affect productivity levels, and; X-factors adopted by regulators around the world. Although there is some variation in the actual X- > Recent evidence suggests that technological factors set by regulators, based on this selected catch-up and the possibilities for greater sector sample, when a majority of the operator's services growth in developing countries mean that are included in price cap regulation, many regulators productivity growth should be higher than in have selected an X-factor in the range of 3.5% to industrialized economies. This would suggest 4.5% as the initial X-factor. This range is generally 4 - 22 infoDev McCarthyTetrault Module 4 - Price Regulation Table 4-3: A Summary of British Telecom' s Price Cap Plans Duration X Services Subject to Price Other Main Pricing Main Services Not Caps Constraints Subject to Price Caps 1984-89 3.0 Subscription; local and Residential subscription Rental, international calls, national calling (RPI+2) operator services , con- nection charges, public telephone calls 1989-91 4.5 Subscription; local and Subscription (RPI+2); Rental; international calls national calling connections (RPI+2); and public phone calls. l ___________ private circuits (RPI+0). 1991-93 6.25 Subscription; local and Residential and single line Telephone rental; public national call charges; subscription (RPI+2): telephone calling. international calls; volume multi-line subs. (RPI+5); discounts. connection (RPI+2); private circuits (RPI); median res.bill (RPI) 1993-97 7.5 Subscription; local and All subscriptions (RPI+2); Public telephone calling. national calling; intema- all individual prices in tional calls; connection basket limited to RPI charges. including connection charges; private circuit basket (RPI). 1998-2001 4.5 Retail charges: residential Business assurance Public telephone calling. connection subscription; package, including local, national and inter- subscription (RPI), national calls. Based on analogue private circuits expenditure pattems of (RPI). lowest spending 80% of residential customers. I 8.0 Network charges: non- Services divided into three competitive access baskets, each basket services (call origination subject to RPI-8 cap. and termination, single transit, local conveyance) and interconnection specific service. _ Source: Adapted from OECD (1995) and Oftel (2000a) consistent with the differential approach to calculat- discussed below may assist in regulatory ing the X-factor. The more detailed guidelines judgements to set the X-factor. McCarthyTetrault infoDev 423 Telecommunications Regulation Handbook Table 4-4: X-Factors of Selected National Table 4-5: X-Factors of Selected State Price Price Cap Regulation Plans Cap Regulation Plans in US Country X-Factor State X-Factor Argentina 5.5 Connecticut 5.0 Australia 7.5 Delaware 3.0 Canada 4.5 Georgia 3.0 Chile 1.1 Illinois 4.3 Colombia 2.0 Maine 4.5 Denmark 4.0 Massachusetts 4.1 France 4.5 Michigan 1.0 Ireland 6.0 New York 4.0 Mexico 3.0 North Carolina 2.0 Portugal 4.0 Ohio 3.0 UK 4.5 Rhode Island 4.0 US '6.5 Wisconsin 3.0 Regulatory Benchmarking - Direct Approach :- Differential Approach The long-term historical productivity performance of the telecommunications sector is generally The long-term historical productivity differential accepted to be 3% to 3.5% or higher. We between the telecommunications sector and the discussed this range in the previous section. This economy is generally accepted to be 2% to 2.5% benchmark could be higher where productivity in or higher. We discussed this range in the the telecommunications sector is expected to previous section. This benchmark can be higher grow at a rate significantly higher than that of the where the telecommunications sector is economy. expected to grow at a rate significantly higher than that of the economy. Regulatory Benchmarking - Adjustments The long-term historical input price differential Adjustments can be made for the effects of the (IPD) between the telecommunications sector introduction of incentive price regulation, competi- and the economy is generally accepted to be tion, and privatization, where these conditions apply. positive, but smaller than 1%. The IPD could be These factors and their effects are discussed above. lowered if, for example, a telecommunications Table 4-6 provides a numerical summary of the worker's wages grew faster than that of the benchmark estimates discussed in this Section. average worker. Conversely, the IPD should be These are of a general nature. It is recommended raised if the rate of productivity-improving tech- that each country carry out an appropriate TFP or nological development in the telecommunications benchmarking study based on specific national industry increases. conditions. 4 - 24 infoDev McCarthyTetrault Module 4- Price Regulation Table 4-6: Summary of Benchmark Estimates for Sefting X-Factor (%) Differential Approach | Direct Approach Basic Offset 2.0 to 2.5 3.0 to 3.5 Adjustment Factors Incentive Regulation 0.5 to 1.0 Competition 0.0* Privatization 0.5 to 1.0 Note: * Could be increased to up to 0.5 if competition is combined with privatization. Source: Based on McCarthy Tetrault review of the literature and experience with price cap regulation in industrialized countries. Estimates may be less applicable to developing countries. These estimates are of a general nature. It is recommended that each country carry out an appropriate TFP or benchmarking study based on specific national conditions. 4.3.6 Capped and Non-Capped Services ultimately reflected in retail prices. Access services can also be placed in a separate basket from retail A basic decisions to be taken in price cap regulation services to prevent the dominant supplier from "price is the selection of which services to regulate. In squeezing" its competitors through its control of both general, regulators apply price cap regulation to retail and wholesale pricing. services that are provided on a monopoly or domi- nant provider basis. The rationale for price regulation 4.3.7 Service Baskets is discussed in Appendix B of the Handbook. Having selected the services to be included in price In many markets, the distinction is made between cap regulation, the structure of the price cap plan "basic services" which are price-capped, and other should be determined. One of the features of price K services which are not. Services provided in fully cap regulation is that the regulated operator competitive markets are normally excluded from maintains some pricing flexibility. This flexibility is price cap plans. There is sometimes a grey line particularly important when significant rate rebal- between the categories, and regulators have treated ancing is required within the price cap plan. It is also the same types of services differently. Table 4-7 and important when the operator is facing competition Table 4-8 describe the types of services covered by and must respond quickly to competitive price price cap plans in the same jurisdictions as in Table challenges. Nevertheless, there are a number of 4-4 and Table 4-5 around the world. reasons for the regulator to restrict pricing flexibility. Services are sometimes included in price cap One reason is to restrict the operator's ability to baskets to promote competition and to protect con- engage in inappropriate cross-subsidization. Such a sumers. An example is the case of interconnection restriction can be implemented through the creation charges. Interconnection access charges can be of groups of services, or service baskets, within the included under a global price cap that could price cap plan. An example of how service baskets incorporate consumer "retail" and access constrain flexibility is provided in Box 4-9. "wholesale" services. This would make it possible for expected productivity gains in the provision of ac- It is common practice to place capped services in cess services to be passed on to competitors and be more than one basket. For example, Figure 4-3 and McCarthyTetrault infoDev 4-25 Telecommunications Regulation Handbook Table 4-7: Service Coverage of Selected Table 448: Service Coverage of Selected National Price Cap Regulation Plans Price Cap Regulation Schemes in US Country Service Coverage State Service Coverage 'Argentina Basic services Connecticut Basic and non-competitive services 'Australia Basic and mobile services Delaware Basic services Canada Basic local services Georgia Basic and other services Chile. Local and access services Illinois Non-competitive services* Colombia' Local services Maine All services Denmark Basic and ISDN services Massachusetts Non-competitive services* France Basic services Michigan Non-competitive services Ireland Basic and ISDN Services New York Basic services 'Mexico Basic services North Carolina Basic services Portugal . Basic and leased line services Ohio Basic Services* UK Basic residential services Rhode Island Basic services US Interstate access services Wisconsin Basic and other services Note: * excludes basic residential services Figure 4-4 illustrate the service baskets for the - degree of substitutability of each service. Telecom Australia price cap plan. Different types of services are grouped in. different baskets, and serv- 4.3.8 Individual Service Pricing Restrictions ices with common characteristics are grouped within a single basket. Restrictions can be placed on the relative and/or absolute movement of prices of individual services, Many regulators have established different "sub- as well as on service baskets. This may be done, for caps" on different baskets. In.effect, these basket- example, if the regulator is concemed that the resi- pricing restrictions are used.by regulators to further dential subscription rate may rise too quickly as a constrain the pricing flexibility of the operator. For result of rate rebalancing. instance, in Figure 4-4, subscription services would be subject to the CPI-2% sub-cap of its service The maximum allowable price increase for individual basket and also to the overall price cap of CPI-5.5%. services will be inversely proportional to the weight of the individual service within the services basket. The assignment to baskets is intended to replicate As a result, the price for services with relatively small the effects of competition. The following are general weights could increase significantly if the allowed criteria for assigning capped services into service increase were channelled towards one of these baskets: services and there were smaller compensating decreases in charges for services with relatively : degree of competition in each service basket; larger weights. Conversely, a service with a relatively heavy weight within the proposed services > homogeneity of services (including similarity in basket would be subject to only moderate price demand price elasticities); and increases H the allowed increase were channelled to 4 - 26 infoDev McCarthyTetrault Module 4 - Price Regulation this service, even though compensating decreases provide sufficient flexibility to permit necessary rate were made in services with relatively smaller rebalancing, while protecting consumers from weights. excessive rate increases and competitors from anti- competitive subsidization. Too many restrictions on There are two alternatives to individual restrictions, prices will eliminate pricing flexibility, one of the main each of which may be applied to restrict the benefits of price cap regulations. decreases and/or increases in prices. 4.3.9 Duration and Review of Price Cap One of these methods, commonly referred to as Plans "banding", limits the price movement of specific services relative to another variable, usually the The longer the term of a price cap plan, the stronger inflation factor. For instance, if the regulator is the incentive *for the* operator to improve its concerned about increases in the residential performance. In theory, the duration of a price cap subscription price, an upper restriction could provide plan should be indefinite, so that the regulator would that the price could not increase at a rate greater not intervene in the setting of future prices. than the inflation factor plus 5% (CPI + 5). If the X- factor has been set at 4% and the corresponding 1- In practice, however, this type of price cap regime is factor was 7%, the weighted average of prices could neither feasible nor desirable. A regulator cannot increase by approximately 3% (7% - 4%). The estimate future productivity growth with certainty; nor residential subscription price, however, could can it set the X-factor at the right level for an increase up to a maximnum of approximately 12% indefinite period. With the X-factor set imperfectly, (7% + 5%). This is an example of a relative restric- tion. In the case of Telecom Australia provided in Figure 4-3, the residential subscription and local Box i-9: How Service Baskets Constrain calls are subject to an individual restriction of CPI. Pric'e-Flexibility - Example The other type of restriction is absolute. For As§ume a one-basket price cap plan. It example, if the regulator is concemed that national inGllg!s-riternational services and residential long-distance rates may decline too quickly, a scnption services. Assume both have the downwards restriction could provide that the aver- s weight In the prce cap index. Holding age price of these calls should not decrease by all-oher'prices constant, a decrease in more than 20% per year. domestic long distance prices (say 30°b) can -b-be offset by'a significant increase (also 30%. It is generally considered that relative restrictions are assumring the same revenue weights) in the preferable to absolute ones because they provide residenial subscnption rates the regulator with greater certainty as to the To cs f- offsetting rate movement of the real (inflation-adjusted) prices of arsidenibscription services the services. l.er Scan -be placed in separate baske.s. If thion7ere.-ckone price Restrictions may be upwards or downwards, but do I ds i ric e -offseth b not necessarily have to be symmetrical. For Eq t inr --e o example, if access prices are included in the price cap, they could be subject to relative restrictions with Wri cr glatbr' should not upward and downward bounds (e.g. inflation factor constrain oera f ieing ±5%)n r r ai I al- pnce 5constraintsor bands cn !ed- to limit price in es to particularlyi sensitive Restrictions on the regulated operator's pricing flexi- si i lon the overall bility have been implemented by most regulators. priin e o oa s Care must be taken to design restrictions that are intemally consistent and do not unduly constrain the __ operator. Judgment is required to set restrictions that McCarthyTetrault infoDev 4-27 Telecommunications Regulation Handbook L,ca'Ca"', _ _______,__a r__ W~~~~-a Ca-- Su 1aI 2~~~~~~~, l. P l ,_ D'~~C, .a.sh;c D Ca-.aloEla l |. v- Oe31PcCr P- t =3 n.op,a, aP R ""o' C I CMoes C I--: I . , i * Don esol; L,caJ'r | l ,rrr.onDr. n | . | * lnrPTlLr arlu Callsa | a . ara mes. n mua' the operator would either earn insufficient revenues Theprice capns CPI Crevi s Sprocess ld ineffici nd! i esut ina r. r , an ., p u3erp rt i t hea CXac Om r T t i t.w... l-CSc .. Rcju-X5*Dnru Deaofl3ed world p*ice cap plan, the regulator generally sets a will be C6aprary1 u o lernanmDecucavew l revised. At the4 end ofe thelduration period, a review is grapplewith. the operator would either eam insufficient revenues The pance cap plan review process should be or unacceptably high profits. Both outcomes are carefully designed. The key variable that will have to inefficient and unsustainable. As a result, in a real- be reviewed, and perhaps reset, is the X-factor. This woud price cap plan, the regulator generally sets a otll be a primary focus of the review. It involves minimum period during which the X-factor will not be some complex incentive issues for the regulator to revised. At the end of the duration pe stod, a review is grapple with. undertaken. Regulators have typically chosen periods of three to five years. If producnc vity improvements achieved by the operator exceed the X-factor by a substantial The duration of the plan should be sufficiently long to amount, the particull mfte significant profits. allow effciency incentives to be acted on. However, There may be pressure on the regulator to adjust the it should not be so long that market developments value of the X-factor upwards. Rate of retumn or underminththtr. e Regulatory Bench- other profit indicators are generally used to reset the marking Section, above, it was suggested that a X-factor. This review mechanism will reduce the prudent approach would be to set an initial X-factor regulated operator's incentive to continue to conservatively. In such as case, the plan should be increase its productivity. The incentives for further reviewed reasonably soon, to minimize the negative efficiency improvements will tend to fall as the impact of miscalculations or errors of judgement in review approaches, particularly if the operator knows setting the X-factor. that any additional cost savings will result in a higher X-factor resulting from the review process. In this 4 - 28 infoDev McCarthyTe-trault Module 4 - Price Regulation instance, price cap regulation will approximate ROR regulation during the review period. The optimal Box 4-10: Examples of Unexpected Input selection of incentives/disincentives will ultimately be Price Change Outside Control of based on regulatory judgement. Regulated Operator The approach to, resetting the X-factor will depend An increase in customs duty from 20% to on how the regulator evaluates the need for the op- 40% is imposed on imported capital erator to earn higher profits to increase its ability to equipment, including telecommunications attract investment, compared to the consumer equipment. The telecommunications operator benefits of lower prices (operator-consumer equity faces a significant input price increase. objective). It will also depend on the relative Assuming new equipment purchases account importance placed on productive and dynamic for 20% of the annual costs of the operator, efficiency. The higher the weight placed on costs by 4%. This change may not be fully consumer benefits relative to profits in the short reflected in the inflation factor. Assuming that term, the more the regulator will tend to reduce new foreign equipment purchases account for future profits by setting a higher X-factor at the time 5% of economy-wide costs, an economy-wide of the review. inflation index would increase by only 1%. As a result, the operator would have to absorb 4.4 Price Cap Variations the remaining 3% increase in its costs. 4.4.1 Introduction This Section considers some of the variations that inflation factor. Most developing country price cap have been applied to the basic price cap formula. plans do not include a Z-factor. However, the situa- Depending on national telecommunications market tion may be quite different in emerging markets conditions, regulators may include some of these where significant exogenous events are more variations in their price cap plan. common. ment, the amended price cap formula would be as As discussed above, the inflation factor is a proxy for follows: the changes in the regulated operator's input prices. There may be instances, however, when the PCI' = PCI-' x (1 + I'- X ±Z) EL operator faces a significant change in input prices that are outside its control and not captured by the It should be recognized that the practical application inflation factor. An example is provided in Box 4-10. of a Z-factor adjustment could be administratively Regulators must decide whether to include in the challenging and a source of controversy. Some of price cap formula a cost pass-through variable (also the uncertainty can be eliminated by carefully referred to as an "exogenous" variable or "Z-factor') defining the types of cost changes covered by the Z- to address this possibility. factor. The inclusion of a Z-Factor in a price cap formula is Based on the considerations outlined in Box 4-11, not always warranted. Many US state regulators the regulator should define the exogenous factor to have not included a Z-factor in their price cap plans. promote certainty in price regulation of the sector. In They may consider that there are very few truly preparing this definition, the criteria should be exogenous events that are not captured in the general enough to capture the impact of certain events without diminishing the operator's incentive to control its costs. McCarthyTetrault infoDev 4-29 Telecommunications Regulation Handbook Box 4-11: What are Exogenous Cost Changes? The following considerations are relevant in determining which cost increases may be covered by a Z- factor: r Generally, legislative, judicial or administrative actions that have a signiricant impact on the regu- lated operator should be considered. Such actions are usually beyond the control of the operator. With respect to 'significant", there may be an advantage to setting a threshold below which adjustments would not be considered. A threshold in the range of 1% to 2% of revenues may be reasonable. > Regulators should only consider events that do not represent normal business risk. In assessing whether costs should be included in a Z-factor, the regulator should consider whether the operator can take reasonable measures to mitigate the consequences of the cost-producing events. >- The Z-factor costs should not otherwise be reflected in the price cap formula and must be such that they have specific or disproportionate impact on the operator. The burden of proof should be on the operator to show that the proposed event is not already accounted for in the inflation factor and would be reflected in prices charged by operators operating in competitive markets. > Events, such as an economic downturn, that affect the whole economy would generally not be considered to produce exogenous cost increases eligible for Z-factor treatment. While such events may have a negative impact on the demand for the operator's services, and decrease its ability to recover costs, the purpose of the Z-factor is not to guarantee a rate of return for the operator. Such a guarantee would not be consistent with the objective of using price cap regulation as a proxy for competitive market conditions. >- Z-factor costs should be quantifiable and known. The operator must be able to estimate the spe- cific costs in monetary terms. In theory, the impact of the exogenous event should operator to request the consideration of an event be allocated across capped and uncapped services, that has increased its costs. Where an event has with only the impact allocated to capped services decreased the operator's costs, however, the being included in the price cap formula. In practice, operator has no incentive to request consideration. If the regulator could use revenue shares or other a Z-factor exists, the regulator will likely have to weights to allocate the impact to capped services ensure that savings are passed on to consumers. only. 4.4.3 Quality of Service Generally, the regulator will design the exogenous factor so that the regulated operator must request Like other services, telecommunications services the inclusion of exogenous cost changes in the price have a quality component and a price component. In cap formula. The onus is placed on the operator to theory, a telecommunications operator subject to take action in the matter. The regulator only has to price cap regulation could increase profit by lowering decide on the issue if and when there is an applica- the quality of its service. This prospect is of most tion before it. concern when the operator is a monopolist, or is dominant so that it's service levels are not subject to An exogenous event may increase or decrease the effective competitive pressure from other operators. costs of the operator. It will be in the interest of the 4-~ 30 infoDev McCarthyTetrault Module 4 - Price Regulation Table 4-9: Q-Factor Example -Rhode Island Scheme The price regulation plan for the incumbent operator in Rhode Island, NYNEX, includes a Service Quality Adjustment Factor 'SQAF". It was added to the basic price cap formula in the following manner NYNEX provids PCI= PCI" x (1 + t_ X ± SQAFt) A i Each month, NYNEX provides reports to the regulator on QoS performance. As illustrated in the table below, the maximum value for the Service Quality Index (SQI) is 42. The regulator has determined that a passing monthly score is 25. The price cap formula is adjusted once a year. At that time, for each of the 12 most recently measured months that NYNEX has not achieved a passing score in the SQI, the SQAF will be increased by .0417%. Hence, if NYNEX does not. receive a passing score in 6 months, the SQAF will take the value of 0.25%, and prices must be decreased by that amount in the next period to compensate for poor QoS performance. Nynex Performance Points New Installations orders not completed <12 2 within 5 working days (%) 12.0-13.99 1 _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ Ž1 4 .0 0 'Installation appointments missed (%) < 2.5 I 2 2.5 - 3.49 1 Ž3.5 0 Line out of service > 24 hours (%) < 40 4 40- 44.99 2 Ž_~45 0 Repeat repair reports (%) < 1 1 2 11.0 -13.99 I I 14 0 Repair service answer time (sec.) < 14.0 4 1.0 -17699 1l2ll Ž17 i 0 Directory assistance answer time (sec.) < 4.0 2 4.0 -5.991 Ž 6.0 0 Average duration time - special access < 2.5 2 1.5 Mbps Circuits (hours) 2.5 -4.49 1 24.49 0 Sub-total (maximum available) 22 Customer trouble reports per 100 lines < 4.0 2 per central office (CO) 4.0 -4.99 1 Ž5 I 0 Sub-total (maximum available assuming 20 10 CO's reviewed) TOTAL POSSIBLE POINTS/MONTH 42 McCarthyTetrault infoDev 4-31 Telecommunications Regulation Handbook Telecommunications Quality of Service (QoS) has minimum quality standards similar to minimum price many aspects. It has traditionally been measured by floors. It should be recognized that the incorporation a number of QoS indicators, such as: of a Q-factor can be complex and administratively challenging. Few regulators have integrated QoS - Call Completion Rate and price cap regulation in this manner. - Dial Tone Delay 4.4.4 New Services > Delivery Precision A key objective of telecommunications sector reform is to promote innovation, particularly in the introduc- > Call Failure Rate tion of new services. The regulator must determine whether or not to subject new services to price - Fault Clearance regulation. If the decision is affirmative, price cap regulation is sufficiently flexible to accommodate ) Complaints most new services. - Billing Accuracy. In markets that are subject to competition, many regulators have concluded that it is not in the public If a regulator decides to regulate QoS of an operator interest to regulate most new services. Such subject to price cap regulation, it can adopt several decisions provide an additional incentive for opera- approaches. The traditional approach is to set a se- tors to introduce innovative services; mobile services ries of QoS targets or standards for each indicator. are a common example. Sub-standard performance can be dealt with on a case-by-case basis, or by pre-set sanctions (e.g. Where such a decision is taken, it is important for monetary fines or penalties payable by the the regulator to ensure that a regulated operator's operator). "new" service is truly new. Operators will have an incentive to try to repackage existing services as An innovative approach is to integrate a QoS "new" services in order to avoid price regulation. To variable, often referred to as a Q-factor, in the price avoid confusion in the industry, the regulator may cap formula. This is a relatively new approach. It is want to consider publishing a definition of a new being implemented in a few states of the US. Table service based on the criteria, such as the following: 4-9 provides a summary of such an approach in the US State of Rhode Island. A similar approach has - Does the new service include a new technology also been recently adopted in Colombia at the or functional capability? national level. This approach is consistent with the objectives of incentive regulation. In addition, it has > Does the new service replace an existing the advantage of directly linking QoS with the price service and consequently not expand the range mechanism, thus mimicking the quality/price trade- of services available? off in competitive markets. The following formula illustrates how a Q-factor fits into the basic price cap 4.4.5 Rate Rebalancing and Price Caps formula: Rate or price rebalancing is discussed in Section PCIt = PCI'l- x (1 + It- X i Q') 4.1.2 and in Appendix 4.2. It refers to the adjustment of price levels for different services to more closely The objective of including a Q-factor is that a reduc- reflect the costs of providing each service. Rebal- tion in quality should result in lower prices for ancing can be achieved under most forms of price consumers. Conversely, increased quality may lead regulation. to higher prices. If there is concern that quality may drop to unacceptable levels, the regulator may set 4 - 32 infoDev McCarthyTetrault Module 4 - Price Regulation A regulator that implements a price cap plan should 4.4.6 International Accounting Rates consider including a transitional period for rate rebalancing, either before the plan comes into effect Technological developments and the liberalization of or as part of the plan. The transition period should telecommunications markets have put downward be kept as short as possible and, depending on the pressure on international accounting rates. level of price-cost imbalances, should not last more Accounting rates are the charges payable to inter- than 5 to 7 years. This will ensure that prices at the connecting intemational operators under traditional beginning of a price cap plan are more in line with settlement arrangements for mutual termination of costs than they would be without a transition period. traffic between their networks. In most countries, In a number of countries, regulators have allowed during the last few decades of the 20th Century, the the regulated operators a period of several years to level of accounting rates was well above the cost of providing intemational service termination. achieve limited rebalancing. This decision is based on the conviction that the benefits of price cap Profits from high accounting rates provided a signifi- regulation are greater when prices are balanced. cant source of cross-subsidies, particularly to Rebalanced prices are clearly closer to those found developing countries. It also led to a major in a competitive market. imbalance in payment of accounting rates from countries that originated more calls than they A new regulator will likely be confronted with the terminated. There has been strong pressure from necessity to rebalance prices and to introduce a the US and other countries with outbound account- form of price regulation for the first time. Given the ing rate imbalances to reduce accounting rates. This benefits of rebalancing and price cap regulation, pressure, the ITU response, international service neither should be delayed. Hence, there may be no competition and technological developments have opportunity to attain any significant rebalancing prior all led to significant decreases in accounting rates. to the implementation of price cap regulation. It will have to be done as part of a price cap plan. The One recent technological development that under- regulator may prescribe the specific targets or target mines the accounting rate regime is Internet ranges for some or all prices for regulated services. telephony, also referred to as "Voice over the Some regulators have only specified end-of-period Internet', or "voice over IP" (VoIP) technology. targets while others have also specified intermediate Internet telephony generally bypasses the account- targets. In this manner the regulator may be sure ing rate regime, and hence allows VolP providers to that over the transition period the operator will move price their services below those of operators of prices in the desired direction. If this is done, the conventional PSTN networks. operator should be given sufficient pricing flexibility to achieve rebalancing. The downward trend in intemational accounting rates can be seen as an international form of rate Establishing a transition period for rebalancing rebalancing - between international and national before a price cap plan is implemented is only a service. Operators in a large number of countries will practical option when there is another form of price need to increase revenues from national services to regulation in place. In Canada, the incumbent offset potential losses from international settlements. operators were subject to ROR regulation during the transition period. Clearly, where the operator is a The demand for international calling is generally privately-owned monopoly or dominant operator, considered to be price elastic, especially at higher some form of price regulation is preferable to none prices. Reductions in international rates will there- at all. In countries where price cap regulation is the fore usually lead to increases in international calling. first form of price regulation to be introduced, the Local access and calling, on the other hand, are more desirable option will be to undertake rate generally less price elastic. The result of this rebalancing within a price regulation regime. rebalancing could therefore be higher overall revenues for operators providing both services. McCarthyTetrault infoDev Telecommunications Regulation Handbook The need to rebalance intemational and national implement rebalancing. The potential volatility of rates has important implications for price cap regula- intemational prices and uncertainty of customer tion. For many countries, a significant amount of rate response, may make it beneficial for the regulator to rebalancing may be both desirable and necessary. implement a fixed-weights scheme for the price cap Accordingly, pricing restrictions should not deprive formula, at least until the majority of the rebalancing the operator of sufficient pricing flexibility to has occurred. infoDev McCarthyTetrault Module 4 - Price Regulation Appendix 4-1: OECD Rate Rebalancing This appendix provides an overview of the OECD greater than a local call at 3 km. In 1998, the margin tariff comparison methodology and recent analysis was reduced to about seven times. of rate rebalancing trends in the OECD member countries. There are a number of reasons for postalized rates. Incumbent operators typically tend to reduce the Figure 4-5 and Figure 4-6 show the most recent number of long-distance bands in response to com- Business and Residential Tariff basket comparisons petitive entry. Another reason is the prevalence of for OECD member countries. Note that these discount plans that require consumers to sign up to baskets are based on standard listed prices rather a specific operator, often having to pay a fee. In than the myriad of discount schemes generally return, loyal consumers receive significant savings available in competitive markets. over standard listed prices. Figure 4-1 in the main text of this Module indicates that rate rebalancing is In its 1999 publication, Communications Outlook, the also evident in the price trends of calls at different OECD noted significant rate rebalancing in its 29 distances. member countries. For instance, it noted a major trend towards postalized rates at the national level. Rebalancing has been slower for the residential Postalization is the term given for the trend towards basket, as shown in Figure 4-8, than the business flat rates for long distance services regardless of the basket, which is illustrated in Figure 4-2 in the main distance. In other words, long distance service is text of this Module. When rate rebalancing occurred heading for a world where, like postal services, it is in 1994, however, significant cost savings for both usually priced the same irrespective of distance. residential and business consumers were realized. This has been referred to in the industry as "the Fixed charges are now slighty lower than in 1990. death of distance." Combined with usage charge reductions in the order of 25%, the overall price of the basket has been For instance, Figure 4-7 shows the dffference reduced by nearly 15%. Note that overall teledensity between the cost of long distance calls and a local in the OECD countries has increased steadily, call (3 km) between 1990 and 1998. In 1990, the despite rebalancing. average price of a call at 490 km was 20 times .~ x~:2 OEDTrf GomarsoVMt5 _ _Io i ____ In19 e stablsda harmonie to g h Mnables international comparisons of naitionaltelgecommunicatons is using abasket thdifferentelemrenis for a particular service. This = 3N = = ', , ...oss....n...es.an....acr,,- .iI nreh all esidian ce p b s landusiness consumers, the [ cn a Residntialbasket d Busi basketEcnbs de up of two elements, ra = IE § ;1 e l z =9Fubscription with the installation @ne h fie chrg is clcltd th usglhreiae on.E-CD averages for the overall aloato of fie chrgs to usage chrgs. Bae ntelpoeuaeitrste usage charge canl bealctdt ainlcls hs cals aethnpicdoto acof the countries to arrve at the m ary aut in o exchange rates or based on McCarthyTetrault infoDev 4~3 Telecommunications Regulation Handbook Figure 4-5: OECD Business Tariff Basket 100 I~~~~~~~~~~~~~~6 I Figure 4-6: OECD Residential Tariff Basket w ~ I am 7W0 532 300 -lTF l-flHh 14M 4-36 ~~~~~~~~~~~~infoDev McCarthy T&rau1t Module 4- Price Regulation Fiue -: ne of 0ED Taifeanin,byya- Th Daho Istn 2 t t i | 2000 2(KI 1000 1000 3 kM 7 W. 12 cm 17 krn 22 1cm 27k AOr . m r 75 ,nIc 110krn 135krn 175c Žr 501c 3(Km 9c ._ _ __ _ _ __ _ __ I McCarthyTe'trault infoDev Telecommunications Regulation Handbook Appendix 4-2: Welfare Benefits of Rate Rebalancing This Appendix provides an overview of the potential Table 4-10 provides a summary of the main esti- benefits to public welfare that may be expected from mates used in the model. By way of explanation, the rate rebalancing. unit of measurement for access is connections. For local calling, it is number of calls, for long distance The OECD study of telecommunications price trends and international calling, it is minutes. Net revenue is (Appendix 4-1) indicates that rate rebalancing pro- the difference between price and cost (LRIC) times vided most consumers with lower prices in a majority the quantity. For instance, the net revenue loss for of the countries surveyed. This is not the only benefit residential access of $614 million is equal to the of rebalancing. Rate rebalancing will also increase difference between price $139.80 and LRIC social welfare by moving prices closer to costs. This $235.00, times 6.45 million connections. Note that will provide benefits to the economy in addition to the sum of the net revenue is $2,909 million, which those that result in lower overall prices. Rate rebal- we later assume to be its net revenue requirement. ancing, therefore, should be undertaken whether competition is being considered or not. The price elasticity of demand was based on a review of available estimates that were considered Regulators may* be requested to justify rate appropriate for national conditions. With the rebalancing. The recent modelling of rate exception of local calling elasticity, the estimates are rebalancing that carried out in Australia may be within the intervals discussed in the Appendix B of useful in this regard. The model was prepared for the Handbook. Australia's incumbent operator, Telstra, to estimate the potential efficiency gains from different The concept of efficiency loss requires some expla- rebalancing scenarios. Similar analyses have been nation. It is based on the theory that marginal cost carried out in other countries. This example uses a pricing is optimal, that is, it maximizes the sum of number of concepts, including long run incremental consumer and producer surplus. (This concept is costs (LRIC), demand elasticities, revenue discussed in Appendix B of the Handbook.) When requirement, and Ramsey Pricing, which are prices do not equal marginal costs, there are effi- discussed in Appendix B of the Handbook. ciency losses because either consumer or producer Table-1O: Estimates Used in thee-Telstra Rate Rdbiancio - ~ Price LURIC, Markets . T t R E i E f *ari | ($ per unit) rS unit) mLs() ea Resess 13980- 235 00 - 5m -61 ,1i l .BBus tcess 240:00 23500 2--76 i o'IocalmiIs 0.2321 0-099 i1120Pb - 149 . - d Dom.i calls 0.311 0-124 : 2 9w51 60 1782 . lhII tnl.aiis 1.1'290 - 0'w -759- 6098 s '6 l . I lk _ _-__ _ __ _ 290 _,_ aO . Cl =Sourc ,Australia Productivity Cetr(1997) T- 4 - 38 infoDev McCarthyTetrault Module 4 - Price Regulation surplus are reduced. Figure 4-9 provides a graphical $402 million, or nearly 15% of total operator presentation of the main estimates used in the revenues. Note, however, that while marginal cost analysis. The black shaded areas are the efficiency pricing will eliminate this loss in economic efficiency, losses associated with each instance of non- it will not meet Telstra's net revenue requirement, marginal cost pricing. Note that efficiency losses which is assumed to be equal to $2,909 million. As increase when the price-cost disparity is greater and discussed in Appendix B of the Handbook, the solu- when demand is more elastic. (Note the light shaded tion to this dilemma is to calculate the corresponding areas represent net revenues for each service). Ramsey prices, that is, the set of prices that minimize efficiency losses and meet the revenue The price-cost gap at initial conditions (the base requirement. scenario) imposes a loss in economic efficiency of Residential access (connections) Business access (connections) ,. ILRIC = 235 240 , | _ ~~~~~~~~~~~~~~LRiC -235 . P- 13980 l 3 l~ . .6.45m 2.76m Local Calling (calls) Domestic LD Calling (minutes) P 0.232 P01 00991 ~~~~~~~~~LRIC =0.124 l , ~~~LRIC =0.099t|lC 11.2b 9.51 m International Calling (minutes) ~,Nt:Fgr s ar noIosae P=1.129_.l LRIC 0 759| l 638m. e.. McCarthyTetrault infoDev Telecommunications Regulation Handbook Table 4-11 presents the results of five rebalancing Scenario #2 holds the business access price to scenarios, with the corresponding net revenue con- $350 and calculates the constrained Ramsey prices. tribution and efficiency losses, and contrasts these Scenarios #3, #4, and #5 are other permutations to the base scenario. that put further constraints on prices. Note that the more constraints that are placed on Ramsey prices, Scenario #1, which totally eliminates the efficiency the smaller the efficiency gains. Note also, however, loss, would appear to be an extreme case. Ramsey that even modest price movements towards LRIC prices call for the highest price over cost mark-up for can result in significant efficiency gains. These gains the least price-sensitive service. In this instance, are likely to be greater in developing countries business access price is raised to $1,287 and because of the generally greater disparity between contributes the entire net revenue of $2,909 million prices and costs. because it has an estimated zero price elasticity. Table 4-11: Results of Rate Rebalancing Scenarios Variable Residential Business Local Domestic International Total Access Access Calls LD Calls Calls Scenarios LRIC $ 235.00 235.00 0.099 0.124 0.759 Base Scenario Price ($) 139.80 240.00 0.232 0.311 1.129 Net. rev ($m) -614 14 1492 1782 236 2909 Eff. Loss ($m) 8 0 26 322 46 402 Scenario 1: Price ($) 235.00 1287.00 0.099 0.124 0.759 Unconstrained Ramsey Pricing Net. rev ($m) 0 2909 0 0 0 2909 Eff. Loss ($m) 0 0 0 0 0 0 Scenario 2: Price ($) 354.00 350.00 0.235 0.148 0.804 Constrained Ramsey Prices Net. rev ($m) 723 318 1529 301 38 2909 l Eff. Loss ($m) 13 0 27 5 0 45 Scenario 3: Price ($) 235.00 350.00 0.291 0.158 0.822 Constrained Ramsey Prices Net. rev ($m) 0 318 2120 418 53 2909 Eff. Loss ($m) 0 0 54 10 1 65 Scenario 4: Price ($) 235.00 350.00 0.232 0.209 0.919 ConstrainedI Ramsey Prices Net. rev ($m) 0 318 1492 975 124 2909 Eff. Loss ($m) _ 0 0 26 67 8 101 Scenario 5: Price ($) 140.00 350.00 0.232 0.272 1.036 Constrained Ramsey pices Net. rev ($m) -614 318 1492 1520 194 2909 Eff. Loss ($m) 8 0 26 203 25 262 Source: Australian Productivity Centre (1997) 4-~ 40 infoDev McCarthyTetrault MODULE 5 Competition Policy Table of Contents Module 5- Competition Policy 5.1 General Principles 1 5.1.1 The Rationale for Competition Policy 1 5.1.2 Government Intervention to Implement Competition Policy 2 5.1.3 The Interplay of Competition and Telecommunications Policies 3 5.1.4 The Transition from Monopoly to Competition in Telecommunications 7 5.2 Basic Concepts of Competition Policy 10 5.2.1 Market Definition 10 5.2.2 Barriers to Entry 11 5.2.3 Market Power and Dominance 11 5.2.4 Essential Facilities 13 5.3 Remedies for Anti-Competitive Conduct 14 5.3.1 Abuse of Dominance 14 5.3.2 Refusal to Supply Essential Facilities 16 5.3.3 Cross-Subsidization 17 5.3.4 Vertical Price Squeezing 24 5.3.5 Predatory Pricing 27 5.3.6 Misuse of Information 28 5.3.7 "Locking-in" Customers 28 5.3.8 Tied Sales and Bundling 29 5.3.9 Other Abuses of Dominance 31 5.3.10 Restrictive Agreements 31 5.4 Mergers, Acquisitions and Other Corporate Combinations 33 5.4.1 Concerns About Mergers 33 5.4.2 Merger Analysis 34 5.4.3 Merger Remedies 36 5.4.4 Joint Ventures 40 McCarthyTetrault infoDev 5-i Boxes and Tables List of Boxes Box 5-1: Substantial Lessening of Competition: Proposed Malaysia Approach 6 Box 5-2: Case Study: Canadian (CRTC) Forbearance Analysis 7 Box 5-3: Case Study: The Telecommunications Mandate of the Australian Competition and Consumer Commission 8 Box 5-4: Market Dominance: A European Commission Definition 13 Box 5-5: Essential Facilities - WTO Definition 13 Box 5-6: Abuse of Dominance by a Telecommunications Operator: Common Examples 16 Box 5-7: Some Powers to Remedy Abuse of Dominance 16 Box 5-8: Example of Vertical Price Squeeze by Incumbent Operator 25 Box 5-9: Basic Elements of Wholesale Cost Imputation Requirement 25 Box 5-10: Case Study - The CRTC Imputation Test 26 Box 5-11: What is Predatory Pricing? 27 Box 5-12: Case Study - OFTEL Investigation of BT's Internet Services 28 Box 5-13: Case Study - DG IV Intervention in "SIM Locking" 29 Box 5-14: Case Study - CRTC Bundled Service Conditions 31 Box 5-15: Some Other Forms of Abuse of Dominant Position 32 Box 5-16: Examples of Restrictive Agreements 33 Box 5-17: Case Study - The Telia / Telenor Merger 37 Box 5-18: Case Study - FCC Review of Bell Atlantic/Nynex and SBC/Ameritech Mergers 38 Box 5-19: Case Study - The BT/AT&T Joint Venture 40 List of Tables Table 5-1: Typical Differences Between a Competition Authority and a Sector-Specific Regulator 4 Table 5-2: Scenario A: No competition in basic telephone services; competition in cellular and value-added services (e.g. Internet access, e-commerce services) 20 Table 5-3: Scenario B: No competition in local access services; competition in long distance, international cellular and value-added services (e.g. Internet access, e-commerce services) 20 Table 5-4: Scenario C: (same assumptions as Scenario B) No competition in local access services; competition in long distance, international cellular and value-added services (e.g. Internet access and e-commerce) 21 5 - ii infoDev McCarthyTetrault COMPETITION POLICY 5.1 General Principles supplier. There would be no negative external fac- tors associated with supplier or consumer behaviour. 5.1.1 The Rationale for Competition Policy No single supplier would be able to distort the efficient operation of the market, or the setting of When competition exists in market-based econo- prices or supply conditions. mies, two or more different suppliers contend with each other to sell their goods or services to However, no markets are perfectly competitive. customers. Competitive suppliers may offer lower Many markets are not truly competitive, but are prices, more or better quantities, and packages or dominated by a small number of large or well- qualities of service to attract customers. Competition established firms. Producers or suppliers in such serves the public interest by inducing suppliers to markets often have market power that can be exer- become more efficient and to offer a greater choice cised to the detriment of consumer welfare and of products and services at lower prices. overall industry performance. In a competitive market, individual suppliers lack Imperfect competition gives rise to an inefficient 'market power". They cannot dictate market terms, allocation of resources. Imperfect competition is an but must respond to the rivalry of their competitors in important source of "market failure". Market failure order to stay in business. Market power is generally occurs when resources are misallocated or allocated defined as the power to unilaterally set and maintain inefficiently. The result is waste or lost value. prices or other key terms and conditions of sales; that is without reference to the market or to the Monopoly actions of competitors. Monopoly can be the result of market failure. A Imperfect Competition monopolistic market is often associated with exces- sively high product prices, reduced supply levels or In a perfectly competitive market, there would be other behaviour that reduces consumer welfare. little or no reason for government intervention to Collusive agreements among suppliers are another implement competition policy. Such a market would example of market failure. Supplier collusion can be ideally consist of a large number of suppliers of directed to increasing prices or restricting output, products or services, as well as a large number of behaviour that is similar to the exercise of monopoly consumers. Consumers would have complete power. information and freedom to deal with any chosen McCarthyTetrault infoDev 5-1 Telecommunications Regulation Handbook Telecommunications has, in most jurisdictions, Types of Government Intervention developed in a monopoly environment. As competi- tion is introduced into telecommunications markets, Competition policy is generally applied through two there are typically concems about the continuing different types of govemment intervention. exercise of market power by the incumbent opera- tor. This exercise of market power constitutes a The first type is behavioural. In this type of interven- special form of market failure that must be tion, a public authority attempts to modify the addressed by regulators and competition authorities behaviour of a particular firm or group of firms in many countries. through regulation of their behaviour. Price regula- tion is an example of behavioural intervention. Other 5.1.2 Government Intervention to Implement examples are orders prohibiting collusive practices Competition Policy or agreements, and orders requiring interconnection of competitors' networks. Objectives A second form of intervention is structural. Such Governments intervene in the operation of a market- intervention affects the market structure of the based economy for a variety of different reasons. In industry. For example, govemments may intervene the case of competition law and policy, the main to prevent a merger of the two major telecom net- objectives of govemment intervention are to respond work operators in a market. Similarly, a dominant to market failures, to limit abuses of market power supplier might be required to separate its operations and to improve economic efficiency. This Module will into distinct corporate entities, or to divest itself of focus on competition laws and policies that are lines of business entirely. The 1984 AT&T divestiture aimed at achieving those objectives. in the United States provides a well-known example of the latter. Public intervention can have other objectives. For example, a govemment may adopt rules and Flexibility policies that limit the participation of foreign capital or companies in order to create or cultivate a domestic Govemment intervention in markets generally industry. Such intervention may deliberately limit requires flexibility and an ability to tailor rules and competition and compromise economic efficiency in principles to specific circumstances. In some favour of other public interests. instances, competition rules can be formulated as outright prohibitions (for example, against price fixing There is a long history of govemment intervention to agreements). In many situations, however, pro- preserve and stimulate the operations of competitive competitive rules are formulated so that there is dis- markets. Many useful precedents for competition cretion in their application. For example, price policy have developed in the US, where the term discrimination is not always inappropriate; only anti- "antitrust policy" is used to refer to what is often competitive or otherwise harmful forms of price dis- called "competition policy" in other countries. This crimination are generally prohibited. term "antitrust" comes from an old form of anti- competitive conduct once engaged in by the owners Competition policy is applied to curb abuses of of different companies that had the power to jointly market power and to prevent a powerful firm from dominate a market (e.g. steel or rail transport). forcing competitors out of the market. However, These owners delivered the majority of their shares there is a tension between the objective of protecting to a central body, which would hold the shares "in competition and the more problematic practice of trusf' for the owners. The trust's control of the protecting individual competitors. This tension is shares was then used to direct the actions of the particularly evident in the regulation of the telecom- different companies. The objectives of such joint munications industry during the transition period direction included raising prices across the industry, from the introduction of competition to the time com- restricting supply and otherwise acting to reduce petition becomes self-sustaining. competition. 5 - 2 infoDev McCarthyTetrault Module 5 - Competition Policy Competition policies generally have no iron-clad The types of policies typically adopted by sector- rules that must be rigourously applied in all circum- specific regulators can also be contrasted with those stances. The policies must be applied flexibly to suit of competition authorities. Sector-specific regulation the circumstances of different markets. is often unrelated to (and even inconsistent with) the key competition policy goals of facilitating competi- 5.1.3 The Interplay of Competition and tion and improving economic efficiency. Competition Telecommunications Policies policy is typically directed at preventing market participants from interfering with the operation of Some countries have both a general competition competitive markets. Traditional telecommunications authority and a sector-specific telecommunications regulation, on the other hand, often manipulated regulator. Where two or more authorities exist, it is competitive market circumstances to achieve other important that they not subject an industry to dupli- public goals. cative or inconsistent intervention. An example is the prices approved by telecommuni- Not all countries have separate telecommunications cations regulators. Most regulators traditionally regulators and competition authorities. For example, supported price structures that were very different New Zealand has long had economy-wide competi- from prices that would prevail in a competitive tion law, but no sector-specific regulator. While New market. Telecommunications regulators often Zealand is an anomaly in this regard, other countries supported such price structures in an effort to have telecommunications sector regulators, but no increase availability of basic telecommunications economy-wide competition law or authority. Some services. Examples include various types of cross- countries have neither. In any case, it is important subsidization: local service by long distance serv- for those involved in the regulation or supervision of ices, residential subscribers by business subscribers the telecommunications sector to understand and and rural subscribers by urban subscribers. These have access to the basic tools provided by competi- price structures were typically developed in a period tion law and policy. of public monopoly supply. These structures are not sustainable in a competitive market. They require Sector-Specific Regulators and Competition adjustment as competition develops. (See Module 4 Authorities for a further discussion of telecommunications pricing.) Table 5-1 sets out the typical difference The roles of a sector-specific telecommunications between a competition authority and sector-specific regulator and a general competition law authority regulator. can be compared and contrasted in several ways. Rationale for a Telecommunications Sector Sector-specific regulation typically involves both Regulator prospective and retrospective activities. A telecom- munications regulator, for example, will often render An industry-wide competition authority may play a decisions that establish conditions for firms useful role in overseeing the telecommunications participating in telecommunications service markets, industry. However, there are good reasons to estab- such as the approval of prices or the terms and con- lish and retain telecommunications sector-specific ditions for interconnection between operators. Such regulation, at least until the relevant markets are conditions have forward-looking application. Tele- reasonably competitive. These reasons include: communications regulators are also typically authorized to respond to particular complaints, or to > the need for sector-specific technical expertise to remedy existing or past behaviour which contra- deal with some key issues in the transition from venes telecommunications policies or laws. monopoly to competition (e.g. network intercon- Competition authorities, by contrast, tend to exercise nection, anti-competitive cross-subsidization); their powers on a retrospective basis and with a - the need for advance rules to clearly define an view to correcting problems which result from environment conducive to the emergence of actions by particular firms that harm competition. competition, and not just retrospectively apply McCarthy T&rault infoD-v McCarthyT'etrault infoDev Telecommunications Regulation Handbook remedies to 'punish" anti-competitive behaviour ) As a separate matter, it may be efficient to or restructure the industry; combine, in a single entity, the regulation of the telecommunications sector and other sectors, the need to apply policies, other than competi- such as pipelines, electrical power, commercial tion-related policies, that are perceived important water supply, etc. The advantages and by national governments (e.g. universal service disadvantages of such a multi-sectoral regulator policies, national security and control policies); are discussed in Module 1. and the need for ongoing supervision and decisions Implementation of Competition Policy by on issues such as interconnection, quality of Telecommunications Regulators service, and the establishment and enforcement of licence conditions, particularly for dominant operators. Telecommunications sector regulators often apply These factors, among others, suggest that, even competition law or policy in carrying out their man- where an economy-wide competition authority dates. Four examples from the UK, Malaysia, whee a ecnom-wee cmpeitin athoity Canada and Australia are set out below. exists, a telecommunications regulator can play an important role. Table 5-1: Typical Differences Between a Competition Authority and a Sector-Specific Regulator Feature Competition Authority Sector-Specific Regulation Timing/Process > Typically applies remedies retro- > Prospective as well as retrospective spectively (i.e. after the fact) - Decisions or other processes of > Specific complaint or investigation general application, as well as spe- driven cific issue proceedings > Formal investigative, other proce- > Mix of formal and less formal dures procedures - Narrow scope for public intervention > Typically broader scope for public intervention Policy Focus >- Objective to reduce conduct which - Typically applies multple policy impedes competition objectives > Focus on allocative efficiency/ - Traditional (monopoly) regulation preventing abuse of market power or likely to pursue social objectives other misconduct other than allocative efficiency (universal service for example) - Transitional regulation may focus on preventing anti-competitive behaviour as market becomes competitive; (ultimately, forbearing from regulation may be a policy objective as competition becomes sufficient to protect public) Scope > Economy wide, multiple industries - Usually industry-specific (usually > Powers of intervention and remedies develops greater sectoral expertise) tend to be narrowly defined. - Powers tend to be more broadly defined (correspond to breadth of policy objectives and procedures). 5-~ 4 infoDev McCarthyTetrault Module 5 - Competition Policy United Kingdom Under the Canadian Telecommunications Act, the sector-specific regulator, the CRTC, has a duty to In the UK, Oftel has concurrent authority to deal with forbear (refrain) from regulation where telecommuni- matters arising under the Competition Act. Oftel cations services are subject to sufficient competition must co-ordinate its efforts with the Director General to protect the interests of users. Forbearance is also of Fair Trading, who is primarily responsible for en- permissible in certain other circumstances. A forcing the Competition Act. Oftel has also been forbearance order may not be made by the CRTC responsible for enforcing the Fair Trading Conditions where such an order would likely impair the estab- of U.K. telecommunications licensees, including BT. lishment or continuance of a competitive market for a service. The Canadian approach to forbearance is Oftel has published Guidelines on the Application of described in Box 5-2. the Competition Act in the Telecommunications Sector. The guidelines address subjects such as Australia market definition, measures of market power and the assessment of individual agreements and A more general example of the interplay of com- conduct. The guidelines reference conventional petition policy and telecommunications sector approaches to competition rules from a number of regulation can be found in Australia. In July,1997, sources and jurisdictions, and anticipate how these the Australian government implemented a package standard tools will be applied in the tele- of statutory reforms to both its competition and communications sector. telecommunications laws. These reforms changed the Trade Practices Act 1974 (the primary Malaysia competition law) and introduced a new Telecom- munications Act. The Malaysian Communications and Multimedia Commission has prepared similar guidelines. These As a result of these reforms, the Australian Com- indicate how the Commission will apply competition petition and Consumer Commission (ACCC) was law concepts such as "substantial lessening of com- given a significantly expanded role in telecommu- petition" and "dominant position" in exercising its nications regulation. It became responsible for both authority under the Malaysian Communications and (1) implementation of competition rules and policies Multimedia Act 1998. The guidelines identify the in the telecommunications sector; and (2) economic concepts and analytical processes that the Commis- regulation of telecommunications operators, sion will use in evaluating certain conduct. The including the incumbent operator, Telstra. guidelines borrow conventional tools and concepts from competition theory and indicate how they will Box 5-3 provides details on the scope and per- be applied in the context of the domestic telecom- formance of the telecommunications regulatory munications industry. responsibilities of the ACCC. Box 5-1 sets out the Malaysian Commission's These four examples from the experience of differ- proposed analytical process for evaluating whether ent countries illustrate the overlap of telecommuni- particular conduct constitutes a substantial lessening cations and competition policy. The examples of competition. indicate how some telecommunications regulators apply standard competiton policy and analysis, and Canada how competition authorities must understand sector- specific telecommunications regulation. The Canadian law provides for changes in the extent of competition policy concepts used in these examples sector-specific telecommunications regulation de- are discussed in greater detail below (in Section pending on the level of competition in specific tele- 5.2). communications markets. McCarthyTetrault infoDev Telecommunications Regulation Handbook Box 5-1: Substantial Lessening of Competition: Proposed Malaysia Approach Define the Context Deflne the Market Assessment of Condu Objective Ensure that the Commission Define the boundaries of the Determine whether there is has appropriate powers to relevant market (or may be) a substantial act. lessening of competition within the relevant market. Process Consider which section of Identify all demand substi- Assess the likely changes in the Act the assessment is tutes for the service. the degree of competitive being made under. Identify all supply substitutes rivalry in the absence of l Identfy all supply substitutes ~~Commission intervention in Identify the circumstances for the service. the light of test criteria. l I ~~~~~which initiated the assess- th lihlfts rtra w ment. Determine the relevant prod- Assess the likely changes in uct market. the degree of competitive Identify the key stakeholders Determine the relevant geo- rivalry in the case of Com- in the process. graphical market. mission intervention in the Determine the relevant tem- light of test criteria. poral market. Assess the difference in the level of rivalry between the two cases. Assess whether the difference is substantial in the light of the objects of the Act and national policy objectives. The Regulated Conduct Defence deemed to be in the public interest. Where the defence applies, a telecommunications operator that A final point to consider in the interplay of telecom- carries on activities authorized by a telecommunica- munications sector regulators and industry-wide tions regulator will generally not attract liability under competition authorities is the regulated conduct competition laws for those activities. Questions can defence. A number of jurisdictions recognize such a arise, however, as to whether particular anti- defence. The defence can shield regulated firms competitive activities were subject to active regula- from the application of competition laws in certain tion. For example, competition laws that are circumstances. generally inapplicable to the activities of regulated telecommunications operators may become The essence of the defence is that activities that are applicable where a regulator decides to forbear from authorized under a valid scheme of regulation are regulation. 5 - 6 infoDev McCarthyTetrault Module 5- Competition Policy Box 5-2: Case Study: Canadian (CRTC) Forbearance Analysis The CRTC may withdraw ("forbear") from regulation of telecommunications markets or services when there is sufficient competition. In Telecom Decision CRTC 94-19, the CRTC set out the criteria for decisions to forbear from regulation pursuant to Section 34. The criteria for forbearance reflect standard competition policy concepts and principles. They can be summarized as follows: )- The CRTC should forbear from regulation when a market becomes "workably competitive". > A market cannot be workably competitive if a dominant firm possesses substantial market power. - Market power is assessed in terms of three factors: (i) the market share held by the dominant firm; (ii) demand conditions affecting responses by customers to a change in price of the product or service in question; and (iii) supply conditions affecting the ability of other firms in the market to respond to a change in the price of the product or service. :> High market share is a necessary but not a sufficient condition for market power. Other factors must be present to enable a dominant firm to act anti-competitively. The CRTC's method of assessing market competitiveness begins with a definition of the "relevant market". The CRTC defines the relevant market as "the smallest group of products and geographic area in which a firm with market power can profitably impose a sustainable price increase" The CRTC then proceeds to an assessment of the market share held by the largest and other firms in the relevant market. In addition to an assessment of market share, the CRTC assesses other aspects of market power, including the availability of substitutes, whether a particular product or service is an essential input or bottleneck and the extent of barriers to entry. Among the other indicators of competition highlighted by the CRTC is evidence of rivalrous behaviour (price competition and effective marketing activities for example). The CRTC decided in Decision 94-19 to refrain from regulating the sale, lease and maintenance of certain forms of customer premises equipment. The CRTC subsequently applied Section 34 to forbear from the regulation of a number of other services, including wireless services, services provided by non-dominant long distance operators and certain of the long distance services provided by the incumbent telephone companies. The CRTC has also forborne from the regulation of other services, including retail services provided by competitive local exchange operators and the supply of retail Internet services. 5.1.4 The Transition from Monopoly to It is generally desirable to minimize government Competition in Telecommunications intervention in competitive markets. However, there is a general consensus that regulatory An effective competition policy must take into intervention is required to implement a successful account the specific characteristics of the market transition from monopoly to competitive to which it is applied. Telecommunications network telecommunications markets. The introduction of service markets raise unique challenges for the effective competition into telecommunications application of competition policy. These challenges markets around the world has generally been arise from the specific manner in which some more difficult and intrusive than in the case of most incumbent network operators are able to continue other markets. to dominate their markets after the introduction of competition. M.CarthyT6trauknfo v - 7 McCarthyTe'trault infoDev Telecommunications Regulation Handbook Box 5-3: Case Study: The Telecommunications Mandate of the Australian Competition and Consumer Commission The ACCC's telecommunications mandate is performed by the Telecommunications Group, which is considered a part of both the ACCC's Regulatory Affairs Division (for economic regulation) and the Compliance Division (for competition enforcement). The revised Trade Practices Act 1974 (TPA) includes two parts which address telecommunications matters specifically. Part XIB gives the ACCC authority to issue competition notices in cases of anti-competitive con- duct. Competition notices are enforceable in the Federal Court. Part XIB also governs tariff filing and record keeping requirements (the latter reinforce the ACCC's implementation of accounting separation in appropriate cases). Part XIC of the TPA establishes a framework for access to the networks of competing operators. The ACCC has power to declare a body to be a recognized "telecommunications access forum" or "TAF" (a facilitator of access arrangements); to approve any "access code" prepared by the TAF; to approve 'access undertakings" or model terms and conditions submitted by individual operators; and to arbitrate access disputes. The ACCC has complementary authority under the Telecommunications Act, the Radiocommunication Act 1992 and the Telstra Act 1991. Specifically, the ACCC has regulatory authority: > to oversee the conduct of intemational telecommunications operators;. " to issue directions on technical issues such as the implementation of number portability and intercon- nection: > to arbitrate a range of operator disputes (i.e., in addition to interconnection disputes); > to administer price regulation, such as price caps, for those services of Telstra which remain subject to price regulation; and l to assess the acquisition of radio-frequency spectrum by incumbent operators to determine whether such acquisition is likely to have anti-competitive effects. The ACCC also has authority to monitor telecommunications markets and activity in order to determine whether the general provisions of the TPA should be applied to promote competition and fair trading Advantages of Incumbent Operators Some major advantages of incumbent operators are listed below. Technical terms used in this list are The nature of telecommunications networks discussed in greater detail in the following sections provides strong advantages to well-established net- of this Module. work operators. These advantages often call for pro- competitive measures that are relatively unique to Control of Essential Facilities - Incumbent the telecommunications sector. Such measures are operators often own "essential facilities" that were discussed throughout this Module and in Module 3 - built and paid for under a regime of govemment Interconnection. Without such measures, new ownership or guaranteed rate-of-return regulation. entrants may never overcome the "incumbency The concept of essential facilities is discussed in advantages" of established operators. Incumbents in detail in Section 5.2.4 below. In telecommunications other types of markets (e.g. steel, chemicals, and network markets, essential facilities may include food products) generally do not enjoy similar public rights-of-ways, support structures such as advantages and, therefore, those types of markets poles and conduits, local loops, telephone numbers typically require less detailed sector-specific regula- and frequency spectrum. New entrants typically re- tion. quire access to these facilities in order for competition to be feasible. Duplication of these 5 - 8 infoDev McCarthyTetrault Module 5 - Competition Policy facilities may be either technically difficult, or more service" incremental cost than new entrants, and often, economically inefficient. spreads its "joint and common costs" across a large established customer base. A new entrant must Control of essential facilities can give an incumbent often cover a much higher long-run total-service in- numerous advantages over new entrants, particu- cremental cost, since this must be recovered from a larly in the absence of strong pro-competitive smaller customer base. regulation. For example, an incumbent can use its control over essential facilities to increase a Vertical Economies - Many incumbents have competitor's costs, and make its services less "vertically integrated" upstream and downstream attractive to customers. The competitors' costs can production facilities. For example, they may operate be increased by increased prices of essential facili- local access networks, national long-distance net- ties. The incumbent may be able to shield its own works and international networks. These incumbents customers from the impacts of such higher essential would usually enjoy vertical economies. For exam- facility prices, either by not "charging itself' those ple, it is less expensive to co-ordinate local, long price increases, or offsetting them with cross- distance and international telecommunications within subsidies from its monopoly or less-competitive a single firm than through arm's-length negotiations services. and transactions with different (often competing) operators. Incumbents may also enjoy vertical An incumbent can also discriminate in the provision economies related to integrated network planning, of essential facilities to make its competitors' construction, operations (e.g. traffic aggregation) services less attractive to end-customers. In the ex- and maintenance. treme case, it can simply refuse to supply essential facilities to competitors. It can also discriminate by Control Over Network Standards and providing inferior quality essential facilities to Development - An incumbent usually has a signifi- competitors, as compared to itself. For example, it cant advantage in that its existing technologies and can provision local loops to its own customers within network architecture have become de facto network a week, but delay provisioning of local loops to cus- standards to which all competitors must adapt their tomers of competitors for months. Anti-competitive networks. Unless competitors are notified well in discrimination in the provisioning of essential advance, the incumbent may obtain a substantial facilities can take many forms, some of which are head-start in the deployment of new network difficult to detect. services or features that rely on switching, transmis- sion or software upgrades installed by the Economies of Established National Networks - incumbents. As a related matter, incumbent network operators might enjoy "economies of scale and scope" that Cross-subsidies - Incumbent operators are often cannot be matched by new entrants for many years able to cross-subsidize some services from others. (or decades). For some network elements (e.g. a Many different forms of cross-subsidy are possible. national local access (loop) network), the cost of In most countries, local access services have tradi- duplicating an incumbent's facility may be prohibi- tionally been cross-subsidized by international tively high. At the same time, the facility may have a services. Profits from the latter were used to large enough capacity that one or more competitors maintain below-cost tariffs in the former. New I may be able to share use of the facility with the entrants typically do not have a similar range of incumbent without imposing any congestion costs. services to cross-subsidize. Some incumbents have engaged in anti-competitive practices by which In addition, many established telecommunications competitive services (e.g. mobile telephone services operators have a long history of providing local or Internet access services) are priced below costs access service at subsidized rates. This provides the and effectively subsidized by monopoly or less- incumbent with advantages in terms of economies of competitive services, such as international services. density, scale and scope. In competing for a new customer, an incumbent can often set a relatively Customer Inertia - Telecommunications network low price, which reflects a lower long-run "total- markets are often characterized by a high degree of McCarthyTerault infoDev 5-9 Telecommunications Regulation Handbook customer inertia. New entrants may find it very diffi- from the demand side, that is from the perspective of cult to persuade customers to switch from an buyers of the product. incumbent that has served them for many years. This is particularly true for lower-volume users (e.g. For example, the definition of the market for intema- residential customers) when marketing costs and tonal telephone service in a country could include IP customer-switching costs and inconveniences can Telephony services that are available through the be high (e.g. dialing extra digits to reach a new PSTN, by dialing a specific access number or code. entrant's network, dealing with two telephone bills, However, the definition would generally exclude changing telephone numbers, etc.). In some cases, "computer-to-computer" IP Telephony services that incumbents may intentionally take actions to "lock in" require special software, computers at both ends of their customers, and to make switching to competi- a call, and pre-arranged calling times, etc. to the tors more difficult and costly. average buyer of intemational telephone services, such "computer to computer" services would not be The "natural" advantages of incumbent operators a close substitute for international telephone service. (e.g. economies of scale and scope and customer inertia) can be augmented by anti-competitive The Product Market conduct on the part of such operators. This is where telecommunications regulators (and competition A widely accepted approach to market definition authorities) often face difficult challenges. Their goal begins with the assumption that there is a monopo- is to promote competition without unfairly "handicap- list in the relevant product market. The question is ping" incumbents. then asked: could the hypothetical monopolist raise the price of the product by a small but significant Before dealing with specific types of anti-competitive amount and for a non-transitory period? If a suffi- conduct, we will describe some of the basic con- cient number of buyers would switch to other cepts that are widely used in competition law and products so as to make the price increase policy. unprofitable for the monopolist, those substitutes would be included in a new definition of the market. 5.2 Basic Concepts of Competition This analysis will be repeated until the boundaries Policy are set so that substitution does not make the price increase an unprofitable strategy. 5.2.1 Market Definition The Geographic Market The definition of a market is a key issue in competi- The second dimension is the definition of the geo- tion policy and analysis. It is necessary to define a "relevant markef' in order to establish whether a firm graphic scope of the market. In defining the has a dominant position in that market. Similary, in geographic boundaries of a product market, the aim analyg wg is to identify the extent to which the proximity of rival analyzing whether a restrictive agreement amamong. firms has an appreciable effect on reducing compe- suppliers can impose competitive constraints on the ition in a market, it is necessary to define the hypothetical monopolist or actual market participant. relevantI market,and Ithenecessar to eval e the impaAgain, the definition of the geographic scope of the relevant market and then to evaluate the Impact of market is based on an assessment of substitutability the agreement in that market. Market definition is an initial step in competition analysis. It provides the in response to product prce changes. context in which to evaluate the level of competition Geographic areas are more important in defining and the impact of anti-competitive conduct.GegahcrasremeIpotnIndfig some telecommunications markets than others. For There are two aspects to the definition of a market - example, the market for local access in Mumbai is the product, including a service, and the geographic not affected by the degree of competition in the area in which the product is sold. In defining the Johannesburg local access market. These are product, close substitutes are normally included. The clearly separate markets. However, geography is analysis of substitutability is generally conducted increasingly less important in defining the level of competition in markets for Intemet Service Providers 5-10 infoDev McCarthyTetrault Module 5 - Competition Policy (ISPs), E-mail providers or even international long characterized by economies of scale. The distance services. The markets for these products establishment of a local facilities-based network also are rapidly becoming global markets. Consider the requires a large investment in fixed costs. Local substitution test described earlier in this Section. It telecommunications operators often require would be difficult, if not impossible, for an E-mail govemment licences, which may be granted on an service provider in Mumbai to raise the price of its E- exclusive or otherwise restrictive basis. Entry into mail service if customers in Mumbai have local wireless local networks is also restricted by access to substitute E-mail service providers (e.g. spectrum scarcity. Certain local telecommunications Hotmail) that are based in other geographic areas. services may operate on network plafforms which have patent or copyright protection (complicating or Having said that, the definition of product and geo- preventing the launch of a competing service). graphic markets remains very relevant for the services that remain most subject to market In addition to these barriers to entry, it is also possi- dominance, particularly local and national long- ble for a dominant firm to engage in conduct that distance services. establishes additional barriers to entry. Refusal to supply essential facilities and refusal to interconnect 5.2.2 Barriers to Entry networks are two classic examples of anti-competi- tive conduct that an incumbent operator may The evaluation of competitive markets and market engage in to discourage or prevent new entry. behaviour often focuses on the extent to which one These and other examples of anti-competitive or more firms can introduce and sustain price conduct are discussed in Section 5.3. increases. If it is easy for a new supplier to enter a market and provide a substitute product, then estab- 5.2.3 Market Power and Dominance lished suppliers will be reluctant to implement significant long-term price increases. Such price As a practical matter, most of the concern of compe- increases would invite market entry, which will tition authorities (and telecommunications regulators increase competition. promoting competitive markets) is focussed on established telecommunications operators that have The existence of barriers to market entry will limit market power. Firms without market power are sim- this competitive response. There are many types of ply not able to cause serious problems in the barriers to entry in different markets. Among the economy or in the sector. If they raise their prices most commonly recognized barriers are: above market levels, for example, they will simply lose customers and profits. > government restrictions such as monopoly fran- chises or restrictive licensing practices; This Section discusses the related concepts of market power, significant market power and market > economies of scale (i.e., where per unit produc- dominance. ton costs fall as output increases, a large established supplier can produce at a lower per Market Power Derined unit cost than new entrants); In general, market power is defined as the ability of a > high fixed/capital costs; and firm to independently raise prices above market levels for a non-transitory period without losing sales > intellectual property rights such as copyright and to such a degree as to make this behaviour unprofit- patent protection (which may affect the availabil- able. ity to a competing supplier of key inputs or outputs). Factors frequently considered in determining whether a firm has market power include: Multiple barriers to entry may exist in a single tele- communications market. For example, local > market share; networks are typically regarded as being McCarthyTetrault infoDev 5-11 Telecommunications Regulation Handbook )'- barriers to market entry; Significant Market Power > pricing behaviour; A related concept is that of "Significant Market Power' (or SMP). This is a relatively arbitrary meas- ) profitability; and ure of market power utilized in European Commission competition analysis. A number of the > vertical integration. European Commission's Open Network Provision (ONP) directives permit the imposition of additional Market share can be measured in several ways, obligations on operators that have SMP. In its July including monetary value, units of sales, units of 2000 package of proposed policy reforms, the production and production capacity. Market share Commission proposed to change its approach, and alone can be an inaccurate measure of market to focus more on traditional measures of market power. However, it is unlikely that a firm without sig- dominance. Nevertheless, since the SMP approach nificant market share will have sufficient market is frequently referred to, we will discuss it here. power to behave anti-competitively on its own. Therefore, market share is usually a starting point in Article 4 of the European Commission's determining market power. Interconnection Directive states that "an organization shall be presumed to have significant market power Assessment of barriers to entry is also important. when it has a share of more than 25% of a particular The extent to which established suppliers are con- telecommunications market". The article imposes an strained by the prospect of new market entry is a obligation on organizations with SMP to "meet all key factor in whether the established suppliers have reasonable requests for access to the network market power. including access at points other than the network termination points offered to the majority of end- Pricing and profitability are other factors relevant to a users". determination of market power. The existence of true price rivalry is inconsistent with a finding of mar- The 25% SMP threshold is not fixed in stone. The ket power. Price competition, which consists of Directive permits national regulatory authorities to "follow the leader' behaviour is consistent with the determine that organizations with less than 25% exercise of market power by the price leader. market share have significant market power; and to determine that organizations with market share The profitability of existing suppliers in a market can greater than 25% do not have significant market also be indicative of the extent of true price competi- power. In making such determinations, regulators tion. Excessive profitability typically indicates are directed to take into account factors such as: insufficient price competition and the exercise of market power in setting prices. > the organization's ability to influence market conditions; Finally, vertical integration is relevant to an assess- ment of whether a firm which enjoys market power > turnover relative to the size of the market; in one market is able to extend its power into upstream or downstream markets. In telecommuni- > control of means of access to end-users; cations, incumbent operators that are vertically integrated (e.g. that provide local access as well as > access to financial resources; and long distance or international services) can often use their market power in the local access market to > experience in providing products and services in competitive advantage in the long distance and the market. international markets. They may abuse their market power, for example, by inflating local access prices Characterization of an organization as having SMP (including interconnection prices) and using the does not necessarily lead to a finding of market surplus revenues to subsidize rate cuts to their power or dominance on the part of that organization. competitive long distance or intemational services. The SMP designation is simply a trigger for the ap- 5-12 infoDev McCarthyTetrault Module 5 - Competition Policy plication of additional obligations under the various - ONP Directives. B Market Dominance: A European i .eoommission Definition Market Dominance _ _ ___ A posiLionofeconomic strength enjoyed by an Market dominance is a more extreme form of market which enables it to prevent power. The definition of market dominance varies eci mpetition being maintained in the significantly in the laws and jurisprudence of different rv market by affording it the power to countries. In general, however, two factors are key ba an appreciable extent. in the determination of market dominance. First in n of its competitors, customers there must usually be a relatively high market share a tiaely consumers. (usually no less than 35%, often 50% or more). d nds v. Commission. ECR 207). Second, there must normally be significant barriers to entry into the relevant markets occupied by the 1___I dominant firm. Some definitions are more qualitative than quantita- Definitions of essential facilities have been devel- tive. Consider Box 5-4, which sets out the definition oped by a number of national regulations and established in European Commission jurisprudence. multilateral agencies. Box 5-5 includes a benchmark definition of essential facilities was included in the Other definitions exist. The U.K. Office of Fair WTO Regulation Reference Paper Trading has said that describing an operator as dominant raises the implication that it possesses The complete WTO Regulation Reference Paper is more market power than any of its competitors. The reproduced in Appendix A. The Reference Paper European Court of Justice has found that there is a indicates when and how signatory countries must presumption of market dominance, in the absence of ensure essential facilities are provided to competi- evidence to the contrary, if a firm has a market share tors. consistently above 50%. As is the case for market power generally, market dominance is not a matter The phrase "bottleneck facility" is sometimes used of market share alone. However, some commenta- as a synonym for "essential facility'. However, the tors have suggested that a market share in excess term "bottleneck" puts the emphasis on the facility of 65% is likely to support a finding of dominance. being a necessary part of a communications link, the supply of which is restricted, rather than on the 5.2.4 Essential Facilities ability of competitors to replicate the facility. The concept of essential facilities is important to the application of competition law in the telecommunica- Esent) Facilities - WTO tions sector. In the sector, an essential facility is Dintn - generally defined as one which has the following __ _______ characteristics: Essential facilities mean facl sities of a public f it is supplied on a monopoly basis or is subject elecommuic sport network or to some degree of monopoly control; I .7 -~) (ar exclusively "or predminantly provided > it is required by competitors (e.g. interconnect- by a s o t t Eirbrof suppliers. ing operators) in order to compete; and z iJ caThnot feaIbly bd 6'coriom ically or - it cannot be practically duplicated by competitors . y usttein oder to provide for technical or economic reasons. - sevie McCarthyT6trault infoDev 5-13 Telecommunications Regulation Handbook Common examples of essential facilities are network from being able to obtain necessary network com- access lines (local loops) and local exchange ponents on appropriate terms. Too broad a definition switching. Local loops are the circuits between a can stimulate uneconomic entry or provide customer's premises and the first "node" or insufficient incentives for competitors to invest in and exchange which connects the customer with the develop altemative network infrastructure. PSTN. It can be seen that in many countries, local loops fall within the definition of essential facilities Various approaches to defining essential facilities because they are: are discussed in Section 3.4.5 of Module 3. That Section considers which facilities an incumbent (1) required by competitors in order to compete for operator should be required to unbundle and provide the business of end customers; to competitors, The balance of this Module 5 illus- trates the use of the concept of essential facilities in (2) predominantly supplied by the incumbent, and competition policy as it applies to the telecommuni- cations sector. (3) technically or economically difficult to substitute, at least on a widespread basis. 5.3 Remedies for Anti-Competitive Conduct Accordingly, regulators in the US, Canada, Europe and elsewhere have required incumbents to facilitate 5.3.1 Abuse of Dominance competition by providing local loops to competitors. If alternative sources of fixed and wireless local The concept of abuse of dominance includes a loops become available, they may no longer be broad range of anti-competitive conduct recognized designated as essential facilities. in the laws and policies of many countries. It is similar to, but broader than the concept of "monopo- More examples of essential facilities, and a more -lization" that is found in some laws. detailed discussion of the concept are set out in Section 3.4.5 of Module 3 under the heading While there are dierent definitions of abuse of "Access to Unbundled Network Components". dominance, there are common themes in the defini- tions. The essential characteristics of abuse of A telecommunications operator that controls an es- donance include. sential facility often has both the incentive and the dominance include: means to limit access to the facility by competitors. It (i) Afirm has a dominant market position in the becomes a matter of public interest to ensure that relevant market; and essential facilities are available to competitors on reasonable terms. Without such access, competition (ii) The firm uses that position to engage in will suffer, and the sector will operate less efficiently "abusive" conduct which is or is likely to be than it could. harmful to competition. Consider, for example, how much more efficient it is to have a variety of different ISPs, international Thecconcept of abuse of dominance covers many operators and other telecommunications service spc ri tpsocndt.Nwfrsfabiv conduct are being recognized today. Recent exam- providers use the same network access lines and pies can be found in the Microsoft litigation in the local switches to reach subscribers in a locality. This US, or in other areas of intellectual property is far more efficient than having each operator licensing. Other actions that were once considered construct network access lines to serve the same abusive are considered acceptable today, depend- locality. ing on the circumstances. This Section and The determination of which telecommunications subsequent sections describe some specific types of network resources constitute essential facilities has conduct that have been considered abuses of domi- great practical importance. Too narrow a definition nance in the telecommunications industry. These can impede competition by preventing competitors descrptions should not be considered exhaustive. 5-14 infoDev McCarthyTetrault Module 5- Competition Policy Before discussing different types of abusive conduct, ways. Box 5-6 sets out common examples of the we will review the concept of market dominance. types of behaviour that are seen as abusive, if carried out by a dominant telecommunications When Does a Firm Dominate a Market? operator. The concepts of market power and dominance are Different approaches are used to define conduct that discussed earlier in this Module. The first step in amounts to an abuse of dominance. These evaluating whether a firm dominates a market approaches all focus on conduct that is harmful to involves the definition of the relevant market in which competition in a market. the possible abuse occurs. As discussed earlier, once the relevant product and geographic market Abusive conduct is sometimes divided into "exploita- must be considered. Then the degree of dominance tive abuses" and "exclusionary abuses". Conduct exercised by the firm in the relevant market can be such as charging excessive prices or offering poor evaluated. service to subscribers can be characterized as ex- ploitative abuses. This type of conduct exploits the A narrow definition of the relevant market will gener- dominant position a firm enjoys in a market and ally suggest a higher market share for a particular reduces consumer welfare. Predatory pricing or firm, and an appearance of greater dominance. refusal to supply essential facilities, on the other Conversely, a broad definition of the market will hand, can be characterized as exclusionary abuses. suggest lower market shares and less dominance. These forms of conduct are aimed at foreclosing The definition of the relevant market will, therefore, market entry or forcing market exit. Other ap- often be critical to an assessment of market proaches to classifying abuses of dominance exist in dominance. various laws as well as in the legal and economic literature. Once the relevant market has been defined, the evaluation of whether a firm occupies a dominant The main types of abuse of dominance encountered position will typically depend on two main factors: (i) in the telecommunications industry are discussed in the market share of the particular firm; and (ii) the greater detail below. They include refusal to supply extent of barriers to market. essential facilities, anti-competitive cross-subsidiza- tion, vertical price squeezing, predatory pricing, tied A finding of dominance must be based on the sales and bundling. context and circumstances of the relevant market. It is difficult to provide general guidelines to determine Legal Prohibitions Against Abuse of Dominance the particular measure of market share which will support a finding of dominance. Many commentators National and international laws and treaties include suggest that a market share of less than 35% is prohibitions against abuse of dominance. Some unlikely to be associated with a dominant position; prohibitions are broad and general; others more while a market share of greater than 65% is likely to specific. be. It is widely observed that even a very large market share may not result in market dominance. A good example of a broad prohibition against This is particularly the case when barriers to entry abuse of dominance is found in Article 82 of the EC are so low that price increases or output decreases Treaty (formerly Article 86). It provides a general by a firm with a large market share will stimulate new prohibition at the level of European Union law. entry and additional competition. Article 82 states that: When is a Firm Abusing its Dominant Position? "Any abuse by one or more undertakings of a dominant position within the common market or If it is determined that a firm has a dominant position any substantial part of it shall be prohibited as in a relevant market, the next question is: Is the firm incompatible with the common market insofar as abusing this position? In telecommunications it may affect trade between member states." markets, abuse of dominance can occur in many McCarthyTetrault infoDev 5-15 Telecommunications Regulation Handbook The broad prohibitions of the EC Treaty have been incorporated into the laws of member countries of Box 5-7: Some Powers to Remedy Abuse the European Union. In addition to being bound by of Dominance the requirements of the EC Treaty, public telecom- _ munications operators in EC member countries are >' Power to issue enforceable orders generally subject to additional and more specific against the dominant entity, national legal prohibitions against abuse of domi- nance. (a) to cease abusive behaviour or (b) to prescribe specific changes in its Abuse of Dominance - Remedies behaviour to limit the abusive aspects - Power to revoke the licence of the Different approaches are taken to prevent, correct or dominant entity (NB. In practice, this has punish abuse of dominance. To properly investigate limited applications since no regulator and remedy abuse of dominance complaints, a wants to deny service to the public) regulator or competition authority must have Power to fine the dominant entity and sufficient powers to conduct a proper investigation. the individual persons responsible for At a minimum, investigative powers typically include the abusive conduct the ability to compel the dominant entity to disclose I information and documents. > Power to order compensation (damages) to be paid to subscribers or competitors injured by the abusive I If an investigation indicates that abusive conduct has conduct occurred, an effective legal framework generally provides powers to remedy the situation. Examples > Power to restructure the dominant entity of the types of powers that are granted to remedy (such as the divestiture of some lines of abuse of dominance are set out in Box 5-7. Some of business or strueparate ut affliated these powers may be granted to a telecommunica company) l tions regulator, some to a general competition l authority, and some to the courts. > Power to facilitate and approve informal settlements in cases of abuse of dominance (e.g. to pay compensation, Box 5II: Abuse of Dominance by a restructure, voluntarily cease or change | Box 5-6: Abuse of Dominance by a||cnut| Telecommunications Operator: Common conduct) Examples | Refusal or delay in providing essential facilities to competitors; The question of establishing an effective regulatory Providing services or facilities to framework, including investigative and remedial competitors at excessive prices or on powers, is discussed in Module 1 - Overview of discriminatory terms; Telecommunications Regulation. Specific remedies I for different types of abuse of dominance and other sus Predatory pricing and/or cross- | forms of anti-competitive conduct are set out in the l subsidization of competitive services || following sections. with revenues obtained from services 11 which are subject to less competition; 5.3.2 Refusal to Supply Essential Facilities ] Bundling of services designed to provide the dominant firm with exclusive The concept of "essential facilities" is introduced in require a competitor to obtain services or Section 5.2.4. above, and discussed in greater detail facilities which it does not truly need. in Section 3.4.5. of Module 3. We will only deal with the matter briefly here. 5-16 infoDev McCarthyTT&rault Module 5 - Competition Policy The competition policies of a number of countries ii) overlapping authority between national and EU require dominant firms to provide competitors with institutions, and between competition and sector- access to essential facilities controlled by dominant specific regulatory authorities. The Access Notice firms. The so-called "essential facilities doctrine" is builds on earlier Commission guidelines on the closely related to the concept of "refusing to deal" application of competition rules in the telecommuni- with competitors, which is an offence under compe- cations sector. tition law in some, but not all circumstances. The Notice adopts a conventional approach to Some experts have discouraged telecommunica- market definition. It uses the concepts of demand tions regulators and competition authorities from substitutability and non-transitory price increases as developing excessively broad principles requiring the main tools for defining separate product markets. incumbent operators to provide network facilities to Based on its analysis, the Commission concludes their competitors. They point out that such principles that telecommunications network access constitutes would discourage competitors from building their a distinct market from the market for end user serv- own competitive facilities. ices. However, most telecommunications experts agree Much of the Notice is directed toward an evaluation that the introduction of competition can be greatly of market dominance and the application of accelerated by requiring incumbents to provide principles of abuse of dominance to the network access to a broadly defined range of essential access market. The first principle is that a company facilities to new entrants. For the provision of controlling access to an essential network facility is telecommunications services to the general public, in a dominant position within the meaning of EU law for example, interconnection to the incumbents' on abuse of dominance (specifically, Article 82 of the PSTN and related switching, signaling, Operational EC Treaty - formerly Article 86). Support Systems (OSS) and database systems can significantly speed up the introduction of competitive The Commission concludes that abuse of domi- new services. nance can be made out where a network operator refuses access to its network, withdraws access or Most of the debate about essential facilities in the provides access subject to unjustifiable delays or telecommunications context relates to interconnec- excessive prices. The Commission identifies other tion facilities. The issues related to the supply and conduct which may be abusive, including tying or unbundling of essential facilities are discussed in bundling network elements without adequate justifi- more detail in Module 3- Interconnection. cation, configuring a network so that access by competitors becomes more difficult, unjustly Abuse of Dominance and Essential Local discriminating in the terms of access offered to Network Facilities - The EU Example competing operators or pricing access so as to "squeeze" competitors' profit margins. These con- The European Commission's 1998 "Access Notice" cepts are discussed later in this Module. provides a good example of the treatment of essen- tial network facilities in current competition and 5.3.3 Cross-Subsidization telecommunications law and policy (Notice on the Application of the Competition Rules to Access In some key telecommunications markets, there is a Agreements in the Telecommunications Sector). concem that incumbent telecommunications opera- tors will abuse their dominant position by engaging The Access Notice illustrates how an established in anti-competitive cross-subsidization. The concem telecommunications network operator can abuse its is that an operator that dominates one market may dominant position in controlling network access increase or maintain its prices above costs in that facilities. The Notice sets out how competition rules market. It can then use its excess revenues from the are to be applied to telecommunications network dominant market to subsidize lower prices in other access agreements in the context of: i) specific tele- more competitive markets. As a result, a dispropor- communications market liberalization directives; and tionately large share of the costs of the operator's McCarthyT&rault infoDev 5-17 Telecommunications Regulation Handbook entire business can be recovered from the markets Prohibitions Against Cross-Subsidies the operator dominates. Prohibitions against anti-competitive cross-subsidy This results in a "cross-subsidy' between services have been incorporated into the laws and regulatory and subscriber groups. The more competitive framework of many countries. Many countries that services are subsidized by the less competitive did not do so before have established such prohibi- services. Such cross-subsidies can be significant tions as part of their obligations under the 1998 barriers to competition. WTO Agreement on Basic Telecommunications. Without the ability to cross-subsidize its own com- The WTO's Regulation Reference Paper (see petitive services, a new entrant may not be able to Appendix A) requires signatory countries to maintain match the incumbent's low prices in competitive appropriate measures to prevent major suppliers markets. This may prevent new entry into the from engaging in or continuing anti-competitive incumbent's less competitive markets. Alternatively, practices. The list of anti-competitive practices spe- it may drive new entrants out of business or prevent cifically includes "engaging in anti-competitive cross- them from raising enough capital to expand into the subsidization". incumbent's dominant markets. National prohibitions against cross subsidies can be Regulatory treatment of anti-competitive cross- found at various levels, including laws, regulations, subsidies in telecommunications markets is regulatory guidelines, rules, orders or licences. complicated due to the patterns of "social" cross- subsidies which characterized the monopoly era of Licence conditions are often used to prohibit cross- telecommunications services in many jurisdictions. subsidy. One example of a licensing prohibition can be found in the General Telecommunications In the monopoly era, governments typically author- Licence granted by the Office of the Director of ized the cross-subsidization of local, residential and Telecommunications Regulation in Ireland. Condi- rural services by other services, such as interna- tion 14 of the Licence permits the Director to enquire tional, long distance and business services. into complaints of cross-subsidization by the Whatever the benefits of social cross-subsidies in licensee, and to issue a binding direction requiring the monopoly era, there is now a widespread the licensee to cease such cross-subsidization. This recognition that they should be abolished. These condition is found in Part 3 of the Licence, which cross-subsidies are gradually being eliminated by includes the conditions applicable to any licensee the implementation of rate rebalancing policies. Rate with Significant Market Power (see definition in rebalancing policies are aimed at aligning prices of Section 5.2.1). This licence also requires licensees different services more closely with their costs. to keep appropriate accounting records in order to Rebalanced rates are closer to the types of permit the Director to evaluate whether conduct "efficient" pricing found in competitive markets. amounts to unfair cross-subsidization. That is not to say that social objectives, such as Another example of a broad prohibition can be found maintenance of affordable access for poor or remote in the licence issued to the Jordan Telecommunica- subscribers, are being ignored today. However, tions Corporation by the Telecommunications most telecommunications policy-makers, regulators Regulatory Commission of Jordan. The prohibition and sector experts agree that implicit cross- reads as follows: subsidies between services should be replaced by explicit subsidies aimed at meeting specific social "The Licensee will not, alone or together with objectives. The issues surrounding targeted subsi- others, engage in or continue or knowingly dies to meet social objectives are discussed in acquiesce in any anti-competitive practices and, greater detail in Module 6. in particular, the Licensee shall: ... not engage in anti-competitive cross-subsidization;" 5-18 infoDev McCarthyTetrault Module 5 - Competition Policy Such broad prohibitions are included in licences or or loses money. Services that do not cover their in other regulatory conditions imposed on incumbent costs are considered to be subsidized by other operators in many other countries. While these services with revenues that exceed their costs. broad prohibitions send a strong signal to incum- bents, they are not generally effective unless they In effect, accounting separations require an operator are accompanied by more specific measures to to account for dfferent services as if they were identify and prevent anti-competitive cross- stand-alone operations. Since telecommunications subsidies. We will now consider several specific operators provide a wide range of services, many measures: accounting separations, structural sepa- accounting separations undertaken for regulatory rations and imputation tests. purposes do not attempt to separate the costs of each individual service. Rather, they separate the Accounting Separations costs of broad categories of service. Accounting separations can be used to determine The focus of regulators is usually on separating the the existence of cross-subsidization. Regulators costs of the categories of services in which an have developed accounting separations, or have operator is dominant, from the costs of providing the required incumbents to do so, in a number of jurs- more competitive services. Such a separation per- dictions. mits the regulator to determine whether the monop- oly (or less competitive) services are generating An example is provided by Article 8 of the EU's excess revenues - and whether these costs are Interconnection Directive. It imposes an obligation being used to subsidize the more competitive on EU member states to ensure that public tele- services. Accounting separations can add communications network operators that have transparency to the costing and pricing process of significant market power keep separate accounts for the incumbent operator. their interconnection-related activities and their other commercial activities. This obligation applies if such Accounting Separations - Cost & Revenue incumbents provide both end user services and Categories interconnection services to new entrants. In addition, the record of interconnection-related activities must Determination of which accounting categories include both interconnection services provided inter- should be established will depend on the state of nally and interconnection services provided to competition in a national telecommunications mar- others. The new Interconnection Directive proposed ket. In general, the more competitive the market, the by the European Commission in July 2000 provides more difficult the accounting separation process. that regulators should have the authority to impose accounting separations in relation to specified Once all segments of a market become workably activities related to interconnection and/or network competitive, it will no longer be necessary to estab- access (Article 11). lish accounting separations, or worry about cross- subsidies. At that point, no firm would retain a More detailed accounting separation approaches dominant position in any market segment. are required by several national regulators. In some Accordingly, it could not raise prices above cases, accounts must be separated for a range of competitive levels and use the excess profits to different services. The most detailed approaches cross-subsidize more competitive areas. have been developed in Canada and the United States. The following are simplified illustrations of possible accounting separations that could be used in The goal of accounting separations is to divide the emerging markets that are subject to a limited costs of an operator between the different services it degree of competition. Three simplified scenarios offers in order to determine the costs of providing are considered in Table 5-2, Table 5-3 and Table 5- each service. The costs of each service are then 4. compared to the revenues generated by that service to determine whether the service recovers its costs McCarthyTetrault infoDev 5-19 Telecommunications Regulation Handbook Several observations can be made about these sim- introducing a new service, and if the deficit for plified scenarios. In Scenario A, the operator Category 2 competitive services is short lived, there appears to be cross-subsidizing its entry into may not be a serious anti-competitive problem. competitive services with revenues from is monop- However, if the cross-subsidy persists, or increases, oly services. Several factors are relevant in that would make it very difficult for new entrants in determining the extent of this cross-subsidy. Any the cellular and value-added services markets to firm will incur start up costs in the early years of compete. They may be driven out of business. Table 5-2: Scenario A: No competition in basic telephone services; competition in cellular and value-added services (e.g. Intemet access, e-commerce services) Accounting Category 1 - Monopoly Services Accounting Category 2 - Competitive Services Revenues 5000 Revenues 100 Costs Costs Local Access Network Services 2500 Cellular Telecommunications Services 300 Long Distance Network Services 1000 Value-added Services (including Internet 200 l ~~~~~~~~~~~Access, e-commerce) International Network Services 400 A Total Costs 3900 Total Costs 500 Surplus 1100 Deficit (400) Table 5-3: Scenario B: No competition In local access services; competition in long distance, international cellular and value-added services (e.g. Internet access, e-commerce services) Accounting Category I - Monopoly Services Accounting Category 2 - Competitive Services Revenues 2500 Revenues 2600 Costs Costs Local Access Network Services 2500 Cellular Telecommunications Services 300 Value-added Services (including Intemet 200 Access, e-commerce) Long Distance Network Services 1000 Intemational Network Services 400 Total Costs 2500 Total Costs 1900 Surplus/Deficit 0 Surplus 700 5 - 20 infoDev McCarthyTetrault Module 5 - Competition Policy Table 5-4: Scenario C: (same assumptions as Scenario B) No competition In local access services; competition in long distance, international cellular and value-added services (e.g. Internet access and e-commerce) Accounting Category 1 - Monopoly Services Accounting Category 2 - Competitive Services Revenues from End Users 1700 Revenues 2600 Local Access Revenues from Competitors 800 Total Revenues 2500 Costs Costs Local Access Network Services 2400 Cellular Telecommunications Services 300 Cost of Providing Local Access Services 100 Value-added Services (including Intemet 200 to Competitors Access, e-commerce) l______ Long Distance Network Services 1000 l Intemational Network Services 400 Total Costs 2500 Total Costs 1900 Surplus/Deficit 0 Surplus 700 Scenario B illustrates a hypothetical accounting competitors are 800, costs are 100). This could separation for an incumbent operator that has increase the costs of competitors to a level where rebalanced its local access prices. Its local access they would find it very difficult to compete with the prices are sufficient to cover associated local access incumbent. The more detailed level of accounting costs - and no more. Based on these data, the firm separation provided in Scenario C illustrates what cannot be said to be cross-subsidizing its seems to be a large cross-subsidy from one cate- competitive services from its monopoly services. gory of monopoly services, i.e. local access services provided to competitors, to other monopoly services. However, a further degree of accounting separation may illustrate a form of anti-competitive cross sub- Scenario C indicates other potential problems that sidization that is potentially damaging to competition. merit further investigation. For example, it is possible This is illustrated in Scenario C. that the incumbent is implicitly charging its own competitive services at lower prices for local access The total costs and revenues illustrated in Scenario services than it is to competitors. This problem is C are the same as in Scenario B. However, discussed later in this Section. Scenario C separates out the costs and revenues of the incumbent in providing local access services A comparison of Scenarios A, B and C indicates that (e.g. call termination) to competitors. In so doing, it is important to design accounting separation cate- Scenario C illustrates what appear to be anti- gories to meet dfferent market circumstances, and competitive cross-subsidization practices on the part to take into account the type of cross-subsidy that is of the operator. being investigated or monitored. It appears that the operator is charging competitors 8 times as much as it costs to provide them with local access services (local access revenues from McCarthyTetrault infoDev 5-21 Telecommunications Regulation Handbook Accounting Separations - Cost Allocation Issues pricing the competitive services below cost, and subsidizing them from excess basic service In practice, it is sometimes difficult to separate the revenues. costs to telecommunications operators. Cost accounting approaches are well developed in some There is no simple solution to the accounting highly competitive industries, where business separation problems identified above. If there are managers carefully monitor the financial serious concems about anti-competitive cross- performance of different services or "profit centres". subsidies, the regulator will have to "roll up its However, the same has not generally been true of sleeves", and work to understand the cost structure incumbent telecommunications operators. of the incumbent. The help of experienced telecom- munications accounting or economic consultants will Identifying the costs of different services was simply be useful, if not essential, in most cases. not required in the monopoly era. Telecommunica- tions managers and regulators typically focussed on International benchmarks can assist in some cases. the overall profitability of the firm, not on the For example, consider two services: (1) local profitability of individual services. If some services termination services provided by an incumbent to lost money, these losses were covered by profits in interconnecting competitors, and (2) cellular other services. Detailed cost separation approaches telephone services provided to end users in compe- were never required or developed. tition with the same competitor. A benchmarking study may show that the incumbent charges twice Some difficult issues of cost separation are rooted in as much for service (1) in comparable countries, and the nature of telecommunications costs. Many of the only half as much for service (2). In such a case, the costs of operating a multi-service telecommunica- regulator will want to take a closer look at the costs tions operator can be characterized as joint or com- and pricing of the incumbent to ensure it is not mon costs. These concepts are defined and engaging in anti-competitive cross-subsidization. discussed in detail in Appendix B. In conclusion, accounting separations can be chal- As discussed in Appendix B, it is difficult to assign lenging for both the regulator and regulated opera- joint and common costs directly to a service. tors. However, some simplifying assumptions and Accordingly, such costs are often "allocated" or benchmarking can. assist in providing "order of 'distributed" among the different services. Various magnitude" indications of possible cross-subsidies. approaches can be used for such cost allocations. Whatever techniques are used, accounting Most involve some degree of judgment. separations remain a valuable tool for regulators. Given the arbitrary nature of some cost allocations, The accounting separations approach does have incumbent operators will often have the opportunity drawbacks. These include the discretionary nature to allocate more costs to their less competitive serv- of some cost allocations and the large amount of ice offerings. This "shifting" of costs will make the resources required for detailed cost separations. For more competitive services appear less costly and example, the.Canadian regulator spent the better more profitable. For example, an incumbent might part of a decade to develop its "Phase IlIl" category- allocate 95% of its head office expenses to its basic wide cost separations process. These drawbacks telephone services, because those services account suggest that detailed accounting separations should for 95% of its revenues. However, in reality, over not be relied on exclusively as a tool to identify and 30% of the time of head office staff may be devoted prevent anti-competitive cross-subsidies. In to competition with new entrants in value-added, countries with limited resources, it may be more Internet and e-commerce services, which accounts efficient to use a combination of benchmarking and for only 5% of its revenues. By shifting its head- very high level cost separations. quarters' costs away from the more competitive services, the incumbent could justify charging a very low price for these services. The incumbent might thus be able to convince the regulator that it was not 5 - 22 infoDev McCarthyTetrault Module 5- Competition Policy Structural Separation and Divestiture For example, there may be efficiencies (economies of scale and scope) inherent in providing common Two other approaches, namely structural separation administrative services to both companies. On the and divestiture, have been used by competition other hand, the sharing of administrative services, authorities and telecommunications regulators in such as accounting services, provides potential for cases of serious anti-competitive cross- anti-competitive conduct and for developing covert subsidization. Both approaches tend to be used only cross-subsidies. Similarly, sharing head office space where there is evidence of significant anti- can lead to efficiencies. On the other hand, it competitive conduct. This usually involves not only provides opportunities for collusive conduct between cross-subsidization, but related conduct such as managers of the two companies. If structural predatory pricing, anti-competitive use of information separation is to be required, there should be a real and discriminatory practices. separation of the two lines of business, including their management, premises, customer data bases, Structural separation generally refers to the separa- accounts and operations. Otherwise, the structural tion of different lines of business of a telecommuni- separation may be a sham. cations operator into separate corporate entities. The initial question, however, is not whether there As an example, a cellular business can be operated should be structural separation between the compa- by a separate company from a wireline telephone nies, but whether the advantages of separation business. Both may be owned by the same outweigh the disadvantages given the realities of a shareholders. However, existence of a separate particular market. Other disadvantages of structural cellular company makes it easier to ensure that the separation include high transaction costs (the costs incumbent operator with which it is affiliated does not of creating the separate companies) and the distrac- discriminate unfairly against cellular competitors as tion for employees and customers as they work compared to its own cellular operations. Rules can through the separation. Despite those be established to ensure that both cellular disadvantages, structural separation may be the companies are treated the same, for example, with only way to ensure a level playing field for respect to interconnection charges. Other examples competition in some markets. of telecommunications lines of business that are frequently separated include ISPs and various types Structurally separate companies can often continue of mobile operators. to operate under common ownership. Divestiture refers to a situation where a company, such as an When structural separation is mandated by regula- incumbent, not only runs a particular line of business tion, the different companies must typically be run on through a separate company, but divests (i.e. sells) an "arm's length" basis. In that case, the companies some or all of the ownership of that separate must deal with each other on the same terms and company to independent parties. conditions as they deal with third parties, such as competitors. The separate companies must normally Some competition advocates argue that only dives- not only have separate accounting records, but also titure of ownership can ensure that a separate separate management, offices, facilities, etc. company is run in the interests of its separate shareholders, rather than merely as an operating Regulatory conditions normally determine the arm of its parent company (e.g. the incumbent). degree of separation required in the companies' Without divestiture, it is argued, a great deal of operations. Development of these conditions can regulatory effort will be expended to detect anti- pose challenges. Regulators must balance two competitive dealings between affiliated companies. competing objectives. One is to create sufficient Once there are separate shareholders, the man- separation to minimize the potential for cross- agement of the separate companies must act in the subsidization, collusion or other anti-competitive interests of those shareholders. It will be safer to actions between the separated companies. The assume that the companies are actually run on an other is to minimize the inefficiencies that will almost arms-length basis. inevitably be created by structural separation. McCarthyTetrault infoDev 5 - 23 Telecommunications Regulation Handbook Structural Separation - The EU Cable Directive Divestiture is generally viewed as an extreme remedy that is only appropriate in cases of over- An example of a structural separation directive can whelming dominance by very large operators in be found in the EU's 1999 Cable Ownership large economies such as the US. Policy-makers in Directive. This Directive requires dominant tele- other countries have been reluctant to consider communications operators to place their cable dismembering incumbents, which are often seen as television operations in a structurally separate "national champions". company. The Directive builds on the EU's ONP Directives and other efforts to implement a However, this view may be changing. The EU Cable competitive framework for telecommunications. It is Ownership Directive indicates a willingness by the intended to address specific problems which the EU EU to consider divestiture of at least some types of Commission has concluded result from the joint business lines. Consideration of the divestiture operation of cable television networks and conven- option may increase as more incumbents around the tional telecommunication networks. world become fully privatized. The changing market, economics and financing of the telecommunications The Cable Ownership Directive makes it clear that sector suggest that there are advantages as well as the Commission views structural separation as the disadvantages in divesting some lines of telecom- minimum corrective measure required at this time, munications business from others. For example, it is and that it may impose further measures, including often easier to finance an e-commerce or GSM divestiture of cable interests to third parties, in cellular business on a stand-alone basis than as part specific cases. The Commission also appears to be of a large multi-service operator. Finally, in countries adopting a practice of requiring dominant companies with limited competition, divestiture may provide the to divest their cable interests as a precondition to means to create other strong players with the critical securing Commission approval for new mergers mass to become successful telecommunications among telephone companies. (See, for example, the service providers. discussion of the Commission's approval of the merger of Telia AB of Sweden and Telenor AS of 5.3.4 Vertical Price Squeezing Norway in Section 5.4.2 below.) Vertical price squeezing is a particular type of anti- Divestiture - The AT&T Model competitive conduct that may be engaged in by incumbent operators. This form of conduct can The most famous example of a telecommunications occur if the incumbent provides services in two or divestiture involved the separation of AT&T from the more "vertical" markets. Vertical markets are some- Regional Bell Operating Companies (RBOCs) in the times labelled "upstream" and "downstream" United States in 1984. Not only were the local markets. For example, the oil production market is operations of AT&T structurally separated from its upstream of the oil refining market, which in turn is long distance and international operations, but own- upstream of the gasoline sales market. Instead of ership of the two groups of companies was upstream and downstream, the terms "wholesale" separated by means of a share swap. The and "retail" are often used. divestiture was, by most accounts, a great success. Vertical price squeezing can occur when an operator With their ownership separate from AT&T, the with market power controls certain services that are RBOCs no longer had an incentive to favour AT&T key inputs for competitors in downstream markets, over its long distance competitors, such as MCI and and where those same key inputs are used by the Sprint. Therefore, all long distance competitors operator or its affiliates to compete in the same obtained access to local telecommunications serv- downstream market. ices from the RBOCs on similar, non-discriminatory terms. More relevant to this Section, the divestiture To take an example, in telecommunications eliminated concerns about anti-competitive cross- markets, incumbents often control local access and subsidies between AT&T's local and long distance switching services. Consider one such service - the operations. provision of dedicated local circuits from customer 5 - 24 infoDev McCarthyTetrault Module 5 - Competition Policy premises to local exchanges. Dedicated local In this example, it is evident that there is no margin circuits can be viewed as "upstream" services. available for the competitor. The competitor must These services are used as an input by the buy the upstream service, a dedicated loop, from the incumbents in providing "downstream" services, incumbent at $120. Assume that it will incur $20 in such as dedicated Internet access services. Dedi- additional costs before it can provide retail services. cated local circuits are also a key input for Thus, it must spend $140 to provide the retail competitors who provide dedicated Intemet access service to end-users. Since the incumbent provides services. In other words, both the incumbent and the same retail service for $130, it is unlikely that the other suppliers compete in the downstream market competitor could attract any customers away from for dedicated Internet access services. the incumbent. If the incumbent decided to engage in vertical price Wholesale Cost Imputation Requirement squeezing, it could increase the price to competitors for the upstream input (i.e. dedicated local circuit To prevent vertical price squeezing, a telecommuni- rates) - while leaving its downstream prices the cations regulator may impose a wholesale cost same (i.e. prices for its dedicated Internet access imputation requirement, along the lines set out in services). The effect would be to reduce or eliminate Box 5-9. the profits (or "margins") of competitors. Their margins would be "squeezed". To increase the squeezing effect, the incumbent could also reduce Box 5-9: Basic Elements of Wholesale its downstream prices for Internet access. This Cost Imputation Requirement would be a "two-way or margin squeeze. Conditions for Ano lication: Put another way, an incumbent can often squeeze the margins of competitors by raising wholesale 1. Applies to a monopoly or dominant prices paid by competitors, while at the same time provider of 'wholesale services" lowering retail prices on competitive services. 2. Where the dominant provider also competes in market for 'retail services" A simplified numerical example of a vertical price that require the wholesale services as squeeze is included in Box 5-8. inputs. Basic Rules: Dominant provider must provide evidence to Box 5-8: Example of Vertical Price l the regulator that its retail prices are no lower Squeeze by Incumbent Operator l than the sum of the following: A. The price it is charging competitors for the Cost to incumbent of upstream $ 90 wholesale services that form part of the facility (e.g. dedicated loop) retail service (this price is said to be Price charged by incumbent to $ 120 "imputed" in the cost of the dominant competitor for loop provider whether it actually incurs this cost or not); plus Cost of providing retail services to B. The actual incremental costs (above the end users (e.g. dedicated Inteoet $ 20 imputed wholesale costs) that are incurred access service) in addition to loop l by the dominant supplier in providing the cost (e.g. marketing, billing) retail service. For example, marketing, Price charged by incumbent to $ 130 billing, etc. costs. end users for dedicated Internet access services McCarthyTetrault infoDev 5-25 Telecommunications Regulation Handbook Variations on this type of imputation approach have All long distance operators, including new entrants, been used by various regulators and competition are required to make "contribution" payments to authorities. It is relatively simple to use (compared to subsidize the deficHt described above. However, as detailed accounting separations or cost allocations). noted in our detailed discussion of the Canadian To return to the margin squeezing example in Box 5- example in Module 6, incumbent local operators 8, it does not matter whether the actual cost of the continue to receive the vast majority of contribution wholesale service is $90, $120 or some other payments. Initially, the CRTC did not specifically number. What the imputation requirement assures is require the incumbent operators to account for their that the same cost for essential wholesale services own use of the local access network in providing is imputed to the dominant operator's retail services competitive services. That is, it did not require as is passed on to its competitors. incumbents to make contribution payments to themselves. This led to the potential for vertical price Imputation - A Canadian Example squeezing by incumbents. The CRTC's response to this situation is described in Box 5-10 below. A form of the wholesale cost imputation requirement has been applied by the Canadian regulator in This imputation test is similar to the one described in response to complaints of targeted retail price dis- Box 5-9. The main difference is that the CRTC counting by incumbent operators. The CRTC's imputes "contribution" subsidies, as well as approach was tailored to the rather unique wholesale facilities costs, as costs that must be circumstances of the Canadian market. In that covered in the incumbents' retail prices. The CRTC market, the CRTC established a universal service took the position that so long as a service recovers program in the form of a subsidy for the access these imputed costs, plus the direct causal costs of deficit incurred by operators in higher-cost areas. the retail service, targeted pricing would not be anti- competitive. Box 5-10: Case Study - The CRTC Imputation Test In 1994 (Decision 94-13), the CRTC described the targeted price cutting responses of incumbent operators to new entrants as follows: 'Under a scenario of unrestrained targeted pricing by the telephone companies, competitors could be faced with the situation in which they must compete against telephone company prices that embody a contribu- tion amount that is lower than the competitor contribution cost in that market segment ... The Commission considers that, due to their previous status as monopoly toll providers, the telephone companies have an established and generally predominant share in all market segments. As a result, their traffic mix, the presence of barriers to entry and the existence of customer inertia would permit them, on a sustained basis, to recover contribution from the most highly contested market segments at a level below the contribution amount [payable by competitors]." As a result of these concerns, the CRTC implemented an "imputation test" to ensure that incumbents' prices in competitive networks were subject to similar cost recovery requirements as competitors. This imputation test, as modified in a later CRTC decision (Telecom Decision CRTC 94-19), has the following requirements: Revenues for each service offered by an incumbent must equal or exceed the sum of-- (a) the costs for "bottleneck services" used by the company in the provision of the services in question, using tariffed rates for those bottleneck services (the "Operator Access Tariff"); (b) the causal costs specifically attributed to the services, which are additional to the costs covered in (a) above; and (c) any applicable contribution payments. 5 - 26 infoDev McCarthyTetrault Module 5- Competition Policy 5.3.5 Predatory Pricing deter predatory behaviour. Wholesale cost imputa- tion requirements, which are discussed in the Predatory pricing is the practice of providing services previous Section, provide an example of this at prices that are low enough to drive competitors approach. out of a market, so as to monopolize the market. There is considerable debate about what prices and Predatory pricing is a particularly difficult type of what conduct constitute predatory pricing. While the conduct to prove in the telecommunications industry. competition laws of various countries differ, it is As previously discussed, the industry is character- generally agreed that a number of elements must ized by substantial joint and common costs which exist to constitute predatory pricing. Typical ele- are difficult to assign to particular services. The ments for the definition of predatory pricing are set economic cost tests used to determine predatory out in Box 5-11. pricing, such as Average Variable Costs and Long Run Incremental Costs are difficult to apply to many Predatory pricing is often prohibited under national types of telecommunications prices. Again, these competition laws. It may also be prohibited under the tests and related costing issues are discussed in laws or policies applied by a telecommunications Appendix B. regulator. Either way, it will be necessary for the regulator to have the means to investigate and stop Predatory Pricing - Example of a Complaint instances of predatory pricing and to implement suitable penalties or remedies. The case study provided in Box 5-12 summarizes Oftel's investigation into certain of BT's Internet Remedies vary. Predators may be penalized, services after a competitor raised predatory pricing competitors which have been the victims of concerns. It illustrates some of the problems of predatory pricing may be compensated, or both. establishing that low pricing amounts to predatory Another regulatory approach is to anticipate pricing. predatory pricing by implementing price regulation to Box 5-11: What is PrdgtoiyR'ricng? Generally, the foll to constitute predatory pricing: > The predator u e r (power to unilaterally increase its prices. etc.) -The predaorsW ms carge prictaaltvbelow a predatory=price stand tT standard vanes 1 somehat beween ountris. Geer all y,i competitionlaw, pi2 i ti sctrms b eo Average To aiwfta Iteeeo uctn . t pri!S2ces must usually bebelow Lon;ig Rn Inocremental t:osts (LRl-)E or Total $ ZRlcSLong-Run zud7bR5oseo--l *. Norall, | eM ther.e mrustbe a resnble expectation tha the prdatorwlie ablesto -recoup its lo'sses ~ 0 McCarthy T.trau1t infoDev ~ 27 McCarthyTe'trault infoDev 5-2 Telecommunications Regulation Handbook Box 5-12: Case Study - Oftel Investigation of BT's Internet Services The complaint: A competing Internet service provider complained to Oftel that BT was engaging in predatory pricing. The complaint was that BT was offering its BTNet services at a price 9 times less than other comparable BT services (X.25 packet services). Other elements of the complaint were that BTNet was not recovering an appropriate measure of costs and that BT was offering a free initial period of subscription. The analysis: Oftel observed that barriers to entry were low in the Internet services market, and so predatory behaviour was not feasible (BT would not be able to raise prices and recoup early losses in the longer run). Oftel also noted that the BTNet service was distinguishable from the X.25 packet service, which the complainant relied on to demonstrate unreasonably low pricing. Oftel looked at the business plan for BTNet and performance against plan, and concluded that early losses were consistent with being a start up business and that projected results indicated a move into profitability. Finally, Oftel observed that free subscription periods were common in the industry and that BTNet had limited these offers to its initial launch. The conclusion: Oftel concluded that BT was not engaged in predatory pricing in its BTNet offers. Oftel did state its intention to continue to monitor the situation closely (given BT's potential influence over the market). 5.3.6 Misuse of Information 5.3.7 "Locking-in" Customers Dominant providers of local telephone services and Telecommunications network operators may attempt certain other monopoly services are in a position to to "capture" particular subscribers through agree- collect competitively valuable information on their ments that make it difficult or impossible for a interconnecting competitors. For example, a com- customer to move to another network operator or petitor might require a local access circuit from an service provider. Examples include long term incumbent operator in order to provide a dedicated contracts and discounts for exclusive dealing, as Intemet service to a business customer. The well as agreements which tie a customer to a competitor would order the circuit from the incum- particular technology or hardware plafform. bent. Not all agreements that lock-in customers are anti- An incumbent should not be able to misuse the competitive. Most do not warrant regulatory interfer- information obtained in its capacity as a supplier of ence. However, there are cases, particularly where a essential facilities to the competitor. For example, dominant competitor locks in customers in advance the incumbent should not be permitted to approach of the introduction of competition, that merit regula- the competitor's prospective customer to induce the tory review. Dominant firms certainly can injure the customer to switch to (or remain with) the prospects for competition in a market by locking incumbent's own dedicated Internet services. customers into exclusive arrangements. These arrangements can amount to an abuse of Most of the information received by an incumbent dominance. which is subject to competitive misuse, is received in the course of interconnection arrangements. One clear form of abuse involves a requirement by a Therefore, the types of potential anti-competitive monopoly operator that a customer enter into a long- abuse, and the remedies for such abuse are term exclusive contract in advance of the introduc- discussed in Module 3, Sections 3.4.2 and 3.4.3. tion of competition, as a condition of receiving continued service. Regulators should prohibit such 5 - 28 infoDev McCarthyTetrault Module 5 - Competition Policy practices. Clearly, monopoly services should not be A practical example of the approach taken by a discontinued if customers refuse to enter into long- competition authority to a case of locking-in tele- term contracts that would undermine the introduction communications customers can be found in the EU's of competition. Such a practice clearly involves an "SIM Lock" case. The approach taken by the EU's abuse of dominance. This is a form of anti- Director-General for Competition (DG IV) in this competitive tied sale, as well as a form of locking-in case is illustrated in Box 5-13. customers. 5.3.8 Tied Sales and Bundling Other cases of locking-in customers are less clear. Much will depend on the degree of competition in A tied sale is the sale of one product or service on the market and the effect of the locking in- condition that the buyer purchases another product arrangements on competition in the market. The or service. Bundling is the practice of assembling more dominant a telecommunications operator, and multiple products or services (or multiple product / the more injurious to competition the locking-in service elements) together in an integrated offer. arrangement is, the stronger the case for interven- tion by the regulator or competition authority. Some Tied or bundled sales are not necessarily abusive or regulators and competition authorities will be more anti-competitive. The sale of one product or service vigilant than others regarding the potential harm may be tied to another for reasons of consumer through locking-in arrangements. safety or technical interdependence. Bundled sales may also be provided to respond to consumer pref- erence or convenience. Box 5-13: Case Study- DG IV Intervention in "SIM Locking" The following approach was taken by the Director-General for Competition (DG IV) of the European Commission in the case of the "SIM Lock" feature on mobile phone handsets. This feature was, at one time, common on European handsets. The SIM Lock feature had at least two characteristics: (i) It could be used as a theft deterrent (since the 'subscriber identification module" - or "SIM' - integrated circuit card was uniquely associated with a particular handset); and (ii) It effectively locked a particular handset and subscriber to a single mobile telephone service operator. The SIM card authorized a particular handset and subscriber to use a particular service provider's network. Locking the SIM card and preventing its replacement in the handset prevented subscribers from changing their service provider. The SIM Lock feature could be "unlocked". However, service providers tended to impose significant charges for overriding the SIM Lock feature. On 30 May 1996, DG IV wrote a letter to the manufacturers of the handsets and to network operators notifying them that it considered the SIM Lock feature as having anti-competitive effects. Further consultations and correspondence ensued. As a result, manufacturers agreed to modify their handsets and include the ability for subscribers to unlock the SIM Lock feature.l DG IV also set out a number of additional restriceons on the use of the SIM Look feature. These included full disclosure to consumers that they could unlock the handsets. Where service providers had subsidized handset prices, the amount of the subsidy and specific commercial terms for recovering that subsidy had to be disclosed. Providers also had to disclose any effect that this subsidy might have on the subscriber's ability to unlock the feature. DG IV permitted service providers to keep the handsets locked until such time as the subsidy had been recovered. McCarthyT&rault infoDev 5-29 Telecommunications Regulation Handbook Anti-competitive Aspects situation are discussed above under the title Vertical Price Squeezing. Tied sales can be abusive when they have signifi- cant adverse effects on consumers or competitors. A related concern arises where the dominant An example of an abusive form of tied sales is tying operator chooses to provide the upstream service to a product or service offered in a highly competitive competitors on a bundled basis: In other words, the market to another product in a monopolistic or less dominant operator may require competitors to competitive market. The first product would typically acquire not only the minimum upstream service have low prices and profit margins; the latter, higher elements they require, but also other services. Such prices and profit margins. Another example is tying a bundling would impair the competitors' efficiency. It requirement to buy a maintenance service contract would also inflate revenue flows from competitors to with the sale of the product itself, where the service the dominant operators. market is highly competitive but the product market is not. The issues related to the bundling of services pro- vided by incumbents to their competitors are Bundling has become a popular marketing approach discussed in detail in Section 3.4.5 of Module 3, in the telecommunications industry. Many incumbent under the title Access to Unbundled Network Com- operators and competitors are offering bundled ponents. packages of services. A popular bundle in Canada, for example, includes wireless telephone service, Unbundling Conditions Internet access service and cable TV service, sold together for a price which is 10% lower than the Dealing more generally with the issue of bundling of combined price of the individual services. Like tied retail packages by incumbents, a number of regula- sales, bundling can be convenient to customers. tory approaches are possible to prevent anti- Among other things, it cuts down on the number of competitive conduct. Outright prohibition should bills to pay. However, regulators have been asked to generally be seen as a last resort. Other approaches deal with anti-competitive aspects of bundling in can often be used. various countries. Steps can often be taken to level the playing field Regulatory Intervention between dominant operators and new entrants, even when monopoly services are part of a bundle. Regulatory intervention is usually focussed on a few Where this is the case, regulators can impose resale types of bundling activity. One type occurs where an requirements on the dominant operator. In other incumbent offers bundles of products or services on words, the dominant operator may be permitted to terms which cannot possibly be met by competitors. sell monopoly services as part of a service bundle, This concern is particularly serious where the but only if it makes the monopoly services available operator includes a service in the bundle, such as to competitors on reasonable terms to resell as part basic local telephone service, of which it is the of their own competing bundles. monopoly or dominant supplier. Box 5-14 provides an example of conditions im- Another area where regulatory intervention may be posed by one regulator on dominant operators that required occurs where a dominant operator supplies want to provide bundles of services that include services to a competitor which the competitor needs monopoly service elements. The conditions estab- as an input to its own services in order to compete lished in this example include a resale requirement, with the incumbent. In other words, the dominant a cost imputation test and a general requirement operator provides both the upstream and down- that competitors must be able to offer similar stream services, but the competitor only provides bundles in competition with the dominant operators. downstream services. Some concems about this 5-~ 30 infoDev McCarthyTetrault Module 5 - Competition Policy 1 ;vBox 5 14 s Study dled .Service Conditions ,n~j~~~en local services wer~ffered on a monopoly basis in the Canadian market. the CRTC establshedh fwin I co nditions (in Telecom Decision CRTC 94-19). These conditions applied to- dminant trs o offer a bundled service. including monopoly service elements and compet Ie service.elements I ~ ~Thebun ervI ce s rall applicable costs including ) fferatesfor bottle,neck-network components; - Bu ser s csts; and -~th G'o^lribution payments lacc~ess deficit subsidies similar to those paid by competitors): ^eompeito- must be able to offer their own service bundles by combining network or service elements . d - T eaMcqrioMEhe fldRi;Mim .iperator at lariffea rates and the competitor's own network or service .Thedominant o p re'sale of the bundled service by ils competitors. Regulatory conditions of this type can be 5.3.10 Restrictive Agreements incorporated into the regulatory framework to permit provision of bundled services, while safeguarding Types of Restrictive Agreements against anti-competitive conduct. Such conditions can be included in licences or specific guidelines, Most telecommunications regulators and virtually all decisions or directions of regulators. competition authorities are called upon, from time to time, to review potentially anti-competitive agree- 5.3.9 Other Abuses of Dominance ments involving telecommunications operators. Some types of regulatory review are ex ante, such When the concept was introduced in Section 5.3, it as where laws or licence conditions require prior was indicated that abuse of dominance involved two approval of some types of agreements entered into factors: (1) existence of market dominance, and (2) by regulated operators. Other reviews are ex post, conduct by the dominant firm that is harmful to com- such as in cases where a competitor complains petition. The most common types of abuse of about the anti-competitive effect of an existing dominance in the telecommunications industry have contract. already been reviewed. Some types of telecommunications agreements, However, various other abuses of dominance are such as interconnection agreements, are routinely possible. If conduct by a dominant firm exploits reviewed by regulators. Interconnection agreements consumers, excludes competitors, or otherwise are discussed in Module 3. The following discussion harms competition, it should be reviewed by tele- focuses on other types of agreements between tele- communications regulators or competition authon- communications operators. bes. Box 5-15 lists some other types of abuses of dominance that are found in telecommunications Two categories of agreements may raise concerns and other industries. of anti-competitive conduct. "Horizontal agree- ments" are agreements among competitors. They will cause concern to the extent that they restrict the competitors' ability to compete independently. McCarthyTetrault infoDev 5 - 31 Telecommunications Regulation Handbook Box 5-15: Some Other Forms of Abuse of Dominant Position The following list includes common types of abuses not discussed in detail elsewhere in this Module. This list is not exhaustive. > Excessive Prices - This is perhaps the most common form of "exploitative" abuse of a dominant or monopoly position in the telecommunications sector. It is not an anti-competitive abuse but an exploitation of consumers. (It is discussed in Module 4 and Appendix B.) l Restriction of SupplV - A monopolist or dominant firm may refuse to invest in network infrastructure land supply new customers, preferring to serve a limited range of customers. This limited range of customers may provide a secure stream of profits, and requires less additional capital. >- Refusal to Deal - Refusal by a telecommunications operator to deal with a competitor is not always l anti-competitive. Refusal by a dominant operator to do so may be anti-competitive, where the effect is injurious to competition. The most common example involves refusal by an incumbent operator to provide essential facilities, such as local loops required by competitors to compete (see discussion in this Module and in Module 3). However, other forms of anti-competitive refusal to deal occur in telecommunications markets. | Uniust Discrimination - A dominant firm may discriminate unjustly or unfairly between customers, or between competitors (including itself). Discrimination may involve prices or other conditions of service. Regulators have traditionally prohibited such discrimination where it is exploitative, exclusionary of competition or otherwise harms competition or consumer welfare. Regulators generally do not prohibit all forms of discrimination, particularly those that have no harmful effects. Rules on which forms of discrimination are "unjust" vary from country to country. :- Abuses Involving Intellectual ProDertv - Anti-competitive abuses of dominance may occur, for example in exclusionary IP licensing arrangements, and in attempts to monopolize adjacent markets. 'Vertical agreements" are agreements between difficult new market. Exclusive arrangements can upstream and downstream participants in the same also be used to maintain high levels of customer or related markets. These agreements can exclude support. or restrict competition or harm consumer welfare. Problematic vertical agreements include some Box 5-16 deals with three types of problematic agreements that fix retail prices or grant exclusive agreements found in telecommunications and other distribution rights in a given geographic market. industries: price-fixing, bid-rigging and market allocation agreements. The first two are generally Only horizontal or vertical agreements that have horizontal agreements. Market allocation anti-competitive effects should be prohibited. There agreements can be horizontal or vertical. are many useful forms of horizontal agreements. These include some agreements to adopt common Other types of agreements can have anti- standards, or other product specifications or design competitive effects, depending on the circum- features. Such industry standardization may result in stances. Some are subject to legal prohibitions and greater production efficiency. It can also promote remedies in different countries. Remedies and sanc- competitive entry by establishing an "open" market tions for restrictive agreements are generally similar with increased product interoperability. to those for abuse of dominance. They can include fines, awards of damages or other compensation, Certain vertical agreements can also benefit the orders rescinding agreements and other corrective public, such as exclusive marketing agreements that orders. induce a distributor to invest in the development of a 5 - 32 infoDev McCarthyTetrault Module 5 - Competition Policy Box 5-16: Examples of Restrictive Agreements )i- Price Fixing price fixing agreements among competitors are designed to manipulate pricing. The simplest example is an agreement on the prices to be charged to consumers. Variations include agreements to jointly implement price increases, resist price decreases, establish a formuila to generate uniform prices, or remove lower price products from the market in order to shift demand to higher price products. : Bid-rigging - is collusion among bidders in order to determine who will win or what the winning price or conditions will be. Various forms of bid-rigging can occur. Some bidders may agree not to submit a bid in response to a particular tender. They may agree to submit tenders at higher prices or incorporate conditions that are deliberately inferior. Another variation involves competitors agreeing to take turns as to which of them is to succeed in a particular tender, a practice often referred to as "bid rotation". This can inflate prices for all bidders. - Market Allocation - can be implemented by horizontal or vertical agreements. Market allocation reduces competitive entry. In horizontal agreements, competitors allocate geographic or product markets amongst themselves. They will agree not to compete in each other's markets. Such agreements are anti-competitive, and should almost always be prohibited. In vertical market allocation agreements, it may be acceptable to support a period of territorial exclusivity. This may be required to induce investment to develop a market properly. Competition from suppliers of substitute products or services may also reduce the anti-competitive impact of such agreements. Evidence of Anti-competitive Effect A different approach is taken in Canada. There, only agreements among competitors that lessen compe- Legal and regulatory approaches to restrictive tition "unduly" are prohibited. Accordingly, in agreements vary. In some countries, some forms of Canada, it is necessary to prove: (1) the existence of restrictive agreements are prohibited outright. In a prohibited agreement; and (2) that the agreement other jurisdictions, prohibitions incorporate a lessens competition unduly. This additional require- reasonableness test. ment is a major reason why there have been few successful prosecutions in Canada for agreements In the US, for example, collusive arrangements that would be recognized as anti-competitive in other among competitors, such as price-fixing and market jurisdictions. allocation, are illegal regardless of whether the agreed restrictions are considered reasonable or 5.4 Mergers, Acquisitions and Other not. Participants to a restrictive agreement can be Corporate Combinations punished if it is proven that: (1) such an agreement exists, and (2) it could have anti-competitive conse- 5.4.1 Concerns About Mergers quences. Similarly, Article 81 (formerly Article 85) of the EC The review and approval of mergers, acquisitions Treaty prohibitsall agreeoments between undrftah - EC and other corporate combinations (all referred to as Treaty prohibits a affgreements between undertak- "mergers" for convenience here) is normally ings "which may affect trade between Member entrusted to competition authorites or other States and which have as their object or effect the branches of govemment rather than to telecommu- prevention, restriction or distortion of competition nications regulators. However, there has been a within the common market'. Article 81 specifically high level of merger and acquisition activity in the prohibits price-fixing and production allocation global telecommunications industry in recent years. agreements which prevent, restrict or distort Consequently, the analysis of mergers and competition. acquisitions can be expected to become a more McCarthylTetrault infoDev Telecommunications Regulation Handbook important part of competition policy in the telecom- particular market and another which is a potential munications sector. competitor. Many mergers will have little or no negative impact In the telecommunications industry, vertical mergers on competition. Some mergers may be pro- can also be of concern. The merger of a firm that competitive, for example, by enhancing production provides essential inputs to other firms can be efficiencies resulting from economies of scale or problematic if the supply of those inputs to other scope. Mergers may also create new synergies, firms is threatened. For example, the merger of a lead to innovation by combining talents of different dominant local access provider with a major Intemet firms, and provide additional resources to develop Service Provider can raise concerns about whether new products and services. other ISPs will obtain local access services on fair and non-discriminatory terms. Such a merger might Concerns about mergers, acquisitions and other be reviewed in order to ensure that adequate safe- corporate combinations are generally based on the guards are in place to protect competing ISPs. same concerns about anti-competitive behaviour as discussed earlier in this Module. The main concern 5.4.2 MergerAnalysis is that a larger merged firm may increase its market power. To the extent a merged firm becomes more Large mergers, acquisitions and some other dominant in a market, there is a greater potential to corporate combinations require prior review and abuse this dominance. Merger controls aim to approval in some jurisdictions. As part of their prevent the accumulation and exercise of market review, competition authorities may prohibit mergers power to the detriment of competitors and consum- or approve them subject to conditions. Mergers are ers. usually only prohibited or subjected to conditions if the authority concludes that the merger will substan- The basic rationale for merger control is that it is tially harm competition. Given the discretion inherent better to prevent firms from gaining excessive in the interpretation of this threshold, various market power than to attempt to regulate abuses of competition authorities have published merger their market power once such power exists. In guidelines. These are intended to assist firms and practice, merger reviews and the exercise of related their advisers to anticipate the procedures and crite- powers by competition authorities are usually based Ha which will be applied in assessing a merger. on an evaluation of the impact of a specific merger on competition in the relevant markets. An example of such guidelines is contained in the Horizontal Merger Guidelines published in 1997 by Types of Mergers and Acquisitions the US Department of Justice and the Federal Trade Commission. The Guidelines set out a five-stage Mergers can be characterized according to three analysis of the following subject areas: categories: horizontal mergers, which take place between firms that are actual or potential competi- > market definition; tors occupying similar positions in the chain of production; vertical mergers, which take place >' identification of firms participating in the relevant between firms at different levels in the chain of market and their market shares; production (such as between manufacturers and retailers); and other mergers, such as those which s- identification of potential adverse effects of the take place between unrelated businesses or merger; conglomerates with different types of businesses. > analysis of barriers to market entry; and Merger reviews typically focus on horizontal mergers since, by definition, they reduce the number of com- - evaluation of any efficiencies arising from the petitors in the relevant markets. Also of concern are merger. mergers between a firm which is active in a infoDev McCarthyTetrault Module 5 - Competition Policy The importance of market definition was discussed ity to quantify the positive and negative aspects of in Section 5.2.1. In the context of a merger review, the transaction and arrive at any verifiable net effect. market definition is often the key factor in determin- It may also prove difficult to determine how any effi- ing whether a merger is anti-competitive. If a market ciency or other welfare gains will be distributed is defined broadly, the merging firms may be between the producing firm and its customers. considered to be competitors. A more narrow market Similarly difficult is the development of any means to definition may result in a determination that the firms ensure redistribution of efficiency gains to broader operate in different markets. On the other hand, a public advantage. broad market definition could lead to a conclusion that the merged entity will face sufficient competition In exceptional circumstances, a merger which would from other firms in the market. A narrower definition have anti-competitive effects may be permitted could lead to a conclusion that the merged entity where one of the merging entities is in severe would have excessive market power in a smaller financial distress. The competition authority may be market. persuaded that the public interest is better served by a merger than by the failure of one of the merging The second stage of the analysis is the identification entities. However, transactions of this sort should be of firms competing in the relevant market and their carefully evaluated. Sometimes the merger is not the market shares. The determination of market share best solution. For instance, it may be that another will have a direct bearing on an assessment of firm could expand productive capacity using the market power and the potential for abuse of market assets of the failing firm and that public weHfare power by the merged entity. The evaluation of would be better served by this alternative solution. market participants includes not only firms which Bankruptcy is painful for shareholders, but does not actually participate in the relevant market, but also always have a long-term negative effect on the firms which could be expected to enter it. economy. In assessing the potential adverse effects of a Information in Merger Reviews proposed merger, attention will typically focus on the establishment or increase of the dominant position As part of the merger review process, the merging by the merged entity. There may also be concerns firms must normally provide information to the that the merger, by reducing the number of firms reviewing authority. It is standard practice in jurisdic- participating in a market, will create conditions which tions which impose merger review to require parties make anti-competitive agreements among them to the merger to submit advance notice of the more likely. proposed transaction. The information disclosed in the pre-merger notification will normally be used by The evaluation of barriers to entry is an important a competition authority in the first stage of merger aspect of merger review. A finding that there are low review (i.e., to determine if any anti-competitive barriers to entry can help justify a merger. concerns are present and whether to proceed with a more detailed review of the proposed transaction). Finally, the five-stage analysis concludes with an assessment of any efficiencies to be realized as a The contents of pre-merger notifications are result of the merger. In this stage, the objective is to generally defined by law or regulation. Required in- assess efficiency or other welfare gains which can formation typically includes: be projected to result from the merger. These will be balanced against any anti-competitive effects which > the identity of the firms involved in the proposed have been identified in the earlier stages of the transaction; review. > a description of the nature and commercial Theoretically, substantial efficiency gains or other terms of the transaction; public welfare gains could support approval of a merger even where anti-competitive risks are identi- > the timing of the transaction; fied. In practice, it is difficult for a competition author- McCarthyTe'trault infoDev 5 - 35 Telecommunications Regulation Handbook > financial information on the firms involved The quality of a merger review will depend heavily (including revenue, assets and copies of annual on the quality and range of information available to or other financial reports); the reviewing authority. identification of related ownership interests and 5.4.3 Merger Remedies the organizational structure of the firms involved, and The goal of merger control laws is to prevent or remove anti-competitive effects of mergers. Three - a description of the relevant product and service types of remedies are typically used to achieve this markets in which the firms operate. goal: The initial information filing typically triggers a 9 Prohibition or Dissolution - The first remedy waiting period, during which the reviewing authority involves preventing the merger in its entirety, or will be entitled to request further information. This if the merger has been previously process concludes with a determination by the consummated, requiring dissolution of the reviewing authority whether to proceed with a more merged entity. detailed investigation. > Partial Divestiture - A second remedy is partial If the competition authority decides to proceed with a divestiture. The merged firm might be required further investigation, it will obtain more information to divest assets or operations sufficient to elimi- from the merger participants. Additional information nate identified anti-competitive effects, with is usually gathered from third parties such as com- permission to proceed with the merger in other petitors and customers. Commercially sensitive respects. information is also generally protected from public disclosure. - Regulation/Conditional Approval - A third remedy is regulation or modification of the During a more detailed review, a competition behaviour of the merged firm in order to prevent authority will normally seek information about or reduce anti-competitive effects. This can be matters such as the following: achieved through a variety of one-time condi- tions and on-going requirements. - products, customers, suppliers, market shares, financial performance; The first two remedies are structural, and the third remedy is behavioural. Behavioural remedies :- activity of competitors and competitors' market require ongoing regulatory oversight and interven- shares; tion. Structural remedies are often more likely to be effective in the long run and require less ongoing - availability of substitute products; govemment intervention. > influence of potential competition (including Partial divestiture or behavioural constraints are less foreign competition); intrusive in the operation of markets than preventing a merger from proceeding or requiring dissolution of > pace of technological or other change in the a previously completed merger. Partial divestiture relevant markets, and its impact on competition; can reduce or eliminate anti-competitive effects and while preserving some of the commercial advantages of a merger. Partial divestiture is - nature and degree of regulation in the relevant emerging as a preferred remedy in many jurisdic- markets. tions. Although it has since been abandoned, the proposed Telia/Telenor merger, which is described in Box 5-17 provides a good illustration of the use of this remedy. 5 - 36 infoDev McCarthyTetrault Module 5 - Competition Policy Box 5-17: Case Study - The Telia I Telenor Merger On 13 October 1999, the European Commission approved the merger of Swedish telecommunications operator, Telia AB and Norwegian operator, Telenor AS into a new company to be jointly controlled by the Swedish and the Norwegian governments. On its initial review, the Commission identified a number of concerns due to the breadth of operations and market presence of Telia and Telenor, in their respective domestic markets. In addition, the Commission expressed concern with certain overlapping interests, such as the interest of each operator in competing mobile companies in Ireland. In addition, a significant concern was raised about Telia and Telenors ownership of cable TV networks in each of their domestic markets. To secure Commission approval of the proposed merger, Telia and Telenor volunteered the following commitments: > each of Telia and Telenor would divest its cable television operations; - each company would divest overlapping operations in the Swedish and Norwegian markets; :- one of Telia or Telenor would divest its Irish mobile telephone interests; and > each of Telia and Telenor would implement local loop unbundling in its domestic market to facilitate the development of local competition. The divestiture of cable assets is consistent with the Commission's Cable Ownership Directive. The commit- ments made to secure Commission approval for the merger represent a mix of structural and behavioural remedies to address identified anti-competitive effects. The commitments to divest operations are structural remedies. The commitment to implement local loop unbundling is a behavioural remedy requiring ongoing regulatory oversight. Note: Although the merger was conditionally approved, it was later abandoned due to inability to agree on certain implementation matters. We will now move to behavioural remedies. Some the prevention of anti-competitive pricing practices proposed mergers raise concerns about the poten- by the merged entity. tial for ongoing anti-competitive behaviour by the merged firm. Remedial orders issued in response to A merger may impact existing regulatory treatment these concerns are generally similar to the remedies of one or more of the merged firms in a number of for abuse of dominance discussed earlier in this ways. For example, if a merger significantly Module. Box 5-18 describes the US FCC's decisions increases a firm's market share or market power, the in recent Bell Operating Company mergers in the regulator may review earlier decisions to forbear US. It illustrates the types of behavioural remedies from regulation. Similarly, it may review an earlier that may be imposed in telecommunications industry determination that an entity involved in the merger mergers. These orders are likely to focus on the was not dominant in its market, and was thus enti- supply of products or services to competitors and tled to a lighter degree of regulation. McCarthyTetrault infoDev Telecommunications Regulation Handbook Box 5-18: Case Study - FCC Review of Bell Atlantic/Nynex and SBC/Ameritech Mergers The Bell Atlantic/Nynex Merger On 14 August 1997, the FCC approved the merger of Nynex Corporation into Bell Atlantic Corporation. The FCC's review was conducted pursuant to sections of the Communications Act of 1934, which requires FCC approval for transfers of operating licences and other authorizations. These sections required a demonstration that the merger is in the public interest. Accordingly, the parties to a proposed merger have the onus of proving that the transaction will enhance competition or that it will otherwise be in the public interest. The merger was also subject to approval of the US Department of Justice (DOJ). In this and other merger reviews, the FCC applied the 1997 DOJ/FTC Horizontal Merger Guidelines. The FCC also evaluated the proposed merger on the assumption that the market opening initiatives introduced by the Telecommunications Act of 1996 had been implemented. Applying this framework, the FCC concluded that the merger would have significant anti-competitive effects. The first concern was that the merger would remove Bell Atlantic as a potential Nynex competitor in the New York market. The second concem was that continuing Bell Operating Company consolidation increased the likelihood of co-ordinated action among the remaining market participants. The FCC reviewed claims of merger-related efficiencies put forward by the parties (including cost savings, accelerated broadband deployment and service quality improvements), and concluded that these fell far short of overcoming anti-competitive effects and of demonstrating a net public benefit. The FCC concluded that substantial barriers to entry would remain and that, without the benefit of additional measures, market entry could not be relied upon to constrain the exercise of market power. Ultimately, the FCC decided to approve the proposed merger based on the following market opening commitments volunteered by Bell Atlantic. These commitments were to be made enforceable conditions for approval of the merger: - the provision of detailed performance monitoring reports to competitors and regulators regarding performance of Bell Atlantic's networks and operational support systems (OSS); > negotiated performance standards and enforcement mechanisms covering all major aspects of OSS operation and network performance; > development and implementation of uniform OSS interfaces for the combined Bell Atlantic / Nynex region; > operator-to-operator OSS testing in response to competitor requests, with a further obligation of providing evidence to the FCC that OSS functions could meet demand for resold services and unbundled network elements; > offering interconnection, unbundled network elements and transport and termination services at rates based on forward-looking economic cost; > offering unbundled switching and shared transport services priced on a per minute of use basis, routed in the same manner as Bell Atlantic's phone traffic and without the imposition of access charges; and - optional payment plans permitting new entrants to pay recurring charges for what would otherwise be non-recurring charges, an installment payment plan for co-location and other large non-recurring charges and altemative payment mechanisms for common construction costs and competitor- specific construction and equipment costs (with cost apportionment consistent with earlier FCC orders). These conditions were subject to a sunset limitation. They were due to expire 48 months following the release of the merger approval order. 5 - 38 infoDev McCarthyTetrault Module 5 - Competition Policy Box 5-18: Case Study - FCC Review of Bell Atlantic/Nynex and SBC/Ameritech Mergers (cont'd) The SBC / Ameritech Merger On 6 October 1999, the FCC approved the merger of Ameritech Corp. into SBC Communications Inc. FCC approval was required and proceeded under the same statutory framework as the Nynex / Bell Atlantic merger. As a result of the merger, SBC will control three of the original seven Regional Bell Operating Companies (Southwestern Bell Telephone, Pacific Telesis and Ameritech). Perhaps because of this greater degree of consolidation, the FCC appears to have required a more onerous set of conditions in order to approve the merger. In its review, the FCC was primarily concerned about the effects of the merger in removing a significant potential competitor from each of the participating firms' local markets. Concerns were also expressed about impeding the implementation of the market-opening requirements of the Telecommunications Act of 1996. Again, the FCC concluded that claimed efficiencies and other merger benefits were insufficient to overcome the identified anti-competitive effects. Both the DOJ and FCC reviews of the SBC / Ameritech merger concluded that the merged entity would have to divest itself of cellular telephone licences in identified service markets (14 in all). This would eliminate overlapping operations by the two merged firms in those markets. The FCC concluded that the transfer of Ameritech's international authorizations to SBC would be approved subject to the SBC subsidiaries being classified as dominant international operators on US-South Africa and US-Denmark routes. The most striking aspect of the FCC Decision is the range of conditions to be imposed on the merged entity. The conditions (30 in all) include: l establishing a separate affiliate for the deployment of advanced services (which must obtain facilities and services from SBC companies on the same terms as competitors and be subject to a l"comprehensive" annual audit); l enhanced OSS loop information and loop conditioning to facilitate competition in advance services; >- enhanced OSS and performance measurement data to improve and monitor interconnection and other competitor provisioning (with identified 'incentive payments' to be made by SBC if performance measures are not met); l interconnection agreements to be made available on a multiple state and "most-favoured-nation" basis; >- identified operator-to-operator "promotions", including a loop discount of 25% off the otherwise lowest monthly loop charge (subject to "state-specific quantity limits"); l - a commitment to enter at least 30 out of territory, major markets as a facilities-based competitive local service provider (to business and residential customers) within 30 months of the merger closing (and subject to an "incentive payment" of up to $1.2 billion U.S if the entry requirements are not met in all 30 markets); and l a number of residential service enhancements, including "life line plans" for low-income subscribers and additional quality of service and network reliability reporting requirements. These conditions are of limited duration. SBC undertook that each of the conditions would remain in effect for a period of 36 months from first implementation. McCarthyTetrault infoDev 5 - 39 Telecommunications Regulation Handbook 5.4.4 Joint Ventures competition or result in the exercise of market power to the detriment of competitors or consumers. Joint In some cases, telecommunications competitors ventures can become vehicles for anti-competitive may enter into joint ventures. The competition collusion between firms that would otherwise be analysis of joint ventures generally raises similar competitors. Such ventures can also result in the issues to those discussed under the title Restrictive creation or reinforcement of a dominant position. Agreements earlier in this Module. The process and infonnation requirements for review of a joint venture Box 5-19 illustrates some of the considerations will resemble those discussed earlier under the title taken into account in a large-scale telecommunica- Merger Analysis and Remedies. tions joint venture recently reviewed by the European Commission. Questions will be raised about whether a joint venture will bring about a significant reduction in Box 5-19: Case Study - The BT/AT&T Joint Venture On 30 March 1999, the European Commission approved the creation of a joint venture between British Telecommunications pic and AT&T Corp. to create a global telecommunications services company. The final decision marked the conclusion of an in-depth inquiry commenced in December 1998. This inquiry was prompted by concerns that: l The joint venture would create or reinforce a dominant position in the supply of international telecommunications services to large corporations and other telecommunications operators; - the joint venture would create or reinforce a dominant position for certain telecommunications services in the U.K.; and - the joint venture would result in anti-competitive co-ordination in the U.K. market given AT&T's ownership interests in competitors to BT (ACC and Telewest). The joint venture was assessed with a view to determine whether it would create or strengthen a dominant position and significantly impede competition contrary to Article 2 of the European Community Merger Regulation and Article 85 (now 81) of the EC Treaty. The Commission concluded that the presence of substantial competition in the international services markets, as well as "plentiful additional capacity" supported the conclusion that the joint venture did not create or strengthen a dominant position. Although the Commission found that AT&T and BT had about half the traffic volume on the U.K./US route, it also found that the parties controlled only about 20% of capacity with planned additional capacity and falling prices for new capacity supporting competitive entry. However, the Commission expressed a number of 'co-ordination concems" regarding U.K. markets. These included concerns about AT&T's interests in BT competitors ACC and Telewest (the former a competitive long distance telephone services provider, the latter a major operator of telephony enabled cable TV systems). The Commission was also concemed about the distribution of AT&T /Unisource international telecommunications services in the U.K. To overcome these concems, AT&T volunteered undertakings to: > divest its interests in ACC U.K., - reinforce the structural separation between AT&T and its Telewest holdings, and : facilitate the appointment of another Unisource services distributor in the U.K. (since the existing U.K. distributor, AT&T U.K., would be wound up). The Commission granted approval for the joint venture subject to compliance with these undertakings. 5-~ 40 infoDev McCarthyTetrault MODULE 6 Universal Service Table of Contents Module 6- Universal Service 6.1 Universal Service and Universal Access 1 6.1.1 Introduction 1 6.1.2 Objectives of Universality Policies 3 6.1.3 The Economics of Universality 4 6.2 Defining Universality: What to Fund? 8 6.2.1 Different Countries: Different Approaches 8 6.2.2 Universal Service in Industrialized Economies 9 6.2.3 Universal Access in Developing and Transitional Economies 9 6.3 Implementing Universality: How to Fund It? 12 6.3.1 Criteria for Selecting Universality Mechanisms 12 6.3.2 Promoting Universality: Comparing the Options 15 6.3.3 Sector Reform and Universality 15 6.3.4 Mandatory Service Obligations 19 6.3.5 Cross-Subsidies 19 6.3.6 Access Deficit Charges 21 6.3.7 Universality Funds 22 6.4 Universality Funds 23 6.4.1 Introduction 23 6.4.2 Sources of Fund Revenues 23 6.4.3 Determining the Amount of Subsidy 25 Appendix: Universality Case Studies 1 Chile 29 2 Peru 33 3 European Commission 37 4 United Kingdom 39 5 Spain 41 6 CEE and CIS Countries 43 7 Canada 45 8 United States 49 9 South Africa 51 10 Australia 53 11 Asia 55 McCarthyTetrault infoDev 6-i Boxes, Figures and Tables List of Boxes Box 6-1: Features of a Good Universality Fund 23 Box 6-2: Key Information in Fitel Tender Documents 34 Box 6-3: Evaluation Process for Bids 36 Box 6-4: Benefits of Being a Universal Service Provider 40 Box 6-5: CRTC Basic Service Objective 46 List of Figures Figure 6-1: Ratios of Urban to Rural Telephone Density by Region 4 Figure 6-2: Teledensity and GDP per capita 5 Figure 6-3: Telecommunications Revenues as % of GDP 7 Figure 6-4: Index of OECD Business Charges and Teledensity 18 Figure 6-5: Index of OECD Residential Charges and Teledensity 18 Figure 6-6: Regional Analysis of FDT Subsidies Awarded (1995-98) 32 List of Tables Table 6-1: Teledensity in Selected Countries 6 Table 6-2: Universality in Selected Industrialized Countries 10 Table 6-3: Universality in Selected Developing and Transitional Economies 11 Table 6-4: Modelling of Financial Viability of Rural Payphones 13 Table 6-5: Options for Promoting Universality 16 Table 6-6: Selected Licence Network Expansion Obligations 20 Table 6-7: Summary of FDT Results 31 Table 6-8: Example of Multiple Project Procedure 35 Table 6-9: Projects Tendered in December 1999 36 Table 6-10: Annual Net Cost and Benefits of Universal Service Provision 40 6 - ii infoDev McCarthyTetrault UNIVERSAL SERVICE 6.1 Universal Service and Universal While US and UA policies can be quite different, the Access concepts are closely related. In some cases, the terms US, USO and UA are used interchangeably. 6.1.1 Introduction In this Module, we use the term universality to refer to both US and UA. This Module deals with the concepts of universal The overiding objectives of universality policies are service (US) and universal access (UA) in the tele- to expand and maintain availability of affordable communications sector. These concepts can be telecommunications services to the public. In described as follows: particular, US and UA policies are aimed at provid- ing or maintaining service to those who would not Universal Service policies generally focus on normally be served. This population includes those promoting or maintaining "universal" availability in high cost service areas, such as rural and remote of connections by individual households to regios swelarerincmegrups. public telecommunications networks. The objec- regions, as well as lower income groups. tive of connecting all, or most, households to This Module reviews the key issues in the develop- public telecommunications networks is generally ment and implementation of universality policies and referred to as the 'Universal Service Obligation" programs (USO). US is a practical policy objective in many p industrialized countries. However it is not Section 6.1 provides background information on economically - feasible- in most developing telecommunications universality. It lists the main countries, where universal access is a more objectives for introducing universality programs, and practical objective. describes the economics of universality. Universal Access generally refers to a situation Section 6.2 deals with the definition of US, UA and where every pers-onf has-at reasonable means of the USO. The definitions vary among countries. The access to a publicly ayai!able telepho;ne. UA underlying economics of universality suggest that may be providedn through pay telephones, richer industrialized countries will focus on providing community telep _6enres, "teleboutiques, community ntemet- access terminalseandusimilar a range of increasingly sophisticated services to community Intemet access terminals and similar means. McCarthyTe'trault infoDev 61 Telecommunications Regulation Handbook every household, while developing countries will Traditionally, most countries have relied to some focus on providing public access. extent on the second and third approaches listed above: that is, mandatory service obligations and Innovative programs in countries such as South cross subsidies. These mechanisms were intended Africa, Chile and Peru dermonstrate that it is possible to subsidize unserved or high cost subscribers from to make advanced telecommunications services, revenues earned from other subscribers or services. including Intemet access, available to the public at a Such transfers are often implicit rather than explicit. reasonably low cost. Good universality policies can International and long distance services, for exam- go a long way to bridging the "digital divide" between ple, have traditionally been priced well above cost. "online" and unserved populations in developing as Surplus revenues from these high-priced services well as industrialized countries. were intended to be used to subsidize higher cost or lower margin services, particularly residential local Section 6.3 addresses the question: How to fund access lines. universality programs? That section reviews the main approaches used in different countries. These Today, cross-subsidies between services are approaches include: increasingly viewed as impractical and anti- competitive. With the onset of competition in > Market-Based Reforms: especially privatiza- intemational and long distance services, rates have tion, competition and cost-based pricing; fallen. This has left smaller subsidies available to support the universality objective. ' Mandatory Service Obligations: imposed by licence conditions or other regulatory measures; Economists and other telecommunications experts have long criticized inter-service cross-subsidies. Cross-subsidies: between or within services Cross subsidies can promote inefficiency and de- provided by incumbent operators; press demand for services (e.g. Internet services) that must pay artificially high international rates. " Access Deficit Charges (ADCs): paid by They also constitute a form of hidden taxation, which telecommunications operators to subsidize the may be regressive. For example, a cross-subsidy access deficit of incumbents; and regime may require poor migrant workers, who will never be able to afford a personal telephone, to pay > Universality Funds: independently adminis- high long distance rates to subsidize individual line tered funds that collect revenue from various services to their wealthier fellow citizens. sources and provide targeted subsidies to implement universality programs. Finally, large cross-subsidies have fallen out of favour with telecommunications experts today These approaches are not mutually exclusive. Most because they simply have not been effective as a countries use more than one approach. tool to promote universality. Some of the countries with the highest intemational, business and long Industrialized countries have gradually introduced distance service rates in the world have retained market-based reforms, such as privatization, some of the lowest telephone penetration or competition and cost-based pricing over the last two teledensity rates. Other countries with similar or decades. Despite concerns to the contrary, the lower levels of GDP have often increased their evidence suggests that teledensity levels increased, teledensity levels significantly after implementing and did not decrease, after these reforms were im- alternative approaches to promoting universality. plemented. Many other countries around the world, with historically lower telecommunications penetra- Access Deficit Charges are used to promote univer- tion levels, have also introduced similar reforms in sality in some countries. An ADC regime is like a recent years. In these countries, well-designed traditional cross-subsidy regime, but modified to fit a sector reforms have led to large gains in competitive market. In an ADC regime, other telecommunications service penetration levels. operators pay subsidies to finance the total local access deficit incurred by the incumbent in providing 6 - 2 infoDev McCarthyTetrault Module 6 - Universal Service local services that are priced below cost. Like cross- The following are some of the major objectives for subsidies that are internal to the incumbent, ADCs implementing universality policies: have been criticized for their reliance on inefficient and potentially anti-competitive subsidies. A number - To permit full participation in 21st Century of regulators, including those in Australia and society. Access to telecommunications is in- Canada, have reformed their ADC regimes by tar- creasingly being viewed by policy makers as a geting subsidies to finance only the access deficit basic right of all citizens, essential to full incurred in providing service to high-cost areas membership in the community. The objective of and/or low-income subscribers. Others, such as the ensuring access is gaining momentum due to UK's Oftel, have abolished ADCs altogether. the increased reliance on the Internet and re- lated new media by all sectors of society. It is The final approach discussed in this Module is the widely recognized today that telecommunica- universality fund. This approach is seen as the best tions services are necessary for far more than option in an increasing number of industrialized and personal and business communications. Today, developing countries. The approach has many telecommunications delivers all types of variations. These are sometimes called USO funds, information, goods and services to the public; US funds or UA funds. including essential government, social, educa- tional and medical services, and a wide range of Universality funds collect revenues from a variety of e-commerce services. Those without access to sources. These include government revenues, telecommunications services risk becoming charges on interconnecting services and levies on increasingly marginalized members of 21st all telecommunications service operators. The reve- Century society. nues collected in these funds are then used in a variety of ways to promote universality objectives. In > To promote national political, economic and contrast to ADCs, universality funds are generally cultural cohesion. These nation-building consid- used to finance specific and targeted high cost areas erations call for the widespread availability of and/or low income subscribers. In practice, the most telecommunications throughout a country's efficient funds provide relatively small subsidies to territory. Creating a single market, and even a incent private sector telecommunications operators single nation-state, requires effective telecom- to expand their networks to serve specifically munications. targeted service areas. These are typically areas where service would otherwise be uneconomic (i.e. To promote economic development. While the where costs cannot be recovered from available relationship between economic and telecom- subscriber revenues). munications development is a complex one, an increasing amount of research suggests that Section 6.4 addresses the main issues involved in telecommunications leads to economic growth. designing an effective universality fund. With the increasing ubiquity of the Intemet and e-commerce, countries or regions without The last half of this Module is devoted to case adequate telecommunications infrastructure will studies of universality policies and programs in a not be able to reap the benefits of the "new range of different countries. The case studies are economy". referred to throughout the Module to illustrate vari- ous approaches and issues. > To encourage more balanced distribution of the population. Telecommunications can encourage 6.1.2 Objectives of Universality Policies development outside congested metropolitan areas. This objective is often cited in industrial- Govemments and regulators pursue universality ized countries, where "telecommuting" can ease policies for dfferent reasons. In many countries traffic and pollution in urban areas. there is strong political support for extending US or at least UA to unserved members of the public. > To eliminate disparity between rural and urban areas. This objective is particularly apt in lower McCarthyTetrault infoDev 6-3 Telecommunications Regulation Handbook income countries. Figure 6-1 illustrates the between the national telephone penetration rate, disparity between urban and rural access to and a nation's per capita Gross Domestic telecommunications in various regions. Only in Product (GDP). Figure 6-2 illustrates the high-income countries is the ratio of urban to ru- relationship between teledensity and per capita ral teledensity close to being balanced. The GDP. ratios of urban to rural teledensities in developing regions is considerably higher, :s- The strong relationship between teledensity and ranging from a high of about 7:1 in South Asia, GDP per capita provides explanations for major to a low of the about 2.5:1 in Eastern Europe, differences in teledensity in different countries. It Central Asia, Latin America and the Caribbean. is not surprising that countries such as the USA, Canada, Japan, France and Germany rank high 6.1.3 The Economics of Universality in teledensity levels, compared to most countries in Africa, for example. A sample of Universality and Economic Development teledensity levels reported by the ITU is included in Table 6-1. The most important determinant of telecommunications universality is economic development. There is a strong relationship Figure 6-1: Ratios ofrenityby Rg - H .jHlgh-Incom me 60 fc o m le s E . Eu ro p e and nd Ce ntral Asila Latin Am e rica - a n d C a rib b e a n S u b .5 a h arer n __ _ _ _ _ _ _ _ _ _ _ _ Af rca M idd le East a .t| a n d N . Africa l _ EEa s A A si a and n d S o u th A 5 ia I~~~~c.: .' *'. -;1 ,~ .' ,. , ~~~~~~~~~~~~.' 6-4 4 6 - 4 ~~~~~~ ~ ~ ~~~infoDev McCarthyTetrault Module 6 - Universal Service Fiue -:Teleden-sityanv DPpe apt 100 dL90 a 0. 80 70 * 6 60- , I 50 ua30. l e 20 t _ _ l 0 5000 10000 15000 20000 25000 30000 35000 40000 GDP/capita (USD)l In general the maximum amount of revenue avail- increased teledensity levels in some countries. able to fund telecommunications networks and However, such sources of external revenues are services depends on per capita income levels within declining. This decline is due, in part, to the wide- a country. It is clear, from Table 6-1, however, that spread perception that scarce public development per capita income levels do not absolutely determine funds should be devoted to other purposes since teledensity levels. Table 6-1 illustrates that there are private capital is generally available to fund tele- many variations in the relationship between GDP communications network development. per capita and teledensity. For instance, the distribu- tion of income within a country will determine the Expenditures on Telecommunications number of households that can actually afford to have access to telecommunications services. The Although national per capita income levels impose a table also makes it clear that penetration of public constraint on universality, there are significant dffer- telephone lines and cell phones varies considerably ences in the percentage of income that is spent on across the range of countries illustrated. telecommunications in different countries. For example, in some countries with a relatively low In some of the least developed countries, aid from GDP per capita, less than 1% of GDP is spent on foreign govemments and multilateral institutions, telecommunications. In other countries with similar such as The World Bank, has provided supplemen- GDP per capita, as much as 4% or 5% of GDP is tary resources to expand teledensity levels. Cross- spent on telecommunications. These differences subsidies from international telephone accounting and the general trend in telecommunications rates, and other extemal sources have also spending are illustrated in Figure 6-3. McCarthyTetrault infoDev 6-5 Telecommunications Regulation Handbook Table 6-1: Teledensity in Selected Countries Country GDP per capita (in Teledensity Public teledensity , Mobile cellular 1997 USD) | (Telephone lines per (Public telephone phones (per 100 100 people 1998) lines per 1000 people 1998) people 1998) Angola 1,684 1.0 0.0 0.1 Argentina 8,214 20.0 2.7 7.9 Bangladesh 262 0.3 0.0 0.1 Cameroon 617 0.5 0.0 0.0 Canada 20,608 63.4 6.1 17.6 Colombia 2,424 17.3 1.4 5.0 Czech Republic 5,052 36.4 3.6 9.4 Egypt 1,195 6.0 0.1 0.1 Germany 25,625 56.7 1.9 17.0 Haiti 447 1.0 -r India 451 2.0 0.4 0.1 Indonesia 1,068 3.0 1.1 0.5 Japan 33,231 50.3 6.2 37.4 Mexico 4,216 10.4 3.3 3.5 Morocco 1,218 5.4 1.1 0.4 Nepal 220 0.9 0.0 Peru 2,676 6.7 2.0 3.0 Russia 3,030 20.0 1.3 1.0 South Africa 2,979 11.5 3.5 5.6 Thailand 2,478 8.4 2.0 3.3 Ukraine 974 19.1 1.1 0.3 USA 30,173 66.1 6.5 25.6 - means zero or a quantity less than half the unit shown. Source: ITU (1999) The international experience provides a good rule of around the world, people spend about 2% to 3% of thumb for testing the effectiveness of universality their incomes on telecommunications. This relation policies. There are dfferences in national telecom- generally holds true for whole countries, regions, munications expenditures. However, on average, cities, and on average to households. 6 - 6 infoDev McCarthyTetrault Module 6 - Universal Service ' ~ gure 6-3: Telec ues as 0/ ofGDP .t ~ w - _ _ _ _____ . . j_ 6 * . , a .4 's ,4 ='3 3:i m sA,E 2 CS*':- . 0 - - ---------- -_ 7 ;;-lr - 0 10000 20000 30000 40000 GDP/capita (USD) . - b o u r O- (- 999 This rule of thumb that an average of about 2.5% of ) No competition in relevant telecommunica- per capita income is spent on telecommunications tions markets worldwide is useful in a number of ways. For example: > No effective universality policies Where the costs of providing telecommunica- In many countries, lack of supply and not lack of tions access is greater than 2.5% of local demand is the principal reason for low teledensity. incomes, extemal subsidies may be required to Problems, such as those listed above, have resulted promote UA. Funding mechanisms, such as a in long waiting lists for telephone service in many universal access fund, can be designed with this developing countries. As illustrated in Figure 6-3, rule of thumb in mind. Local residents will gen- consumers around the world are willing spend a erally be willing and able to pay about 2.5% of reasonable percentage of their income on their incomes on telecommunications services, telecommunications, if service is provided to them. and the fund may be required to subsidize the rest of the costs. A review of intemational experience makes it clear that the actions of governments and regulators Where it would cost less than about 2.5% of determine the level of universality that is achieved in local income to provide telecommunications a specific country. While national incomes place services, but no service is available an area, constraints on the upper level of universality, it is there is often a sector policy problem. In many clear that some countries have been far more suc- cases, one or more of the following problems cessful than others in providing their citizens with exists: access to telecommunications. ) Poortelecommunicationssectorgovemance Specific examples of experience with universality policies are found in the case studies in the - No priority given to telecommunications Appendix to this Module. The case studies of coun- development tries such as Peru and Chile demonstrate that good universal access policies can significantly expand > No reliance on private sector funding to ex- service without large govemment expenditures, pand networks even in remote areas with low income levels. McCarthyTe'trault infoDev 6-7 Telecommunications Regulation Handbook It is clear that low teledensity levels in many devel- mies with former state-owned operators that are in oping countries have two distinct causes: (1) under- transition to market economies. Such definitions of supply of telecommunications services due to universality were sometimes unrealistic, and many inadequate sector policies, and (2) low demand due universality targets have been missed in developing to low incomes. The first cause should be addressed or transitional economies. "Planned" levels of first. The most effective and lowest-cost means to universality will only be effective where they are increase teledensity in countries that have not linked to realistic implementation measures, already done so, is to implement telecommunica- including funding mechanisms. tions sector reforms such as competition, privatization and pricing reform (e.g. price More care should be taken in defining US or UA rebalancing). Evidence around the world when specific universality implementation measures demonstrates that reforms of this type will remove are introduced. Such definitions are generally devel- many supply constraints on the sector. oped to define the mandatory service obligations of an operator that is designated as a "Universal However, such sector reforms will generally not be Service Provider". A definition may be included in sufficient to address the second cause of universal- the licence conditions of the US provider at the time ity problems - insufficient local incomes to support of its privatization. Definitions are also required as the rollout of telecommunications networks. Most of part of specific USO funding mechanisms, such as this Module is devoted to regulatory approaches that ADCs and universality funds. address that second cause of universality problems. The main approaches are mandatory service obliga- Matching Universality Definitions to Local tions, cross-subsidies, ADCs and universality funds. Conditions Before reviewing these approaches, however, we The definitions of telecommunications universality will consider the definitions of US, UA and the USO. are very different, for example, in Switzerland than in Pakistan. Realistic universality definitions reflect 6.2 Defining Universality: What to local economic and sector conditions. The level and Fund? distribution of national income are important factors. Another key factor is the distribution of a country's 6.2.1 Different Countries: Different population. The resources required to provide tele- Approaches communications services to the same number of people will vary depending on whether the majority Reasons to Define US and UA of the population is concentrated in metropolitan areas, or is widely dispersed in rural areas. National Countries have defined universal service ("US") geography, topology and security marters may al and/or universal access ("UA") for a number of be Important factors reasons. In some cases, universality definitions have been estblished s a pato.ainltlcmui Two distinct aspects can be noted In the definition of been estabilshed as a part of national telecommuni- uieslt nalcutis cations development plans. Such definitions sometimes include specific target dates and service Types of access - At the most general level, levels. the difference between US and UA is that the former generally refers to individual or private In some countries, state planners or policymakers (xlsv)acs,wietelte eest prescdbed cranlvlofuiesit. Suc (exclusive) access, while the latter refers to prescribed certain levels of universality. Such comnt orpbi'sae).ces nvr prescribed levels were often included in telecommu- community or pubdic (shared) access. Univer- nications policies or national plans. This was reqirementsor aei evel ivate particularly true in some centrally planned requirements for a certain level of both private economies with state-owned operators, or econo- and publicaccess. 6 - 8 infoDev McCarthyTetrault Module 6 - Universal Service Types of services - Basic access is typically Table 6-3 provides a selected list of universal defined to include voice-grade fixed access to access policies and operator obligations established the PSTN. However, many universality defini- by various developing and transitional economies. tions amplify this requirement. Some countries include enhanced or value-added services, In all but the richest of the developing and transi- including Internet access, within the scope of tional economies, it is unrealistic to set a universal their universality regimes. service objective of providing fixed telecommunica- tions service to each household, at least in the near As a general rule, developing and transitional term. In such economies, the regulatory focus tends countries place greater emphasis on basic public to be expansion of access services. Effective uni- access. Industrialized countries can afford to define versality policies in these countries generally universal service more broadly to include advanced concentrate on: features. Details of different types of universality definitions are included in the following sections. ' Expansion of new access services, rather than support of existing services 6.2.2 Universal Service in Industrialized Economies - Expansion of services to remote or high cost areas and low income subscriber groups, where Table 6-2 provides a summary of the types of it is currently uneconomic to provide service service contained in the definitions of universal service in selected OECD member countries. The >- Priority on public access services, rather than table provides a good sense of the scope of univer- private household access sality as currently defined in those countries. It should be kept in mind that the definitions are not Table 6-3 provides examples of some "disconnects" static. They are evolving with market conditions and between the definition of universal access and the public demand. mechanism to implement such access. For example, in a number of countries where the UA A review of the definitions in Table 6-2 makes it clear definition calls for a phone in every village, no obli- that most of the listed OECD countries have defined gations are imposed on the incumbent operator to universal service to include much more than basic supply such phones. More significantly, in many public access to voice telephony. In most cases, the countries, no funding mechanism is defined to prescribed level of universal service must be implement the universality objectives. provided to individual subscribers on demand at regulated rates. In some cases, these regulated Modelling the Viability of Universality Programs rates are fixed below cost and subsidized through cross-subsidies, ADCs or universality funds. Details A number of analytical tools are available to regula- of funding approaches are provided in Section 6.3 tors and policy makers to develop realistic and in the case studies in the Appendix. universality definitions and implementation policies. Financial models have been developed to determine 6.2.3 Universal Access in Developing and the cost and feasibility of expanding service to Transitional Economies unserved areas. In general, these models calculate the difference between the cost of providing service Many different universality definitions and objectives in specific regions and the projected telecommuni- are used in developing and transitional economies. cations revenues available in those regions. McCarthyTetrault infoDev 6-9 Telecommunications Regulation Handbook Table 6-2: Universality in Selected Industrialized Countries Summary of Definitions of Universal Service in Selected OECD Countries Australia Standard telephone services, including voice telephony and, if voice telephony is not practicable due to a disability, another form of communication equivalent to voice telephony (e.g. a teletypewriter); payphones; prescribed carriage services. Canada Individual line local service with touch-tone dialing, provided by a digital switch with capability to connect via low speed data transmission to the Internet at local rates; enhanced calling features, including access to emergency services, Voice Message Relay service, and privacy protection features; access to operator and directory assistance services; access to the long distance network; a copy of a current local telephone directory. USA Voice-grade access to the PSTN, with the ability to place and receive calls; Dual Tone Multi-frequency (touch-tone) signaling or its functional equivalent; single party service; access to emergency services; access to operator services; access to directory services; access to long distance services. Austria Access to the PSTN via a fixed network connection, through which a fax machine also can be operated, including the transfer of data at rates compatible with transmission paths for voice communication; free access to emergency services; access to directories of subscribers, as well as directory enquiry services; public pay telephones. Denmark A telephony network and an associated telephony service; an ISDN network and the associated ISDN services; leased lines (excluding broadband lines); special services and tariffs for disabled subscribers; public radio-based maritime distress and safety services; directory enquiry services. Italy Voice telephony (also capable of providing fax G3 and data transmission); provision of directory for local area users; provision of customer information service; payphones; special services for the disabled; connection to emergency services. Norway Public voice telephony; operator assistance; emergency and directory inquiry services; public payphones. Spain Basic telephone service including local, national and international access; free directory services; public phones; special services for disabled people. Switzerland Real time voice transmission or voice band and digital data transmission, keypad tone dialing and main entry in telephone directory; additional services such as call forwarding, privacy protection, itemized billing and outgoing call barring; emergency services; directory services; public telephones; text service; operator assistance. United Kingdom Connection to the fixed network able to support voice telephony and with speed data and fax transmission (and the option of a more restricted service package at a lower cost); public telephones; free access to emergency services; itemized billing; selective call barring; access to operator assistance and directory assistance. Source: Adapted from OECD (1999) 6-10 infoDev McCarthyTetrault Module 6 - Universal Service Table 6-3: Universality in Selected Developing and Transitional Economies Summary of Universality Access Definitions and Obligations Country Universal Access policy Operator Obligations Bhutan A phone booth in every village. No obligations. Comoros A phone in every locality. No obligations. Costa Rica Within 1 km of both public and private No obligations. access. Cuba Access to all villages and to communities Licence conditions stipulate by the of more than 500 inhabitants. end of the first 8-year programme l all villages of more than 500 inhabitants must have access. Ethiopia A phone booth in every town. Obligations under preparation. Guinea A telephone box for every locality; a tele- Service and interconnection phone exchange for every administration. expected; no specified obligations. Iran Telephone facilities to all villages of more Expansion, service quality, inter- than 100 people. connection and service to the elderly as part of licence conditions. Kenya A phone within walking distance. A performance contract entails obligations on service quality and expansion. Kyrgyzstan A phone booth in every town; a phone in Expansion, service quality and every home. interconnection contracted with the govemment. Lesotho A public telephone within 10 km of any Voluntary objective to be achieved l _________________ _ ,community. by 2002. Madagascar A public phone in every village. No obligations. Maldives At least one telephone booth per 500 Operator's licence condition is to inhabitants; a phone on every island. provide access to basic telecom- munications services to the whole l _________________ l _____________________________ _ . country by the year 2000. Mozambique A public telephone within distance of less Expansion, service quality and than 5 km. At least one public telephone in interconnection contracted with each of the 144 district centres. the govemment. Pakistan A phone in every village. No obligations. Togo A telephone within a 5 km radius by 2010; Contract with the state to a telephone in every administrative and determine the objectives for economic centre of importance development and plurality of service. Zambia Telephone booths in public places No obligations. (schools, clinics, etc) countrywide. Source: Adapted from ITU (1998a) McCarthyTe'trault infoDev 6-11 Telecommunications Regulation Handbook Cost projections may be based on specific network 6.3 Implementing Universality: How construction studies, or on local or international toF It? benchmark costs for building new lines. Revenue un projections can be developed in different ways. One approach is to start with per capita income estimates 6.3.1 Criteria for Selecting Universality for residents of the target region, and then to multiply Mechanisms those estimates by the number of inhabitants in an area. The results can then be used to determine This secton considers the five main mechanisms in whether the provision of new telecommunications use around the world today to implement universality services is financially viable. policies. These mechanisms are: For example, we know that, on average, people are > Market-Based Reforms: especially privatiza- willing and able to spend about 2.5% of their income tion, competition and cost-based pricing. on telecommunications services (see Figure 6-3). A very rough estimate of the viability of providing a le condato ns orvice Ob latory meases. specified level of service (e.g. one payphone per licence conditions orotherregulatorymeasures. village) can be made by determining whether it will cost more to provide that level of service than about > Cross Subsidies: between or within services 2.5% of the village's estimated income (per-capita provided by incumbentoperators. income multiplied by the number of inhabitants). The same type of study can be conducted for clusters of > Access Deficit Charges (ADCs): paid by tele- villages or regions. communications operators to subsidize the access deficit of incumbents; and If it is determined that a specified level of universal access is not financially viable, the same type of U Universality Funds: independently adminis- model can be used to estimate the shortfall between tered funds that collect revenue from various the projected costs and revenues of providing new sources and provide targeted subsidies to access lines. This type of approach is used in the implement universality programs. successful Chilean and Peruvian universality funds (See Appendix.) It can then be determined whether This list is not exhaustive and the mechanisms are a source of revenues will be available to subsidize not mutually exclusive. One (or more) of these the shortfall between costs and revenues. The mechanisms constitutes the main regulatory tool to financial model can project the amount of subsidies promote US and UA in most countries. There are required to make the service financially viable. many variations on the five mechanisms. Specific examples of the application of these mechanisms Similar types of models have been used to project are included in the case studies in the Appendix to the number of rural pay phones that can be finan- this Module. cially viable in dfferent countries. An example of the results of such a model is presented in Table 6-4. If The following sections of this Module describe the a country's universal service policy requires a five mechanisms. The strengths and weaknesses of greater number of payphones than the market can each are reviewed. In considering the dfferent support, a subsidy mechanism must generally be approaches, a number of criteria should be kept in developed to implement the policy successfully. mind. The following are particularly relevant: 6-12 infoDev McCarthyTetrault Module 6 - Universal Service Table 6-4: Modelling of Financial Viability of Rural Payphones Rural Population Required to Support One Rural Public Phone in Different Countries Country Rural GDP/Capita (USD) lnvestmenVLine (USD) Rural Population to Support One Public.- Phone Argentina 2,327 3,000 28 Bangladesh 171 1,000 187 Bolivia 299 9,000 535 Botswana 1,315 7,000 97 Brazil 843 9,000 190 Colombia 321 8,000 449 Ecuador 446 6,000 251 India 220 2,000 219 Indonesia 444 5,000 216 Kenya 140 5,000 687 Malaysia 1,152 2,000 42 Mexico 1,108 10,000 159 Nepal 139 7,000 574 Pakistan 275 2,000 175 Paraguay 812 7,000 158 Peru 295 10,000 597 Philippines 386 3,000 166 Thailand 1,212 4,000 66 Uganda 134 8,000 1,077 Zimbabwe 236 6,000 474 Source: Dymond and Kayami (1997) Note: GDP/capita and cost numbers are based on data from mid-1990's - Compliance with Intemational Trade Rules: and contains the following provision regarding The WTO Regulation Reference Paper which US: forms part of the WTO Agreement on Basic Telecommunications deals with universality and Universal Service - Any Member has the subsidy issues. The Reference Paper is right to define the kind of universal service reproduced in the Appendix A of the Handbook obligation it wishes to maintain. Such obliga- McCarthyTetrault infoDev 6- 13 Telecommunications Regulation Handbook tions will not be regarded as anti-competitive such cross-subsidies would continue to pay for per se, provided they are administered in a local access even if their rates were rebalanced transparent, non-discriminatory and to cover underlying costs. competitively neutral manner and are not more burdensome than necessary for the Such cross-subsidies also depress demand for kind of universal service defined by the higher cost services that provide the subsidies Member. (e.g. intemational, long distance, Internet and value-added services). This effect not only In addition to this specific section on US, the reduces operator revenues but can reduce Reference Paper has a number of other overall economic activity. Similar inefficiencies provisions that could impact upon the choice of are associated with other universality mecha- universality mechanism, and particularly a nisms that distort prices. This applies, for mechanism that uses cross-subsidies. For example, to ADCs which inflate long distance example, the Paper provides that: rates to provide subsidy to the access services of the incumbent. Appropriate measures shall be maintained for the purpose of preventing suppliers who, In contrast, the most efficient mechanisms are alone or together, are a major supplier from those that provide small targeted subsidies to engaging in or continuing anti-competitive promote specific universal service initiatives. On practices [including ... ] engaging in anti- the revenue side, the more efficient competitive cross-subsidization. mechanisms will collect revenues from govem- ment sources or from a widely-based range of If a country that has committed to the regulatory telecommunications services, rather than only rules in the WTO Agreement on Basic from specific "high margin" services, like inter- Telecommunications maintains a universal national or long distance services. Broadly service mechanism that infringes the based collection mechanisms with uniform Agreement, it will be open to a trade complaint charges will also reduce the inefficiencies to the WTO from other signatory countries. associated with operators "gaming" the system by by-passing highly-taxed services of - Economic Efficiency: Some universal service attempting to have their services classified as mechanisms are more efficient than others. The low-taxed or untaxed. degree of economic efficiency will depend, among other things, on which services receive > Political Considerations: These are undoubt- and provide the subsidies, and on the size of the edly important to any regulator that is appointed subsidy. Among the least efficient mechanisms by, or accountable to, government or a legisla- are implicit cross subsidies between services of ture. Public relations and political considerations an incumbent that are neither quantified nor are often cited as reasons not to introduce targeted. Such cross-subsidies are maintained market-based reforms, such as rebalancing in many countries, particularly those that retain rates, elimination of cross-subsidies, and, in state-owned incumbents. It is generally as- some countries, privatization. Political consid- sumed in such countries that high international erations can also be used to argue against in- and long distance rates are being used to creased taxes or levies on telecommunications subsidize low local access rates and to promote revenues to finance a universality fund. universality objectives. In many cases, hindsight proves that the political In reality, such implicit cross subsidies are often risks of introducing telecommunications sector misdirected and wasteful of resources. For reforms are exaggerated. For example, when example, under such an approach, low-income cost-based rate rebalancing was first proposed intemational callers subsidize low access rates in countries in North America a decade or more for high income local service subscribers. Many ago, there were dire predictions of decreased of the local access subscribers who benefit from teledensity levels or network "drop off'. Looking 6 14 infoDev McCarthyTetrault Module 6 - Universal Service back, it is clear that teledensity levels actually activity if they had the telecommunications services increased in most countries as local access to do so. rates went up. (See Table 6-5.) The same is true in many countries where privatization was Experience in a growing number of countries around introduced. Initially, political and labour reaction the world indicates that the introduction of market- was often strong. In retrospect, most telecom- based reforms can significantly increase the supply munications privatizations in the last decade are of telecommunications services. This experience is now seen as successful initiatives to expand supported by an increasing body of statistical network infrastructure while maintaining reason- evidence, including multiple regression studies. In able rate levels. many countries, a few key telecommunications sector reforms would eliminate most supply con- Many proactive regulators realize that they can straints. Three key reforms will be considered here: play an important role in shaping political and public opinion about telecommunications sector )- Privatization reforms. Some political opposition to sectoral reform is based on ignorance or blatant self- > Competition interest by established players. Regulators can often play an essential role in analyzing and > Cost-based pricing publishing the real costs and benefits of different universality options for politicians and the public. Privatization 6.3.2 Promoting Universality: Comparing the There is a growing amount of data available to dem- Options onstrate that privatization increases the supply of telecommunications services. Privatization has Table 6-5 lists the main options for promoting uni- significantly increased teledensity and public versality dealt with in this Module. Major advantages telephone penetration in a variety of different types and disadvantages are noted for each option. These of countries. advantages and disadvantages are dealt with in more detail in the following sections. Note that in Privatization promotes universality for a number of our detailed discussion of universality funds in reasons. First, network expansion targets are often section 6.4 we provide a set, of criteria for the included in contracts or licences that form part of the selection of the most appropriate revenue collection privatization process. However, that is only one rea- mechanism for that specific universality approach. son. Privatized operators have surpassed many Some of those criteria may also be applicable to the mandatory network expansion targets. Investors in revenue collection aspects of some of the other the privatized operators have demonstrated their universality approaches discussed below. willingness to meet or exceed rollout targets, not simply to comply with legal obligations, but as a 6.3.3 Sector Reform and Universality profit-maximizing strategy. There are other reasons why privatization promotes universality. These In many countries, particularly those with developing include: and transitional economies, outdated sector policies are a principal cause of universality problems. - Availability of private capital to fund network ex- pansion; Many of these countries have low income levels, and undoubtedly have many poor people who could - Commercial incentives to supply service to meet benefit from domestic or international programs to demand; promote universal access. However, in many cases, these countries also have large unserved popula- - Improved management; and tions that are willing and able to pay for personal or community telecommunications access. These s- Reduced political and bureaucratic constraints include businesses that could increase economic on extending service. McCarthyTetrault infoDev 6-15 Telecommunications Regulation Handbook Table 6-5: Options for Promoting Universality Main Options for Increasing Universality - Advantages and Disadvantages Option Advantages Disadvantages 1. Market-Based - Proven effectiveness in ex- - Privatization, competition and Reforms: panding service in economies cost-based pricing will not ex- (Privatization, with state-run telephone mo- pand service to uneconomic Competition & Cost- nopolies areas (however these reforms Based Pricing) Privatization tied to specific net- gan be supplemented by tar- work roll-out obligations (some- geted subsidies to achieve tims icluingnon-economic universality objectives in times including uneconomic areas) I ~~~~~~~~areas) Combination of 3 reformsshould > Some conflict between these 3 pr Combination of 3 reforms should reforms. Direct competition and cprovide incentives for rebalancing may be limited im- continuous service to all areas mediately after privatization to l that are economic to serve maximize network rollout l Reforms are consistent with obligations. Exclusivity periods sector development in all areas are often granted in order to (i.e. not just uneconomic areas) maximize privatization proceeds to the government 2. Mandatory Service - Can be effective, if realistic and > Places burden of financing Obligations: (imposed not anti-competitive universality on specific opera- by licence conditions . . tors; with potentially anti- or other regulatory > Most effectve for newly licensed competitive effects (if USO measures) or newly privatized operators burden outweighs benefits) l Sometimes used as a rationale to limit other sector reforms: rebalancing & competition 3. Cross Subsidies: ) Traditional approach in place in - Promotes inefficiency; demand (between or within many countries; often combined is depressed for higher cost services provided by with mandatory service obliga- services that provide subsidies, incumbent operators) tions and entry is foreclosed in subsidized markets l In most cases, only existing users receive the subsidy. l Anti-competitive effects are difficult to detect and prevent 4. ADCs: (Access - Spreads burden of financing un- > Difficult to calculate access Deficit Charges paid economic access services costs; difficult to implement and by telecommunications across all operators (including administer in a transparent and operators to subsidize competitors) efficient manner he access deficit of Ineffcient (as with cross- incumbent operator) subsidies) 6-16 infoDev McCarthyTetrault Module 6 - Universal Service ~ Difi~iItisc,acuIte benefits of l ^vid 'can lead to .exessve~accsscharges lo 5 1014 'rMstefeciv easIf roidl om amnistrative complexity Ftiu ,J n agtdsusde oepn n~U io'A expenses in orUA fud htclet o upr ncnmcsrieetbIshn f idsome poten- sores anirviePPoetalymstefcinialFo ba~oeance; difficult !' ai 0~~~~~~~~~~~~~li sources- ~ ~ ~ ~~~~~~~~~~rcstasoaled costs and targeted 'subiisuoeMottanprnts~ programsi- ie t n areas i. P1 ~ ~~~~~~ --n WRI W s '1 , -;- r . Competition This result is not surprising since, in most OECD countries, the evidence indicates that rate rebalanc- Competition generally has positive universality ing resulted in lower overall prices of telecommuni- effects. These include increased teledensity and cations service for most consumers. Other reforms, public payphone penetration and reduced waiting such as privatization and introduction of competition, lists. Competition has also resulted in significantly also stimulated price decreases in these countries. increased penetration of wireless service, which is becoming a substitute for wireline services in many In addition, the evidence indicates that the price countries. The relationship between competition and elasticity of access services is very low. In other teledensity has been demonstrated in studies of words, relatively few people will give up telephone both developing and industrialized country markets. access due to an increase in access rates. The research is consistent with the conclusion that local Cost Based Pricing access services and telephone calling services are complementary. Therefore a decrease in the price of As discussed in other Modules, "rate rebalancing" usage will result in an increase in demand for refers to initiatives to align prices for individual access services. In other words, demand for access telecommunications services more closely with service is influenced at least as much by the level of costs. In most countries, this means increasing local usage rates as by the access charge. subscription and usage rates and decreasing international, long distance and Internet access Figure 6-4 and Figure 6-5 demonstrate that there rates. When rate rebalancing was first proposed in has been significant price rebalancing over the last most countries, some predicted that higher local decade in business and residential telecommunica- access rates would lead to lower teledensity levels. tions markets in OECD countries. While fixed charges, such as those for local access, have in- Ten years later, the evidence indicates that such creased significantly, prices have declined overall. concerns were exaggerated. Penetration levels ac- During this period, teledensity increased every year tually increased after rate rebalancing, at least in despite the increase in fixed charges. As Figure 6-4 OECD countries, where most research has been demonstrates, this trend continued even in 1991 and done. 1996, when fixed business charges increased around 10% each year. McCarthyTetrault infoDev 6-17 Telecommunications Regulation Handbook Figure 6-4: Index of OECD Business Charges and Teledensity -T leIC args- - -U . .e C s, .. F1x5d C ha rges a a Tdensity aso 100- Iow 1* 9 sw I 9 Figure 6-5: Index of OECD Residential Charges and Teledensity .- TO.JI Chlag … g - - - oU Ch.rge.. - Fl.d Charges - T-- elede-sty | 0 20 Ilo 100 90 70 61 1990 1991 1992 1993 199. 1995 1996 1997 1999 6 18 ~~~~~~~~~~~~~~infoDev McCarthy Tetrault Module 6 - Universal Service The positive relationship between rebalancing and communications networks in developing economies. teledensity also seems to apply to developing They are used in the case of most privatizations and countries. For instance, as Ros and Banerjee (2000) new licence grants. A major benefit of implementing have shown, higher subscription prices result in such mandatory service obligations is that the fund- higher telephone penetration rates and in reduced ing is generally provided by the private sector. waiting lists. While this relationship seems counter- intuitive, there are good explanations. The main There are disadvantages to imposing excessively reason is that residential subscription rates tend to high roll-out obligations. A privatized operator be set below economic costs. As operators are normally has a commercial incentive to roll out serv- permitted to raise these rates, they are able to ice to previously unserved customers that are able reduce their access deficits. It becomes profitable, to pay for its service. If privatized operators are rather than unprofitable, to construct more network subjected to uneconomic service obligations they access lines. Thus, higher prices lead to increased will have to finance such obligations through mo- supply. nopoly profits, cross-subsidies or future considerations. In other cases, an operator may The experience with rate rebalancing in OECD simply fail to meet its roll-out obligations. countries is discussed further in Appendix 4-1 of Module 4. Table 6-6 presents a sample of recent licence obli- gations in developing and transitional economies. 6.3.4 Mandatory Service Obligations 6.3.5 Cross-Subsidies Perhaps the most commonly used mechanism for promoting universality is the mandatory service obli- For decades, in most countries, internal cross- gation. In some countries, this obligation is subsidization by the incumbent operator has been described as a "duty to serve" all customers willing the main mechanism used to promote universality in to pay the prescribed rates. the telecommunications sector. Such cross-subsidi- zation involves the use of surplus revenues earned Geographic limits are sometimes prescribed for from profitable services to cover losses from provid- areas where service is mandatory. For example, ing non-profitable services. In the context of such areas include urban areas but not remote rural universality, we are primarily concerned with the use areas where no telecommunications infrastructure is of such cross-subsidies to maintain low access installed. In most cases, new services must be rates, particularly in high cost areas. installed within a prescribed tme after an application for service is received. Compliance is monitored Theodore Vail, the driving force behind the early through quality of service indicators. success of AT&T in the USA at the tum of the last century, promoted universal service through cross- The operator with a general obligation to serve all subsidization. This was a means of expanding the customers is usually referred to as the universal reach of the telephone, and thus the value of AT&T's service provider. In most cases, it is the incumbent service to the public. While the public interest was operator. undoubtedly a concem, this policy was also very valuable to the company, which soon became one of In some countries, govemments and regulators the largest business corporations in the world. have imposed mandatory service obligations on newly licensed or newly privatized operators. These Incumbents have often been encouraged by regu- may include obligations to provide service through- lators to maintain a policy of internal cross- out certain areas (especially for wireless operators) subsidization in order to extend telephone access or to install a specific number of lines within a certain services, and to maintain low access rates. Similar period (coverage and rollout obligations). policies were adopted by both state-owned and privately-owned operators during the monopoly era Such mandatory service obligations are currently the of telephony which lasted for most of the 20th most common mechanisms used to expand tele- Century. McCarthyTetrault infoDev 6-19 Telecommunications Regulation Handbook Several types of internal cross-subsidies were income "strata" pay lower access rates than house- commonly used by incumbents: holds in high income "strata". 3- Inter-service cross-subsidization. Connection While internal cross-subsidization has been the most and access services are usually priced below commonly used mechanism to promote universality; cost and long distance and international calling it is being phased out in many countries. The cross- are priced above cost. In this instance, the sub- subsidy approach has a number of weaknesses that sidy flows from long-distance and international make it undesirable and probably unsustainable in calling to access and local calling. Other the long run. These weaknesses include: services may also provide or receive subsidies. Competitive unsustainability: Cross subsidies are Intra-service cross-subsidization. A com- increasingly unsustainable in a competitive mon example is geographic tariff averaging, environment. New entrants typically target profitable where access prices in rural or other higher-cost market segments or classes of service (i.e. the areas are set at the same level as in urban and services or areas that provide subsidies, rather than other lower-cost areas. Another example in- those that receive it.) This reduces or eliminates volves the pricing of business access services, subsidies. which were often set much higher than residen- tial access services. International accounting rate reform: International accounting rates are being significantly reduced in A number of countries maintain more complex the near to mid-term, hence reducing or eliminating targeted cross-subsidy regimes. One example is a major source of funding for cross-subsidization in Colombia, where residential households in low- many countries. Table 6-6: Selected Licence Network Expansion Obligations Country Company Obligation Ghana Ghana Telecom 225,000 new telephone lines within 5 years, starting in 1996. Mexico i Telmex Starting in 1990, average annual line growth of 12% p.a. to 1994. Public payphone density of 2 per 1,000 inhabitants by 1994 and 5 per 1,000 inhabitants by 1998. Panama Cable and Wireless From 1997, increase teledensity to 25% by 2002. Install 600 rural payphones within 2 years. Peru CPT and Entel Starting in 1994, add 978,000 telephone lines by 1998. Install 19,000 public telephones by 1998. Venezuela CANTV Increase telephone lines by 355,000 p.a. from 1992 to 2000. South Telkom Starting in 1997, install 2.69 million new lines by 2002. Install Africa 120,000 new public pay phones by 2002. Philippines 9 International Licensees Each install 300,000 new access lines within 3 years of obtaining licences. 5 Cellular Licensees Each install 400,000 access lines within 5 years of obtaining licences. Sources: Varous, including ITU (1998a) 6 - 20 infoDev McCarthyUTerault Module 6 - Universal Service Inefficiency of untargeted subsidies: All With the onset of competition, regulators in some existing access users generally receive the sub- markets, including the USA, Canada, and Australia, sidy, whether they can afford to pay the full initially established ADC systems to replace or sup- economic price or not. plement internal cross-subsidies. The difference is that in an ADC regime, all providers of subsidizing i- Subsidies promote inefficient consumption: services (e.g. long distance services) must contrib- Demand is depressed for higher cost services ute payments to subsidize access services. In other that provide subsidies, and entry is foreclosed in words, in the example above, the subsidy "tax" is subsidized markets (competitors cannot match expanded beyond the incumbent and spread across low prices). all competitors in the long distance market. )- Anti-competitive use of subsidies: Subsidies Like cross-subsidies that are internal to the incum- from profitable services are intended to support bent, ADCs have been criticized as being inefficient universality. However, in many cases the cross- and anti-competitive. Some regulators, notably subsidy regimes are not quantified or carefully including those in the UK, Australia and Canada, monitored by regulators. As a result, the incum- have recently rejected or reformed ADC regimes. bent may engage in anti-competitive Other regulators, including those in the USA are subsidization as well. For example, surplus reviewing their ADC regimes. ADCs are referred to revenues from monopoly international or long as "supplementary charges" in some countries. A distance services may be used to provide detailed description of the approach to ADCs is below-cost Intemet access services, thereby included in the USA case study in the Appendix. driving competitive ISPs out of the market. ADCs are imposed on designated operators as a > In most cases, only existing users receive means of financing the local access deficit that re- the subsidy. While access rates may be low in sults from local services of the incumbent being many urban areas, those without telephone generally priced below cost. More specifically, ADCs service, in rural areas or on waiting lists, do not may be used to subsidize either broad service cate- benefit from the subsidy. gories (for instance, all access services) or narrower categories (such as only residential access These problems have initiated an international trend services). away from reliance on intemal cross-subsidies. While such cross-subsidies remain important in ADCs are often collected in a similar manner to in- many countries, including most industrialized terconnection charges. In most cases, this means nations, they are increasingly being phased out or they are collected on a per-minute basis. In other supplemented by more efficient targeted mecha- cases they are collected on a per trunk basis, or on nisms to promote universality. some other basis. They may also be collected by means of a levy on telecommunications service An exception to the trend away from cross subsidies revenues earned by contributing operators. In the involves services to physically handicapped and latter case, they resemble a tax. other disadvantaged subscribers. A number of countries maintain subsidized services to the hear- Whatever means is used to collect ADCs, they ing impaired and the blind, among others. should not be bundled or confused with standard interconnection charges. International trade law and 6.3.6 Access Deficit Charges best practice require ADCs and other payments that promote universality to be collected in a transparent, Access Deficit Charges (ADCs) are a variation on non-discriminatory and competitively neutral traditional cross-subsidy mechanisms. Traditional manner. Interconnection charges should be sepa- cross-subsidies are intemal to the incumbent. That rate from ADCs, and should be cost-based and is, the incumbent uses subsidies from some of its unbundled. (See discussion of WTO Agreement on own services to subsidize below-cost prices, usually Basic Telecommunications in Section 6.3.1 above, for local access services. and in Module 4, Price Regulation). McCarthyTetrault infoDev 6 - 21 Telecommunications Regulation Handbook ADCs were traditionally collected and administered network facilities and deprive the incumbents of by the universal service provider in many countries. interconnection revenues they would earn, However, regulatory reform, and the impetus of the except for the bypass. WTO Agreement on Basic Telecommunications, has caused most regulators to establish an independent - Technological and market developments are administrator to collect and disburse ADCs. starting to reduce the distinction between local minutes of traffic and minutes of traffic that pay If an ADC regime is to be maintained, ADCs should ADCs (e.g. international or long distance). IP be calculated based on detailed estimates of the Telephony and "refiling" of long distance traffic access deficits (i.e. access revenues minus costs of by CLECs are two developments that the universal service provider). Such calculations undermine the viability of ADC regimes. These form the basis of the ADC regimes in several coun- developments make it difFicult to detect and tries, including the USA. In other countries, such measure minutes of traffic that should contribute calculations have led to the conclusion that ADCs to ADCs. As a result, the collection of ADCs will should be abolished (as in Australia and the UK), or become increasingly problematic. that there is no need for an ADC regime (as in some European countries). The European Commission > Finally, many of the problems with ADCs are the has established criteria to be applied by its member same as those of traditional cross-subsidies that states in determining whether an ADC regime or are intemal to the incumbent. These problems similar USO charges should be established. These are listed in the previous Section 6.3.5. and other examples are described in the case studies in the Appendix. 6.3.7 Universality Funds The move by several industrialized countries to Universality funds, sometimes called US funds, USO eliminate or replace ADCs is based on a growing funds or UA funds, are generally seen as the best perception that ADCs are a problematic and ineffi- option for promoting universality objectives. This cient mechanism for promoting universality. view is shared in an increasing number of countries, Perceived problems with ADCs include: including those with industrialized, transitional or developing economies. > ADCs inflate the prices of the subsidizing services and, therefore, reduce the demand for Universality funds collect revenues from various them. (e.g. long distance or international serv- sources and disburse them in a fairly targeted man- ices). ADCs are an economically inefficient ner to achieve specific universality objectives. means to collect the required subsidy. The Depending on the country, the source of revenues demand for long distance calling, for example, is may include govemment budgets, charges on inter- relatively price elastic compared to other tele- connecting services, levies on subscribers (e.g. on communications services, such as access access lines) or levies on all telecommunications service. Therefore, ADCs can reduce demand service operators. for these services in a disproportionate manner, hence contributing to economic inefficiency. In contrast to ADCs, universality funds are generally used to finance specific and targeted high cost areas :- ADCs encourage bypass of the PSTN. In coun- and/or low income subscribers. The most efficient tries where ADCs are charged for funds provide relatively small subsidies to incent interconnected services (e.g. the USA), private sector telecommunications operators to competitors have a strong incentive to terminate serve targeted service areas. These are typically services to customers by means other than the areas where service would otherwise be PSTN. Such bypass may be uneconomic, in the uneconomic (i.e. where costs cannot be covered by sense that the competitors could terminate calls available subscriber revenues). Good examples of more cheaply on the PSTN if they did not have the universality funds are included in the case to pay the ADCs for PSTN termination. There- studies of Chile and Peru, set out in the Appendix. fore, ADCs can promote inefficient duplication of 6 - 22 infoDev McCarthyTetrault Module 6 - Universal Service The design and operation of universality funds is considered in detail in the next Section of this Box 6-1: Features of a Good Universality Module. Fund 6.4 Universality Funds > Independent administration - not related to telecommunications operators 6.4.1 Introduction ~- Transparent financing International experience is demonstrating the bene- > Market-neutral - does not favour fits of universality funds. These funds are designed incumbent operators or new entrants to meet universality goais by subsidizing specific - Funding targeted to specific. initiatives to extend or maintain service or access. beneficiaries (e.g. high cost regions, Such funds have most of the benefits and few of the unserved rural areas, low income disadvantages of the other universality funding populations, educational & health mechanisms discussed in this Module. sectors) > Subsidies should be relatively small; Universality funds (USO, US or UA funds) are should only subsidize the uneconomic special-purpose mechanisms designed to achieve portion of service; private sector universality objectives. These funds are generally operators should finance the rest administered independently from the incumbent op- > Competitive bidding process for erator. Subsidies from universality funds are typically implementation of universality projects: used to provide financial support to fund specific i.e. lowest bidder should be awarded programs. Examples include network expansion subsidy and right to build and operate projects and installation of public payphones or call- networks to expand service ing centres. While they come in different forms, good funds have a number of features in common. Some of these features are summarized in Box 6-1. As noted above, two of the most successful univer- and disbursement of funds by an independent or- sality funds in the world today have been ganization. There are various possible sources of established in Chile and Peru. There are 'many such funds. These "collection mechanisms" include: possible variations on such funds. Some of the main considerations in designing funds are discussed in n Direct funding from general government reve- the remaining sections of this Module. nues (e.g. Chile); subsidize existing > Contributions from telecommunications opera- levels of universal service, or to provide new tors (e.g. in proportion to their revenues from universal access or service through new network specified services); rollouts. Both purposes are discussed below. How- ever, it is clear that universality funds are an ideal i Proceeds from telecommunications privat- mechanism for subsidizing new network rollouts to izations, spectrum auctions and/or licencef expand universal access to uneconomic areas. concession payments; Much of the discussion below relates to funds used for that purpose. > A subscriber levy (e.g. on a per access line ba- sis) collected by telecommunications operators; 6.4.2 Sources of Fund Revenues and Unlike cross-subsidies and mandatory service >- Funding from international development agen- obligations, universality funds involve the collection cies. McCarthyTetrault infoDev 6 - 23 Telecommunications Regulation Handbook If funds are collected from telecommunications > Administrative Efficiency: Universality reve- operators, or through them from subscribers, the nues should be collected in an efficient and rules of the WTO Agreement on Basic Telecommu- transparent manner. It may be that the existing nications should be kept in mind (see Section 6.3.1 government revenue collection process is the above). Specifically, the collection and most administratively efficient because the administration of such funds should be transparent, infrastructure to collect taxes and other non-discriminatory, competitively neutral and not revenues already exists. On the other hand, more burdensome than necessary for the kind of experience suggests that the administrative universal service defined by the country's laws or costs of setting up a universality fund to collect policies. Below we discuss some of the principal revenues are reasonably low. The collection criteria used by regulators for selecting amongst mechanism should be designed so that the these collection mechanisms. Most regulators have calculation of the amount that each operator is selected contributions from telecommunications required to pay is relatively simple and not sub- operators (i.e. a proportion of operational revenues ject to interpretation and controversy. This for universality funding.) consideration supports relatively simple and broad collection mechanisms, such as on Criteria for Collection Mechanisms applied to all telecommunications revenues (basic and non-basic services). Regulators have established different criteria to determine the best way to collect revenues for uni- > Sustainability: Collection mechanisms must be versality funds. These criteria include: designed so as to access a relatively stable revenue base. Collection mechanisms based on > Economic Efficiency: All collection a specific service or based on minutes may not mechanisms result in some degree of economic be sustainable in the long term. Universality inefficiency. The goal, therefore, should be to funding based on one-off events such as collect universality fund revenues in a manner spectrum auctions, may also not be sustainable. that minimizes economic efficiency losses. For The advent of distance-insensitive long-distance instance, as discussed in Appendix B of the calling and the significant growth of mobile Handbook, Ramsey pricing principles suggest wireless telephony is blurring the distinction that services with relatively inelastic demand between local and long-distance calling. should pay higher universality charges than Developments in digital and IP technology are those with more elastic demand. In practice, for also leading to doubts about whether minutes administrative and equity considerations, most will continue to be the basic unit of regulators have opted for widely-based uniform measurement for telecommunications. Rather, it universality charges rather than Ramsey-based may be the bit or the IP packet. Therefore, it charges. As discussed in section 6.3.1, a may be prudent to select a constant measure, uniform widely-based charge will reduce the such as revenues, rather than a technology or inefficiencies associated with operators trying to service specific measure, such as minutes of avoid or by-pass highly-taxed services in favour long distance traffic. of low-tax or untaxed services. Other analysts have suggested that collecting universality fund - Equity: The collection mechanism should be revenues from the government budget is the fair. Many regulators have rejected the eco- most efficient option. This conclusion is based nomically-efficient option of collecting on the observation that only the government has universality revenues through a levy on access an overall economic vision and mandate to tax charges due to equity considerations. Such all sectors of the economy, and can, therefore, levies would increase local access rates for all, choose the optimal level and mix of taxation. including low-income subscribers. Many However, many governments are in the process observers have argued that telecommunications of implementing fiscal reforms and hence direct universality objectives are an aspect of govern- government funding is often not a feasible or ment social policy and that they should, reliable option. therefore, be funded from the government 6 - 24 infoDev McCarthyTetrault Module 6 - Universal Service budget rather than exclusively from the tele- nues available in those regions. Cost projections communications sector. However, as a practical may be based on network construction estimates or matter, few governments have made funding on national or international benchmark costs for new available for universality funds. access lines. Revenue projections can be developed in different ways. 6.4.3 Determining the Amount of Subsidy The fund should only pay for the uneconomic part of Funds can be used to finance various types of uni- the project. For example, it may cost USD 10 million versality objectives. However, they are ideal vehicles to provide one or two public telephones per village to for financing the expansion of service to specific 500 very remote villages. However, the financial high-cost areas or populations. The funds in Chile model may indicate that telecommunications service and Peru were used for this purpose, and each revenues from those villages can be expected to country's fund has succeeded in extending new finance USD 6 million of the cost of the network telecommunications access to thousands of rural expansion, plus cover ongoing operating revenues. localities. In this case, the required subsidy from the fund should be no greater than USD 4 million. It may be Where a subsidy is used to fund specific network less once ancillary benefits to the operator are taken extension targets, such as in Chile and Peru, some into account. estimate should be made of the amount of financing that will be required to reach that target. The fund Cost Models for Maintaining Universal Service should not pay too much for a network extension project. Estimating subsidies required to maintain existing levels of universal service is somewhat more difficult There are generally two ways to determine the and controversial than estimating subsidies required subsidy required for a network expansion project. for new network extension projects. This difficulty is They are complementary, and both should generally due, among other things, to the larger and more be used. The first is to estimate the cost of the diverse scope of the services to be costed and due subsidy using a financial model along the lines dis- to the embedded nature of the costs of existing cussed in the next section. The second approach is services. to let the market determine the final amount of the required subsidy, through a competitive bidding Universality funds in industrialized countries have process. generally focussed on providing subsidies to existing services or to maintaining below-cost rates for sub- It is recommended that the competitive bidding scribers already on the network. Under these approach should always be used. However, the fi- circumstances, a detailed cost model incorporating nancial study can be useful for a number of installation and ongoing costs appears to be the only purposes. It can assist in fund budgeting, and assist practical option for estimating the required subsidy. the fund administrator in determining the maximum International best practice suggests that the calcula- subsidies that will be available for the projects. It can tion of the net costs of providing the required level of also act as a safeguard against possible bid rigging universal service should be based on the long run or other attempts to undermine the competitive incremental costing (LRIC) method. bidding process. At best, an LRIC cost model only provides a general Cost Models for New Universal Access estimate of the subsidy costs, not a precise calcula- tion. Models incorporate a series of choices about A financial model can be used to determine the sub- how to assign costs in the network. These choices sidy required to expand new service to rural and are made using expert judgement; the choices are other high cost areas. In general, these financial not black and white. Disagreements may arise about models calculate the difference between the capital what geographic areas should be used as net cost and operating costs of providing service in specific areas, how to assess which technologies could have regions and the projected telecommunications reve- been used to deliver the designated services most McCarthyTe'trault infoDev 6-25 Telecommunications Regulation Handbook efficiently, whether and how to account for deprecia- Competitive bidding is more practical and is adminis- tion, how to calculate the cost of capital, how to tratively simpler in cases where new universal account for the benefits to the operator of being the access is to be provided, for example, in an universal service provider (see discussion below) unserved rural area. As previously discussed, the and how to judge which network and access costs process is more difficult where an incumbent is are truly avoidable, as opposed to costs that would already providing the designated universal services. have been incurred in any event. Most of the discussion in this section relates to subsidies for new services and not existing ones. As a result, there have been significant controver- However, in principle, competitive bidding processes sies about regulatory decisions on the level of could be equally effective in determining the amount funding to maintain existing levels of universal of subsidy required to maintain existing services. services in industrialized countries. In the end, the level of funding is based, in large part, on regulatory For example, an auction could be held to determine judgement. The same controversies will generally the amount of subsidy required to maintain or up- exist whether universality initiatives are funded grade service in a region where an incumbent through ADCs administered by an incumbent or currently operates network facilities at a loss. A through an independent universality fund. universality fund administrator might require the incumbent to submit to a competitive tender process A number of regulators .have found innovative solu- as a condition of receiving a continued subsidy for tions to address universal service costing. For the region. If another financially and technically instance, the FCC in the USA has made publicly qualified operator makes a firm bid to operate the available its Hybrid Proxy Cost Model. As part of a network in that region for a lower subsidy, then the regulatory proceeding, the FCC developed this incumbent's subsidy might be limited to the lower model based on three other cost models that dffer- amount. If dissatisfied, the incumbent could negoti- ent parties had submitted. The FCC selected its ate with the altemative operator to have it take over preferred modules from each of the models and network operations. Alternatively the incumbent created its own hybrid version. could sell the network facilities to the other operator, which would then be required to upgrade them to The FCC model is referred to as a "proxy" because it meet the required universality objectives. A variety of does not model the network of any specific operator. management contracts, joint ventures, build- Rather it may be used with the particular costs of operate-transfer arrangements, and asset purchase dfferent operators to estimate or "proxy" its TELRIC. contracts could be used to implement the transfer of The FCC has made the model publicly available network operations to the lower cost bidder. (free on the FCC's website and at a nominal cost on CD-ROM) for interested parties. Parties are able to The case studies for Chile and Peru provide good input their own data to run the model and to carry descriptions of competitive bidding processes for out sensitivity analyses. licences to serve rural areas. In these countries, licences were granted to the bidders that offered to Competitive Bidding to Implement Universality provide the designated services at the lowest sub- Projects sidy. As a result of the competitive bidding process in those countries, many licences were granted with Even the best regulators or universality fund admin- a zero-subsidy, meaning that there was no need to istrators will generally have less information than subsidize the winning bidder at all. telecommunications operators about the real costs and benefits of implementing universality initiatives. Use of competitive bidding processes means that Therefore, a competitive bidding process is a better the fund administrators need not determine the approach than cost modelling to determine the final actual net cost of fulfilling the universal access re- subsidy amount, if any, required to implement a quirements, but rather only the subsidy that the fund universality initiative. must provide to UA providers. It does not absolutely require the use of economic or financial costing models by regulators, although such models are 6 - 26 infoDev McCarthyTetrault * Module 6 - Universal Service useful to determine the maximum subsidy amount area. The larger the benefits, the lower the subsidy a that may be required. Bidders will use their own bidder would require. Until recently, there were no models and projections to determine their proposed real-world examples to test this theory. However, the subsidy bid. It is clear from the results in Chile and competitive bidding processes in Chile and Peru Peru that competitive bidding has the advantage of provide such evidence. As described in the case reducing the total funding required to meet univer- studies for those countries, the actual winning bid sality objectives. amounts were generally well below the maximum subsidy that was calculated to be required to provide The Peruvian case study illustrates another advan- economic service in the tendered regions. In some tage of the competitive bidding process. There may cases, the proposed subsidy was zero, although the often be synergies in providing service to different subsidy estimated by the fund was much higher. localities or across various regions. An operator's willingness to serve a market at a given subsidy will In Chile, over the 1995-1999 period, the average depend on whether the operator can also serve winning subsidy was about 50% of the maximum other areas. When tendering more than one desig- subsidy offered. Similarly, in Peru, in the last two nated service area, fund administrators can capture years, the average winning subsidy has been about scale economies by allowing applicants to bid to 25% of the maximum subsidy offered. These serve different combinations of areas at different market-based results suggest that operators are subsidy amounts. The methods and effectiveness of prepared to become a UA provider for a compensa- such a multiple bidding approach are discussed in tion which is significantly less than the net financial the Peruvian case study. cost of the activity. The evidence suggests that the difference between the net financial cost and the Intangible Benefits compensation must be equal to the intangible bene- fit that the UA provider expects to receive. Another advantage of a competitive bidding process is that it can transfer the value of the intangible In the absence of a competitive auction, subsidy benefits of being a US or UA provider from the valuations should include a value for such intangible operator to the universality fund. In this sense, benefits. A degree of judgement will be required to intangible benefits refer to financial or other benefits estimate such values. However, it should be possi- accruing to US or UA providers that are not taken ble to establish benchmark estimates for certain into account in traditional costing or revenue models. categories of benefits. Perhaps the best practical The United Kingdom case study in the Appendix example of the valuation of intangible benefits is the describes some of the benefits of being a universal UK. As described in the UK case study, in 1997, service provider. Oftel determined that such benefits offset any net costs involved in the provision of universal service In theory, a bidder that wants to become a US or UA by British Telecom. As a result of this determination, provider would include intangible benefits in its BT does not receive any funding from other opera- calculation of the subsidy required to serve a new tors or the government to subsidize its USO. McCarthyTe'trault infoDev 6-27 Module 6 - Universal Service APPENDIX: UNIVERSALITY CASE STUDIES 1 CHILE The Chilean model of extending public telecommu- The FDT is administered by a special Ministerial nications service to low income and rural areas was Council presided over by the Minister responsible for one of the first to utilize market-based mechanisms Telecommunications. The FDT's Executive to implement a successful universal access policy. Secretary is the head of the telecommunications regulator, SubTel (Subsecretaria de Telecomunica- 1.1 Universal Access Policy ciones). The Chilean telecommunications sector was the first The FDT is financed from the Chilean national in Latin America to be prvatized and opened to government budget. Each year, a specific allocation competition. The introduction of market-opening is approved for FDT purposes. This type of funding policies succeeded in reducing telecommunications was selected for several reasons. First, it avoided prices and increasing teledensity. Despite this the economic inefficiencies that result from cross- success, however, many low income and rural subsidies between telecommunications services. localities continued to be unserved. This lack of Providing tax-based funding was also consistent access to telecommunications services was with the govemment's view that universal access is identified as a market failure. a social policy issue. As such, subsidizing universal access is primarily seen as a govemment The Chilean govemment developed an effective and responsibility, and not that of telecommunications economically efficient approach to address this operators or telecommunications subscribers. market failure. The approach relies on public funding in the form of targeted financial subsidies to provide 1.3 FDT Project Selection Process public telephone access to low income and rural localities. A Regulation to implement the FDT was approved in December 1994. The Regulation established the The Chilean program focuses on providing commu- rules for the operation and administration of the nity access (i.e. universal access) rather than FDT. individual access (i.e. universal service). The program provides one-time subsidies for the The process for the selection of projects eligible for installation of public telephones. It does not provide FDT subsidies is detailed in the Regulation. The ongoing funding. main features of the process are: 1.2 Legislation - Focus on Public Telephone Services: In general, only public telephone services are fi- In March 1994, the General Telecommunications nanced by the FDT. These services may be Law was revised to establish the Telecommunica- provided by individual public telephones or tions Development Fund. The fund is referred to as telecentres. the "FDT" (Fondo de Desarrollo de las Telecomunicaciones). The FDT provides - Publicity: SubTel has undertaken publicity govemment funds to private operators to subsidize campaigns to raise awareness of the FDT and the installation of public telephones in unserved, low to promote participation from unserved localities income and rural areas. The private operators who around the country. receive the subsidies are selected by means of a competitive bidding process. > Application Process: Any person, community or municipal organization may submit a public telephone application to SubTel by 30 September of each year. After the annual McCarthyTerault infoDev 6-29 Telecommunications Regulation Handbook closing date, SubTel compiles a list of localities > Selection of Projects: A list of projects that are requiring public telephony service. (In 1998, eligible for subsidies is then developed by 1,963 rural applications were received, and a SubTel. The projects are ranked based on the total of 1,951 localities were accepted.) financial evaluation. The list is submitted to the FDT Ministerial Council, which selects the Development of FDT Projects: With the as- projects that will be opened to competitive bid- sistance of external consultants, SubTel ding, based on the available FDT budget. In undertakes a technical analysis of the 1998, 80 projects were eligible for subsidy, and applications. SubTel then develops specific rural 31 were selected. These 31 projects covered public telephony projects. Each project is de- 1,023 localities. signed to cover a number of adjacent localities. (In 1998, 80 projects were designed to > Competitive Bidding Process: Once the incorporate all 1,951 eligible applications.) Ministerial Council selects projects eligible for subsidy, SubTel prepares tender documents for Financial Evaluation: SubTel evaluates each a competitive bidding process. These are pub- of the projects based on general government- lished in the country's Official Digest. Tender approved methods of cost-benefit analysis. For documents for each project include the following each project, two measures of net present value information: (NPV) are calculated: private and social. Projects that have a positive private NPV are ) the localities to be served by the project; excluded from the list. Projects with a positive private NPV are those capable of being financed > the minimum quality of service to be solely from project revenues, without a govem- provided; ment subsidy. SubTel then ranks the remaining projects (those with a negative private NPV) > the applicable tariff regime (see further based on the relationship between social and discussion above); private NPV, among other factors. This formulation aims to maximize the social returns ) the time period allowed for the installation of per dollar of private investment. For these the public phones; subsidizable projects, the maximum subsidy is calculated as the private NPV (always negative). > the maximum subsidy available for the The NPV's are calculated based on the tariff project; regime established for rural public telephones. The tariff regime in Chile is based on maximum > available spectrum frequency bands; and rates that are adjusted on an annual basis with reference to an aggregate price index and - any other conditions. productivity offset. Operators are allowed to set their rates lower than the designated maximum. > Selection of Successful Bidders: For each The maximum rates for local calls from rural project, the bidder that proposes the lowest public telephones are approximately USD subsidy is declared the winner by SubTel. In $0.07/minute based on a 5-minute local call. In 1998, firms bid for 27 of the 31 eligible projects. comparison, local calls from urban public tele- In total, the successful bidders proposed phones are priced at approximately USD subsidies of USD 5.5 million, well below the $0.05/minute, also based on a 5-minute call. maximum subsidy of USD 8.9 million available Higher rates are allowed for shorter calls from for the 27 projects. In some cases, no (zero) rural public telephones. Interconnection access subsidy was required by the successful bidder. charges for all telecommunications services, including rural public telephones, are set by > Concessions: The winning bidders must apply SubTel. for a public telephone concession. Concessions are issued by the Ministry responsible for Tele- communications, based on the recommendation 6 - 30 infoDev McCarthyTetrault Module 6 - Universal Service of SubTel. The concessions are non-exclusive. and verified by SubTel, the concessionaire The decree granting the concession includes receives the subsidy it is eligible for. the following information: 1.4 Results of the Bidding Process > name and details of the holder of the concession (the "concessionaire"); Table 6-7 summarizes the results of the FDT bidding process to 1999. At the start of the FTD program, > type of service to be offered; around 6,000 localities were identified as unserved. Between 1995 to 1999, a total of 183 projects were > duration of the concession; approved under the program. These projects covered 5,916 localities with a served population of > geographic zone covered by the concession; over two million people. Therefore, it is evident that the original target of providing telephone service to > technical specifications of the infrastructure unserved areas was met over a five-year period. to be installed; Table 6-7 demonstrates that competition between > deadlines for commencement and termina- bidders significantly reduced the actual subsidies tion of installation; paid, as compared with the maximum subsidies that had been projected to be required to provide ) technical specifications of radio stations, if service. Over the five-year period, only about 50% of any; the estimated maximum subsidies were actually paid. In 1996, only 21% of the estimated maximum - amount of subsidy awarded, if any; and was paid. In 1999, 80% of the maximum was paid. > other conditions. In practice, some delays have been experienced in the installation of public telephones under the FDT - Implementation: Concessionaires must gener- program. For instance, at the end of 1998 about ally install the required public telephones within 1159 or just over 50% of committed telephones had about 20 months. These public telephones must been delivered. As a result of these delays, SubTel be capable of sending and receiving calls from has issued wamings and imposed fines in other subscribers, including local and long accordance with the terms of the concessions. The distance calls from both fixed and mobile termi- fines are calculated separately for different localities. nals. Once the infrastructure has been installed Tabl 6-7 Sumr of F- eut .fe-a r UP1jects~ 11:MxpflhL MInbta i n Maiu SSubsidy Granted .-.h- --- 1 Localiti (USD m) 18z _162 762- 2 l0.9 1997 7! 2146 772 S' 204 8 1 W _ al n _ l, -~~~~~~~~M2 5 5l 1998 2729 .94 M ral 11_ _ - ' - ~~~~~~~~~~~44l .i 1 5916 2157 Y -2!~-7 21.0 McCarthyTetrault infoDev 6-31 Telecommunications Regulation Handbook Fines increase for longer delays. By the end of to provide service in more remote regions. For 1999, an additional 3,264 public telephones were instance, the subsidy was 33 times greater per installed under the programme, for a cumulative total locality in Region I than in Region VII. Therefore, of 4,424 to that date. while the more remote Regions 1, 11, Xl and XII, accounted for 25% of the total amount of subsidies 1.5 Regional Funding Differences for the country as a whole, they represent only about 2% of the newly served population. Chile is divided into 12 regions plus a capital region (R.M.). The Regions range from Region I at the 1.6 Access to the Internet northem end of Chile to Region XII at the southern end. The central Regions IV to X are the most The original FDT target of providing public telephone densely populated areas. Figure 6-6 provides a re- service to approximately six thousand unserved lo- gional analysis of the 1995-98 results. calities was met over the 5 years between 1995- 1999. Having met this target, the President of Chile Figure 6-6 indicates that most localities that received proposed revisions to the FDT in November of 1999. subsidies were located in the densely populated Under these changes, FDT funds may be used to central areas of the country. Not surprisingly, the finance community Telecentres with access to the figure also indicates that the average subsidy per Internet and to other new information and communi- locality is significantly higher in outlying regions as cations technologies. compared to the central regions. It clearly cost more f a. l Ia _1't - I ''~~~~~~~~~~~~~~ I r _.1- -_. r41 1 . . Ru . -. l- Ms _ '' 6 .3 6 - 32 infoDev McCarthyTetrault Module 6 - Universal Service 2 PERU 2.3 Sector Policy Peru's experience with universality programs bears The Peruvian Full Competition Guidelines, published similarities to that of Chile's. Peru's policy, like in August 1998, opened the sector to competition. Chile's, promotes universal access by means of a These Guidelines placed renewed emphasis on ru- rural telecommunications fund. However, the ral telecommunications. Although the privatized Peruvian program is more recent, and includes incumbent operator had met the rollout obligations some notable differences and innovations. imposed as part of its privatization, many rural localities in Peru remained without telecommunica- 2.1 Universal Access Policy tions service. In the 1998 guidelines, the government set a target In the mid 1990s, Peru's government joined a of extending service to five thousand unserved growing number of others in deciding that the tradi- localities by the year 2003. The government defined tional policyoffinancing universal access by internal universal access as access to a set of essential cross-subsidies was no longer feasible or desirable. services provided by public operators and available This decision was consistent with its policy to to the majority of users. Specifically, these services rebalance rates and to eliminate all inter-service included voice telephony, low-speed fax and data, cross-subsidies over a five-year period after the and free emergency calls. privatization of its monopoly operator. The Peruvian government distinguished between 2.4 Regulation the universal service emphasis of maintaining access in industrialized countries, and the emphasis To implement its universal access policy, the in developing countries on extending basic access in government issued the FITEL Regulation in Sep. the first place. Peru clearly fit into the latter situation, tember 1998. The regulation establishes particularly in rural areas. Accordingly, the Peruvian administrative and technical terms for FITEL's govemment established a universal access fund operations. with targeted subsidies to finance new public access telephones in rural areas. The FITEL Regulation establishes criteria to select the localities that will receive funding for service ex- 2.2 Legislation pansion. Such localities include: 9 rural towns (with a population of more than 400 A new regulatory framework for the Peruvian tele- inhabitants and less than 3,000 inhabitants); communications sector was introduced by revisions to Peru's telecommunications laws in 1993 and - district capitals; and 1994. The revisions promoted private sector partici- pation in telecommunications, and among other > towns in high social interest areas (as defined things, authorized the privatization of the main by the Government). wireline operators. FITEL will not finance past or future network The legislative changes also created OSIPTEL as expansion or coverage obligations imposed by the the new sector regulator. In addition, they estab- Goverment on telecommunications operators. lished the universal access telecommunications Therefore, the incumbent operator is excluded from fund, FITEL, which is administered by OSIPTEL. ThereForE, t o finator is exclut om Under the law, OSIPTEL collects 1 % of gross reve- accessing FITEL funds to finance its rollout obliga- nues from the telecommunications sector to finance tions. The Regulation also stipulates that FITEL will FITeLs fromlthetlecotionsstartedin mid ctor4 By mid e not provide direct subsidies to subscribers or provide FITEL. Collection started in mid-1994. By mid-1998, funding for localities that already have access to when FITEL undertook its first pilot project, over telecommunications services. USD 30 million had been collected. McCarthyTetrault infoDev 6-33 Telecommunications Regulation Handbook FITEL refines the list of possible projects by nancing contract that stipulates the conditions under determining which projects have the highest social which FITEL will provide the subsidy. benefit for FITEL's investment, among other things. According to the regulation, FITEL must establish a The maximum subsidy is set at the 'private NPV' of list of projects eligible for subsidy, and forward it for each project. Tariffs for rural public telecommunica- approval by the Ministry responsible for Telecom- tions services are regulated by OSIPTEL, based on munications. Once the list has been approved by the a maximum rate regime. Operators are allowed to Ministry, OSIPTEL prepares tender documents for a set lower rates if they wish. The maximum rate for public bidding process to select operators to local calls from rural public telephones is implement the projects. approximately USD $0.057/minute. In comparison, the price for local calls from urban public telephones The competition is public and international. Notice of is about USD $0.048/minute (based on a three- the tender is published in the country's Official minute call), with each additional minute at about Digest, and in at least one newspaper with national USD $0.029. Domestic long distance charges are circulation. The tender may also be published in set at the same regulated rate as that of the intemational media. dominant long distance provider. The bidder with the minimum subsidy bid is selected Interconnection charges are negotiated by the as the winning bidder. The winner is eligible to operators. If there is no agreement, the general receive the concession to provide the designated interconnection regime established by OSIPTEL services. The winner is required to enter into a fi- applies. This regime includes provisions for default cost-based rates. Box 6-2: Key Information in Fitel Tender Documents FITEL tender documents include the following information for each project: s, the localities to be served; > technical description of the service to be offered; >- timetable for the project, including expected installation dates; > the maximum subsidy offered by FITEL; :> the applicable tariff regime (see below for further discussion); >- a technical, financial and economic profile of the project (i.e. business plan); > a description of the socio-economic situation of the area to be served; > information relating to a guarantee bond; > information relating to a performance bond for the proper operation of the infrastructure; > timetable and procedures for the tender process; > the evaluation process for the offers; > draft financing contract; > draft concession contract (for 20 years, non-exclusive); and > other conditions and requirements. 6 - 34 infoDev McCarthyTetrault Module 6 - Universal Service 2.5 Project Results 2.6 Bidding Procedure FITEL's program began with the Northern Frontier Another innovation introduced after the pilot project pilot project, which was awarded in May 1998. This encouraged bidders to bid simultaneously on more project was a test case used to verify the design of than one project. OSIPTEL's objective was to pro- the program. The project included 213 localities in 4 vide the lowest total subsidy for all three projects. departments, with a total of about 59,000 inhabi- Therefore, OSIPTEL adopted bidding procedures tants. The project required the installation of one designed to capture possible economies of scale new public telephone per locality. (i.e. to pay a lower subsidy if a single operator could serve two or three projects at a lower total cost than The maximum FITEL subsidy for the pilot project one project). was calculated at USD 4.million. The public bidding process was won by a subsidy bid of USD 1.66 OSIPTEL designed a bidding process that permitted million to serve the designated communities. This bidders to bid on any combination of the three sum was equal to 41% of the maximum available projects. Table 6-8 and Box 6-3 use a specific subsidy. example to illustrate this process. This example assumes there are three projects (1, 2 and 3) and The winning bidder completed installation of all three bidders (A, B and C). required public telephones in December 1999. We understand that in this instance the winning bidder In the example in Table 6-8 and Box 6-3, the combi- used VSAT technology to implement the project. nation of bids that minimizes the total subsidy is (iv) The public telephones in the project can send and with a total of 170. Hence the winners would be receive calls to and from other subscribers, including Bidder A for Project 3 with a bid of 50 and Bidder B local and long distance calls from fixed and mobile for projects 1 and 2 together (1&2) with a bid of 120. terminals. , In fact, for the bidding process undertaken by FITEL After the pilot project, a number of changes were in December 1999, the winning firm made a made to the program. These changes applied to combined bid for all three projects for a total of USD projects awarded in December 1999. One change 10.99 million. This bid was well below the maximum required the winning operator to install and maintain available subsidy of USD 50 million. Details are a public Internet telecentre in all district capitals in provided Table 6-9. Projects to be tendered in 2000 the areas covered by the three projects. The three and afterwards will include the requirement to install projects tendered in December 1999 included a re- community Internet telecentres and will incorporate quirement to install 1,937 public telephones and 236 the multiple project bidding process described public Internet telecentres. above. |- D 1 2$W3..-~~~~~~~~~~~~~~~~~~~~~~ - 35 McCarthyel cE i cn fs-ev McCarthyTetrault infoDev 6 -35 Telecommunications Regulation Handbook In September 2000 OSIPTEL modified the FITEL for areas that, while having limited telecommunica- Regulation to among other things, formally introduce tions access, are not expected to fully benefit from the possibility of funding access to the Internet and competition in the near future. In addition, FITEL is other advanced services. The new Regulation also now permitted to provide funding for the operation expanded the geographic and operational coverage and maintenance of the designated services, rather of the Fund. Indeed, FITEL can now provide funding than just installation as was previously the case. Box 6-3: Evaluation Process for Bids Example of Evaluation Process (Multiple Bids): Step 1: Determine the minimum subsidy amounts requested for each project or combination of projects: Min(Project 1) = 80; Min(Project 2) = 45; Min(Project 3) = 50; Min(Projects 1&2) = 120; Min(Projects 1&3) = 130; Min(Projects 2&3) = 100; Min(Projects 1&2&3) = 180 Step 2: Compare the minimum amounts requested, this time for all three projects based on the following possible combinations: (i) Sum (Min(Project 1) + Min(Project 2) + Min(Project 3)) = 175 (ii) Sum (Min(Project 1) + Min(Projects 2&3)) = 180 (iii) Sum (Min(Project 2) + Min(Projects 1&3)) = 175 (iv) Sum (Min(Project 3) + Min(Projects 1 &2)) = 170 (v) Sum (Projects 1&2&3) = 180 Table 6-9: Projects Tendered in December 1999 Project Localities Inhabitants in Maximum Subsidy Granted Localities (k) Subsidy (USD m) (USD m) South 534 136 14.0 Centre South 1029 303 27.0 Jungle North 374 141 9.0 Total 1937 580 50.0 10.99 6 - 36 infoDev McCarthyTetrault Module 6- Universal Service 3 EUROPEAN COMMISSION In the most recent version of the ONP Voice Directive, the Commission defined universal service In developing new policies for the telecommunica- ons sector, the European Commission issued a voice telephony service via a fixed connection Communication in November 1993 on developing which will also allow a fax and a modem to universal service in a competitive environment. This operate; Communication initiated a process that established a consensus within the European Union on key ; operator assistance; issues related to universality. These issues include the scope of universal service, the choice of costing emergency and directory inquiry services methods to determine the actual costs of universal .cd the and director service (if any), and possible universal service fund- (including the provision of subsciber directo- ing mechanisms. Each of these issues is discussed res); and below. bl the provision of public payphones. The European Commission has declared that its The European Commission has recognized that the member states are free to select their approach to The univean ssice may evolved thnol- universal service from three options. The decision concept of universal service may evolve as technol- on the appropriate national option must be based on ogy develops, and as the needs and expectations of the costing method stipulated by the Commission citizens in its member states change. Accordingly, The options are the scope of universal service may need to be The options are: redefined in the future. (See further discussion > Universal service financing is not required (i.e. below.) universal service obligations do not represent an unfair burden to the designated operators pro- 3-2 Costing Method viding universal service); The Interconnection Directive states that universal - Universal service obligations do represent an service regimes must be based on the net cost of unfair burden on the designated operators; universal service obligations. The net cost must be however the State chooses to finance it directly audited by the NRA of the member state. The cal- or indirectly; or culation of the net cost and the structure of the mechanism adopted by the NRA must be based on > Universal service is considered to be an unfair objective, transparent, non-discriminatory and pro- burden on the designated operators and a portionate criteria and objectives. specific universal service financing mechanism scheme is required. In this case the national According to the directive, the costs of universal scheme must comply with European service should, in principle, be calculated based on Community Law. a long-run average incremental cost (LRAIC) meth- odology. Universal service funding mechanisms are 3.1 ScopeofUniversalService only justified when the net cost of the USO is considered to represent an unfair burden on the The European Commission has defined universal operator(s) subject to the obligation by the NRA. service in its Interconnection Directive. Universal The European Commission considers that the service is defined as a minimum set of services of assessment of the net costs of universal service specified quality which is available to all users inde- must be rgourous. The calculation of net costs pendent of their geographical location and, in light of should take into account all of the benefits derived specific national conditions, at an affordable price. by an operator from the provision of universal serv- ice. McCarthyT&rault infoDev 6-37 Telecommunications Regulation Handbook 3.3 USO Funding Mechanisms as a transitional measure and required them to be phased out. The Interconnection Directive stipulates that national universal service regimes may take the form of: Only service obligations that flow from the Commis- sion's definition of universal service may be financed - a universal service fund established at a na- by universal service schemes. European Union tional level, member states may impose other obligations on telecommunications companies and finance such > a system of supplementary charges collected obligations in accordance with Commission law directly by the operators who have the respon- (including fair competition principles). However, sibility of providing the service, or member states may not require other market players to contribute to the resulting costs. > a combination of elements of both mechanisms. * In November 1996, the Commission issued a Universal Service Fund: Such a fund pools contri- Communication on the assessment criteria for uni- butions from operators and service providers versal service schemes. This document provides required to contribute. The funds are then more detailed guidance on various aspects of uni- transferred to operators that are entitled to receive versal service, including some of the manters universal service payments. The fund must be discussed in this section. administered by a body that is independent of the parties who contribute to and benefit from the fund. 3.4 Current Status of USO in the The NRA is responsible for verifying the net cost of European Union the USO. In February 1998, the European Commission com- Supplementary Charges: A supplementary univer- pleted its First Monitoring Report on Universal sal service charge may be added to interconnection Service in Telecommunications in the European charges to recover the net cost of the USO. Such Union. The report concluded, among other things, charges must be distinct from interconnection that it would be premature to propose an expansion charges. The NRA must ensure that such contribu- of the scope of universal service obligations at this tions: stage. In the most recent European Commission communication pertaining to universal service, the > are made in a transparent, non-discriminatory Commission reports that the provision of universal and proportionate manner, and service does not appear to be creating an undue burden on the designated operators in the member - that there is no conflict of interest between an states. operator's commercial activities, and its role in collecting such supplementary charges from In practice, the vast majority of European Union competitors. member states have not established specific USO mechanisms. Some have decided that any burden The Interconnection Directive states that only or- associated with universal service is so low that it ganizations providing public telecommunications does not constitute an unfair burden for the desig- networks and/or public voice telephony services nated operator. Others have determined that any may be required to contribute to a Universal Service USO burden does not justify the administrative Fund or to pay Supplementary Charges. This overheads of a specific mechanism. determination was based on a number of factors. First, contributions should be apportioned amongst market players according to their activity in the relevant market. In addition, the collection mecha- nism must be designed to prevent double contributions. Note that the European Commission considered the use of Supplementary Charges only 6 - 38 infoDev McCarthyTetrault Module 6 - Universal Service 4 UNITED KINGDOM constituted an unfair burden. If so, based on EC practice, such a burden could justify the establishment of a specific funding mechanism. The United Kingdom (UK) provides an interesting specific case study of the European Union's general In February 1997, Oftel reached a preliminary approach to USO issues. Oftel, the UK conclusion that, taking into account the benefits to telecommunications regulator, has determined that BT of providing universal service, there was no specific universal service financing is not required for proven net cost of the USO. Accordingly, Oftel the designated universal service provider, Brtish decided that there was no justification for setting up Telecom (BT). This determination was based on the a USO funding mechanism, at least in the short conclusion that its USO does not represent an unfair term. Oftel confirmed this preliminary conclusion in burden on BT. July 1997. 4.1 Background Early in its process of determining the cost of universal service, Oftel identified some of the In December 1994, Oftel published a consultative benefits to operators of being a universal service paper which examined the evolution of the tele- provider. These benefits are summarized in Box 6-4. communications regulatory framework in the United Kingdom. The paper examined the interconnection 4.3 Calculation of Net Cost of USO regime and the Access Deficit Contributions (ADCs) which provided universal service funding in the UK Table 6-10 below presents two estimates developed at that time. ADCs were made by interconnecting by Oftel of the net cost and benefits of being the operators to pay for the deficit incurred by BT in pro- USO provider. The net cost estimates were based viding access services. The consultative paper set on standard costing and revenue calculation meth- out a number of options to address concerns about odologies, consistent with European Commission ADCs. The options included elimination of ADCs guidelines. Of the various possible types of benefits, and their replacement, if necessary, with other Oftel estimated the value of the following: life cycle universal service funding mechanism(s). effects; ubiquity; corporate reputation (brand In July 1995, Oftel decided to eliminate ADCs from enhancement); marketing from Public Call Boxes. 1997 onwards. In coming to this decision, Oftel The original estimates were released by Oftel in identified what it considered to be critical problems February 1997. In this instance, the total intangible of ADCs in the UK. First, the net costs of universal benefits (f:102m to E151m) were estimated to ex- service in the UK were calculated based on fully- ceed the total net cost (£45m - £65m). These allocated, historical costs and not the preferred LRIC estimates are presented in Table 6-10. method. In addition, the ADC regime was complex and difficult to administer. Oftel also concluded that In July 1999, Oftel released a consultative paper to ADCs provided a major source of uncertainty for review universal service issues. The paper included potential market entrants, since the calculation of revised estimates of net cost and benefits of the ADCs was in the hands of the incumbent, BT. USO. The revised estimates are also presented in Finally, Oftel expressed concerns that maintenance Table 6-10. Oftel noted that the balance between the of ADCs would institutionalize a significant distortion costs and the benefits is closer than previously of the market. estimated. However, Oftel maintained its view that the case has not been made for the establishment of 4.2 Benefits of Providing Universal a universal service fund to share the USO costs with Service other operators. In September 2000 Oftel again stated its belief that the USO is not an unfair burden Once Oftel decided that ADCs were to be eliminated on BT. Oftel expects to be able to issue a definite by 1997, it had to determine whether BT's USO statement on the issue in Spring 2001. McCarthyTetrauk infoDev 6-39 Telecommunications Regulation Handbook L Box 6-4: Benefits of Being a Universal Service Provider Enhanced corporate reputation; Marketing and brand recognition; Access to customers' telephone usage and demand data; Benefits associated with customer life cycle. The life cycle effect refers to the effect of basing a deci- sion on the net present value (NPV) of the business proposition in question, instead of on the current difference between costs and revenues; Ubiquity provides a marketing benefit to an operator within its traditional serving territory. All customers know they can order telephone services from that operator no matter where they are in the serving territory; Avoidance of loss of business through poor image and loss of trust due to disconnecting or discouraging subscribers; Avoidance of disconnection costs; and _ Reduced planning costs. Table 6-10: Annual Net Cost and Benefits of Universal Service Provision Original Estimates Revised Estimates (February 1997) (July 1999) l __ ______________ (£nn) (£mn) Benefits Life cycle 1-10 0 Ubiquity 40 -80 0 Corporate Reputation 50 50 Call Boxes 11 11 Total Benefits 102-151 61 Total Net Cost 45-65 53-73 (conventional) 6 - 40 infoDev McCarthyTetrault Module 6 - Universal Service 5 SPAIN > the right of telephone subscribers to receive, free of charge, a printed and updated telephone Spain is one of the member states of the European directory; Union that has introduced legal provisions relating to > supply of sufficient public telephones; and the creation of a universal service funding mechanism. However, as most other member ddd rights of subscribers who are handicapped, or states, Spain has not yet put the mechanism into have special social needs, to have access to operation. fixed telephone service available to the public under equivalent conditions as other subscrib- 5.1 Legislation ers. Spain's General Telecommunications Law/1998 (the The Law provides that any dominant operator in a "Law") implemented a comprehensive revision of the determined geographic zone may be designated to legal framework for the telecommunications sector in provide any of the services included in the definition Spain. The main objective of these revisions was to of UTS. The telecommunications regulator, the facilitate full liberalization of the sector. It also trans- CMT, is empowered to determine whether the USO posed several European Commission directives into for designated operators results in a competitive Spanish law. Title Ill of the Law created the legal disadvantage. If the CMT so determines, a universal framework for the regulation and financing of service funding mechanism (the National Universal universal service in Spain. Service Fund) will be established to distribute among telecommunications operators the net cost of Title 111 states that operators that provide telecom- universal service provision. The Fund will be admin- munications services to the public and operators of istered and managed by the CMT. telecommunications networks whose operation requires an individual licence are subject to public The Law establishes a method for the calculation of service obligations. Three categories of public the net cost of universal service. The Law's service obligations are established: Universal Tele- approach is in line with the European Commission's communications Services (UTS); obligatory guidelines. If implemented, the specific contribution telecommunications services; and other public scheme will be determined by the CMT. As previ- service obligations. Obligatory telecommunications ously indicated, only operators providing telecom- services include telex, leased lines, and advanced munications services available to the public and services. The Law provides for the possibility of operators of public telecommunications networks external financing only for UTS. would be liable to contribute to the universal service funding mechanism. However, the Law allows the Universal Telecommunications Services ("UTS") are CMT to exempt certain operators from the contribu- defined as a set of telecommunications services of a tion requirement, to promote the introduction of new determined quality that should be accessible to all technologies or the development of effective users independent of their geographic location at an competition. affordable price. This definition is similar to the European Commission's definition. The Law 5.2 Regulation provides that the services included in the UTS concept may be enlarged or revised to take into In July 1998 a regulation was approved to imple- account technological developments. ment Title III of the Law. The regulation defines in more detail the initial set of services to be included in Initially, UTS should include the following elements: UTS. It also sets out UTS quality and technical specifications and establishes the framework for >- the right of all citizens to be connected to the dddetermining UTS affordability. public fixed network and have access to fixed public telephone service available to the public; The regulation authorizes the Ministry responsible for telecommunications to undertake a public McCarthyTetrault infoDev 6-41 Telecommunications Regulation Handbook consultation process to determine whether there are service including the distribution of any contribution operators interested in providing some or all of the payments and the administration of the Fund. services included in UTS in determined geographic areas. This process should be canied out at least On 3 June 1999, the CMT issued a resolution des- once a year before the finalization of the term estab- ignating dominant operators in three national lished to provide universal service. Under this markets (fixed telephony, leased lines, and mobile provision, the Ministry could open a competitive telephony). In the first two markets, CMT designated tender process to determine the US provider for that Telefonica as dominant (having over 95% market zone. The universal service licence will be given to share in both markets). For the third market, the the operator that offers service under the most CMT designated Telefonica Movil and Airtel as advantageous conditions, including its offer with re- dominant operators. spect of the net cost of providing universal service. Since its designation as dominant in relevant UTS The regulation establishes a detailed method for markets, Telefonica may now calculate its net USO calculating the net cost of universal service costs and petition the CMT to rule that its USO provision. Procedures are to be established by the places the company at a competitive disadvantage. CMT to quantify the non-monetary benefits expected This move could lead to the establishment of a to accrue to the designated operator of being of the detailed universal service regime in accordance with universal service provider. The regulation also sets the Law. out detailed provisions for the financing of universal 6 - 42 infoDev McCarthyTetrault Module 6 - Universal Service 6 CEE AND CIS COUNTRIES EU Accession Partnership Documents. The European Commission considers these countries as the most similar to itself in terms of economic and This Section provides a high-level overview of policy development. This group of countries will, universality policies in the countries of CEE (Central therefore, be the first in the region to join the EU. and Eastern Europe) and the CIS (Confederation of Independent States). The telecommunications sector is relatively well de- veloped in these countries. National telecommunica- In summary, in these countries, USO and universal tions and sector policies generally promote access concepts are not currently defined in a man- competition and private sector participation. These ner that would allow the specific implementation of countries have generally relied on internal operator universality funding mechanisms. There are plans to cross-subsidies to promote universality objectives. implement universal service funds in some countries Countries that have privatized their incumbent in the region. However, the most common universal- operators have imposed rollout obligations to ity funding mechanisms in the regions are: promote universality. > inter-service cross-subsidies by the USO New universal service schemes in these countries, operator; and when established, should be consistent with those of the European Commission. In Poland, for example, > (in countries that have recently privatized their the government currently plans to replace the exist- incumbent operators) service performance and ing posts and telecommunications law with separate rollout obligations. laws for each industry. The two new laws will come into force by the end of 2000. The new Telecommu- 6.1 Introduction nications Law will establish a new universal service regime. The regime will implement a universal There are significant variations in the level of eco- service fund called the Fundusz Uslug nomic and telecommunications development among Powszechnych. The goal of the universal service countries in this region. Until the last decade, all fund will be to increase access to universal tele- countries in the region had state-owned monopolies. communications services in less developed areas of Since then, some have privatized, using different Poland, especially rural areas. models, and others have not. Some have relatively open telecommunications markets. Other markets Similarly, in the Czech Republic, the current legisla- remain closed, particularly in the key wireline tion does not specifically deal with the concept of markets. universal service. The concept will be defined in a new Telecommunications Act, which is currently in The policies and practices of the European Union preparation. A new universal service regime is also are increasingly becoming the model for telecom- being prepared in Hungary. munications policy development in the region. The process of accession to the European Union 6.3 CEE Countries - EU Accession requires countries to adopt European Commission Tier 2 Countries directives on policy, regulations and legislation, in- cluding directives on universal service. The following The Tier 2 Accession countries are Bulgaria, Latvia, sections review universal service policies in various Lithuania, Romania, and the Slovak Republic. These CEE and CIS sub-regions. five countries have also signed EU Accession Part- nership Documents and are likely to become 6.2 CEE Countries - EU Accession members of the European Union some time after the Tier 1 Countries Tier 1 countries. The European Commission considers that more preparation is required to align The five Tier 1 countries, the Czech Republic, the policies and regulatory framework of the Tier 2 Hungary, Estonia, Poland and Slovenia have signed countries with those of the EU. McCarthyTerault infoDev 6-43 Telecommunications Regulation Handbook Like those countries in Tier 1, Tier 2 countries have WTO Agreement on Basic Telecommunications and generally relied on inter-service cross-subsidies by is preparing for the privatization of its established na- incumbent operators to promote universality. tional operator. The other countries in this group Countries that have privatized have also imposed have been affected by war and civil unrest which service rollout obligations. For example, network has destroyed significant parts of their telecommuni- rollout obligations were imposed on Lattlelecom, the cations infrastructure. Generally, countries in this main operator in Latvia when it was privatized. group do not have specific definitions of universal service. They generally require their incumbent Some of the Tier 2 countries have started to define operators to cross-subsidize from higher margin more specific universal service regimes. In Bulgaria, services, such as international services, to maintain for instance, the telecommunications sector policy affordable service. incorporates universal service principles that are consistent with those of the European Union. 6.5 CIS Countries Specific universal service policies are currently under preparation, and the interim Bulgarian The CIS countries are Armenia, Azerbaijan, Belarus, universal service definition is similar to the EU Kazakhstan, Kyrgyz Republic, Moldova, Russia, definition. At present, the USO is imposed on the Tajikistan, Turkmenistan, Ukraine and Uzbekistan. main telecommunications operator, the Bulgarian In general, these countries do not yet have detailed Telecommunications Company. policies on universal service or universal access. Universal service is generally not specifically 6.4 CEE Countries - Non EU defined, or is not defined in a manner that imple- Accession Countries ments a specific funding mechanism for universal service or universal access. The traditional model of Other CEE countries, such as Albania, Bosnia, inter-service cross-subsidization by the incumbent Croatia, Macedonia, and Turkey have not yet signed operator is typically still used in CIS countries. EU Accession Partnership Documents, but plan to Where privatization has occurred, some network do so. Turkey has made a commitment under the rollout obligations have been imposed on the privatized operator. 6-44 ssssssssssssssssssssssssssssssssssinfoDev McCarthyTetrault Module 6- Universal Service 7 CANADA the total amount of subsidy available to fund those operators' access services. Canada's main universal service program was In 1998, the CRTC authorized competition in local introduced in 1992. It was established by the federal access markets. At that time, it modified the telecommunications regulator, the CRTC, as part of contribution regime. For instance, it decided to make its decision to authorize infrastructure-based long- the contribution regime portable. Therefore, Local distance competition. Exchange Carriers (LECs), whether incumbents or new entrants, are entitled to use contribution Under Canada's original universal service regime, revenues to subsidize residential access services in long distance operators paid "contribution charges" designated higher-cost areas. Note that to date, to support the USO of the incumbent operators. The given the relatively slow entry of competitors in those net cost of the USO is the access deficit incurred by areas, incumbents continue to receive the vast the USO operators as a result of charging the majority of contribution payments. prescribed "affordable" rates for local service in higher-cost areas. In other words, regulatory con- The CRTC also modified the contribution charge straints require USO operators to maintain rate regime to establish an independent administrator to levels in high cost areas below associated costs. collect contribution charges from long distance Contribution payments are based on the "contribu- operators. These funds are disbursed to LECs ton-eligibution yminutes are baseongdista traffic ofea based on the number of residential customers they tion-eligible" minutes of long distance traffic of each serve. Since competitive LECs (CLECs) have made operator. All long distance providers, incumbents as few inroads into residential markets in Canada, the well as entrants, are required to contribute. The flow vast majority of contribution funds are still presently of contribution funds is administered by an paid to incumbent LECs (ILECs). independent Central Funds Administrator (CFA). The current contribution payments regime is under 7.2 Rate Rebalancing review by the CRTC. As part of this review, the CRTC is considering whether to replace contribution Since 1992, the CRTC has implemented a program charges with a revenue-based contribution regime. of tariff rebalancing to raise access rates to a level Another option under consideration is a levy on closer to costs. This rebalancing program was com- subscribers, similar to the subscriber line charge in pleted prior to the introduction of a price cap tariff the USA. (See discussion of the SLC in USA case regime in 1998. The rate rebalancing resulted in a study below.) reduction of contribution charges from a range of about CD 0.05 to CD 0.08 per minute per end to the 7.1 Background current range of about CD 0.006 to CD 0.023 per 7.1 Background minute per end for average (includes peak and off- peak) rates. This has resulted in the elimination of The CRTC established contribution charges in 1992 the access deficit in lower-cost areas; however, a in order to provide a subsidy to support local access significant access deficit is still incurred in higher- services. Despite rebalancing initiatives in the cost areas by the ILECs. 1990s, Canadian local access services are still priced below their associated costs in a number of As in many countries, social and political concems higher-cost areas. The CRTC policy is intended to have prevailed in Canada to prevent the completion promote and retain Canada's high teledensity levels, of full rate rebalancing in higher-cost areas. New entrants in long distance markets have been The rationale for the 1992 CRTC policy was partly vociferous opponents of the contribution regime, based on the assumption that new entrants in long arguing, among other things, that the regime does distance markets would reduce long distance reve- not take into account the significant benefits that nues of the vertically-integrated incumbents. Thus, it accrue to incumbents in providing universal service. was assumed that the new entrants would reduce Early in 2000, the Canadian government requested a Senate Committee to study a variety of issues McCarthyTetrault infoDev 6 - 45 Telecommunications Regulation Handbook related to the regulatory framework for the telecom- will be significantly lower in the urban core of a city munications sector, including the contribution than in isolated rural areas. Universal service regime. programmes should incorporate these cost differ- ences, where practical. The aim of the CRTC in the The CRTC has frozen the current level of contribu- current proceeding is to have the greatest amount of tion charges until the end of 2002. This move has intra-band exchange cost homogeneity while eliminated the requirement for annual regulatory maintaining an administratively practical programme. proceedings to set contribution rates. It has also provided more certainty to competitive suppliers In a recent decision, the CRTC decided that in the regarding the cost of the contribution regime. future, only residential services in high-cost areas would be eligible for subsidies. This means that 7.3 Cost Classification rates in all but the defined high-cost areas will have to increase in order to eliminate any remaining As in other countries, the territories of the major access deficit. This decision was based on several Canadian ILECs are subdivided into exchanges (the considerations. A major consideration was the fact geographic areas served by a switching centre or that despite concerns to the contrary, telephone cluster of switches). In order to better identify higher- penetration had increased through the period during cost areas, the CRTC has classified exchanges into which rate rebalancing was implemented. The several bands, largely based on the cost to provide CRTC also considered that contribution subsidies telephone service in the exchanges. Only certain should be befter targeted to reduce the overall higher-cost bands are eligible for subsidy. LECs re- subsidy and the resulting economic efficiency ceive a subsidy based on the number of residential losses. lines they serve in those bands. Bands in higher cost areas generally receive higher subsidies per The CRTC has defined a high-cost area as: subscriber line. A clearly defined geographical area where the The CRTC has recently initiated a regulatory pro- incumbent local exchange carrier's monthly ceeding to revise the banding classification. The costs to provide basic service are greater than overall objective of banding is to de-average the the associated revenues generated by an ap- costs to provide services across the territory of the proved affordable rate. Costs are estimated designated operator. The costs of providing service using long-run, incremental costs plus an appropnate mark-up. Box 6-5: CRTC Basic Service Objective This objective defines the level of service which should be extended to as many Canadians as feasible in all regions of the country. This level of service includes; l individual local service with touch-tone dialing, provided by a digital switch with capability to connect via low speed data transmission to the Internet at local rates; l enhanced calling features, including access to emergency services, Voice Message Relay service (for the hearing impaired) and privacy protection features; > access to operator and directory assistance services; | access to the long distance network (the capability to make and receive long distance calls); and | a copy of a current local telephone directory. The basic service objective is independent of the technology used to provide service, and may change over time as service expectations evolve. 6 - 46 infoDev McCarthyTerault Module 6 - Universal Service The CRTC-approved mark-up is intended to cover some of the joint and common costs of the ILECs' operations which are not captured under the LRIC approach. 7.4 Basic Service Objective The CRTC has recently define.d a "basic service objective", which is similar in concept to the defini- tions of universal service adopted in the European Union and elsewhere. The CRTC's basic service objective is described in Box 6-5. McCarthyTetrault infoDev 6-47 Module 6 - Universal Service 8 UNITED STATES the long distance provider which has prescribed to each access line. 8.1 Introduction As part of the most recent access charge reform package that went into effect in July 2000 the FCC The administration of universal service policies is combined the PICC and the SLC into a new SLC. relatively complex in the USA. This complexity is For the first year the new single charge will be lower partly the result of the two-tier state and federal than the existing two charges combined. By July regulatory system in that country. In summary, the 2003, however, the cap for the new SLC is expected USA Telecommunications Act of 1996, confirmed to increase significantly, to USD $6.50 per month that the authority for implementation of universal per residential and single-line business lines. service support programs was shared between the Consequently, the CCLC is expected to decrease to federal govemment (through the federal regulator, below USD $0.005 per minute of interstate long the FCC) and the states. The state regulatory distance traffic (from about USD $0.06 per minute in agencies have authority to impose universal support 1996). Another component of the reform package programmes consistent with FCC principles. The was to remove about USD $650m in implicit implementation of the universal service reform universal service support from access charges, and provisions of the 1996 Act were delayed and have replace that amount with an equivalent amount to be been the subject of various regulatory and judicial collected through the existing federal high-cost appeals. service fund. At the federal level, the USA has two distinct funding 8.3 Universal Service Support - schemes. One is aimed at the financing of access Federal deficits (i.e. the difference between access costs and access revenues). The objective of the second is the promotion of universal service in higher cost the cost of subsidizing high-cost areas is currentlY areas. collected at the federal level. A central high-cost service fund has been established towards which all 8.2 Access Deficit Charges carriers contribute in proportion to their share of interstate revenues. The contributions are paid into A portion of the access deficit of incumbent local the Universal Service Administration Company exchange carriers (ILECs) has been allocated to the (USAC), an independent fund administrator. federal (interstate) jurisdiction. This portion has tra- ditionally been about 25%. This amount is collected This fund supports three principal Federal programs: through a combination of access charges on High-Cost Support, Local Switching Support and interstate carriers and direct subscriber charges. Long Term Support. This regime was introduced in 1984 at the time of the AT&T divestiture. The access charge regime has > High-Cost Support provides funds to rural car- been modified extensively since. Histoncally, the riers in high-cost areas to finance their access main access charges have been: deficit. : the Subscriber Line Charge (SLC) which is : Local Switching Support provides additional levied monthly by LECs directly on subscribers; support to LECs with fewer than 50,000 lines for traffic sensitive switching costs. - the Common Carrier Line Charge (CCLC) which is a per minute charge on interstate long - Long Ternn Support allows high cost providers distance calls levied by LECs on interstate long- to have the same CCLC rate level as other carri- distance providers; and ers. > the Pre-subscribed lnterexchange Carrier Charge (PICC) which is levied by the LEC on McCarthyTetrault infoDev 6 - 49 Telecommunications Regulation Handbook As part of the July 2000 reform package discussed looking cost model to be used from 2001. After this above, an additional and separate program for high- date, federal payments are to be shifted gradually to cost rural support was created. The new program 25% of the difference between forward-looking costs support is provided on a portable, per-line basis. The of high-cost facilities and a benchmark level of central high cost service fund also finances FCC designated telecommunications revenues. This new low-income support programs for eligible approach is intended to replace the existing subscribers. Under a different and separate funding programs described above. mechanism, schools, libraries, and health care providers are eligible for discounted telecommunica- 8.4 Universal Service Support - tions services. States All telecommunications carriers that provide inter- The remaining 75% of universal service subsidies is state telecommunications services must contribute collected at the state level. Collection of these to the cost of universal service. This includes carri- subsidies falls under the jurisdiction of state regula- ers that provide service on a non-common carrier tors. Each state may allow carriers to use a different basis, as well as payphone aggregators. However, mechanism. Historically, most states have relied on the FCC has determined that carriers that provide inter-service cross-subsidies by the ILECs to only international telecommunications services are promote their universal service plans. Many state not required to contribute to universal service. This regulators are now moving to replace internal cross- decision was made, in part, so that foreigners would subsidies with a central high-cost fund at the state not be required to cross-subsidize the national USA level. These funds will collect contributions from network and its universal service regime. carriers operating in each state in proportion to each Contributions for high-cost and low-cost income carrier's share of revenues. support mechanisms are assessed against For example, the State of Arzona has implemented interstate and end-user revenues. Recently, the the Arizona Universal Service Fund (AUSF). The contribution rate has been approximately 3% of AUSF receives its funding equally from long designated revenues. distance customers (based on the total intrastate long distance revenue for a particular carrier) and To date, the FCC has calculated access costs for local customers (based on the number of access the purpose of its universal service charges based lines and interconnecting trunks) of telecommunica- on historc, embedded costs. As part of the reforms tions canriers operating in the state that are initiated by the 1996 Telecommunications Act, the connected topthe PSTN. FCC announced that it would introduce a forward- 6 - 50 infoDev McCarthyTetrault Module 6 - Universal Service 9 SOUTH AFRICA their licences. The two cellular operators licensed in 1993, MTN and Vodacom, were required to install 7,500 and 22,000 cellular payphones (community South Africa provides an interesting case study service telephones) in under-served areas over a because of the high profile that country has given to period of five years. the development of the telecommunications sector in general and to universality objectives in particular. 9.3 Universal Service Fund Telecommunications is high on the Government's economic and social policy agenda. Telecommunications licensees must pay an annual 9.1 Background contribution to the Universal Service Fund (USF), 9.1 Background which was created by the Telecommunications Act of 1996. The USF was allocated R3,000,000 as In South Africa, universal service is considered a start-up funding when it was established in 1997. long-term goal, and universal access a short-term The USE may be used for: goal. A 1995 consultative document (the Green Paper) and the subsequent 1996 White Paper on . providing direct subsidies to targeted priority Telecommunications Policy placed considerable (needy) persons to defray the higher cost of emphasis on these issues. The Telecommunications telecommunications services due to rate Act of 1996 also emphasized universality objectives. rebalancing; and More recently, the newly created Universal Service > subsidizing the cost of network rollout to under- Agency (see discussion below) undertook a consul- served areas by operators, including Telkom, tation process in 1998 to establish specific whose licences impose such rollout obligations universality definitions, mechanisms and targets. (until such time as Telkom has completed rebalancing its rates). Telkom, South Afrca's incumbent operator was partially privatized in 1997 (30% of its equity was The USF is administered jointly by SATRA, the sold to a foreign strategic partner). As part of the national telecommunications regulator, and the Uni- reform package, Telkom was granted five years of versal Services Agency (USA). SATRA monitors exclusivity for PSTN services, ending in 2002. compliance with network rollout and service quality During this period of exclusivity, Telkom has the targets and pricing. It also establishes the basis for primary role in universal service/universal access USF contributions. The USA defines, investigates provision in South Africa. The company is expected and recommends ways to achieve universal service to use its monopoly revenues to cross subsidize its and universal access. network rollout. At the same time, government policy provides that Telkom must rebalance its rates by the The establishment of telecentres has been a priority end of the exclusivity period. for USF financing. Generally, the USA is responsible for establishing telecentres in partnership with 9.2 Network Rollout Obligations communities and donor agencies. NGO's, individual entrepreneurs, women and disabled people in rural According to its licence, Telkom must also install areas and townships are particularly encouraged to 2.69 million new lines by 2002. Of these lines, 1.67 apply to run community telecentres. Telecentres million must be installed in under-served areas. typically contain a number of telephones, fax and Telkom must also convert 1.25 million existing photocopy machines, PCs and access to the analogue lines to digital, as well as installing Internet. 120,000 payphones in the same time period. Over the last three years, 150 telecentres have been Other telecommunications providers also have obli- established or are in the process of being estab- gations related to universal service and universal lished. In the 1997/98 financial year, six standard access. Cellular network operators, for example, telecentres were established. In 1998/99 an have rollout obligations imposed as conditions of additional 12 standard telecentres were set up. In McCarthyTetrault infoDev 6-51 Telecommunications Regulation Handbook 1999/2000 ten mini-telecentres, 10 standard tered by the Ministry of Posts, Telecommunications telecentres and 90 larger multipurpose community and Broadcasting, in consultation with SATRA. The telecentres (MCT) will be established. Thirty of the HRF is utilized to promote the provision of MCT's will be specifically targeted to disabled adequately skilled human resources at all levels of people. the telecommunications sector. The HRF will finance training and educational programs at the All telecommunications licensees are required to pay artisan/technician, undergraduate, and post- annual contributions to the USF. In the most recent graduate levels. It includes support for science and financial year, operators licensed to provide public technology education at schools. switched services (including access, local and long distance services) and mobile cellular services were All licensees are required to pay annual required to contribute 0.16% of their annual revenue contributions to the HRF. In the most recent financial from the provision of the corresponding telecommu- year, operators licensed to provide public switched nications services. Value-added network services services (including access, local and long distance licensees were required to contribute R1500 services) and mobile cellular services were required annually to the USF, while private network licensees to contribute 0.08% of their annual revenues from were required to contribute R1000 annually. the provision of the telecommunications services. Value-added network services licensees were re- 9.4 Human Resources Fund quired to contribute R750 annually to the HRF, while private network licensees were required to The Telecommunications Act of 1996 also created a contribute R500 annually. Human Resources Fund (HRF) which is adminis- 6 - 52 infoDev McCarthyTetrault Module 6 - Universal Service 10 AUSTRALIA 10.3 Eligible Revenue 10.1 Background and Legislation Within 90 days after the end of a financial year, all participating carriers (including universal service providers) may file returns with the ACA setting out The universal service regime in Australia is set out in their designated "eligible revenue" for that financial Part 2 of the Telecommunications Act of 1999. The yeir Act establishes a USO, which is the obligation year. placed on the universal service provider(s). Such Eligible revenue is calculated as follows. First, the providers must ensure that standard telephone canier's gross telecommunications revenue is de- services and payphone services are reasonably termined, based on all sales revenue earned from accessible to all people in Australia on an equitable telecommunications industry activities. The carrier basis, wherever they reside or carry on business. may then make certain deductions to calculate its net telecommunications revenue. Deductions The rates of standard telephone services are regu- include revenue earned entirely in overseas lated. As a result, in high-cost areas, the universal markets, sale of customer equipment, USO levy service provider cannot always recover the full cost credit receipts, supply of content services and of its service from the customer. Losses from the terrestrial radiocommunications broadcasting provision of such USO services are shared among activities. all telecommunications operators. All operators, including Telstra (the incumbent and USO provider) Eligible revenue is then calculated as net telecom- are required to contribute to the costs of providing munications revenue minus "input payments" to the USO in proportion to their overall share of the other carriers. Input payments are payments to other telecommunications market. Contribution shares are carriers for services required to provide the first calculated using an eligible revenue formula carrier's telecommunications services (e.g. intercon- (discussed below). nection charges). The carrier's share of the total eligible revenue of all participating carriers is its 10.2 Net Cost of USO contribution factor. This factor can be seen as a proxy for its market share in the markets from which "Net cost areas" are determined by the Australian a contribution is required. regulator, the ACA. These are geographic areas for which universal service providers may claim 10.4 Payment Mechanism compensation for their losses. They are primarily rural areas. Within 90 days after the end of the The ACA may choose either to accept the net cost financial year, each universal service provider may claims and the eligible revenue returns as correct, or file a claim to the ACA for a credit, based on its make further inquiries. After any such inquiries, the claimed net universal service cost for the financial ACA publishes a written assessment for the financial year. year. The ACA assessment sets out a "levy debit" for each participating carrier, which is its contribution The net universal service cost is calculated as factor multiplied by the total net universal service "avoidable cost" minus "revenue forgone". In cost. essence, avoidable cost is the cost incurred by a universal service provider that it would not have Each participating carrier must pay its levy debit to incurred if it had not supplied services to net cost the Commonwealth's Universal Service Reserve areas. Revenue forgone is the revenue a universal within one month after receiving the ACA assess- service provider would not have earned if it had not ment. The total of a participating carrier's levy debit supplied service to net cost areas. is equal to total net universal service cost. Each participating carrier that is a universal service provider also has a levy credit, which is equal to its net universal service cost. When all carriers who McCarthyTerault infoDev 6-53 Telecommunications Regulation Handbook owe money to the Reserve have paid into the disincentive to investment. Accordingly, the Reserve, universal service providers are paid any government enacted legislation that capped the net amount to which they are entitled. 1997/98 net universal service cost at USD154.5 m and at USD154.5 m plus CPI for 1998/99 and 10.5 Recent Developments 1999/2000. This cap is an interim measure only. These capped amounts represent approximately For the 1996/97 fiscal year, the net universal service 1.4% of gross carrier revenue. cost levied on the industry was agreed between carriers to be USD 153.4 million. For 1997/98, The scale of the Telstra claim and the potential Telstra claimed a net cost of USD 1,115.1 million, a uncertainty it generated has called into question the substantial increase over the previous year. ACA's current USO funding arrangements. It has prompted preliminary review of the Telstra claim suggested it the Australian government to undertake a public would be substantially decreased (to around USD consultation process to review the USO funding 580M). arrangements, including the desirability and practicality of direct government funding. The Australian govemment recognized the potential for Telstra's large universal service claims to gener- ate uncertainty in the industry and serve as a 6 - 54 infoDev McCarthyRTerault Module 6 - Universal Service 11 ASIA In New Zealand, the government maintained some restrictions on the incumbent, TCNZ, when it was privatized in 1990. These restrictions are enforced 11.1 Introduction through the so-called Kiwi Share provisions in the TCNZ Articles of Association. For example, the Kiwi This section provides a very high-level overview of Share provisions oblige TCNZ to maintain rural the status of universal service and universal access customer access charges at rates no higher than the policies in selected Asian countries. In general, standard urban residential rate. New Zealand does universal service is not currently defined in Asian not have a telecommunications regulator or specific countries in a manner that would allow for the regulations for the telecommunications sector. implementation of a targeted funding mechanism. Recovery by TCNZ of the costs of serving high-cost The most common funding mechanism in the coun- areas is left to commercial negotiations and general tries we reviewed remains inter-service cross- competition policy. Accordingly, TCNZ seeks to subsidy by the incumbents. recover costs through commercially negotiated interconnection prices. As of late 1999, In a number of countries, network expansion obliga- interconnection negotiations resulted in an impasse tions are used to supplement cross subsidies as a which the New Zealand government has tried since method of promoting universality. Such obligations to sort out. may be imposed on existing state-owned incumbents, on newly privatized operators, on Hong Kong has established a cost-based universal competitive new operators or on joint service regime funded through charges on external venture/consortia-type entities, for example, as part (i.e. international) traffic. The designated universal of BOT-type arrangements. service provider (CWHKTC) has an obligation to provide PSTN access services in Hong Kong. The There are other variations on the continent. Hong universal service provider may receive fair contribu- Kong has implemented transparent per-minute tions from other licensees towards the net costs of charges to promote universal service in competitive serving customers and providing public telephones. conditions. Malaysia is considering the establish- Customers and payphones for which compensation ment of a Universal Service Fund. In the following is requested by the USP are referred to as "uneco- sections, we highlight a few notable country nomic". The total net cost of CWHKTC (the universal examples and provide a summary of developments service contribution or USC) was calculated at HKD in other countries. 510.5 million for the 1997/98 financial year. Of this amount, HKD 398.2 million was incurred in serving 11.2 Highlights: Selected Countries uneconomic customers and HKD 112.3 million in serving uneconomic payphones. The USC for the In Japan, the NTT Corporation Law of 1997 reor- 1997/98 year was equivalent to HKD 0.136 per ganized the incumbent, NTT into two regional minute external of traffic. The USC accounted for companies for eastern and western Japan, and one about one percent of total sector revenues. The long-distance company. All three operating USC regime has been maintained after the external companies are owned by a single holding company. market liberalization of January 1999. However, an The 1997 Law specifies that NTT has the responsi- independent intermediary was appointed to collect bility to contribute to securing appropriate, fair and and administer the USC. stable provision of nation-wide telephone services. Although universal service is not specifically defined, 11.3 OtherAsian Countries universality objectives have been implemented by requiring uniform geographically-averaged rates for Internal cross-subsidization is widely used in other both access and local calling. In high-cost areas, Asian countries to promote universality. This ap- these charges are cross-subsidized by access proach is used, for example, in China, Bangladesh, charges from more densely-populated, less costly Bhutan, Indonesia, Iran, South Korea, Sri Lanka, areas, and by long-distance charges. Mongolia, Nepal, Philippines and Thailand. McCarthyTetrault infoDev 6-55 Telecommunications Regulation Handbook Network expansion obligations are also widely used mobile operators were required to install 400,000 to promote universality. Some examples follow. local lines within a period of five years. In some cases, licences were awarded to companies for both In India, new and existing telecommunications cellular and intemational services, resulting in a operators are required to install a certain number of requirement to put in 700,000 lines in 5 years. lines in rural areas within specified periods. As an example, in category A concessions, in the most Thailand and Indonesia have adopted joint- desirable areas, the tender conditions for India's venture/consortia models with Build Operate basic service operators stipulated that at the end of Transfer (BOT) type arrangements. Under these 12 months, a minimum of 10% of installed lines arrangements, foreign strategic investors entered must be in rural areas. A similar condition applied to into agreements with local partners (often including the less desirable category B concession areas, but the incumbent operators) to operate telecommuni- the timetable was extended to 24 months. For cate- cations networks in designated areas. In both gory C concession areas, the timetable was 36 Thailand and Indonesia, the licence and contractual months. arrangements included requirements to install a certain number of lines within specified period. In In the Philippines, all nine international service Indonesia, the new operators were also required to providers were required to install 300,000 local lines extend service to rural municipal districts in their within 3 years of obtaining their licences. Cellular serving territories within specified periods. 6 - 56 infoDev McCarthyT&rault Appendices Table of Contents Appendix A - WTO Regulation Reference Paper A - 1 Appendix B - The Economics of Telecommunications Prices and Costs B -1 Appendix C - Glossary C -1 Appendix D - Selected Sources D -1 McCarthyTetrault infoDev APPENDIX A - WTO REGULATION REFERENCE PAPER Annex to the Fourth Protocol to the GATS Agreement, the "Agreement on Basic Telecommunications" negotiated under the auspices of the World Trade Organization (WTO) in February 1997, which came into effect on 1 January 1998. This Reference Paper forms part of the commitments of most of the original 69 signatories to the Agreement on Basic Telecommunications. Several signatories committed to somewhat different wording. Others have subsequently committed to implement the regulatory framework set out in the Reference Paper. REFERENCE PAPER Scope The following are definitions and principles on the regulatory framework for the basic telecommunications services. Definitions Users mean service consumers and service suppliers. Essential facilities mean facilities of a public telecommunications transport network or service that: (a) are exclusively or predominantly provided by a single or limited number of suppliers; and (b) cannot feasibly be economically or technically substituted in order to provide a service. A maior supplier is a supplier which has the ability to materially affect the terms of participation (having regard to price and supply) in the relevant market for basic telecommunications services as a result of: (a) control over essential facilities; or (b) user of its position in the market. 1. Competitive safeguards 1.1 Prevention of anti-competitive practices in telecommunications Appropriate measures shall be maintained for the purpose of preventing suppliers who, alone or together, are a major supplier from engaging in or continuing anti-competitive practices. 1.2 Safequards The anti-competitive practices referred to above shall include in particular: (a) engaging in anti-competitive cross-subsidization; McCarthyTetrault infoDev A-i Telecommunications Regulation Handbook (b) using information obtained from competitors with anti-competitive results; and (c) not making available to other services suppliers on a timely basis technical information about essential facilities and commercially relevant information which are necessary for them to provide services. 2 Interconnection 2.1 This section applies to linking with suppliers providing public telecommunications transport networks or services in order to allow the users of one supplier to communicate with users of another supplier and to access services provided by another supplier, where specific commitments are undertaken. 2.2 Interconnection to Be Ensured Interconnection with a major supplier will be ensured at any technically feasible point in the network. Such interconnection is provided. (a) under non-discriminatory terms, conditions (including technical standards and specifications) and rates and of a quality no less favourable than that provided for its own like services or for like services of non-affiliated service suppliers or for its subsidiaries or other affiliates; (b) in a timely fashion on terms, conditions (including technical standards and specifications) and cost-oriented rates that are transparent, reasonable, having regard to economic feasibility, and sufficiently unbundled so that the supplier need not pay for network components or facilities that it does not require for the service to be provided; and (c) upon request, at points in addition to the network termination points offered to the majority of users, subject to charges that reflect the cost of construction of necessary additional facilities. 2.3 Public Availability of the Procedures for Interconnection Negotiations The procedures applicable for interconnection to a major supplier will be made publicly available. 2.4 Transparency of Interconnection Arrangements It is ensured that a major supplier will make publicly available either its interconnection agreements or a reference interconnection offer. 2.5 Interconnection: Dispute Settlement A service supplier requesting interconnection with a major supplier will have recourse, either: (a) at any time or (b) after a reasonable period of time which has been made publicly known to an independent domestic body, which may be a regulatory body as referred to in paragraph 5 below, to resolve disputes regarding appropriate terms, conditions and A - 2 infoDev McCarthyTetrault Appendix A rates for Interconnection within a reasonable period of time, to the extent that these have not been established previously. 3 Universal Service Any Member has the right to define the kind of universal service obligation it wishes to maintain. Such obligations will not be regarded as anti-competitive per se, provided they are administered in a transparent, non-discriminatory and competitively neutral manner and are not more burdensome than necessary for the kind of universal service defined by the Member. 4 Public Availability of Licensing Criteria Where a licence is required, the following will be made publicly available: (a) all the licensing criteria and the period of time normally required to reach a decision concerning an application for a licence; and (b) the terms and conditions of individual licences. The reasons for the denial of a licence will be made known to the applicant upon request. 5 IndeDendent Regulators The regulatory body is separate from, and not accountable to, any supplier of basic telecommunications services. The decisions of and the procedures used by regulators shall be impartial with respect to all market participants. 6 Allocation and Use of Scarce Resources Any procedures for the allocation and use of scarce resources, including frequencies, numbers and rights of way, will be carried out in an objective, timely, transparent and non-discriminatory manner. The current state of allocated frequency bands will be made publicly available, but detailed identification of frequencies allocated for specific govemment uses is not required. MTfA -3 McCarthyTetrault infoDevA-3 APPENDIX B - THE ECONOMICS OF TELECOMMUNICATIONS PRICES AND COST Table of Contents 1.1 The Economic Rationale for Price Regulation 1 1.1.1 Benefits of Competition 1 1.1.2 When Markets Fail 3 1.1.2.1 Economies of Scale 3 1.1.2.2 Economies of Scope 4 1.1.3 The Monopoly Problem 5 1.1.4 Regulated Monopoly 5 1.1.5 Public Enterprise 5 1.2 Monopoly Pricing 5 1.2.1 Single Product Monopoly 5 1.2.2 Ramsey Pricing 6 1.2.3 Regulation under Increasing Competition 8 1.3 Elasticity of Demand 9 1.3.1 Survey of Elasticity Estimates 9 1.4 Telecommunications Costs 10 1.4.1 Costing Perspectives 10 1.4.2 Costing Terms and Concepts 10 1.4.3 Costing Methods 10 1.4.3.1 Costing Method Comparison 12 1.4.3.2 Historical Cost Approaches 13 1.4.3.3 Forward-Looking Cost Approaches 14 1.4.4 Interconnection Costing Example 15 1.4.4.1 Determining the Size of the Increment 16 1.4.4.2 LRIC Approach 17 1.4.4.3 TSLRIC/LRAIC Approaches 17 1.4.4.4 Allocation of Joint and Shared Costs: Mark-ups 17 1.4.4.5 Structure of Interconnection Prices 18 McCarthyTetrault infoDev B - i List of Boxes, Figures and Tables List of Boxes Box B-1: Price and Income Elasticities of Demand 8 Box B-2: Application of Industrialized Country Elasticity Estaimtes to Less Developed Markets 9 Box B-3: Three Principal Costing Perspectives 11 Box B-4: Principal Costing Terms and Concepts (in alphabetical order) 12 List of Figures Figure B-1: Market Demand Curve 2 Figure B-2: Market Supply Curve 2 Figure B-3: Market Supply and Demand 3 Figure B4: Social Welfare of Marginal Cost Pricing 3 Figure B-5: Average Cost under Economies of Scale 4 Figure B-6: Firm Loses Money at "First Best" Pricing under Economies of Scale 6 Figure B-7: Example of Application of Ramsey Prices 7 Figure B-8: The Relationship Between Costs, Costing Methods and Allocations 14 Figure B-9: Interconnection Costing Example: Analysis of Access and Local Calling Networks 16 List of Tables Table B-1: Point and Interval Estimates of Price and Income Elasticities of Demand for Selected Telephone Services 10 B - ii infoDev McCarthyTetrault APPENDIX B - THE ECONOMICS OF TELECOMMUNICATIONS PRICES AND COSTS This Appendix provides an overview of the 1.1 The Economic Rationale for economic theory and practice of price regulation Price Regulation (tariff setting) and costing in telecommunications. It contains background information relevant to several In the following Section, we review the economic of the modules in this Handbook. It is particularly theory relating to the benefits of competition. We relevant to Module 4, which focuses on pice also review the cost characteristics of telecommuni- regulation. cations networks that constrain competition and that The concepts addressed in this Appendix are also provide a rationale for continued price regulation of relevant to other Modules. In particular, do telecommunications costing and pricing concepts tor. underlie many of the issues related to . Interconnection (Module 3), Competition Policy 1.1.1 Benefts of Compettion (Module 5), and Universal Service (Module 6). Having said that, the world of economic theory and According to economic theory, price regulation is practice is not for everyone. We have concentrated justified when markets fail to produce competitive a discussion of these concepts in this Appendix to prices. if markets are competitive and function be read by those with a particular interest in the smoothly, theory predicts that they will lead to subject. "effficienY~' prices that maximize society's welfare. Specifically, efficient prices will equate the amount of We start this Appendix with a discussion of the a service that sellers want to supply to the amount of benefits of competition and the alternatives available a service that buyers demand. Efficient prices will when markets fail to produce socially-optimal results. equal the benefit that buyers get from the last unit We then review the theoretical and practical consumed and the cost of producing the last unit applications of monopoly pricing, including Ramsey supplied (the marginal cost). pricing. We provide a survey of telecommunications The general economic theory of efricient competitive elasticity estimates. The last half of this Appendix is markets is illustrated below. Figure B-I shows the devoted to a survey of telecommunications costs, market is curved fow. Figu r service, including different costing perspectives, terms and market demand curve, D, for a particular service. definitions. We discuss some of the costing The demand curve is plotted on a graph with the methodologies adopted by regulators around the price of the service (the "own-price"), P, on the methordoilogies athe FCC's TELRIC and the vertical axis (the "y-axis") and the quantity of the world, includingssion 's TELRIC and the service, Q, on the horizontal axis (the "x-axis"). European Commission's LRAIC. We conclude with a Because consumers will want more of the service specific interconnection costing example. when the price is lower, the demand curve is drawn This Appendix covers a range of topics, from sloping downwards from left to right, to show that general economic theory to very specific economic market demand increases as price decreases, and applications of the theory in the telecommunications vice-versa. Total market demand is determined by sector. We have only provided a summary treatment adding together the demand curves of individual of the principal topics, and we have simplified the consumers. discussion of certain issues. Readers interested in a more detailed and technically specific treatment are Figure B-2 shows the market supply curve, 5, for the directed to the selected sources listed in Appendix service. This curve slopes upward to the right, D. showing that more services will be provided by firms as the price of the service increases. In this example of a perfectly competitive firm, we assume constant or decreasing retums to scale (see discussion of these and other cost concepts below). Under this assumption, the supply curve of a perfectly McCarthyTetrault infoDev B-i Telecommunications Regulation Handbook ID P) D 0> Q Q competitive firm is that portion of the marginal cost Total surplus may be divided into consumer surplus (MC) that lies above the average variable cost of AP*B (the difference between total willingness to curve. Total market supply is determined by adding pay OQ*BA less what consumers must actually pay together the supply curves of individual firms. OQ*BP*), and producer surplus of P*CB (the total dfference (profit) between the revenues OQ*BP* and Figure B-3 shows the market equilibrium when firms the costs incurred OQ*BC). It can be shown that no (suppliers) and consumers interact. At market other combination of prices will result in as much equilibrium, the demand and supply curves intersect total surplus. In short, equating price and marginal at the market price P* and market output W*. In cost at output Q* maximizes total surplus and, summary, competitive markets will lead to an hence, social welfare. This is why economists refer efficient price P*, at which the amount suppliers want to marginal-cost pricing as "efficient'. to provide, Q*, equals the amount buyers demand. Given that for each firm the supply curve is the This, then, is the situation in this ideal competitive marginal cost curve, at market equilibrium the firm marketplace. For this efficient ideal to be realized, will produce up to the point where the price is equal the market must meet a number of conditions. For to marginal cost - that is, the level of output at which instance, the market must have several sellers P* equals marginal cost. (suppliers) and buyers (consumers), with none so large that it can affect prices: no one can be Figure B4 shows that social welfare is maximized at dominant in the marketplace. In addition, there must the competitive equilibrium (price P*, output Q*). be no significant externalities, loosely defined as Assuming that the area under the demand curve spillover benefits or negative effects to/from other represents consumers' total willingness-to-pay and markets. There should also be free entry to and exit the area under the supply curve represents from the market. Finally, as mentioned above, this suppliers' total cost, the dfference between these market should not be characterised by economies of two concepts is area ABC. This is often referred to scale. as "social surplus" or "total surplus". B8- 2 infoDev McCarthyTetrault Appendix B F9 ~ ~ ~ ~ ~ ~ ~~~ jgr - oIa Welfare of Marginal Cost -Po s~ 1--- 1 P.. ., P. 0 I"'~~~ ~ ~~~~ I i - S- ~~~~~~~~~~~~~~~~~~~ ; . D ; . DQ. 0 i O _ * ; # es =~~~~0 Q This conventional description of competitive markets production are such that it is less expensive for generally will not be applicable to the market demand to be supplied by one operator than telecommunications sector because of the specific by several. A natural monopoly arises from two cost characteristics of telecommunications networks. sources: economies of scale and economies of We discuss these cost issues in the sections below. scope. Economists use the concept of "subadditivity" to describe and test for natural monopoly. 1.1.2 When Markets Fail 1.1.2.1 Economies of Scale Where all the conditions mentioned above are not present, the market will not generally produce Economies of scale exist when the average (total) socially-optimal results. Economists call this "market cost of the firm decreases with the volume of failure". Market failure occurs when resources are production. Figure B-5 illustrates how a supplier's misallocated, or allocated inefficiently. The result is long-run average cost (AC) declines as a result of waste or lost value. In such a situation, there is economies of scale. Economies of scale are also justification for government intervention to improve referred to as increasing returns to scale. social welfare. Clearly, the impetus for regulation Conversely, diseconomies of scale, or decreasing must be weighed against its economic and retums to scale, exist when average costs increase bureaucratic costs, in order to avoid or minimize with the volume of production. Constant returns to "regulatory failure". Module 1 of this Handbook scale exist when average costs are constant with the provides guidelines for effective and efficient volume of output. regulation in the telecommunication sector. Economies of scale can arise from a number of In traditional economic theory, natural monopoly is technological and managerial factors. One common cited as a prime example of market failure. Loosely source of economies of scale, especially in the tele- defined, a natural monopoly exists when the costs of communications sector, is fixed costs (i.e. costs that McCarthyTerault infoDev B-3 Telecommunications Regulation Handbook are incurred regardless of how many units of output combined behaviour of these two components as are produced). Fixed costs are significant in tele- output increases. communications and in other industries that require networks. When output expands, average fixed For a single service firm, a natural monopoly exists if costs will decline. This phenomenon will exert a economies of scale arise over the relevant range of downward pressure on average cost that may result output relative to actual and future demand. When in economies of scale. Note that the existence of the firm produces more than one service, average fixed costs does not necessarily mean that the firm costs are not clearly defined. In this instance, will have economies of scale. As noted above, economists have developed a number of criteria to economies of scale can be due to factors other than represent and test for economies of scale. The gen- fixed costs. eral idea remains the same as in the single service example: a multi-service firm with economies of Economies of scale can exist over some ranges of scale can increase all of its services in proportion outputs, but not others. For instance, at high levels with a less than proportional increase in its total of output, management might not be able to oversee costs. closely all the operations of the firm, giving rise to inefficiencies that can dominate any technological 1.1.2.2 EconomiesofScope cost advantages of large-scale operation. When more than one good is being produced, a The existence of economies of scale depends on natural monopoly can arise from economies of whether average (total) cost increases or decreases scope as well as from economies of scale. With in the long run. Average total cost is made up of two several goods, there are sometimes shared components: average fixed cost and average equipment or common facilities that make producing variable cost. As discussed above, average fixed them together less expensive than producing them cost decreases with output. However, average separately. Economies of scope exist if a given variable cost may increase more or less rapidly than quantity of each of two or more goods can be pro- output. Economies of scale depends on the duced by one operator at a lower total cost than if each good were produced separately by different operators. Figure B-5: Average Cost under Economies of Scale- Economies of scope refers to the cost advantage of one operator supplying two or more products or services compared to different operators each pro- Pi\ viding one. A local PSTN operator, for example, already has a network for local subscribers. With appropriate interconnection to long distance facilities, the local network can also be used to provide long-distance service to customers. Using the local network for long distance service will | provide the local operator with economies of scope AC | that would be unavailable to a new operator that aimed to provide just long-distance services. The latter would have to replicate the local network to access subscribers. Q A somewhat similar curve to that in Figure B-5 would represent the effect of economies of scope on aggregate average costs of an operator providing several products or services, recognizing that differ- ent curves would appear for each individual output. B - 4 infoDev McCarthyTetrault Appendix B As with economies of scale, it is possible for econo- 1.1.5 Public Enterprise mies of scope to exist at some levels of output and not at others. Economies of scope can exist with or The most common alternative model to regulated without economies of scale. private monopoly is public ownership of the operator in a monopoly environment. This model is based on 1.1.3 The Monopoly Problem the belief that sector objectives are more likely to be achieved through direct public control and ownership The traditional view was that the entire telecommu- of the enterprise actually providing the services. In nications sector had natural monopoly characteris- such a model, therefore, regulation is often thought tics. This implied that key telecommunications to be unnecessary. Until recently, monopoly public markets would fail to meet the competitive condition ownership was the prevalent sector model in many that there be many sellers in the market. In effect, countries in Europe, Africa, Asia, Latin America and the traditional industry structure was that of the Caribbean. monopoly. In practice, however, public enterprises are used for The problem is that the monopolist may exploit its a variety of tasks of which handling the natural mo- position by charging excessive prices or restricting nopoly problem is just one. Given these conflicting output. This leads to losses of social welfare (market tasks and historically poor performance, many failure) and sets the scene for govemment governments have abandoned or are abandoning intervention to ensure that consumers and potential the unregulated public enterprise model. In some competitors are not exploited by the power of the jurisdictions, there was a recognition that the ration- monopolist. ale for economic regulation was strong whether the operating firm was private or public. State-owned 1.1.4 Regulated Monopoly operators were sometimes established as separate 'commercialized" or "corporatized" entities, subject Govemments have addressed the monopoly to regulation by a different government body. problem in a number of ways. The main one is regulation. Government policy makers that believed 1.2 Monopoly Pricing the telecommunications industry to be a natural monopoly decided that citizens would best be 1.2.1 Single Product Monopoly served by a single monopolist that can exploit economies of scale and scope. However, traditional There is a substantial body of economic theory and telecommunications policies imposed regulations to practice on the regulation of prices charged by a prevent the monopolists from exercising monopoly monopoly. A sample of this literature is included in power and charging excessive prices. This compro- the Selected Sources to this Appendix. mise was aimed at capturing the benefits of productive efficiency without permitting an As seen in the foregoing discussion of the social unrestrained monopolist to eam excessive profits or welfare in an ideal competitive marketplace, restrict supply of its services. economic theory states that "first-best' pricing sets prices equal to marginal cost. For a firm with In some cases, this view that monopoly was the economies of scale, such as a natural monopoly, socially optimal market structure provided a rationale however, this efficient pricing prescription is for creating regulatory or legislative baniers to entry problematic. For such a firm, marginal cost is in monopoly markets. This transforms a natural generally below average costs in the relevant range monopoly into a legal monopoly. In practice, the of output. This situation is illustrated in Figure B-6, regulated monopoly model was implemented where the demand curve and the marginal cost through privately owned operators in a number of curve intersect below the average cost curve. In this countries, including the US and Canada. instance, setting a regulated price equal to marginal cost, P1, will not allow the firm to recoup all of its costs. In such a case, the firm will lose money and McCarthyTetrault infoDev B - 5 Telecommunications Regulation Handbook go out of business. Accordingly, regulators must find Note that unlike the perfectly competitive firm that viable solutions to avoid this result. has a well-defined supply curve (the marginal cost curve that lies above the average variable cost In practical terms, this means that price will have to curve), the natural monopolist has no supply curve be set above marginal cost. But at what level? To that is independent of the demand curve. The maximize social welfare, departures from marginal amount that an unregulated monopoly produces costs should be set to minimize total surplus losses depends on its marginal cost curve and on the while allowing the supplier to break even. This is shape of the demand curve. referred to as the second-best price; in the case of a single-product monopoly, it is the average cost. This 1.2.2 Ramsey Pricing price, P2, is set at the intersection of the average cost curve and the demand curve in Figure B-6. Telecommunications operators produce more than one service. The problem that first-best pricing is not Notice that the quantity associated with second-best commercially viable also applies to a multi-service pricing, Q2, is less than that related to first-best telecommunications monopoly. Marginal cost pricing pricing, Q'. This reduction in quantity is an indication will not cover all the monopoly operator's costs, so of the welfare losses due to economies of scale. prices must be raised until the operator can break These welfare losses, however, are small compared even. With more than one service, however, there to those that would result if the monopolist were not are an infinite number of price combinations that will price regulated. An unregulated monopolist would produce this result. equate its marginal cost with its marginal revenue (MR curve in Figure B-6 and set a monopoly price, Economic theory provides a recommendation as to pM, higher than its average cost. This pricing would how to deal with this issue. Out of all the these price result in monopoly profits for the firm, a reduction in combinations, the second-best prices (i.e. the ones the quantity supplied, QM, and additional welfare that result in the smallest loss of social welfare losses. compared to marginal-cost pricing) are those that equate the amount by which price exceeds marginal cost in inverse relation to the elasticity of demand for Figure B*-6: Firm Loses Money at "First Best" each service. In other words, prices are raised Pricing under Economies of Scale above marginal costs more for services with a lower elasticity of demand and less for services with higher elasticity. P) These second-best prices are often referred to as Ramsey prices named after the British researcher who originally studied the issue. This is also referred to as the "inverse elasticity rule." Ramsey prices pM minimize the changes in quantity purchased com- p2=AC ...IAC pared to the quantities that would be bought at P2=Ac . I; }.< ..... AC | prices equal to marginal cost. The general principle MC is that the products with the least price-sensitive P1=MD demand should have the highest prices relative to *MR D . l their marginal costs. MR: O QM Q2 Q1 Q Figure B-7 shows a simplified example of the appli- N.tos P= Firmt-bes P-ng cation of Ramsey pricing principles when the PP 55ofldob5 PnPaOnfl operator provides two services. Ramsey principles are general enough to account for differences in cost; however, for simplicity, our example shows that the two services have the same marginal cost (MC) and that these costs are constant. Under this B - 6 infoDev McCarthyTetrault Appendix B assumption, both services have the same "first best" improvements is presented in the Appendix to prices, P1, set at their marginal cost. In order to raise Module 4. additional revenue, for instance, to cover all of its costs or to pay for regulatory levies (such as The informational requirements to implement Ram- universal service, etc.) prices have to be raised sey pricing are less onerous for operators, who may above marginal cost. The application of Ramsey be presumed to have a much better sense of the principles would mean that the price of the service elasticities and costs involved than the regulator with the relatively inelastic price demand would be (another example of the "asymmetry of information" raised proportionately more than the price of the regulatory problem). Fortunately, recent research service with relatively elastic demand. The resultant suggests that under certain conditions price caps second-best Ramsey prices, P2, are higher for the regulation provides the operator with the correct relatively inelastic than for the elastic service. incentives for it to set prices in a manner consistent with Ramsey prices. That is, an operator subject to To apply Ramsey prices in an exact manner, price caps will tend to set economically efficient regulators face two challenges. One is to determine prices as a result of trying to maximize its profit - an the elasticity of demand for various telecommunica- example of incentive-compatible regulation. tions services. The other is to identify, as accurately as possible, the costs of providing these services. Ramsey prices may also be referred to as Ramsey While the perfect application of Ramsey principles mark-ups. As explained in more detail in the next requires a great deal of information and hence Section, a mark-up is a percentage or a fixed presents implementation challenges, this does not monetary amount that is used to take into account mean that the basic Ramsey lesson (that relative joint and common costs, to supplement certain in- demand elasticities of telecommunications services cremental costing methodologies. Mark-ups may be affect social welfare) should be ignored. Reasonable uniform or non-uniform. While regulators have measures that approximate Ramsey principles will generally set uniform mark-ups to promote competi- result in welfare improvements relative to altemate tion, the application of Ramsey principles suggests measures. A numerical example of these welfare that a non-uniform mark-up may be more economically efficient. 5 PC:~M SeP.e IrElsl MemndSM~ce MchIeI5I McCarthye 1T-FratubestrfcongDEman i~~~~~P Ie Seon-- s (Rmsy pri-icing 11 Ca_IhyTe Irliult infJDev Telecommunications Regulation Handbook 1.2.3 Regulation under Increasing much. Given the historically poor performance of Competition most legal monopolies, especially in developing countries, most policy-makers do not believe that the Policy-makers and regulators are quickly eliminating theoretical benefits of natural monopoly can be legal monopolies around the world. However, the realized in a legal monopoly environment. Hence, end of legal monopoly does not mean the end of there is a growing consensus that there is a monopoly power or of natural monopoly. Hence, the favourable trade-off for the sector as a whole from end of legal monopoly does not mean the end of the introduction of competition. There may be some price regulation. loss of economies of scale, for instance, but these losses are more than offset by the gains in improved Economists now generally agree that many efficiency and responsiveness due to competition. segments of the telecommunications sector are not characterised by natural monopoly. Infrastructure- After the introduction of competition, many former based competition between multiple operators in monopoly (incumbent) operators will retain residual long distance and mobile cellular service, for monopoly power (or "market power"') for extended instance, has proven to be durable and sustainable. periods of time. This will especially be the case in There is no economic consensus, however, on certain market segments, for instance the access whether the access network remains a natural network. Market power exists when incumbent monopoly and, if so, to what extent. operators are still able to unilaterally (or in combination with other operators) influence market The existence or not of natural monopoly conditions, especially prices. Firms with market characteristics in the access network may not matter power are therefore generally price regulated in Box B-1: Price and Income Elasticities of Demand The effects of many demand factors are typically measured by elasticities: > Price elasticities measure the percentage by which the quantity demanded for a telecommunication service changes in response to a small percentage change in price. - For example, if a 1% decrease in the price of national long distance service leads to a 0.5% increase in national long distance calling, the price elasticity is -0.50. > Elasticities with a value between 0.0 and -1.0 reflect inelastic demand. - Elasticities with a value smaller than -1.0 reflect elastic demand. > Elasticities with a value of -1.0 are said to be of unitary elasticity. - One of the critical characteristics of elastic demand is that a reduction of prices will result in sufficient increased demand - stimulation - that revenues will in fact increase after the price decrease. On the other hand, revenues will decrease after a decrease in the price of an inelastic service. - The elasticity of demand may be deduced from the slope of the demand curve. Generally, the steeper the demand curve, the more inelastic the demand. At one extreme, a vertical demand curve shows zero elasticity. In this instance of totally inelastic demand, the quantity demanded does not vary by price at all. For example, research suggests that business demand for telecommunications access can be almost totally inelastic. >- Income elasticities measure the percentage by which the quantity demanded for a telecommunica- tion service changes in response to a small percentage change in income. B - 8 infoDev McCarthyTetrault Appendix B order to constrain their ability to charge excessive most price and income elasticities for important prices. The subject of market power and its impact classes of telecommunications services. on pricing is discussed further in Module 5 - Competition Policy. Table B-1 summarizes the subjective estimates from the classic 1980 study conducted by Lester Taylor. 1.3 Elasticity of Demand (The results from this study are used as benchmarks by many consulting economists in industrialized and In this section, we discuss the responsiveness of developing countries.) A second edition of the Taylor demand for telecommunications services to changes study was published in 1994. in prices. This is referred to as the (own-price) elas- ticity of demand and is of critical importance in a The elasticity studies show that there is a range of number of applications, including in the determina- price elasticities among telecommunications tion of Ramsey prices and the calculation of the services. Access service is very pnce inelastic. De- welfare benefits of rate rebalancing. Box B-1 mand for access is more inelastic at higher rates of provides an overview of demand elasticities. penetration. Domestic long distance and intemational calls are the most elastic services.. As for most other products, the demand for tele- Demand for calling is more elastic the longer the communications services depends on factors such distance of the call. Demand for any given service is as consumers' demographic characteristics, their less elastic for business users than for residential incomes, the prices of the services, and the users. availability and price of other communications options. o B iApplication-of Industrialized In considering price elasticities, it should be noted t t aimtes to Less that telecommunications demand generally has two I :- .Drvlp arkes,-l interrelated parts - access and usage. Local, long distance and international calls depend on having re a ihterpreing elasticity es- access, and access is of value only if using the net- tri lelecommunications work (calling) has value. Whereas most economic - s deeprBg' countries. One of the goods are substitutes, access and usage are of dpenetration rates In complements. That is, if the price of access ,f demand, but rather increases, the demand for access and usage both p n - longtandigver- decrease. If the price of usage increases, demand for calls and access decreases. cg ca,jeni «n'fbapacity-constrained tele- - .Lcor_mmunication' markets is not likely to affect demnd s mch s i sggestedby the elas- 1.3.1 Survey of Elasticity Estimates ty e pe i seo c _werexcal lated inenironmets whiiFere supply Most studies of telecommunications demand have snt tre ior e. that concentrated on voice telephony services. They are cngntries are divided into studies of residential and business de- - temah e ir coun- mand for access, local, long distance and - terprina eteeo mu a rkets intemational calls. - e hpothesis. 1- I3rr ft fi n studyingthe ent. rate Estimates of elasticities are usually based on histori- _ r,ab5lning t inmerican cal consumption pattems and are calculated using - n, Ro n je O)und that complex statistical techniques. As a result, w incese mion prices determining the magnitude of elasticities is an aMtCall ed to ncrseas-es in etration rates - empirical matter. Most of the elasticity studies to _ tt)atis ity d date have been done in industrialized countries. A significant and consistent body of literature now exists to provide point and/or interval estimates of McCarthyTT&rault infoDev B9 Telecommunications Regulation Handbook Table B-1: Point and Interval Estimates of Price and Income Elasticities of Demand for Selected Telephone Services Price Elasticity Income Type of Demand Connection Subscription Long Distance Elasticity Access -0.03 (±0.03) -0.10 (±0.09) 0.50 (±0.10) Local Calls -0.20 (±0.05) 1.00 (±0.40) Domestic LD Calls Shorter distance -0.375 (±0.125) 1.15 (±0.25) Medium distance -0.65 (±0.15) 1.25 (±0.25) Longer distance -0.75 (±0.20) 1.50 (±0.40) International Calls -0.90 (±0.30) 1.70 (±0.40) Notes: In each cell, the first figure indicates the point estimate of the elasticity - that is the one best estimate of the variable. The second figure, preceded by ±, indicates the subjective interval estimate for the elasticity - that is, the possible range of the variable. For example, medium distance domestic LD calling the price elasticity is estimated at about -0.65 with a possible range of -0.50 to -0.80. LD refers to long distance Source: Adopted from Taylor (1980) and supplemented by Taylor (1994) and other elasticity studies. 1.4 Telecommunications Costs 1.4.1 Costing Perspectives Determining or verifying the costs for telecommuni- Most telecommunications cost analyses use one or cations services are among the most difficult more of the main perspectives outlined in Box B-3. challenges facing regulators. Nevertheless, cost Each is associated with the perspectives of a analysis can be of crucial importance. In particular, particular profession. regulators use cost analysis in setting or approving prices, including "retail" prices for consumers and 1.4.2 Costing Terms and Concepts "wholesale" prices for competitors (e.g. interconnec- tion and unbundled network elements, etc.), and in Box B-4 provides descriptions and some examples enforcing competition policy, of the principal terms and concepts used in tele- communications cost analysis. These are the basic The practice of determining costs in the building blocks of cost analysis. telecommunications industry is often complex and controversial. Different cost approaches, concepts, 1.4.3 Costing Methods definitions, interpretations and data sources lead to this complexity. Generally, the nature of the problem In this section, we briefly review and compare some being addressed and the purpose of the costing ex- of the main costing methods used by telecommuni- ercise will determine which is the most appropriate cations regulators over the years. approach to use. Most costing methods are based on the principle of cost "causality" (also referred to as cost causation). Simply stated, cost causality means that costs B -10 infoDev McCarthyTetrault Appendix B I iAcco n e :os tivess 4~ ~ This perspording of-the'actual!incurred costs by the operator. The focus is on the historically recorded costs (ie9is b adcrlkin-g). ,Data- sources include corporate q rinacial ccounin an oemngmn conigmeasures. In the past, regulators I r ostl e I ir- o rmation for cost studies. . fr-ward4toking rmanagemnent decisions. Engineering ays ass in wy eetinga- specifi6d'objective, such as provisioning a certain -amount of capacity. The goal of enineenng. c6st anlysis is generally to determine the optimal I .: m ethod Qfbuilding telecommunications facilities. --I ~~ ~~~Economic Costs~-frQnen~.sru t v- e~ objective oX this costing perspective Is to determo ,the structure of efficient prices. that is, prices thcet mxi c Li r surEcooiic costing uses a forward-looking approach.that emphasizes *b concepts~ ost vanariiity. incremental costs and opportunity costs. These concepts are discussedcremntabelow should be recovered (e.g. through prices, etc.) from Costing methods and models can be "top-down" or the source that caused the costs to be borne. While "bottom-up". Top-down approaches are generally this principle is relatively easy to implement in many associated with historic costs, while bottom-up instances (variable or incremental costs), it is more models are generally associated with forward- complex to apply in the presence of fixed, joint and looking costs. shared costs. We discuss this issue in more detail below in the section containing the interconnection One matter that we have not dealt with so far is the pricing example. cost of capital. The required return on investment in the network and other related assets is the cost of One of the most important distinctions between capital. It should reflect the opportunity cost to costing methods is between methods that use investors, so that the return earned on network historical data and ones that use a forward-looking assets and other related assets would be broadly approach. We adopt this distinction in our detailed equal to the likely return on altemative comparable discussion of costing methods in the following investments. section. Generally, forward-looking costs are preferred because they better reflect the workings of Because the telecommunications industry is capital- competitive markets. In such markets, from the mo- intensive, the cost of capital is a critical issue in ment an investment is made, the asset's value to the determining telecommunications costs, regardless of operator depends more on what use can be made of the costing methodology used. The main point to it than what it cost. If a competitor is more efficient, recall is that the regulator has to incorporate the the operator will need to respond by adjusting its correct measure of the cost of capital in its costing prices, rather than to continue pricing on the basis of methodology in order for the regulated operator to its historical costs. In other words, competitive recover all of its efficient capital costs, including its operators are compelled to look forward to set equity and debt costs. prices, and hence be able to compete, rather than to look backward to prices based on their original investments. McCarthyTetrault infoDev B-il Telecommunications Regulation Handbook 1.4.3.1 Costing Method Comparison Recall from Box B4 that LRIC, TSLRIC/LRAIC and TELRIC are generally required to be supplemented This introductory section provides a graphical by mark-ups to recover a portion of joint and shared comparison of the main costing methods that are costs. Hence, mark-ups are included in Figure C-15 discussed in greater detail in the following sections. for those cost methods. This is in contrast to FDC/FAC approaches that generally allocate all joint Much of the controversy associated with cost and common costs to the services, based on alloca- analysis relates to the allocation of indirect costs to tion formulae. In this instance, there is no dfferent telecommunications elements or services. requirement for mark-ups. Recall that if all joint and The allocation issue is highlighted in Figure B-8 shared costs are included, the resultant cost concept which provides a simplified comparison between is stand-alone cost. We discuss the allocation issue LRIC, TSLRIC/LRAIC, TELRIC, FOD/FAC and further in the section that contains the stand-alone cost for a specific telecommunications interconnection cost analysis example. element or service. Box Ba-: Principal Costing Terms and Concepts (in alphabetical order) Allocated Cost - A joint or common cost that has been divided among services in accordance with a set formula or by judgement. This is also known as a distributed cost. Average Cost - A specified cost divided by the quantity of output. [By default, usually refers to the average of total cost, which is total cost divided by the specified volume of output.] Avoidable Cost - A cost that would not be incurred if output volume was reduced. Common Cost - A cost incurred when a production process yields two or more services. This is also re- ferred to as shared cost if it applies to all of the operations of the operator. For example, the cost of the building to house a telecommunications exchange may be described as a common cost of serving both business and residential customers. The salary of the operator's president may be considered a shared cost of all services (this type of cost is often also referred to as an 'overhead" cost). Direct Cost - A cost that can be attributed solely to the production of a specific item. A direct cost does not require a cost allocation (or distribution) to separate it from the costs incurred in the production of other items. An indirect cost, however, does require such an allocation. An operator that produces a single product sold in a single market incurs only direct costs. When an operator is engaged in producing multiple products or serving multiple markets, however, it will normally also incur indirect costs such as joint and/or common costs. Fixed Cost - A cost that does not vary by volume of production. A specific type of fixed cost is sunk costs, costs that cannot be changed or avoided even by ceasing production entirely. For instance, head office space is a fixed cost, but the labour component of the installation of the copper wire in the local loop is a sunk cost. Neither fixed nor sunk costs enter into marginal-cost pricing decisions because neither varies with output. Increment - A specific non-minimal increase or decrease in volume of production. Incremental Cost - The change in total cost resulting from an increment. Incremental cost equals total cost assuming the increment is produced, minus total cost assuming the increment is not produced. Because a wide variety of different increments can be specified, incremental cost can conceptually range all the way from total cost per unit (entire output as the increment) to marginal cost (one unit as the increment). The size of the increment used in any specific cost analysis will be a matter of judgement. The most common practice is to use the entire service or element as the increment, in which case the service or element specific fixed costs of the service or element would be included in the increment B -12 infoDev McCarthyTetrault Appendix B Box B-4: Principal Costing Terms and Concepts (in alphabetical order) (cont'd) Joint Cost - A specific kind of common cost incurred when a production process yields two or more outputs in fixed proportion. Joint costs vary in proportion to the total output of the joint production process, not to the output of the individual joint products. Long Run - A period over which all factors of production, including capital, are variable. In practice, a period of 10 to 15 years is sometimes selected by regulators for the purpose of LRIC analysis, for example. Long Run Incremental Cost (LRIC) - The incremental costs that arise in the long run with a specific increment in volume of production. LRIC is generally calculated by estimating costs using current technology and best available performance standards. When a cost study is based on the 'costs of an efficient firm", it usually refers to LRIC-type methodology. In the presence of joint or common costs, the sum of the LRIC for all of the operator's services will be less than the total costs of the operator. Hence, the operator will not be able to recoup all of its costs. Regulators will generally allow a mark-up to be added to LRIC or LRIC-type costs for the firm to help recover all of its costs. Marginal Cost - The change in total cost resulting from a very small change in the volume of output produced. Due to a number of practical issues, including the lumpiness of capital increments (i.e. the inability of telecommunications plant to be divided into very small parts, or scaled to provide an exact fit with the actual requirements of the network), marginal cost is difficult to estimate. Accordingly, most estimates of marginal cost are based on incremental cost. Mark-Up - A percentage or a fixed monetary amount that is used to take into account joint and common costs, for example, to supplement certain costing methodologies. Cost concepts that do not fully allocate (or distribute) all indirect costs generally require mark-ups. These cost concepts include incremental costing methodologies, including LRIC (and TSLRIC/LRAIC and TELRIC as discussed in detail in the cost methods section below). The mark-up may be uniform or non-uniform. While regulators have generally set uniform mark-ups to promote competition, the application of Ramsey principles suggests that a non- uniform mark-up may be economically efficient. Stand-alone Cost - The total cost to provide a particular product or service in a separate production process (i.e. without benefit of scope economies). Total Cost - The aggregate amount of all costs incurred in producing a specified volume of output. The sum of fixed and variable costs equals total cost. Variable Cost - A cost that varies with increased volume of production. Source: Adapted from Johnson (1999) and other sources. 1.4.3.2 Historical Cost Approaches focuses on broad categories of service rather than on individual services. For instance, the These approaches generally involve the compilation study might show the cost of local exchange and analysis of accounting and other historical data. service, different lengths of long distance and One of the advantages of these approaches is that miscellaneous services. they reflect the real-world workings of the actual telecommunications operator under study. is The challenge (and inherent weakness) of this type of study is how to allocate joint and com- Fully Distributed Cost (FDC) mon costs to the specific classes of services. The joint and common costs are often allocated > This method, also, referred to as fully allocated to the various categories of service using cost (FAC), is generally based on a historical formulas that reflect relative usage or other accounting of costs. Typically, an FDC study factors. McCarthyT&rault infoDev B-13 Telecommunications Regulation Handbook Fi ; ¢e MOM -s VAN -3-ims- ~¶~J ffilj j ran-id --- TELRi,C Inrne,F, *1re- e, .~~~~~~I I I -olI -., TELRIC | I,:eTSna *S;-[3l: | | J 5 lt + . TSLR1C,LRAiC A,oemer, l . Ce Ie AlIr.c- l . 11 * n - -uD' CGSj Jo'nI & Con.mn c, FDC:FAC' Imerlal . 711711J71 FAC b aeda liocai,c.r. F, | ' c il j J | F.l*rr t ~ oA j l l ill J,., G aommor Co:i l, sLanadai a.11 * ir|. 3err.| All Jr.CI ir Cun-.Cmol gj~ LfSfllSed{OIlll 1 f Notes I ; . L-' L~-| Ic.e.r e.T.& IS I :- .3.as 66 M A I r.Ice Her e e . . . ..,oO....:e .o:lew-. ..--.V.T- .6 -G,.O .0 3 . 2 Ir.. *is: e ..e S.C. FC AC .3 a: s.Ta IC, >C col.: .M.3 Dmi v6 00l: rr. I .:.ox nrC' l i ir.-fiCe i carn a I:-.. a COO nC'.. ... . .3 IT.|:, 6 r,, a.. T'A - .- lI',c,ea.e....,..:.:or.Jm,r:.ri....3. ,O5i..e.Ojr ,.-A.,,:..,n.......................-...................0 Source.Adapted frorrm ODTR1999n ,su - For instance, if network access lines in an lower cost using current technology or efficient exchange are used 70% for local calls, 20% labour and/or management practices. for national long distance calls and 10% for intemational calls, an FDC study may Embedded Direct Analysis (EDA) allocate the joint costs of these lines based on the same percentages. These allocations 9 This is also a type of study based on historical are arbitrary. accounting of costs, but it dffers from FDC. An EDA study will only assign those costs that can > FDC/FAC methods do not require a mark-up be directly traced to a particular service to recover a portion of joint and common category. Joint and common costs will be left costs. The FDC/FAC allocation may or may unassigned, typically as one or more lump sum not be the same as the one that would result amounts. from the use of a mark-up. 1.4.3.3 Forward-Looking Cost Approaches ' Another criticism of this type of study is that the historic costs may reflect certain operational or These approaches typically involve the development technological inefficiencies of the incumbent op- of engineering-economics models that are used to erator. Using historic costs, for example to calculate the costs of network elements and, in turn, calculate interconnection costs, leads to services provided using those elements. These concems that incumbent operators are "passing models estimate the costs of rebuilding specific on their inefficiencies" to the interconnecting elements of the network using current technology. operators. The reason for this is that the Generally, this modelling approach assumes services in question could likely be provided at a B -14 infoDev McCarthyTetrault Appendix B operating and capital costs will be incurred efficiently. > The FCC developed TELRIC to implement the The LRIC approach is discussed in Box B-4. 1996 Telecommunications Act. In the FCC's words: Total Service Long Run Incremental Cost (TSLRIC) ... prices for interconnection and unbundled elements.. .should be set at forward-looking ' TSLRIC measures the difference in cost long-run economic cost. In practice, this will between producing a service and not producing mean that prices are based on the TSLRIC it. TSLRIC is LRIC in which the increment is the of the network element, which we will call total service. Hence, mark-ups are required to ... TELRIC, and will include a reasonable recoup a portion of joint and common costs, allocation of forward-looking joint and which are not included in TSLRIC. common costs... The European Commission has adopted a - In coming up with its own costing method, the TSLRIC-type approach, called, Long Run FCC distinguished between its approach to Average Incremental Cost (LRAIC) as its costing network elements and TSLRIC. preferred costing methodology. The term "average" is intended to capture the policy ' The FCC required that certain joint and common decision that defines the increment as the total costs be included in TELRIC, even if they do not service. LRAIC, hence, includes the fixed costs vary with the presence or absence of the specific to the service concemed: "service- element in question. This is not consistent with specific fixed costs." the standard definition of TSLRIC. > TSLRIC can be useful in public policy and 1.4.4 Interconnection Costing Example pricing decisions. For example, TSLRIC estimates can highlight the presence or absence This section provides a numerical example of a of subsidies for a service. Similarly, incremental forward-looking costing analysis to determine an costs can be useful in developing or examining interconnection price. This example incorporates the regulatory or pricing policies that apply to a many of the concepts introduced in this Appendix. particular service or group of customers. Note, however, that it deals only with the on-going costs of interconnection. It does not include the )i- One of the weaknesses of this method, and of .start-up" costs associated with actually inter- all forward-looking studies, is that the results are connecting the two operators (transmission links, estimations that may or may not occur in etc.). These "start-up" costs, which can be relatively practice. small compared to the "ongoing" or 'recurrent" costs discussed in this example, are discussed in Module Total Element Long-Run Incremental Cost 4. (TELRIC) Figure B-9 provides a simplified graphical repre- ' TELRIC is a term coined by the FCC to describe sentation of the costs of an incumbent operator that a specific approach to costing. TELRIC includes provides access services and local calling services. the incremental cost resulting from adding or The specific division between access and calling subtracting a specific network element in the service costs varies depending on the purpose of long run, plus an allocated portion of part of the the cost analysis. Generally, access service costs joint and common costs. Hence, mark-ups may include costs of the local loop and some associated also be necessary to recoup a portion of the fixed costs. Calling service costs generally include "residual" joint and common costs not already those associated with the rest of the network, included in TELRIC. including switching and transmission. Note that "calling" services are referred to as conveyance in the UK and other countries. McCarthyTetrault infoDev B-15 Telecommunications Regulation Handbook 1.4.4.1 Determining the Size of the Increment Total incremental costs are 120. These costs constitute the incumbent operator's direct costs. The In this example, we generally assume that the size indirect costs total 30 and include joint cost of 10 of the increment is the entire service. This assump- (e.g. carrier services or network division, etc.) and bon is consistent with the principle of cost causation shared cost of 20 (e.g. president's salary, etc.). as it has been interpreted by many regulators. This assumption means that the service-specific fixed In this example, we assume that a long-distance costs of each service are included in calculation of operator requests interconnection with the the respective incremental costs. In practice, this incumbent (access and local) operator at the local assumption will mean that the entrant makes a switch. Let us assume that the parties do not agree contribution to the incumbent operator's service- on interconnection price, or that the regulator wishes specific fixed cost. to provide interconnection pricing guidelines in advance. What is the appropriate interconnection As shown in Figure B-9, the incremental costs for amount? This question is addressed in the following access, transmission, tandem switching and local sections. switching are 50, 40, 15 and 15. Local switching may be further disaggregated into fixed costs of 10 and variable costs of 5. Figureii-9: Interconnection Costing Example: An'alyss of A s fand Access Calling "U'-~~~~- -__7h Increm ental i Cost (IC) 50 'A' IncremIentalmeta. t Cost (IC) 40 )1 = 5I: Increm ental S J 11) - -r o _n II m 0 Indireci Costs T ran sm Is si|on T ar. e,tr Lcr;a I 1 I Direct Cosis Switching I Nola. In [he colcui0n )l IC, ihe s,ze ol [he incrermcni is assumed lo he Ine enilre service B - 16 D:cC:s oich e Tasiso infoDev McCarthyTerault Appendix B 1.4.4.2 LRIC Approach incumbent operator for the use of its network. Such rates will generally not provide sufficient compensa- Based on a narrow application of the principle of tion for the incumbent operator to properly maintain cost causation, the entrant should pay the its network and to build additional needed incumbent operator only for the additional costs that infrastructure. result from the entrant terminating and originating traffic on the latter's network. Based on the LRIC 1.4.4.3 TSLRICILRAIC Approaches methodology, therefore, the entrant should pay the incumbent operator only a proportion of the variable The LRIC approach discussed above does not cost of the local switch. That proportion may be include service-specific fixed costs. The fixed costs based on market share or other criteria. For in- of the local-switching services (10) are being borne stance, the proportion could be the percentage of wholly by the incumbent operator. Most regulators entrant minutes routed on the incumbent operator's have established that the size of the increment network. For this example, we assume the entrant should be set as the entire service. This issue was has a 10% market share. Using this methodology, discussed in section 1.4.4.1. the regulator would set an interconnection amount of 0.5. This amount is based on the proportion (10%) of Under the TSLRIC/LRAIC approaches, the regulator the variable cost of local switching (5). would set an interconnection charge of 1.5. As indicated in Figure C-15, this charge is made up of Based on this perspective, the entrant does not LRIC plus a proportion (for example 10%, equal to cause the incumbent operators to bear any other the entrant's market share) of the service-specific additional costs, and should therefore pay only the fixed cost of the local switch (10). amount indicated above. The LRIC approach does not include service-specific fixed cost or joint and 1.4.4.4 Allocation of Joint and Shared Costs: shared costs. These cost concepts are discussed in Mark-ups the sections below. The TSLRIC/LRAIC approach does not include any Note that the entrant is not required to pay for the of the joint and shared costs of the incumbent use of the incumbent operator's access services. operator. Generally, most regulators have deter- This is because these are traditionally considered as mined that the interconnection amount should fixed with respect to the volume of traffic. Hence the include a component that accounts for an allocated entrant does not cause any additional access cost to part of joint and shared costs. This has traditionally the incumbent operator. Most telecommunications been implemented by including a mark-up to economists suggest that the costs of access serv- supplement TSLRIC/LRAIC. ices (including the local loop) should generally be recovered from the incumbent operator's This situation is analogous to that discussed in the subscribers through connection and subscription natural monopoly pricing section. In that section we prices. found that marginal cost is below average costs, and setting a regulated price equal to marginal cost will Given that the entrant is requesting interconnection not allow the operator to recoup all of its costs. In at the local switch, it is not using the incumbent order for the operator not to lose money and go out operator's transmission or tandem switching of business, the regulator had to set at least some services and hence should not have to pay for them. prices above marginal costs. The sum of all the 'mark-ups" over marginal should be set so that the Regulators have not generally set the interconnec- operator could break even. tion amount charges solely on LRIC. Interconnection prices based only on LRIC will generally be lower Similarly, in our example, the regulator should be than those based on other costing methodologies. concerned that the incumbent operator is able to Such low prices may promote market entry. Prices recoup all of its forward-looking costs, including joint based solely on LRIC are generally considered to be and shared costs. The issue is one of overall cost too low, and to not adequately compensate the recovery. If no mark-up is included in the McCarthyTetrault infoDev B-17 Telecommunications Regulation Handbook interconnection amount, the incumbent operator will > Usage-based (e.g. minutes, calls, etc.); have to recoup all of its joint and shared cost from its own customers and/or other entrants. Many > Fat-rated (fixed amount per period, independent regulators have determined that this would not be a of usage); fair and equitable distribution of these indirect costs. i Time-of-day (peak and off-peak, etc.); The mark-up may be uniform or non-uniform. Regulators have generally set uniform mark-ups. In :- Network functionality (call set-up and call our example, a uniform percentage mark-up would duration, etc.); and be 20%. This is calculated as the percentage of indi- rect cost (30) to the total costs (150) of the firm. - Capacity-based (fixed available capacity, Applying the 20% mark-up on the TSLRIC/LRAIC measured in bandwidth, El's, Ti's, etc.). amount would result in an interconnection amount of 1.8. Generally, the structure of interconnection prices should reflect the underlying cost structure, if this is As noted in Box B-4, Ramsey principles would known. The price structure should also be relatively suggest that a non-uniform mark-up, based on the easy to implement and administer and should inverse-elasticity rule, may be more economically ensure adequate cost recovery. efficient than a uniform mark-up. Regulators have not generally adopted such an approach. For instance, in the TSLRIC/LRAIC plus uniform mark-up discussion above, the total interconnection 1.4.4.5 Structure of Interconnection Prices amount was determined at 1.8. Recall that the local switch had a fixed cost of 10 and a variable cost of Note that in our example we have referred to inter- 5, a 2:1 relation between fixed and variable costs. connection amounts. These amounts are similar to Hence, one option is to have flat-rated pricing to re- the revenue requirement concept introduced in coup the fixed cost component of the interconnec- Module 4. That is, the interconnection amount tion amount, 1.2 and usage-based pricing to recoup constitutes the total monetary sum to be paid over a the variable cost component, 0.6. Flat-rated prices certain period. This is not the same as could include fixed monthly charges for the number interconnection prices or rates. These relate to the of ports used by the entrant in the incumbent's local manner in which the interconnection amount is switch or other altematives. Usage-based prices recovered. We also refer to this issue as the struc- could include per minute or per call charges for the ture of interconnection prices. The structure of entrant's calls. interconnection prices is an important matter that will have an impact on the economic and administrative Note that in practice most regulators have adopted efficiency of the entire interconnection regime. usage-based pricing only. In our example the entire interconnection amount of 1.8 would be collected by For any specific interconnection amount, there are a per minute or per call charges. This decision has number of altemate pricing structures. For example, generally been based on a number of factors, interconnection prices may be set based on one or a including administrative efficiency. Pricing based on combination of the following: usage only is also recommended when the regulator is uncertain of the relation between fixed and variable costs. 8- 18 infoDev McCarthyTetrault APPENDIX C - GLOSSARY Note: This glossary includes terms commonly used in telecommunications regulation and the telecommunications business generally. Definitions are adapted from non-definitive reference sources, including ITU reports (see sources note). The definitions have no official status. Terms in italics are defined elsewhere in the Glossary. Abuse of Dominance - Conduct by a firm, made Amplifier - Device used to boost the strength of an possible by its dominant position in a market (see electronic signal over an analogue transmission Dominance and Market Power), that is or may be facility. harmful to competition in that market. The concept of abuse of dominance is a broad and evolving one Analogue - Analogue signals carry information in that covers different types of conduct. Examples continuous, varying electrical waves. Analogue was include anti-competitive cross-subsidization, and the original recording and transmission technology vertical price squeezing. (See Module 5.) (preceding digital technology). It is still used in many communications applications. Access charge - A form of interconnection pay- ment, usually consisting of an amount per minute, Asynchronous Transfer Mode (ATM) - A method charged by network operators for the use of their to send data packets at irregular intervals by network by other network operators. (See Module 3) preceding each packet with a starter bit and follow- ing the data packet with a stop bit. It is Access Deficit Charge (ADC) - Mechanism used asynchronous in the sense that time between to finance universal service in competitive markets. packets varies. New operators typically pay ADCs to subsidize incumbent operators for the deficit they incur in Asynchronous Transmission - Transmission of providing local access services that are priced below data over a network in which each character of cost. (See Module 6.) information is individually synchronized by means of a start and stop bit to provide character framing. The Agreement on Basic Telecommunications (ABT) time between characters may vary (see ATM). - This World Trade Organization (WTO) agreement came into effect on 1 January 1998. Properly cited Automatic Number Identification (ANI) - as the Fourth Protocol to the General Agreement on Application able to transmit and display the tele- Trade in Services, this agreement is discussed in phone number of the calling party to the party Module 1. See also the entry below for the WTO answering the call. (See also Calling Line Regulation Reference Paper, which is reproduced in Identification) Appendix A. Average Cost - A specified cost divided by the Advanced Mobile Phone System (AMPS) - An quantity of output. [By default, usually refers to the analogue cellular telephone service standard average of total cost, which is total cost divided by utilizing the 800 to 900 MHz band (and recently also the specified volume of output.] (See Appendix B: the 1800-2000 MHz band). The Economics of Telecommunications Prices and Costs) Air time - The minutes of calls a subscriber makes from a mobile phone. Also referred to as talk time. Avoidable Cost - A cost that would not be incurred if output volume was reduced. (See Appendix B: Allocated Cost - A joint or common cost that has The Economics of Telecommunications Prices and been divided among services in accordance with a Costs) set formula or by judgement. This is also known as a distributed cost. (See Appendix B: The Economics Backbone Network - A network that links smaller or of Telecommunications Prices and Costs) lower-speed networks. McCarthy Tetrault infoDev C-1 Telecommunications Regulation Handbook Bandwidth - The range of frequencies that can pass = 10 million bits per second; 10 Gbps (Gigabits) = along a transmission line or other medium. In ana- 10 billion; 1 Tbps (Terabits) = 1 trillion) logue systems it is measured in terms of Hertz (Hz) and in digital systems in bit/s per second (bit/s). The Broadband -. Broadband communications use higher the bandwidth, the greater the amount of transmission media with a large bandwidth such as information that can be transmitted at the same time. wireless, coaxial or fibre-optic cable. This allows High bandwidth channels are referred to as transmission at higher speeds (bps). Broadband broadband which typically means 1.5/2.0 Mbitls or transmission techniques can permit more than one higher. device to transmit at the same time using different frequencies. Services provided include video, voice Bandwidth on demand - Capability of an end user and additional data channels. or network device to access available network capacity at a rate as required by the application be- Build-Operate-Transfer (BOT) - A project whereby ing utilised for a specified period. a private company is awarded a concession to build a telecommunications network or service and oper- Base station - A radio transmitter/receiver and ates it for a certain period of time before handing antenna used in the mobile cellular network. It over ownership to the national telecommunication maintains communications with cellular telephones administration or PTO. (See Module 2) within a given cell and transfers mobile traffic to other base stations and the fixed telephone network. Build-Transfer-Operate (BTO) - A project whereby a private company is awarded a concession to build Basic telecommunications service - Generally a telecommunications network or service, hands refers to voice telephony service, though some over ownership to the national telecommunication definitions also include telex and telegraph services. administration or PTO, and operates it for a certain period of time. (See Module 2) BDT - ITU Telecommunication Development Bureau. (See Module 1 for description of the ITU) Byte - (1) A set of bits that represent a single char- acter. A byte is composed of 8 bits. (2) A bit string Best effort - The service model for standard Internet that is operated upon as a unit and the site of which service. In the face of congestion of a network inter- is independent of redundancy or framing techniques. face, packets are discarded without regard to user or application until traffic is reduced. Calling Line Identification (CLI) - Relies on ANI to capture and use the telephone number of a calling Bill and Keep - Interconnection arrangement where party for various purposes (e.g. calling line no charges are payable between interconnecting identification display, or call blocking). operators for termination of each other's traffic. (Another term for Sender Keep All; See Module 3). Calling Party Pays (CPP) - The billing option whereby the person making the call is charged. This Bit ("Binary Digit") - A bit is the primary unit of is in contrast to billing the recipient of the call. Calling electronic, digital data. Written in base-2, binary party pays is the norm on fixed telephone networks language as a "1" or a "0". and is used for an increasing number of mobile networks. Blocking - The inability to complete a call because all possible paths between the calling station and the Carrier - See Common Carner. This term is also destination are already in use. Users are alerted to used to describe the presence or absence ("no this condition through a busy signal. carrier") of information on a cable or other transmis- sion medium. Bps - Bits per second is a measure of the rate of data communications representing the number of CCITT - Comit6 Consultatif Intemationale de bits transmitted every second. (10 Mbps (Megabits) Telegraphique et T6l6phonique (International Consultative Committee on Telephones and C - 2 infoDev McCarthyTetrault Appendix C Telegraphs). The former name of ITU-T, CCITT was errors. Coaxial cable is subject to distance limitations the primary intemational standards body for tele- and is relatively expensive and difficult to install. communications. (See description of ITU in Module 1). Code Division Multiple Access (CDMA) - A technology for digital transmission of radio signals CCSS7 - See Signalling System Number 7. based on spread spectrum techniques where each voice or data call uses the whole radio band and is Cell - The geographic area covered by a single base assigned a unique code. Used in cellular and other station in a cellular mobile network. wireless mobile services. Cellular - A mobile telephone service provided by a Collocation - Facility-sharing in which an operator, network of base stations, each of which covers one often an incumbent operator, provides space in its geographic cell within the total cellular system switching exchanges or other premises for commu- service area. nications equipment, such as transmission cables, of competitive operators to facilitate interconnectivity to Central Office - Location where local subscriber end-users. (See Module 3.) loops are controlled, connected and switched to other destinations in the public switched network Common Carrier - A North American term for a system. Central Office is the term used in North telecommunications operator that provides public America for a local telephone Exchange (see telecommunications services, including access to below). In addition, the term "Central Office" is the public switched telecommunications network and frequently used as a synonym for the switching telecommunications transport services. equipment itself. Common Cost - A cost incurred when a production CEPT - Committee of European Post and Telephone process yields two or more services. This is also re- (See Table of International Organizations, Module ferred to as shared cost if it applies to all of the 1). operations of the operator. For example, the cost of the building to house a telecommunications Channel - (1) A path for electrical transmission. exchange may be described as a common cost of Also called a circuit, line, link or path. (2) A specific serving both business and residential customers. and discrete bandwidth allocation in the radio The salary of the operator's president may be frequency spectrum. considered a shared cost of all services (this type of cost is often also referred to as an "overhead" cost) Circuit - A telecommunications channel established (See Appendix B: The Economics of between two or more points, allowing the exchange Telecommunications Prices and Costs.) of sources information between these points. Competitive Local Exchange Carrier (CLEC) - Circuit Switched Connection - A temporary Term originating in North America to identify a new connection that is established on request between entrant in the local exchange network services two or more terminals (stations) in order to allow the market. It generally competes with an ILEC. exclusive use of that connection until it is released. Connectivity - The capability to provide, to end Coaxial Cable - A type of electrical communications users, connections to the Intemet or other communi- cable used to provide cable television and also used cations networks. in the LAN environment in other networks. Coaxial cable consists of an outer conductor and an inner Corporatization - Corporatization involves legal conductor, separated from each other by insulating changes to grant a government-owned material, and covered by some protective outer telecommunications operator administrative and material. This medium offers large bandwidth, sup- financial autonomy from the central government. porting high data rates with relatively high immunity to electrical interference and a low incidence of McCarthyTetrault infoDev c3 Telecommunications Regulation Handbook Cross-subsidy - Covering the cost of offering some Digital Network - A telecommunication network in services through excess revenues earned from which information is converted into a series of dis- other services. In telecommunications, the term tinct electronic pulses and then transmitted as a "anti-competitive cross-subsidy" normally refers to a digital bit stream (see also Digital and Analogue practice by a dominant firm of offering services in network). competitive markets at low (e.g. below-cost) prices, while maintaining overall firm profitability by charging Digital Signal Level I (DSI) - Digital Signal level 1 above-cost prices in monopoly markets, or in other refers to a digital hierarchy of circuits or channels markets where the firm enjoys Market Power. (See operating at 1.544. This corresponds with the North Module 5). American and Japanese Ti designation. Customer Premises Equipment (CPE) - A term Direct Cost - A cost that can be attributed solely to developed in North America to describe any the production of a specific item. A direct cost does apparatus from PBX switching systems to telephone not require a cost allocation (or distribution) to handsets that are located on the customer's prem- separate it from the costs incurred in the production ises, rather than on the telephone company's of other items. An indirect cost, however, does premises. The term CPE is commonly used to refer require such an allocation. An operator that to equipment that is owned by the customer (end produces a single product sold in a single market user). incurs only direct costs. When an operator is engaged in producing multiple products or serving Dedicated Access Lines - Telecommunications multiple markets, however, it will normally also incur lines dedicated to or reserved for use by particular indirect costs such as joint and/or common costs. users along predetermined routes. They intercon- (See Appendix B: The Economics of nect a switching system to a dedicated customer Telecommunications Prices and Costs.) and may be connected to specific telephone, key telephone system or PBX. Also referred to simply as Domain Name - The registered name of an individ- "dedicated lines". ual or organization eligible to use the Internet. Domain names have at least two parts and each Dial Tone - A signal heard when the telephone part is separated by dot. The name to the left of the handset is off-hook, indicating that the exchange or dot is unique for each top-level domain name, which PBX is ready to accept and process a dialled is the name that appears to the right of the dot. For number. instance, The International Telecommunication Union's domain name is itu.int. "ITU" is a unique Dial Tone Delay - Refers to the time it takes to name within the gTLD "int". obtain a dial tone after a telephone handset is taken off hook. Average dial tone delay is a common Dominance - An extreme form of Market Power. measure of service performance quality. (See below) While the definition of market domi- nance varies with the laws of different countries, a Digital - A communications technique in which finding of dominance usually requires proof of a sound is represented as discrete Bits. The digits are relatively high market share and the existence of transmitted as a series of pulses. Digital transmis- significant barriers to entry into the markets in which sion differs from analogue transmission in that digital a firm is dominant. (See Module 5.) technology converts analogue sounds or electrical signals into the Bits, which can be transmitted Download - The process of loading software or files without distortion or need of amplification. Digital from one device to another across a network. networks allow for higher capacity, greater functionality and improved quality. GSM, CDMA and Dual Tone Multi-Frequency (DTMF) - A method of TDMA networks are all digital. The Internet is also a signalling initiated from the pushbutton touch-tone digital network. keys of the telephone. The exchange recognizes each digit dialled by the caller by means of a unique frequency generated by the touch-tone keys. DTMF C-4 4 . C - 4 ~~~~~~~infoDev McCarthyTetrault Appendix C is used for many value-added features, such as as easily as to those of incumbent operators. (See voice-mail, tele-ordering and automated response Module 3.) software. Essential Facilities - In telecommunications regula- E-1 - A European and international digital standard tion, this term generally refers to facilities associated referring to any transmission line or connection with a telecommunications network or service that operating at the rate of 2.048 Mbps. (See also T-1 are exclusively or predominantly provided by a for a description of the comparable North American monopolist or a small number of suppliers, and that standard.) cannot feasibly be substituted by competitors for economic or technical reasons. The concept of Electromagnetic Interference (EMI) - Interference Essential Facilities is discussed in detail in Modules caused to telecommunications signals by electro- 3 and 5. magnetic radiation. Exchange - The term Exchange is generally used to Electronic Data Interchange (EDI) - EDI is the refer to Switches that are connected to the PSTN. computer-to-computer exchange of business Local exchanges connect local loops from end users documents between companies, using a public to trunks which are connected to other exchanges, standard format. Rather than preparing paper and including tandem exchanges and international sending it through the mail, or using other gateway exchanges, all of which are different types communications methods such as fax, EDI users of switches. In North America, the term Central exchange business data directly between their Office is usually used to refer to a local Exchange. In respective computer systems. some countries, including those in North America, the term Exchange or Exchange Area refers to the Electronic Mail (E-Mail) - Host computer or LAN- local area served by one or more local Exchanges. based electronic mail systems employ software- (See also definition of Switch.) defined "mail boxes." Other computer terminals can access the E-mail program to view, answer, Exchange Point - Points within a network at which broadcast, delete, forward, or file E-mail message IP packets are exchanged between ISPs. text and images. Extranet - An Extranet is an Intranet that is partially Encryption - The translation of data into a secret accessible to authorized outsiders through the use code. Encryption is the most effective way to of passwords. achieve data security. To read an encrypted file, one must have access to a secret key or password that Facilities-based Operator - A PTO that operates its enables it to be decrypted. own network transmission facilities (wires, cables, microwave routes, radio transmitters and receivers, End User - The individual or organization that satellite transponders, etc.). A facilities-based originates or is the final recipient of telecommunica- operator is usually contrasted with a "Reseller" (see tions messages or information (i.e. the consumer). definition below). Enhanced services - Telecommunications services Fibre Optics - A technology that uses pulses of light provided over public or private networks which, in as a digital information carrier, transmitted through some way, add value to the basic carriage, usually thin strands of glass. Fibre Optic Cable is a trans- through the application of computerized intelligence, mission medium composed of such glass strands. for instance, reservation systems, bulletin boards, Fibre optic cable provides higher transmission rates information services. Also known as Value Added than wire or co-axial cable and is immune from Services. electrical interference. Equal Access - The ability of telecommunications Fixed Cost - A cost that does not vary by volume of users to access the services offered by new entrants production. A specific type of fixed cost is sunk costs, costs that cannot be changed or avoided even McCarthylTetrault infoDev c5 Telecommunications Regulation Handbook by ceasing production entirely. For instance, head Gigabit - One billion bits. office space is a fixed cost, but the labour component of the installation of the copper wire in Global System for Mobile communications the local loop is a sunk cost. Neither fixed nor sunk (GSM) - European-developed digital mobile cellular costs enter into marginal-cost pricing decisions standard. For more information, see the GSM because neither varies with output. (See Appendix Association website at B: The Economics of Telecommunications Prices http://www.gsmworld.comfindex.html. and Costs.) Graphic User Interface (GUI) - A computer terminal Fixed Line - A physical line connecting the interface that employs a bit-mapped screen. subscriber to the telephone exchange. Typically, Graphical interfaces typically have Windows, Icons, fixed-line network is used to refer to the PSTN (see Mice, Menus and Pointers. The GUI permits mixed below) to distinguish it from mobile networks. graphics and text, and incorporates easy-to-use visual representations of system functions. The GUI Frame Relay - A fast packet switching technology was popularized in personal computing, with the that eliminates much of the processing and delay of introduction of the Apple Macintosh computer, and traditional X.25 packet switching. later with Microsoft's Windows operating system. Frequency - The number of cycles per second at Half-Circuit - A component of an intemational circuit which an analogue signal electrical current alter- between two countries that originates in one country nates, usually measured in Hertz (Hz). One Hertz is and terminates at a theoretical midpoint between the one cycle per second. It is also used to refer to a countries. location on the radio frequency spectrum, such as 800, 900 or 1800 Mhz. Hand-off - A central concept of cellular technology, enabling mobility for subscribers. It is a process by Fully Distributed Costs (FDC) - Approach for which the Mobile Telephone Switching Office passes allocating telecommunications costs to different tele- a mobile phone conversation from one radio fre- communications services (also referred to as "fully quency in one cell to another radio frequency in allocated costs"). This approach is usually based on another as a subscriber crosses the boundary of a an allocation of historical accounting of costs to cell. various broad service categories. After assigning direct costs to each category, the Joint and Common Head-End - The point in a broadband network that Costs are allocated to applicable service categories receives signals on one set of frequency bands and based on formulas that reflect relative usage or retransmits them on another set. The head end of a other factors. (See Appendix B: The Economics of cable TV network generally receives satellite, off-air Telecommunications Prices and Costs.) and wireline TV and multimedia signals, and retransmits them to end users through a fibre optic Gateway - Any mechanism for providing access to or co-axial cable distribution network. another network. This function may or may not include protocol conversion. Hertz (Hz) - The frequency measurement unit equal to one cycle per second. GATS - General Agreement on Trade-In Services (See Module 1 and WTO) High Speed Circuit Switched Data (HSCSD) - An intermediary upgrade technology for GSM based on Gbps - Billion bits per second. circuit-switched technology and enabling data service speed of 57 kbps. General Packet Radio Service (GPRS) - An enhancement for GSM, based on packet-switched Host - Any computer that can function as the technology enabling high-speed data transmission beginning and end point of data transfers. Each (115 kbitls per second). Internet host has a unique Internet address (IP address) associated with a domain name. A host C - 6 infoDev McCarthyTetrault Appendix C computer provides services such as database Incumbent Operator - The established access, computation or other processing, and spe- telecommunications network operator(s) in a cial programs or other content. A host computer is country. Normally the entity that operates all or most the primary or controlling computer in a multiple of the PSTN infrastructure in a country. In many computer installation. countries this was the Posts, Telephone and Tele- graph (PTT) administration of the national HTTP - HyperText Transport Protocol (see WWW). government. In some countries it was or now is a private sector operator. In both cases, incumbent IEEE - Institute of Electrical and Electronic PTOs generally operated as monopolies. (See also Engineers. An international standards-setting definition of PTO). organization. Incumbent Local Exchange Carrier (ILEC) - Term IETF - Internet Engineering Task Force. An originating in North America to identify the organization responsible for updating and maintain- incumbent operator that runs the local exchange ing TCP/IP standards. network. It is or was typically the dominant provider of local PSTN services. See also Competitive Local IMT-2000 - Intemational Mobile Telecommunica- Exchange Carrier. tions. The ITU third generation mobile cellular standard. For more information see the website at Inflation Factor - Variable included in a price cap http://www.itu.int/imt. formula to reflect or represent changes in the input costs of telecommunications operators. (See also In-Band Signalling - A communications technique Price Cap.) (See Module 4.) used between switches and communications equipment in which the control signals are Information infrastructures, Information exchanged within the standard bandwidth of the superhighway - High-speed communication net- telecommunications signal. works capable of carrying voice, data, text image and video (Multimedia) information in an interactive Increment - A specific non-minimal increase or mode. decrease in volume of production. (See Appendix B: The Economics of Telecommunications Prices and Integrated Services Digital Network (ISDN) - A set Costs.) of CCITT standards that provides for the transport of digital voice, data, image and video services. Incremental Cost - The change in total cost resulting from an increment. Incremental cost equals Interactive Voice Response (IVR) - A voice total cost assuming the increment is produced, processing system that allows the storage and re- minus total cost assuming the increment is not trieval of digital data, including data in the form of the produced. Because a wide variety of different human voice, through user interaction with the increments can be specified, incremental cost can touch-tone keys of the telephone. The IVR's pre- conceptually range all the way from total cost per recorded voice commands guide the caller through a unit (entire output as the increment) to marginal cost menu, and the caller responds by touching the (one unit as the increment). The size of the appropriate numbered or lettered key(s). increment used in any specific cost analysis will be a matter of judgement. The most common practice is Interconnection - The physical connection of tele- to use the entire service or element as the phone networks owned by two different operators in increment, in which case the service or element order to allow customers connected to different specific fixed costs of the service or element would networks to communicate, to ensure the be included in the increment. (See Appendix B: The interoperability of services. (See Module 3) Economics of Telecommunications Prices and Costs.) Interexchange Carriers (IXC) - A term originating in North America to describe long-distance telecom- McCarthyRTerault infoDev C7 Telecommunications Regulation Handbook munications operators that provide service between computers and other products. It developed the OSI cities or other local exchange areas. model for data communication. Interface - The logical or physical connection ITU - Intemational Telecommunication Union. (See between two networks, systems or devices; the Module 1 for a description of the ITU and its various point of interconnection of two components and the components, including ITU-R, ITU-T and ITU-D.) basis on which they exchange signals according to some hardware or software protocol. ITU-D - Telecommunication Development Sector of the ITU. (See Module 1 for descrption of the ITU.) Internet - The collection of interconnected networks that use the Internet Protocols (IP). ITU-R - Radiocommunication Sector of the ITU. (See Module 1 for description of the ITU.) Intemet Backbone - The high-speed, high capacity lines or series of connections that form a major ITU-T - Telecommunication Standardization Sector pathway and carry aggregated traffic within the of the ITU. (See Module 1 for description of the ITU.) Internet. Joint Cost - A specific kind of common cost incurred Internet Content Provider - A person or organiza- when a production process yields two or more tion, that provides information via the Internet either outputs in fixed proportion. Joint costs vary in with a price or free of charge. proportion to the total output of the joint production process, not to the output of the individual joint Intemet Exchange Point (IXP) - Refers to a products. (See Appendix B: The Economics of Tele- Network Access Point (NAP) where connections are communications Prices and Costs.) made to dedicated Intemet backbone networks or where ISPs connect with one another. NAPs serve Kbps - Kilobits per second. as data interchange points for backbone service providers. NAPs and Metropolitan Area Exchanges Key Telephone System - A multi-line telephone (MAEs) are generally referred to as public Internet system designed to provide shared access to Exchange Points (IXPs). several outside lines through buttons on the telephone set. It typically offers identified access Intemet Protocol (IP) Numbers - An IP number lines with direct line terminations on a telephone set. (also referred to as Internet address number) is the The system is located on the user's premises and address of a host or other intelligent devices on the can operate independently or in conjunction with a Internet. All servers and users connected to the PBX. Internet have an IP number. Kilobit - One thousand bits. Internet Service Provider (ISP) - ISPs provide end- users and other ISP access to the Internet. ISPs Layer - A conceptual level of network processing may also offer their own proprietary content and functions. In the OSI model, network processing is access to online services such as e-mail. thought of as taking place in layers, from the physical transmission of data up to the issuing of an Intranet - An Intranet is a network, based on TCP/IP end-user command. Layers communicate only with protocols, accessible only by an organization's those immediately above or below in the layer proto- employees, or other authorized users. Intranet col stack, or with peer-level layers on other systems. websites are similar to other websites, but are surrounded by firewalls that prevent unauthorised Leased Line - A point-to-point communication access. channel or circuit that is committed by the network operator to the exclusive use of an individual ISO - International Standards Organization - ISO subscriber. Depending on the country, leased lines promotes the development of standards for may or may not be permitted to interconnect with the PSTN. C - 8 infoDev McCarthyT'etrault Appendix C Licence - A telecommunications licence generally Long Run Incremental Costs (LRIC) The refers to the authorization to provide incremental costs that arise in the long run with a telecommunications services or operate telecom- specific increment in volume of production. LRIC is munications facilities. A telecommunications licence generally calculated by estimating costs using usually defines the terms and conditions on which current technology and best available performance the licensee is authorized to operate and sets out its standards. When a cost study is based on the "costs rights and obligations. (See Module 2.) of an efficient firm", it usually refers to LRIC-type methodology. In the presence of joint or common Licensing - Term used to refer to the administrative costs, the sum of the LRIC for all of the operator's steps followed by an NRA or other licensing author- services will be less than the total costs of the ity to issue a licence. (See Module 2.) operator. Hence, the operator will not be able to recoup all of its costs. Regulators will generally allow Line - It usually refers to the communications a mark-up to be added to LRIC or LRIC-type costs channel whereby end users connect to the PSTN. for the firm to help recover all of its costs. (See Also called a circuit, trunk or facility. Appendix B: The Economics of Telecommunications Prices and Costs.) Local Area Network (LAN) - A communications network that provides high speed data transmission Main Telephone Line - Telephone line connecting a and a low error rate in connecting computers and subscriber to the telephone exchange equipment. other terminal devices, usually within relatively small This term is synonymous with the terms main areas. Most LANs are confined to a single building station, Direct Exchange Line (DEL) and main or group of buildings. However, one LAN can be access line. connected to other LANs over any distance via tele- phone lines and radio waves. (See also Wide Area Marginal Cost - The change in total cost resulting Network.) from a very small change in the volume of output produced. Due to a number of practical issues, Local Exchange Carrier (LEC) - The telecommu- including the lumpiness of capital increments (i.e. nications operator that provides service to end users the inability of telecommunications plant to be through its local exchanges, which are connected to divided into very small parts, or scaled to provide an the PSTN. (See also ILEC and CLEC.) exact fit with the actual requirements of the network), marginal cost is difficult to estimate. Accordingly, Local Loop - The transmission path linking end most estimates of marginal cost are based on users (i.e. subscribers) to the nearest exchange. It incremental cost. (See Appendix B: The Economics generally consists of a pair of copper wires, but may of Telecommunications Prices and Costs.) also employ fibre-optic or wireless technologies. The local loop is sometimes referred to as the "last mile". Mark-up - A percentage or a fixed monetary amount (See also unbundled local loop.) that is used to take into account joint and common costs, for example, to supplement certain costing Long Run - A period over which all factors of methodologies. Cost concepts that do not fully production, including capital, are variable. In allocate (or distribute) all indirect costs generally practice, a period of 10 to 15 years is sometimes require mark-ups. These cost concepts include selected by regulators for the purpose of LRIC incremental costing methodologies, including LRIC analysis, for example. (and TSLRIC/LRAIC and TELRIC as discussed in detail in the cost methods section below). The mark- Long Run Average Incremental Costs (LRAIC) - up may be uniform or non-uniform. While regulators A variation on LRIC (See below) in which the have generally set uniform mark-ups to promote increment is defined as the total service. Thus, it competition, the application of Ramsey principles differs from LRIC and marginal cost approaches in suggests that a non-uniform mark-up may be that it includes fixed costs that are specific to the economically efficient. (See Appendix B: The service. (See Appendix B: The Economics of Tele- Economics of Telecommunications Prices and communications Prices and Costs.) Costs) McCarthyTe'traukt infoDev c- Telecommunications Regulation Handbook Market Power - Generally, a telecommunications National Regulatory Authority (NRA) - See operator or other firm is considered to have market definition of Regulator below. power when it is able to establish and maintain prices or other key terms and conditions of sales in a Network - A public and/or private communications market for a non-transitory period, without regard to transmission system that provides interconnectivity the market or the actions of competitors, without among a number of local or remote devices (e.g. losing sales to such a degree as to make this telephones, exchanges, computers, television sets). behaviour unprofitable. (See also Dominance, above The PSTN is operated by local PTOs. Like the and see Module 5.) PSTN, other private and public networks can comprise many point-to-point transmission media, Megabit - One million bits. Mbps - Megabits per including wire, cable and radio-based ones. second. Network Access Point (NAP) - Point at. which Mobile Cellular Service - A communication service dedicated Internet backbone lines are reached or at in which voice or data is transmitted by radio which ISPs connect with one another. NAPs serve frequencies. The service area is divided into cells, as data interchange points for backbone service each served by a transmitter. The cells are providers. NAPs and Metropolitan Area Exchanges connected to a controlling switching exchange, (MAEs) are increasingly referred to as public Internet which is connected to the worldwide telephone exchange points (IXPs). network. Network Redundancy - A telecommunications path Modem - Modulator/Demodulator. A conversion that has backups connecting various points in case device installed in pairs at each end of analogue one path fails (e.g. if a cable is cut). communications lines. The modem at the transmit- ting end modulates digital signals received locally New Entrant - A new telecommunications service from a computer or terminal. The modem at the provider, including a new PTO. receiving end demodulates the incoming analogue signal, converts it back to its original digital format Node - A computer, switch or other device when it is and passes it to the destination device. considered as part of a network. Multimedia - The presentation of more than one Number Portability - The ability of a customer to medium, typically images (moving or still), sound transfer its service account from one operator to and text in an interactive environment. Multimedia another without requiring a change in the customer's requires a significant amount of data transfer and number. invariably requires computational facilities. Online Service and Software Companies - Multiplexer - A device that combines several Companies which operate Internet sites whose communications channels onto a single circuit. The principal function is to provide services in electronic channels are combined by paralleling the channels form, including transactions with third parties, sales in real time on the single circuit and distributing them and support for its products and software which can in frequency (Frequency Division Multiplexing--FDM) be downloaded by end users for a fee or without or by time-sharing the channel (Time Division charge. Multiplexing-TDM). Open System - A computing system that uses Multiplexing - (1) To combine the signals of two or publicly available standards so that it can communi- more channels into one single channel for cate with other systems using the same standards. transmission over the telecommunications network. (2) Division of a transmission facility into two or more Open Systems Interconnection (OSI) - The overall channels. name for ISO's classification of standards for global connectivity. ISO has developed a seven-layer model for standards-based networking and is in the C-10 infoDev McCarthyTetrault Appendix C process of developing protocols that comply with this Peak rate - Term used for calls made during the model. busy part of the working day, at full tariff. Off-peak refers to calls made at other times, often with Operating System - Software that provides the link discounted tariffs. between a computer's application programs and its hardware. Peering - The exchange of routing announcements between two Intemet Service Providers for the Out-of-Band Signalling - A communications purpose of ensuring that traffic from the first can technique used between switches and other tele- reach customers of the second, and vice-versa. communications equipment in which the control Peering takes place predominantly at IXPs and signals are exchanged through a control channel usually is offered either without charge or subject to that is separate from the channel(s) carrying the mutually agreed commercial arrangements. information. Penetration - A measurement of access to tele- Packet - A unit of information identified by a label at communications, normally calculated by dividing the layer 3 of the OSI reference model. The term is used number of subscribers to a particular service by the to describe a collection of bits that contain both population and multiplying by 100. Also referred to control information and content. Control information as teledensity (for fixed-line networks) or mobile is carried in the packet to provide for addressing, density (for cellular ones). sequencing, flow control and error control at each of several protocol levels. A packet can be fixed or Personal Communication Services (PCS) - In the variable in length, but generally has a specified United States and Canada, refers to digital mobile maximum length. networks using the 1900 Mhz frequency. In other countries, refers to digital mobile networks using the Packet Switching - A data telecommunications 1800 Mhz frequency (See DCS-1800). The term technique in which information is grouped into Personal Communications Network (PCN) is also packets for ease of handling, routing, supervising used. and controlling on telecommunications networks. Packets are sent to their destination by the fastest Point of Interconnection (POI) - The physical route. The transmission channel is occupied only location at which two networks interconnect. while the packet is being transmitted and the channel is then available to transfer other packets Point of Presence (PoP) - A Point of Presence is a between other data terminal equipment. Individual switch, node or other facility offering users access in packets may reach the destination by different a particular market (e.g. dial-up access to the routes and in the wrong order. The destination node Internet via a specific telephone number). The is responsible for reassembling the packets into the greater the number of PoPs, the higher the proper sequence. Packet switching is used in most likelihood that users can connect using a local data networks, including those that use the older telephone call. X.25 protocol, and the Intemet, which uses TCP/IP Protocols. Port - The physical access point to a computer, switch, device, or network where signals may be Paging - A mobile radiocommunication service supplied, extracted or measured. offering - usually one-way - of numeric or textual information to small pocket terminals. Portal - Although an evolving concept, the term "portal" commonly refers to the starting point, or a PCM - Pulse Code Modulation. The technique most gateway through which users navigate the World frequently used to sample and convert analogue Wide Web, gaining access to a wide range of signals to a digital format. In telephony, PCM is used resources and services, such as e-mail, forums, to convert analogue voice signals to an 8-bit digital search engines, and shopping malls. A mobile portal format at an 8 Khz rate, producing a serial bit stream implies a starting point, which is accessible from a of 64 kbps. mobile phone. McCarthyTetrault infoDev c-u Telecommunications Regulation Handbook Post Telephone and Telegraph Administration Private Network - A network based on leased lines (PTT) - Term used to designate government or other facilities which are used to provide departments or agencies that traditionally owned telecommunication services within an organization operated the PSTN as monopolies mainly in Europe, or within a closed user group as a complement or a Asia and Africa. substitute to the public network. Post, Telegraph and Telephone Administration Private Ownership/Privatization - The transfer of (PTT) - The traditional organization of the communi- control of ownership of a state enterprise to private cation sector in many countries was the PTT (the parties generally by organizing the enterprise as a Post, Telegraph and Telephone Administration) share company and selling shares to investors. wherein the government owns and operates both More generally, the term is sometimes used to refer telecommunication and postal services. to a wide range of modalities whereby business is opened to private enterprise and investment. Predatory Pricing - Anti-competitive practice of providing services at prices that are low enough to Proprietary Standard - A standard that is owned or drive competitors out of a market, or prevent new controlled by a single person or legal entity. A entry by them, so as to monopolize the market. (See proprietary standard can be used for interoperability Module 5.) if the company that controls it is willing to license it and publish its specifications. Price Cap - Is a rules-based form of price regulation that uses a formula to determine the maximum Protocol - A set of formal rules and specifications allowable price increases for a regulated operator's describing how to transmit data, especially across a services for a specified year or number of years. The network or between devices. formula typically allows an operator to increase its rates annually for a service or basket of services by Public Switched Telephone Network (PSTN) - an amount equal to inflation, less an amount equal The infrastructure of physical switching and trans- to the assumed rate of productivity increases. Other mission facilities that is used to provide the majority variables may be taken into account in the price cap of telephone and other telecommunications services formula such as 'exogenous factors' outside of the to the public. In a monopoly environment, one PTO operator's control and the quality of service provided owns and operates the PSTN. In a competitive by the operator. (See Module 4.) environment, the PSTN typically comprises the interconnected networks of two or more PTOs. Primary Rate Interface - Also called Primary Rate Access. A term used to designate an integrated Public Telecommunications Operator (PTO) - services digital network (ISDN) interface standard normally a "facilities-based operator" such as a that is designated in North America as having telephone company, which provides telecommuni- 23B+D channels, in which all circuit-switched B cations services to the public for compensation. The channels operating at 64 kb/s and in which the D term "public" relates to the consumer rather than the channel also operates at 64 kb/s. The PRI ownership of the PTO. In some countries the terms combination of channels results in a digital signal "telecommunications common carrier', "common level I (or TI) interface at the network boundary. carrier" or simply "carrier' are used instead of PTO. Private Branch Exchange (PBX) - Equipment that RAG - Radiocommunication Advisory Group of the is located on a customer's premises that controls ITU. (See Module 1 for description of the ITU.) and switches information between local terminal equipment, such as telephones or data terminals, Rate of Retum Regulation (ROR) - Is a rules- and provides access to the PSTN. Sometimes PBXs based form of price regulation designed to provide are referred to as Private Automatic Branch the regulated operator with relative certainty that it Exchanges (PABXs). (See also Key Telephone can meet its revenue requirements and that prices System.) will be adjusted, as required to meet that objective. Under this scheme, the regulated operator's C - 12 infoDev McCarthyTetrault Appendix C revenue requirement is calculated and then service RRB - Radio Regulations Board of the ITU. (See prices are adjusted so that its overall service Module 1 for description of the ITU.) revenues cover such revenue requirement. (See Module 4.) Sender Keep All - Another term for Bill and Keep. (See Module 3.) Rate Rebalancing - It refers to the adjustment of rates charged for different services to more closely Server - (1) A host computer on a network that reflect their costs. In most countries, this means sends stored information in response to requests or increasing local access rates and decreasing queries. (2) The term "server" is also used to refer to international, long distance, local usage rates and the software that makes the process of serving Internet access. (See Appendix B, Module 4 and information possible. Appendices to Module 6.) Short Message Service (SMS) - A service available Regulator - This term is used to refer to government on digital networks, typically enabling messages with agency, institution or official responsible for up to 160 characters to be sent or received via the regulation of all or part of the telecommunications message centre of a network operator to a sector in a country. In some countries it is a National subscriber's mobile phone. Regulatory Authority (NRA), an independent regulatory authority, or a Ministry of the Government. Signalling System Number 7 - AN ITU-T common Sometimes, one entity is the regulator for some channel signalling protocol providing enhanced con- purposes and another entity for other purposes. trol functions such as look-ahead routing for high- Different institutional approaches to regulation are speed digital communications services between discussed in Module 1. intelligent network nodes. Signalling information is sent at 64 kbps. Also referred to as Common Reseller - A public telecommunications service Channel Signalling System Number 7 (CCSS7), or provider that does not own network transmission CCITT Number 7 Signalling. facilities but obtains transmission facilities or services from others (usually from a PTO) for resale Significant Market Power - Test set out in several to its customers. These facilities or services may be European Directives to identify operators that have resold with other services (e.g. value-added greater than a 25% share of a particular telecommu- services) or without ("simple resale"). Some resellers nications market and that are required to meet operate their own switches, routers and processing certain obligations (e.g. Article 4 of the equipment. Others do not. Interconnection Directive mandates operators with significant market power to "meet all reasonable Roaming - A service allowing cellular subscribers to requests for access to the network, including access use their handsets on networks of other operators. at points other than the network termination points offered to the majority of end-users"). (See Module Router - Specialized computers that receive 5.) transmissions of packets and compare their destination addresses to internal routing tables and, Spectrum - The radio frequency spectrum of depending on routing policy, send the packets out to Hertzian waves used as a transmission medium for the appropriate interface. This process may be cellular radio, radiopaging, satellite communication, repeated many times until the packets reach their over-the-air broadcasting and other wireless intended destination. services. Routing Policy - An expression of how an ISP will Splifter - A device used in a cable system or wire choose to direct traffic on or off network. For network to divide the power of a single input into two example, ISPs may choose to route traffic with or more outputs of lesser power. It can also be used preference to certain paths or through other ISPs when two or more inputs are combined into a single depending on the commercial relationships between output. the parties. McCarthyTetrault infoDev c- 13 Telecommunications Regulation Handbook SS7 - See Signalling System Number 7. Total Cost - The aggregate amount of all costs incurred in producing a specified volume of output. Stand-alone Cost - The total cost to provide a The sum of fixed and variable costs equals total particular product or service in a separate production cost. (See Appendix B: The Economics of process (i.e. without benefit of scope economies). Telecommunications Prices and Costs). (See Appendix B: The Economics of Telecommunications Prices and Costs.) Transmission Control Protocol/lntemet Protocol (TCP/IP) - The suite of protocols that defines the Standards - Recommendation for the protocol, Internet and enables information to be transmitted interface, type of wiring or some other aspect of a from one network to another. network. Recommendations range from a conceptual definition for a general framework or TSB - Telecommunication Standardization Bureau of model for communications architecture to specific the ITU. (See Module 1 for description of the ITU). interfaces. Standards are developed by intemationally or nationally recognized bodies such Type Approval - An administrative procedure of as ITU-T or telecommunications equipment vendors. technical tests and vetting applied to items of telecommunication equipment before they can be Subscriber Identity Module (SIM) Card - A small sold or interconnected with the public network. Also printed circuit board inserted into a GSM-based known as homologation. mobile phone when signing on as a subscriber. It includes subscriber details, security information and UMTS Terrestrial Radio Access (UTRA) - The a memory for a personal directory of numbers. European third-generation mobile standard ETSI has agreed on which draws upon both W-CDMA Switch - Telecommunications equipment that estab- and TDMA-CDMA proposals. lishes and routes communications paths between different lines, trunks or other circuits. Switches Unbundled Local Loop - Access to the full and establish circuits or paths between different end exclusive use of the copper pair connected to the users or between other devices attached to customer and/or some form of shared access to the telecommunications networks. A PBX is a form of local loop. Full unbundling refers to access to raw switch located on customer premises. The term copper local loops (copper terminating at the local Exchange is generally used to refer to switches that switch) and subloops (copper terminating at the are connected to the PSTN. remote concentrator or equivalent facility). Shared access refers to the non-voice frequencies of a local Synchronization - Timing pulses to maintain the loop and/or access to space within a main proper identity between the transmitted and received distribution frame (MDF) site of an operator for pulses. attachment of DSL access multiplexers (DSLAMS) and similar types of equipment to the local loop of T-1 - A North American digital standard referring to the notified operator. any transmission line or connection operating at the DS1 rate of 1.544 Mbps. (See T-1.) Unbundling - Refers to the provision of components on a stand-alone basis. Therefore, interconnecting T-3 - Refers to transmission at 44.736 Mbps, etc. carriers can obtain access to single unbundled (See E-1) component without an obligation to buy other com- ponents as part of an "interconnection package" Telecommunications Facility Provider - An entity (See Module 3.) that supplies underlying transmission capacity for sale or lease and either uses it to provide services or Uniform Resource Locator (URL) - The standard offers it to others to provide services. way to give the address or domain name of any Intemet site that is part of the World Wide Web Teledensity - Number of main telephone lines per (WWW). The URL indicates both the application 100 inhabitants. C -14 infoDev McCarthyTetrault Appendix C protocol and the Internet address, e.g. bulletin boards, and information services. Also http://www.itu.int. known as value added network services (VANS) and enhanced services. Universal Access - A term generally used to refer to a situation where every person has a reasonable Variable Cost - A cost that varies with increased means of access to a publicly available telephone. volume of production. (See Appendix B: The Universal Access may be provided through pay Economics of Telecommunications Prices and telephones, community telephone centres, Costs.) teleboutiques, community Internet access terminals or similar means. (See also Universal Service; see Vertical Price Squeezing - Occurs when an Module 6.) operator with market power controls certain services that are a key input for competitors in subordinated Universal Mobile Telecommunications System or'downstream'markets and where those same key (UMTS) - The European term for third generation inputs are used by the operator or its affiliates to mobile cellular systems. For more information, see compete in the same downstream markets. For the UMTS Forum website at http://www.umts- example, an incumbent telecommunications forum.org. operator often controls local access and switching services which are key for competitors to compet