Access and Termination Charges in Telecoms Jonathan Sandbach Head of Regulatory Economics Vodafone Group June 2006

Friday, 23 June Net Neutrality in context of 2SM

Friday, 23 June Net Neutrality Debate Net Neutruality debate started in US......appying to “incumbent“ network platforms: Access networks (DSL, fibre, CATV) Next generation networks (NGN) Non-discriminatory access to all content providers Net Neutrality Opposing View Networks make judgements on how different types of content are to be handled and priced

Friday, 23 June SM Model 2SM model incorporates two special cases: Content providers (e.g. Google, Yahoo) want to push content onto networks with lots of subscribers Networks want to pull content (e.g.UEFA champion league) onto their networks to get subscribers Assumes first case only applies - and so is special case of 2SM Net Neutrality Opposing View Networks have flexibility to arrange and price content to maximise value to subscribers

Friday, 23 June When can net-neutrality be applied? Non-discriminatory access to all content providers Net Neutrality Opposing View Networks make judgements on how different types of content are to be handled and priced Mature/incumbent monoply platforms ? Developing/competing platforms ?

Friday, 23 June Mobile networks in developing markets 2SM and investment incentives

Friday, 23 June Mobile networks as 2SM 2SM: Call origination and termination Developed markets...where platform coverage is complete  interest:  price structures Developing markets...where platform coverage is incomplete (and function of investment)  interest:  price structures  endogenously determined investment levels

Friday, 23 June Numerical example (1) Assumptions Annualised cost of a mobile network rural base station$1,200 Expected incremental traffic (both originating and terminating) 10,000 minutes/year Simplistic assumption: orig. & term. calls incur equivalent capacity cost on the base station  Average cost of a call minutes12 cents. Ratio of inbound to outbound call minutes for this rural base station2:1 Ratio of incremental/average cost of minute on whole network50% Retail price of a call minute 20 cents. Overall impact of investment in new rural base station Total incremental revenue $2,000(10,000 minutes x 20 cents/minute). Incremental cost of base station$1,200 Other Incremental capacity investment$600(10,000 minutes x 50% x 12 cents) Total cost$1,800 Incremental profit$200  Worthwhile investment.

Friday, 23 June Numerical example (2) Impact on individual network operator …with a market share of 25% when termination rate is set at cost of 12 cents. Incremental minutes10,000 …Outbound3,333 …Inbound6,667 …On-net outbound833(25% x 3,333) …On-net inbound1,667(25% x 6,667) …Other operator outbound5,000(6,667 less 1,667) …Other operator inbound2,500(3,333 less 833) Outbound revenue on new base station$667(3,333 minutes x 20 cents) Outbound revenue in rest of network$333(6,667 minutes x 25% x 20 cents) Inbound revenue$600(5,000 minutes x 12 cents), Total incremental revenue$1,600 Incremental cost of the base station$1,200 Other incremental capacity investment$150(2,500 minutes x 50% x 12 cents) Terminating outpayments$300(2,500 minutes x 12 cents) Total incremental cost$1,650 Incremental profit-$50  Investment will not be made In fact, if the investment were made, the other operators would gain $250, arriving back at the net industry gain of $200. The point is that no operator will be incentivised to make the investment that is profitable for the industry as a whole.

Friday, 23 June Numerical example (3) Impact on individual network operator …with a market share of 25% when termination rate is set at cost of 15 cents. Incremental minutes10,000 …Outbound3,333 …Inbound6,667 …On-net outbound833(25% x 3,333) …On-net inbound1,667(25% x 6,667) …Other operator outbound5,000(6,667 less 1,667) …Other operator inbound2,500(3,333 less 833) Outbound revenue on new base station$667(3,333 minutes x 20 cents) Outbound revenue in rest of network$333(6,667 minutes x 25% x 20 cents) Inbound revenue$750(5,000 minutes x 15 cents), Total incremental revenue$1,750 Incremental cost of the base station$1,200 Other incremental capacity investment$150(2,500 minutes x 50% x 12 cents) Terminating outpayments$375(2,500 minutes x 15 cents) Total incremental cost$1,725 Incremental profit$25  Worthwhile investment Higher termination incentivises investment

Friday, 23 June Numerical example (4) In this simple example incentives to invest in new base stations will be positively related to the termination charge… …when inbound/outbound traffic ratio is skewed towards incoming calls (which will be the normal case for marginal base stations in developing markets). …when inbound/outbound traffic ratio is skewed towards outbound calls incentives would be reversed. Numerical example of what may effect optimal level of investment (profit maximising & welfare maximising): –regulated price structure –demand and network externality characteristics of incremental users on each side of market (e.g. incoming/outgoing call asymmetries) –High market share, or more on-net traffic, will internalise the effect (profit maximising investment converges on welfare maximising) Application to roll-out of mobile platforms in developing markets