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Independent Pricing and Regulatory Tribunal

Pricing NSW Government radio servicesDeveloping a pricing methodology and recommending prices for 2011/12

Other Industries — Final Report and Recommendations August 2011

Pricing NSW Government radio services Developing a pricing methodology and recommending prices for 2011/12

Other Industries — Final Report and Recommendations August 2011

ii IPART Pricing NSW Government radio services

© Independent Pricing and Regulatory Tribunal of New South Wales 2011

This work is copyright. The Copyright Act 1968 permits fair dealing for study, research, news reporting, criticism and review. Selected passages, tables or diagrams may be reproduced for such purposes provided acknowledgement of the source is included.

ISBN 978-1-921929-34-2 S9-67

The Tribunal members for this review are:

Mr James Cox PSM, Acting Chairman and Chief Executive Officer

Ms Sibylle Krieger, Part Time Member

Inquiries regarding this document should be directed to a staff member:

Dennis Mahoney (02) 9290 8494

Thomas Clay (02) 9290 8425

Linda Li (02) 9113 7729

Independent Pricing and Regulatory Tribunal of New South Wales PO Box Q290, QVB Post Office NSW 1230 Level 8, 1 Market Street, Sydney NSW 2000

T (02) 9290 8400 F (02) 9290 2061

www.ipart.nsw.gov.au

Contents

Pricing NSW Government radio services IPART iii

Contents

1 Executive summary and recommendations 1 1.1 Introduction 1 1.2 Summary of our pricing methodology 1 1.3 Summary of our 2011/12 recommended prices and their impact 3 1.4 List of recommendations 5

2 What was our approach in this review? 8 2.1 What were we asked to do? 8 2.2 How did we approach the task? 9 2.3 What does the rest of this Report cover? 9

3 What is the evolving nature of NSW Government radio networks? 10 3.1 What role do government radio networks play? 10 3.2 What is the GRN’s present size and who uses it? 11 3.3 What future developments are likely to affect the GRN? 13

4 How did we derive our pricing methodology? 15 4.1 The building block approach and efficient costs 15 4.2 Impactor-pays approach to cost allocation 18 4.3 Allocating costs between users 19 4.4 Other aspects of the pricing methodology 23

5 How did we arrive at our recommended prices for 2011/12? 26 5.1 Establishing efficient costs in 2011/12 26 5.2 Net revenue required in 2011/12 29 5.3 Allocation between users 30

6 How will our recommended prices affect users and statutory contributors? 33 6.1 Assessing the impact of prices on non-core users 33 6.2 Assessing the impact of prices on core users 35 6.3 Assessing the impact of prices on statutory contributors 36

7 Other matters 38

Contents

iv IPART Pricing NSW Government radio services

Appendices 41 A Terms of Reference 43 B List of submissions 45 C List of participants at the Roundtable 46 D Deriving a WACC for the GRN 47 E This review in relation to its Terms of Reference 48

1 Executive summary and recommendations

Pricing NSW Government radio services IPART 1


1.1 Introduction

The NSW Government has asked IPART to assist the Minister for Finance and Services by reviewing the pricing of shared government mobile radio network services so as to:

develop a methodology for setting prices in the future, and

apply that methodology to recommend prices for 2011/12.

The only shared government radio network in NSW is the Government Radio Network (GRN) so it is to this network that our recommended pricing methodology and 2011/12 prices apply. The purpose of cost-reflective pricing is to ensure that the resources devoted to the GRN are used efficiently, neither overused because they are too cheap nor underused because they are too expensive.

We released an Issues Paper in March 2011 in which we addressed the Terms of Reference (set out in full in Appendix A) and called for submissions. We then held a Roundtable on 26 July 2011 to discuss the key issues in light of the submissions we received (these are listed in Appendix B). A transcript of the Roundtable was posted at www.ipart.nsw.gov.au (a list of participants is in Appendix C). Finally, we received further information from the NSW Government Telecommunications Authority (Telco Authority) in the weeks following the Roundtable.

We have considered all the evidence and submissions presented to us. Our recommendations, and how we reached them, are set out in this report (Report) for the Minister’s consideration.

1.2 Summary of our pricing methodology

Our recommendations set out a pricing methodology that is consistent with full cost recovery principles and is equitable and simple to implement. The methodology consists of five components, which we outline below.

1. A building block model of efficient GRN costs

The pricing methodology employs what is widely known in regulatory circles as ‘the building block approach’ to the setting of fully cost-reflective prices. This approach


2 IPART Pricing NSW Government radio services

sets the level and structure of prices in such a way that the revenue generated by the business is equal to the forecast efficient costs of running that business. The costs of running the business are assembled in blocks that relate to operating costs, a return of capital (depreciation) and a return on capital.

2. An approach that recognises a key distinction amongst the GRN’s users

The second component of our methodology is the allocation of the revenue to be raised between users of the GRN. The GRN is specifically designed to provide mission-critical standards of radio communication to NSW law enforcement, public safety and emergency service agencies. At present, the Ambulance Service of NSW (ASNSW), Fire & Rescue NSW (FRNSW), the Rural Fire Service (RFS) and the State Emergency Service (SES) are the 4 agencies that use the GRN. These users would not effectively function without the network, and drive most of its costs.

Accordingly, we chose to apply what is known as an ‘impactor-pays approach’ to the allocation of required revenues between users. This approach allocates the costs of providing the network’s services among those users which are ‘ïmpactors’, or which create and sustain the need for those services. On this approach, the bulk of the GRN’s costs should be allocated to the 4 ‘core’ agencies mentioned above.

However, an impactor-pays network often has other, non-impactor, users. These users effectively ‘piggy-back’ on a network that has spare capacity and can service the impactors under all circumstances. Non-impactors connect to the GRN because it provides cheaper and/or better services than the alternatives, such as a commercially provided mobile phone or radio network. Some, such as the essential services agencies, may require interoperability with the core agencies when an emergency response requires their close involvement.

3. A sensible way to allocate costs between users in light of that distinction

The third component of the pricing methodology allocates the required revenue or costs of the GRN between impactors and non-impactors. On the basis of the information we received, costs could not be meaningfully apportioned between the 2 groups. Instead, we have allocated revenue to the non-impactor group by pricing its access to the GRN on comparative commercial terms. We have done this by examining the prices charged by a commercial radio network for services that are the closest proxy to the services provided by the GRN.

By pricing non-impactor access to the GRN on commercial terms, the revenue required from the 4 core agencies is the balance of revenue required.



4. Price structures that are equitable and simple to implement

The fourth component of the pricing methodology sets a price structure for the impactors that simply and fairly recovers the balance of the required revenue. In keeping with their role as impactors, we set a flat fee for each core agency that reflects its impact on the GRN in terms of the costs it incurs in supplying the agencies with communications capacity and footprint coverage.

5. A pricing methodology that will accommodate future developments

Finally, to ensure that the pricing methodology will remain robust as the GRN expands in the future, we have recommended that the Telco Authority be required to assess the impact of each core agency at annual intervals and to reach agreement with the core agencies on the allocation of GRN costs that they will be charged.

1.3 Summary of our 2011/12 recommended prices and their impact

We have applied the above pricing methodology to the information provided to us during the course of this review. We recommend that prices be set so as to recover $33.86m in revenue from the users of the GRN in 2011/12. This is marginally higher than the $32.89m that would have been levied had the current interim prices remained in place throughout 2011/12.

Our recommended prices are:

that all 24 non-impactor users of the GRN pay $50 (excluding GST) per month for each terminal registered with the GRN as at 1 April 2011, and

that the 4 impactors each pay an annual flat fee of $7.669m (excluding GST).

The effect of these price recommendations on the bills of all the non-impactor users is shown in Table 1.1 and on the impactor users in Table 1.2.

If our recommendations are implemented, all except 3 of the non-impactors will face lower bills. The lower bills result because $50 is a lower monthly price per terminal than the current interim prices which are $118.33 (state-wide users) and $59.17 (local users).

The 3 non-impactors that would face higher bills only do so because they currently pay subsidized prices of $41.67 (2 local councils) and $37.51 (a non-government organisation). We recommend that the Minister continue to subsidize these 3 users.

As a group, the non-impactors will pay a total annual bill of $3.19m instead of $7.09m. Under our recommendations, the core agencies will pay a total of $30.67m with a significant redistribution away from the RFS towards the ASNSW and FRNSW.



In summary, the $33.86m revenue required from the GRN’s users for 2011/2012 will be fully recovered, with non-impactors providing $3.19m (paying commercial prices for the service), and impactors paying $30.67m.

Table 1.1 Non-impactor bills in 2011/12 with and without our recommended prices

Agency Regist-ered

terminals

Bill under interim

prices ($)

Bill 2011/12

($)

Absolute change ($)

Percent change

(%)

RailCorp 1,290 1,831,748 774,000 -1,057,748 -58

Ausgrid 818 1,161,527 490,800 -670,727 -58

Endeavour Energy 598 849,136 358,800 -490,336 -58

DAG&J - Corrective Services 595 844,876 357,000 -487,876 -58

DAG&J - Sheriff's Office 436 619,103 261,600 -357,503 -58

Roads & Traffic Authority 344 488,466 206,400 -282,066 -58

ARTCb 255 362,090 153,000 -209,090 -58

State Transit Authority 168 119,287 100,800 -18,487 -15

NSW Maritime Authority 137 194,535 82,200 -112,335 -58

Sydney Water 128 90,885 76,800 -14,085 -15

Sutherland Shire Council 126 63,005 75,600 12,595 20a

Hunter Water 121 85,915 72,600 -13,315 -15

Dept of Premier & Cabinet 83 117,857 49,800 -68,057 -58

DAG&J - Juvenile Justice 45 63,898 27,000 -36,898 -58

ICAC 29 41,179 17,400 -23,779 -58

ABC 27 38,339 16,200 -22,139 -58

Central Tablelands Councils 21 10,501 12,600 2,099 20a

NSW Dept of Transport 20 28,399 12,000 -16,399 -58

Chevra Hatzolah 19 8,552 11,400 2,848 33a

Dept of Defence 16 22,719 9,600 -13,119 -58

National Parks & Wildlife 15 21,299 9,000 -12,299 -58

Sydney Catchment Authority 15 10,651 9,000 -1,651 -15

ITSR 7 4,970 4,200 -770 -15

Sydney Ports Corporation 3 2,130 1,800 -330 -15

Totalc 5,316 7,081,068 3,189,600 -3,891,468 -55 a The current prices paid by these 3 users are subsidized by the Department of Finance and Services. If the Minister were to increase the subsidies for these users, their prices (and bills) would not rise. b Full agency names are shown in Table 3.1. c Totals may not add in this and subsequent tables due to rounding.

Source: Email from the Telco Authority to IPART 6 June 2011 and IPART



Table 1.2 Impactor bills in 2011/12 with and without our recommended prices

Agency Revenue required

($000)

Impact percentages

(%)

Flat fee 2011/12

($000)

Bill under interim prices

($000)

Absolute change

($000)

Percentage change

(%)

RFS 25 7,669 12,159 -4,491 -37

SES 25 7,669 5,816 1,852 32

ASNSW 25 7,669 4,311 3,358 78

FRNSW 25 7,669 3,523 4,146 118

Total 30,674 30,674 25,810 4,865 19

Note: the concept of an “impact percentage” is explained in Chapter 4.

Source: IPART.

1.4 List of recommendations

The Recommendations fall into four parts. They relate to:

the pricing methodology (Recommendations 1 to 9)

the recommended prices for 2011/12 (Recommendations 10 to 14)

their impact on users and statutory contributors (Recommendations 15 to 17), and

any other matters required by the terms of reference (Recommendations 18 to 20).

1.4.1 Recommendations on the pricing methodology

We recommend that the Minister:

1 Adopt the building block method as a way of ensuring that pricing of the services of the Government Radio Network (GRN) are fully cost-reflective. 17

2 Require the Telco Authority to undertake thorough, independent reviews of the cost efficiency of the operating and capital costs of the GRN every 2 years during its current expansion phase. The results of reviews should be made available to all the core agencies. 17

3 Adopt an impactor-pays approach to allocating GRN costs amongst users and thus distinguish between the impactors as core users and all other users as non-core users. 19

4 Recover costs from non-core users by charging them commercially-reflective prices with the balance of costs to be recovered from core users. 21

5 Require the Telco Authority to set a fee per terminal for non-core users. If a non-core user causes the GRN to incur capital costs, those costs should be met by a capital contribution which is levied independently of the fee per terminal and which does not add to the asset base for pricing purposes. 21



6 Require the Telco Authority to set a flat fee for each of the core agencies. This fee is to reflect each agency’s impact on the GRN’s capacity and coverage. For simplicity, that impact should be summarised as an ‘impact percentage’ for each agency. 23

7 Direct the Telco Authority to set prices for other, minor ancillary services that are commensurate with their efficient cost and the efficient use of GRN resources. 24

8 Require annual recalibration of the measures of impact (coverage, capacity) as existing core agencies expand on the GRN or as a new core agency is added. The Telco Authority should reach agreement with all core agencies on the appropriate allocation of flat fees across agencies by 1 April each year. In the event that agreement is not reached, the Minister should decide on the appropriate impact percentage to be applied to each core agency. 24

9 Recognise that any assets that are vested into the GRN (that is, without cost to the GRN) as it consolidates and expands should not be included in the regulatory asset base for pricing purposes. The same applies to any capital contributions that might occur under Recommendation 5. 25

1.4.2 Recommendations on recommended prices


10 Accept the GRN’s estimate of its costs for 2011/12 and the $33.86m net revenue requirement that flows from those costs under the building block method. 30

11 Require the Telco Authority to undertake a thorough, independent assessment of the efficiency of the operating and capital costs of the GRN prior to the setting of prices for 2012/13 and to make the results of that assessment available to its core users. 30

12 Set the price to be paid by all non-core users at $50 per month per terminal registered on the GRN as at 1 April 2011. 31

13 Set a flat fee for each core agency of $7.669m for 2011/12. This fee assumes that the impact percentage for each core agency is the same, based on information provided to IPART by the Telco Authority. 32

14 Direct the Telco Authority to set prices for other, minor ancillary services in 2011/12 that are commensurate with their efficient cost and the efficient use of GRN resources. 32



1.4.3 Recommendations on effects of our recommended prices on users and statutory contributions


15 Continue the subsidy arrangements for the 2 local councils and the non-government organisation (NGO) that are currently in place. 35

16 Note that the total bill for all the core agencies combined will increase by $4.9m or 19% to $30.7m in 2011/12. The bill for the RFS will fall by $4.5m; the bills for the SES, ASNSW and FRNSW will rise by $1.9m, $3.4m and $4.2m respectively. 35

1.4.4 Recommendations on other matters raised from the terms of reference


17 Note that statutory contributors will be required to pay their legislated percentages of the change in the bills faced by the RFS, SES and FRNSW. In 2011/12 their combined GRN bill will rise by $1.507m. 37

18 Accept that there are no issues of competitive neutrality in relation to the GRN as long as it charges the same commercially-reflective prices to all non-core users regardless of their ownership structure. 39

19 Accept the present payment arrangements between the Telco Authority and the ACT Emergency Services for access to the GRN’s central control centre and for various data links. 39

20 Note that the Mobile Data Radio Network is not a shared service and that, as such, is outside the scope of pricing for the GRN. 39

2 What was our approach in this review?



In this chapter we outline how we approached the review.

2.1 What were we asked to do?

The Terms of Reference for this review directed us to:

1. Develop a pricing methodology based on full cost recovery principles for application to users of shared mobile radio network infrastructure. The methodology was to take into account the current and future operating and capital costs to maintain shared networks. It was also to be simple and equitable to implement.

2. Consider applicable risk factors including:

a) the cost impacts on NSW mobile radio users from reforms by the Commonwealth Government for the pricing and availability of radio spectrum

b) the cost impacts on government and non-government user agencies based on their different requirements for shared mobile radio network usage and coverage levels

c) the application of competitive neutrality principles for public trading agencies that are users of the shared mobile radio network infrastructure

d) a phased introduction of the proposed state-wide service.

3. Provide advice on the cost impact of the proposed methodology on eligible users and government agencies from 2011-12.

4. Examine the cost impact and implications of the proposed methodology on statutory contributions for mobile radio for the insurance industry and local government.

5. Based on the methodology, recommend prices to commence on 1 July 2011.

The Terms of Reference are set out in full in Appendix A.

A delay in the NSW Government submission resulted in a commensurate delay in submitting this report until late August 2011.



2.2 How did we approach the task?

We applied the same general approach to this review that we use for other pricing reviews. Centred around public consultation, our approach involved:

deciding on the most suitable method for setting fully cost-reflective prices

establishing the total efficient costs of providing the radio services of the GRN

deciding how best to allocate costs among the GRN’s users

ensuring that the pricing methodology was accompanied by a price structure that was both simple and equitable to implement

using the pricing methodology to recommend prices for 2011/12

assessing the impacts of the recommended prices on the GRN’s users and their statutory contributors

ensuring that all other matters required by the Terms of Reference were addressed.

2.3 What does the rest of this Report cover?

The following chapters outline our recommendations and our reasons for them:

Chapter 3 considers the role of government radio services in NSW and how they are expected to change in the light of future developments

Chapter 4 derives our recommended pricing methodology

Chapter 5 applies this methodology in light of the available data to recommend prices for 2011/12

Chapter 6 shows how the users of the GRN and the statutory contributors to the costs of the RFS, SES and FRNSW will be affected by our recommended prices

Chapter 7 deals with other matters required by the Terms of Reference.

3 What is the evolving nature of NSW Government radio networks?



In this chapter we explain the role of government radio services and the GRN and outline how they might evolve in the next decade. The pricing methodology we recommend must be able to accommodate these developments.

3.1 What role do government radio networks play?

Government radio networks support a range of operations of government agencies. They provide staff with a way of communicating either 'one-to-many' or 'one-to-one' and in a manner that is private, secure, reliable and subject to Government oversight.

The highest priority of these networks is to support law enforcement, public safety and emergency services agencies in circumstances where life and property are in danger. Commercial mobile telephone services cannot be relied upon to meet the mission-critical standards that are required in emergencies.

Other users of radio communications include essential service providers in transport, energy and water supply. These providers use mobile radio networks for day-to-day operations, as well as in times of emergency.

At present the 5 law enforcement, public safety and emergency service agencies in NSW operate their own single-agency conventional radio networks. Most agencies also connect to the GRN. All of the 5 agencies support the consolidation of their networks with the GRN where possible, in order to achieve efficiencies in operations and capital investment.1

The GRN is a trunked network that pools its frequencies and allocates them as required. Motorola has noted many advantages that a trunked radio network has over a conventional one. Perhaps the most important is that:

Multiple agencies can communicate in groups on virtual channels, known as “talkgroups”. Because the next available radio channel is automatically selected from the pool, all base station resources are used more efficiently, requiring less frequency spectrum, and less base equipment at the site. Everything being equal in terms of traffic patterns and loading, it can be shown statistically that if 3 or more conventional channels are required at a site (either for 3 different agencies or an agency needing more capacity), trunking will provide a more efficient grade of service, and therefore less spectrum required.2

1 NSW Government submission, p 1. 2 Motorola submission, p 5.



The growing scarcity of spectrum has been one of the reasons behind the strategic review of NSW Government mobile radio services that was undertaken in recent years, and a number of the reforms - relevant to this review - that flowed from it.

These include increasing operational efficiency for whole of government, removing unnecessary duplication and introducing full cost recovery for shared services through a revised pricing model. The Telco Authority was charged with implementing operational efficiencies while we were to develop pricing recommendations to be implemented for users of the GRN.

3.2 What is the GRN’s present size and who uses it?

Our review focused on the GRN because it is the only government trunked or shared radio network in NSW.3 It now covers one-third of the state (Figure 3.1).

Figure 3.1 Stages in the expansion of the footprint of the GRN

Note: Reach and density on the South Coast improved markedly post-2008. Source: DPC, Strategic Review of NSW Government Mobile Radio Services, Draft Report, October 2010.

The GRN is designed to meet the mission-critical standards of the state’s 5 law enforcement, public safety and emergency services agencies. These standards are more comprehensive and exacting than those required of other commercial radio and mobile phone services. At present 4 of the 5 agencies use the GRN.4

3 The Mobile Data Radio Network was excluded because it is used exclusively by the ASNSW

and so is not a shared service. 4 At present, the GRN is not used by the NSW Police Force.



Another 24 agencies use the GRN, including

5 state-owned corporations

18 (Federal, NSW and local) government departments and authorities, and

1 non-government organisation (NGO).

The 4 public safety and emergency services agencies dominate the use of the GRN, at least in terms of the number of terminals they have registered on it (Table 3.1).

Table 3.1 Users with registered terminals on the GRN, 1 April 2011

Agency Registered GRN terminals

NSW Rural Fire Service 8,563

NSW State Emergency Service 4,096

Department of Health (Ambulance Service) 3,036

Fire & Rescue NSW 2,481

RailCorp 1,290

Ausgrid (formerly EnergyAustralia) 818

Endeavour Energy (formerly Integral Energy) 598

Department of Attorney General & Justice – Corrective Services 595

Department of Attorney General & Justice – Sheriff’s Office 436

Roads and Traffic Authority of NSW 344

Australian Rail Track Corporation 255

State Transit Authority of NSW 168

Sutherland Shire Council 150

NSW Maritime Authority 137

Sydney Water Corporation 128

Hunter Water Corporation 121

Department of Premier & Cabinet 83

Department of Attorney General & Justice – Juvenile Justice 45

Independent Commission Against Corruption 29

Australian Broadcasting Corporation 27

Central Tablelands County Councils 21

NSW Department of Transport 20

Chevra Hatzolah 19

Department of Defence 16

NSW National Parks & Wildlife Service 15

Sydney Catchment Authority 15

Independent Transport Safety Regulator 7

Sydney Ports Corporation 3

Total 23,516 Source: Email from Telco Authority to IPART 6 June 2011. Agency names have been updated where appropriate.



3.3 What future developments are likely to affect the GRN?

Our pricing methodology must not only be applied to the GRN in its present state for 2011/12, but must also be able to accommodate future changes that are expected to result from various state-wide and national developments. These developments may have major implications either for the capacity and coverage of the GRN or for the cost of the spectrum on which the GRN relies.

3.3.1 State-wide developments

In 2010, the NSW Government decided that NSW’s mobile radio networks would undergo significant structural and operational changes over the next few years.5 The most important of these changes (in the context of our review) is the new role for the Telco Authority.

The Telco Authority has been given the responsibility of improving service levels for government radio users by more integrated, cost-efficient delivery of mobile radio infrastructure and services. To achieve this goal, it has been empowered to:

1. Assume ownership over time (through the vesting of assets) of all NSW Government-owned mobile radio communications networks and associated budget allocations. The vesting is not to occur where the ‘releasing agency’ can demonstrate that such vesting is inappropriate.

2. Consolidate, to the extent possible, conventional networks and integrate them into the GRN so as to provide improved cost efficiency and better service levels across all the (reconfigured) networks.

The Telco Authority is also required to audit existing mobile radio infrastructure, develop sector-wide policies on spectrum acquisition and allocation and manage spectrum-related negotiations with the Federal Government. In addition, it is required to reduce the duplication of existing and new assets, consolidate maintenance costs and promote and co-ordinate volume discounts in purchasing.

The Telco Authority is required to proceed in stages, in the following order of priority:

1. Consolidate the conventional network of the NSW Police Force within the GRN metropolitan footprint.

2. Consolidate conventional networks outside the GRN footprint (focusing first on emergency and essential services).

3. Integrate the consolidated conventional networks and the consolidated GRN/NSW Police Force network to create a single state-wide mobile radio service.6

5 DPC, Strategic Review of NSW Government Mobile Radio Services, Draft Report, October 2010

(DPC, Strategic Review). The DPC Strategic Review has been published within Government only. 6 For more information, see NSW Premier’s Memorandum No 2010-16.



3.3.2 National developments

Like all radio services, the GRN will also be subject to other developments during the next decade. At the national level, these include:

the aim of the Federal spectrum regulator, the Australian Communications and Media Authority (ACMA), to harmonise the radio spectrum and provide a dedicated allocation in the 400MHz band to state and territory governments for law enforcement, public safety and emergency purposes

the National Framework to Improve Government Radiocommunications Interoperability as endorsed by COAG,7 and

the rollout of the National Broadband Network.

If the Federal Government decides to charge the states and territories higher prices for the spectrum it allocates to them, the full-cost pricing methodology we have recommended for the GRN will mean that any extra costs associated with spectrum will be passed through to the GRN’s end-users.

The effect of more highly priced spectrum will be to reinforce the incentive to use spectrum more effectively and efficiently. This would put downward pressure on the costs of the GRN in the future.

At this stage, the extent to which any of these national developments will affect the costs and structure of the evolving GRN is not clear, so none has been quantified by submissions or by other evidence provided to us during the course of this review.

In addition to state-wide and national developments, the GRN will also be subject to technological developments. These include the increasing technical capabilities of cellular phone networks and related services, such as radio-over-internet-protocol, PABX and pagers. Such advances, and/or others that cannot be foreseen, may allow mobile phone networks to displace some of the functions in some or all of the agencies currently performed by radio.

In light of all these developments, the tasks facing the Telco Authority and its GRN over the next decade could substantially change the shape and increase the capacity of the network. To the extent that operating and capital costs rise in step with expansion, the pricing methodology recommended in this Report should accommodate the growth in the GRN while continuing to sustain fully cost-reflective pricing for its services.

7 Commonwealth of Australia, National Framework to Improve Government Radiocommunications

Interoperability, 2009. The framework was endorsed by the Council of Australian Governments (COAG) in late 2009. Its purpose is to provide the guiding principles and key areas of work for jurisdictions to enable transition towards radiocommunications interoperability.

4 How did we derive our pricing methodology?



The Terms of Reference required us to recommend a pricing methodology that was based on full cost recovery principles and was simple and equitable to implement. To do this, it was necessary to measure the GRN’s efficient costs and allocate them fairly between its classes of users.

This chapter presents the various aspects of the pricing methodology we recommend and why we have made the choices we have in establishing it.

4.1 The building block approach and efficient costs

A fully cost-reflective pricing methodology must measure all the efficient costs of running a business and then set prices so as to ensure that revenues fully recover those costs.

The submissions we received in this review accepted that the most appropriate (if not the only feasible) method by which fully cost-reflective pricing could be achieved was known as ‘the building block approach’.

This approach is already widely used by IPART and other Australian regulators in setting prices in network industries. It takes full account of both the operating and capital costs incurred in providing the relevant services. It also ensures that the costs are measured and monitored in a transparent manner, thereby promoting economic efficiency.

The building block approach excludes costs that are inefficiently incurred. This is consistent with the Government’s efficiency aims in reforming its mobile radio networks and with good regulatory practice that insists that buyers of a regulated business’ services ought not to pay for costs incurred because of inefficiencies.

4.1.1 The revenue requirement

The approach ’builds up’ the total efficient costs of providing the services concerned. The revenue requirement is defined as the amount of revenue required to recover these costs. Total costs are determined in 3 cost ‘blocks’, as illustrated in Figure 4.1:



Figure 4.1 Illustrating the building block approach

operating expenditure (opex), which includes all operating, maintenance, administration and overhead costs

a return of capital (or depreciation), which recovers the capital invested in the business over the life of that capita.

a return on capital, which recovers the opportunity cost of having capital invested in the business.

To determine opex, we draw on expenditure data, both actual and forecast, from the business. We may employ an expert consultant to review the data, assess the efficiency with which it has, or will be, incurred and recommend any efficiency gains that would reduce the forecast expenditure. We consider the business’ information, the consultant’s findings and recommendations and stakeholder comments before deciding on the forecast efficient operating costs in each year of the determination period under review.

To determine allowances for depreciation and a return on assets, we require the initial value of the regulatory asset base (RAB). The RAB includes all infrastructure used in providing the services being priced. We usually assess whether the assets have been prudently and efficiently acquired, and whether the forecast capital expenditure (capex) for the forecast period is also being efficiently incurred.8

8 To assess the prudency and efficiency of past and forecast capital expenditure, we typically

obtain information from the relevant business on this expenditure, and engage an expert consultant to assess the information. This assessment usually includes considering any scope for deferring capital programs and any efficiency improvements that can be made by the business. We then consider the information, the consultant’s findings and stakeholder comments in order to make a finding.

Depreciation

Return on Capital

Operating Expenditure

Tota

l Effi

cien

t Cos

ts

Reve

nue

Requ

irem

ent



Depreciation is usually calculated on a ‘straight line’ basis, which means that assets in the RAB are depreciated by an equal amount each year of their remaining economic life. This can be done by asset class or by depreciating the RAB in aggregate.

The rate of return we use is a weighted average cost of equity and debt capital (WACC). It varies by industry sector and reflects several market-based and non-market-based parameters. It is used in Chapter 5 and discussed in Appendix D.

None of the submissions or Roundtable participants raised significant objections to the use of the building block method or its components as outlined above.

Because the pricing methodology is only to be applied in the first instance for one year, we did not undertake a thorough investigation into the efficiency with which the GRN will incur its costs.

However, repeated scrutiny of the GRN’s operating and capital costs will be essential as the network expands, possibly to many times its current size. Such scrutiny is best achieved by independently assessing the efficiency of costs and releasing the assessments to the core users.

Regular cost reviews should be undertaken, commencing with a review of costs for 2012/13. The frequency of such reviews after 2012/13 will depend on how rapidly the GRN expands. In other IPART pricing reviews, thorough cost reviews were not required until the end of the determination period, which is up to 4 or 5 years long.

But for a network that is undergoing rapid expansion, 4 or 5 years is too long. For the GRN, annual reviews might be taxing on resources, but a review every 2 years is probably needed, at least until the size of the GRN asset base, coverage and capacity have stabilised.

Since the core agencies will be required to cover most of the costs of operating the GRN, it is appropriate that the assessments of efficient costs be released to them.


1 Adopt the building block method as a way of ensuring that pricing of the services of the Government Radio Network (GRN) are fully cost-reflective.

2 Require the Telco Authority to undertake thorough, independent reviews of the cost efficiency of the operating and capital costs of the GRN every 2 years during its current expansion phase. The results of reviews should be made available to all the core agencies.



4.2 Impactor-pays approach to cost allocation

The Issues Paper outlined 2 fundamental approaches to the allocation of costs between users. They were:

the ‘impactor pays’ approach, and

the ‘beneficiary pays’ approach.

Under the first approach impactors pay most of the cost of establishing and maintaining the network. In the second approach every user pays. Approaches that blend these 2 methods are also possible.

The ‘impactor pays’ approach allocates the costs of providing the network’s services to the users that create the need for those services. These are the users who could not effectively function without the network, and who drive most of its costs.

An impactor-pays network might still have other users, but they will be ‘piggy-backing’ off the network’s existence and will be using it because it provides cheaper and/or better services than any alternatives (such as a mobile phone network or comparable commercial radio network).

Under the beneficiary-pays approach, all users are allocated costs on the basis of the benefits they derive, or stand to derive, from being on the network. However, it often proves difficult to measure these benefits.

Few stakeholders commented directly on the principles by which costs should be allocated among users of the GRN. Those who did were generally supportive of the impactor-pays approach, mainly on the ground that the GRN is designed for the specific purpose of meeting ‘mission-critical’ needs for communication.

Given this criterion, the 4 public safety and emergency service agencies are impactors because they all require the GRN to meet their “mission-critical” standards. For the same reason, the Government submission called these the ‘core’ users. Any agency that requires such standards would be classified as an impactor. This status would apply to the NSW Police Force if and when it migrates to the GRN.

At the Roundtable, the Telco Authority, Treasury and Motorola stressed that the GRN is designed or ‘dimensioned’ to meet the requirements of the 4 core agencies. Two major aspects of such dimensioning are coverage and capacity:

coverage refers to the geographical area that the network supports, and

capacity refers to the volume of simultaneous communication that can be accommodated across the network at any one time.



Following the Roundtable, the Telco Authority has indicated that each core agency requires effective access to all the network sites in an emergency, which implies that the maximum coverage and the maximum capacity must both be available to them.9

All other users of the GRN are, by definition, non-impactors or ‘non-core’ users because none requires mission-critical standards from the network. As noted in Chapter 2, there are presently 24 non-core users on the GRN.

As an alternative to cost-reflective pricing for the non-core users, prices can be set to reflect prices charged on a different commercial network. These prices are effectively proxies for the minimum benefit that users must be receiving for them to remain connected to the GRN. Another advantage of charging commercial prices to non-core users is that the GRN would receive a contribution towards the high fixed costs it incurs to provide its mission-critical network.

In light of these considerations:


3 Adopt an impactor-pays approach to allocating GRN costs amongst users and thus distinguish between the impactors as core users and all other users as non-core users.

4.3 Allocating costs between users

4.3.1 Costs to be paid by non-core users

We considered 2 issues to be relevant when recommending the prices to be charged to non-core users:

1. the level of revenue that should be collected from non-core users.

2. how that level of revenue should be allocated between non-core users.

Level of revenue non-core users should pay

One approach to determining the level of revenue would have been to examine the costs that the GRN was incurring in servicing the non-core users. The Telco Authority was unable to supply data to this level of detail.

The other approach, already noted in passing above, is to recognise that non-core users are deriving benefits from their access to the GRN and that those benefits are at least as great as the cost that they would have to pay if they used an alternative network (if this were not the case, they would have already left the GRN for the alternative network).

9 Email from Telco Authority to IPART dated 24 August 2011.



At the Roundtable, several participants agreed that prices for non-core users could be based on “an equivalent commercial service”.10 We consider that setting prices at commercial rates is an appropriate pricing principle because it is a reasonable way of capturing the benefit that each user derives from its access to the GRN.

As to being able to find a comparable commercial network, Motorola considered that there were few, if any, networks that offered services to the mission-critical standards required of the GRN. However, Motorola did provide us with the publicly available price schedule of what it considered to be a broadly comparable digital network. The Telco Authority has also provided a comparison between various price and service features of the GRN and a commercial trunked radio network.

We consider commercial pricing in Chapter 5 and conclude that it is possible to define a price for non-core users that is a reasonable reflection of the price charged by commercial networks.

Allocating revenue between classes of non-core users

As to how the level of revenue might be allocated between users, some submissions and participants at the Roundtable suggested that distinctions could be made between various non-core users.

The Telco Authority suggested that a distinction could be drawn between essential service users and the rest (who are much smaller users). The RFS suggested that a geographic distinction could be made for those users whose requirements are confined to a local area (eg, Sydney Catchment Authority and Sutherland Shire Council).

RailCorp considered a possible 3-way split between commercial agencies (who seek to be profitable), government agencies (who are not for profit) and charitable organisations.11

While all these distinctions have validity when viewed in their proper context, we do not see that they are necessary in the context of the present review. The key distinction is between impactors and non-impactors. Further, the Terms of Reference require us to set prices in such a way that competitive neutrality is maintained for the public trading enterprises. One way to ensure this would be to initially set the same price for all non-core users regardless of their commercial status, size or impact on the GRN.

In addition, the Terms of Reference indicate that we are to provide advice on the impact of our pricing methodology on all the users of the GRN, and that it is for the Government to assess the implications.12

10 Michael Clark-Lewis, NSW Treasury, Transcript page 14 line 45 to page 15 line 1. Motorola

supported commercial network pricing “as a starting point” (Transcript page 20 lines 6 to 9). 11 The detailed discussion may be found in the Transcript at pp 22-26. 12 Terms of Reference, numbered paragraph 3.



Therefore, for pricing purposes, we have made no distinctions between the various non-core users.

Capital costs and non-core users

One other topic that might have had implications for the prices to be charged to non-core users was the Telco Authority’s observation that non-core users may, at times, cause the GRN to incur capital costs to service non-core requirements.13 Hunter Water can be cited as an example. Its use of the GRN is highly localised but can, at times, require much of the GRN’s capacity in the Hunter region.

It is not clear to us to what extent capital spending has taken place, or will take place, specifically to service a non-core user. It would therefore be inappropriate to recommend a pricing methodology that applied a flat fee or capital charge to a non-core user as a matter of course.

However, the Telco Authority may be able to demonstrate to a non-core user in a particular case that it would cause the GRN to incur capital costs. If so, the extra capital costs would best be met by a capital contribution from the user. The contribution would be levied independently of user fees and the value of the assets bought with it would not be added to the asset base for pricing purposes.

In light of these considerations:


4 Recover costs from non-core users by charging them commercially-reflective prices with the balance of costs to be recovered from core users.

5 Require the Telco Authority to set a fee per terminal for non-core users. If a non-core user causes the GRN to incur capital costs, those costs should be met by a capital contribution which is levied independently of the fee per terminal and which does not add to the asset base for pricing purposes.

4.3.2 Costs to be recovered from core agencies

Participants at the Roundtable considered the merits of four pricing options before indicating that the best way of allocating costs would be to reflect the demands each core agency made on the GRN in terms of capacity and coverage.

The 4 pricing options considered were:

Option A - a fixed fee calculated as the revenue requirement divided by 4 (the number of core agencies).

Option B - a fee calculated in proportion to the number of terminals each core agency had registered with the GRN as at 1 April 2011.

13 Shaun Smith, Telco Authority, Transcript page 13 lines 28-42.



Option C - a combination of Option A and Option B.

Option D - a fee that reflected the actual cost drivers in the GRN.

The core agencies were of the view that any flat fee under Option A would have to differ between agencies because each agency would have a different impact on the GRN’s coverage and capacity. However, no agency quantified its own capacity and coverage requirements to us.

None of the core agencies supported Option B or any option that included a fee per terminal. The RFS pointed out that a distinction should at least be made between registered terminals that are inside and outside the GRN footprint because those outside cannot be used on the GRN unless they are brought inside the footprint.

The RFS stated that it registered all its terminals so that there would be no delay in deploying any of them in an emergency. Several participants at the Roundtable considered that the pricing methodology would be perverse if it penalised such risk-averse behaviour.

In short, we agree with the view of the participants that Options B and C are inappropriate because they depend on the use of terminal numbers. Further, we consider that Options A and D are effectively amalgamated so that the option becomes that of a flat fee that ought to reflect each agency’s call on the GRN’s capacity and coverage.

Defining each agency’s call on the GRN appears to be a difficult task. Subsequent to the Roundtable, the Telco Authority indicated that all the core agencies require connectivity to maximum capacity across the whole trunked footprint in the advent of an emergency. It suggested that it would therefore be feasible and appropriate to levy the same flat fees on each agency in 2011/12.14

This may not be the case in the years beyond 2011/12. The Telco Authority has suggested circumstances in which the same flat fee per core agency may and may not be appropriate:

Each of the core user agencies has a requirement to be able to access all of the network sites in the event of an emergency. There has been no equipment specifically deployed and no specific dimensioning for any individual agency at present. The capacity of the network across the coverage area must be sufficient to meet the worst case scenario for emergency response by the four core users. There is an equal impact on the network created by each of the four core users requirements to meet a likely worse case scenario therefore a 25% apportionment was derived for 2011/12.

14 Email from Telco Authority, 10 August 2011.



If, in the future, assets are deployed for an individual agency’s specific and exclusive use then that may alter the equal percentage apportionment. A re-evaluation of coverage and capacity impacts will be carried out when the planning phase of migrating NSW Police to the trunked network is completed (estimated to be in first quarter of 2012).15

In light of these considerations, we conclude that the key allocating principle is that the core agencies pay in proportion to their impact on the cost of establishing and maintaining the GRN. Further, we recommend that the impact on the GRN be measured by data on each core agency’s call on capacity and coverage and that these measures be summarised as an ‘impact percentage’ for each agency.

For 2011/12, equal impact percentages represent a significant departure from using the distribution of registered terminals as the basis of cost allocation, as is the case under the interim pricing arrangements (Table 4.1).

Table 4.1 “Impact” of core agencies on the GRN compared with terminal distribution

Agency Registered terminals

1 Apr 2011

Registered terminals

(%)

Assumed “impact” on

GRN (%)

RFS 8,563 47.1 25

SES 4,096 22.5 25

Ambulance 3,036 16.7 25

F&RNSW 2,481 13.7 25

Total 18,176 100.0 100

We recommend that the Minister

6 Require the Telco Authority to set a flat fee for each of the core agencies. This fee is to reflect each agency’s impact on the GRN’s capacity and coverage. For simplicity, that impact should be summarised as an ‘impact percentage’ for each agency.

4.4 Other aspects of the pricing methodology

4.4.1 Ancillary services

The NSW Government submission indicated that the GRN provides some minor ancillary services. It suggested that these services be priced by us as well. We have insufficient detail on the cost of these services to attempt to price them. We recommend that the Telco Authority price them in line with the general principle that the prices be cost reflective of the services efficiently supplied.

15 Email from Telco Authority, 24 August 2011.




7 Direct the Telco Authority to set prices for other, minor ancillary services that are commensurate with their efficient cost and the efficient use of GRN resources.

4.4.2 Annual recalibration of impact percentages

Existing core agencies will expand their presence on the GRN in the coming years. The NSW Police Force will also be added to the list of core agencies in due course.

The pricing methodology takes account of this expected expansion by requiring the Telco Authority to regularly recalibrate its measures of coverage and capacity by agency. In addition, the Telco Authority is to reach agreement with all core agencies on the appropriate impact percentages for allocating flat fees among them.

The recalibration should be performed annually because the capacity and/or coverage of the GRN are likely to change significantly each year, at least for the foreseeable future. The recalibration should be completed by 1 April each year.

If agreement cannot be reached between the relevant core agencies and the Telco Authority, the Minister should decide on the appropriate impact percentage for each core agency for the next financial year.


8 Require annual recalibration of the measures of impact (coverage, capacity) as existing core agencies expand on the GRN or as a new core agency is added. The Telco Authority should reach agreement with all core agencies on the appropriate allocation of flat fees across agencies by 1 April each year. In the event that agreement is not reached, the Minister should decide on the appropriate impact percentage to be applied to each core agency.

4.4.3 Treatment of vested assets and capital contributions

Consolidating and integrating the conventional networks, or parts of them, either into the GRN or placing them under the Telco Authority’s ownership and control is likely to result in the vesting of valuable assets in the coming years.

The assets may be valuable, and may be shown on the books of the GRN as possessing a value. But if they have been vested into the GRN, they will be acquired at no cost to the Telco Authority. It would make little sense, therefore, for the core agencies to vest their established assets into the GRN and then pay the Telco Authority a return of capital and a return on capital against those assets.



The vested assets are contributed capital, akin to capital contributions required of customers when an electricity network is expanded to meet their particular requirements. (On the same reasoning, any capital contributions made by non-core users should not be included in the regulatory asset base for pricing purposes.)

Of course, any expenditure by the GRN to maintain, upgrade or replace those assets would be included in operating costs or in the GRN’s regulatory asset base.


9 Recognise that any assets that are vested into the GRN (that is, without cost to the GRN) as it consolidates and expands should not be included in the regulatory asset base for pricing purposes. The same applies to any capital contributions that might occur under Recommendation 5.

5 How did we arrive at our recommended prices for 2011/12?



The Terms of Reference not only required us to derive a pricing methodology that is fully cost-reflective, but to also apply it to the 2011/12 pricing period.

On the basis of the data available to us regarding 2011/12 costs, impact percentages and other relevant information, our recommendations on prices, which are simple in structure and equitable to implement, are:

That the 24 non-core users each be charged $50 (excluding GST) per month for each terminal registered on the GRN as at 1 April 2011.

That the 4 core users be each charged a flat fee of $7.669m each (excluding GST).

The sections below detail the 2011/12 pricing recommendations derived from the pricing methodology discussed in chapter 4 for core and non-core users. We discuss the effect of our recommended prices on the bills of each user in Chapter 6.

5.1 Establishing efficient costs in 2011/12

5.1.1 Operating expenditure (opex)

The Government has indicated that opex, which was $14.4m in 2006/07, is expected to be $27.0m in 2011/12 (Figure 5.1). This is a cumulative rise of 88%. Such a rise over 5 years sounds large, but it seems to reflect 2 broad factors:

1. Rising capacity of the network. One reflection of this is the growth in the number of base stations by about 60% between 2007/08 and 2010/11.

2. The enlarged coverage of the GRN since 2006 (as the map in Figure 3.1 indicates).

In 2011/12 opex is expected to rise by around 14.9% over the estimated opex for 2010/11. That would mean it had risen by 22.4% since 2008/09, or at an annual average rate of 7.0%. After adjusting for inflation the annual average rise in real terms will have been 3.8%16. This seems reasonable in light of the growth in capacity and coverage.

16 We have used the Reserve Bank of Australia’s forecast for inflation for the year ended June 2012

as our forecast for 2011/12.



Figure 5.1 GRN operating expenditures ($m)

-

5

10

15

20

25

30

2006/07 2007/08 2008/09 2009/10 2010/11 (e) 2011/12 (f)

Note: e = estimated, f = forecast. Source: Email from the Telco Authority, 18 February 2011 and 24 August 2011.

Actual expenditure in 2011/12 will depend on whether any conventional networks are consolidated and integrated into the GRN this year. Operating expenditures in future years are likely to rise as consolidations and integrations proceed.

Over the longer-term, the DPC Strategic Review and the NSW Government and Motorola submissions all indicated how consolidation and expansion of the GRN would cause a substantial upward trend in GRN costs over the next decade.

Given the uncertainty about the accuracy of forecast expenditure, and the potential for it to increase significantly from 2012/13 and beyond, we considered that it would not be cost-effective to conduct an expert review of the efficiency of the Telco Authority’s forecast expenditures in 2011/12.

Therefore, for recommending prices only for 2011/12, we have used the Telco Authority’s forecast expenditures as the best available information, having assessed the real opex cost growth in recent years as reasonable in light of the GRN’s rising capacity and coverage.17

At the Roundtable, the Local Government and Shires Association (LGSA) expressed some concern that we had not undertaken an intensive analysis of the efficiency of the GRN forecast costs but understood our reasoning – set out above and below - in terms of assessing the opening asset base and capex.

17 Since most of the GRN’s opex is fixed under contract, it would be inappropriate to apply the

NSW Government’s efficiency dividend target to this expenditure.



5.1.2 Depreciation and the return on capital

To determine these allowances, we would normally undertake a rigorous process to establish the initial opening value of the business’ RAB. For the purpose of recommending the GRN’s prices for 2011/12 only, we consider that this would not be cost-effective, for 2 reasons:

the GRN was recently upgraded to an open standard P25 digital system that required a business case and procurement strategy subject to Treasury approval

the digital upgrade rendered analogue equipment obsolete and thus reduced the value of the GRN asset base to the extent that at 1 July 2011 it largely reflects the cost of the P25 digital upgrade.

Given the small size of the asset base relative to the size to which it will shortly grow, we considered that it would not be cost-effective to undertake an efficiency review to set an initial value for the RAB.

Instead, we noted that the Telco Authority’s estimate of $35.5m as the written down value of the GRN’s assets as at 30 June 2011 was quite low relative to the value of assets usually associated with a radio network that consists of 150-160 base stations.18

We also noted that the planned capital expenditure in 2011/12 of $7.96m is a 13.7% increase on the estimated capex for 2010/11, and is broadly the same as the expected increase in opex. The rise does not seem unreasonable given that the Telco Authority is beginning a consolidation and expansion phase this year.

For future years, as Recommendation 2 of the pricing methodology requires, an assessment of the efficiency of GRN operating and capital costs will be essential at various points in the current GRN expansion phase.

18 Motorola submitted that a radio network with 150 base stations would usually have assets with

an acquisition value of around $80m (excluding terminals). The GRN has assets with an acquisition value of around $74m (Government submission, p 9) for which their written down value is $35.5m. If anything, the acquisition value of the GRN with its 160 stations looks low compared to Motorola’s indicative network of 150 stations.



5.2 Net revenue required in 2011/12

Given the forecasts for opex and capex for 2011/12, we have derived the GRN’s net revenue requirement for 2011/12 based on the following other inputs:

an opening asset base of $35.5m19

an average remaining asset life of each asset class in the asset base20

an average economic life of 10.35 years for capex in 2011/12

a WACC of 5.9% derived from data available to mid-August 2011.

The calculations for depreciation and return on capital both include the opening value of the asset base and the year’s capital spending. The components of the building block are all shown in Table 5.1. The net revenue requirement for the GRN for 2011/12 is a little under $34m.

Table 5.1 Deriving the GRN’s net revenue requirement for 2011/12

Forecast cost or income item Method of calculation $m

Operating costs Supplied by Telco Authority 27.00

Depreciationa 5.61

Return on capital (Opening asset base + half of Capex)*WACC 2.33

Revenue requirement 34.94

Income from rents and ACTES Supplied by Telco Authority 1.07

Net revenue requirement 33.86

a Calculated as the sum of depreciation by each asset class plus half of capex divided by its average asset life of 10.35 years. Depreciation for each asset class is the value of assets in that class divided by their average remaining life.

Notes: We assume that capex occurs evenly across the year. ACTES = ACT Emergency Services agency.

Source: IPART.

The building block approach is based on efficient costs that are reviewed at regular intervals. Therefore, in addition to recommending that $33.86m be the revenue required in 2011/12, we also recommend that a detailed review of the GRN’s costs be undertaken before 2012/13 prices are determined when the Telco Authority should have a much better idea of the pace at which expansion of the GRN is likely to proceed.

19 The Telco Authority provided us with written-down values for 11 asset classes as at 30 June

2011. Two asset classes dominated - base stations and network operating centre equipment. 20 The Telco Authority provided acquisition dates and the average economic life of each asset

class. We calculated the average remaining asset life for each class and derived depreciation in each asset class. This was then summed to obtain total depreciation.




10 Accept the GRN’s estimate of its costs for 2011/12 and the $33.86m net revenue requirement that flows from those costs under the building block method.

11 Require the Telco Authority to undertake a thorough, independent assessment of the efficiency of the operating and capital costs of the GRN prior to the setting of prices for 2012/13 and to make the results of that assessment available to its core users.

5.3 Allocation between users

5.3.1 Costs to be paid by non-core users

The pricing methodology recommends that non-core users of the GRN should pay a fee commensurate with the prices they would pay were they connected to another commercial digital network. Some of the various price and service dimensions of the GRN and a commercial network are compared in Table 5.2.

Table 5.2 Prices for selected private mobile radio services

Feature/Function GRN Commercial

Grade of Service and Quality of Service offered

Mission Critical Business Critical

Network coverage area 160 sites across 1/3rd of NSW 21 sites across Greater Sydney Area (GSA) only

Push to Talk connection to Talk Groups

Multiple Talk Groups across foot print

$39 per terminal per month for 1 Talk Group based in the GSA

Additional Talk Groups Currently non-core users have on average 6 Talk Groups

$3 per terminal per month per extra Talk Group

Seamless mobility Terminal connectivity will roam across entire network

Terminal connectivity will roam across GSA network

GPS locator and associated functions

Standard feature Extra charge $15 per terminal per month

Terminal Security Over the Air disabling if lost or stolen

Over the Air disabling if lost or stolen

Message security Over the Air high level encryption available

No encryption offered

Emergency button function for assistance

Instant alarm, standard feature Instant alarm, standard feature

Source: Adapted from an email from the Telco Authority to IPART dated 12 August 2011.



Not all the features of both networks are comparable, but three price aspects are relevant:

The commercial network charges $39 per terminal per month for 1 talk group for users who provide their own terminals.

An extra $3 per terminal per month is charged for each additional talk group. Since non-core GRN users employ, on average, 5 extra talk groups, they would pay an extra $15 per terminal per month on the commercial network.

The commercial network charged users of its GPS locator $15 per terminal per month.

These 3 charges add to $69 per terminal per month. However, the extent to which non-core users would require the GPS locator services on the GRN is not apparent to us so we removed this service to derive a ‘comparable’ price of $54 per terminal per month. The comparable price might be higher, of course, if it were argued that non-core users would pay a premium for access to a network with mission-critical standards. However, it is not apparent what value non-core users place on having access to such standards and a greater area of coverage.

On balance, we consider $50 per terminal per month to be a reasonable approximation to the commercial price that the GRN’s current non-core users would have to pay for connection to a commercial network.

This commercially-reflective price of $50 would raise $3.19m from the current non-core users based on their holdings of registered terminals on the GRN as at 1 April 2011. That revenue is 9.4% of the GRN’s estimated net revenue requirement for 2011/12. The balance of $30.67m is to be recovered from the 4 core agencies.


12 Set the price to be paid by all non-core users at $50 per month per terminal registered on the GRN as at 1 April 2011.

5.3.2 Costs to be paid by core users

The revenue required to be raised from core users in 2011/12 is $30.67m.

We concluded in Chapter 3 that impactors should pay in direct proportion to their impact on the cost of establishing and maintaining the GRN and that that impact was best measured by data on capacity and coverage.

Since, on the advice available to us, their impact is the same, the same “impact percentage” of 25% should be allocated to each agency.



Apportioning $30.67m on an equal basis means that each core agency would pay a flat fee of $7.669m for 2011/12. This apportionment based on equal impact percentages should only apply to 2011/12. It will be essential to review the data to ensure that the core agencies are being fairly treated in any cost apportionment beyond 2011/12.


13 Set a flat fee for each core agency of $7.669m for 2011/12. This fee assumes that the impact percentage for each core agency is the same, based on information provided to IPART by the Telco Authority.

The NSW Government submission indicated that the GRN also provides some minor ancillary services and suggested that these be priced as well. We have insufficient detail on the cost of those services and suggest that for 2011/12 the Telco Authority price them in line with the general principle that the prices be cost-reflective and thus that the services be used efficiently.


14 Direct the Telco Authority to set prices for other, minor ancillary services in 2011/12 that are commensurate with their efficient cost and the efficient use of GRN resources.

6 How will our recommended prices affect users and statutory contributors?



The Terms of Reference required us to consider the cost impacts on government and non-government user agencies based on their different requirements for shared mobile radio network services. We were also directed to advise on the cost impact of the pricing methodology from 2011/12 so that the Government might assess the implications of the methodology for user agencies.

The sections below discuss the impact the pricing methodology and pricing recommendations in Chapters 4 and 5 will have on the core and non-core users of the GRN and also on the statutory contributors who fund the RFS, SES and FRNSW.

In all cases we have compared the bills that our recommended prices would generate with the bills that would result if the interim pricing arrangements that were introduced from 1 January 2011 were applied throughout 2011/12. The interim prices are based on the number of terminals each agency had registered with the GRN and were levied on a state-wide and local basis at $118.33 and $59.17 respectively.21

6.1 Assessing the impact of prices on non-core users

The bills for non-core users are shown in Table 6.1 which compares:

what the bills would be for 2011/12 on the assumption that our prices apply to the whole year, with

the size of bills that would occur if the interim prices applied throughout 2011/12.

Under the recommended price for 2011/12, the non-core users as a group pay $3.19m or less than half of the $7.09m due under the interim price arrangements.

Except for 3 agencies, all would face bills that are lower than under the interim price arrangements. The 3 agencies that would face higher bills are the NGO and the 2 local councils and all 3 are currently paying subsidized prices. If these subsidized prices were unchanged, their bills would likewise be unchanged.

21 The bills paid by users in 2010/11 reflected the charges levied for the first half of the financial

year at pre-interim prices plus the charges levied under the interim prices for the second half of the year. The total was $20.11m, made up by $3.66m (first half) and $16.45m (second half). If interim prices had applied to the whole year, the total bill would have been $32.89m.



Table 6.1 Non-core agency bills in 2011/12 with and without our recommended prices

Agency Regist-ered

terminals

Bill under interim

prices ($000)

Bill 2011/12

($)

Absolute change

($)

Percentage change

(%)

RailCorp 1,290 1,831,748 774,000 -1,057,748 -58

Ausgrid 818 1,161,527 490,800 -670,727 -58

Endeavour Energy 598 849,136 358,800 -490,336 -58

DAG&J - Corrective Services 595 844,876 357,000 -487,876 -58

DAG&J - Sherriff's Office 436 619,103 261,600 -357,503 -58

RTA 344 488,466 206,400 -282,066 -58

ARTC 255 362,090 153,000 -209,090 -58

STA 168 119,287 100,800 -18,487 -15

NSW Maritime Authority 137 194,535 82,200 -112,335 -58

Sydney Water 128 90,885 76,800 -14,085 -15

Sutherland Shire Council 126 63,005 75,600 12,595 20a

Hunter Water 121 85,915 72,600 -13,315 -15

Dept of Premier & Cabinet 83 117,857 49,800 -68,057 -58

DAG&J -Juvenile Justice 45 63,898 27,000 -36,898 -58

ICAC 29 41,179 17,400 -23,779 -58

ABC 27 38,339 16,200 -22,139 -58

Central T’lands Councils 21 10,501 12,600 2,099 20a

NSW Dept of Transport 20 28,399 12,000 -16,399 -58

Chevra Hatzolah 19 8,552 11,400 2,848 33a

Department of Defence 16 22,719 9,600 -13,119 -58

National Parks & Wildlife 15 21,299 9,000 -12,299 -58

Sydney Catchment 15 10,651 9,000 -1,651 -15

ITSR 7 4,970 4,200 -770 -15

Sydney Ports 3 2,130 1,800 -330 -15

Total 5,316 7,081,068 3,189,600 -3,891,468 -55 a The current prices paid by these 3 users are subsidized by the Department of Finance and Services. If the Minister were to increases the subsidies for these users, their prices (and bills) would not rise.

Note: Agencies names are shown in full in Table 3.1.

Source: Email from the Telco Authority to IPART 6 June 2011 and IPART.

The subsidies, worth $23,905 in the 6 months to 30 June 2011, are designed to:

keep monthly charges per registered terminal at their December 2009 levels for Chevra Hatzolah ($37.51), Sutherland Council and Central Tablelands Councils ($41.67), and

permit Sutherland to pay for 126 registered terminals rather than 150.22

22 We applied our recommended price to 126 terminals when comparing the bills in Table 6.1.



In light of the increased bills faced by the local councils and the NGO, we recommend that the Minister continue the subsidy arrangements that were put in place upon introduction of the interim prices in January 2011.

An alternative to Government subsidy would have been for us to consider different prices for different non-core agencies in the light of their commercial/non-commercial or government/non-government natures. As discussed in Chapter 4, we carefully considered, but ultimately dismissed, this suggestion.


15 Continue the subsidy arrangements for the 2 local councils and the non-government organisation (NGO) that are currently in place.

6.2 Assessing the impact of prices on core users

The impact on bills of our recommended flat fee of $7.669m for the core users is shown in Table 6.2.

Table 6.2 Core user bills in 2011/12 with and without our recommended prices

Agency Revenue required

($000)

Impact percentages

(%)

Flat fee 2011/12

($000)


($000)

Absolute change

($000)

Percentage change

(%)

RFS 25 7,669 12,159 -4,491 -37

NSWSES 25 7, 669 5,816 1,852 32

ASNSW 25 7, 669 4,311 3,358 78

FRNSW 25 7, 669 3,523 4,146 118

Total 30,674 30,674 25,810 4,865 19

Source: IPART. As in other tables, totals may not add due to rounding.

We note that the aggregate bill for the GRN’s services across all core agencies will increase by $4.9m or 19% to $30.7m in 2011/12. This is a substantial increase but it is the consequence of the derivation of a pricing methodology which is based on the principle that impactors should rightly pay the bulk of the costs of creating and maintaining a GRN which is specifically designed to meet their requirements.

The bill for the RFS will fall by $4.5m; the bills for the SES, ASNSW and FRNSW will rise by $1.9m, $3.4m and $4.2m respectively. This may have implications, which we consider shortly, for the local councils who are statutory contributors to the costs of 3 of these agencies.


16 Note that the total bill for all the core agencies combined will increase by $4.9m or 19% to $30.7m in 2011/12. The bill for the RFS will fall by $4.5m; the bills for the SES, ASNSW and FRNSW will rise by $1.9m, $3.4m and $4.2m respectively.



6.3 Assessing the impact of prices on statutory contributors

The Terms of Reference required us to examine the cost impact and implications of the pricing methodology on statutory contributions for mobile radio for the insurance industry and local government. We were also to note that our Local Government Cost Index included categories related to mobile radio such as operating leases, emergency service levies, and telecommunications services.

Statutory contributions are made by the insurance industry and local councils to the running of RFS, SES and FRNSW. The insurance industry is required to cover 73.7% and the local government sector 11.7% of the estimated total costs of the 3 services.

The actual cost of operating these agencies in 2009/10 was $937m.23 The costs on which the statutory contributions are based are estimated prior to the start of the financial year. We understand that it is these estimates which form the basis for the Annual Assessment Notices formerly issued to statutory contributors by Emergency Services NSW and now by the Ministry for Police and Emergency Services.

The impact on the statutory contributors depends on the impact our recommended prices make on the GRN bills faced by the 3 agencies and on the lag between the impact of the GRN bills on actual costs and when these actual costs are reflected in the estimates of costs that form the basis of the Annual Assessment Notices.

We understand that the statutory contributions for 2011/12 are yet to be released. If the interim prices were to continue throughout this year, the total bills of the 3 agencies would be around $21.5m. Of this sum, the insurers would be required to contribute just under $16m and the local government sector about $2.5m (Table 6.3).

Table 6.3 GRN bills and statutory contributions

Agency GRN bills

2nd half 2010/11 ($) Annualised ($)

RFS 6,079,661 12,159,322

SES 2,908,127 5,816,254

FRNSW 1,761,490 3,522,980

Total 10,749,278 21,498,556

Statutory contributions ($)

Local Government (11.7%) 1,257,644 2,515,331

Insurance Industry (73.7%) 7,922,084 15,844,436

Source: IPART, drawing on data provided by the Telco Authority.

23 This figure has been derived from the Annual Reports for 2009/10 of the 3 agencies. The

Insurance Council of Australia submission indicates that its contributions rose to $672m in 2010/11, which at 73.7% of the total, suggests that the cost of the agencies upon which statutory contributions were based in 2010/11 was $912m.



The effect of our recommended prices is to increase the GRN bills payable by the 3 agencies by around $1.5m or 7% (Table 6.4).

Table 6.4 Effect on the 2011/12 bills of the core agencies for whom statutory contributions are required

Agency Flat fee 2011/12

($000)


($000)

Absolute change

($000)

Percentage change

(%)

RFS 7,669 12,159 -4,491 -37

NSWSES 7, 669 5,816 1,852 32

FRNSW 7, 669 3,523 4,146 118

Total 23,006 21,498 1,507 7

Source: IPART.

Our recommended prices would add $1.111m to the statutory contributions of the insurance industry (73.7% of $1.507m) and $0.176m to the statutory contributions of local governments.

The higher GRN bills may flow through to the Annual Assessment Notices for statutory contributions either in 2011/12 or 2012/13. Either way, their effect on total contributions is likely to be small because the GRN component of total contributions is small. For example, the insurance industry paid $672m in statutory contributions in 2010/11.24 A $1.111m rise on $672m is a little less than 0.2%.

For local councils, 2 other considerations apply. First, the $0.176m rise will not be spread proportionately across councils. Instead, councils that contribute relatively more to RFS costs benefit from the reduction in the RFS’s GRN bills while other councils will pay the higher GRN bills of the SES and Fire & Rescue NSW.

Secondly, all councils will receive some consideration in the calculation of their rate peg. Emergency service levies (that is, statutory contributions) have a 1.4% weight in IPART’s Local Government Cost Index.25 We estimate that GRN bills comprise about 2.3% of total emergency service levies (ESLs).26

In practice, there could be lags between the rise in the GRN bills and the revenue that flows to local councils because of the rate peg adjustment.


17 Note that statutory contributors will be required to pay their legislated percentages of the change in the bills faced by the RFS, SES and FRNSW. In 2011/12 their combined GRN bill will rise by $1.507m.

24 Insurance Council of Australia submission, p 2. 25 IPART, Local Government Cost Index, Information Paper December 2010, p 5. 26 The 2.3% is based on $21.5m in GRN bills under the interim prices divided by $937m in costs to

the 3 agencies in 2009/10 (footnote 19).

7 Other matters


7 Other matters

The Terms of Reference required us to consider 3 other matters that have not been addressed so far in this Report. They concern competitive neutrality for the public trading agencies that use the GRN, financial arrangements with the ACT Emergency Services and the Mobile Radio Data Network.

7.1.1 Competitive neutrality

The Terms of Reference required us to consider competitive neutrality principles for the public trading agencies that used the GRN.

Competitive neutrality requires that public ownership confers no benefits on a government enterprise relative to private sector competitors.

The Issues Paper cited 5 criteria by which to judge whether a government business was being competitively neutral. A competitively neutral government business is required to:

1. charge prices that fully reflect costs

2. pay, or include an allowance for, taxes and charges paid by the private sector

3. pay commercial rates on borrowings

4. generate commercially acceptable profits

5. comply with the same regulations that apply to private businesses (eg, planning and environmental laws).

The building block method ensures that the GRN’s prices are fully cost-reflective (criterion 1) and that borrowing costs (criterion 3) and profits (criterion 4) are satisfactory (via the WACC). The extent to which private sector competitors pay taxes and charges that the GRN does not pay is not apparent (criterion 2). Finally, the GRN appears to have to comply with the same regulations as private businesses (criterion 5).

Therefore, it is not apparent that public ownership as such confers benefits on the GRN that are unavailable to private sector competitors.

7 Other matters



18 Accept that there are no issues of competitive neutrality in relation to the GRN as long as it charges the same commercially-reflective prices to all non-core users regardless of their ownership structure.

7.1.2 Arrangements with ACT Emergency Services

The Terms of Reference noted that the NSW Government radio network and the ACT Government radio network are effectively one integrated network with a shared network operations control centre. Further, the ACT Government currently contributes to the capital and recurrent costs of operating the GRN based on the proportion of their use of the centre network infrastructure.

The Government submission observed that the connection of the ACT to the GRN Central Control and Disaster Recovery centres is paid for through a contractual agreement between the Telco Authority and the ACT Emergency Services Agency. These services are expected to be the subject of separate commercial agreements with the respective agency and are not part of the GRN pricing model.


19 Accept the present payment arrangements between the Telco Authority and the ACT Emergency Services for access to the GRN’s central control centre and for various data links.

7.1.3 Mobile Radio Data Network

The Terms of Reference required us to review the pricing of shared mobile radio services and suggest that the MDRN is within the scope of this review. However, the MDRN is used exclusively by the Ambulance Service so that it is not a shared service.


20 Note that the Mobile Data Radio Network is not a shared service and that, as such, is outside the scope of pricing for the GRN.

7 Other matters


Appendices

A Terms of Reference



Background

On 6 October 2010, the Cabinet Standing Committee on the Budget (Budget Committee) made determinations on NSW Government Mobile Radio Services.

The Committee approved the application in 2010-11 of full cost-recovery principles for the future provision of NSW mobile radio services.

Furthermore, the Committee requested that the Independent Pricing and Regulatory Tribunal (IPART) review pricing for mobile radio services for user agencies from 2011-12 with terms of reference to be confirmed in consultation with IPART.

In general mobile radio services fall into three broad categories - mobile voice, mobile data and fixed data (SCADA - Supervisory Control and Data Acquisition - and paging) services.

The mobile voice networks are either shared or multi -agency (the NSW Government Radio Network) or single agency only.

The NSW Government radio network and the ACT Government radio network are effectively one integrated network with a shared network operations control centre. The ACT Government currently contributes to the capital and recurrent costs of operating the GRN based on the proportion of their use of the centre network infrastructure.

The review will:

1. Develop a pricing methodology (methodology) based on full cost recovery principles for application to users of shared mobile radio network infrastructure. The methodology would take into account the current and future operating and capital costs to maintain shared networks. It would be both simple and equitable to implement.

2. In developing the methodology, take into consideration applicable risk factors including:

– The future cost impacts on in-scope NSW mobile radio users from reforms by the Commonwealth Government (Australian Communications and Media Authority) for the pricing and availability of radio spectrum.

– The future cost impacts on government and non-government user agencies based on their different requirements for shared mobile radio network usage and coverage levels.

– The application of competitive neutrality principles for public trading agencies that are users of the shared mobile radio network infrastructure.



– a phased introduction of the proposed state-wide service.

3. Provide advice on the cost impact of the proposed methodology on eligible users and government agencies from 2011-12. This will enable the Government to assess the implications of the new methodology for user agencies.

4. Examine the cost impact and implications of the proposed methodology on statutory contributions for mobile radio for

– the insurance industry and

– local government, noting that IPART’s Local Government Cost Index already includes categories related to mobile radio such as operating leases, emergency service levies, and telecommunications services.

5. Based on the proposed methodology, recommend prices to commence on 1 July 2011.

Scope

Lead law enforcement, public safety and emergency service organisations (NSW Police Force, NSW Fire Brigades, Ambulance Service of NSW, the Rural Fire Service and the NSW State Emergency Service) have the most critical operational need and requirements for mobile radio services.

However, other essential service providers (such as transport, water and energy suppliers) rely on mobile radio services for their business operations and in times of emergency.

There are about ten entities which are not NSW Government entities (nor State Owned Corporations) who use the government mobile radio network. These entities such as CareFlight and the Department of Defence account for about 2 per cent of the total number of registered handset devices. The ACT Emergency Services account for about 8% of the total number of registered handset devices. The way in which the ACT contributes to NSW capital and operating costs is in scope. Mobile data services, other than the Mobile Data Radio Network, and SCADA systems are out of scope.

IPART is requested to consult with key stakeholders.

Timing and Resources

The review is to report to the Minister for Commerce in order that a pricing regime commences on 1 July 2011. The Department of Services, Technology and Administration will provide senior officer level support to the review team.

B List of submissions


B List of submissions

Table B.1 List of public submissions to the issues paper

Name Organisation

Peter Duncan NSW Government – Department of Premier & Cabinet

Stuart Wilson Sydney Water Corporation

David Hill Motorola Solutions

James Hewitt ACT Emergency Services

David Ipp NSW Independent Commission Against Corruption

Robert Whelan Insurance Council of Australia

C List of participants at the Roundtable


C List of participants at the Roundtable

Table C.1 List of participants at the roundtable

Name Title Organisation

Representing IPART

Mr James Cox PSM Acting Chairman IPART

Ms Sibylle Krieger Tribunal Member IPART

Mr Steve Lyndon Secretariat IPART

Dr Dennis Mahoney Secretariat IPART

Representing Telco Authority

Mr Shaun Smith Director, Business Development Telco Authority

Mr Rob Crawford Manager, Radio Reform Telco Authority

Representing NSW Government agencies

Mr Peter Barrie Assistant Commissioner NSWPF

Mr John Shenstone Assistant Director, IT Communications FRNSW

Mr Bruce McDonald A/Director, Infrastructure Services RFS

Mr Patrick Clague Manager Communications SES

Mr Roger Hanssen Director Information Technology ASNSW

Mr Julian Richards General Manager, Communications & Control Systems

RailCorp

Mr Michael Clark-Lewis Director Treasury

Mr Peter Connelly Executive Director Dept of Premier and Cabinet (DPC)

Mr James Koulouris Director, Performance Improvement & Review

DPC

Representing other agencies or organisations

Mr David Hill Area Manager, Gov’t & Public Safety Motorola

Mr Jim Hewitt ACT Radio Networks Manager ACTES

Mr Alex Sanchez GM Economics & Taxation Insurance Council

Mr Trevor Rowling GM Administration Sutherland Council

Mr Shaun McBride Senior Strategy Manager, Finance, Infrastructure and Planning

LGSA

Rabbi Mendy Litzman President Chevra Hatzolah

D Deriving a WACC for the GRN


D Deriving a WACC for the GRN

The derivation of the weighted average cost of capital (WACC) was set out in the Issues Paper and an update of calculations was included in the Roundtable Notes.

Some of our parameter values have drawn on research by the ACCC regarding the credit rating, gearing levels and beta estimates of a large telecommunication service provider relative to the Australian market.27 The parameters we have chosen are appropriate for telecommunications businesses in Australia.

At the Roundtable, we used an indicative WACC of 6.5% to derive the GRN’s return on capital. That WACC reflected a nominal risk free rate of 5.0%, an inflation rate of 2.9% and a debt margin of 2.1%, all of which have changed since the Roundtable.

The latest estimates, derived as 20-day averages to 15th August, are in Table D.1. They generate a WACC of 5.9%, as used in the text. The biggest change since the Roundtable has been to the risk-free rate. It has fallen 70 basis points as markets re-assessed the outlook for the local and global economies and for cash rate reductions in Australia.

Table D.1 Parameter and WACC valuations – GRN pricing

Value

Nominal risk free rate 4.3%

Inflation adjustment 2.8%

Debt margin (A rated company) 2.3%

Market risk premium 5.5% - 6.5%

Debt to total assets (gearing) 40%

Gamma 0.5 - 0.3

Tax rate 30%

Equity beta 0.7

WACC range (real pre-tax) 5.4% - 6.4%

WACC mid-point (real pre-tax) 5.9%

If required, we will update our estimate of the WACC for any future pricing review upon request from the Telco Authority.

27 ACCC, Assessment of Telstra’s Unconditioned Local Loop Service Band 2 monthly charge undertaking –

Final Decision, April 2009; ACCC, Public inquiry to make final access determinations for the declared fixed line services – Discussion Paper, April 2011.

E This review in relation to its Terms of Reference


E This review in relation to its Terms of Reference

The following table indicates where the matters raised in the Terms of Reference have been considered in this report.

Table E.1 Where matters raised by the Terms of Reference are discussed in this report

Terms of Reference Addressed in the Report

Future cost impacts of spectrum reforms by the Commonwealth Government

Chapter 3

A phased introduction of the state-wide service Chapter 3

Pricing methodology Chapter 4

Recommended prices for 2011/12 Chapter 5

Impacts on government and non-government users of the GRN Chapter 6

Impact on users in 2011/12 Chapter 6

Impact on statutory contributors Chapter 6

Competitive neutrality principles for public trading enterprises Chapter 7

Treatment of the ACT Emergency Services Chapter 7

Treatment of Mobile Data Radio Network Chapter 7

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