2010/11 upgrades to the NITA fixed LRAIC model

Transcription

1 . Report for the National IT and Telecom Agency 2010/11 upgrades to the NITA fixed LRAIC model Implementation of an economic depreciation calculation 1 February 2011 Ref:

2 Contents 1 Introduction 1 2 Overview of the economic depreciation methodology Merits of economic depreciation Principles of economic depreciation 3 3 Description of the economic depreciation implementation Expenditures C+F Model ED C+F Model Plotting results 14 Copyright Analysys Mason Limited has produced the information contained herein for the National IT and Telecom Agency. The ownership, use and disclosure of this information are subject to the Commercial Terms contained in the contract between Analysys Mason Limited and NITA. Analysys Mason Limited St Giles Court 24 Castle Street Cambridge CB3 0AJ UK Tel: +44 (0) Fax: +44 (0) enquiries@analysysmason.com Registered in England No

3 2010/11 upgrades to the NITA fixed LRAIC model 1 1 Introduction The National IT and Telecom Agency ( NITA ) has commissioned Analysys Mason Limited ( Analysys Mason ) to undertake a series of upgrades to its long-run average incremental cost (LRAIC) model for fixed networks. The objective of this project is to upgrade the LRAIC model to inform future NITA decisions on the pricing of regulated services, where required, in Markets 3 5. Specifically these upgrades relate to understanding the costs of: wholesale fixed voice termination consistent with the EC Recommendation (Market 3) wholesale access on TDC s fibre network (Markets 4 and 5) bitstream access (BSA) on TDC s cable-tv network (Market 5). As part of these upgrades, NITA has determined that it would be useful to investigate the costs of the modelled networks using multi-year economic depreciation, in addition to the single-year tilted annuity depreciation in the existing LRAIC model. This document describes how this implementation has been undertaken and is set out as follows: Section 2 provides an overview of the economic depreciation (ED) methodology Section 3 describes the implementation of the ED calculation within the LRAIC model.

4 2010/11 upgrades to the NITA fixed LRAIC model 2 2 Overview of the economic depreciation methodology This section provides an overview of the concepts underpinning ED. Section 2.1 describes the merits of ED over other methodologies. Section 2.2 describes the principles behind ED. 2.1 Merits of economic depreciation There are four main potential depreciation methods: Historical cost accounting (HCA) depreciation Current cost accounting (CCA) depreciation Tilted annuities Economic depreciation. Figure 2.1 summarises the factors considered for the various depreciation methods used in regulatory cost models. HCA 1 CCA 2 Tilted annuity Economic depreciation MEA 3 cost today Forecast MEA cost Output of network over time Financial asset lifetime 4 (feasible) (feasible) Economic asset lifetime Figure 2.1: Factors considered by depreciation methods [Source: Analysys Mason] Theoretically, economic deprecation is a highly appropriate method for regulatory costing since it takes into account all the underlying factors influencing the economic value of an asset: projected trends in operating expenditures associated with the asset (MEA opex trends) projected trends in replacing the asset with its MEA (MEA investment trends) the economic output that can be generated by the network asset over time Historic cost accounting Current cost accounting Modern equivalent assets Both tilted annuities and economic depreciation can use financial asset lifetimes, although the latter should strictly use economic lifetimes (which may be shorter, longer or equal to financial lifetimes).

5 2010/11 upgrades to the NITA fixed LRAIC model 3 It is this third factor that specifically differentiates economic depreciation from the other methods that take into account the MEA cost trends (both CCA and tilted annuity depreciation can do this, albeit in different ways). HCA does not take the MEA cost trends into account. Although tilted annuities determine cost recovery in a way that reflects the underlying costs of production over time, the method effectively assumes a steady rate of network output over the network lifetime. Adding a tilt can reflect price trends in network equipment over time; tilt adjustments can also allow for networks undergoing a small and gradual change in network output over time (i.e. closely approximate the results of a full economic depreciation calculation). Hence, in the situation where the output of an asset is not expected to change much over its lifetime, the result of an economic depreciation calculation is similar to a tilted annuity. Until now the change in demand on the modelled fixed networks (i.e. the copper access network) have been sufficiently small that tilted annuities have been sufficient for the purposes of cost modelling. They are also considerably simpler to implement. However, the upgraded LRAIC model now also takes into consideration the fibre network purchased by TDC in late 2009, which is a network with a small footprint and low level of utilisation (in subscriber terms). It has a nonnational footprint and (currently) a very small base of active subscribers. The existing tilted annuity deprecation method may therefore give results that are not suitable for the network cost calculation of services on these networks. Changing utilisation over time is also recognised to be an important factor for the core voice and data platforms. This changing utilisation of the platform can be captured in the model by implementing an ED calculation. Therefore, ED is a useful approach for considering the costs of services on both the fibre and other platforms. A further advantage of ED is that it deals consistently with operating expenditures and capital expenditures. The projected cost recovery profile fully recovers expenditures plus the opportunity cost of tying-up capital (i.e. a return on thus-far unrecovered capital or operating costs). 2.2 Principles of economic depreciation An ED algorithm recovers all efficiently incurred costs in an economically rational way by ensuring that the total of the revenues 5 generated across the lifetime of the business are equal to the efficiently incurred costs, including cost of capital, in present value (PV) terms. This calculation is carried out for each individual asset class, rather than in aggregate, in order to allow the price trends and opex cost trends for each asset to be reflected. 5 Strictly cost-oriented revenues, rather than actual received revenues.

6 2010/11 upgrades to the NITA fixed LRAIC model Present value calculation The calculation of the cost recovered needs to reflect the time value of money. This is accounted for by the application of a discount factor on future cashflows, which is equal to the weightedaverage cost of capital (WACC) of the modelled operator. The business is assumed to be operating in perpetuity and investment decisions are made on this basis. This means it is not necessary to recover specific investments within a particular time horizon (e.g. the lifetime of a particular asset), but rather throughout the lifetime of the business. In the ED model, this situation is approximated by explicitly modelling a period of 80 years. At the real discount rate applied (which is derived using the WACC), the PV of the cashflows in the last year of the model is very small and thus any perpetuity value beyond 80 years is regarded as immaterial to the final result Cost recovery profile The constraint on cost recovery (NPV of costs = NPV of output calculated unit costs) can be satisfied by (an infinite) number of possible cost recovery profiles. However, it would be impractical and undesirable from a regulatory pricing perspective to choose an arbitrary or highly fluctuating recovery profile. 6 Therefore, we choose a cost recovery profile that is in line with revenues generated by the business. In a competitive and contestable market, the revenue that can be generated is a function of the lowest prevailing cost of supporting that unit of demand, thus the price will change in accordance with the costs of the MEA for providing the service. 7 The unit cost is therefore assumed to follow the MEA price trend for that asset class. The cost recovery profile for each asset class is therefore the product of the demand supported of the asset (i.e. its economic output) and the MEA price trend. This gives a unique solution Capex and opex The efficient expenditure of the operator comprises all the operator s efficient cash outflows over the lifetime of the business, meaning that capex and opex are not differentiated for the purposes of cost recovery. As stated previously, the model considers costs incurred across the lifetime of the business to be recovered by revenues across the lifetime of the business. Applying this principle to the treatment of capex and opex leads to the conclusion that they should both be treated in the same way since they both contribute to supporting the revenues generated across the lifetime of the operator. Although capex and opex are not treated differently by the calculation, their economic costs must be derived separately. This is because the cost trends for these two components for a given asset can 6 7 For example, because it would be difficult to send efficient pricing signals to interconnecting operators and their consumers with an irrational (but NPV=0) recovery profile. In a competitive and contestable market, if incumbents were to charge a price in excess of that which reflected the MEA prices for supplying the same service, then competing entry would occur and demand would migrate to the entrant which offered the costoriented price.

7 2010/11 upgrades to the NITA fixed LRAIC model 5 differ, and hence the ED calculation needs to be applied separately to each. In fact, since the existing model distinguishes between equipment and installation cost, which can also have different cost trends for the same asset, capex must in fact be further subdivided into these two components in order for the calculation to work correctly Details of implementation The PV of the total expenditures is the amount which must be recovered by the revenue stream. The discounting of revenues in each future year reflects the fact that delaying cost recovery from one year to the next accumulates a further year of cost of capital employed. This leads to the fundamental of the ED calculation that is: PV (expenditures) = PV (unit cost output) The unit cost output which the operator gains from the service in order to recover its expenditures plus the cost of capital employed is modelled as output year 1 unit cost MEA price index. This quantity is discounted because it reflects future cost recovery. (Any costs recovered in the years after a network element is purchased must be discounted by an amount equal to the WACC in order that the cost of capital employed in the network element is also returned to the operator.). output the service volume carried by the network element MEA price index the cumulated input price trend for the network element which thus proportionally determines the trend of the unit cost that recovers the expenditures (effectively, the percentage change to the cost of each unit of output over time). This leads to the following general equations: cost recovery (year n) = unit cost in year 1 output MEA price index Using the relationship from the previous section, the above equation is equal to: PV (expenditures) = PV (unit cost in year 1 output MEA price index) This equation can be rearranged as follows: unit cost in year 1 = PV (expenditures) / PV (output MEA price index) Then, returning to the original equation for cost recovery in year n, the yearly access price over time is simply: yearly unit cost over time = unit cost in year 1 MEA price index This yearly access price over time is calculated separately for the capital equipment, capital installation and operating components in one step in the model.

8 Economic Depreciation Models 2010/11 upgrades to the NITA fixed LRAIC model 6 3 Description of the economic depreciation implementation We have implemented ED in the LRAIC Model using an exogenous approach. This enables the existing LRAIC model to be used as the central engine of the network design calculation, by deriving the demand volumes, asset counts and associated network costs for each year in the modelling timeframe. The output asset counts and costs are then stored in separate files in order to undertake the ED calculations. Due to the volume of data involved, separate multi-year models have been assembled for the ED calculations. The new ED models are thus bolted on to the other workbooks in the LRAIC model, as illustrated in Figure 3.1. Pure LRIC Model Core Model Consolidation Model Co-location Model Access Model Copper Fibre/Cable-TV Access Model Non-national cable-tv Non-national fibre Figure 3.1: Relationship of the new ED model to the existing LRAIC model [Source: Analysys Mason] The existing workbooks developed for the single-year cost calculations (Access, Core, Consolidation, Co-location, CATV+Fibre Access and Pure LRIC) are largely unchanged, apart from some additional named ranges or output tables for use by the ED calculations. In particular, these workbooks can still function as a single-year LRAIC model, independently of the ED models.

9 2010/11 upgrades to the NITA fixed LRAIC model 7 Figure 3.2 illustrates the relationship between the multi-year models and the existing model. Pure LRIC Model Single-year models Core Model Consolidation Model Co-location Model Access Model Copper CATV+Fibre Access Model Cable-TV Fibre Macro to run the model for a number of years Expenditure C+F model Multi-year models ED C+F model Figure 3.2: Relationship of the ED, multi-year models to the whole LRAIC model [Source: Analysys Mason] Implementations of ED will normally use a long timeframe. NITA s mobile LRAIC model uses a timeframe of up to 50 years, with the longest lifetime being 20 years. Since the longest lifetime in the fixed network model is 40 years, we have included the ability to model up to 80 years into the future (i.e. two full asset cycles for the longest-lived assets, as described in Section 2.2.1). The user, if they so wish, can restrict the timeframe for an ED calculation to a smaller number of years. The modelling period is thus at most The first year in which deployment is considered is usually assumed to be However, the years are required in order to capture advance purchase of assets for installation in the network. This is because, in a multi-year calculation, it would be unreasonable to assume simultaneous purchase, installation and activation of assets. Currently, a planning period of 1 12 months is included in the model for each asset to allow prior purchase. Therefore, assets are purchased 1 12 months prior to when they are actually installed and activated. The periods used can be found on the I_Asset worksheet in the CATV+Fibre Access Model.

10 2010/11 upgrades to the NITA fixed LRAIC model 8 Each ED model contains a macro that should be used to run the single-year models (Core, Access, Consolidation, Co-location and CATV+Fibre) for each year in the modelling timeframe. The macro: clears the data stored from the previous run pastes data into the single-year models and re-calculates the network costs for each year in the modelling timeframe pastes the output demand, assets and network costs into the ED model restores any inputs to their 2010 values (the current costing year). When this macro has been run, all models can be closed except for the ED models to make calculations faster. The ED models are designed to be mutually independent and do not need to be all run at the same time (although their inputs are consistent). In the rest of this section we describe the four multi-year models in greater detail. Sections 3.1 and 3.2 describe the Expenditures C+F Model and the ED C+F Model respectively, which are used to calculate ED for both the modelled cable-tv and fibre networks Section 3.3 describes how results for a service can be viewed graphically in the ED models For each model, we summarise the workbook structures, explain how to run the model and then describe (as required) first the expenditure calculations and then the economic cost calculations. For the avoidance of doubt, the cable-tv and fibre network calculation is split into two workbooks for size purposes, since the expenditure calculation must be completed for twenty geotypes. It should be noted that the ED Models each contain the same hard-coded inflation rate. If this needs to be updated, then it must be separately updated in each of the workbooks. It should also be noted that all of the models (single-year and multi-year) should all be kept in the same directory, as illustrated below. This will ensure that the inter-workbook links are maintained. Multi-year models Figure 3.3: Directory structure for the models [Source: Analysys Mason] Single-year models

11 2010/11 upgrades to the NITA fixed LRAIC model Expenditures C+F Model The Expenditures C+F Model is a multi-year, multi-geotype model. It contains a macro that runs the single year models for a specified number of years. The major outputs of the models are then collated in the Expenditures C+F Model, which performs intermediate calculations whose outputs are then fed into the ED C+F Model. The links to external workbooks should always be verified before any calculation using the Edit Links dialog box (this can be found using the shortcut key Alt+E+K) Workbook structure In Figure 3.4, we describe the worksheets within the Expenditures C+F Model. The worksheets in this model are prefixed with a two-character string, e.g. A1, B0. These are intended to optimise calculation sequence in order to reduce the calculation time in earlier versions of Excel. Since this prefix could change, a worksheet in these models called A1WorkSheet1 will be referred to in this document without the prefix i.e. as WorkSheet1. Worksheet name Description C V S I_wkbk I_Lists I_Ctrl I_Links I_Demand I_Asset_Inp I_Capex_Inp C_Calc O_Output Contents sheet, summarising the worksheets within the workbook Summary of the version history of this workbook Describes the cell formatting used within the workbook Lists the workbook names within the LRAIC Model Defines the names of commonly used lists in the Expenditures C+F Model Contains button to run the multi-year calculation via a macro Contains external workbook links from the other models Determines demand profiles over time for the fibre and cable-tv network Storage sheet for asset data over time by geotype Storage sheet for capex data over time by geotype Calculation engine for automated calculations by geotype over time Stores results across the geotypes. It also stores opex results pasted by the macro. These are then output to the ED C+F Model Figure 3.4: Description of the Expenditures C+F model worksheets [Source: Analysys Mason] Running the model As demonstrated in Figure 3.5, the control panel worksheet I_Ctrl contains a macro button labelled Update model. The multi-year calculation can be triggered by pressing the Update model button on the I_Ctrl worksheet. By default the macro would rerun the single year models 80 times, once for each year. Then it would record the relevant time-varying outputs in relevant sections in the Expenditures C+F Model. A full rerun of the single-year models requires several minutes.

12 2010/11 upgrades to the NITA fixed LRAIC model 10 When running the macro in the Expenditures C+F Model, the Consolidation, Core, Access, Co-location and CATV+Fibre Access Models should also be open. If the user determines that a modelling timeframe of less than 80 years is appropriate, inputs have been included on this worksheet to rerun the single-year models for a subset of years, defined by the two parameters First year and Last year. This does not allow a partial re-run of a calculation, since all arrays of stored data are cleared at the start of the macro. Figure 3.5: Control panel of the Expenditures C+F Model [Source: Analysys Mason] After the macro is completed, the ED C+F Model (described in Section 3.2) can then be opened to complete the ED calculation. The single-year model workbooks can be closed to reduce calculation time. The ED C+F Model can then be re-calculated by pressing Ctrl+Alt+F9. The ED Model for the cable-tv/fibre networks are unable to generate economic costs by geotype. In order to determine such costs, the macro must be run for the desired sub-national network. For example, in order to determine the access network costs of the existing fibre network, the user should run the C+F Expenditure Model with PTP only deployed in the CATV+Fibre Access Model for geotypes 1 6 and 18 (active geotypes are set on the I_Ctrl worksheet) Expenditure calculation The major data points from the single-year models pasted into the Expenditures C+F Model are: year average network element required for each asset unit capex per network element (nominal DKK), split into equipment and installation components total opex across all geotypes by network element (nominal DKK). The asset and capex inputs are geotype-specific. They are stored in the I_Asset_Inp and I_Capex_Inp worksheets. The opex is not split by geotype and is stored directly in the O_Output worksheet. Having stored all of this data, the macro then uses the C_Calc worksheet to determine the equipment purchased (accounting for planning periods and replacement) in each year using the year-average network elements, as well as the total equipment capex and total installation capex across all geotypes. All three of these outputs are stored, by asset, in the O_Output worksheet.

13 2010/11 upgrades to the NITA fixed LRAIC model 11 Once the macro has been re-run, the Expenditures C+F Model can be fully re-calculated by pressing Ctrl+Alt+F9. This calculation flow is illustrated in Figure 3.6 below, including how it relates to the calculations undertaken within the macro. For each geotype (within the macro) Year-average elements required (asset, time, geotype) Aggregated Retirement delay (asset, geotype) Deployed assets with retirement (asset, time, geotype) Total opex (nominal) Asset lifetime (asset, geotype) Annual activation, inc. replacement (asset, time, geotype) Total opex for annualisation (real) Planning period (asset, geotype) Equipment purchase, inc replacement (asset, time, geotype) Annualised or expensed index (asset) Total opex for annualistion (real) Unit opex cost trend index (real) Unit capex per element (nominal) (asset, time, geotype) Real discount rate (time) Unit capex per element (real) (asset, time, geotype) Total capex per element (real) (asset, time, geotype) Total capex per element (real) Total annual capex for annualistion (real) Unit capex cost trend index (real) Time varying inputs Colour key General inputs Calculations Outputs (pasted using the macro) Figure 3.6: Calculation of capex and opex in the Expenditures C+F Model [Source: Analysys Mason] When running the single-year model over the modelling timeframe, the CATV+Fibre Access Model can model a network which is deployed in (geotype-by-geotype) over time, rather than just in one-year. The inputs governing this calculation can be found in cells I_Ctrl!F29:H48 and I_Ctrl!K85:M104 for the cable-tv and fibre networks respectively. For each geotype, the parameters are first-year of deployment in that geotype and the number of years required to cover that geotype. Furthermore, the total buildings to pass in Denmark can also be assumed to increase over time, using the forecast functionality in the new I_NwDsFrcst worksheet in the CATV+Fibre Access Model. The capex index (separately for equipment and installation) will not vary by geotype, so it is calculated using the trends from geotype 1. The full-time equivalent (FTE) opex index by network element is calculated based on the real opex cost trend being equal to the nominal change in unit FTE maintenance costs less inflation. All expenditures are converted into real 2010 Danish kroner (DKK), by removing inflation, for the purposes of the ED calculation. The WACC is also converted into real terms, using the inflation rate forecast from NITA s mobile LRAIC model. After the macro has been completed, the single-year models can be closed (they do not need to be saved, since the inputs will not have been changed) and the ED C+F Model (described below in Section 3.2) can then be opened.

14 2010/11 upgrades to the NITA fixed LRAIC model ED C+F Model The ED model is a multi-year model. It links in the outputs from the Expenditures C+F Model and then performs further calculations to arrive at the LRAIC and LRAIC+ results. The links to external workbooks should always be verified before any calculation using the Edit Links dialog box (this can be found using the shortcut key Alt+E+K) Workbook structure In Figure 3.7, we describe the worksheets within the ED C+F Model. Similarly to the Expenditures C+F Model, the worksheets are prefixed with a two-character string, e.g. A1, B0. Worksheet name C V S I_Lists I_DF I_Inputs C_ED C_LRAIC+ O_Results Description Contents sheet, summarising the worksheets within the workbook Summary of the version history of this workbook Describes the cell formatting used within the workbook Defines the common lists referenced within the workbook within the ED C+F Model Calculates inflation rates and discount factors Contains external workbook links from the other models Calculation engine for ED Performs calculations of LRAIC and common costs Outputs the LRAIC and LRAIC+ results based on ED also carries out several checks to ensure overall consistency of the various calculations Figure 3.7: Description of ED model worksheets [Source: Analysys Mason] Running the model This model uses outputs from the Expenditures C+F Model. When the Expenditures C+F Model macro has been re-run, the ED C+F Model can be re-calculated by pressing Ctrl+Alt+F Economic cost calculation The calculation flow of the ED C+F Model is illustrated in Figure 3.8.

15 2010/11 upgrades to the NITA fixed LRAIC model 13 Recovery profile Demand (service, time) Service routeing factors (asset, service) Network element output Opex cost weighted output Opex cost index Proportion of assets that are common (time) Real discount rate divider (time) Opex cost per unit output Capex cost per unit output Total opex for annualisation (real) Total capex for annualisation (real) Total cost per unit output Total economic costs LRAIC result (service, time) Total common cost EPMU (time) Total incremental cost Capex cost weighted output Capex cost index (asset, time) LRAIC+ result (service, time) Colour key Input Calculation Output Figure 3.8: Calculation of the LRAIC(+) in the ED C+F Model [Source: Analysys Mason] The total annual capex and capex cost index are linked into the I_Inputs worksheet from the Expenditures C+F Model. These are used to derive the capex cost weighted output. When combined with the real discount rate, this gives the capex contribution per unit service output. The distinction between installation and equipment capex is maintained to this point (i.e. we have equipment capex contribution per unit service output and installation capex contribution per unit service output derived separated). Separate discount rates are applied to the cable-tv network assets and fibre network assets, since the two networks have separately defined WACCs in the model. The opex contribution per unit of service output is derived in a similar fashion, using the opex cost weighted output and the real discount rate (distinguishing between that for fibre assets and cable- TV assets). The total cost per unit of service output is then taken to be the sum of these contributions. Within the C_ED worksheet, routing factors and the network element output are applied to the total cost per unit of service output to derive the LRAIC. A recovery profile is used to restrict cost recovery to the years in which the assets are active. The proportions of assets that are common are then used to derive the total common costs in the C_LRAIC+ worksheet. These are applied to the LRAIC unit costs using the equi-proportionate mark up (EPMU) method. The resultant output is the unit LRAIC+ by service. The output results can be found on the O_Results worksheet. There are also several cross-checks at the top of this worksheet, which verify that: all assets required in the lifetime are purchased

16 2010/11 upgrades to the NITA fixed LRAIC model 14 all assets have routing factors the discounted economic costs are equal to the discounted expenditures. 3.3 Plotting results There is a dropdown input that allows the unit costs of a chosen service to be plotted. This is illustrated in Figure 3.9 for the ED C+F Model. Figure 3.9: Viewing the LRAIC results of the ED C+F Model [Source: Analysys Mason] By selecting different services in cells B516 and B517 from the drop-down selection (ringed in blue above), the unit cost result for either one or two services can be plotted on the chart embedded within the worksheet. The cross-checks described at the end of Sections can also be viewed in Figure 3.9 (ringed in red).