Session 1
Regional Seminar on the economic and financial
aspects of telecommunications Study Group 3
Regional Group for Latin America and Caribbean
(SG3RG-LAC)
Costs and tariff methodologies
Antonio Garcia Zaballos
July 2010
Santo Domingo, Dominican Republic
Contents
1.
Why regulate? Why cost accounting?
2.
Steps in the design of a regulatory
policy for an accounting model
3.
Identification of the main levers of an
accounting model
4.
Phases of an accounting model
5.
When should be used a bottom-up?
6.
Cost accounting as a tool for
Regulators
7.
2
Recommendations
1. Why regulate? Why
cost accounting?
3
Why regulate? Why cost accounting?
Encourage competition
throughout the
different telecom markets
Guarantee the quality
Standards in the provision
of the different services
Avoid anticompetitive
behaviours as
cross subsidies
REGULADOR
Guarantee the access
to the basic telephony
Services
(Universal Service
Obligation)
4
Avoid excessive prices
which eventually affects
the competition level at
the retail and wholesale
level
Encourage the investment
and innovation and increase
the infrastructure based
competition rather than
the access based
Why regulate? Why cost accounting?
I. MARKET DEFINITION
II. MARKET STRUCTURE
Are there elements to consider
the existence of dominance? Yes
No
Typology of ex ante
remedies:
End
III. DOMINANT POSITION
Is there a dominant position?
Yes
No
Analysis of individual
dominant position
Is there an individual
dominant
position? Yes
• Price control: Cost
based vs reasonable
prices
Analysis of joint
dominant position
Is there a joint
dominant
position?Yes
No
No
• Accounting separation
• Carrier selection and
preselection
IV. ANALYSIS OF THE RESULTS
Is there effective competition? Yes
No
It is enough with the
Competence Law
Yes
No
Necessity of
Regulation
5
The existence of
competence is due to the
current regulation?
No
End
Yes
• Guarantee the access to
the network
• Non discrimination and
transparency
• Functional separation
Why regulate? Why cost accounting?
NRA
Control on …
… the accounting model
Accounting
principles
Model
approval
Approve
Modification
to the model
… the key levers
WACC
External
auditory
Life spam
Auditory done
Auditory done
by the
by the NRA
Operator
Ad hoc
studies
Access
Deficit
elimination
6
… the results
Cross
subsidies
Price-Cap
Cost based
Intercon.
Conexe
markets
Annual
Results
USO Cost
estimation
Predatory
prices
Retail price
control
Why regulate? Why cost accounting?
• The cost model will be a key tool to guarantee the cost based
principle so that those operators who pay interconnection are only
paying for the network components that are used in the provision of
the wholesale service
• The cost model will show the costs and margins associated to the
different services and guarantees that non-discrimination occurs in
the provision of the services (transfer prices).
• The cost model provides information which contributes to increase
transparency and to guarantee that no anticompetitive behaviors
occurs.
7
2. Steps in the design of
a regulatory policy
for an accounting
model
8
ANR
Steps in the design of a regulatory policy for an
accounting model
Analysis
of the
model
presented
by the
SMP
Designatio
n of SMP
Operator
Agree?
Yes
Accountin
g model
approved
External
Auditory
Fill up of
the model
and
results
Presentation
of the audited
results
Final
decision on
the approval
of the results
No
Operator
Notification
Design of the
accounting
model
according to
the principles
defined
(*)
Presentation
of the
accounting
model to the
NRA
The NRA shouls execute control mechanisms throughout the whole production process
(*) It could take from 6 to 9 months
9
Utilization of
the results
in the
regulatory
policy
Steps in the design of a regulatory policy for an
accounting model
Causality
The cost and revenue allocations should be made through the parameters
that generate them (generating cost drivers)
Objetivity
The cost drivers must be objective and quantifiables
Transparency
The final value assigned to each service must be decomposed, by nature,
in various costs
Auditabiliity
The cost system must be properly integrated with other company systems to
facilitate auditability
Desagregability
Regardless of the number and order of all costs charges will go through an
intermediate state called "activity centers"
Neutrality
Internal transfers will be produced at cost value and not at market value
Compromise
The accounting standards which requires estimations and forecast of
particular variables should be on future management plans
Enough information
The cost accounting system must provide all information necessary for the
regulator
10
In addition to the aforementioned principles, should be considered the principles of
compensation and reconciliation
Steps in the design of a regulatory policy for an
accounting model
Principles, criteria
and conditions
Implementation of accounting principles
Accounting system
Accounting manual
(MICC)
Costs / Revenues
Review of the
inventory
Inventory
Implementation of the MICC
Mistakes?
Financial
accounting
Reconciliation
Externally audited
Allocatino process
Mistakes?
Estimatino of the
current costs
Margins allocated to
the different
services
Implementacion del MICC
Inventory software
and applications
Equivalence rules
Absolute
valuation
Implementation of accounting principles
Analitic Review
Re-concilliation
Analysis of the inventoryde inventario
Review of the current costs
Review of the amortization criteria
11
Principles, criteria
and conditions
Depreciation
criteria
3. Identification of the
main levers
12
Identification of the main levers
The WACC is defined as the average return required by the different
Definición
Investors (shareholders/debt holders) who finance the investment
decisions of the company
Formula
E  
D 

WACC  Ke 

Kd

(
1

t
)

D  E  
D  E 

 Ke is the return required by the shareholders
 Kd is the return required by the debt holders
Componentes
 E is the market value for equity
 D is the market value for debt
 D+E is the market value of the company
 t is the tax rate
13
Identification of the main levers
E  
D 

WACC   Ke 
  Kd  (1  t ) 

D E 
D  E 

*
Risk free asset
(Rf)
+
Market risk
premium (RmRf)
X
Systematic
Risk
()
Risk free
asset (Rf)
X
Risk primum
on debt
X
(1 – t)
X
% Equity on total market
value
% Debt on total market
value
=
=
WEIGHTED AVERAGE
COST OF CAPITAL FOR
EQUITY
14
+
+
WEIGHTED AVERAGE
COST OF CAPITAL FOR
DEBT
=
WACC
Identification of the main levers
CAPEX  BV  Depreciation WACC

Annuity 
Net Value
BV WACC
n
1  1  WACC 
NV
Annuity
n
n
VN
Annuity
n*
15
n
4. Phases of an
accounting model
16
Phases of an accounting model
Phase 1
Phase 2
Phase 3
Phase 4
Financial
Accounting
Determination of
incomes and
cost from the
financial
accounts
Cost allocation
by activity
centres
Cost and income
allocation to
services
Cost and income
allocation to
margins
Incomes by
nature
Financial
Incomes
CAPEX
Costs by
nature
Network
Component
Directly
allocated
OPEX
17
Incomes from
different
services
Non
directly
allocated
Costs
attributable to
the different
services
Margin
accounts
Phases of an accounting model
OPEX
Operating
expenses
Provisions
Personnel
Rental
Suppliers
Advertisement
Handsets
Itx
Taxes
Fees
Renew handset
Apoyo Promoc.
Subcont. Serv.
Depreciat.
Financ. Exp.
Financial Exp.
Extraordinary
Extraordinary
Taxes
Cost of Capital
18
Activity
Costs
Network
Maintenance, Circuits, Power, VAS,
Network management, etc
Commerc.
Customer care, Risks and fraud, Billing,
Logístics, New service creation
Supportive
HR, General Services
Structure
Tax and legal, Management,
Strataegic planning
Cost of
Sales directly
allocated
Handsets provision, insolvencies, fees,
interconnection, roaming, taxes, Promotion,
Handsets renewal
Other provssions
Fixed current
Otras Amort.
Taxes
Activity costs based
CAPEX
They are allocated taking into account the roating
Factor Matrix
Cost of
Sales NO
directly
allocated
Finance, extraordinary costs, etc
Phases of an accounting model
Activity Costs Base
Activity Centres
Services
Activity costs
Prepay and
postpaid services
Network
Commerc.
Supporti
Network
Component
• Connection
Structure
• On net
• Off Net
Costs of sales
Directly allocate
• International
CAADS
• Roaming
• FTR/MTR
Costs of sales
No directly
allocated
19
• etc
CANADS
5. When should be
used a bottom up?
20
When should be used a bottom up?
Differences between the acquisition value and the current costs
Extraordinary expenses
Over sizing in the equipment and other inneficciencies
Historic
Costes
Accounting
Long run fixed
costs
Current Cost
Accounting
Mark- up?
Current cost
accounting
adjusted with
efficiency
Incremenatl
costs
Fixed costs
Incremenatl
Costs
Top-down from the accounting of the SMP Operator
bottom-up?
21
Stand alone
costs of an
efficient
telecom
operator
When should be used a bottom up?
% Hogares
100%
Zonas presencia redes fijas
90%alternativas
Tecnologías
inalámbricas
80%
Sin banda ancha
70%
Brecha
Digital
60%
>5.000 hog./ mun.
50%
>2.500 hog./ mun.
40%
0%
10%
20%
30%
>150 hog./ mun.
40%
50%
60%
70%
80%
Zona de muy baja penetración en BA
Cost-based prices
22
vs
90%
100%
% Municipios
Reasonable prices
6. Cost accounting as a
tool for regulators
23
Costs accounting as a tool for regulators
• Wholesale price setting (interconnection and access)
• Symmetric vs asymmetric prices (FTR/MTR –Waterbed
effect)
• Universal Service Cost estimation (Access deficit)
• Estimation of the productivity factor X (price cap/glide
path)
• Analysis of bundling offers
• Cost/benefit analysis of the regulatory policy
• Commercial strategy of the operators
• Improvement of the production process and increase in
the competitiveness
24
7. Recommendations
25
Recommendations
1.
2.
3.
4.
5.
6.
26
Accounting models (top-down) are a useful tool not only for telecom operators but
also for regulators, because that allows them to monitor the regulatory policies and
how they impact on the results of regulated operators .
Accounting models (top down) are very sensitive to the weighted average cost of
capital (WACC), the depreciation method and lifespam, so that the regulator, in
addition to defining the principles, criteria and conditions should have some control over
these variables,.
We need a verification (audit) of the results presented periodically to ensure that they
comply with legislation and guidelines issued from the regulator.
Accounting models (top down) usually are supplemented with theoretical models
(bottom up) as these take into account the concept of productive efficiency thus has a
direct impact on allocative efficiency ...
No model is better than the other, everything depends on competitive conditions
(orientation of prices and costs vs reasonable prices) and information available to
develop each of them.
The cost models are useful not only for setting access charges and interconnection
but also for estimating the deficit, setting X, replication of commercial offers, etc.
Antonio García Zaballos
Fernando Huerta
Antonio García Zaballos is PhD in Economics at Universidad Carlos III de Madrid.
Currently he is senior advisor to the Global ICT Department of the World Bank and
expert to the International Telecommunications Union (ITU).
agz@profesor.ie.edu
Móvil: 617 66 87 60
Areas of expertise:
•Telecommunications
•Regulation
• Strategy
Academin Background:
• PhD in Economics,
Universidad Carlos III de
Madrid
•PDD IESE business School
•Higher Education en
Administración de Empresas
en Heriot-Watt University
(Edinburgh)
•Bachelor degree in
Business Organization at
Universidad de Salamanca
27
Dr. García Zaballos was Head of the Cabinet for Economic Studies and Regulation
(GEER) at Telefónica España, and was also Deputy Director at CMT, the Spanish
telecoms regulator, where among others he was responsible for market analysis and
economic issues applied to the estimation of the cost of Universal Service
Obligations (USO), Fixed-Mobile convergence, regulatory policy applied to bundling,
regulatory policy applied to retail and wholesale services and auditory of cost
accounting models. He has a broad experience in economic consulting applied to the
telecom sector in countries as: Saudi Arabia, Dominican Republic, Guatemala, Costa
Rica, Argentina, Latvia, Bulgaria, Poland and Albania.
Additionally, Dr. García Zaballos is a professor at Instituto de Empresa Business
School and University Carlos III in Madrid, where he teaches telecoms economics
and applied finance at the Global MBA and the Master in Industrial Economics.