Wholesale NGN charging
alternatives
An examination of NGN price setting and cost analysis
ITU Seminar on tariff policies, tariff models and
methodologies for the determination of costs of services
provided with NGN
Geneva, September 2008
Roger Steele
Deloitte UK
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NGN charging options
©2008 Deloitte & Touche LLP. Private and confidential
About the author
• Roger Steele:
• Director in Economic Consulting
• Formerly Head of Ovum Consulting
• Engineering background
• Over 25 years in telecoms
• Has worked with operators and regulators across the world covering:
– Interconnection cost models for regulators, fixed and mobile operators
– Bottom up and top down models
– FAC and LRIC: tools have been used to set interconnect prices
– Commercial cost and profit systems for retail pricing, management decisions and price bundles
– Business strategy
– Legal disputes
– NGN costing
– Retail pricing
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©2008 Deloitte & Touche LLP. Private and confidential
Agenda
• NGN primer
• Key issues
• Charging options
• Look at the “required answers” to NGN prices – examine cost-calculations for prices
• An alternative: value based pricing
• EU recommendations
• Implications and conclusions
The ideas, views and content of this presentation need not reflect any
view held by Deloitte & Touche LLP or its affiliates or clients.
The work presents ideas from the author. The author does not maintain
the ideas are applicable in any or all situations
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©2008 Deloitte & Touche LLP. Private and confidential
NGN Primer
Next generation networks have several well known attributes
Devices
Access network
Core network
ASPs
Radio Access
Network
(RAN)
Mobile
Hybrid access network
(Fibre & radio/WiFi)
Content /ASPs
Fixed
Fixed Access
(Fibre and/or
copper)
• Services and
content may
be delivered
over a variety
of devices
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• Higher speed
• Boundary of core
and access is
unclear
• Routers and
• May be
delivered over concentration
equipment may
alternative
move to street or to
technologies
premises
• Mobile and fixed
networks might
converge
• Core network carries
many services
• Application
Service Providers
• Service provision
is more separate
from the network
than today
©2008 Deloitte & Touche LLP. Private and confidential
NGN Primer
NGN costs should be lower and less dependent on traffic volumes
Traditional (PSTN)
Cost
NGN
Variable costs increase at
a lower rate with the
increase in demand
compared to traditional
networks and form a lower
proportion of total costs
Fixed costs form a large
proportion of total cost
Volume (Demand)
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©2008 Deloitte & Touche LLP. Private and confidential
Key Issues
NGN features create fundamental problems if we wish to cost an
individual service for “cost-based wholesale price” remedies
Issues
Network
• Already shared access costs cannot be sensibly/easily split to services (BSA and PSTN
rental). How to deal with fixed/common costs is central problem
• “Customer dependent costs” are mixed with traffic dependent costs and co- exist in the
access network or even at customer premises
Access
• Core traffic may be route via the “access” network
• Copper local loop is no longer a clear demarcation:
–
Even in traditional networks, the definitions have been a problem with some “arbitrary” allocations
of nodes from access to core
• Traditional definitions (often in directives or law) cannot be easily applied
• NGN access seems to be the enduring bottleneck
• Services share the same network – in the past each had their own dedicated network (and
costs). A large amount of costs are fixed/common to many services
Core
• In the past shared systems’ cost could be split based on technical/economic factors that
were generally agreed on and based on good cost driver logic
• NGN services are delivered by application severs - more separate from the networks
• Service providers should be able to configure the network (say QoS – speed, priority) to
suit the service
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NGN charging options
©2008 Deloitte & Touche LLP. Private and confidential
Key Issues
Costing methods for traditional networks are well established, but;
• NGN services share the same network components. The cost driver to each
service is not as clear as PSTN
– Legacy PTSN has a well established routing table technique to allocate costs to each
voice service
• A routing table technique can be defined for NGN IP based services
– The allocation of costs to diverse services such as IP TV, broadband, voice call minutes,
content downloads, video calls is not as simple
• The problem is not how to make an NGN cost model
– We can cost the entire network (probably accurate)
– We can define a service routing table to cost services for the total of network
components
• The real issue is how to get a service-costing allocation scheme that is:
– Economically rational
– Conforms with technical and commercial reality
– Does not cause the telecoms industry to go into melt-down
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©2008 Deloitte & Touche LLP. Private and confidential
Charging options
Main wholesale pricing alternatives
Bill and keep
• Customer pays services provider
• Service provider pays nothing to other network or service providers
• Few rules but termination network might not block traffic (no price control)
Peering
• Service providers do not pay each other, if they are peers
• Lower tier service providers must pay higher level tiers
• Rules apply
Cost based (LRIC
etc)
• Source network pays destination network for the cost it incurs
• Basis for most regulated wholesale pricing
• Simulates theoretical competitive market outcome
Value based
pricing
• Prices are not related to directly to network costs
• Willingness to pay and the customer needs define the prices
Marginal cost or
very low price
• Only minimal costs of the termination network are recovered
• Tends towards bill and keep
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©2008 Deloitte & Touche LLP. All rights reserved.
Bill and keep: main pros and cons
Bill and
keep
•
•
•
•
•
Charging options
Simple
No wholesale pricing requirements
Little or no regulation required
No/little harm to any service provider if termination traffic is balanced
May work well if terminating network also provides similar retail services
• Opens up re-selling options
• Major traffic volumes may be terminated and this could cause network
problems (technical as well as financial)
• Terminating network has limited controls – mainly blocking of traffic
• Network neutrality debate (no regulatory controls if competition exists in
service provision)
• Traffic flows need not be balanced – major asymmetry can be a
problem
• Not the same as peering
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©2008 Deloitte & Touche LLP. Private and confidential
Peering: main pros and cons
Peering
•
•
•
•
•
Charging options
Relatively simple
Commercial arrangements
No wholesale pricing between peers, but prices exist for lower peers
Little or no regulation required – Internet is based on this
Rules exist – traffic flows have controls and balances
• Might be hard for smaller players to get a good deal unless they group
together
• Could limit specialised players – advantages lie with larger players
• Rules and obligations exist and can be an area for disputes
• Retail revenues may be slow/hard to get through to underlying network
providers (who get more and more traffic but perhaps little more
revenue)
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©2008 Deloitte & Touche LLP. Private and confidential
LRIC and cost based pricing: main pros and cons
Charging options
• Well established over many years
• Standard economic theory supports prices based on this approach
LRIC and
cost-based
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• The costs of NGN services are very hard to define in a way that can be
agreed on (many alternative cost analysis methods exist)
• Limited cost information exist
• Cost drivers are uncertain – the network is shared by many services
• Common/fixed costs dominate
• Easy to come out with “almost any result”
©2008 Deloitte & Touche LLP. Private and confidential
Charging options
Value based pricing: main pros and cons
Value
based
prices
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•
•
•
•
•
Deals with customers’ willingness to pay
Extends Ramsey pricing theory
Could reflect competitive market outcome
Overcomes lack of cost data
Precedent: Bit Stream Access (BSA)
•
•
•
•
•
Hard to define value
Links wholesale prices to retail prices
Retail prices become more opaque with price bundles
Disputes might easily arise
May be difficult for a regulator to intervene
©2008 Deloitte & Touche LLP. Private and confidential
Marginal and very low prices: main pros and cons
Charging options
• Some costs at least are recovered
• Minimal price provides some limitation to possible abuse by large
volumes from terminating network
• Marginal pricing is economically sensible, if other costs (especially
fixed/common costs) are recovered by other services
• Some parts of marginal cost are easy to define
• When low price is set, perhaps accuracy of calculation is less relevant –
it becomes more a token
Marginal /
low cost
prices
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•
•
•
•
Hard to calculate (but probably easier than LRIC +)
Moves towards bill and keep
Opens up re-sale and re-filing
Low controls on traffic volumes from other service providers
©2008 Deloitte & Touche LLP. Private and confidential
An alternative: look at the answers
An alternative approach that starts at the “Required results”
This reveals problems with any cost calculation
•
Consider NGN is based on provision basic four services:
1.
2.
3.
4.
•
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Voice calls
Broadband (Internet surfing)
Premium content down-loads
TV (broadcast type)
Common cost recovery:
–
Consider the level of retail prices – a proxy for the value placed by customers
–
Assume wholesale costs are a fraction of retail prices and both need ultimately to be
covered by retail revenues
–
Look at how services’ cost drivers can be related to the retail (and implied wholesale)
prices
–
This approach “works backwards,” to traditional thinking but serves to illustrate the
dangers of applying cost-based thinking without considering the answers and
implications
NGN charging options
©2008 Deloitte & Touche LLP. Private and confidential
“Cost drivers” are not related to value
Capacity and value (retail price) of services do not match
Type of service
Capacity
(Mbyte/month)
Estimated current value to a
UK customer (euros/month)
Retail costs as
fraction of price
Traditional voice
40-80
>30. Falling
Medium
Internet Browsing
2,000-50,000 for a
low to high user and
rising
10-40. Steady or falling
Low
Streamed premium TV
content, e.g. football
clips
Up to 20,000
<10. Possibly rising.
Especially from mobile
High
Full TV service
20,000-200,000
20-50. Steady or falling
High
• Note the major differences in volumes
• Contrast: values are of similar order of magnitudes
• Data are based on typical fees and usage rates. Even if not the same in different
markets, the differences are not by the orders of magnitude needed to change the
primary message
• Capacity downloads are clearly not a good basis for wholesale charging – the money
maker (traditional voice - PSTN) then is almost free
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©2008 Deloitte & Touche LLP. Private and confidential
Volume trends are further disconnected from value
Volume trends make a simple capacity pricing model even worse
Volume
?
Data
TV
Traditional
voice (PSTN)
Time
Already data services dominate voice traffic volumes, yet do not contribute
proportionately more revenue and certainly do not contribute as much margin
Almost all cost models will reduce the costs of voice as volumes of data rise
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©2008 Deloitte & Touche LLP. Private and confidential
Cost-based pricing
Cost calculations used to set prices give major problems
•
Making a calculation is not a problem. But:
–
The cost drivers are not easy to agree on
–
“Arbitrary” allocations for large common/fixed costs
–
It is very easy to vary the calculation to get widely varying results – any of which can be
technically and economically justified
–
Results are altered significantly by traffic of other services
–
Current cost modelling principles could give unhelpful outcomes when applied to NGN
•
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Could value based thinking provide an alternative?
NGN charging options
©2008 Deloitte & Touche LLP. Private and confidential
Cost versus value based pricing
It is not unreasonable to think about value based pricing
• A look at NGN costing from (the debatable) “desired outcomes” shows that cost
models based on traditional “cost drivers” may be problematic: costs for some
services too low and others too high for current market revenue assumptions
• If implemented, NGN cost models could have major implications to the telecom
market, as they can easy give the “wrong” answers
• The choice of “cost-drivers” is wide and the assumptions required open up a
wide range of outcomes
• “Cost drivers” that might give the “right answer” today, may not do so tomorrow
due to market and demand changes
• Can regulatory experts gain consensus (as for PSTN) regarding traditional
approach versus value approach and is this the right consensus answer?
• Value based pricing is not proposed as “the solution” but it could be valid, plus it
should be understood in order to appreciate the dangers of capacity-based price
calculations
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©2008 Deloitte & Touche LLP. Private and confidential
Value based pricing
Value based pricing – a challenge for the “regulatory industry,” but
it might save the telecoms industry
• This is what every shopkeeper understands and other communications sector
businesses already do it
• It is effectively a type of cost orientation with Ramsey pricing (familiar to
economists and shopkeepers)
– Higher mark-ups for customers with higher willingness to pay
– Implement price changes according to price elasticity and demand (e.g. provide higher
decreases for customers with more elastic demand)
– Ramsey pricing is acknowledged to be sensible for mark-ups, but is not used much in
regulation as it is considered difficult to implement
• Relating wholesale prices to value is a different logic but may be similar
• Questions:
–
–
–
–
Is there a problem having retail influencing wholesale prices?
Should we remain focussed on the “sacred cow” of cost-orientation?
Does “cost-orientation” not include other views of dealing with the fixed cost?
Can we agree on a value related basis, or use cost calculations and steer these to be
closer to value thinking?
• Note that functional separation is a possible way to value based pricing…
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©2008 Deloitte & Touche LLP. Private and confidential
Value based pricing
Functional separation can make use of value based pricing and
avoid cost modelling
• Functional separation is being recognised
as a legitimate remedy
• NGN NetCo can deliver wholesale
services to the retail Servco, and to other
operators on equivalent basis
Customers
• NetCo is regulated to make an overall
return of (say) 15% WACC
Retail services
• Each service from NetCo is priced based
on risk and customer value – using
commercial business logic
ServCo
• Other operators cannot be disadvantaged
as high prices adversely affect NetCo’s
own ServCo – controls wholesale prices
• Allows NRAs to avoid making NGN
service-cost models, but still need
account separation (total cost & ROCE
evaluation) and strict monitors on
equivalent outputs
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Alternative
operator
Equivalent
outputs
NetCo
©2008 Deloitte & Touche LLP. Private and confidential
EC recommendations
Summary of EC recommendations for pricing NGN termination
Main recommendations
• Use NGN technology as the Modern
Equivalent Asset (basis of cost
calculation)
• No costs of migration
• No costs of dual network provision
during transition
• No recovery of asset write-down in
values of existing assets (costs are
assumed to be recovered)
• Build the network to provide all
services then add on the terminating
traffic – only the cost driven by the
additional traffic volume is to be
considered as relevant
• Seems to be a move towards bill and
keep/token payment
• Bottom up modelling techniques
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Comments
• Does not consider originating traffic
• Major change from existing rules and
economic principles (implies that
regulators have to accept doing a u-turn
on what they specified “last year”)
• Current Cost Accounting and Financial
Capital Maintenance rules no longer
apply
• Gives maximum benefit of economies of
scale to other operators (who have lower
cost to buy than the NGN-provider for the
same service)
• Still not easy to define the cost driver, but
marginal costs are easier than calculating
full costs (LRIC +)
• Very likely to be adopted, at least to some
degree
©2008 Deloitte & Touche LLP. Private and confidential
EC recommendations
Structural separation may have a problem with marginal or low
prices
• Structural separation may happen
voluntarily
Customers
• NGN NetCo can deliver wholesale
services to the other retail and network
operators on equivalent basis
• If only marginal costs are recovered,
NetCo must charge more for other
services
Retail services
• If NetCo has no retail business, then
wholesale access service must be used
(no retail customers)
Alternative
operators
– Marginal cost for prices works best with
balanced traffic flows and both networks
are close to peer
Equivalent
outputs
• Opens up re-filing and re-sale dangers
• May make NGN network business an
unattractive investment
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NetCo
©2008 Deloitte & Touche LLP. Private and confidential
Conclusions
• NGN pricing is fraught with problems: cost models can give many answers
• There are major dangers if prices are set wrongly and new thinking towards
marginal/low pricing increases possible dangers, but there is a rationale for low
pricing
• Need to concentrate on NGN Access
• Bill & Keep and Peering are not the same
• Peering for the Internet may not apply to NGN bottleneck regulation
• Value based pricing needs to be thought about – it may steer application of other
pricing solutions
• Retail pricing should have no controls (other than competition law) but wholesale
pricing must not undermine retail prices and revenue streams
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©2008 Deloitte & Touche LLP. Private and confidential
Contacts
Roger Steele
rsteele@deloitte.co.uk
+44 777 1787607
+44 20 7007 5342
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©2008 Deloitte & Touche LLP. Private and confidential
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