19 december 2003 PTS-ER-2003:45
The final hybrid model
LRIC – The final hybrid model
Post- och telestyrelsen
In 2001, PTS conducted a review of the calculation models used for calculating cost oriented charges for fixed and mobile interconnection services and unbundled local loops. As a result of this review, work was initiated with the aim of determining cost oriented access and interconnection charges for the fixed telecommunications network.
In spring 2002, PTS initiated the work of developing a new calculation model. The new model is based on the Long Run Incremental Cost (LRIC) methodology, recommended by the EU-Commission and adopted by the majority of the Member States. The advantage of the LRIC-methodology is that it provides both new operators as well as TeliaSonera with a better basis for making investment decisions, leading to a more effective competition in the long run. PTS has undertaken the work of introducing the new calculation model in cooperation with the operators, who have had the opportunity to participate in the development of the model and comment on the different sub-results developed during the process.
Today, PTS can present the final result of the work in the form of the final calculation model along with the costs of access and interconnection services calculated on the basis of the model.
Stockholm, December 2003
Nils Gunnar Billinger
During 2001, PTS performed a pre-study regarding cost oriented access and interconnection in Sweden. The purpose of this study was:
• to evaluate the existing models used to calculate cost oriented charges;
• to describe what different methods can be used to calculate cost oriented charges for access and interconnection; and
• to recommend which methods should be used in the future.
The final recommendation in the pre-study was to change the existing calculation models for access and interconnection and instead base cost oriented charges for these services on LRIC plus mark-up. In a public consultation with the Swedish operators this view was generally confirmed.
On this basis, a LRIC process was initiated by the National Post and Telecom Agency (PTS) in May 2002.
2 Objectives of the LRIC process
The specific objectives of PTS’s work, implementing LRIC plus mark-up, have been to:
• develop a reliable model that is supported by the industry in order to calculate costs for access and interconnection according to the LRIC-method which is recommended by the Commission; and
• create a regulatory tool for PTS to be used in order to establish cost oriented prices for access and interconnection in the fixed network.
The expected effects of implementing LRIC according to the objectives mentioned above are to:
• Encourage the use of existing facilities of the SMP operator where this is economically desirable, avoiding inefficient duplication of infrastructure costs by new entrants (incentive to buy);
• Encourage investment in new facilities where this is economically justified by
1. new entrants investing in competing infrastructure
2. the SMP operator upgrading and expanding its networks (incentive to build);
• Increase the transparency of the cost calculations underlying the access and interconnection charges; and
• Increase predictability for both the SMP operator and the other operators with regards to future determination of access and interconnection charges.
When access and interconnection charges are based on LRIC they do not distort the build/buy decision of new entrants – they will be encouraged to use existing facilities if it is economically desirable to do so. Just as important, LRIC-based access and interconnection charges also mean retaining investment incentive for incumbents to upgrade or extend the existing network when new technology is available.
When charges are set on the basis of LRIC, infrastructure competition is encouraged in those areas where it is efficient to have competing infrastructure, whereas service competition is encouraged in those areas where the investment in competing infrastructure is not efficient.
To send the right investment signals and promote efficient competition, prices should reflect the LRIC of an efficient operator facing the demand of the existing SMP operator (currently this means TeliaSonera). The efficient operator is defined as the theoretical operator that would exist if it were in a fully competitive market in Sweden, but with the same scope and demand of the existing SMP operator.
This approach ensures that the economies of scale and scope are divided equally between the SMP operator and the interconnecting operators allowing the interconnecting operators to compete with the SMP operator on equal terms.
At an early stage of the process, PTS released for discussion a proposed timetable showing how each of the main activities would be conducted. This timetable was discussed and accepted by the parties. The key dates were as follows:
May 2002 – September 2002: Structuring the process
August 2002 – March 2003: BU modelling
August 2002 – June 2003: TD modelling
June 2003 – December 2003: Reconciliation and hybrid modelling
Consultations with the Swedish telecommunication industry have been conducted at all stages of the process and opportunities have been given to influence the model structure and features.
To ensure a maximum level of transparency into the process an LRIC web site was established, where all relevant information developed during the process has been published.
Model Reference Paper – Guidelines for the modelling work
Subsequent to an industry consultation, PTS published on 13 September 2002 a Model Reference Paper (MRP) specifying criteria and guidelines for the development of two costs models to be used for determining the Long Run Incremental Costs (LRIC) of providing (wholesale) access, interconnection and co-location services in Sweden:
• A bottom-up model to be developed by PTS in co-operation with the industry; and
• A top-down model to be developed by TeliaSonera.
The MRP has been published on the PTS web site.
The bottom-up model was developed in a Bottom-Up Working Group (BUWG), chaired by PTS. All operators were invited to participate in the working group. A team of PTS’ consultants, the so-called Bottom-Up Modelling Team (BUMT), established under the BUWG, undertook the technical modelling work. PTS did not form part of the BUMT.
A draft version of the bottom-up model was subject to industry consultation before the final version of the bottom-up model was published on 27 June 2003. The final model was populated with data supplied by the industry and the consultants.
On 1 July 2003, TeliaSonera delivered the top-down model to PTS. TeliaSonera did not provide PTS with the actual model but with supporting documentation and a selection of underlying calculations. The material was reviewed by PTS and its consultants to check for compliance with the criteria and guidelines of the MRP. Following this review, TeliaSonera was requested to provide PTS with a revised version of the model and, in particular, to elaborate on the documentation of the model. The top-down model was audited by Ernst & Young.
Following the delivery of the revised top-down model, PTS reconciled the results of the two models in a draft reconciliation report and invited the industry to comment on the findings and proposed changes to the bottom-up model. Following the industry consultation, a final reconciliation report was published
on10 October 2003 on the PTS web site. This report presents the findings of the reconciliation exercise, highlighting the differences between the two models andpresenting PTS’ initial view on the way forward in the hybrid-modelling phase and where appropriate requesting additional information from the industry.
Judgements in the hybrid-modelling phase
The reconciliation process has formed the basis for PTS judgement in the hybrid modelling phase.
When making choices on the most appropriate methodology to use in the hybrid model, PTS has considered the following key factors:
• The overall intentions of the new electronic communications legislation (2003:389).
• Practical and technical feasibility of the modelled network
• Criteria and guidelines of the MRP, which are not specific to the bottom-up or top-down model.
• Documentation provided for bottom-up and top-down figures respectively.
• International experience with LRIC modelling.
• Transparency of the hybrid model.
Draft hybrid model
A draft hybrid model was published for public consultation on 31 October 2003. The consultation responses have been published on the PTS website and are addressed in a separate consultation note on the draft hybrid model published together with this report.
All the changes made to the draft hybrid model following the public consultation have been documented in appendix 1 to the model documentation, accompanying the final hybrid model. PTS has also updated the model with estimated demand for 2003.
5 Results – the final hybrid model
The final hybrid model consists of the following material, annexed to this report:
• LRIC hybrid model TRUE version 1.2 (Excel) (Confidential)
• LRIC hybrid model PUBLIC version 1.2 (Excel)
• Model Documentation (Word document)
• User guide (Word document)
• Results of LRIC hybrid model (Word document).
In the public version of the hybrid model, confidential data have been randomized or “camouflaged” in such a manner that all results, based on these data, will not differ more than 5% from the results, calculated from the real data (presented in the note on results).
It should be emphasized that the hybrid model estimates costs – not prices. Based on these costs estimated, TeliaSonera will determine prices in accordance with a LRIC pricing methodology prescribed by PTS. A draft pricing methodology was published by PTS on 7 November 2003 for public consultation and updated for shared access on 14 November 2003. The final pricing methodology will be published in January 2004.