Regional Seminar on Costs and Tariffs for TAL Group Member Countries
Trinidad & Tobago – February 2008
Opal Lawton
Independent Consultant
Telecommunications Policy, Costing & Pricing

What is price cap regulations?
Objectives of price cap regulations
The Jamaican telecoms market
The Jamaican Price Cap Model
Regulatory process used to specify the regime
Data requirements
Approaches to estimating the X factor
Overview of the regime
Determination of the rules
Key
Performance of the Jamaican Price Cap Regime
Lessons learnt
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Price regulation has its roots in the theory of competition.
In an effectively competitive market, prices will be efficient and equate market supply with demand (i.e. the price point is where marginal cost equals marginal revenue).
Efficient prices will result in the maximization of society’s welfare.
Price regulation is geared at simulating and promoting effective competition.
Approaches to price regulation have evolved as the telecommunications market landscape has evolved.
Various approaches include:
Rate of return
Price cap
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What is price cap regulations?
Price cap regulation uses a formula to determine the maximum allowable prices for a basket of services provided by a regulated firm.
The formula is designed to allow the operator to recover unavoidable costs increases (e.g. inflation) through price increases.
The formula requires the operator to lower prices to reflect productivity gains of an efficient operator.
Once the price cap has been set, the operator is incentivised to reduce cost, because it is allowed to keep the extra profit until the cap is reset.
This incentive based element, which tends to mimic the workings of a completive market makes price cap the preferred regulatory tool.
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Objectives of price cap regulations?
Provide incentives for the operator to strive for greater efficiency
Can provide the operator with more price flexibility than the other approaches
Reduce regulatory costs, through reduced regulatory intervention and a more streamlined regulatory process
Protect consumers and competitors from the pass thru of inefficient costs
Limit the opportunity for cross subsidization
Simulate and stimulate competitive market forces
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The Jamaican Telecoms Market
March 2001 the market was fully liberalized
Prior to this Cable & Wireless Jamaica (CWJ) the incumbent provider, offered fixed line, mobile, data, internet and related services.
Number of fixed line in 2000 – 494 (k)
Number of mobile in 2000 – 367(k)
Today there are three mobile service providers.
Two fixed line providers but CWJ continues to be the main provider of fixed line services.
Number of fixed lines in 2006 – 342(k)
Number of mobiles in 2006 – 2,495(k)
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The Jamaican Price Cap Model
The price cap regime took effect on September 1, 2001, five months after full liberalization.
Prior to this rate of return was the approach used to regulate the prices of fixed line services.
The prices of retail mobile services were never regulated.
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The Jamaican Price Cap Model
The Office of Utility Regulations (OUR) was mandated by The
Telecommunications Act to establish rules for the imposition, monitoring and enforcement of price caps.
The OUR used a series of public consultative processes to determine the regime.
Policy
General Rules (January 2001)
Specific Rules (April 2001)
Regulations
CWJ Price Cap Plan Determination Notice (August 2001)
Revised Price Cap Plan (May 2002)
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The Jamaican Price Cap Model
The General Rules set out the high level principles of the regime and included issues such as:
Basis for the application of price cap
Obligation of operators subject to the cap to provide requisite information
Penalties for failure to comply with the rules
Review & renewal period for price cap control
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The Jamaican Price Cap Model
The Specific Rules outline more details on the principles of the regime including issues such as:
Timing of the price cap
Services that would be subject to price caps
The structure of the service baskets
The basis and process to remove services from price caps
Treatment of new services
Provision of information to consumers & competitors plus the filing of rate changes
Information to be supplied with a price change
How to demonstrate compliance with the cap
Treatment of unused cap
Treatment of discounts & promotions
Use of sub caps for rebalancing
Treatment of international settlement rates (Exogenous factor)
Quality of service
Price cap index
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The Jamaican Price Cap Model
Preparations for the specification of the regime and demonstration of compliance to the price cap regime is very data and information intensive.
Information requirements include:
Productivity estimates – X Factor
Projections of revenues & costs
Product quantity and prices at the rate element level
Asset values – based on current costs
Depreciation rates
Cost of capital
Elasticities
Inflation rates
Demand/ Volume Growth
Market share
Inflation
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The Jamaican Price Cap Model
CWJ explored three approaches to estimate the productivity factor (X factor)
Zero Profit Constraint
Unit Cost
Total Factor Productivity (TFP)
The Zero Profit Constraint (business planning) approach was preferred by the regulator and the approach used.
This approach resembles a business planning exercise where X is set directly to generate adequate revenues over the duration of the cap to allow a reasonable rate of return under assumptions of the expected market environment for that period.
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Demand Elasticities:
Underlying growth
Price elasticities
Access elasticities
Price of services
Cost Volume
Elasticity
Cost of services
Depreciation,
WACC & OPEX
Market share loss
Productivity
Change
Exogenous
Factor
Set X so return on assets is reasonable
CPI
Profit / Return on assets
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The Jamaican Price Cap Model
The regulations were outlined in details 1n the Determination Notice of August 2001.
PARAMETER OUR DECISION COMMENTS
Price cap period
Services &
Structure
4 years Short period equates to rate of return regulations
Fixed line services
• Retail fixed to mobile
(cost based)
• Interconnection (cost based)
• All other fixed line services
(price cap formula)
• Sub cap on line rental
& local call charges
Too long negates benefits of efficiency pass thru to customers
Retail mobile & internet services in competitive basket
Regulations required that interconnection rates be cost based
Sub caps used to control rebalancing in original plan but removed in revised plan .
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The Jamaican Price Cap Model
PARAMETER OUR DECISION COMMENTS
Price cap index
Actual price index:
Basic basket
Sub basket
PCI t
= PCI t − 1
* (
PI t
PI t − 1
− X − Q + Z )
1.02
1.10
The change in the PCI from one year to the next equals the rate of general price inflation during the previous year, modified by three adjustment factors, X, Q and Z
In year 1 the weighted average price of the services in the basic basket, using a quantity weight
Sub basket contained line rental & local call charges
Structure designed to achieve rebalancing
Productivity factor (X)
6% - Original plan This was revised to (-2.4% ) in the revised plan
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The Jamaican Price Cap Model
PARAMETER OUR DECISION COMMENTS
Quality of service factor
Exogenous factor
Carry over
Treatment of discounts
Included as a factor but set to ‘0’
Difficult to quantify
Set at 0.6
Carry over unutilised headroom from one year to the next.
To adjust for reduced profitability from falling international settlement rates
International settlement rates outside cap, historically provided over 100% of profits
& subsidized access & local calls
Allows greater flexibility, for example company is allowed to price below the cap
Not considered as rate reductions for compliance purposes
To guard against discrimination only non discriminatory price reductions considered for compliance purposes
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The Jamaican Price Cap Model
PARAMETER OUR DECISION COMMENTS
Compliance
Notification period
Continuous compliance With each price change the API must remain less than or equal to the PCI for compliance with the Price Cap regulation.
No need for annual reconciliation process as with annual compliance
30 days for rate increases
7 days for rate decreases
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The Jamaican Price Cap Model
Estimating the productivity factor
Establishing the correct starting point for rates in the context of unbalanced tariffs
Information gathering / availability
Basis of asset valuations
Reliability of elasticity assumptions
The specification of the exogenous factor
Market forecasting (e.g. market share forecasting in context of changing market conditions)
Learning curve to develop the required skills
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After the first three years of operation:
Estimate of cumulative inflation rate - 36%
Estimate of cumulative headroom - 47%
Estimate of cumulative change in average price - 27%
After six years of operation:
Estimate of cumulative inflation - 80% (approx)
Estimate of cumulative headroom - 85%
Cumulative change in average price is less than the allowable headroom.
The fact that the X factor has remained negative is an indication that line rental and possibly local calls are below cost.
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The evolution of the market (e.g. growth in mobile & decline in fixed line) has reduced the effectiveness of the regime.
The fact that the OUR removed the rebalancing constraint in the revised cap is instructive.
Fixed to mobile substitution & other market developments have had a greater constraining impact on fixed retail rates.
Factors that drive mobile substitution include
Prepaid plans
Need for mobility
Personal communication
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Voice over internet protocol (VOIP) offered by legal and illegal service providers is driving cost reductions & change in technology.
The FCC Benchmark Order which precipitated reductions in settlement rates has impacted profitability.
Market realities have reduced the effectiveness of the regime in terms of driving efficiencies.
The regime has allowed the regulated firm more pricing flexibility than the previous regime.
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The regime was set to run from 2001 to 2005.
AT the end of the period CWJ petitioned for the lifting of the cap as the company is operating below the approved level.
The OUR has opted to freeze the level of the cap:
The law provides for price caps to be in place
The cap provides a process to remove competitive services
The OUR continues to deal with allegations of dominance & anticompetitive behaviour
The OUR is using competition rules to deal with dominance iContemplating the implementation of a new regime
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The need to evaluate the effectiveness of a price cap regime in the context of unbalanced tariffs
Suitability of the economy wide inflation index to reflect telecommunications input costs and basis for the estimate of the productivity index for the sector
Need to have an extensive database of required information for a reasonable period before the establishment of the regime in order to establish reliable treads
Need for the regulator & the regulated company to have skilled personnel to implement and administer the regime
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Consider more fully the role of competition law in stimulating effective competition in these markets
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Opal Lawton
Independent Consultant,
Telecommunications Policy, Costing & Pricing
Tel - 1.868.741.9833
Email - olawtonconsults@tstt.net.tt
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