© Copyright Incyte Consulting 2008 Establishing cost-based interconnection: regulatory challenges and solutions Presentation to Infofest conference Budva, 30 September 2008 David Rogerson

2 © Copyright Incyte Consulting 2008 Agenda  Background to this presentation  What is cost?  How to measure cost  How to set interconnection rates  Overcoming objections  Questions and discussion Good regulation: - understands the principle, - implements the practical, - anticipates the problematical Good regulation: - understands the principle, - implements the practical, - anticipates the problematical

© Copyright Incyte Consulting 2008 Background to this presentation

4 © Copyright Incyte Consulting 2008 About Incyte Consulting  Incyte Consulting is a global consultancy that provides expert advice to policy makers, regulators, operators and investors on policy and regulatory issues in telecommunications.  We have offices in the UK and Australia, and our directors have worked on telecommunications policy and regulatory issues in over 40 countries worldwide.  From November 2007 to September 2008 we have been part of a consortium led by Great Village International Consultants advising Agentel on the regulation of tariffing and interconnection in Montenegro. The assignment was funded by EBRD.

5 © Copyright Incyte Consulting 2008 Why interconnection charges need to be cost-based In a competitive market interconnection is the fulcrum on which the market is balanced Up to 40% of an operator’s costs may be from interconnection Interconnection costs for one operator are revenues for another operator Imbalance of market power means interconnection charges cannot be left to commercial negotiation Regulated interconnection rates have to be set with absolute fairness

© Copyright Incyte Consulting 2008 What is cost?

7 © Copyright Incyte Consulting 2008 Cost changes need to reference only the services that an entrant wants to purchase Cost changes need to reference the decision period of a normal investment decision Long Run Incremental Cost LRIC is the “gold standard” for setting interconnection charges

8 © Copyright Incyte Consulting 2008 What is LRIC?  LRIC is an economic cost concept designed to:  Encourage use of existing facilities where desirable  Encourage investment in new facilities where justified Increasing desire for entrants to build rather than buy Decreasing desire for incumbent to sell Interconnect tariff LRIC Neutral benefits

9 © Copyright Incyte Consulting 2008 In summary…  Cost models provide evidence of cost structures and a sound basis for price setting  LRIC provides the best balance in the interests of all stakeholders  LRIC has been adopted by various international bodies (e.g. The European Regulators Group ("ERG"), ITU) and widely implemented around the world The Regulator LRIC Entrants Government IncumbentsConsumers Businesses LRIC is international best practice for interconnection cost modelling

© Copyright Incyte Consulting 2008 How to measure cost

11 © Copyright Incyte Consulting 2008  Top down models:  adapt the operator’s accounts to meet the LRIC standard  Bottom-up models  model an efficient network based on a simplification of network design  Benchmarks:  Compare prices with other countries that use LRIC  All are extensively and successfully used in both mobile and fixed markets around the world Three approaches to LRIC modelling

12 © Copyright Incyte Consulting 2008 Top-down LRIC models Top-down models are typically used for incumbent fixed networks Strengths Based on actual costs Accounts for cost minutiae Includes capital and operating costs Strong audit trail Weaknesses Accounting for potential efficiency gains Requires substantial up-front investment Data sources and data confidentiality Historic costs only Needs to be re-calculated annually

13 © Copyright Incyte Consulting 2008 Bottom-up LRIC models Bottom-up models are more commonly used for mobile networks Strengths Starts with the network elements required to deliver service increment Accounts for theoretical operational efficiency Avoids data confidentiality problems Enables cost forecasting Weaknesses May not match actual costs May omit to include some costs Can’t easily deal with operational costs

14 © Copyright Incyte Consulting 2008 Benchmarks Benchmarks are at best temporary solutions and cross-checks Strengths Simple to develop and update Transparent – all necessary data is generally published Incorporates best practice efficiency Weaknesses Benchmark prices may not be cost-based Does not account for variations in costs between countries Leads to arguments about which countries to include

15 © Copyright Incyte Consulting 2008 The Interconnection square  LRIC does not produce a single indisputable cost figure  There is room for regulatory policy manoeuvre  Rates should fit within the “Interconnection Square” …  … but where they fit is a matter of judgment. Reasonable cost-based interconnect charges Top-down LRIC model Bottom-up LRIC model International benchmarks International benchmarks

© Copyright Incyte Consulting 2008 How to set cost-based interconnection rates

17 © Copyright Incyte Consulting 2008 Glide paths smooth the transition to LRIC  LRIC rates are often well below starting levels  Interconnection prices may be set on a “glide path” to LRIC levels.  Typical glide paths are 3-4 years to allow smooth adjustment  They should be reviewed during the implementation period.

© Copyright Incyte Consulting 2008 Overcoming objections

19 © Copyright Incyte Consulting 2008 In our experience: The stakes are high:  There will be opposition in principle to LRIC from the incumbent operators  There may also be opposition from other parties when the LRIC- based charge proposals are announced Being strong at the implementation stage will mean:  Competition will run that much more smoothly afterwards  There will be fewer and smaller battles in the future Failing to go through with LRIC will mean:  Substantial focus of energies on interconnection disputes  Lack of focus on bringing the benefits of competition to customers

20 © Copyright Incyte Consulting 2008 Operator tactic Regulator’s response Argue that LRIC is too complex, too costly and shouldn’t happen yet LRIC is the best approach in theory and supported by international best practice LRIC will undermine our financial viability Show me an incumbent whose value has been hit by LRIC. Whatever else, seek delays Set reasonable timelines and stick with them. Threaten court action over unreasonably low rates. Always leave room for a worse outcome if challenge is taken to court. Talking tactics

© Copyright Incyte Consulting 2008 The End. Thank You