Introduction
• The pressure on all types of operators to implement costbased pricing, especially for interconnect services, is
growing
• I will deal with issues around the determination of tariff
levels, and how to determine tariff structures.
• I will also touch upon how tariffs for commercial services
will typically be determined in a negotiation process
SEMINAR ON ITU PRICING
MODELS
TBILISI, GEORGIA, NOVEMBER 14-15, 2002
Price Determination
By
Cleveland Thomas
Why are interconnection rates so important?
Sellers of Services
Regulators
•
• “Protect” retail
•
customers
• Promote
•
competition
• Give efficiency •
incentives
• Deter uneconomic
entry etc.
Protect retail
market positions
- discourage
cherry-picking
- protect retail
tariffs
• Increase revenues
Buyers of services
Minimize overall
costs
Enable competitive
tariffs
Simplify roll-out of
own retail services
Key issues for pricing wholesale /
interconnect services
• The growing importance of jointly-provided services
• The importance of taking both long and short-term considerations
• The importance of recognizing that the interests of the regulator are,
in the longer term, fundamentally opposed to the interests of the
telecoms industry
• The need to understand the implications of pricing decisions across
retail and wholesale services
• The need to understand that wholesale relations between operators
are bilateral (both sides are buyers and sellers)
Key differences between a
Regulatory & Commercial Approach
Commercial Approach
Regulatory Approach
• Driven by demands
rather than costs
• Cost-based
– FAC vs.. LRIC
– historic vs.forwardlooking
• Mark-up
– zero
– uniform
– Ramsey
– ECP
• Long-term profit maximizing
•
Must fit with overall strategy
and retail tariff structures
• Art based on science
Tariffing must be approached in an
integrated manner.
Wholesale
Retail
Cross
elasticity’s
Cross
elasticity’s
Service N
Service 2
Service 1
Value to
Customer
Expected
competitive
Price action
Service N
Service 2
Service 1
Value to
Customer
Own costs to
produce
Expected
competitive
Price action
Own costs to
produce
Optimization
Regulatory interests
Incr. Cost
Microwave
alt.
Chosen
Price
FAC
100
90
80
70
60
50
40
30
20
10
0
Retail
Tariffs
Value-Based Price of a Wholesale Service
Different cost-bases can provide the starting
point for (cost-based) tariffs
• Short Run Marginal Cost (SRMC)
– Cost of one additional unit of output, given existing capacity
• Long Run Incremental Cost (LRIC)
– Cost of adding a service or increment, including capacity costs
• Stand Alone Cost (SAC)
– Cost of providing one service by itself
• Fully Allocated Cost (FAC)
– Directly attributable cost plus a pro rata share of overheads
These cost types will be addressed in more detail later
Tariffs must also include a mark-up
Type of mark-up Pro’s
Cons
• Zero mark-up
 stimulates entry
 threatens viability of seller
 strong efficiency
 promotes uneconomic entry
incentives
 distorts competition
 prevents excess profits
• Uniform mark-up
 easy to calculate
 balances conflicting
objectives
• Ramsey Pricing
 arbitrary
 inefficient
 promotes efficient final  impact depends on flexibility
svc. Prices
of final service prices
 prevents excessive
 inelasticity may be due to lack
profits
Tariffs must also include a mark-up
Type of mark-up
Pro’s
• Efficient
Component Pricing
- promotes fair
competition
- deters uneconomic entry
- ensures viability of
seller
Cons
provides
weak
efficiency incentives
does not address
monopoly profits
The Choice of mark-up can have a dramatic
effect on tariff levels
Illustrative Interconnect Charges (pence/call minute)
Call
Type
Local
Note:
LRIC Ramsey AC/Unif
with no
orm
Markmark-up
Up
1.1
2.8
2.3
ECPR
2.1
National
1.1
1.6
2.3
4.3
Int’l
1.1
1.4
2.3
8.0
Price for the use of a local Tandem
Tariff structure is an important as tariff level
• A generic tariff is a combination of one or more of the following
elements :
– initial charge (one-off charge - only one time)
– fixed charge (time-based)
– call set-up (unsuccessful vs. only successful calls)
– charge per unit
• Other dimensions also need to be considered
– geographical structure (distance)
– time-of-day structure
– charging unit (per minute, per second)
• The link to the retail tariff structures must also be considered
– same structure ?
– closer links to cost-drivers ?
– higher complexity ?
Examples of importance of tariff structures
An infinite of solutions give the
same result (3 minute call)
• True results depend on
expected calling patterns
• expectations will differ
among operators depending
on
Call set-up
16
14
12
10
8
6
4
2
0
– retail customers served
– retail services offered
0
1
2
3
4
5
6
Charge per minute
• each wholesale customer will
have individual wishes for
the optimal tariff structure
Arriving at tariffs in this market segment will
involve a set of negotiations
Regulator
Operator 2
Operator 1
Overview of typical positions
Start
Target
Walk-away
Position
- Tariffs based on
historic FAC
- Tariffs based on
WACC of 18%
- Tariffs based on
LRIC + equal mark-up
- WACC equal 15%
Reasoning
- Tariffs should cover
all historic costs
- Risk of business is
high
- Tariffs should cover
incremental costs
- Level of cost of
capital is more important
than cost
- Tariffs based on
LRIC + equal markup
- WACC equal 12.5%
- Cost of capital at
minimum level to
ensure viable
business
Impact of different views on revenues
20
18
16
14
12
10
8
6
4
2
0
Scenario A - Expected
short calls duration
Call Set-up
Minute Rate
Net Impact
Scenario B - Expected
longer calls
Key Conclusions
• Pricing is an integral part of your overall commercial strategy
for dealing with wholesale and interconnect
• All parties negotiation interconnect and wholesale tariffs should
address the issues with a broad, long-term view to ensure that
value stays in the industry
• Regulatory-lead, cost-based pricing of these services should
only be a last resort when negotiations fail
• Developing optimal tariff structures is as important as
determining the tariff level
• Determining tariff levels and structures is not a one-off
exercise, but rather part of an ongoing negotiation process