Excerpts of TAL Agreement, Cancun

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2 Excerpts of TAL Agreement, Cancun Subject to unspecified amendments, TAL interconnect and access cost models were stable enough to software application phase. Revised methodologies will constitute Appendices 3& 4 of Recommendation D 400 R. Deadline date for submission of contributions to revision of models prior to progress to software phase was August 31, February 2004 initial date for completion of software. 2

3 Revision, TAL Interconnect Model Objectives To simplify basic interconnect services for software application in terms of: a) Unit costs of single transit interconnect traffic. b) Unit costs of Double transit interconnect traffic. 3

4 General Objective Regulator Service Provider Investment Opportunity Service Provider Fair Proxy Market price reflective of reasonably efficient cost Incumbent Service Provider Consumer 4

5 Traffic Definition According to Recommendation D 600 R : Incoming national, single transit: Traffic terminated on the network of an Operator in a country which originated on the network of another Operator in the same country and where the interconnection point between the two networks is located within the local tariff zone of the Operator which is terminating the traffic. Example: traffic between telephone G and A or telephone K and B at Diagram 1. 5

6 Zone 1 Telephone "B" Telephone "D" Telephone "A" Telephone "C" Zone 2 6

7 Distant Intertional Satellite Distant International IGW Telephone "E" IGW Telephone "F" Neighbouring country IGW h Telephone "C" Point of Interconnection Telephone "B" Point of Interconnection Neighbouring country Telephone "A" Telephone "D" National network operator XCloud National Network Operator Y Telephone "G" Telephone "H" Telephone "K" 7

8 Double Transit Traffic Incoming national, double transit: Traffic terminated on the network of an Operator in a country which originated on the network of another Operator in the same country and where the interconnection point between the two networks is located outside the local tariff zone of the Operator which is terminating the traffic. Example: traffic between telephone G and B or telephone K and A at Diagram 1. 8

9 Network & Non-network network Resources Used Switching Components (including signaling network). Transmission Components. Other resources used to support network and general delivery of the services. Unit Cost = ƒ(cost caused due to usage of network and other resources to deliver traffic in period n/volume of traffic delivered) in period n. 9

10 Stages of cost-orientated Unit Costs Cost of network components Operation and maintenance costs Service traffic Amortization rules Equipment price trends Cost of capital Cost of functional support Identifiable direct and indirect costs Other common costs Routing table Cost distribution Unit endogenous cost of services COSITU - The ITU tariff model 23 10

11 Two Basic Costing Principles Causality: The demonstration of a clear cause-and and-effect relationship between service delivery, on the one hand, and the network elements and other resources used to provide it, on the other hand, taking account of relevant cost determinants (cost inducers/drivers). Efficiency: The provision of a forecast of cost reductions that result from a more efficient combination of resources. 11

12 Diagram 2 LRAEC Cost 11/11/2003 Marginal Cost Subtitle C1 11/11/2003 Efficient Cost Quantity Q1 12

13 Parent Formula General LREC formula: C = A(ß)/M o Where: C= per minute cost of traffic A= total cost (direct, indirect and common) ß = Efficiency factor = x/y x = required capacity y = installed capacity M o = traffic throughput. 13

14 Cost Adjustment? Historical costs: Based on the cost price of equipment and services, Current costs: Take account of the changing environment: falling prices of telecommunication equipment, currency depreciation.. The TAL Model utilizes current costs as confirmed on the relevant market. 14

15 Fully Distributed or Incremental Costing Accounting Methods Cost Methods Historical Costing Current Costing Hybrid Costing (Adjustment toward Current costs) Fully Distributed Costing Incremental Costing Actual Cost incurred (includes inefficiencies) Current Costs of Providing Service (Reduction of over pricing) Actual Costs adjusted for market changes and efficiency Total Cost is allocated to Services Long Run Incremental Costs are allocated to Incremental services 15

16 Clarity re consistency with Fundamental Costing Principles Parent TAL formula: C = A(ß)/M o Interconnect Model Formulae: LEC = (A/M o ) *( ) IEC = (?( A/? M o ) *( ) The efficiency factor, is estimated in terms of adjustment in OPEX and or adjustment for avoidable excess network capacity. 16

17 LEC & IEC EEC = A å /M 1 A å = total cost adjusted for unavoidable dis- economies of scale (inefficiency). M 1 = total traffic (current + expected) IEC= /M -1 = cost of additional components to deliver interconnect traffic, subject to adjustment for inefficiency M - 1 = interconnect traffic 17

18 Current Cost Adjustment Effect of Exchange rate adjustment on cost may be estimated by: C AD = D [(1+ A t)dp/2 /(1-e) DP/2 1] Where: C AD AD = Adjustment to current cost; = Depreciation allowance; D A t = Average annual variation in equipment price; 18

19 DP = Depreciation period; e = Average per annum rate in currency movement. 19

20 Cost of Capital Combined effect of debt and equity (i) Creditors demand interest (ii) Owners demand dividends Firms normally raise capital through: Long term & short term debt Sale of Preferred stock Sale of common stock Retained earnings These cost are basic determinants of the cost of capital. 20

21 Cost of Debt Cost of debt is determined by: Interest rate on debt; subject to: Adjustment for taxes where interest payment on debt are deductible for income tax purposes. After tax cost of debt can be expressed as: (interest rate) * (1- tax rate) E.g. If interest rate is 9% and tax rare of 25% The after tax cost of debt = (0.09)*(1-0.25) =

22 Marginal Cost of Debt Cost of debt should be calculated at marginal cost: Current interest rates on the market Taking into account interest rates on similar enterprise on the international market 22

23 Cost of Equity Required rate of return (s ) on the common stock of the firm Firms use Expected rate of return. The Expected Rate of return on a stock is a risky variable. σ s = risk-free rate of return (R F ) + Risk Premium (R P ). R F is normally reflective of interest on government security. R P is the difference between the required rate & risk free rate of return 23

24 R F = ƒ(rate on government securities) R P = ƒ(different methodology of estimation) Interest on firms long term bonds (i( C ) + a percentage-points points addition based on historical returns per year on the financial market (i( A ). Let R F,i C & i A be 6%, 9% and 5% respectively: i C + i A = ( ) = 0.14 R P = = 0.08 s =

25 Jeorgenson Method The cost of capital d is calculated using the formula: d = D i* (i-t) + E s D + E D + E Where: D = amount of medium and long term debt; σ E i t = before tax return on capital; = equity; e and = average interest rate. = rate of corporation tax. 25

26 Operating and maintenance costs Cost of inputs Purchases and variations in stock; Transport; Outside services Personnel costs Taxes and levies (corporation Tax not included Other charges Other Financial and similar charges Operating provisions 26

27 Cost of Network Elements Total Network Costs Operating Costs Depreciation Expenses Capital Cost Operating & Maintenance costs (OPEX) Other Operating Costs Text Network Technology Text Text Asset Valuation (Adjusted) Depreciation Text Text Profile (time, method etc) Text Text Interest rate: equity & debt Text Contribution to Text Service prooduction Text Text Production Efficiency Text Cost relationship Cost Drivers Routing: :Component Usage Disaggregated Component Costs Interconnect Service Costs 27

28 Total Product/Service Efficiency Total Service Efficiency (T( se ) could be expressed as: T se = OZ e + N e Where: OZ e = Organization and Operational efficiency. N e = Network efficiency. Oz e ƒ(s i, M i, L er, A i, W s,t i, µ i ) Where: S i = Relative Salaries and wage levels; M i = Managerial competences; L er = Line/employee ratio; A i = Employees work ethic; W s = Skill of Average Worker; T i = Availability state-of of-the- art technology at work place; µ i = Other factors. 28

29 Network Efficiency (N( e ) N e = t c + t c+1 -? = 0 Where: t c is Current traffic; t i is Expected traffic where i = 1 to n;? is Network capacity. 29

30 Evaluating Total Efficiency Factor Let the network efficiency be expressed as Q 1(used capacity +backup capacity ) /Q 2(installed capacity) = ß Total Service Efficiency, (T( se ) is: T se = (ß( + S i + M i + L er + A i + W s + T i + µ i ) = (ß( + OZ e ) 30

31 Issue /Decision a) Except for the element: employee line ratio, the other elements that comprise OZ e are extremely difficult to model. b) The fundamental question: do the elements that comprise OZ e satisfy the SG3 practicability criterion for inclusion in any cost model??????. c) ß is measurable, with some degree of difficulty. 31

32 Practicability 1. Sg3 documents the need for a model to be practicable. 2. Two fundamentals of Practicability are a) Availability of data; and b) Simplicity of methodology for quantitative estimation. 32

33 Evaluating Network Efficiency Assumptions: Efficiency requires network dimensioning to accommodate full-capacity busy hour traffic (including factor for traffic growth and breakdown). If not, the network is inefficient either in terms of excess or under capacity. An important concern, in terms of cost, of the regulator is excess capacity. 33

34 Estimating Network factor, v TBHE j = ß j (1+ g +? ) = Required capacity Where: ß j is current busy hour traffic in erlangs. g is the growth factor for busy hour traffic;? = network backup factor j = 1 to n. So: v =ß j (1+ g +? ) IC(installed capacity) 34

35 Likely Outcome ϖ = 1 OPTIMA ϖ < 1 % Excess capacity ϖ > 1 % Under capacity 35

36 Avoidable/Unavoidable Excess Capacity Key efficiency questions: 1. Is excess network capacity avoidable? 2. Example when not and when: i. If computed required capacity for consistent busy hour traffic demand at a particular switch is Q, but closest manufacturing specification for that switch is of capacity Q 1 where Q 1 > Q, the excess capacity Q 1- Q is unavoidable. 36

37 ii. However, if the operator elects to install a switch with capacity Q 2, where Q 2 > Q 1, there is a gap Q 2 - Q 1 iii. If pqp 2 > pq 1, the efficiency gap is negative and avoidable and requires an efficiency adjustment factor: v = (Q u 1 / Q 2 ) So the LEC unit cost of interconnect traffic is: (Total induced cost of Traffic)*(v ) u Volume of traffic 37

38 Possible Cost Model Architecture for (PSTN) Fixed Network Sources of Data Extract following data from the Plant Accounts Reclassify to Technology Groups Classify plant account records into following technology groups and determine annualized capital cost Unbundle Technology Groups to Technology Elements Group Elements into Cost Pools Apply cost drivers and routing factors Determine network cost of services (1) Opening & Closing Net Book Values Depreciation Charge for the period Date of Commissioning of Assets Determine capital works in progress by asset class Identify network support costs from general ledger Determine weighted average cost of capital (2) Annualized Capital Cost Local Loop Switch Engineering Studies (3) Technology Element / Functionality Poles Underground Conduit Cable etc. Line termination Signalling and Setup Trunk Termination (4) Cost Pool Loop distance sensitive costs Signalling & Setup/ (5) Cost Driver # lines in service Line miles in service Minutes of Use No. of call attempts Routing Factors (6) Services Services Minutes of Use Transmission Electronics Satellite Equipment Microwave Equipment Fibre Optic Equipment Conveyance Direct 38

39 National Network 39

40 Unit Service Cost Interconnect formula per individual service becomes: (Total induced cost of Traffic)*(v u ) R ij Volume of traffic of Service, j R ij is the factor which represents the intensity and frequency of use of the network in the delivery of service, j where j = 1 to n 40

41 COSITU REVISION Old Efficiency factor COSITU = Used capacity/installed capacity. Efficiency Factor TAL = Used capacity + backup capacity / unavoidable installed capacity. This adjustment was effected in COSITU. 41

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