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MODULE 1

OVERVIEW OF TELECOMMUNICATIONS REGULATION

1.1 Regulatory Objectives

1.1.1 Why Regulate Telecommunications?

The last decade of the 20th Century sawunprecedented changes in the global telecommuni-cations industry. Numerous state-ownedtelecommunications operators were privatized, anda wave of pro-competitive and deregulatory tele-communications policies swept the world. Newmarket-based approaches to the supply oftelecommunications services were introduced inscores of countries.

This liberalization of telecommunications marketswas motivated by various factors, including:

➢ Increasing evidence that more liberalized tele-communications markets were growing andinnovating faster and serving customers better

➢ The need to attract private sector capital toexpand and upgrade telecommunicationsnetworks, and to introduce new services

➢ Growth of the Internet, which caused data trafficto overtake voice traffic in many countries, andled to the introduction of many new serviceproviders

➢ Growth of mobile and other wireless services,which provided alternatives to fixed networks

and introduced new service providers to tele-communications markets

➢ Development of international trade in telecom-munications services, which are increasinglyprovided by transnational and global serviceproviders

As market-based approaches were adopted duringthe 1990s, the number of national telecommunica-tions regulatory authorities increased from 12 to over90 around the world. To some this appears ironic.Shouldn’t the market-based supply of telecommuni-cations be accompanied by less regulatoryintervention, rather than more?

The consensus answer around the world is yes – inthe long run, but no in the short run. The successfultransformation of monopolistic telecommunicationsmarkets into competitive ones requires regulatoryintervention. Without it, viable competition is notlikely to emerge. In fact, the times when privatizationand the introduction of significant competition occurcan be the busiest periods in the life cycle of aregulatory organization.

Regulatory intervention is required for a variety ofreasons. Typically, regulators must authorize orlicense new operators. They must often removebarriers to market entry by new operators. Theymust oversee interconnection of new entrants withincumbent operators. Regulatory intervention may

Telecommunications Regulation Handbook

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also be required to ensure competitive markets donot fail to serve high cost areas or low incomesubscribers.

The objectives of telecommunications regulationvary from country to country. Governments in mostcountries continue to see telecommunications as anessential public service. Even after telecommunica-tions networks are no longer run by them,governments normally retain a regulatory role toensure that telecommunications services aresupplied in a manner consistent with nationalperceptions of the public interest.

With the widespread adoption of market-basedapproaches to the supply of telecommunicationsservices, there is a growing consensus that regula-tors should not be involved in detailed“management” of the sector. Instead, the regulators’role is seen to involve maintenance of a regulatoryenvironment conducive to the efficient supply of

telecommunications services to the public. Theservice suppliers will generally be private sectoroperators.

The trend today is toward deregulation. Sometraditional forms of telecommunications regulationare now viewed as having been more damagingthan beneficial to the development of national tele-communications infrastructure and services. Today,when regulatory measures are proposed orreviewed, governments and regulators mustgenerally ensure that (1) there is a demonstratedneed to regulate, and (2) the most efficient measureis selected to meet the specific regulatory objective.

While regulatory measures vary from country tocountry, the main objectives of telecommunicationsregulation are often similar. Box 1-1 lists someregulatory objectives that are widely acceptedaround the world today.

Box 1-1: Widely Accepted Regulatory Objectives

➢ Promote universal access to basic telecommunications services

➢ Foster competitive markets to promote:

➢ efficient supply of telecommunications services

➢ good quality of service

➢ advanced services, and

➢ efficient prices

➢ Where competitive markets do not exist or fail, prevent abuses of market power such as excessivepricing and anti-competitive behaviour by dominant firms

➢ Create a favourable climate to promote investment to expand telecommunications networks

➢ Promote public confidence in telecommunications markets through transparent regulatory and licensingprocesses

➢ Protect consumer rights, including privacy rights

➢ Promote increased telecommunications connectivity for all users through efficient interconnectionarrangements

➢ Optimize use of scarce resources, such as the radio spectrum, numbers and rights of way

Module 1 – Overview of Telecommunications Regulation

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Overview

1.1.2 Expansion of TelecommunicationsRegulation

Government regulation of private sector telecommu-nications operators began in the US and Canada inthe late 19th Century. However, in most of the world,telecommunications networks were operated bygovernment administrations for most of the 20thCentury. In most countries, governments ran tele-communications operations in the same way asgovernment postal, rail or highway transportationservices. This situation changed dramatically overthe past ten years, as dozens of countries privatizedtheir telecommunications operations.

The number of telecommunications regulators hasincreased rapidly over the past few years. Severalfactors precipitated this growth in regulation. Themajor factor is the implementation of telecommuni-cations reforms that led to the separation of thepolicy, regulatory and operational functions oftelecommunications.

Regulatory agencies were established at the sametime that many government telecommunications

administrations were privatized. The overallobjective of these new regulators was to ensure thatpublic policy objectives for the sector continued to bemet. While government monopolies are notperceived to require regulation, private monopoliesgenerally are. Introduction of competitors in manynewly privatized markets also increased the need fornew regulators, to act as referees between the newentrants and incumbent operators.

ITU data indicate that in 1990, 12 countries hadtelecommunications regulatory agencies thatfunctioned separately from telecommunicationsoperators. The term “separate regulators” generallyrefers to agencies that operate separately fromgovernment ministries or PTTs that are alsoresponsible for the provision of telecommunicationsservices. By August 1999, that number hadincreased to 84. Nine new regulators were estab-lished between mid-1998 and mid-1999. In late2000, the number was around 96 and increasing.The growth in the establishment of separateregulators is illustrated graphically in Figure 1-1.

Figure 1-1: Growth in Number of Regulators

Separate regulators, by region, 1999Total: 84

Africa 24%

Americas 26%

Europe 31%

Asia-Pacific 13%

Arab States

6%

Establishment of separate regulators

12

30

53

96

1990

22

1992 1994 1996 1999 2000

84

Source: ITU (1999a) and (2000)


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While the growth of regulatory authorities is remark-able, it should be kept in perspective. In manycases, new regulators replace existing PTT orMinistry functions. Therefore, in some countries, theestablishment of separate regulators may not resultin an increase in the number of government officialswith regulatory functions. Also, while there is likely tobe an increase in regulatory activity around the timeof privatization and the introduction of competition,the level of regulatory intervention can be expectedto drop significantly once competitive markets areestablished.

1.1.3 Implementing TelecommunicationsSector Reform

While government policy officials usually introducetelecommunications sector reforms, regulators mustimplement many of these reforms. Good regulationis required to ensure the success of sectoralreforms. Table 1-1 summarizes major reforms thathave been introduced, and are continuing to beintroduced around the world. The table also listsmajor objectives for the introduction of thesereforms.

Table 1-1: Major Global Telecommunications Sector Reforms and Associated Objectives

Reforms Major Objectives

Privatization of PTTs ➢ Attract financing to expand telecommunications infrastructure

➢ Increase sector efficiency, introduce new services

➢ Generate government revenues from privatization proceeds

Licensing of CompetitiveOperators

➢ Expand range of services; serve unserved markets

➢ Increase sector efficiency through competition

➢ Decrease prices, improve range and supply of services

➢ Stimulate innovation and introduce advanced services

➢ Generate government licensing revenues

Introduction ofTransparent RegulatoryProcesses

➢ Increase success of licensing processes & government credibility

➢ Increase government revenues from licensing new services

➢ Increase market confidence, attract more investment

MandatoryInterconnection andUnbundling of PSTN

➢ Remove barriers to competition

➢ Promote competition in advanced services (e.g. broadband Internet)

Price Cap Regulation ➢ Better incentives for efficient service supply by dominant firms

➢ Simpler method that ROR regulation to prevent excessive pricing

➢ Reduce regulatory lag; ensure timely price adjustments

Targeted Universal AccessFunds

➢ Increase efficiency and effectiveness of universality policies

➢ Replace less transparent and potentially anti-competitive cross-subsidies

Removal of Barriers toInternational Trade inTelecommunications

➢ Increase investment in telecommunications sector

➢ Improve competition in telecommunications markets

➢ Improve global communications


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Overview

While a number of these reforms were perceived asradical when they were first proposed 10 or 20 yearsago, many have become the generally acceptedstandards today. As these reforms were introducedin an increasing number of countries, some havebecome incorporated into trade agreements andinternational trade policies. Most significantly, theWTO Agreement on Basic Telecommunications(ABT) and its Regulation Reference Paper incorpo-rate a number of these reforms. The ABT isdiscussed in several Modules of this Handbook andthe Reference Paper is reproduced in Appendix A.

1.2 Regulatory Organizations

1.2.1 The Role of National GovernmentAuthorities

Until recently, in many countries, a single Ministry orother government administrative unit performed theroles of telecommunications policy maker as well asowner and operator of the national telecommunica-tions network. No need was perceived for aregulator in this environment. The same governmentofficials were often involved in policy decisions,policy implementation and operation of thetelephone service.

Privatization and market liberalization has led to are-organization of the government institutionsinvolved in the telecommunications sector. The mostcommon institutional model used in developedmarket economies around the world today, isillustrated in Table 1-2.

The structure set out in Table 1-2 is compatible withthe market-based supply of telecommunicationsservices, rather than government-based supply. It

also facilitates compliance with the WTO RegulationReference Paper, in that it provides for a regulatorthat is separate from the telecommunicationsoperator, and that can resolve interconnectiondisputes. This structure has the following features:

➢ Government officials can set policies in thenational interest, without conflicting concernsbased on their role as owners, managers oremployees of telecommunications operators. Inparticular, governments are more inclined tointroduce significant competition in telecommu-nications markets if they do not also run themain operator.

➢ Separate regulatory authorities can implementgovernment policy in an objective and impartialmanner. Separation from state-owned telecom-munications operators increases the ability ofregulators to act impartially toward all marketparticipants, for example in matters involvingcompetition policy or interconnection.

➢ Market confidence in the impartiality of regula-tory decisions generally increases with thedegree of independence of regulators from bothoperators and governments. Such marketconfidence promotes increased foreign anddomestic investment in both incumbentoperators and new entrants in the sector.

➢ Privately owned operators can make rationaleconomic decisions about the supply of tele-communications services, without conflictingconcerns arising from government ownership.

Table 1-2: Standard Institutional Structure in Developed Market Economies

Function Responsible Organization

Policy Development Government Ministry or Executive Branch

Regulation Separate Regulatory Authority

Network Operations/Service Provision PTOs (privately or commercially operated)


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➢ For example, some PTTs traditionally main-tained excessively large work forces for politicalor other non-economic reasons. This resulted ininefficiency and added costs for consumers. Inmost cases, privatization of telecommunicationsoperations has increased the supply of tele-communications services and reduced costs.“Commercialization” of state-owned operatorscan also increase immunity from governmentinterference, relative to traditional PTTs.However, the degree of immunity depends onthe degree of independence granted to the“commercialized” state operators.

While there continue to be different views about thebest institutional structure for the telecommunica-tions sector in different countries, the modeldescribed above has clearly become the standardone. Other models are often seen as transitional,with recognition that the “standard” model willultimately be adopted.

In some countries, other government ministries oragencies may play key roles in the telecommunica-tions sector. For instance, a competition authoritymay be an important component of the institutionalstructure (the respective roles of a general competi-tion authority and a sector-specific telecommunica-tions regulator are discussed in detail in Module 5).Other organizations that may play a significant rolein determining the overall economic environment ofthe telecommunications sector include ministries offinance and ministries of planning, as well asprivatization and tax authorities. All of theseinstitutions can play particularly important roles atthe time of privatization. However, once privatizationis completed, they often take on a more secondaryrole to the three entities described in the “standardmode”.

1.2.2 The National Regulatory Authority

An increasing number of governments havedeveloped an institutional structure of the type illus-trated in Table 1-2, which includes a separatenational regulatory authority. A variety ofapproaches have been developed to establish andoperate such regulatory authorities. In the followingsections we consider five major issues thatfrequently arise:

➢ Independence of the Regulator

➢ Funding of the Regulatory Process

➢ Single Regulators and Collegial Commissions

➢ Multi-Sector Regulators

➢ Organization of Regulatory Staff

1.2.2.1 Independence of the Regulator

As illustrated in Table 1-2, the standard institutionalstructure for the telecommunications sector aroundthe world today includes a separate regulator. Whatis most important in this regard is separation of theregulator from the telecommunications operator(s) inthe market. Such separation inspires marketconfidence and promotes compliance with interna-tional trade obligations.

Of equal importance in the eyes of manyexperienced telecommunications experts isindependence of the regulator from governments. Inpractice the degree of such independence variesconsiderably from country to country. It depends onthe legal, political and institutional structure of eachcountry. Regulators in few, if any, countries enjoycomplete independence from governments. At aminimum, most regulators are appointed and paidby governments, and have budgets established orcontrolled by them.

There are good reasons for increasing the degree ofindependence of regulators from governments. Suchindependence increases perceived neutrality andinsulation from political or operational pressures.This perception of independence is particularlyimportant where a government retains ownership ofthe PTO.

Telecommunications operators and investors willgenerally have greater confidence that anindependent organization will regulate a marketobjectively and transparently. This can lead toincreased investment in the sector and to relatedbenefits for the economy. Such confidence will,however, depend on the credibility of the regulator. Itmust have a demonstrated capability to regulate in aprofessional and impartial manner.


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Overview

In some countries, separation of regulators from thegeneral government administration also provides anopportunity to pay higher salaries to regulatoryofficials. This can be important in developing andtransitional economies where extremely low gov-ernment pay scales can make it difficult to attractand retain highly qualified and non-corruptible staff.The best staff of regulators in such countries caneasily be lost to the private sector if the regulators’pay scale is not competitive.

Finally, it must be clear that “independence” of theregulator does not mean independence from thelaws and policies of a country. The mandate of anindependent regulator should be clearly spelled outin national laws. Regulators should be accountableto legislatures or other government bodies. Suchaccountability should include mechanisms, such asannual reports or legislative hearings, in which theregulator must demonstrate in a transparent mannerthat it has properly exercised its mandate.

1.2.2.2 Funding the Regulatory Process

It is essential to provide adequate funding for theregulatory process. Funding is required to hire goodcalibre professional staff and consultants that canimplement regulatory objectives. Without adequatefunding, regulation will not usually be effective.Regulatory objectives related to the opening ofcompetitive markets and the establishment of a levelplaying field are not likely to be achieved.

Separate regulators can be funded in a number ofways. Traditionally, regulatory functions were fundedout of general government budget appropriations,particularly when the functions were carried outwithin Ministries of Communications or PTTAdministrations. Budget appropriations are alsoused for many separate regulators. However,licence fees and spectrum fees paid by operatorsprovide an increasingly common means to fund theregulatory function.

A typical approach to levying licence fees is todistribute the costs of running the regulatoryfunctions among all licensed telecommunicationsoperators in proportion to their gross telecommuni-cations revenues. Thus, in the early years, theincumbent operator (e.g. the former PTT) may pay90% of the regulator’s costs because it earns 90% of

telecommunications revenues in the sector. Overtime, however, the licence fees payable by theincumbent will decrease, as other operators gainmarket share.

There are advantages to funding a regulator throughlicence and spectrum fees rather than governmentappropriation. Licence fees provide a way of recov-ering the costs of government services on a “userpay” basis. Telecommunications sector licence feescan generate a sufficiently large source of revenuesto ensure the regulatory function is carried out in aprofessional manner, something that cannot alwaysbe assured by cash-strapped governments indeveloping economies. Other segments of societyand the economy are not burdened with the regula-tory costs. There is some accountability and greatertransparency to determine when regulatory budgetsare being spent well, and when they are not. Theissue of licence fees is discussed further in Module2.

1.2.2.3 Single Regulators and CollegialCommissions

Telecommunications regulators first emerged in theUS and Canada at the end of the 19th Century.These regulators were structured as quasi-judicialboards or commissions. While these regulators wereled by a chairperson, they were essentially collegialorganizations. Decisions were typically made byconsensus or, in case of controversy, by a majorityvote. As the complexity of regulation increased,these regulators eliminated some of their judicialtrappings, and hired an increasing number oftechnical, professional and support staff.

When new telecommunications regulators wereestablished around the world in the 1990s, manywere headed by a single director general, or otherofficial. This structure was similar to other govern-ment organizational models used in some of thecountries where the new regulators were estab-lished. An early example was Oftel, the UKregulator, which was established in 1984, whenBritish Telecommunications was privatized. As withthe commission model, regulators headed by asingle official are usually assisted by varioustechnical, professional and support staff, as well asoutside consultants.


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In the latter part of the 1990s, the commissionapproach became more popular again. The 1999ITU Trends Report indicates that six of the nine newregulators established between July 1998 andAugust 1999 were collegial bodies, composed ofbetween five and eleven members. New regulatorsestablished in Albania, Bulgaria, Egypt, Greece,Kenya, Malawi and Malaysia are all collegial bodies.

There are advantages and disadvantages to boththe hierarchical and collegial approaches. Neithercan be said to be superior in all cases. However,several observations can be made:

➢ Single regulators can act more quickly anddecisively than collegial bodies.

➢ Collegial bodies provide checks, balances andcollegial support for the decision-makers.Decisions can therefore be more thoroughlydebated and considered.

➢ Large collegial bodies can lead to less cohesionand consistency than small ones or singleregulators.

➢ Some countries with large collegial bodies havereduced them in size to increase decision-making efficiency (e.g. the US).

➢ Some collegial bodies, especially large ones,have part-time members. Such membersusually find it more difficult to keep abreast ofdevelopments in rapidly changing telecommuni-cations markets.

➢ Collegial bodies are somewhat less susceptibleto “capture” by regulated companies. However,financially insecure regulators of both types maybe motivated by future career prospects in theindustry. Government tenure or other forms ofsecurity can mitigate this concern.

In practice, both single regulators and collegialcommissions often rely heavily on professional staffand consultants for fact gathering, analysis, andrecommendations. In some cases, regulatory staffare empowered to make some types of regulatorydecisions. This is the case, for example, for staff

Bureau Chiefs of the FCC in the US. Thus, while thefinal decision on important regulatory matters anddirections will rest with the single regulator orcommission, depending on the model, much of thestaff work and more routine decision-making can bevery similar under both models.

1.2.2.4 Multi-Sector Regulators

Telecommunications regulators usually have sector-specific regulatory functions. In most cases, they areresponsible for regulating only telecommunicationsmarkets. In some cases, they also have regulatoryfunctions in adjacent markets. Examples includebroadcasting (e.g. Canada and the US) andinformation services generally (e.g. Singapore andMalaysia). South Africa has established a mergedtelecommunications and broadcasting regulator(ICASA) on 1 July 2000.

A different approach that is well worth consideringinvolves the establishment of a multi-sector regula-tor. Such an agency typically regulatestelecommunications as well as other industry sectorswith similar economic and legal characteristics.Examples of such sectors include electrical powergeneration and distribution, oil and gas pipelines,postal services, transportation and water utilities.

Multi-sector regulators, often referred to as publicservice commissions, existed for many years inCanadian provinces and states of the US. Theyhave also been established in some developingeconomies, such as Bolivia, El Salvador, Jamaicaand Panama. The multi-sector approach was alsoseriously considered, but recently rejected in the UK.Box 1-2 sets out some of the advantages anddisadvantages of the multi-sector regulatoryapproach.

Other considerations are relevant in decidingwhether a multi-sector regulatory approach works inany particular country. In most countries, reformoccurs at different times in different industry sectors,such as telecommunications, energy, and water. Itmay be impractical to establish multi-sectorregulatory agencies , for example, where the tele-communications industry has been privatized, butenergy and water services continue to be suppliedby government administrations.


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Overview

Box 1-2: Advantages and Disadvantages of Multi-Sector Regulators

Key Advantages Key Disadvantages

➢ Reduce risk of “industry capture” becausethe creation of a regulator with responsibilityfor more than one sector can help avoid therule-making process being captured byindustry-specific interest groups

➢ Reduce risk of “political capture” because aregulator with responsibility for more thanone sector will necessarily be moreindependent of the relevant line Ministries.The broader range of entities regulated bysuch a regulator will be more likely to resistpolitical interference in a decision on, say,price regulation in one sector since thatcould set a precedent for other sectors

➢ Create more precedents, and therefore lessuncertainty, for investors because a decisionby an MSR in relation to one sector on aregulatory issue common to other sectors(e.g. the application of price cap regulationor cost accounting rules) will set a precedentthat is valuable to potential investors in thoseother sectors

➢ Economies of scale in the use of one set ofhigh-calibre professionals (e.g. economists,lawyers, financial analysts). Such economiesare particularly important during the earlystages of liberalization and privatization in aTDC when there is likely to be a scarcity ofregulatory experience

➢ Increase risk of “industry capture” by adominant industry player not only of the singlesector regulator but of the entire MSR body

➢ Increase risk of “political capture” by adominant ministry of not only the single sectorregulator but of the entire MSR body

➢ Increase risk that a precedent set in relationto one sector could be applied inappropriatelyin another sector (although this can also bemitigated by creating strong sector-specificdepartments underneath a central cross-sectoral decision-making body)

➢ Dilution of sector-specific technical expertiserequired where, for example, the skills of atariff expert for one sector are not transferableto similar tariffing issues in another sector, or,for example, of a frequency engineer

Other Advantages Other Disadvantages

➢ Economies of scale in administrative andsupport services (e.g. computers, officespace, support staff), particularly importantwhere the costs of regulation can have a realimpact on the affordability of basic services

➢ Flexibility in dealing with “peak load” periods,such as periodic price reviews, whereintensive regulatory expertise is neededwhich may be spread across sectors if amulti-sectoral approach is adopted

➢ Economies of scale in the development andimplementation of the regulatory agencywhereby, for example, uniform rules onlicence award or dispute settlementprocedures can extend to more than onesector and, therefore, avoid the need to “re-invent the wheel” for each sector

➢ Failure by the regulator cascades to othersectors

➢ Difficulty in achieving acceptance by relevantline Ministries of the concept of having anMSR

➢ Subsequent difficulty in achieving consensusfrom the relevant line Ministries on the type ofMSR to be established

➢ Greater complexity in establishing the legalframework for the MSR, including the level ofindependence and allocation of functions asbetween the Minister and the regulator

➢ Potential delays in the reform process due tothe disadvantages mentioned above


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Box 1-2: Advantages and Disadvantages of Multi-Sector Regulators (cont’d)

➢ Transfer of regulatory know-how betweenregulators responsible for different sectors;again, this is particularly important when acountry has limited experience in regulation

➢ Effective means of dealing with convergingsectors (e.g. telecommunications and broad-casting where it is increasingly difficult todecide what is a telecommunications andwhat is a broadcasting service, for examplevideo-on-demand, or telecommunicationsand posts, for example email and fax re-mailing)

➢ Effective means of dealing with the bundledprovision of services (e.g. provision of bothtelecommunications and electricity by thesame company) and with co-ordinationrequirements between sectors (e.g. wherecompanies from a number of differentsectors all need to dig up the same roads toconstruct their networks)

➢ Avoidance of market distortions due to theapplication of different rules to competingsectors (e.g. electricity and gas, or road andrail)

➢ Merging existing agencies may beproblematic

Source: Schwartz, T. and Satola, D. (2000)

Finally, many variations are possible on the theme ofmulti-sector regulation. The choice is not simplybetween one single multi-sector regulator and aseries of single-sector ones. As indicated above,Canada’s CRTC regulates two similar andconverging sectors, telecommunications and broad-casting, but no others. The CRTC’s predecessor,the Canadian Transportation Commission, regulateda variety of industries, including telecommunications(but not broadcasting), air and rail transportation.However, at that time, gas pipelines, electrical powerand other infrastructure industries fell under theauthority of different regulators. Other combinationsare possible.

1.2.2.5 Organization of Regulatory Staff

There are many ways to organize the decision-makers, management, staff and other advisors of aregulatory agency. No one approach is ideal. Muchwill depend on the institutional structure and the

workplace culture of a country. The structure of theregulator will also play a role. For example, the staffof collegial commissions may be, but is not always,structured differently from that of an organizationreporting to a single director general. Multi-sectorregulators will have different structures from single-sector regulators, since professional staff such aseconomists, lawyers and accountants will deal withtelecommunications issues one day, and electricalpower regulation the next.

The main factors determining organizational differ-ences are the functions and objectives of differentregulatory agencies. Some telecommunicationsregulators are responsible for spectrum manage-ment, licensing of new operators and regulation ofbroadcasting and other content services. Others arenot. Some must actively regulate prices. Others aremerely responsible for verifying compliance with aprice cap regime prescribed in a long term licence,or adjusting the X-factor in a price cap regime every


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Overview

few years. Different functions and objectives requiredifferent types and levels of professional assistance.

For these reasons, it would not be useful toprescribe an ideal model for a regulatory organiza-tion. However, some general observations can bemade:

➢ Regulatory decision-making requires multidisci-plinary skills. Specific types of regulatorydecisions require qualified economists,engineers, lawyers, accountants and financialanalysts. However, many other decisions benefitfrom having a range of different professionalskills and perspectives brought to bear. Wherehigh-calibre professional skills are notimmediately available within the public service,outside experts should be brought in. Expertswith hands-on experience with establishedregulators can be particularly valuable. Outsideexperts can be replaced as good permanentstaff are hired and trained.

➢ The telecommunications environment is chang-ing rapidly. Accordingly, regulatory organizationsshould not establish rigid hierarchies; theyshould be flexible and adaptable. Many effectiveregulatory organizations employ a “task force” or“working group” approach to staffing teams toadvise on important regulatory decisions. Thesetask forces are often selected from differentbranches of the regulatory organization. Theyare frequently brought together solely for aspecific project.

➢ Consideration should be made to contractingout specific regulatory functions, rather thanbuilding large permanent staff organizations.This approach is recommended by the authorsof the regulatory strategies checklist fordeveloping economies (Table 1-4). They providethe following examples. Audit firms can monitorcompliance with operating licence conditions. InArgentina, a private contractor monitors compli-ance with radio spectrum rules. External expertscan also resolve operator disputes, leaving finaldecisions to the regulators. Many other exam-ples exist.

1.2.3 International Agencies

The following sections describe the organization andfunctions of various international organizations thatplay an important role in telecommunicationsregulation.

1.2.3.1 International TelecommunicationsUnion (ITU)

Overview of the ITU

The ITU was founded in Paris in 1865 as theInternational Telegraph Union. It changed its nameto the International Telecommunication Union in1934, and became a specialized agency of theUnited Nations in 1947.

The ITU is a global organization which includespublic and private sector participation on telecom-munications matters. The ITU’s mission covers thefollowing areas or “domains”:

➢ technical domain: to promote the developmentand efficient operation of telecommunicationsfacilities, in order to improve the efficiency oftelecommunications services, their usefulness,and their general availability to the public;

➢ development domain: to promote and offertechnical assistance to developing countries inthe field of telecommunications; to promote themobilization of the human and financialresources needed to develop telecommunica-tions; and to promote the extension of thebenefits of new telecommunications technolo-gies to people everywhere;

➢ policy domain: to promote, at the internationallevel, the adoption of a broader approach to theissues of telecommunications in the globalinformation economy and society.

As of 1 July 2000, the ITU comprised 189 MemberStates and over 600 Sector Members. The latterinclude scientific and industrial companies, publicand private operators, broadcasters andregional/international organizations.


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Structure of the ITU

Under its constitution, the ITU’s organizationalstructure comprises the following elements:

➢ The Plenipotentiary Conference, which is thesupreme authority of the Union. It meets everyfour years to:

(a) adopt the strategic plan and fundamentalpolicies of the organization;

(b) amend the Constitution and Convention asrequired; and

(c) adopt a financial plan for the next four-yearperiod.

➢ The Council, which is composed of 46 ITUMember States (representing 25% of theUnion's membership). The Council acts onbehalf of the Plenipotentiary Conference andmeets annually to consider broad telecommuni-cations policy issues in order to ensure that theUnion's policies and strategies respond to theconstantly changing telecommunicationsenvironment. The Council is also responsible forensuring the efficient co-ordination of the workof the Union and the approval of its budgets.

➢ World Conferences on International Telecom-munications, which are convened periodically toreview and revise the International Telecommu-nication Regulations. The Regulations are aninternational treaty governing the provision andoperation of public telecommunicationsservices, as well as the underlying transportmechanisms used to provide them. The Regu-lations provide a broad, basic framework fortelecommunications administrations andoperators in the provision of international tele-communications services.

➢ The Radiocommunication Sector (ITU-R) ischarged with establishing technical characteris-tics and operational procedures for wirelessservices. The Sector also plays a key role in themanagement of the radio frequency spectrum.In its role as global spectrum co-ordinator, theRadiocommunication Sector develops the RadioRegulations, a binding set of international rules

that govern the use of the radio spectrum bysome 40 different radiocommunications servicesaround the world. The Sector also acts, throughits Bureau, as a central registrar of internationalfrequency use. It records and maintains theMaster International Frequency Register whichcurrently includes around 1,265,000 terrestrialfrequency assignments, 325,000 assignmentsservicing 1,400 satellite networks, and another4,265 assignments related to satellite earthstations.

In addition, the ITU-R is responsible for co-ordinating efforts to ensure that communica-tions, broadcasting and meteorological satellitescan co-exist without causing harmfulinterference to one another’s services. In thisrole, the ITU facilitates agreements betweenoperators and governments, and providespractical tools and services to help frequencyspectrum managers carry out their day-to-daywork.

The legislative and policy functions of theRadiocommunication Sector are performed byworld radiocommunications conferences, whichadopt and revise the Radio Regulations, byregional radiocommunications conferences, andby radiocommunications assemblies supportedby study groups.

➢ The Telecommunication StandardizationSector (ITU-T) co-ordinates the internationaltelecommunications standards-setting activitieswhich result in the ITU-T Recommendations.The Standardization Sector carries on the stan-dardization efforts of the ITU which span morethan 130 years. Today, these efforts includedevelopment of standards for Internet Protocol(IP) networks, and IP-based systems.

The majority of the membership of the ITU-Tcomes from the private sector. Given the rapidpace of technical and market developments, theTelecommunication Standardization Sector’smain challenge is in speeding up time-to-marketprogress of its Recommendations. The legisla-tive and policy functions of the StandardizationSector are carried out through World Telecom-munication Standardization Assemblies,supported by study groups.


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Overview

➢ The Telecommunication Development Sector(ITU-D) discharges the ITU’s responsibilities asa United Nations specialized agency and as anexecuting agency for implementing projectsunder the United Nations development systemor other funding arrangements.

The ITU calculates that a lack of reliable access tobasic telecommunications services affects aroundtwo-thirds of its 189 member countries. It is the taskof the ITU-D to help redress this imbalance bypromoting investment and the implementation oftelecommunications infrastructure in developingnations throughout the world.

The ITU-D maintains a regional presence via 11offices located in Africa, the Arab States, Asia, theCaribbean and Latin America. The Telecommunica-tion Development Sector's two Study Groupsdiscuss key telecommunications developmentissues and policies. They also establish bestbusiness practices for the deployment, managementand maintenance of networks and services. Specialattention is paid to the needs and concerns of theUN-designated Least Developed Countries.

Sector activities range from policy and regulatoryadvice, advice on the financing of telecommunica-tions and on low-cost technology options, assistancein human resource management, as well as well asthe development of initiatives targeting ruraldevelopment and universal access. The ITU-Demphasizes partnerships with the private sector.

ITU-D also produces a range of informationresources which provide analysis of trends in theglobal telecommunications sector backed by officialstatistics from the world's leading source of tele-communications information. Examples include theWorld Telecommunication Development Report(WTDR), which provides a comprehensive overviewof transition in the telecommunications industry andthe annual Trends in Telecommunication Reform(Trends). Trends is based largely upon the annualTelecommunication Regulatory Survey conductedby the Telecommunication Development Bureau.The Bureau monitors world telecommunicationsreform and maintains a regulatory database forgovernments reforming their telecommunicationssectors.

The policy functions of the Development Sector arefulfilled by World and Regional TelecommunicationDevelopment Conferences supported by studygroups.

➢ The General Secretariat: Manages theadministrative and financial aspects of the ITU’sactivities, including the provision of conferenceservices, the management of the ITinfrastructure and applications, long rangestrategic planning, and corporate functions(communications, legal advice, finance,personnel and common services).

The General Secretariat is also responsible fororganization of the world and regionalTELECOM Exhibitions and Forums.

1.2.3.2 Other International Organizations

Organizations Interested in TelecommunicationsRegulation

A large number of international organizations play arole in telecommunications regulation and regulatoryreform. For some, telecommunications regulation isa major part of their mandate. Others deal with it asan ancillary matter. An example of the latter is theWTO, which has dealt with telecommunicationsregulation as a means of promoting its coreobjective of facilitating international trade.

The focus of the organizations listed below variesconsiderably. Some have regional or globalmandates to improve regulation, or to carry outspecific regulatory functions. Some promoteregulatory reform. Others provide technicalassistance and fund consulting resources, studies,workshops and other activities to increase regulatoryknow-how. Still others act as focal points for theexchange of information between regulators andother stakeholders in the telecommunications regu-latory process.

International organizations with a major role in tele-communications regulation are listed in Table 1-3.


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Table 1-3: Selected International Organizations Interested in Telecommunications Regulation

Organization Activities

African Development Bank(AFDB )

http://www.afdb.org

Like its Asian and Inter-American counterparts, the Asian DevelopmentBank provides financial and technical assistance for the establishment,expansion, improvement and integration of public telecommunicationssystems in Africa. Its programs are aimed at infrastructure development,increasing access to telecommunications services and improving thecontribution of the telecommunications sector to its members’ economicgrowth. It also aims to improve the competitiveness of Africa’stelecommunications industry, and provide the conditions for its participationin the information economy. Among the main activities of the bank is theprovision of support for privatization and strengthening of institutionalframeworks.

African TelecommunicationsUnion (ATU)

ATU co-ordinates the development of an African telecommunicationsnetworks. It promotes telecommunications development in Africa by servingas a regional discussion forum. (Formerly known as Pan-AfricanTelecommunications Union.)

CaribbeanTelecommunication Union(CTU)

http://www.ctu.org

CTU promotes telecommunications development and regulatory reform byserving as a regional discussion forum. It also promotes co-ordination of theinternational policies of its 13 English-speaking Caribbean member states.

Common Market for Easternand Southern Africa(COMESA)

http://www.comesa.org

COMESA serves the English-speaking sub-regions of Eastern and SouthernAfrica. In collaboration with the ITU, COMESA’s Transport andCommunications Division provides technical assistance in several areas,including network connectivity and tariffs.

European Bank forReconstruction andDevelopment (EBRD)

http://www.ebrd.org

The EBRD is an international financial institution established alongsomewhat similar lines as The World Bank Group, and particularly one of itsmembers, the International Finance Corporation (see description of TheWorld Bank below this table). The EBRD supports telecommunicationsprivatization in Central and Eastern Europe and in the former Soviet Union(FSU) through the provision of equity or long-term debt financing to newlyprivatized companies and by providing pre-privatization finance. The EBRDprovides support for new network operators in local, domestic andinternational long distance, and mobile telephone services. It also supportsregulatory reform through its Technical Co-operation Programme, which hasprovided assistance to national authorities in establishing and improving thetelecommunications legal and regulatory framework.

European Conference ofPost andTelecommunicationsAdministrations (CEPT)

http://www.cept.org

CEPT’s Telecommunications Committee (ECTRA) promotes co-operationbetween member administrations and bodies responsible fortelecommunications policy and regulation. Its activities includeharmonization of licensing conditions, spectrum management andnumbering.


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Overview

Table 1-3: Selected International Organizations Interested in Telecommunications Regulation (cont’d)

European Commission –DGIS

http://www.europa.eu.int

The EU shapes telecommunications law and policy in Europe throughlegally binding instruments. Its directives on different aspects oftelecommunications liberalization aim at developing a common market fortelecommunications service and equipment throughout Europe. TheDirectorate-General for the Information Society (DGIS) implements theEuropean Commission’s policies in the area and elaborates the economic,political and social analyses on which such policies are based. The DGISsupports telecommunications sector reform through programs andinitiatives, which include monitoring activities and assistance in theestablishment of regulatory frameworks consistent with the Commission’spolicies. The European Union provides additional support for economicreform in Central and Eastern Europe through development programs suchas PHARE and TACIS.

EuropeanTelecommunications Office(ETO)

http://www.eto.dk

ETO supports the establishment of new regulatory regimes for liberalizedtelecommunication markets and promotes the harmonization of existingregulations. It promotes the establishment of common procedures forlicensing and numbering. ETO also provides a forum for discussion andanalysis of national situations and undertakes studies on issues of topicalconcern. Recent ETO studies cover the areas of licensing, pricing,numbering and mobile number portability.

Gulf Co-operation Council(GCC)

The Telecommunications Department of the GCC has assisted Persian Gulfmember states to co-ordinate telecommunications services tariffs, adopt theGSM mobile telephony standard and harmonize the curriculum taught atacademic institutions and training centres in GCC member states. It alsoworks with the ITU to promote harmonization and standardizationprocesses.

Inter-American DevelopmentBank (IADB)

http://www.iadb.org

The IADB provides financial assistance for the establishment, expansion,improvement and integration of public telecommunications systems. It alsoprovides technical assistance at all stages of the projects it finances andsupports its member countries in the rationalization of telecommunicationsactivities, with special emphasis on institutional reform and strengthening ofregulatory capabilities. Its areas of involvement include local networks andrural telephony.

Inter-AmericanTelecommunicationsCommission (CITEL)

http://www.citel.oas.org

As the principal advisory body to the Organization of American States (OAS)on matters related to telecommunications, CITEL’s main objectives are tofacilitate and promote the development of telecommunications in theAmericas, in order to contribute to the overall development of the region.

International FinanceCorporation (IFC)

http://www.ifc.org

A member of The World Bank Group (see separate description below thistable). Together with the World Bank, IFC works through the new GlobalInformation and Communications Technology Group (GICT) to promote thedevelopment of the telecommunication sector in emerging economies,particularly through private participation. The IFC has financed a largenumber of telecommunications projects throughout the developing world inareas such as basic wireline services, cellular telephony, equity funds fortelecommunications service providers and equipment manufacturers, aswell as satellite, wireless local loop and cable television operations.


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International Institute ofCommunications (IIC)

http://www.iicom.org

The IIC is a multidisciplinary organization that brings together policy makers,regulators, academics and industry players. It provides a forum for theexchange of ideas on topics related to telecommunications and theircommercial, cultural, political and social implications. It maintains an activepublication program, hosts an annual conference and organizesinternational fora on a regular basis.

InternationalTelecommunication Union(ITU)

http://www.itu.int

See separate description of ITU above this table.

Latin American Forum ofTelecommunicationsRegulators (REGULATEL)

http://www.regulatel.org

REGULATEL encourages co-operation and co-ordination of efforts among16 Latin American telecommunications regulatory agencies and promotesthe development of telecommunications in the region. It provides a forum fordiscussion and for the exchange of information and experience intelecommunications policy and regulation.

Mercosur (SouthernCommon Market)

http://www.mercosur.org.uy

Mercosur supports telecommunications liberalization among its members(Argentina, Brazil, Paraguay and Uruguay). Through its PublicTelecommunications Services Commission, Mercosur promotes regionaltelecommunications development, harmonization of spectrum managementand equipment certification and homologation as well as the exchange ofinformation on telecommunications topics.

Organization for EconomicCo-operation andDevelopment (OECD)

http://www.oecd.org

The OECD publishes data and studies on telecommunications markets. Itpromotes telecommunications reform as a means to achieve sustainablegrowth and employment that contributes to economic and social welfare, aswell as to the expansion of world trade.

Pacific TelecommunicationsCouncil (PTC)

http://www.ptc.org

PTC membership includes individuals, businesses and non-profit entities. Itprovides a forum for discussion and exchange of information ontelecommunications in the Pacific area. It promotes regulatory reform andgeneral awareness of the telecommunications sector in the area. PTCorganizes conferences and seminars and interacts with national, regionaland international organizations responsible for telecommunications policyand regulation.

Regional African SatelliteCommunicationsOrganization (RASCOM)

http://www.rascom.org

Among RASCOM’s main objectives is the improvement of inter-urbancommunications in its member states through the establishment of directsatellite links between African countries. It also promotes the provision oftelecommunications service to rural and remote areas.

Regional Commonwealth inthe Field of Communications(RCC)

RCC co-ordinates network development, technical standards and spectrummanagement activities in CIS countries. It also co-operates with itsmembers in the development of principles governing tariff policy as well asnetwork interconnection and interoperability. In addition, the RCC is involvedin joint research and development programs, and the training ofcommunications specialists.


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Overview


TelecommunicationRegulators Association ofSouthern Africa (TRASA)

http://www.trasa.org

TRASA’s main goal is to increase communications and co-ordinationbetween regulatory authorities in the Southern Africa region. TRASA seeksto encourage investment in the telecommunications sector by supporting thecreation of a common enabling environment. The member states of theSouthern African Development Community (SADC) are committed toundertaking initiatives to improve the economic and social well-being of theirpopulations through telecommunications sector reform.

West AfricanTelecommunicationsRegulators Association(WATRA)

WATRA was formed in September 2000 by West Africantelecommunications regulators, as a regional organization similar to TRASA(see above).

The World Bank Group

http:www.worldbank.org

See separate description below this table. Members of The World BankGroup provide loans, equity and guarantees to developing countries. Theyalso provide information, advice and assistance on telecommunicationssector reform and national information infrastructure strategies.

World Trade Organization(WTO)

http://www.wto.org

The WTO is the international body responsible for the administration of theGeneral Agreement on Trade in Services (GATS), which includes an Annexon Telecommunications and a Protocol regarding basic telecommunicationsservices. This Protocol, officially known as the Fourth Protocol to the GATSAgreement, is referred to throughout this Handbook as the WTO Agreementon Basic Telecommunications (see Appendix A and Appendix C: Glossary).The WTO provides a global forum for trade negotiations and disputeresolution. The WTO also monitors national trade policies and providestechnical assistance and training for developing countries concerning theimplementation of their WTO commitments, including required regulatoryreforms.

Multilateral and Bilateral DevelopmentOrganizations

A number of multilateral and bilateral developmentorganizations have an interest in telecommunica-tions regulation. These organizations focus oncountries with developing and transitionaleconomies. The goal of such developmentorganizations is generally to assist in establishing aregulatory framework that will promote telecommu-nications sector development – and with it, generaleconomic development.

These organizations generally provide technical as-sistance to governments and regulators to promotethe development of a sound regulatory structure.Such technical assistance may include advice fromexpert staff resources, payment for independenttelecommunications advisors (economists, lawyers

and other consultants), training programs, seminars,workshops and staff exchanges.

Some major multilateral development organizationsactive in promoting telecommunications sectorrestructuring and regulatory reform are listed inTable 1-3. These organizations include:

➢ The World Bank Group, including:

➢ International Bank for Reconstruction andDevelopment (IBRD);

➢ International Development Association (IDA);

➢ International Finance Corporation (IFC); and


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➢ Multilateral Investment Guarantee Associa-tion (MIGA).

➢ European Bank for Reconstruction andDevelopment (EBRD);

➢ Asian Development Bank;

➢ African Development Bank;

➢ Inter-American Development Bank; and

➢ Andean Development Corporation.

Many bilateral development organizations also playa role in promoting regulatory development. Theseinclude national development organizations such asUS AID, Denmark’s DANIDA, and Canada’s CIDA.They also include regional programs aimed atpromoting telecommunications development, suchas the European Commission’s PHARE program.

A comprehensive review of the role of multilateraland bilateral development organizations in tele-communications sector regulation is outside thescope of this Handbook. We will describe one keyinstitution, The World Bank, in greater detail. TheWorld Bank has been active in the telecommunica-tions field for many years, and a description of itschanging role illustrates a trend common to someother major development organizations.

The World Bank

The World Bank Group has played an important rolein telecommunications sector reform, includingregulatory reform, in developing and transitionaleconomies.

In the past, the Bank provided a significant source ofdirect financing for the expansion of telecommunica-tions infrastructure by PTTs. Since the mid-1990s,Bank lending to state-owned enterprises has beencontingent on a firm commitment from its clientgovernments to sector reform. Such commitmentshave included a clear exit strategy for government'sinvolvement in the ownership and management oftelecommunications operators. Alternatively,commitments have included specific progress inreform aimed at commercializing, privatizing, facili-

tating entry into the sector and making the sectormore efficient.

The Bank has been a catalyst in promotingprivatization and market-based solutions to thedevelopment of the telecommunications sector. TheBank’s goal has been to create a sustainableenvironment to attract private investment required toaccelerate and sustain telecommunications sectordevelopment. Accordingly, Bank policy advocatesusing scarce official funds mainly to support sectorreforms, including regulatory reform, that are likely tomobilize private capital and management to developthe sector.

In terms of a regulatory framework, the Bankadvocates separating the government’s policy andregulatory functions from telecommunicationsoperations. It supports (a) strengthening thegovernment’s capacity to formulate and overseepolicy, and (b) creating a regulatory regime andinstitutions that emphasize competition whilekeeping regulatory intervention to a minimum.

Consistent with its poverty-reduction goals, the Bankencourages governments to develop strategies toextend telecommunications services throughout thepopulation, including the least privileged groups.

Today, the Bank is leading the way in supportingsolutions to alleviate the effects of the digital divide.The Bank’s aim is to encourage investments as wellas policy and regulatory reforms to create aliberalized environment which will foster thedevelopment of communications infrastructure. Suchan environment should also promote access to anduse of the emerging knowledge-based globaleconomy in the fight against poverty.

The Bank is also active in the development anddissemination of information resources to promoteregulatory reform and to strengthen regulatorycapabilities. For example, infoDev, a multi-donorgrant facility administered by the Bank, providesfunding for innovative projects that use informationand communications technologies to facilitateeconomic and social development at the local,national, regional and global levels.

infoDev, through its networking with governments,multilateral and bilateral donors, the private sector


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Overview

and not-for-profit organizations, provides links totechnical, informational and communicationsexpertise available throughout the world. Theprogram has provided funding to support the ITURegulatory Colloquia and other initiatives to expandregulatory knowledge and experience, including thepreparation of this Telecommunications RegulationHandbook.

1.3 The Regulatory Process

Regulators employ a variety of regulatoryprocedures. Depending on the legal framework, theymay issue different types of “regulatory instruments”,such as regulations, decisions, orders, decrees,rules, policies, notices, resolutions. In general, theeffect of these instruments is to make “decisions”that implement regulatory policies, resolve disputes,or deal with other matters within the regulators’mandate. In this section, we focus on the generalprocess used in making regulatory decisions. Thediscussion in this section disregards the country-specific legal form that such decisions may take.

Regulatory decision-making can be difficult.Interested parties may vigorously promote and lobbyin support of different outcomes for many regulatorydecisions. In most cases, some parties will be happywith a regulatory decision, and others will not.Decisive regulators necessarily create winners andlosers in some situations. Indecisive regulators maytry to avoid offending anyone by delaying decisions,or creating unworkable compromises. Suchindecision and compromises can damagedevelopment of the sector and ultimately help noone.

The principles of good regulatory decision-makingare well known. They include:

➢ Transparency;

➢ Objectivity;

➢ Professionalism;

➢ Efficiency; and

➢ Independence

The laws and jurisprudence of most countriesprovide guidance and constraints on the regulatorydecision-making process. Procedural rules vary fromcountry to country and legal system to legal system.However, there are common trends.

Two “fundamental rules” of procedural fairness incommon law countries are worth noting. While theyare not legally binding on regulators in many othercountries, they are widely respected. Adherence tothem will often alleviate political and public relationsproblems as well as legal challenges. These rulesare:

(1) Provide all interested parties with anopportunity to comment or otherwise make theircase, before making a decision that affectsthem. This rule is sometimes expressed bymeans of the Latin maxim audi alteram partemor “hear the other side”. Breach of thisprocedural rule will lead the courts to quashregulatory decisions in some common lawjurisdictions. In other jurisdictions, this rule ispart of the unwritten code of basic proceduralfairness applied by regulators. The rule has apragmatic basis, as well as a legal one. Unlessperspectives of all interested parties are takeninto account, regulators risk making decisionsthat ignore important factors. Taking thosefactors into account can lead to different andbetter decisions. Application of this rulepromotes transparent decision-making.

(2) “Don’t be a judge in your own cause”. Thisrule is based on another Latin legal maxim:nemo judex in sua causa debet esse. The rulehas been interpreted to mean that regulatorsshould avoid bias as well as the perception ofbias. They should not make decisions onmatters in which they have a personal interest.Nor should they make decisions on matterswhere a reasonable person, knowledgeable ofall the facts, would perceive a real likelihood ofbias. In the words of the jurisprudence: “justicemust not only be done, it must be seen to bedone”. Perceptions of regulatory bias can stemfrom any number of factors, from a relative’sfinancial interest in a matter, to a former positionas part of the management of a PTO that is thebeneficiary of a regulatory decision. Application


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of this rule promotes objectivity and credibility ofthe regulatory process.

While these common law rules are not mandatoryand do not cover all the bases of good decisionmaking, they will promote credible and impartialgood decision-making. Various other rules andprinciples for good regulatory decision-making havebeen promulgated by different regulators. A goodexample of such principles was developed by theAustralian regulator. These principles aresummarized in Box 1-3.

A variety of procedures are available to assistregulators to make better regulatory decisions. Thechoice of procedures will vary with the objectives ofthe decision-making process. Depending on thecircumstances, the following approaches shouldhelp regulators achieve the hallmarks of gooddecision-making, namely: transparency, objectivity,professionalism, efficiency and independence:

➢ Use public processes, wherever time permits.Issue public notices inviting comments onproposed rules or approaches to regulating theindustry and other major decisions. Publish adsin newspapers or other media to let the publicknow about such opportunities.

➢ Design public processes that will improve thequality of public input. Provide backgroundinformation and options for the decision to bemade, in notices or consultation documents.This approach helps to focus industry commentsand to provide more useful input on the issuesto be determined by the regulator. Thisapproach has been used successfully in a widerange of countries, such as Jordan, SouthAfrica, the US, the UK and Colombia.

➢ Publish all significant regulatory developmentson a regulatory web site. The web site can alsobe used to invite the industry and othermembers of the public to comment on pendingregulatory decisions. Publish decisions, rules,procedures, notices, and consultation papers onweb sites. Provide links to other useful sites forparties wishing to participate in the regulatoryprocess. Require major operators to provideuseful public information, such as rates, serviceoptions and complaint procedures, on their websites.

➢ Provide written information requests to majoroperators on complex matters. Have themprovide the regulator with technical, financial

Box 1-3: Principles of Proper Decision Making

1. Decisions must be within legal authority of regulator

2. The regulator must consider all relevant matters and disregard irrelevant ones

3. Decisions must be made in good faith and for proper purposes

4. Factual underpinnings of decisions must be based on evidence

5. Decisions must be reasonable

6. Those affected by a decision must be accorded procedural fairness (including the right torespond to prejudicial arguments and evidence that may be taken into account)

7. Government policy must be properly applied

8. Independent regulators must not act on the direction of other persons

Note: These principles were adapted from those developed by the Australian CommunicationsAuthority


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Overview

and economic information necessary to makeinformed decisions. Ask them to providedetailed arguments and evidence on actionsthat the regulator is considering.

➢ Encourage electronic filing of applications,comments and all other material filed byinterested parties. If necessary to protectsensitive confidential information, provide forsecure electronic filing. In other cases,encourage public filings that are accessible andtransparent to the industry and other interestedparties.

➢ Use alternative dispute resolution techniques toresolve complex issues. These includemediation and arbitration. Consider hiringindependent experts as mediators andarbitrators. They can report to the regulator forguidance or a final decision, where necessary.

➢ Follow the basic steps to informed decision-making. Decide what type of information wouldbe relevant in making a decision. Determine thebest means to gather appropriate information(e.g. staff research, consultants studies,information requests to operators, etc.). Providean opportunity for comment on the evidence byinterested parties and the public; and make adecision based on the public record, whereverpossible.

➢ Streamline decision-making where possible.Establish and publish schedules for decision-making processes – and stick to them.

1.4 Principles for EffectiveRegulation

Although telecommunications markets around theworld are in transition, the basic direction of changeis similar in most countries. It is therefore notsurprising that the principles of effective regulationaround the world are converging. However, applica-tion of these principles will vary considerably,depending on the structure and state of evolution ofa particular telecommunications market, theresources of the country, its legal framework andregulatory capabilities.

In the following sections, we review basic principlesfor effective regulation that can be applied indifferent circumstances.

1.4.1 Minimize Regulatory Intervention AfterCompetition is Established

Regulation should be kept to a minimum, particularlyin competitive markets. The evidence from aroundthe world indicates that freely competitive marketsare better able to meet the demands of consumersthan government controlled ones. The advantagesof privatization and liberalization can be lost, orseverely limited by burdensome regulatorymeasures.

The extent of regulation should be geared to thestate of development in a market, and particularlythe level of competition. As competition increases,regulation should decrease.

However, there must often be decisive regulatoryintervention in the early stages of market liberaliza-tion, in order to ensure effective competition has achance to emerge. Clear decisions to removebarriers to competition early in the process willstimulate competition and permit greaterderegulation down the line. While markets are beingopened to competition, regulation should normallybe focussed on the incumbent operators, whosenetworks must be open to interconnection andunbundled to permit new entrants to be viable.

There is a tendency among new regulators to try tobe “even-handed” and to treat incumbent operatorsand new entrants the same. This approach canactually increase regulatory intervention over thelonger term. It can impose unnecessary burdens onnew entrants, and prevent implementation of“asymmetrical” regulatory initiatives that will openthe PSTN to competition.

This lesson has taken some time to learn. Initially,for example, many regulators have declined tointervene decisively in interconnection disputes,suggesting that competitive entrants and incumbentoperators should “freely negotiate” the terms of inter-connection with the PSTN. It took years for someregulators to realize that most incumbent PSTNoperators had few incentives to negotiate favourableinterconnection agreements with their would-be


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competitors. Rather than minimizing regulation, thishands-off approach can lead to repeated regulatoryintervention on interconnection issues over aprotracted period of time.

Over the years, more and more regulators haverealized that decisive regulatory intervention isrequired to implement interconnection arrangementsthat will substantially increase competition. Suchintervention includes proactive regulation, that isadvance guidelines, as well as dispute resolution.Regulatory thinking is evolving on this subject.

Regulation of interconnection represents one of asmall number of exceptions to the general rule. Inmost cases, regulation can and should beminimized. Interventionist measures should alwaysbe assessed against their objectives. Are theobjectives valid? If so, are the measures the leastintrusive means of achieving the objectives?

A recent European case provides an example wherethese questions were asked, and a less interven-tionist regulatory approach was adopted. For manyyears governments in various countries haveadministered testing and certification programs forterminal equipment attached to telecommunicationsnetworks. This approach was reviewed by the EU inan effort to reduce unnecessary regulation. As aresult, the EU recently decided to abandon itsprevious approach to regulation of terminalequipment in favour of industry self-reporting. The1999 EU Directive on Radio and TelecommunicationTerminal Equipment, requires only manufacturers’declarations of conformity with essential require-ments. This type of regime should permit newtechnologies to be introduced more quickly, withfewer regulatory delays or other barriers.

This European example may not be applicable insome developing countries, where, for examplethere is no effective frequency spectrum monitoring.However, in all countries, new regulatory measuresshould be assessed carefully to ensure they providethe most efficient means of achieving validobjectives.

1.4.2 Harmonize with Regional and GlobalRegulatory Standards

The basic technologies and economics of the tele-communications industry are the same around theworld. Today, a small group of manufacturers isresponsible for producing the majority of switching,transmission, terminal, software and related networkfacilities used almost everywhere. Even where thereare variations in technology or local applications, thesame basic network architectures are employed.The trend to harmonization of telecommunicationstechnology is increasing.

The basic economics of telecommunications servicemarkets is also the same in most countries.Businesses and consumers all demand telecommu-nications services, with increasingly advancedfeatures, at the lowest possible price. Other thingsbeing equal, suppliers that meet that demand bestwill succeed. Those that fail to compete successfullywill be bypassed by consumers and their competi-tors. While the ability of businesses and consumersto pay for services varies greatly, this variation doesnot account for the large differences in approachesto regulation around the world. Equally rich countrieshave often taken very different regulatoryapproaches, as have equally poor ones.

Regulatory differences are often ascribed todifferences in the legal, institutional, political orcultural framework of different countries. Thesedifferences are important, but generally do not justifysubstantial differences in technical or economicaspects of regulation.

Telecommunications markets are increasinglybecoming regional and global markets. Whilesuccessful telecommunications service providers willalways be close to their customers, they must thinkglobally in terms of their business and competitivestrategies. Regulators should do the same.

Regulators that impose uniquely local regulatoryburdens, or more costly requirements than othercountries, can handicap players in their nationalmarkets. Similarly, regulators that protect nationaloperators from regulatory disciplines that apply inother countries are doing them no favours. Suchregulators will retard competition, service innovationand possibly economic growth by failing to


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Overview

implement the same pro-competitive regimes asneighbouring countries.

Over time, global regulatory standards or “bestpractices” are emerging. Some of those are evidentfrom the list of major global telecommunicationssector reforms in Table 1-1. Others are discussedthroughout this Handbook. Examples of suchstandards are price cap regulation and targeted uni-versal service funds (as opposed to inter-servicecross-subsidy by incumbent PSTN operators). Otherregulatory practices are newer, such as the variousapproaches to requiring unbundling of the local loop.

Some regulatory standards or practices are beingadopted in trade agreements and other internationalaccords. Prime examples are the regulatorydisciplines included in the WTO RegulationReference Paper (see Appendix A).

In this context, it is interesting to note that in late July2000, the US announced that it would request WTOconsultations with Mexico regarding that country’salleged failure to implement its commitments underthe Agreement on Basic Telecommunications. Thisis the first time a country has taken a dispute onbarriers to competition in a telecommunicationsmarket to the WTO. The three issues put forward bythe US for the consultations are: 1) lack of effectivedisciplines over the former monopoly, Telmex, whichis able to use its dominant position in the market tothwart competition; 2) failure to ensure timely, cost-oriented interconnection that would permitcompeting carriers to connect to Telmex customersin order to provide local, long-distance, andinternational service; 3) failure to permit alternativesto an outmoded system of charging U.S. carriersabove-cost rates for completing international callsinto Mexico.

Regulators that are concerned about maintaining thecompetitiveness of their domestic telecommunica-tions markets should monitor international regulatorytrends and become early adopters of trends that willincrease efficiency and competition in their markets.Telecommunications regulation can be complexwithout re-inventing the wheel in each market. Inmost cases, economic and technical regulatorytechniques that have proven themselves in somemarkets will work in other similar markets. Increasedcommunication between regulators and regulatory

organizations to harmonize regulatory approachescan certainly improve regulation.

1.4.3 Introduce Competition

It is widely recognized that the benefits of competi-tion in the supply of telecommunications servicesand facilities far outweigh any disadvantages.Today, telecommunications markets have beenopened to varying degrees of competition in mostcountries around the world.

Over the last decade, the most dramatic progress inliberalizing telecommunications markets occurred inEurope and other OECD countries. Most telecom-munications services in Europe were provided on amonopoly basis at the beginning of the decade. Bythe end of the decade, over 96 per cent of theOECD market, measured by totaltelecommunications revenues, was open tocompetition.

Significant liberalization has also occurred in tele-communications markets in other economiesthroughout the Americas, Eastern Europe and theFSU, Africa and the Asia-Pacific region. Based onITU data for 1999, the most open telecommunica-tions markets globally were in cellular services (67per cent) and Internet services (72 per cent). Basictelecommunications services markets remainedfairly closed. About 73 per cent of global basictelecommunications markets continued to havemonopolies at the beginning of 1999. However,there is no doubt about the trend. Basic telecommu-nications markets are being opened to competitionin all regions. It is in this area that regulators will facethe greatest challenges.

Regulatory involvement is generally required toensure the establishment of viable competition. Thisis not the case in all industries. However, thestructure of the telecommunications industry and thenature of telecommunications networks are suchthat regulation is required. Regulatory intervention isrequired to meet a number of objectives related tothe introduction of competition. Key objectivesdiscussed in detail later in the Handbook are:

➢ To license new competitors and existing opera-tors on terms and conditions that will provide a


1 - 24

clear and certain basis for both to attractinvestment (see Module 2).

➢ To ensure interconnection of networks andservices, and to resolve interconnectiondisputes (see Module 3).

➢ To prevent incumbent operators from abusingtheir dominant position to drive new competitorsout of telecommunications markets (see Module5).

➢ To prevent dominant operators from chargingexcessive prices for services over which theyhave market power, and using the proceeds tocross-subsidize their services in competitivemarkets (see Module 4).

➢ To ensure universality objectives are achieved ina competitive environment (see Module 6).

Without regulatory intervention to achieve suchobjectives, there is a good prospect that competitionwill fail to produce the benefits that have beenachieved in the world’s more competitive markets.

1.4.4 Regulate by Principle

Regulators are prone to regulate “after the fact”.Sometimes, they wish to avoid regulatoryintervention. In other cases, they are unsure of theright approach to take on a disputed regulatoryissue. In some cases they do not have theresources and professional advice necessary to ruleconfidently on complex issues.

Delays in deciding major regulatory issues canretard development in the sector. Interconnectionissues provide prime examples. If regulators do notprovide clear advance guidance on interconnectionprinciples, parties may negotiate for months oryears, and service introduction will be delayed.

Regulators will understandably want to be careful toavoid decisions on complex issues without carefulconsideration. However, in many cases they canestablish principles to be applied by the industry,without spending an undue amount of time on thedetails of implementation. Those details can often beleft to the industry. Announcement of the principlesin advance can often expedite industry discussions.

Good international practices are emerging on theprinciples for dealing with many types of regulatoryissues. An example is the pricing of unbundled inter-connection facilities. The calculation of telecommu-nications costs can be very complex and timeconsuming for a regulator. However, making adecision in principle that interconnection facilitiesshould be priced at a level equal to estimated LRIC(Long Run Incremental Costs) plus a mark-up forforward looking common costs, is not that difficult.General principles and practices for such costingand pricing decisions have been adopted in manycountries. Best practices are often clearlyestablished and it is not that risky to adopt them.

Regulatory decisions, even ones to adopt generalprinciples, should always be made in a transparentmanner. Providing opportunities for public commenton whether a regulatory principle should be adoptedwill generally improve the quality of the decision aswell as the credibility of the regulatory process.

1.4.5 Establish Operational Efficiencies

Sharing experiences with other regulators can oftenlead to operating efficiencies. Regulatory operationscan clearly be more efficient today than ever before.The Internet, electronic filing of regulatory applica-tions and electronic publication of regulatorydecisions have vastly improved the efficiency andtransparency of regulation. The costs of establishinga regulatory web site and arranging for electronic

Box 1-4: Highlights of 1999 Plan toOverhaul the FCC

➢ Receive 70% of filings electronicallywithin two years, and by 100% withinfive years

➢ Reduce backlogs of pending itemsfor action by 60% in two years; andby 100% in five years

➢ Reduce staff by authorizing“buyouts” of surplus FCC employees

➢ Authorize use of “nonagency expertsand consultants”


1 - 25

Overview

filing of reports, applications and other regulatorycommunications has declined to a level where everyregulator can use such approaches to increaseregulatory efficiency.

Regulators have adopted many different approachesto improve operational efficiency. An example of oneregulator’s approach is set out in Box 1-4, whichincludes highlights of the FCC’s plan to expedite itsinternal processes in the US.

1.4.6 Strategies for Effective Regulation inDeveloping Economies

While the principles of effective regulation are similarin most countries, some may be applied differently indeveloping economies. There are significantdifferences in resource and other constraints indeveloping economies from those of OECDeconomies. This obviously has implications forregulation. Regulators in developing and transitionaleconomies have a greater need for practical andstraightforward approaches.

Table 1-4: Regulatory Strategy Checklist: Primary (••••) and Secondary (√√√√) Benefits

Measure Reduce Need forAgency Decisions

Enhance RegulatoryCredibility

Use ResourcesEffectively

Accelerate competition • √ √

Prepackage regulatory rules • √ √

Establish rules forinterconnection

• √ √

Keep operators’ obligationsreasonable

• √

Focus licensing on the mainoperators

• √

Rebalance prices early • √

Reduce regulation ascompetition develops

•

Adopt transparent process •

Harness public support •

Lock in principles throughinternational commitments

•

Outsource regulatoryfunctions

•

Adopt alternative disputeresolution

√ √ •

Put the operators to work √ •

Consider multisectoralagencies

•

Create regional capacity •

Source: Smith, P. and Wellenius, B (1999)


1 - 26

The principles listed above can generally be adaptedto the needs of developing and transitionaleconomies. However, telecommunications expertswith experience in telecommunications regulation insuch economies have developed additional

strategies, which have proven to be effective there.A good paper on such strategies was published bythe senior telecommunications experts of The WorldBank in 1999. The regulatory strategies checklistfrom this paper is reproduced in Table 1-4.

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2 - 1

MODULE 2

LICENSING TELECOMMUNICATIONS SERVICES

2.1 Introduction

2.1.1 Telecommunications Licences

A telecommunications licence authorizes an entity toprovide telecommunications services or operatetelecommunications facilities. Licences alsogenerally define the terms and conditions of suchauthorization, and describe the major rights andobligations of a telecommunications operator.

Licences for new entrants in telecommunicationsmarkets are frequently granted by means of a com-petitive licensing process, which involves the selec-tion of one or more operators from a group ofapplicants. In other cases, general authorizationsare issued. These authorize any entity that complieswith the basic terms and conditions of the authoriza-tion to provide a telecommunications service,without the need for an individual licence.

Licensing is a relatively recent development in manytelecommunications markets. Historically, state-owned incumbent operators provided telecommuni-cations services on a monopoly basis in mostmarkets. Telecommunications operations weretreated as a branch of the public administration,along with postal services, road transportation andother government services, and licences were notconsidered necessary.

In many cases, licences for incumbent operatorswere prepared as part of their privatization process.By specifying the rights and obligations of suchoperators, investors were provided with some cer-tainty as to the business in which they are investing.The licence provides all stakeholders, includingconsumers, competitors and the government with aclear understanding of what the operator is and isnot permitted or required to do.

Licences are particularly significant in the context ofemerging and transitional economies. Licencesprovide certainty for investors and lenders, and withit the confidence that is required to invest the millionsor billions of dollars required to install or upgradetelecommunications infrastructure in such econo-mies.

Licences do not have the same importance in allcountries. In a few countries where monopoly tele-communications operators have long been privatelyowned, notably the US and Canada, there havetraditionally not been telecommunications licences.Instead, regulatory terms and conditions wereimposed through decisions, orders or tariff-approvalprocesses of a government regulatory authority. Insome other countries, including Latin Americancountries, privately-operated telecommunicationscarriers were traditionally granted concessions orfranchises.


2 - 2

While the terms “licence”, “concession” and“franchise” may be defined differently in the laws ofdifferent countries, these terms generally refer to thesame basic concept. In the context of telecommuni-cations regulation, they all refer to a legal documentgranted or approved by a regulator or other govern-ment authority that defines the rights and obligationsof a telecommunications service provider. For thesake of simplicity, we will use the term “licence” onlyin this Module. In most cases, however, what is saidabout licences applies equally to concessions andfranchises.

The process of licensing incumbents and newentrants is sometimes handled by independent tele-communications regulators and sometimes directlyby governments or Ministers. In this Module, forease of reference, we will generally refer to thelicensing authority as the “regulator”. This term isintended to include other licensing authorities, suchas Ministers.

No matter which government authority is responsi-ble, the licensing process is generally one of themost important “regulatory” processes undertaken inthe course of reforming the telecommunicationssector. The licensing process is integrally tied to thestructure of telecommunications markets, the num-ber and types of operators, the degree of competi-tion between them, the revenues earned bygovernments in opening markets, and, ultimately,the efficiency of the supply of telecommunicationsservices to the public.

2.1.2 Licensing Objectives

Governments and regulators normally have severaldifferent objectives for licensing telecommunicationsoperators. Common licensing objectives are set outbelow:

(i) Regulating Provision of an EssentialPublic Service – Basic telecommunicationsis viewed as an essential public service inmost countries. While there has been anirreversible trend toward privatization andreliance on market forces, most govern-ments continue to impose some controls toensure basic telecommunications servicesare provided in the public interest. Licences

are an important tool for exercising suchcontrol in most countries.

(ii) Expansion of Networks and Servicesand Other Universal Service Objectives –This is a major reason for licensing newtelecommunications operators in mostcountries. Network roll-out and servicecoverage obligations are often included inlicences. This is particularly the case wherea state-owned incumbent operator (a PTT)is privatized, or some degree of exclusivityis granted (e.g. a duopoly cellular licence,with a right to use scarce spectrum).Licences are an important tool for expand-ing infrastructure investment and promotinguniversal service and universal accessobjectives in developing countries.(Universal service objectives are discussedin detail in Module 6).

(iii) Privatization or Commercialization – Alicence is necessary where a state-ownedincumbent (a PTT) is privatized. The licencespecifies the rights and obligations of theoperator. It is a key document in the privati-zation process. It specifies what the investoris buying and what the government expectsfrom the operator and the investor.

(iv) Regulating Market Structure – A keyaspect of regulation is the determination ofthe market structure of the telecommunica-tions sector, and in particular, the number ofoperators licensed to provide telecommuni-cations services. In many countries a primereason for licensing new telecommunica-tions operators is to increase competition.Licensing of new operators has madecompetition the dominant mode of supply insome telecommunications markets (e.g.cellular, ISP), but not yet in others, includingbasic services. Figure 2-1 illustrates thedifferent levels of competition in varioustelecommunications markets around theworld. A major objective of the licensingprocess in many markets is to ensure theviability and benefits of new competitiveentry. On the other hand, while licensinginitiatives can increase competition,licensing requirements can also provide a

Module 2 – Licensing Telecommunications Services

2 - 3

Licensing

means to limit market access. This is theobjective of licensing authorities in somecountries, where licences have granted orretained monopoly, duopoly or other exclu-sive rights. Such rights are often retained forpolitical or financial reasons. For example,governments in many countries haveincreased privatization proceeds to gov-ernment coffers by granting monopoly rightsto the newly privatized operator for a fixedterm. While maintenance of monopoliesgenerally reduces efficiency in telecommu-nications markets, many governments haveaccepted this as a “transitional” problem, inorder to generate cash for purposes likedebt reduction. In these cases, liberalizationgenerally proceeds in stages.

(v) Establishing a Competition Framework –Licences frequently include conditions toestablish a “level playing field” for competi-

tion, and to limit the prospects thatincumbent operators will abuse theirdominant position in telecommunicationsmarkets. Such conditions are generallyreferred to in licences as “anti-competitivesafeguards” or “fair trading conditions”.(Examples of such conditions are discussedin greater detail in Modules 3, 4 and 5).

(vi) Allocation of Scarce Resources – Finiteresources required in the operation of atelecommunications service (such as radiospectrum, numbers and rights of way)should be allocated between operatorsfairly, efficiently and in the public interest.This allocation often requires a balancing ofcompeting interests and priorities. Spec-trum, for instance, may be auctioned to thehighest bidder or allocated at low cost toreduce prices or to encourage the rollout ofnew services. Access to rights of way can

Figure 2-1: Licensing Competitive Operators

0102030405060

Perc

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Sig

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International

Level of Competition in Basic Services: WTO Signatories

Monopoly Competition

Source: ITU (1999)

0

20

40

60

80

100

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ent o

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ntrie

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Cellular Cable TV ISPs

Level of Competition: Various ServicesMonopoly Competition


2 - 4

be a source of revenue to governmentauthorities or public utilities, but economic orother restrictions on access can delay therollout of services and lead to higherconsumer prices.

(vii) Generating Government Revenues –Licensing of telecommunications operatorsand of radio spectrum can provide signifi-cant revenues to governments. An auctionfor new licences can generate one-timerevenues. In addition, annual licence feesoften provide a continuing source ofrevenue to fund the operations of the regu-lator, or for other purposes. In addition,licensing of new operators can increase theoverall size of telecommunications marketsand thus generate higher tax revenues forgovernments.

(viii) Consumer Protection – Conditions relat-ing to consumer protection are oftenincluded in telecommunications licences.Such conditions may relate to matters suchas price regulation, billing practices,consumer complaint mechanisms, disputeresolution, limitations of liability for servicedefaults, and mandatory services to con-sumers (e.g. directory services, operatorassistance and emergency services).

(ix) Regulatory Certainty – By clearly definingthe rights and obligations of the operatorand the regulator, a licence can significantlyincrease confidence in the regulatory re-gime. Regulatory certainty is a criticalelement of the licensing processes wherethe aim is to attract new operators andinvestment. This is particularly true in thecase when foreign investment is sought inriskier developing or transitional economies.

2.1.3 Licences and Other RegulatoryInstruments

In most countries, licences comprise only one ele-ment of the regulatory framework. Other rules thatgovern operators are included in telecommunica-tions laws, sector policies, regulations, decrees,orders, decisions, guidelines, directions and otherdocuments of general application.

Whether an operator’s rights and obligations are setout in a licence or by some other means is generallydetermined by two factors:

➢ requirements of local law, and

➢ the level of development of the local regulatoryframework.

Matters that are dealt with in licences in somecountries are dealt with in other regulatory instru-ments in different countries. For example, in Mexico,the quality of service standards and targets forTelmex were included in the licence (concession)prepared for Telmex prior to its privatization. InCanada, quality of service standards and targets areset out in decisions and orders of the regulator, theCRTC.

Privatization and liberalization first occurred inEurope in the United Kingdom in the early 1980s. Atthat time, the concept of telecommunications regula-tion was new to the UK. There was no existingregulatory framework. Therefore, the licence issuedto British Telecom was prepared as a largely self-contained regulatory code. It governed most aspectsof the operations of BT and granted a variety of ex-clusivity rights, such as a limited monopoly for basicvoice services and limitations on simple resale.Similarly, the licence for Mercury, the first fixed-linkcompetitor in the UK, contained a fairly comprehen-sive regulatory code for that operator.

A similar model was adopted in a number of othercountries in Europe and elsewhere as incumbentoperators were privatized and new operators werelicensed.

As indicated above, some countries, particularly inNorth America, have no tradition of issuing compre-hensive licences that spell out detailed regulatoryregimes. In the United States and Canada, detailedregulatory rules are typically contained in regula-tions, decisions, orders or tariffs made or approvedby the regulator. Accordingly, when Canadaimplemented a licensing regime for certain tele-communications operators for the first time in 1998,the regulator issued very short (2 page) licences forinternational service operators. The balance of therules governing these operators is set out in otherregulatory instruments.


2 - 5

Licensing

Countries that do not have a clear regulatory frame-work and that intend to license new operators, orattract investment in incumbents, will need todevelop fairly comprehensive licences. Somecountries that have initiated privatization andliberalization without clear and detailed licences orother regulatory instruments have experiencedserious problems due to regulatory uncertainty.

In other countries, without a clear regulatory frame-work, certainty has been achieved at an early stagethrough the use of comprehensive licences.Examples include Hungary, Uganda, Morocco andJordan. The more detailed licences have contributedto the success of privatization and new competitiveentry. Table 2-5 provides an example of the fairlycomprehensive contents of a PSTN licence in adeveloping country without a clear regulatoryframework.

With increasing competition in telecommunicationsmarkets, it should be possible to reduce the detail ofthe regulatory framework included either in licencesor in other regulatory documents. This trend isrecognized in the 1997 European Union Directive onLicensing, and the subsequent July 2000 licensingproposals, which favour minimal licence conditionsand the eventual elimination of the licensingrequirement.

However, the situation remains different in lessdeveloped telecommunications markets, and espe-cially in those with perceived high country risk,economic and governance problems. Most of thesemarkets do not have clear or consistent regulatorypolicies or frameworks. In such markets, it will beimportant to develop clear and detailed licences aspart of privatization and liberalization initiatives.There should be two key goals in preparing suchlicences:

➢ Regulatory Certainty – Where privatization andlicensing transactions are implemented before aclear regulatory framework has been developed,the rights and obligations of operators should beclearly defined in licences. Regulatory certaintyon key issues (such as interconnection, priceregulation and competitive safeguards) will pro-mote success of privatization and initiatives topromote new market entry. Uncertainty willreduce investor interest. It will also reduce

proceeds to governments from privatizationsales or licensing fees.

➢ Defining Exclusivity Rights – Sector policymay call for the licensing of multiple operators,or it may grant exclusive monopoly (or duopoly)rights for specified periods of time. The grantingof exclusivity rights generally increases govern-ment revenues from privatization and licensingtransactions. However, as noted in Modules 1, 4and 6, maintaining monopolies can limit sectorgrowth and reduce operator efficiency to thedetriment of consumers. Whatever policy isadopted on exclusivity, it should be clearlyreflected in the licences of new operators inorder to provide certainty to them, their investorsand lenders.

2.1.4 Multilateral Trade Rules

The General Agreement on Trade in Services(GATS) and the 1997 WTO Agreement on BasicTelecommunications (ABT) of the World TradeOrganization (WTO) include trade rules applicable totelecommunications regulation and licensing. Sig-natories to the ABT, as well as countries wishing tojoin the WTO, must bring their regulatory andlicensing practices into compliance with WTO traderules.

The trade rules relevant to the licensing process aresummarized below. Further detail is provided inother Modules (e.g. trade rules affecting intercon-nection, fair competition and universal service). Thecentral themes of all of these rules are evolutiontowards open competitive markets and transparentlicensing processes.

(i) General GATS Requirements

All WTO member states are bound by the “generalobligations and disciplines” of the GATS. Three ofthese are directly relevant to the licensing process:

(a) Most Favoured Nation (MFN) Treatment (GATSArticle II)– A licensing regime must grant marketaccess to operators from a WTO membercountry on terms “no less favourable” than theterms applicable to operators from “any othercountry”.


2 - 6

(b) Transparency (GATS Article III) – All laws andrules affecting trade in services must bepublished. The Telecommunications Annex tothe GATS specifically requires publication of,among other things, all notification, registrationor licensing requirements, if any as well as anyother forms of recognition and approval (e.g.type approval of terminal equipment) neededbefore foreign service suppliers can do businesslawfully in a member country.

(c) Barriers to Trade (GATS Article VI) – Licensingrequirements must not “constitute unnecessarybarriers to trade”.

(ii) Specific ABT Commitments

The schedules to the GATS contain additional tradecommitments by individual member countriesconcerning specific services, including basic tele-communications services. Further, nationalcommitments made as part of the WTO Agreementon Basic Telecommunications require many coun-tries to provide greater telecommunications marketaccess. In many cases, implementation of thesecommitments is phased in over a period of severalyears.

The WTO Regulation Reference Paper, which wasannexed to many countries’ ABT commitments,binds them to adopt certain regulatory practicesapplicable to basic telecommunications services.Two of these commitments, which are set out in Box2-1, are directly relevant to licensing.

The complete text of the WTO Regulation ReferencePaper is set out in Appendix A.

2.1.5 The EU Licensing Directive

The 1997 EU Licensing Directive provides a detailedframework for telecommunications licensing inEurope. This framework is consistent with the WTOcommitments of the EU. While it is only bindingwithin the EU, the Directive provides a goodapproach for other countries to consider in develop-ing their own licensing regimes.

The EU has recently published a proposal for newlicensing Directive (Proposal for a Directive on theauthorization of electronic communications networksand services, 12 July 2000). However, as discussedbelow, this new proposal largely represents arenewed effort to implement the harmonized and

Box 2-1: Licensing Rules in WTO Regulation Reference Paper

WTO Regulation Reference Paper – Commitments on Licensing Process

4 Public Availability of Licensing Criteria

Where a licence is required, the following shall be made publicly available:

(a) All the licensing criteria and the period of time normally required to reach a decision concerning anapplication for a licence, and

(b) the terms and conditions of individual licences.

The reasons for the denial of a licence will be made known to the applicant upon request.

6. Allocation and Use of Scarce Resources

Any procedures for the allocation and use of scarce resources, including frequencies, numbers and rights ofway, will be carried out in an objective, timely, transparent and non-discriminatory manner. The current stateof allocated frequency bands will be made publicly available, but detailed identification of frequenciesallocated for specific government uses is not required.


2 - 7

Licensing

deregulatory approach set out in the 1997 Directive.Therefore, we will focus on the 1997 Directivebelow.

The objectives of the EU in adopting the Directiveare set out in Box 2-2.

The Directive encourages the use of generalauthorizations, which the British refer to as classlicences. The proposed use for individual licences isrestricted to public voice telephony and servicesusing scarce resources. Conditions of generalauthorizations should be limited to those relating to“essential requirements”. The contents of this type ofcondition are described in Box 2-3. The licence con-ditions and eligibility criteria for generalauthorizations are to be published by the licensingauthority. Any person who meets the criteria will beauthorized to provide service without any furtherselection process, regulatory decision or individuallicensing requirement.

Under the 1997 Licensing Directive, restrictions arealso placed on the types of conditions that may beapplied to individual licences. These conditions aredescribed in Box 2-4. Specific provisions of theDirective relating to the form and content of licencesare discussed in more detail later in this Module.

In its July 2000 proposal for a new LicensingDirective, the European Commission renewed itsefforts to harmonize and reduce European licensingrequirements. Although the 1997 Licensing Directivegives priority to general authorizations, the ECdetermined that it still leaves too wide a margin forMember States to use individual licences. In fact, theEC found that individual licences have become therule rather than the exception in most Europeannational licensing regimes. In order to furtherpromote market entry, the EC’s July 2000 proposalwould cover all services and networks under ageneral authorization scheme, and would limit theuse of individual licences to the assignment of radiofrequencies and numbers only. The proposed direc-tive would also further limit the number of conditionsthat may be imposed on service providers. Itrequires strict separation between conditionsestablished under general law (applicable to alloperators), conditions under the general authoriza-tion and conditions attached to individual licences.

Box 2-2: EU Licensing Objectives

Objectives of the 1997 EU LicensingDirective

To extend competition in telecommunicationsmarkets by means of a licensing regime which:

➢ Eliminates all barriers to entry except forobjective, transparent, non-discriminatory and proportionaterestrictions relating to the availability ofscarce resources, such as numbers,spectrum and rights of way,

➢ Simplifies and harmonizes licensingprocesses across the EU, and

➢ Establishes licence conditions that aretransparent and constitute “the lightestpossible regulation, compatible with thefulfillment of applicable requirements”.

The EC’s July 2000 proposal aims to ensure that noinformation is required as a prior condition for marketentry. It also places limits on subsequent verificationof compliance with conditions. In addition, theproposed Directive would reduce administrationcharges considerably, and would require regulatorsto publish annual overviews of costs and charges. Ifcharges collected by regulators exceeded theiradministrative costs, the regulators would be re-quired to adjust the level of charges the followingyear.

2.2 Types of Licensing Regimes

In general, there are three approaches to authorizingtelecommunications operators and services:

1. individual operator licences;

2. general authorizations; and

3. no licensing requirements (i.e. open entry).

These 3 categories are reflected in the regulatoryframework of a number of countries. The categoriesare used in the EU’s 1997 Licensing Directive. Whilethe existing legal framework in all countries does not


2 - 8

Box 2-3: EU Rules on Conditions for General Authorizations

1. Any conditions which are attached to authorizations must be subject to the principle of proportionality andconsistent with the EU’s competition rules.

2. Conditions which may be attached to all authorizations:

2.1 Conditions aimed at ensuring compliance with relevant essential requirements,

2.2 The provision of information reasonably required for the verification of compliance with applicableconditions and for statistical purposes,

2.3 Conditions intended to prevent anti-competitive behaviour in telecommunications markets, includingmeasures to ensure that tariffs are non-discriminatory and do not distort competition,

2.4 Conditions relating to the effective and efficient use of numbering capacity.

3. Specific conditions which may be attached to general authorizations for the provision of publicly available. Telecommunications services and networks:

3.1 Conditions related to the protection of users and consumers, in particular, in relation to:

➢ The prior approval by the national regulatory authority of the standard subscriber contract,

➢ The provision of detailed and accurate billing,

➢ The provision of a procedure for the settlement of disputes,

➢ Publication and adequate notice of any change in access conditions, including tariffs, quality and theavailability of services.

3.2 Financial contributions to the provision of universal service, in accordance with Community law.

3.3 Communication of customer database information necessary for the provision of universal directoryinformation.

3.4 Provision of emergency services.

3.5 Special arrangements for disabled people.

3.6 Conditions relating to the interconnection of networks and the interoperability of services, in accordancewith the EU’s Interconnection Directive and obligations under Community law.

Source: CEC (1997)

reflect this categorization, it is a useful approach forconsidering licensing requirement. (Once again, theNorth American situation is different. There havegenerally been no licensing requirements for tele-communications operators or services, except forspectrum licences, FCC Section 214 facilitiescertifications, CRTC international service licences,and, historically, public convenience and necessitycertificates in some states and provinces.)

The main features of each of the three approachesto licensing are outlined in Table 2-1.

The form of a licence depends on the legal regime ofeach country. Matters of form are largely irrelevantto good licensing practice. What is more important isthat the licence conditions are clear, proportionateand enforceable.

In many countries the grant of a telecommunicationslicence is a unilateral act of the regulatory authority.The licence is granted to one or more licenseessubject to the terms and conditions specified in thelicence. The grant of the licence is a purely adminis-trative act.


2 - 9

Licensing

Box 2-4: EU Rules on Conditions for Individual Licences

Specific conditions which may be attached to individual licences, include:

➢ Specific conditions linked to the allocation of numbering rights (compliance with national numberingschemes).

➢ Specific conditions linked to the effective use and efficient management of radio frequencies.

➢ Specific environmental and specific town and country planning requirements, including conditionslinked to the granting of access to public or private land and conditions linked to collocation and facilitysharing.

➢ Maximum duration, which shall not be unreasonably short, in particular in order to ensure the efficientuse of radio frequencies or numbers or to grant access to public or private land, without prejudice toother provisions concerning the withdrawal or the suspension of licences.

➢ Universal service obligations.

➢ Conditions applied to operators having significant market power, intended to guaranteeinterconnection or the control of such significant market power.

➢ Conditions concerning ownership which comply with European Community law and the Community’scommitment vis-à-vis third countries.

➢ Requirements relating to the quality, availability and permanence of a service or network.

➢ Specific conditions relating to the provision of leased lines.

Source: CEC (1997)

In other countries, a licence is a contract betweenthe regulator and the operator. This approach isused where licences are granted by way of tradi-tional “concessions”. Licences in this form generallyset out rights and obligations of both the regulatorand the operator in some detail and are signed byboth parties. This “contractual” form of licence ismost common and useful in countries where thelegal and regulatory framework is less developed.

Over time the need for individual licences will dimin-ish in many liberalized markets. In a highlycompetitive market the main justification forindividual licences will be the need to fairly allocatescarce resources such as spectrum. This is onereason to separate the licensing of spectrum fromthe other aspects of licensing.

Whatever the legal form and process of licensing,good licensing regimes have common features.These include clarity, transparency and the avoid-ance of unnecessarily burdensome conditions.These features are discussed further in Section 2.4of this Module.

2.3 The Licensing Process

The last section considered different types oflicensing regimes. In this section, we consider thedifferent processes by which licences are issued.The process will depend on the sector policies, lawsand market structure in a particular country. Fivecommon types of licensing process are discussedbelow.

2.3.1 Licensing Incumbent Operators

The telecommunications reform process in mostcountries includes privatization of PTTs and thegranting of competitive licences in various marketsegments. Many countries have completed this pro-cess; others are in the midst of implementing it, anda few have not started.

A major step in the privatization and liberalizationprocess in many countries is the issuance of alicence to incumbent operators. This step generally


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Table 2-1: Types of Licensing Regimes

Type of LicensingRequirement

Main Features Examples

IndividualLicences

(Operator SpecificLicences)

➢ usually a customized and detailed licencedocument

➢ frequently granted through some form of com-petitive selection process

➢ useful where:

(i) a scarce resource or right is to be licensed (e.g.spectrum) and/or

(ii) the regulator has a significant interest inensuring that the service is provided inparticular manner (e.g. where the operator hassignificant market power)

➢ basic PSTN services ina monopoly market

➢ mobile and fixedwireless services

➢ any service requiringspectrum

GeneralAuthorizations

(Class Licences)

➢ useful where individual licences are not justi-fied, but where there are significant regulatoryobjectives which can be achieved byestablishing general conditions

➢ normally contain provisions relating to con-sumer protection and other essentialrequirements

➢ generally issued without competitive selectionprocess; all qualified entities are authorized toprovide service or operate facilities

➢ data transmissionservices

➢ resale services

➢ private networks

Services whichmay be providedwithout a licence(fully liberalizedservices)

➢ no licensing process or qualification require-ments

➢ useful where an activity is technically caughtwithin the definition of activities subject toregulation (e.g. offering a telecommunicationsservice to the public) but where there is no jus-tification for imposing licence requirements

➢ general requirements (e.g. registration with theregulator) can be imposed through a generalregulation or order

➢ Internet serviceproviders (ISPs)

➢ Value-added services

does not involve competitive selection or otherformal public process. New telecommunicationslaws or amendments often authorize the licensing ofthe incumbent operator. The licensing processinvolves the detailed identification of existing andnew rights and obligations of the operator. In somecases, incumbent operators may be granted general

authorizations. Others, including the PTT, generallyreceive individual licences. While the EC licensingproposals advocate a move away from individuallicences in mature competitive markets, there arestill good reasons for individual licences forincumbents in less competitive markets with lesswell-defined regulatory frameworks.


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Licensing

Table 2-2: EU Licensing Directive: Types of Regulation of Competitive PSTN Operator

Type of Regulation Form of Regulation

➢ Allocation of spectrum ➢ individual spectrum licence issued throughcompetitive selection

➢ essential requirements ➢ general operating authorization or classlicence available to all qualified operators

➢ anti-competitive practices and universalservice

➢ general laws and regulations applicable to alloperators in the sector

The rights and obligations incorporated in newlicences for incumbents must generally be adaptedto a new sector policy and regulatory regime. Inparticular, they must often be adapted to the realitiesof a market based economy, especially where theoperator is to be privatized and to face competitionfor the first time in some markets. It is generally ad-visable to obtain good market input before settlingthe terms of such licences. This can be achievedthrough a public process, although it is more com-mon to do so by retaining good professionaladvisors with experience in privatization andliberalization in other markets.

In practice, the licensing of incumbents ofteninvolves a process of negotiation between the PublicTelecommunications Operator (PTO) and the regu-lator. Additional input generally comes from profes-sional advisors, including investment bankers andlawyers hired by the PTO, government or regulator.It is important for the regulator (or other licensingauthority) to obtain a good balance of views on thecontents of the licence. In this regard there are oftencompeting agendas between the PTO, which maywant to retain as much exclusivity and market poweras possible, and those promoting a competitive tele-communications policy. Ministries of Finance andinvestment bankers for PTOs often focus ongranting exclusivity and market advantages asmeans of increasing privatization proceeds.Ministries of Communications and regulators areoften more focussed on promoting competition as ameans of increasing efficiency of telecommunica-tions markets and delivering better services to thepublic.

Parallel Licences for PTO and New Entrants

In some countries, established PTOs are grantedlicences for new services (e.g. cellular, data com-munications, ISP, value added services) whilelicences for those services are also granted to newentrants. The PTOs generally receive the licenceoutside the competitive selection process that maybe used to select new entrants, such as new mobileoperators. This has been the case for cellular mobilelicences in both developed and less developedcountries.

Issues of competitive fairness arise in this process.Often the new entrant pays a significant amount forthe licence under a competitive selection processbut the incumbent does not. This issue has some-times been addressed by requiring incumbentoperators to pay a fee equal to the amount of thewinning bid or a fixed percentage of that amount.This occurred recently when Jordan licensed asecond GSM operator. When Colombia licensedsecond cellular operators in each of three regionalmarkets, the existing operators were required to pay95% of the amount of the winning bid in theapplicable region.

In other countries the incumbent operator has notbeen required to pay licence fees, even though newentrants do pay. Some argue that the incumbentwas awarded a licence in accordance with pastpractice and law, and that it would be unfair to retro-actively tax it. Others have pointed out that theincumbent may have taken risks and incurredexpense in developing the market. From this


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perspective the retroactive imposition of a substan-tial licence fee may be considered inappropriate.While there is not always a right answer in thesesituations, care must be taken to provide a levelplaying field. If preferential treatment is granted to anincumbent, there should be clear benefits to thepublic for doing so. These may include maintenanceof network rollout obligations or other specificuniversal service objectives.

2.3.2 Licensing New Entrants - IndividualLicences

The issuance of individual licences to new operatorsrequires some form of selection process. Where noexisting operator holds a licence, it is best to imple-ment a competitive and transparent licensingprocess in accordance with the practices discussedin detail later in this Module (especially in Section2.4).

2.3.3 General Authorizations

Issuance of general authorizations (class licences)involves the definition of licence eligibility criteria andlicence conditions. Ideally, both processes shouldinvolve prior public consultation. This improves thetransparency of the licensing process and ensuresall relevant information is taken into account. Noselection process is required for general authoriza-tions, since all eligible operators or service providerswill be licensed.

Implementation of a general authorization regimecan be more complicated where existing individuallicences authorize the same services as thosecovered by the general authorization. For example,general authorizations are frequently used toestablish conditions for the provision of value addedservices. However, many PTO operators are alsoauthorized to offer value added services under theirindividual licences.

To ensure fair competition, regulators should ensurethat any differences between general authorizationsand individual licence conditions are competitivelyneutral. A good solution is to indicate that individuallicences do not authorize the offering of any servicethat can be offered under a general authorization. Inthis way, regulators can ensure that all providers of

the same service are subject to the same licenceconditions.

2.3.4 Spectrum Licences

Many telecommunications services require anauthorization to use radio frequencies. Spectrumlicences that are required to provide a service areoften granted as part of an individual licensingprocess. It is necessary, for instance, to authorizecellular operators to use the required spectrum aswell as authorizing them to operate the cellular net-works.

Authorizations to operate a telecommunicationsservice and to use the required radio spectrumshould be granted at the same time. There shouldbe no delays or risks of inconsistent regulatory re-quirements as between the two types of authoriza-tions. If two separate licences are issued, theyshould be issued simultaneously. A good approachis to attach a draft spectrum licence as well as adraft operator’s licence to a call for applications forlicences. This approach is discussed later in thisModule.

One reason for retaining two separate licences isadministrative convenience in management of thespectrum. In most countries spectrum managementis delegated to a different administrative group fromthe group that regulates other aspects of telecom-munications operations, such as price regulation oranti-competitive conduct. By having a separate,consistent form of spectrum licence, technical,reporting and compliance requirements can bestandardized across all users of the radio spectrum.

2.3.5 Spectrum Auctions, Lotteries andComparative Evaluation Processes

The radio spectrum is universally acknowledged tobe a valuable, limited public resource and thussubject to government regulation. Technologicaldevelopments have expanded the usable portions ofthe spectrum and enabled the transmission of moreand more information in the same amount of band-width. Despite these developments, an increasingnumber of telecommunications services andapplications rely on spectrum, and thus demand forspectrum often exceeds availability. Hence there is aneed to develop policies and approaches to assign


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Licensing

spectrum. These approaches have similarities withother licensing processes, but there are alsodifferences.

In the era of public telecommunications monopolies,PTTs were often responsible for spectrum assign-ment, and they assigned spectrum for their own useas the need arose. Many countries have since de-veloped new approaches to spectrum assignment toreplace those used in the era of public monopolies.The development of new approaches was spurredon by the WTO Regulation Reference Paper.Section 6 of the paper requires that procedures forthe allocation and use of scarce resources, includingfrequencies, be carried out in an objective, timely,transparent and non-discriminatory manner.

Different approaches have been adopted to assignspectrum where demand exceeds availability. Noconsensus exists as to which approach is best inwhich cases.

Traditionally, governments often allocated spectrumto particular applications and then assigned parts ofthe spectrum to entities to use for specific purposeson a “first come, first served” basis. This approach isfast, practical and inexpensive, but not appropriate intoday’s competitive environment. The increase in thenumber of competitors and demands for spectrumhave led to the development of competitiveapproaches for its assignment. These approachesinclude lotteries, comparative evaluation approachesand auctions. Various combinations of theseapproaches have also been used. For example,applicants may be short-listed using a “comparativeevaluation” approach and then participate in anauction or lottery for the final assignment ofspectrum.

Lotteries

Lotteries provide a fast, inexpensive and transparentapproach for selecting from substantially similar orequally qualified applicants. Lotteries should gener-ally be preceded by a formal qualification process toselect lottery participants. Otherwise, their use mayhinder sector development. In the US, for example,experience demonstrates that some past lotteryparticipants had no intention of operating telecom-munications services, but simply planned to reselltheir spectrum licences for a profit. Other lottery

winners proved to be financially incapable of startingup service.

Comparative Evaluation Processes

Under a comparative evaluation approach, theregulator (or another government agency) decidesto whom the relevant spectrum is to be assigned.Comparative evaluation provides an approach forchoosing among multiple applications that are sub-stantially equal. It also allows regulators to matchspecific sectoral objectives with the operators incharge of achieving them.

There are many forms of comparative evaluationschemes. In some cases, spectrum licences areawarded to applicants expected to make the bestuse of spectrum to serve the public. Comparativeevaluation processes may involve the application ofa variety of qualification and selection criteria. Inmost cases, these criteria will be published inadvance, and applicants will strive to demonstratehow their applications meet the criteria better thanother applications.

Minimum qualification requirements generallyinclude evidence of financial resources, technicalcapability and commercial feasibility of the relevantspectrum application. Selection criteria may includeproposed tariffs, coverage (geographical and interms of users), network rollout targets, quality andrange of service commitments, and efficient use offrequencies. Some of the above criteria are appliedin some cases as qualification criteria and in othersas selection criteria, depending on the country andeven on categories of services within a country.

There have been many criticisms of the comparativeevaluation approach. Criticism generally focuses onlack of transparency. No matter how stringent theevaluation criteria, there is a subjective element tomost comparative evaluation processes. Hence theyare sometimes referred to as “beauty contests”.Because of the subjective element, it is oftensuspected that regulators or other decision-makersmay not exercise their judgement impartially. Insome cases these suspicions have led to litigation.In others, the suspicions are not acted upon, butthey nevertheless undermine the credibility of thelicensing process and the government or regulator.


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Other criticisms of the comparative evaluation proc-ess focus on its speed. The process is often slow.Careful evaluations of financial capability, technicalplans, etc. can take time. Finally, comparativeevaluation processes are sometimes criticized asinvolving inappropriate or questionable regulatoryintervention in the selection of winners and losers. Itis often said that auctions provide a better alternativeto comparative evaluations, in that they rely on mar-ket forces rather than regulatory fiat to determinecompetitive outcomes.

Auctions

Auctions are increasingly used by regulators to grantspectrum licences to the highest bidders. In the caseof auctions, the market ultimately determines whowill hold the spectrum licences. However, in manyauction schemes, bidders are pre-qualified usingcriteria similar to those used in comparative evalua-tion processes. As a result, participation in someauctions is limited to bidders with proven financialand technical capabilities.

Experience with spectrum auctions in the US illus-trates the importance of using rigourous technical,financial and commercial criteria to pre-qualifybidders. In that country, some successful bidderslater proved to be incapable of financing theiraggressive bids. It appeared that others had neitherthe technical capability nor the intention of operatingtelecommunications services utilizing the frequen-cies they had successfully bid on.

There are different types of spectrum auctions. Themost common are:

➢ One round or simple auctions (open or closed);and

➢ Multiple-round auctions (sequential or simulta-neous).

Initially developed in the US in the mid 1990s, thesimultaneous, multiple-round auction has becomethe most widely used auction approach. While thereare variations from country to country, the approachgenerally involves a simultaneous auction fordifferent spectrum licences. There are “rounds” ofbidding, that is series of consecutive bids, for eachlicence. The bids continue to increase during these

rounds until a high bidder is determined for eachlicence.

At the beginning of each round, every bidderreceives information about its eligibility to bid andabout the standing high bid on each licence. Newbids must normally be higher than the standing highbid by at least a minimum pre-set amount. In somecases, bidders may have the opportunity to withdrawbids made in earlier rounds, although this action isusually subject to penalties. Sometimes an “activityrule” penalizes bidders who are inactive by reducingtheir “bidder eligibility points”. The rounds continueuntil there are no new bids on any licence.

The bidding process in simultaneous multiple roundauctions is usually computerized, so that bids andother auction information can be posted and calcu-lations made quickly. Bids are typically encrypted forsecurity and submitted electronically.

Some key features of simultaneous multiple roundauctions are illustrated in Box 2-5, which describesthe Canadian auction process.

There are many arguments in favour of spectrumauctions. Auctions provide an efficient, transparentand objective means of awarding spectrum licencesto the bidders who value them most highly. A properpre-qualification process can ensure that successfulbidders have the technical and financial capabilitiesto implement services quickly and efficiently. Thehigh investments required to win an auction can beviewed as incentives for rapid roll-out of infrastruc-ture and services, since that is the only way thesuccessful bidder can recoup its investment in thelicence fee. Another argument in favour of spectrumauctions is that they provide the means to providethe public with the highest “rents” for the use of apublic resource. Governments can use the proceedsof auctions for deficit reduction and other publicpriorities.

There are also arguments against spectrum auc-tions. First, it is argued that the high costs paid bysuccessful bidders are usually passed on tocustomers. The result can be excessive rates forconsumers of wireless services, and reduced pene-tration, particularly among lower income consumers.Some argue that capital used to pay high auctionfees will not be available to invest in network


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Licensing

Box 2-5: Features of Multiple Round Auctions: The Canadian Example

1. Bidder Eligibility Points: Each licence in an auction is assigned a number of points proportionate tothe bandwidth and population covered by that licence. Each bidder must indicate which licences, and thenumber of “points-worth” of licences, it may wish to bid on.

2. Activity Rule: A bidder is considered active on a particular licence if it has the current high bid from theprevious round or if it submits an acceptable bid in that current round. In each stage of bidding, a biddermust be active on licences whose corresponding points add up to a certain percentage of the bidder’seligibility point level.

3. Bid Withdrawals/Penalties: If a bidder makes a bid and later wishes to change it, it may do so subjectto paying a penalty which corresponds to the potential loss of revenue caused by the withdrawn bid.

4. Bid Increments: Bid increments are used to expedite the auction. They are set in percentage and/orabsolute dollar terms and are changed during the course of the auction.

5. Waivers: Waivers protect bidders against mistakes they may make or in the case of technical or commu-nication problems. They prevent a bidder from losing bidder eligibility points when it does not satisfy theactivity requirements in a given stage.

6. Stopping rule: The auction generally stops when a round finishes with no acceptable bids or waivershaving been submitted on any licences.

7. Forfeiture: A bidder who submits the high bid on a licence but fails to pay will forfeit its right to thelicence and must pay a penalty

Source: Department of Industry Canada (1998)

infrastructure. While it is arguable that a well-financed applicant should be able to pay for both, itis not possible to prevent strategic bidding to obtainspectrum. Banks, rating agencies and financialadvisors have been critical of recent record-highauction fees paid for UMTS mobile spectrum inseveral European countries. Share prices and debtratings of some successful bidders have droppeddue to widely-held perceptions that too much waspaid by them in the auctions. Finally, high auctionfees may discourage smaller participants fromentering a telecommunications market. The resultmay be increased market concentration, and ulti-mately also higher consumer prices.

Simultaneous multiple round auctions have recentlybeen used to license wireless service providers inAustralia, Canada, Spain, the Netherlands, theUnited Kingdom and Germany. The recent UMTS(3G Cellular) licensing process provides some inter-esting case studies in different spectrum licensingapproaches. Box 2-6 describes the quite differentUMTS licensing processes utilized in a variety ofEuropean countries.

2.4 Licensing Practices

While telecommunications licensing approachesvary considerably from country to country, there arecommon features, particularly among better licens-ing practices. The following sections review goodpractices that will help ensure the success of alicensing process.

2.4.1 Transparency

Procedural transparency is one of the fundamentalrequirements of a successful licensing process. Theimportance of transparency in the licensing processis evidenced by its inclusion in the WTO RegulationReference Paper (see Box 2-1).

Transparency requires that a licensing process beconducted openly and that licensing decisions bemade based on criteria published in advance. Theserequirements apply to all licensing decisions,including ones to award or revoke a licence. Thelicensing processes described later in this Module


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Box 2-6: Auctions and Comparative Evaluations – UMTS Case Studies

Germany – In August 2000, Germany auctioned off 12 blocks of UMTS spectrum. The German regulator(RegTP) published the rules applicable to the award of the UMTS licences on 18 February 2000. The rulesprovided that eligibility to take part in the auction would be governed by the basic eligibility requirements ofthe Telecommunications Act. Bidders were required to bid successfully for at least two blocks of spectrum toqualify for a licence. Minimum bid increments were set at 10 percent. Additional rules were established toprevent bidders from influencing the outcome or controlling the pace of the auction. While the auction tookplace, for example, small groups of representatives of each bidder were isolated from 8 a.m. to 6 p.m. eachday, with two observers from RegTP present with each group at all times. Bidders were not able to see whatrivals were bidding. Only the highest bids for each block were made known to bidders.

Germany’s UMTS spectrum auction lasted for 14 days and 173 rounds of bids. At the end, six operatorseach obtained two blocks of spectrum and 20-year licences. The licences require operators to providecoverage of at least 50 percent of the German population by the end of 2002. This auction concluded withrecord bids for UMTS licences: a combined total of over USD 46 billion. As a result of the enormousamounts paid, concerns were expressed that some operators may well end up spending more on acquiringthe licences than on building their networks.

United Kingdom, Spain and Netherlands – The UMTS spectrum auction held in the United Kingdom inApril 2000 raised USD 32.58 billion. That process continued for more than 100 rounds over a period of morethan four weeks. The Netherlands auctioned off five licenses for USD 2.3 billion in July 2000. Spain, on theother hand, raised only USD 425 million from its sale of four UMTS licences in March 2000.

Norway – In Norway, a comparative evaluation process was used instead of an auction to grant UMTSspectrum licences. Applicants were required to meet minimum eligibility requirements, such as acommitment to meet specific coverage and roll out obligations, and proof of financial strength/capability. Thetwo main selection criteria were coverage (geographical and in terms of population) and roll out. Financialaspects, quality of service, environmental impact and previous experience were secondary criteria.

Norway’s emphasis was not on raising as much money as possible from the licensing of spectrum for 3Gmobile systems. Rather the goal was to encourage rapid network development and to increase the country’soverall competitiveness. In Norway, wireless operators are required to pay moderate administrative and fre-quency management fees. Operators awarded 3G spectrum licences were required to pay a special annualfee of approximately USD 2 million. In addition, subject to parliamentary approval, 3G licensees wererequired to pay a one-time lump sum of approximately USD 11 million. These sums are very smallcompared with the results of the spectrum auctions in the United Kingdom and Germany.

Sweden – In Sweden, spectrum licences for 3G mobile communications systems will also be awardedusing a comparative evaluation process. Swedish law provides that spectrum licences must be awardedbased on specific criteria. As in Norway, the main selection criteria for the award of 3G spectrum licences inSweden are coverage and roll out. Modest fees will be charged for the spectrum licences. This approach isconsidered beneficial in that it will enable operators to invest in network development. High spectrum feespaid by operators will not be passed on to customers.

reflects the principles of transparency. Key featuresof such processes include:

➢ advance publication of a call for applications,with application process (tender) rules, quali-fication and selection criteria;

➢ separation of qualification and selectionprocesses;

➢ return of unopened financial offers (bids) toapplicants who do not meet the publishedqualification criteria; and


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Licensing

➢ public opening of sealed financial offers fromqualified applicants.

A transparent process can be different in the case ofelectronic applications or auctions. These arediscussed above under the heading Auctions.

Transparency is best measured from the point ofview of the participants in the licensing process. It isgood practice for a regulator to take all reasonablesteps to ensure that participants in the licensing pro-cesses, including applicants, existing licensees, andcompetitors as well as the general public, perceivethe process to be fair.

Conducting a transparent licensing process issometimes perceived to be more time consumingand difficult than less transparent alternatives. Theprocess, for instance, of publishing procedural rulesand selection criteria in advance can be difficult for anewly formed regulator in a country where proce-dural transparency is not entrenched in governmentpractice.

However, the absence of transparency underminesinvestor confidence in the fairness of the entireregulatory process and in the telecommunicationsmarket itself. Lack of transparency can significantlyslow the process of liberalization and reduce thebenefits of privatization.

2.4.2 Public Consultation

It is good practice to engage in public consultationbefore and during a licensing process. To start, it isoften useful for a regulator to invite public commenton the approach to be taken in a proposed licensingprocess before it starts. Consultation withstakeholders reinforces the perception of a trans-parent process. Consultation allows the regulator toreceive directly the views of consumers, existingoperators and prospective applicants on a proposedlicensing initiative. This allows licence terms andconditions and licensing procedures to be fine-tunedto maximize the prospects for a successful licensingprocess.

Consultation is particularly important where ageneral authorization is to be issued. Advancepublication of proposed conditions of generalauthorizations provides the main opportunity for

public comment. By contrast, in a competitive li-censing process there are usually other ways forstakeholders to make their views known, such aspre-bid conferences and written exchanges ofquestions and answers.

Consultation can be formal or informal. In thecontext of any major licensing initiative, it is generallyadvisable for the regulator to establish a formal andtransparent consultation process. A good approachis for the regulator to publish a notice stating itsintention to launch a licensing process, and invitingcomments on the proposed approach. The noticeshould set forth in some detail the proposedapproach and any specific issues on which com-ments are sought. Where the regulator is unsure ofthe best approach, comments can be invited ondifferent options.

Notices of this kind should be sent to all interestedparties, including prospective applicants, existinglicensees, consumer and industry interest groups. Insome cases, a public meeting is held to allow apublic exchange of views by interested parties.Copies of written comments can also be published.

A pre-licensing consultation process increases thelikelihood that the regulator’s approach to licensingwill be based on a good understanding of all relevantconsiderations. Consultation also helps to ensurethat even those who may disagree with the regula-tor’s approach will believe that their views have beenconsidered.

2.4.3 Licence Fees

In the telecommunications industry, the term “licencefee” is used to describe different things. It mayinclude one or more of the following:

➢ a fee paid as a premium or “rent” to agovernment or licensing authority for theright to operate a network, provide a serviceor use a limited resource, such as radiospectrum or numbers;

➢ administrative charges to compensate aregulator for its costs in managing and su-pervising use of the radio spectrum; and


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➢ administrative charges to compensate aregulator for costs incurred in performingother regulatory functions, such as licensingoperators, ensuring compliance with licenceterms, resolving interconnection disputes,establishment and supervision of otheraspects of the regulatory framework, etc.

It is good practice to differentiate the above-notedtypes of fees. This improves transparency andmakes it easier to determine that the administrativecharges related to cost recovery are indeed cost-based. Separating administrative licence feesrelated to spectrum management from otheradministrative fees improves transparency andaccountability. Spectrum management is usuallyhandled by a separate branch, and sometimes awholly separate ministry or agency from the tele-communications regulator.

It is generally accepted that administrative feesshould not impose unnecessary costs on the tele-communications sector. The most transparentmanner by which to achieve this objective is anexplicit cost-recovery scheme. Cost recoveryschemes involve establishment of licence feesbased on the projected or actual costs of theregulator. Once that overall level of cost-recoveryhas been set, it is necessary to allocate the costsamong licensees or market participants. This alloca-tion can be based on different factors, including tele-communications revenues, licensed coverage areasor types of services. The most common allocationfactor is revenues.

The July 2000 EC proposal to replace the 1997Licensing Directive criticized the “lack of transpar-ency and high fees” of its European Member States.It provides the following proposal:

“(15) Administrative charges may be imposed onproviders of electronic communications servicesin order to finance the activities of the nationalregulatory authority in managing the authoriza-tion system and for the granting of rights of use.Such charges should be limited to cover theactual administrative costs for those activities.For this purpose transparency should be createdin the income and expenditure of national regu-latory authorities by means of annual reportingabout the total sum of charges collected and the

administrative costs incurred. This will allowundertakings to verify that administrative costsand charges are in balance. Administrativecharges should not act as a barrier to marketentry. Such charges should therefore be distrib-uted in proportion to the turnover on the relevantservices of the undertaking concerned ascalculated over the accounting year precedingthe year of the administrative charge. Small andmedium sized undertakings should not berequired to pay administrative charges.

(16) In addition to administrative charges, usagefees may be levied for the use of radio frequen-cies and numbers as an instrument to ensure theoptimal use of such resources. Such fees shouldnot hinder the development of innovativeservices and competition in the market.”

2.4.4 Balancing Certainty and Flexibility

Telecommunications licences should balance regu-latory certainty with the flexibility necessary toaddress future changes in technology, marketstructure and government policy.

In many countries, a balance between regulatorycertainty and flexibility is achieved by using regula-tory instruments other than licences as mainelements of the regulatory framework. However,where a country’s regulatory regime is not welldeveloped, it is often necessary to include areasonably comprehensive codification of the basicregulatory regime in a licence. This is necessary toprovide the certainty required to attract new entrantsand substantial investment to the sector.

Licence conditions should be sufficiently flexible toallow their integration into the general regulatoryframework for the sector as it develops. Licensing anoperator should not preclude future regulatoryreform.

There are several approaches to providing suchflexibility, including:

➢ permitting unilateral licence amendment bythe regulator;

➢ establishing short licence terms;


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Licensing

➢ permitting licence amendments with themutual consent of the licensee and regulator;and

➢ permitting unilateral amendments by theregulator only of specific licence conditionsthat should constitute part of the country’sgeneral regulatory regime, provided suchamendments are made in a procedurally fairand competitively neutral manner.

The first two approaches are not consistent withregulatory certainty. They will generally make it diffi-cult, if not impossible, to attract the investment andfinancing required for a major licence, such as afixed line or cellular licence.

The fourth approach is more attractive in this regard.To implement it, a distinction can be made betweenlicence conditions that are of a regulatory nature andthose which can only be amended with the agree-ment of the licensee. For example, licenceconditions on industry-wide universal servicemechanisms or general terms of interconnectionmay be subject to amendment by the regulator.Other conditions of a purely contractual nature orwhich are fundamental to the economic value of thelicence may be subject to modification only onconsent of the operator. These would normallyinclude conditions such as the term of the licenceand the licence acquisition fee payable.

Where the regulator has the right to amend thegeneral regulatory conditions of a licence, suchamendments should be made in a transparent andcompetitively neutral manner. Any amendmentsshould be preceded by consultation with the licen-see and other affected parties. In some cases, aright of appeal or review may be warranted.

2.4.5 Distinguishing Licensing fromProcurement

The process of licensing a telecommunicationsoperator should be distinguished from the govern-ment procurement process. In many countries therehas been confusion between the two types ofprocesses, sometimes with adverse consequencesfor the licensing process.

In licensing a telecommunications operator, a regu-lator is not buying goods or services using publicmoney. In essence, licensing involves offering abusiness opportunity to qualified investors whoagree to comply with the licence conditions. Theregulator is more a seller than a buyer.

This observation leads to two important recommen-dations for licensing processes:

➢ The regulator must offer to licence applicants anopportunity that is financially attractive to experi-enced and competent telecommunicationsoperators. While some licensing opportunitiessell themselves, others, particularly those inemerging and transitional markets, must becarefully structured and marketed to attractqualified applicants. Experience shows thatalmost any call for applications for telecommu-nications licences will attract some bidders.However, many are not financially or technicallycapable of meeting the regulator’s objectives toexpand and improve services.

➢ Government procurement procedures aregenerally not suitable for a telecommunicationslicensing process. Many countries have bureau-cratic centralized procurement administrations.Detailed government procurement proceduresare often developed for good reason - to reducecorruption. However application of these proce-dures can cause legal and administrativeheadaches, and delay and confusion about thereal goals of the licensing process. For example,government procurement officials generallywant to see detailed specifications for everyaspect of the goods and services beingpurchased and a careful inspection andmonitoring of installation and performance afterselection and delivery. This kind of micro-management is inappropriate in a telecommuni-cations licensing process. As discussed below,clear qualification requirements should beestablished. However, the regulator is generallyconcerned only with results. What matters iswhether - not how - licence conditions arecomplied with. From this perspective, suchissues as technology choices, managementstructures and marketing strategies should notbe the subject of licence conditions or selectioncriteria.


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Other problems are experienced in trying to applystandard government procurement procedures to atelecommunications licensing process. It is generallybest to avoid such procedures, and to use a simpleand transparent competitive licensing process,based on internationally accepted telecommunica-tions licensing procedures.

2.4.6 Concessions, BOTs and SimilarArrangements

A licence is a grant by a public authority of a right tooperate a service, subject to the terms and condi-tions specified in the licence or in other regulatoryinstruments. The issuance and enforcement of alicence is therefore always, to some extent, a matterof public or administrative law. As indicated above,licences, concessions and other types ofgovernment permits to operate telecommunicationsfacilities and services have more in common thannot.

However, in some cases, private sector investorshave entered into business arrangements withgovernments or state-owned operators that aremore in the nature of joint ventures with governmententities than independent rights to operate telecom-munications facilities or provide services.

Before describing these arrangements, the term“concession” should be discussed. In mostcountries, this term is used to refer to a documentthat establishes a commercial agreement between agovernment and the private builder, owner or op-erator of an element of public infrastructure (such asa toll road, power plant or telecommunicationsnetwork) or a business located on public property.Contractual remedies, such as money damages, areavailable for breach of a concession through civilcourts or arbitration. Governments can fine tuneconcession terms to establish the protections andincentives necessary to attract investors and toguarantee performance by the concession holder.

Some licences have both regulatory and concessionfeatures. It is important to distinguish between thetwo. A good approach is to deal with the concessionfeatures in a concession contract between the hostgovernment (not the regulator) and the investor. Inproject finance terms, such an agreement would becalled a government support agreement.

It should be noted that the term concession hasdifferent meanings in different countries. Forexample, in some Latin American countries, such asMexico, the term concession is used to refer to adocument (e.g. the Telmex Concession) that is es-sentially a licence, not a commercial agreement,although it is signed by the government and theconcession holder.

Some countries, particularly in Asia, have grantedconcessions that are in the nature of joint ventureagreements rather than granting full licences tooperate telecommunications networks independentof the government.

Many variations are possible on the theme of “jointventures” between private sector investors on theone hand and governments or PTTs on the other.These include Build-Operate-Transfer (BOT), Build-Transfer-Operate (BTO), Build-Operate-Own (BOO),and an alphabet soup full of alternatives limited onlyby the imagination of project finance lawyers andbankers. Some examples of countries where sucharrangements have been implemented are listedbelow:

➢ BTO: Thailand, Philippines

➢ BOT: Lebanon, India, Indonesia (JointOperating Schemes or KSOs)

➢ BOO: Malaysia, Solomon Islands

In general, these are all project finance structuresaimed at attracting investment and managementexpertise required to develop telecommunicationsinfrastructure. A variation on such structuresinvolves contracts where an investor does not buildor own any facilities, but shares in revenues from astate-owned operator in return for providing financ-ing, management or both. Financing contracts of thistype have been entered into in China and Indonesia.An example of a management contract with revenuesharing is the Vietnamese “Business CooperationContract”.

Most of the types of structures discussed in thisSection have experienced initial success in promot-ing network expansion. In part this was becausethey were not characterized as licences to privateoperators but rather as contracts under which


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Licensing

private contractors would build and operatetelecommunications services “owned” by thegovernment or by a state-owned operator. Thisarrangement allowed for private sector participationin telecommunications operators without breachinglaws or policies that prevented private sector owner-ship of operators.

However, experience in Lebanon, Indonesia andelsewhere suggests that these models are not viablein the long term. Investors in BOT projects lack thelong-term security and equity interests of a licensee.They are therefore motivated to maximize short-termprofitability at the expense of long term network orservice development. A BOT must either terminate,with the resulting withdrawal of the private investor,or it must be converted into a true licence. If theinvestor withdraws, the operator may or may not beable to continue to expand and manage the serviceon its own. If the concession is converted to alicence, serious questions may arise regarding thefairness and transparency of the licensing process.

2.4.7 Service Areas

The definition of geographic service areas to becovered by a new licence presents unique chal-lenges. Different approaches have been taken indifferent countries. In some cases, national licencesare issued, while in others, a distinction is madebetween regions or between rural and urban areas.In some cases, national licences are offered inparallel with competing regional licences for thesame service.

There is no one right approach to designatingservice areas. However, some approaches are likelyto be less successful than others. One approach thathas experienced limited success in a number ofcountries is to preserve the profitable urban marketsfor a state-owned PTT, and to invite private sectoroperators to serve only financially less viable ruralareas. In some cases, the failure of the private sec-tor operators to perform well in such areas has beenused as evidence to argue against further sectorliberalization.

The following points are relevant in selectinglicensed service areas:

➢ Financial viability must be a key factor. If finan-cially non-viable rural or high cost areas arelicensed, a universality fund, or similarmechanism should be established. A preferredapproach in such cases is to select a licenseefrom among competing applicants, based on thelowest requested subsidy. Universality fundingmechanisms and approaches for measuringfinancial viability are discussed in Module 6.

➢ Experience shows that regional licensees oftenmerge with, or are acquired by, other regionallicensees to serve larger regions or formnational operators. Examples range from theColombian cellular operators to the U.S.Regional Bell Operating Companies. Thesemoves are often driven by economies of scale.Regulators may want to keep this trend in mind,and license several competing national opera-tors at the outset, rather than numerous finan-cially weaker regional operators. The result willbe lower transaction costs for the sector, andless disruption due to integration of differentoperating systems.

➢ Licensing operators to serve larger areas willpermit them to cross subsidize from more profit-able areas to less profitable ones. Thisapproach can be used to extend service to lessprofitable areas. However, it can lead to anti-competitive conduct where an incumbentoperator retains the right to serve profitableurban markets as well as less profitable ruralones, while new entrants can serve only therural markets. Problems of anti-competitivecross-subsidy are discussed in detail in Module5.

➢ National licences and large service areas areconsistent with the consumer interests in ob-taining seamless “one stop shopping” servicefrom a single service provider. This is particularlytrue where technical or other barriers to efficientinterconnection or roaming are present.

2.4.8 Qualification Criteria

It is important to distinguish between criteria relatingto the qualification of an applicant to participate in alicensing process and criteria for the selection of a


2 - 22

successful licensee from among the qualified appli-cants.

In the case of a general authorization, only the quali-fication criteria are relevant because there is noselection to be made. In the case of a selectionprocess for an individual licence, both qualificationand selection criteria are normally developed. It isgenerally advisable to conduct a licensing process inat least two phases. The qualification phase iscompleted first. Only qualified applicants participatein the second phase – the licensee selectionprocess.

Qualification criteria are minimum requirements forthe right to participate in the selection process.Generally, qualification criteria are limited to ensur-ing applicants have the financial and technicalresources and experience to successfully operatethe licensed service.

Some countries impose foreign ownership restric-tions that establish minimum levels of localownership for licensed operators. Foreign ownershiprestrictions are generally contrary to the spirit, if notthe letter of foreign trade agreements, including theGATS. However, various WTO signatory countrieshave registered exceptions permitting them tocontinue to apply foreign ownership restrictions.Over time, such restrictions are likely to be phasedout in most countries.

The importance of establishing clear and rigourousqualification criteria is related to the level of competi-tion in the applicable service. In the case ofindividual licensees that will enjoy monopoly or otherexclusive rights, it is of critical importance to ensurethat the licensed operator is financially and techni-cally able to meet its licence obligations. Otherwise,the licensee may fail to meet important licenceconditions, such as those related to network rollout,service coverage and quality. The process ofenforcing licence compliance or revoking and re-tendering a licence in the case of default is timeconsuming, costly and disruptive for consumers.

In the case of competitive services, competition willgenerally discipline the market. If a market issufficiently competitive, consumers will switch froman operator that fails to provide adequate service to

another operator that does provide it. A qualificationprocess is therefore less important.

Recent experience in spectrum auctions demon-strates, however, that even in relatively competitivemarkets, such as mobile services in Brazil and theUS, it is important to establish some minimumqualification requirements. These requirements willensure that valuable spectrum and other scarceresources are awarded to applicants who are finan-cially and technically capable of providing the publicwith service using such resources.

Some licensing processes involve more than onequalification phase. In issuing a large individuallicence, a pre-qualification requirement is oftenestablished. This limits the eligibility of applicantswho can participate in the final qualification process.It is justified, for example, where there are high costsincurred by the regulator (and applicants) in con-ducting a detailed qualification process or whereconfidential access to information or facilities isgranted to applicants.

In those circumstances it makes sense to discour-age participation in the process by applicants whoare unlikely to meet the qualification criteria or tosubmit a competitive application. Various pre-qualification options exist. These include:

➢ payment of a substantial registration fee;

➢ a substantial document purchase fee; and

➢ use of a proxy indicator of experience andresources (e.g. minimum number of custom-ers or lines in service for similar services inother markets).

It is important to specify whether qualification criteriaare in any way relevant to selection. Transparencyrequires that applicants be told whether minimumcompliance with qualification criteria is sufficient.There has been litigation against regulators in somecountries where certain qualification criteria werespecified, and then some qualified applicants wererejected on the basis that they were less qualifiedthan others.

Table 2-3 sets out possible qualification criteria for avariety of different services.


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Licensing

2.4.9 Selection Criteria

There are two basic types of selection processes:

➢ Competitive selection based on a singlequantitative criterion. Examples include:

➢ an auction where the highest bidder wins;and

➢ a subsidized rural service competition, wherethe operator that bids the lowest subsidywins.

➢ Comparative evaluation where based on a moresubjective evaluation of one or more quantitativeor qualitative criteria.

Advantages and disadvantages of both approachesare discussed above under the heading SpectrumAuctions, Lotteries and Comparative EvaluationProcesses. The single criterion approach is clearlythe most transparent and simplest to use. It is themost consistent with international trade agreements,and the most frequently recommended approach ofinternational financial institutions and internationaldevelopment organizations that promote telecom-munications sector reform. However, it may notalways result in the selection of the best qualifiedapplicant, and, in the case of an auction, it mayresult in the imposition of excessive costs on thesector.

There are many variations on these two basicapproaches. For example, in some cases, there ismore than one quantitative criterion, with a weightingscheme for the various criteria that will result in asingle “score”. In other cases, numerical scores aregiven for essentially subjective measures, such asthe experience record of an applicant, or the qualityof its management

Several observations can be made about the choiceof selection criteria:

➢ Qualified applicants are motivated to devotefinancial and other resources to those aspects oftheir applications that will form the basis of theselection decision. Licensing selection is a zero-sum game. Each applicant has a finite amountof cash and other resources to devote to the

proposed service. Resources which are allo-cated to one aspect of an application on whichselection is based (i.e. the financial offer oraccelerated roll-out commitments) are notavailable to fund other aspects of the operationwhich are not related to selection criteria (i.e.universal service, lower prices, introduction ofenhanced services).

➢ Transparency is increased by use of simplequantitative selection criteria. A competitiveselection process that is based on subjective orqualitative criteria will be less transparent. Thesame is true of multiple criteria that cannoteasily be compared. A lack of transparencyundermines the credibility of the process and ofthe regulator. It also opens the door for com-plaints of bias, corruption or incompetence. Tomaximize transparency, a single financial orother quantitative selection criterion should beused. This can be derived by use of a formulawhich combines a number of selection criteriainto a single numeric factor if desired.

Use of a single financial criterion does not meanother service factors or licensing objectives areirrelevant. Important factors and objectives not usedas selection criteria can be indirectly included in thequalification process. For example, coverage, rolloutand universal service commitments can be specifi-cally incorporated as licence conditions that anysuccessful applicant will have to comply with. Allapplicants will then incorporate these minimumrequirements into the calculation of their financialbid.

Table 2-4 describes possible types of selectioncriteria and summarizes their advantages anddisadvantages.

2.5 Contents of Licences

The contents of licence documents vary considera-bly depending on the country, the service and theoperator. As indicated above, much depends on thestate of development of the regulatory regime in acountry. Where it is well developed, licences tend tobe shorter. Where it is not well developed, licencesmust often include considerably more detail, in orderto provide a comprehensive regulatory frameworkfor the operator or service being licensed. For


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Table 2-3: Possible Qualification Criteria

Licence Type Possible Qualification Criteria Rationale

First newcompetitivefixed network(local orinternationalservice)

➢ Applicant not currently licensed tooffer a competitive service; notassociated with the incumbent

➢ Applicant has a minimum number offixed lines in service in other coun-tries/markets (an international PTO aspartner)

➢ Relevant experience in similar mar-kets (direct or by contract)

➢ Financial comfort letter from recog-nized bank

➢ Business plan, including pro formafinancial statements and a marketingplan

➢ Technical plan, including details ofnetwork planning and roll out andtechnology selections

➢ Effective competition will not developbetween related entities

➢ Only experienced operators canmeet the significant challenges fac-ing a start up fixed line competitor

➢ Experience and contacts in localmarket increases prospects ofsuccessful start-up

➢ Evidence of access to requiredfinancing

➢ Evidence of financial viability andlikelihood of success of the project;disadvantage in that it is costly toprepare plan

➢ Business plan and technical plancan demonstrate detailed and viableservice plans and knowledge of localeconomic and other conditions

Competitivecellularservice (firstnew entrant inan emergingmarket)

➢ Similar to, but less onerous than,above

➢ Presence of competition reduces(but does not eliminate) public costsof failure

➢ Significant economic and sector de-velopment objectives will beachieved by successful launch

➢ Valuable and scarce spectrum willbe allocated to the selected operatoron an exclusive basis

Datatransmissionservice inhighlycompetitivemarket

➢ None ➢ General authorization is bestapproach

➢ No scarce resources involved

➢ Existing competition makes successor failure of this operator relativelyunimportant

Broadbandwirelessservices inhighlycompetitivemarket

➢ Financial comfort letter

➢ Evidence of experience in successfuloperation of similar businesses in anymarket

➢ Spectrum is a scarce and valuableresource. Regulator has a importantrole to play in ensuring efficient useand avoiding warehousing


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Licensing

example, if a price regulation regime already existsin a country, it will not be necessary to spell it out ina licence. However, where no rules on price regula-tion exist, it is essential that they be spelled out in

the licence document (even to say that prices will beunregulated). Certainty is the key theme in goodlicensing practice.

Table 2-4: Possible Selection Criteria

Selection Criteria Advantages Disadvantages

Comparative Evaluation –based on subjective assess-ment and comparison by theregulator of applications basedon a list of qualitative and/orquantitative criteria

➢ Maximum flexibility and dis-cretion to select the mostattractive application

➢ Allows applicants to focuson factors they believe areimportant and to convinceregulator accordingly

➢ Non-transparent

➢ Subject to accusations ofbias or corruption fromlosing bidders which arehard to refute and damageregulatory credibility

➢ Risk of confusion amongbidders who may not clearlyunderstand regulatory pri-orities

Pure Auction – selection fromamong qualified bidders basedon the highest financial bid

➢ Maximum transparency

➢ Market efficiency – licenceawarded to the bidderwhich values it most

➢ High bidder will have strongincentive to roll out servicequickly to recover its bid

➢ Suited to licensing incompetitive markets

➢ Payment of fee can divertfinancial resources fromservice provision to auctionfees (government revenue)

➢ Encourages applicants tominimize resources devotedto other important priorities(i.e. rollout, coverage etc.)

Pure Auction – selection basedon quantitative criteria, otherthan cash, relating to theservice (i.e. time required tomeet roll-out target,commitments on maximumprices for consumers)

➢ As above

➢ Regulator can focus bidderresources on service devel-opment or other priorities asopposed to governmentrevenues

➢ Encourages applicants tominimize resources devotedto priorities which are notselection criteria, unlessthey make business sense

Combined auction/comparativeselection via weighted formula

➢ A compromise which hasmany of the benefits of bothauction and comparativeselection

➢ Applicants are awardedpoints based on selectioncriteria

➢ Difficult to develop a soundformula that compares“apples to apples”

➢ Compromise has disadvan-tages of both comparativeselection and auctions

➢ Less transparent than pureauctions


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Table 2-5 provides an example of the contents of afairly comprehensive licence. It is based on thecontents of a PSTN operator’s licence in an emerg-ing economy without a well-developed regulatoryframework. This type of licence has been chosen asan example since it is fairly comprehensive. It alsocovers many of the areas often dealt with in licencesfor other services, such as mobile services – exceptthat licences for such other services can usually bemuch less comprehensive. Some additional anddifferent conditions will be required in licences forparticular services.

Not all of the matters included in Table 2-5 will benecessary in all licences for PSTN services. In manycountries some of the matters included in the tablewill already be covered in general laws, regulationsor policies. Examples include general regulations onuniversal service or licence fees, a competition lawor general rules of practice and procedure governinglicensee information reporting or licence terminationand renewal. It generally does not matter which typeof legal document is used to deal with these issues,provided the provisions are stated clearly and areenforceable under local law.

Table 2-5: Contents of a PSTN Operator's Licence (Example for Emerging Economy)

Contents Notes

Part 1 – Background and Identification of Parties

Recitals ➢ Provides background, governing law, licensing circumstances, etc.

➢ Important for posterity, and for courts and governmentsinterpreting the licence

Naming of parties ➢ Ensure licensed entity has legal and financial substance

Definitions ➢ Key to clarity of licence conditions

➢ Should repeat relevant definitions from laws, regulations, etc.,since these may change

Part 2 – Grant of Licence

Describe scope of licence:services, facilities andspectrum licenses

➢ Approaches may differ (e.g. licensing of facilities or services)

➢ Spectrum often licensed separately – refer to separate licence

➢ Sometimes useful to define exceptions – i.e. what licensee is notentitled to do

➢ Specify services licensee may not offer (e.g. to implementcompetition policy)

Exclusivity rights ➢ Define precisely, including time limits, possible extensions and anypre-conditions for extensions

Term of licence ➢ Duration of licence and renewal terms, if applicable

➢ Include effective date of licence

Part 3 – Licence Fees

Licence acquisition fee ➢ Usually based on competitive bid or fixed in advance

➢ One time fee

➢ May be payable in installments, with revocation penalty


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Licensing

Table 2-5: Contents of a PSTN Operator's Licence (Example for Emerging Economy) (cont’d)

Operating licence fees ➢ Periodic fee (usually annual)

➢ Often intended to recover administrative costs of regulation

➢ Fees should not exceed demonstrable administrative costs

➢ Should be impartial assessment of fees across industry

Spectrum fees ➢ Usually provided for in spectrum licence

➢ Cost recovery for spectrum management

➢ Sometimes higher fees (if no licence acquisition fee)

Part 4 – General Conditions of Licence

Application ➢ Include essential requirements and public interest matters applica-ble to all or most licences for telecommunications services

Eligibility ➢ Cite requirements to retain eligibility to hold licence (if any)

Ownership and control rules ➢ Cite any restrictions on ownership and control of licensee (e.g.cross-ownership with major competitors, foreign ownership restric-tions)

Facilities and equipment ➢ Rules on equipment that may be used (e.g. type approval rules)

Books, records and reports ➢ Any applicable rules (e.g. to verify price or revenue cap regulation)

➢ Specify reporting requirements and rules on provision ofinformation to the regulator

Co-operation with regulator ➢ Specific obligations to provide access by regulator to informationor premises, and to co-operate with regulator for specificregulatory purposes

Co-operation with othergovernmental authorities

➢ Specify obligations to co-operate with other authorities (e.g. policeand national security forces regarding interception of communica-tions, environmental protection, health and safety rules if notcovered by law of general application)

Access to rights of way andother public property

➢ Rights of operator to access streets, sidewalks, road allowancesand other public property and rights of way for the purpose of con-structing, operating and maintaining facilities

➢ Cite legal authority for any such rights

➢ Include rules for access, if not stated elsewhere (e.g. payment, ifany, public safety and convenience, aesthetics, compliance withapplicable law)

Access to private property ➢ Any rights of operator to access private property (e.g. rights of wayfor cable or microwave routes) including expropriation rights, ifapplicable

➢ Cite legal authority for any such rights


2 - 28


Part 5 – Specific Conditions of Licence

Use of radio spectrum ➢ Often dealt with in separate spectrum licence

➢ Include rules on efficient spectrum use

Numbering ➢ Assignment of numbers, if applicable

➢ Refer to national numbering plan, if applicable

➢ Rights and obligations regarding implementation of numberportability arrangements

Directory and EmergencyServices

➢ Obligations to provide such services, and co-operate with otheroperators in providing them jointly

Universal Access and/orUniversal Service Obligations

➢ See Module 6 – Universal Service

Network roll-out and servicecoverage obligations

➢ Specific obligations (usually set out in Appendix, including maps,number of access lines, etc.)

➢ See Module 6

Quality of service ➢ Specific obligations (usually set out in Appendix, including specificindicators, standards to be met by specified dates, reportingprocedures, etc.)

➢ May be covered or supplemented in other regulatory documents

Security for Performance ofLicence Obligations

➢ Reference details of performance bond or other method used tosecure performance of licence obligations

➢ Bond or security document(s) may be annexed to licence

Part 6 – Relations with Customers

Terms and conditions ofservice

➢ Terms and conditions usually set out in regulatory documents

➢ May include mandatory contents of customer contracts

➢ May include consumer “code of rights”

Customer complaints ➢ Rules on handling and recording complaints

➢ May be set out in regulatory documents

Consumer protection ➢ Provisions may be in regulatory documents or approved customercontracts (to provide notice to customers)

➢ Include protection of privacy

➢ Rules often published in telephone directories

Price regulation ➢ Price regulation (tariff) regime usually specified (e.g. price caps)

➢ Specify services to which price regulation regime applies

➢ Review period and rules for review often specified

➢ Key to financial viability of licence

➢ Details in appendices or referenced regulatory documents


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Licensing


➢ See Module 4 – Price Regulation

Dispute resolution ➢ Method to resolve disputes over application of licence

Part 7 – Relations with Other Operators

Interconnection ➢ See Module 3

➢ Include rights and obligations to interconnect

Anti-competitive practices ➢ See Module 5

➢ Include remedies and sanctions, if not specified elsewhere

Access to shared facilities(poles and conduits)

➢ Rights and obligations regarding collocation and access to poles,towers, conduit, etc.

➢ See Module 3

Resale ➢ Rights and obligations regarding resale by licensee and by otherservice providers (e.g. for payphones, Internet services, valueadded and simple resale)

Dispute resolution ➢ Method to resolve disputes with other licensees, e.g. regardinginterconnection (see Module 3)

Part 8 – Amendment, Renewal and Termination

Amendment by regulator ➢ See Section 2.4.4

➢ Unilateral modifications should only apply to certain regulatorymatters, not key commercial terms of licence

➢ Procedural safeguards

➢ Competitive neutrality should be maintained

Amendment by mutualagreement

➢ Provides certainty, where needed

➢ Key commercial terms usually only subject to amendment byagreement between licensee and regulator

➢ Competitive neutrality should be maintained

Compliance ➢ Specify sanctions and penalties for failure to comply with variousterms of licence (e.g. fines, forfeiture of performance bonds,revocation)

Renewal ➢ Include renewal rights (e.g. if certain performance targets met)

Termination for cause ➢ Termination, revocation and/or suspension may be included

➢ Grounds (usually certain major, unresolved breaches only)

➢ Procedure (include due process)

➢ Include lesser penalties (e.g. fines) which will not disrupt service

Termination if no renewal ➢ Clarify surviving rights of licensee, property rights, treatment of as-sets, and other effects of non-renewal


2 - 30


Part 9 – General

Force Majeure ➢ Excuses performance in case of specified types of events beyondcontrol of licensee

Assignment ➢ Often no assignment (at least without consent)

➢ Rules and restrictions on assignment of licence

Transitional provisions ➢ Rules and timetable for coming into full compliance with licence(important in licensing of PTT or other incumbent operator)

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3 - 1

MODULE 3

INTERCONNECTION

3.1 Interconnection Principles

3.1.1 The Importance of Interconnection

Interconnection of telecommunications networks hasbeen important for a century, but never more so thantoday. Originally, operators, such as PTTs and theNorth American Bell companies, interconnected withneighbouring operators. However, these operatorsretained monopolies over all networks andequipment in their geographic serving areas. Fordecades, few other types of interconnectionoccurred.

Beginning in the 1970s, customers began tointerconnect a growing range of terminal equipmentand private network facilities to the incumbentoperator’s facilities. With the liberalization oftelecommunications markets over the last fewdecades, effective interconnection arrangementshave become key to the operations of anincreasingly wide range of services. These servicesinclude local, long distance and international fixed,mobile and satellite services, providing everythingfrom basic voice telephony to high speed Internetconnectivity to Internet multimedia services.

Competition is the key to the growth and innovationof today’s telecommunications markets. Intercon-nection is a critical factor for the viability of

competition. For most of the history oftelecommunications, operators and governmentadministrations negotiated with each other to set theterms of interconnection without regulatory interven-tion. The emergence of competition has changedthis. Incumbent operators have little incentive tomake things easy for their new competitors, andmost of the bargaining power in negotiations lieswith the incumbents.

Strategic anti-competitive behaviour on interconnec-tion matters by incumbents has retarded orprevented competition in many telecommunicationsmarkets around the world. Incumbents can engagein a wide range of behaviour to frustrate effectivecompetition. For example, they can charge exces-sive rates for interconnection, refuse to build ormake available adequate interconnection capacity,and refuse to unbundle network elements orservices necessary for efficient interconnection. Newentrants in telecommunications markets have little tooffer in negotiations to remove these barriers tocompetition. Today, there is a consensus amongtelecommunications experts and policy makers thatdecisive and informed guidance by regulators is re-quired to pave the way for effective interconnectionarrangements.

Interconnection is an important consumer issue.Telecommunications users cannot communicate


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with each other or connect with services theydemand unless necessary interconnection arrange-ments are in place. Interconnection of a multitude ofdifferent types of networks has brought tremendousbenefits to consumers and businesses around theworld in the last decade. Without efficient intercon-nection arrangements, services such as directinternational dialing, all Internet-delivered services,automated teller machines and e-commerce wouldnot be possible.

Increasing network interconnection will continue toimprove the convenience and utility of telecommuni-cations service for users around the world in thenext decade. Inadequate interconnection arrange-ments not only impose unnecessary costs andtechnical problems on operators - they also result indelays, inconvenience and additional costs forbusinesses, consumers and, ultimately, for nationaleconomies.

According to ITU’ surveys, Interconnection-relatedissues are ranked by many countries as the singlemost important problem in the development of acompetitive marketplace for telecommunicationsservices, interconnection has been a highlycontentious issue in Europe. Almost half of allcountries in the Asia-Pacific region indicated thatinterconnection issues were a top regulatory priority.While fewer countries in the Arab states (20%) andthe Americas (30%) pointed to interconnection as aregulatory priority, the general level of networkcompetition was still low in those regions. That ischanging. The importance of interconnection issueswill increase in all regions as network competitiondevelops.

This Module examines the arrangements that mustbe put in place between operators, and the stepsthat can be taken by regulators, to facilitate effectiveinterconnection.

3.1.2 Scope of Interconnection Issues

Interconnection is defined in different ways in thedifferent regulatory and policy regimes that deal withit. A good recent definition is included in the 12 July2000 proposed European Commission Directive onaccess and interconnection:

“interconnection” means the physical and logicallinking of public electronic communicationsnetworks used by the same or a differentundertaking in order to allow the users of oneundertaking to communicate with the users of thesame or another undertaking, or to accessservices provided by another undertaking.Services may be provided by the parties involvedor other parties who have access to the network.(Article 2 – CEC(2000d))

This definition differs from others in that it includesinterconnection of networks used by the sameundertaking and not just networks of differentoperators. The proposed Directive also differs fromsome other regulatory interconnection regimes inthat it includes a separate concept of “access”,defined differently from interconnection:

“access” means the making available of facilitiesand/or services, to another undertaking, underdefined conditions, on either an exclusive or non-exclusive basis, for the purpose of providingelectronic communications services. It coversinter alia:

➢ access to network elements and associatedfacilities and services, which may involve theconnection of equipment by wire or wirelessmeans;

➢ access to physical infrastructure includingbuildings, ducts and masts;

➢ access to software systems, including opera-tional support systems;

➢ access to number translation or systemsoffering equivalent functionality;

➢ access to mobile networks, in particular forroaming; and

➢ access to conditional access systems fordigital television services.

Interconnection is a specific type of accessimplemented between public network operators.Access in this Directive does not refer to accessby end-users.

Module 3 - Interconnection

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Interconnection

The last sentence of the definition is important. Itdistinguishes the Commission’s use of the term“access” from its normal meaning, which relates toend-user access, for example in the terms “accesslines” or “network access service”. Despite this po-tential confusion, the types of inter-operator “access”listed in the Commission’s definition are very impor-tant in the context of interconnection.

The types of “inter-operator access” listed in theCommission’s definition are treated as an integralpart of “full” or “efficient” interconnection in otherjurisdictions. They may also be considered as“supplemental” or “ancillary” forms of interconnec-tion. These types of access arrangements aretypically addressed in interconnection agreementsentered into between experienced operators.

Whatever the regional or local definition of intercon-nection, the matters included in the Commission’sproposed definition of “access” must be dealt with aspart of a comprehensive approach to interconnec-tion. In this Handbook, therefore, we will deal withthis type of “inter-operator access” in detail, as anintegral part of full interconnection.

3.1.3 Interconnection Issues

Commercial, technical and operational arrange-ments must be made to facilitate interconnectionbetween network operators. A number of issuesmust be agreed upon by the operators, or deter-mined by the regulator, in order to finalize thesearrangements.

The major commercial issues of concern to newentrants are generally related to the cost of intercon-nection. In North America and Europe, for example,up to 50% or more of the total costs of some long-distance operators have been paid out in intercon-nection charges to local operators. Suchinterconnection charges are particularly significantfor operators that rely heavily on resale or that mustpay a subsidy or contribution component as part ofinterconnection charges. The practice of combiningsubsidies and cost-based charges is widelydiscouraged, for the reasons set out in Section.3.3.5.4. Even without a subsidy component, the levelof interconnection charges is often an importantfactor in determining the financial viability of a newtelecommunications service provider.

Interconnection costs are certainly not the onlymajor issue. Various technical and operationalissues are also critical to both incumbent and newoperators. Box 3-1 lists some of the most importantinterconnection issues encountered in manycountries.

3.1.4 Regional Interconnection Rules

In recent years, the development of regional tradingareas and the implementation of multilateral tradeagreements has accelerated the liberalization ofinterconnection policies.

A leading example is the 1997 European Intercon-nection Directive (97/33/EC). It contains rulesspecifically aimed at liberalizing nationalinterconnection regimes. The Directive requiresinterconnection arrangements to be public and non-discriminatory. It also requires interconnectioncharges to be cost-based. Related EU Directivessupplement and amend the European interconnec-tion regulatory framework. These Directives includeobligations on special access (98/10/EC) andprovision of leased transmission capacity(92/44/EC).

The provisions of the European Directives related tointerconnection are fairly general in nature. Thisapproach permits adaptation to the EU’s differentnational legal regimes and regulatory frameworks.The European Commission has taken additionalsteps, beyond the Directives, to improve intercon-nection arrangements. One such step is thepublication of “best current practice” interconnectionrates. These interconnection rates are significantlylower than those of some member countries, sug-gesting that these countries should take action tomeet international cost benchmarks. Another majorstep was the recent adoption of rules and aproposed regulation to require unbundling of thelocal loop. These rules are discussed later in thisModule.

The European Commission has also reviewed itsinterconnection-related Directives. As previouslyindicated, on 12 July 2000, the Commissionpublished a proposed new Directive on access to,and interconnection of, electronic communicationsnetworks and associated facilities (COM(2000) 384).The proposed new Directive seeks to respond to the


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convergence phenomenon by covering a broaderrange of electronic communications networks andservices. It also contains some new and differentprinciples. However, under the proposed newDirective, the key provisions of the three previous(above-noted) Directives will continue to be legallybinding on European Union Member States,pending further reviews.

Other multilateral organizations have also developedinterconnection guidelines. For example, the Asia-Pacific Economic Co-ordination (APEC) Telecom-munications Working Group has developed aFramework for Interconnection. Unlike the EU

Box 3-1: Some Key Interconnection Issues

Framework and Procedural Issues

➢ Adequacy of regulatory guidance for interconnection negotiations

➢ Availability of interconnection with incumbent operators for various types of services

➢ Access to standard interconnection terms with incumbent operator

➢ Independent and timely dispute resolution

➢ Non-discriminatory access to interconnection facilities and services

➢ Access to PSTN network specifications (including planned network changes)

➢ Treatment of Universal Service, Universal Access or Access Deficit Charges

Commercial Issues

➢ Level and structure of interconnection charges; basis for calculation (i.e. type of costs used tocalculate charges, revenue sharing, bill and keep, etc.)

➢ Unbundling of interconnection charges for different network components and related services

➢ Resale of network facilities and services

➢ Payment for network modifications to facilitate interconnection

➢ Confidential treatment of competitive and customer information

Technical and Operational Issues

➢ Open network standards and technical compatibility

➢ Location of Points of Interconnection (POI)

➢ Access to signaling systems, advanced digital features, billing system, operations support systems(OSS), call-related databases and other software to provide advanced services

➢ Access to unbundled network components, including local loops

➢ Equal ease of customer access to competitive networks (e.g. customer dialing parity)

➢ Access to numbers and implementation of number portability

➢ Collocation and sharing of infrastructure (e.g. buildings, poles, conduits, ducts, towers)

➢ Quality of interconnection, including availability of sufficient interconnection capacity to avoidcongestion, and to ensure the timely provisioning of interconnection services and facilities


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Interconnection

approach, this framework is not binding on APECmembers. The APEC framework is intended toprovide principles, examples of interconnectionapproaches in APEC economies, and other usefulinformation to assist in the development of nationalinterconnection policies. Similarly non-bindingapproaches have been taken in interconnectionprinciples published by other regional organizations,such as CITEL in Latin America.

3.1.5 Multilateral Interconnection Rules

The 1997 WTO Agreement on BasicTelecommunications (formally known as the FourthProtocol of the General Agreement on Trade inServices or GATS) was the first widely acceptedmultilateral trade agreement to include bindinginterconnection rules. These rules were included inthe so-called Reference Paper, an informal textcontaining regulatory principles negotiated amongWTO Members. The Reference Paper becamelegally binding on WTO Members that attached it aspart of their “additional commitments" in their GATSSchedule of Commitments on telecommunicationsmarket access. The Reference Paper was attachedin whole or with minor modifications by 57 of the 69signatories to the Fourth Protocol. Six additionalsignatories elected to list some of the principles intheir Schedules, but not the entire document.

All WTO Members have the option of undertakingthe obligations of the Reference Paper in theirGATS Schedules on interconnection or othermatters, whether or not they participated in theFourth Protocol. As of late 1999, a total of 64 WTOMember governments had committed to theinterconnection obligations of the Reference Paper.This increase from 57 was due to the submission ofcommitments by seven more countries since theFourth Protocol. Of these, four WTO Membersattached the Reference Paper to telecommunica-tions commitments they made after the Protocolnegotiations ended and three countries attached it tothe GATS Schedules they filed upon accession tothe WTO. Most of the nearly 30 additional countriesseeking accession to WTO are expected to alsocommit to the Reference Paper and its interconnec-tion obligations.

The most important interconnection-related rules setout in the WTO Regulation Reference Paper are

summarized in Box 3-2. The full text of theReference Paper provides more detail than the box.

The paper’s central principles are non-discrimina-tion, transparency, and the availability of reasonableinterconnection terms, including cost-oriented ratesand unbundled access, from "major suppliers". Theconcept of "major suppliers" in the Reference Papercan generally be assumed to refer to operators witha dominant position vis-à-vis essential infrastructureor market share. Thus, at present, the Paper’sinterconnection disciplines would most commonlyapply to monopoly or former monopoly fixed-lineoperators.

The Reference Paper was designed as a set ofgeneral rules or principles to be observed, ratherthan as detailed prescriptive guidelines on how theprinciples are to be implemented. This approachmakes the paper adaptable as telecommunicationsmarkets evolve, and provides flexibility for applica-tion to different legal systems and regulatory inter-connection frameworks.

Box 3-2: Interconnection Rules of WTORegulation Reference Paper

Interconnection With “Major Suppliers” must beassured:

➢ At any technically feasible point in thenetworks

➢ In a timely fashion

➢ On non-discriminatory and transparentterms (including quality and rates)

➢ Sufficiently unbundled to avoid charges forunnecessary components

➢ At non-traditional interconnection points ifrequestor pays charges

Procedures

➢ Procedures for interconnection to majorsuppliers must be made public

Transparency

➢ Agreements or model interconnection offerof major supplier must be made public


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As a practical matter, therefore, more detailedguidance is essential to turn the general ReferencePaper principles into workable interconnectionarrangements, agreements, national regulations orregulatory directives. The experience of other coun-tries can provide valuable precedents in this regard.

When the GATS Agreement on BasicTelecommunications came into effect on 15February 1998, many signatory countries did not yethave detailed interconnection rules in place. Somestill do not. Given the general nature of theReference Paper principles, it will be a challenge formany countries to develop sufficiently detailedinterconnection regimes to put “flesh on the bones”of their GATS obligations.

Before examining the details of interconnectionarrangements, the following sections of this Modulewill review the basic principles underlying most inter-connection rules.

3.1.6 Interconnection Principles

3.1.6.1 Providing Advance RegulatoryGuidelines

There continues to be a regulatory debate about therelative advantages of providing ex ante or advanceinterconnection guidelines versus ex post regulation.Proponents of the ex post approach generally favournegotiation of interconnection agreements betweenoperators, with recourse to regulatory dispute reso-lution or competition law remedies, if negotiationsfail.

Several years ago, there were more advocates ofthe ex post approach, particularly outside of NorthAmerica, than there are today. This approach wasbased on the belief that regulation should be mini-mized in competitive markets. Many regulatorsrecognized that the financial, technical andoperational details of interconnection arrangementscould be complex. They considered that incumbentoperators and new entrants would generally have amuch better understanding of these arrangementsthan regulators. They were also concerned thatinappropriate regulatory intervention in interconnec-tion matters could impose high costs on the sector.

For these reasons, a large number of regulators andtelecommunications experts promoted industrynegotiation as the main approach for developinginterconnection arrangements. Ex ante regulatoryintervention was discouraged. The focus of regula-tory attention was on dispute resolution, in the eventindustry negotiations broke down.

In recent years, there have been increasing doubtsabout the effectiveness of the ex post approach.There appears to be a growing consensus thatadvance regulatory guidelines, or even specific inter-connection rules, are necessary to facilitatesuccessful negotiations. This view has beenexpressed recently by the European Commission, inits 12 July 2000 proposed Directive on access andinterconnection. The Commission stated:

“…there is a consensus that ex-ante sectorspecific rules will continue to be neededalongside competition rules to regulate accessand interconnection, until such time as there isfull and effective competition in all segments ofthe market.” (CEC (2000c))

This view has long been held by regulators andpolicy-makers on the other side of the Atlantic.During the 1980s and 1990s, US and Canadianregulators issued a series of detailed guidelines anddecisions on most aspects of interconnection withdominant operators, including interconnection ratesand technical terms and conditions. The more inter-ventionist approach of the North Americanregulators appears to have led to more unbundlingof network services, more competition, and arguablymore service innovation and growth.

The issues of negotiating interconnection arrange-ments and approaches to regulatory intervention arediscussed in detail in Section 3.2.2 of this Module.

3.1.6.2 Focus Interconnection Obligationson the Incumbent Operator

One generally accepted means of minimizing regu-latory intervention is to limit imposition ofinterconnection obligations to dominant incumbents.In practice, this is the most effective and efficientmeans of utilizing limited regulatory resources.


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This approach is sometimes subject to criticism byincumbent operators. They argue that this approachamounts to regulatory “handicapping” and construc-tion of “non-level playing fields”. Others suggest thatuniversal imposition of interconnection obligationswould provide more interconnection opportunities forall operators.

However, this is a minority view. The consensusview is that universal imposition of interconnectionobligations on all operators, large and small,generally amounts to over-regulation. In principle,only firms with a dominant market position have theability to establish interconnection termsindependently of competition. Non-dominant com-petitors would find it difficult to independentlymaintain excessive interconnection rates, ordiscriminatory conditions. Other service providerswishing to interconnect could avoid such unfavour-able interconnection arrangements by interconnect-ing with a competitor, including the dominantsupplier. Over time, as markets become increasinglycompetitive, it may be possible to deregulate moreinterconnection arrangements, including those ofonce-dominant operators. However, in the transitionperiod to full competition, a degree of asymmetricregulation is required in order to level a playing fieldthat is tilted in favour of incumbents.

For these reasons, the regulatory approach to inter-connection in this Module focuses on interconnec-tion arrangements with dominant incumbentoperators.

This approach is consistent with the ReferencePaper of the WTO Agreement on BasicTelecommunications, which only imposesinterconnection obligations on dominant operators(i.e. “major suppliers”). It is also consistent with theEuropean Commission’s 12 July 2000 proposedDirective on access and interconnection. Theproposed Directive aims to expand the scope of itsinterconnection framework to a wider range ofelectronic communications networks. However, onlydominant operators will be subject to the ex anteregulatory obligations proposed by the Commission,such as mandatory interconnection, resale,collocation, etc.

3.1.6.3 Transparency

Transparency is a major policy objective of multilat-eral trade agreements as well as the nationaltelecommunications policies of many countries.While there is a lot to be said for protecting theconfidentiality of business agreements in a competi-tive marketplace, interconnection with dominantincumbents is generally considered an exception.

Confidential treatment of interconnection arrange-ments would provide incumbents with an opportunityto act strategically to thwart competitors. Forexample, such operators could enter into confiden-tial interconnection agreements that provideunfavourable interconnection arrangements withcompetitors, and more favourable ones withaffiliates. Dominant operators could also limit thefunctionality of the types of interconnection offered,levy excessively high charges, and otherwise actstrategically to limit competition.

Transparency of interconnection arrangements is aneffective means of discouraging anti-competitivestrategic behaviour by dominant operators. It iseasier for regulators to detect and remedy suchbehaviour if interconnection arrangements are madepublic. Publication of agreements also makes iteasier for regulators and all industry participants tocompare interconnection rates, terms and condi-tions. Transparency also assists in developingindustry standards and benchmarks, as well as bestpractices on operational and administrative issues.

Many countries require publication of referenceinterconnection offers or model interconnectionagreements. To further promote transparency, someregulators maintain public registries of interconnec-tion agreements, or require publication of agree-ments by operators. In some cases, interconnectionagreements are available over the Internet.

Where interconnection agreements are made public,various mechanisms can be used to protectconfidential commercial information. For example,Indian legislation requires the regulator to maintain aregistry of interconnection agreements. However, atthe request of parties, the regulator may direct thatparts of an agreement be placed in a confidentialportion of the registry. In such cases, a summary of


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the confidential parts must be made publicly avail-able.

3.1.6.4 Non-Discrimination

Avoidance of discrimination is a central objective ofmost interconnection policies. Discrimination ininterconnection arrangements can take severalforms. One form involves discrimination by a domi-nant operator in interconnection arrangementsentered into with several different new competitors.For example, new entrant B may obtain betterarrangements than new entrant C. Such discrimina-tion is relatively easy to detect if interconnectionagreements are public.

It should be noted that interconnection arrange-ments may vary from one competitor to anotherwithout being “unduly” or “unjustly” discriminatory.The two competitors may have voluntarily agreed todifferent arrangements, for example, to suit theirdifferent operating conditions. The real test, there-fore, should not be “discrimination” in the sense of“differences” in interconnection arrangements. Thetest should be “unjust”, “undue” or “unfair” discrimi-nation, in the sense that an interconnectingcompetitor is placed at a significant disadvantage asa result of less favourable interconnection arrange-ments.

The other major form of discrimination is oftenharder to identify. It involves the provision of morefavourable interconnection arrangements by adominant firm to its own operations or its affiliatesthan to competitors. Disputes or complaints aboutthis form of discrimination are often difficult forregulators to resolve. For example, it is sometimesimpossible to grant a competitor exactly the sametype of interconnection arrangements as it is possi-ble to provide to an internal operation.

Various approaches have been developed to identifyand resolve cases of discrimination of the secondtype. Since interconnection arrangements need notbe identical, the objective of preventing undue dis-crimination has been described as one ofdeveloping “comparably efficient” interconnectionarrangements.

Some incumbents discriminate against competitorsby treating them as “customers” rather than “peers”

or “co-carriers”. This approach often leads to higherprices and inferior interconnection arrangements.Regulators should generally insist that intercon-necting carriers should be treated on an equal andreciprocal basis, as peers and not customers.

One type of discrimination can be fatal to theprospects of competition. It involves providinginsufficient network capacity to interconnectingoperators, as compared to an incumbent’s ownservices. Network congestion can be a deadly anti-competitive barrier. Regulators must sometimesintervene to ensure non-discriminatory rationing ofnetwork access and transport facilities. They mustoften also ensure that established PSTN operatorsconstruct sufficient capacity to handle growingdemand that can be expected in a competitive tele-communications market.

One regulatory approach to reduce, or at least assistin the identification of, discrimination between adominant firm and its competitors involves the es-tablishment of structural or accounting separationsor divestiture. Under structural separationapproaches, a dominant firm is required to move itscompetitive operations into a separate affiliatedcompany, with separate management, accountingrecords, etc. Divestiture involves selling all or part ofthe separate affiliate to other persons. Accountingseparations involve setting up separate accountingrecords only, and not actually requiring the estab-lishment of a separate legal entity for the competitivebusiness. These approaches are discussed inSection 5.3.3 of Module 5 – Competition Policy.

Another less interventionist approach that iscommonly used by regulators and competitionauthorities to prevent undue price discrimination bya dominant firm is an “imputation approach”. Suchan approach is applied to vertically integratedsuppliers. Such suppliers include operators that pro-vide a retail service, like local telephone accessservice, on a competitive basis, and also provide awholesale service, like international telephoneservice, on a monopoly basis to itself and othercompetitors.

Under an imputation test, a vertically integratedsupplier would be required to include the sameamount it charges to its competitors for internationalservice in its own retail rates, and to add an amount


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sufficient to cover its additional costs of providinglocal services. Imputation tests are discussed underthe heading Vertical Price Squeezing in Section5.3.4. of Module 5.

3.1.6.5 Cost Orientation

Interconnection principles, such as those set out inthe Reference Paper for the WTO’s Agreement onBasic Telecommunications and the EuropeanUnion’s Interconnection Directive, require intercon-nection charges to be “cost-oriented”.

There are various reasons for specifying that inter-connection charges should approximate costs.Without a cost-based standard for setting intercon-nection charges, an established monopolist ordominant operator would have an incentive todemand a high price for terminating calls thatoriginate on a new competitor’s network. Similarly, adominant operator would have an incentive to paylittle or nothing to the competitor to terminate calls

originating on the dominant operator’s network. Inthe absence of regulatory intervention, some newcompetitors might have little choice but to acceptsuch a deal or remain unable to interconnect.

Serious problems can result from a dominant firmcharging competitors interconnection prices that aresignificantly above cost. First, it deters market entryand the development of competition. Second,customers of the competitors will ultimately have topay for these excessive charges. Third, the exces-sive prices can provide a pool of revenues that thedominant firm can use to subsidize losses, forexample losses incurred as a result of predatorypricing action taken by the dominant firm to drivecompetitors out of a market.

The approaches used by telecommunicationseconomists and regulators to calculate interconnec-tion costs, and telecommunications costs generally,are discussed in Section 3.3 of this Module, inModule 4 and in Appendix B of the Handbook.

Box 3-3: Summary of Widely Accepted Interconnection Principles

➢ Terms of interconnection should not discriminate unduly between operators or between a dominantfirm’s own operations and those of interconnecting competitors

➢ Interconnection should be permitted at any technically feasible point, but the requesting operatorshould pay any additional costs of non-standard interconnection

➢ Interconnection charges should generally be cost-based (i.e. the evolving best practice specifiesthat the cost standard should be forward-looking long-run incremental costs; there is normally amark-up to cover forward-looking joint and common costs)

➢ Cost inefficiencies of incumbent operators should not be passed on through charges tointerconnecting operators

➢ Where reciprocal interconnection and costs can be expected to be reasonably balanced, bill andkeep arrangements are an efficient alternative to cost-based interconnection

➢ Regulatory guidelines and procedures should be prescribed in advance, to facilitate interconnectionnegotiations between operators

➢ Standard terms and procedures should be published for interconnection to dominant operators➢ Interconnection procedures and arrangements should be transparent➢ Interconnection arrangements should encourage efficient and sustainable competition➢ Network elements should be unbundled, and charged separately➢ Charges related to universal service obligations should be identified separately, and not bundled

with interconnection charges➢ An independent regulator (or other third party) should resolve interconnection disputes quickly and

fairly


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3.1.6.6 Other Interconnection Principles

A number of other interconnection principles havebeen proposed and adopted by regulators, policymakers and trade organizations. In many cases,these are variations on the same themes. Box 3-3summarizes widely accepted interconnection princi-ples.

3.1.7 Contents of InterconnectionAgreements

The contents of interconnection agreements varyconsiderably. Much depends on the regulatory

framework. If the existing regulatory frameworkprovides sufficient detail on the terms and conditionsof interconnection, then interconnection agreementscan be shorter. The same is true if an incumbentoperator, or an industry group, has publisheddetailed interconnection tariffs, technical standards,procedures, etc. which can be incorporated into anagreement. In other cases, interconnection agree-ments must be more comprehensive.

Bearing these variations in mind, Table 3-1 providesa list of the possible contents of a “typical” intercon-nection agreement.

Table 3-1: Contents of a Typical Interconnection Agreement

Contents Detail and Comments

Interpretation

Recitals ➢ “Whereas” clauses add historical and legal context to assistunderstanding by future readers of agreements

Definition of Key Terms ➢ Terminology varies significantly among different countries andoperators

➢ It is important to ensure compatibility of terminology to the localenvironment when adapting interconnection agreements from othercountries

➢ Definitions in other documents may be referenced, e.g. definitions inlaws or regulations, regulatory guidelines, ITU definitions

Scope of Interconnection

Description of Scope andPurpose of Interconnection

➢ Different types of interconnection agreements have differentpurposes (e.g. two local networks, local to longdistance/international, fixed-to-mobile, mobile-to-mobile, local ISP toISP backbone)

➢ The purpose of some interconnection agreements is to providetermination services or transit services; others involve provision ofunbundled facilities, etc.

➢ Interconnection architecture (annotated diagrams)

Points of Interconnection and Interconnection Facilities

Points of Interconnection(POI) and Related FacilitySpecifications

➢ POI locations (e.g. exchanges, meet points) usually listed in anappendix; may be modified from time to time. Typically includesexchange types and street addresses

➢ Specific POI facility locations (e.g. digital distribution frame; manholesplice box)


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Table 3-1: Contents of a Typical Interconnection Agreement (cont’d)

➢ Description of network facilities to be interconnected (e.g. OC-3 fibreoptic terminals with interconnecting single-mode optical fibres)

➢ Specify capacity and/or traffic volume requirements

➢ Indicate which party is to provide which facilities (include diagram ofPOIs and interconnected facilities)

➢ Technical specifications, for example:

➢ Calling Line Identification (CLI) specs

➢ Other advanced digital feature specs, e.g. call forwarding, callername ID, etc.

➢ Basic and ISDN call control interface specs

➢ Local Number Portability (LNP) query-response network specs

Signaling Interconnection ➢ Specify type of signaling networks/standards (e.g. CCS7)

➢ Signaling POIs locations to be specified (i.e. Signal Transfer Pointsor STPs)

➢ Point Codes to be specified

➢ Technical interface specifications (e.g. signaling links to be dedicatedE-1 or DS-1 transmission facilities; operating at 56 kbps)

➢ Diagram of signaling interconnection architecture

Network and Facility Changes

Planning and Forecasts ➢ Requirement for mutual notification of network changes and capacityforecasts, for example:

➢ traffic forecasts for each POI

➢ local number and portability requirements

➢ area code saturation and changes to increased digit phonenumbers

➢ default and redundant routing arrangements

➢ Periodic network planning reports may be specified

Facility Ordering Procedures ➢ Specify rights and obligations of each party with respect to orderingand provisioning of interconnection facilities (including unbundlednetwork elements – see below).

➢ Confidentiality requirements and procedures to ensure same

➢ Ensure no anti-competitive use of order information (e.g. no contactswith end users; competitive service divisions of operator receivingorders)

➢ Specify points of contact (e.g. Interconnection Service Groups; E-mail addresses, etc.)

➢ Specify order format and procedures (e.g. standard order forms maybe utilized in paper or electronic (EDI) format)


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➢ Procedures to expedite specific orders

➢ Co-ordination process for migration of customers between operators(e.g. coordination of cut-overs to prevent or minimize serviceinterruptions to end users)

➢ Procedures for ordering operator to arrange for all equipmentinstallations and changes at end-user premises

➢ Order confirmation and order rejection procedures, timelynotification, notification of additional charges, etc.

➢ Order completion notification and reporting requirements

Traffic Measurement and Routing

Traffic MeasurementResponsibilities andProcedures

➢ Describe party responsible; measurement and reporting procedures(see billing procedures below):

➢ Rules for routing of different types of traffic, if any (e.g. Bill and Keeplocal traffic that is to be terminated reciprocally without charge maybe carried on “Bill and Keep” trunks; traffic to which terminationcharges apply may be carried on other trunks, e.g. transit trunks,national traffic trunks, etc.)

Infrastructure Sharing and Collocation

Sharing of Infrastructure,Procedures and Costs

➢ Availability of poles, conduits, towers, rights of way, etc.

➢ Procedures, if any, for determining available capacity; procedures forallocating capacity among requesting operators (e.g. first come/firstserved)

➢ Prices and/or costing method

➢ Provision and pricing of supplementary services (electrical power,security systems, maintenance and repairs, etc.)

➢ Sub-licences on property of third parties (e.g. right of way owners,municipal and other public and private property owners, whereinfrastructure is located), insurance and indemnification for damages

Collocation ➢ Availability of actual or virtual collocation (e.g. for transmissionfacilities on exchange premises); list of addresses where collocationis available; procedures for determining available space; reservationof expansion space

➢ Prices and/or costing method for collocated space

➢ Provision and pricing of supplementary services (e.g. electricalpower and emergency backup power, lighting, heating and airconditioning, security and alarm systems, maintenance and janitorialservices, etc.)

➢ Procedures for ensuring access to and security of collocatedfacilities (notification; supervised repair and provisioning work and/orseparated premises, etc.)


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➢ Negotiation of other lease and/or licence arrangements, includingissues of sub-licences on property of third parties (e.g. buildingowners, right of way owners, municipal and other public propertyowners), insurance and indemnification for damages

Billing

Scope of BillingArrangements andResponsibilities

➢ May include different arrangements, for example:

➢ Operators billing each other for interconnection services (e.g.termination) and facilities (e.g. unbundled loops and other networkelements)

➢ Performance of billing functions by some operators for others (e.g.local operators billing end-users for long distance or internationaloperators, ISPs, etc.)

Billing Procedures ➢ Interconnection billing media – discs, tapes, paper and/or electronic(EDI) transfers; format and software specifications

➢ Guidelines for production of interconnection billing outputs, including:

➢ Applicable industry standards (e.g. CABS, BOS, SECABS, usedwith or without modifications)

➢ Billing data format and data elements

➢ Standardized codes and phrases

➢ Billing schedule

➢ Customer Service Record (CSR) provision, including:

➢ details to be supplied by provisioning local operator (e.g. record ofinterconnection elements used, including circuit and other (e.g.DSLAM) equipment identification numbers)

➢ media (e.g. tape, paper, etc.) and schedule for delivery

➢ other requirements to facilitate efficient verification and billing ofend-user by non-provisioning operator

➢ Retention periods for billing data

Payment Terms andConditions

➢ Billing fees and related charges.

➢ Payment terms and conditions, including late payment penalties;service disruption credits, etc.

Billing Disputes andReconciliation Procedures

➢ Contact details for reconciliation and billing queries

➢ Responsibilities to provide back-up records

➢ Notification of billing disputes

➢ Initial resolution procedures (e.g. escalation to more seniormanagement)

➢ Final resolution (referral to arbitration, regulator or courts)


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Quality of Service/Performance and Trouble Reports

Quality of Service ➢ Service performance standards may be specified in appendix, forexample:

➢ Average time for provisioning interconnection circuits

➢ Percentage of interconnection cut-overs made on scheduleddates

➢ Comparative provisioning performance for competitors and self(or affiliates)

➢ Switching and transmission quality measures on interconnectedcircuits (e.g. probability of blockage at peak hours, transmissiondelay and loss – consider referencing ITU-T recommendations

Testing and Maintenance ➢ Right to make reasonable tests, and to schedule serviceinterruptions; procedures to minimize disruption

Trouble Reports ➢ Procedure for trouble reports; notice periods; response timestandards

➢ Duty to investigate own network before reporting faults tointerconnecting operator

➢ Responsibility for costs incurred to second operator in investigatingfaults subsequently found to exist in first operator’s network.Calculation of charges (labour, etc.) for investigating trouble reports

System Protection andSafety Measures

➢ Responsibilities of parties to take necessary precautions to preventinterference with, or interruptions of, other parties’ networks orcustomers

Interchange and Treatment Information

Data Interchange Format ➢ Method and format of data interchange between carriers, includingdata interfaces, software, forms, etc.

Data to be Exchanged ➢ Specify all data types and systems for which data is to beinterchanged, for example:

➢ New facilities and service orders, network changes and forecasts,billing, etc. (see above)

➢ Number allocations and other data required for call routing andlocal number portability (where applicable, e.g. where LNP systemis operated by incumbent operator rather than an independentparty)

➢ Customer listings in directories and databases

➢ Access to network databases, for provision of advanced services


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Interconnection


Access to and use ofCustomer Information

➢ Confidentiality procedures for customer information, including:

➢ Establishment of separate interconnection services group withsecure data (password protection for electronic files; locks fordata rooms and filing cabinets, etc.)

➢ Confidentiality forms to be completed by all relevant employees(penalties and bonding optional)

➢ Procedures to ensure protection of customer privacy

Access to and use ofOperator Information

➢ Confidentiality procedures (see customer information procedures –above)

➢ Intellectual property rights

Equal Access and Customer Transfer

Equal Access Procedures ➢ Procedures depend on equal access approach, e.g. carrier pre-selection; casual selection. Detailed procedures normally incumbentfor carrier pre-selection, including:

➢ Customer authorization requirements (signature on prescribedform, clear choice requirements)

➢ Authentication and measures to prevent unauthorized customertransfers (slamming)

➢ Penalties for unauthorized customer transfers

➢ Methods of reporting customer transfers (contact points and data tobe provided)

➢ Order confirmation procedure (format, medium, etc.)

➢ Schedule to implement transfers

➢ Procedures to implement transfers

➢ Dispute resolution process (e.g. escalation through seniormanagement, arbitrator and regulator); information to be provided indispute resolution process

➢ Procedures for dealing with disputed customers (which operator maycontact customer, information to be provided to and/or obtained fromdisputed customers)

Ancillary Services

Operator Assistance ➢ Types of operator assistance services to be provided, includingdirectory assistance, translation services, fault report routing, etc.

➢ Call handling and operations procedures

➢ Fees and billing procedures


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Other Ancillary Services ➢ Subscriber listings in telephone directories

➢ Information and billing inserts

➢ Repair and maintenance services

➢ Other services provided by one or other operators to increasemutual operating efficiencies

Termination

Grounds for Termination andRestrictions

➢ Termination may only be permitted subject to certain restrictions (e.g.regulatory approval for termination of interconnection by incumbentoperator)

➢ Grounds for termination by incumbent may include:

➢ Regulatory or court orders

➢ Bankruptcy, insolvency, receivership, etc.

➢ Cessation of business

➢ Fewer, if any, termination restrictions in competitive markets, and bynon-dominant operators

Termination Procedures ➢ Advanced notice requirements

➢ Payment of non-recoverable interconnection costs incurred bydisconnected operator

➢ Computation and payment schedule for disconnection costs

➢ Dealings with end-users, communications restrictions, etc.

➢ Disconnection cutover procedures.

Other Provisions

Force Majeure ➢ List of conditions for which non-performance of interconnectionagreement obligations will be excused

Assignment ➢ Rights of assignment and restrictions on same (e.g. consent orregulatory approval requirements)

Applicable Laws ➢ Agreement to be governed by, and interpreted in accordance with,the laws of relevant jurisdiction

Regulatory Approvals ➢ Specify regulatory approvals required for effectiveness and/orrenewal, amendment, termination, etc. of agreement

Breach of Agreement ➢ Remedies and penalties

➢ Liabilities, indemnification and limitation of liabilities

Legal Interpretation ➢ Standard provisions for legal interpretation and enforcement ofagreement (e.g. entire agreement clause, effect of unenforceableterms, cumulative rights and remedies, etc.)


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Interconnection


Dispute Resolution ➢ Procedures for resolution of disputes under agreement that are notspecifically dealt with elsewhere. For example:

➢ Good faith negotiations, time schedule for same, escalationthrough management levels

➢ Referral to regulator, arbitrator or court (e.g. of different types ofissues)

➢ Selection of, and procedures for, arbitration

Term ➢ Duration of term

➢ Renewal rights and procedures

Amendment ➢ Review and re-negotiation procedures

➢ Impact of regulatory changes

3.2 Interconnection Procedures

3.2.1 Establishing InterconnectionArrangements

A variety of different approaches have been used toestablish interconnection arrangements. The mainapproaches are listed below. Combinations of theseapproaches have been used in different countries atdifferent times.

➢ Regulatory prescription (ex ante) of intercon-nection arrangements.

➢ Negotiation between operators.

➢ Establishment of general regulatory guidelinesfor operators to negotiate.

➢ Regulatory mediation to facilitate operator-negotiated agreements.

➢ Regulatory prescription (ex ante) of defaultinterconnection arrangements, for example,based on other jurisdictions, that will apply ifnegotiations fail.

➢ Regulatory decisions to resolve interconnectiondisputes.

➢ Independent arbitration or mediation of inter-connection disputes.

➢ Regulatory review, variation and approval ofnegotiated arrangements.

Active industry participation is necessary to developpractical interconnection arrangements However,there has also been a growing consensus that it isnecessary to have regulatory involvement to provideadvance guidelines for operator negotiations and toresolve disputes. Different approaches to balancingindustry participation and regulatory intervention arediscussed in the following sections.

3.2.2 Negotiation of InterconnectionArrangements

In many countries, industry negotiation has been themain approach to establishing interconnectionarrangements. As previously discussed, there aregood reasons for this. Operators understand theirnetworks and operational requirements better thanregulators, and they have the technical informationrequired to implement effective interconnectionarrangements.

However, without regulatory intervention and direc-tion, interconnection negotiations do not usuallyproceed successfully. Incumbent operators are


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generally suspicious that interconnecting operatorswill seek subsidized access to their extensiveexisting networks. Indeed, interconnection at almostany price is less expensive for a new entrant thanduplicating major parts of the PSTN. However, thepurposes of interconnection include minimization oftotal network costs, and speedy introduction of com-petition and rollout of new services, such asbroadband access services. Interconnectionobligations must often be imposed on incumbents,whether or not they agree with them, in order topromote sector development.

Some incumbents may also act strategically duringthe course of negotiations to implement arrange-ments that can effectively prevent or hindercompetitive entry. Consequently, regulators mustfind ways to overcome incumbents’ reluctance tointerconnect their network to new competitors’networks on efficient, cost-based terms andconditions.

Despite encouragement from governments andregulators, the reality is that dominant incumbentshave little incentive to enter into agreements thatexpedite competitive entry by interconnectingoperators. Incumbent operators hold all thebargaining power in negotiations. New entrants havelittle to offer in exchange for favourable interconnec-tion terms. They can promise market expansion,which should benefit all operators. However, mostincumbents see this benefit as being outweighed bythe loss of existing markets to new entrants.

Delays and failure have characterized many inter-connection negotiations. In some of these situations,regulators subsequently realized that delays anddisputes could have been resolved by appropriateregulatory intervention. For example, regulatorscould have applied benchmarks or best practicesfrom other countries. In other cases, while negotia-tions did produce interconnection agreements, thesewere sometimes one-sided, costly and inefficient.Sometimes, new entrants accepted one-sidedagreements as the only means available to start upbusiness and avoid bankruptcy.

As a result of this experience, many regulators andinterconnection experts have concluded that it isgenerally impractical to direct dominant incumbentsto negotiate interconnection agreements with new

entrants, without adequate regulatory guidance. Exante regulatory direction and ongoing supervision ormediation are generally required for operators tonegotiate reasonable interconnection agreementson a timely basis.

3.2.3 The Regulator’s Role inInterconnection Negotiations

Once it is decided that regulators should play a rolein promoting the successful conclusion of intercon-nection negotiations, the next question is: how canthe regulator intervene most effectively? Regulatorshave a variety of tools available to expedite negotia-tions and to assist in the successful completion ofinterconnection agreements. Some provenregulatory approaches are described below.Variations and combinations of these approachescan be used in some cases:

➢ Establishing guidelines in advance ofnegotiations – As indicated in Section3.1.6.1, there is a consensus that ex anteinterconnection guidelines are a necessaryand effective means to promoting good in-terconnection agreements. The task ofdeveloping such guidelines has been madeeasier for newer regulators due to thegrowing number of published interconnectionprinciples and guidelines established byother regulators. The increasing availabilityof precedent interconnection agreementsand the development of “best practices” andbenchmark interconnection charges in othercountries also make it easier for regulators toestablish such guidelines. The remainingsections of this Handbook also discussapproaches that can be used in establishingex ante guidelines.

➢ Setting default interconnection arrange-ments in advance of negotiations –Regulatory interconnection guidelines areusually fairly general. As a result, there areoften disputes among operators about howbest to apply guidelines. This can causedelays and impasses, and the need forfurther regulatory intervention. One approachto deal with this issue, is for the regulator topublish default interconnection arrangementstogether with guidelines. If the negotiations


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Interconnection

fail, the default arrangements will apply.Such an approach was adopted for someinterconnection issues by the US regulator inits landmark 1996 interconnection order.

In the case of a first interconnection agree-ment with an incumbent, it may be difficult fora regulator to establish appropriate defaultarrangements. The regulator may need toreview the issues in depth, obtain informa-tion and submissions from the operators, etc.before it is in a position to establish defaultarrangements. However, defaultarrangements will usually be easier toestablish for subsequent agreements.

As with guidelines, published interconnectionagreements and the development of “bestpractices” and “benchmark” interconnectioncharges in other countries is making it easierfor regulators to establish defaultarrangements. Benchmarking has beenused extensively by the EuropeanCommission, and at the international level,such as in the US-Japan bilateral telecom-munications negotiations.

Finally, if there is a concern about the appro-priateness of the default arrangements, theregulator can provide a “sunset” clause fortheir applicability. In other words, theregulator can indicate that the defaultarrangements will cease to have effect after,for example, one year. That will provide timefor a more detailed review between the timenegotiations fail and the sunset of the defaultarrangements.

➢ Establish deadlines for various stages ofthe negotiations – Deadlines should be setat the outset of negotiations for completion ofvarious steps or deliverables. For example,the incumbent might be asked to produce aproposed interconnection agreement in 30days. Alternatively, deadlines can beproposed as soon as it appears delays willoccur. Consequences of the failure to meetthe deadlines can include regulatory inter-vention to impose an agreement andindependent mediation or arbitration.

Another option that is sometimes proposedis final offer arbitration. In final offer arbitra-tion, an independent arbitrator must selectone of the final offers put forward by twodisputing parties. In theory, this provides anincentive for the parties to make reasonableoffers. In practice, this approach is generallyinappropriate for interconnection negotia-tions, due to the number of issues involved,their complexity, and to the regulatory goal ofdeveloping efficient and non-discriminatoryarrangements. The regulatory goal is notsimply to establish an interconnectionarrangement, but to establish a good one.

➢ Establish Industry Technical Committees– Bilateral or multilateral industry committeesare often the best forum for establishing thedetails of interconnection arrangements. Ifnegotiations are proceeding smoothly,incumbents and new entrants may take theinitiative to delegate the details of technicalinterconnection arrangements to workinggroups or committees. However, in somecases, it may be necessary for the regulatorto take the initiative to ensure appropriatetechnical committees are established. Ineither case, it is usually good practice to setdeadlines for reports by such committees.

Depending on the degree of co-operationbetween operators, representatives of theregulator may also be able to play a usefulrole on the committees. They can often fa-cilitate agreement on interconnectionarrangements, suggest alternativeapproaches when there is an impasse, andotherwise mediate the discussions. In somecases, it will be necessary or useful for theregulator to retain expert consultants toassist in this role, and particularly inassessing the merits of conflicting positionsof operators.

Sometimes industry technical committeework can drag on for months or years. Insuch cases, the committees actually slowdown the process of reaching interconnec-tion agreements. Delays can result from theestablishment of committees with rigid workschedules, lack of familiarity with intercon-


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nection technologies on the part of theregulatory participants, unnecessary processconcerns, and other factors. The regulatorshould be flexible and willing to adoptalternative approaches to ensure that theindustry technical committee processproduces results on a timely basis.Alternatively, in some cases, the processshould be abandoned, and otherapproaches adopted.

The industry technical committees estab-lished under regulatory supervision inCanada have generally been consideredvery successful. The CanadianInterconnection Steering Committee (CISC)and its sub-committees included participationfrom interested industry firms, as well as rep-resentatives of the regulator. CISC wasestablished after a regulatory decision thatprovided ex ante guidance on the terms andconditions of interconnection. However muchdetail remained to be determined by CISC. Ittook about 2 years to reach agreement onmajor issues, and regulatory interventionwas required from time to time. However,CISC managed to achieve consensus onmany important interconnection issues. TheCISC committees continue to deal withongoing issues that arise, for example, inconnection with new types ofinterconnection.

➢ Incentives to complete interconnectionarrangements – A carrot can be moreeffective than a stick. Various incentives canoften be provided to conclude interconnec-tion agreements. Incumbents depend onregulators for approvals or actions that cansometimes be linked to the successful con-clusion of interconnection arrangements.

An example of this approach can be found inCanada. In 1984, the incumbent operators(the “wireline operators”) were licensed toprovide new cellular telephone services. Atthe same time, licences were issued to anew entrant cellular operator. As an incen-tive, the incumbents were prohibited fromstarting up their cellular services until theyhad completed interconnection agreements

with the new entrant. The arrangements thatapplied to the new entrant would also applyto the incumbents’ own cellular operations.This “no head start” rule proved to beeffective. Mutually acceptable agreementswere quickly concluded. The incumbent op-erators did not want to delay the introductionof their own cellular services.

In developing positive incentives for incum-bents to complete interconnectionagreements, regulators must take care toensure that they do not create incentives fornew entrants to stall or frustrate the negotia-tions. In the Canadian example discussedabove, for instance, if the new entrants hadnot been ready to start up service, theymight have delayed start up by theincumbents by stalling completion ofagreements. Regulators must provideincentives for both sides to completenegotiations.

Finally, the prospect of receiving compen-satory interconnection charges can providean incentive for incumbents to concludeinterconnection agreements. Mostincumbents focus on short-term loss ofmarket share to competitors. However, thosethat take the longer view, and build appropri-ate network facilities, can earn significantinterconnection revenues as a result of thenew traffic stimulated by their competitors.

➢ Appoint mediators or arbitrators – Wherenegotiations fail, or where they are likely tofail, success can often be achieved byappointment of a mediator or arbitrator. Thetwo are different in that arbitrators areempowered to make binding decisionswhere an agreement cannot be reached.Mediators can provide additional information,develop compromises, propose alternatives,and persuade. However, they cannot imposetheir own decision on the negotiations.

It is possible for regulators or regulatory staffto act as mediators and arbitrators. However,this in not always the best approach,particularly in the case of inexperiencedregulators and staff. Interconnection is a


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Interconnection

complex area, and the costs of delays andimproper regulatory intervention can be high.There is a growing body of internationalinterconnection “know-how”. Experiencedindependent interconnection experts canoften add valuable experience. They canrecognize issues from other countries,suggest options for unresolved issues, andotherwise save time. In addition, the use ofoutside experts maintains the independenceand credibility of the regulators. The regula-tors can act as a final decision-maker in theevent the mediation process fails. They canalso review the final decision of an arbitrator,if necessary.

One or more of the foregoing regulatory approachesis usually required to promote the successful con-clusion of interconnection negotiations. Whateverthe approach, it is important for regulators to beproactive in establishing interconnection proceduresand guidelines that will promote the negotiation ofeffective interconnection agreements. Further,where negotiations fail, regulators must be preparedto take steps to bring them to a successful conclu-sion.

3.2.4 Dispute Resolution

In most countries, it is the regulator’s role to resolveinterconnection disputes. The WTO RegulationReference Paper requires signatories to theAgreement on Basic Telecommunications toestablish an independent dispute resolutionmechanism. The Paper requires recourse to anindependent domestic body to resolveinterconnection disputes within a reasonable time.This may be the regulator or another independentbody.

In practice, regulatory dispute resolution can be adifficult task. Most regulators will normally be lessinformed than the operators on the details of inter-connection. The risk of making an unsatisfactorydecision deters many regulators from wading intointerconnection disputes.

However, regulators must resolve disputes in adecisive and timely manner, or competition andsector development will be retarded. If informationon local costs is insufficient, international bench-

marks can be applied. Other practices applied inforeign jurisdictions can provide useful precedents.Discussions with other regulators and assistancefrom expert advisors can facilitate the regulators’task.

If interconnection negotiations fail, an operator,usually the new entrant, may apply to the regulatorto resolve the interconnection dispute. There is nosingle best approach to resolving a complex inter-connection dispute, but some approaches are betterthan others. Table 3-2 suggests some approachesregulators may use in resolving interconnectiondisputes.

The WTO Regulation Reference Paper defines anindependent regulator as follows:

“Independent Regulator” - The regulatory body isseparate from, and not accountable to, anysupplier of basic telecommunications services.The decisions of and the procedures used byregulators shall be impartial with respect to allmarket participants.

As discussed in Module 1, the degree of independ-ence of regulators varies in different countries. Insome countries, the regulator is a governmentministry, or a government agency that also hasresponsibility for the operations of a state-ownedincumbent. Many observers would not consider sucha regulator independent for the purpose of resolvinginterconnection disputes. While such a regulatormay technically be in a separate organization fromthe incumbent, it has similar interests. Both are partof the government telecommunications bureaucracy.Both may consider the financial and operatinginterests of the incumbent as their prime concern.

In such cases, other independent dispute resolutionbodies should be considered, possibly using someof the approaches set out in Table 3-3. These mightinclude an independent arbitrator or mediatoracceptable to both parties. One option is to have anindependent dispute resolution body established bya senior branch of government (the executive orlegislature). This body need not be set up as acostly, permanent bureaucracy. It can be staffed ona temporary basis with independent domestic andinternational telecommunications experts. Anotheroption is to request an international agency with re-


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sponsibility in the telecommunications sector, suchas the ITU or The World Bank, to appoint orrecommend an independent dispute resolutionexpert or panel to assist in the domestic disputeresolution process.

3.2.5 Ex Ante Regulatory Guidance

In some countries, regulators have prescribeddetailed interconnection conditions before intercon-nection arrangements are made. Examples are the1996 US and the 1997 Canadian interconnectionorders for competitive local operators. In these

countries, lengthy regulatory interconnectionproceedings were held before the rulings weremade. Input was obtained from incumbents, newentrants and other interested members of the public.In the end, detailed decisions were issued,specifying many of the approaches and specificrates, terms and conditions on which interconnectionshould occur.

This experience produced a wealth of information,analyses and insights into interconnection issues.However, the work effort required to produce a de-tailed set of interconnection rules should not be

Table 3-2: Approaches to Resolving Interconnection Disputes

Improving the informationbase for decision-making

➢ Require parties to clearly define areas of agreement and dispute

➢ Send written information requests to operators to clarify disputed issuesand provide information for interconnection decisions

➢ Require written argument (with supporting facts and research, ifnecessary) to assist in clarifying the issues in dispute

➢ To increase transparency, consider making the arguments (but notconfidential business data) available for comment by other interestedparties and the public

➢ Consider inviting other interested parties (e.g. other interconnectingoperators, service providers, or user groups) to comment on the issues

Obtaining expert assistance ➢ Hire an experienced interconnection expert to assist in clarifying theissues, formulating information requests, and providing general adviceto the decision-makers

➢ Consider appointing a mediator (or, if the parties agree, an arbitrator)

➢ Use outside parties for informal mediation, arbitration, informationgathering or other participation in the negotiations. This approach isparticularly useful in countries where direct regulatory involvementwould “taint” the legality or politically prevent it from making an unbiasedfinal decision.

Improving accuracy andcredibility

➢ Consult with other regulators on their experience in similar cases

➢ Review decisions and interconnection agreements approved by otherregulators

➢ Consider circulating a draft of the decision to resolve the dispute to thedisputing operators and other interested parties. Their comments shouldbe made public. Comments and corrections can improve the accuracyof the final decision.


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Interconnection

underestimated. Moreover, these lengthyinterconnection proceedings did not produce the“final word” on interconnection arrangements. Inboth Canada and the US, there have been lengthyfollow-up proceedings before the regulators and inthe courts. In Canada, much of the detail ofinterconnection arrangements was left to a numberof industry technical committees led by regulatorystaff. This CISC process (which is referred to above)produced very useful results, but it took about 2years to resolve most of the issues.

It should be recognized that interconnection is adynamic issue. The types of telecommunicationsinfrastructure and services are constantly changing.As a result, interconnection requirements continue tochange as well. Where regulators prescribe inter-connection arrangements, they should be viewed asflexible rules that should evolve with telecommuni-cations networks and markets.

3.3 Financial Terms ofInterconnection

3.3.1 Interconnection Charges

Interconnection charges often account for a verysignificant part of the costs of new telecommuni-cations operators. This is particularly the case withnew entrants that do not own end-to-end networks.The level and structure of interconnection charges

are, therefore, major determinants of the viability ofoperators in a competitive telecommunicationsmarket.

Over the years, a variety of approaches have beenused to calculate interconnection charges andgenerally to determine the financial terms of inter-connection. In this Section, we first consider thegeneral approaches that have been used todetermine interconnection charges. Later in theSection, we review specific types of interconnection-related costs that are often treated in specific ways.Examples are start-up costs, costs of interconnec-tion links and collocation and infrastructure sharingcosts.

3.3.2 Approaches to Setting InterconnectionCharges

This Section reviews the general approaches thathave been used to determine interconnectioncharges. While there is no single correct approach,there is a consensus among telecommunicationsand trade experts that the best approaches are cost-based. However, other approaches have their meritsin some circumstances. Table 3-3 provides anoverview of the main approaches used to determineinterconnection charges. Readers interested in moredetail on the costing concepts and economictheories underlying them should refer to Appendix Bof the Handbook.

Table 3-3: Main Approaches to Interconnection Charges

Approach Description and Examples Comments

ForwardLookingIncrementalCosts

➢ Charges based on forward-lookingcosts of facilities and services providedto interconnecting operator (usuallyestimated over the long run, i.e. LongRun Incremental Costs or “LRIC”)

➢ Examples: Australia, Canada, theHong Kong SAR of China, Chile, andUS local operators

➢ Variations of LRIC include LRAIC,TSLRIC and TELRIC. Theseapproaches include different elementsof fixed and common costs (e.g.

➢ Generally accepted as best practice

➢ Approach sends most efficient pricesignals; based on current technologyrather than existing book assets

➢ Closest approximation of costs in afully competitive market

➢ Requires study and some cost anddemand estimates.

➢ Usually leads to lower interconnectionrates; this stimulates competition butprovides lower revenues to incumbent


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Table 3-3: Main Approaches to Interconnection Charges (cont’d)

overheads, and fixed-servicecosts).that are excluded fromtraditional LRIC analyses. Thesevariations are growing in acceptanceas “best practices”. They are describedin Appendix B of the Handbook

operator

➢ May be substantially out of line withactual book costs of inefficientincumbents

Can be inappropriate if end-user prices areseriously unbalanced (e.g. set well belowcosts and below interconnection charges

HistoricalAccountingCosts

➢ Charges based on the accountingrecords of the operator supplying theinterconnection facilities or services

➢ Generally includes an assignment ofdirect costs and an allocation ofcommon costs booked in theaccounting records

➢ Examples: UK, 1995 Japanesesystem, and Sweden

➢ Common practice; less favoured byregulators and experts today

➢ Less efficient since historical costswere often incurred less efficiently thanthose based on current technology andoperational circumstances (e.g.privatization)

➢ Accounting records often misstate realvalue of assets: based on subjectiveaccounting policies and politicaldecisions regarding investments

➢ Usually requires study to as-sign/allocate booked cost tointerconnection facilities and services

SenderKeep All(SKA)

(Bill andKeep)

➢ No charges payable betweeninterconnecting operators fortermination of each other’s traffic

➢ Typically, each operator pays for itsown facilities up to the point ofinterconnection, plus charges for anyunusual costs incurred by the otheroperators to accommodate its traffic

➢ Examples: Indian, US and Canadianlocal operators, and Indonesianregional operators

➢ Works best where the two operatorsare similarly situated and exchangeapproximately the same amount oftraffic (e.g. for interconnecting localoperators)

➢ Charges can apply to compensate fortraffic imbalances

➢ Without such charges, SKA can retardfinancing and development of rural orother services, where there is animbalance of traffic (i.e. moreincoming)

➢ Was the main model for interconnec-tion of ISPs in many markets.However, this is changing as largerISPs, with substantial backbonefacilities and reach, increasingly treatsmaller ISPs as customers rather thanpeers

RevenueSharing

➢ Typically, new entrants pay theincumbent operator a share of theirrevenues from interconnected services(or all services)

➢ In some revenue-sharing arrange-ments, no additional charges are

➢ This approach is simple – no need forcost studies to determineinterconnection charges

➢ Generally considered non-transparent

➢ Potentially inefficient and anti-


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Interconnection

Table 3-3: Main Approaches to Interconnection Charges (cont’d)

payable between interconnectingoperators for termination of eachother’s traffic; in others, additionalcharges do apply for direct intercon-nection costs (e.g. transmission links,interconnection interfaces)

➢ Examples: Thailand, Indonesia, andChina

competitive (i.e. when excessiverevenue shares are paid)

➢ Sometimes prescribed by governmentsor PTTs as the only basis on whichinterconnection will be permitted in anotherwise closed market; sometimestreated as a “tax” for doing business ina country. May be a transitional step toa more efficient approach

InterconnectChargesbased onRetail Prices

➢ Interconnection charges based onprices to end users

➢ A discount is sometimes applied forinter-operator charges. This can beestimated based on the avoided costsof the supplying operator (e.g. retailbilling and marketing costs).

➢ Examples: US local resale prices, pre-1995 Japanese approach

➢ Difficult to estimate appropriatediscount – may lead to inefficiency (i.e.high discount discourages constructionof competitive facilities; low discountundermines financial viability ofcompetition)

➢ Specifically rejected in some jurisdic-tions (e.g. Hong Kong, China whichdifferentiate “carrier-to-carrier” chargesfrom retail rates)

OtherNegotiatedInterconnectCharges

➢ Interconnection charges have beennegotiated between operators basedon a wide range of other approaches;some principled, many arbitrary

➢ Example: International accountingrates, and some reseller agreements

➢ Efficiency of charges depends on howclosely they approximate efficientcosts; many negotiated chargesinclude implicit subsidies betweenoperators and customers

➢ Level of negotiated charges oftendepends on the bargaining power ofthe operators

3.3.3 Comments on Different Approaches

Internationally accepted interconnection principlesgenerally require interconnection charges to be cost-based or “cost-oriented”. This is the case with theinterconnection principles of the WTO’s Agreementon Basic Telecommunications and the EuropeanUnion’s Interconnection Directive. Cost-basedpricing of interconnection services is consistent withbest practices adopted by regulators in mostcountries. This issue is discussed further in Section3.1.6.5.

Forward-Looking Costing Approaches

There remains a fair amount of debate in regulatorycircles about the best approaches to use to calculate

interconnection costs in different circumstances.However, today most regulators and expertsgenerally agree that the ideal approach for calculat-ing the level of interconnection charges would beone based on forward-looking costs of supplying therelevant facilities and services. This ideal is usuallyimplemented by means of some variant on the long-run incremental cost (LRIC) approach. Thisapproach has been entrenched in the regulations ofsome countries (e.g. India) and the laws of others(e.g. the US).

The major variations of the LRIC approach that havebeen most widely accepted by regulators andexperts are:


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Long Run Average Incremental Costs (LRAIC) -A long-run costing approach that defines theincrement as the total service. It differs fromtraditional marginal and incremental costmeasures by including allowance for the fixedcosts specific to the service concerned: “service-specific fixed costs”. The European Commissionhas adopted this approach.

Total Service Long Run Incremental Costs(TSLRIC) - This approach, developed by theFederal Communications Commission (FCC) inthe USA, measures the difference in costbetween producing a service and not producingit. TSLRIC is LRIC in which the increment is thetotal service.

Total Element Long Run Incremental Costs(TELRIC) -This approach, also developed by theFCC, includes the incremental cost resulting fromadding or subtracting a specific network elementin the long run, plus an allocated portion of jointand common costs.

Other variations - There are other variations onthe LRIC approach. In Canada, for example, theregulator uses an incremental cost approach(Phase II Costing) and adds a mark-up toapproximate forward-looking fixed and commoncosts. Other regulators have developed differentapproaches.

A well-designed LRIC-type approach provides anestimate of the costs of an operator to provide inter-connection in a fully competitive market. An LRIC-type calculation generally starts by estimating thedirect costs incurred by an operator in providing theinterconnection services in question. These costsare calculated over the “long run”, usually at leastten years, in order to average out the inherently“lumpy” nature of the investment costs of intercon-nection facilities in the year they are introduced.

In addition to the directly attributable costs, LRIC-type calculations generally include a capital costcomponent. This component is intended toreimburse the operators for the costs of financingthe interconnection facilities, since these costs arenecessarily incurred by the operator providing thefacilities.

As can be seen from the preceding descriptions, themost widely accepted LRIC-type approachesgenerally include a reasonable allocation of joint andcommon costs. Such costs can also be calculatedon a forward-looking basis, to approximate the costsof an efficient operator. Joint and common costs are,by definition, not directly caused by the interconnec-tion services, but are nevertheless incurred by anoperator in connection with its interconnectionfacilities and services. Common examples of suchcosts are the salaries of the president, managingdirector or legal counsel of the operator. By includingcapital, joint and common costs, a LRIC approachcan approximate costs in a competitive market,while providing reasonably full compensation to theoperator supplying the interconnection – assuming itoperates efficiently.

Further descriptions of the methods used tocalculate long-run incremental costs, includingLRAIC, TELRIC and TSLRIC are included inAppendix B and in Module 4.

While variations on the LRIC approach areconsidered the best practices by most experts, thereare practical limitations on their applicability. Someof these are listed in Table 3-3. Some of these limi-tations are particularly significant in countries withless developed telecommunications sectors. Forexample, if local retail telecommunications rates areset well below costs, setting interconnection pricesat LRIC may not permit a new, local services entrantto run a viable business. The new entrant’s inter-connection costs may exceed its retail prices. Whilerate rebalancing is the long-term solution to thisproblem, in the short term interconnection rates mayneed to be discounted in order to permit competitionto emerge. There are other practical problems withthe application of LRIC-type approaches in someenvironments.

Other Approaches

The applicability of the non-LRIC-type approacheslisted in Table 3-3 depends on the circumstances ofdifferent countries. The comments in the Tabledescribe strengths, weaknesses and other consid-erations. Several other comments follow.

Modifications are often made to the variousapproaches to attempt to compensate each operator


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Interconnection

more closely for costs resulting from its interconnec-tion. An example is the Sender Keep All (Bill andKeep) approach. As indicated in Table 3-3, thisapproach is appropriate where the two operators aresimilarly situated and exchange approximately thesame amount of traffic. Thus, it is often used for in-terconnection of local operators in the same city orneighbouring regional operators.

The Sender Keep All approach may be modified toadd charges to compensate for traffic imbalances.For example, operator no. 1 may receive and termi-nate more traffic from operator no. 2 than it sends tothat operator. Operator no. 1 will then usually incurhigher costs as a result of the interconnection thanoperator no. 2. To compensate for this imbalance,operator no. 2 may pay a cost-based interconnec-tion charge to operator no. 1 for every minute oftraffic it sends that exceeds the traffic it receives.

A word or two about revenue sharing approaches.An element of revenue sharing may be appropriatein some cases to distribute surplus revenues afterpayment of cost-based interconnection charges.However, in some cases, revenue shares paid toincumbents have included a wide range of compo-nents, ranging from interconnection costs to a“licence fee” for operating in a jurisdiction or“compensation” to an incumbent for loss of businessto new entrants, or fulfilment of universal serviceobligations.

The latter three components are typically not costbased. They are usually not transparent and are notrecommended in any jurisdiction where the regulatorwishes to improve efficiency in the telecommunica-tions sector. These approaches can be subject toabuse. For example, excessively high revenue-sharing arrangements have been imposed in somejurisdictions in a short-sighted attempt to earn addi-tional operator or government revenues. The effectis to prevent efficient competition.

If revenue-sharing schemes must be used, thenregulators should consider identifying each compo-nent of the revenue share separately. This includes,for example, shares to pay for cost-based intercon-nection charges, for concession or licence fees, etc.This approach adds transparency and allows for thegradual elimination of revenue-sharing componentsthat are not cost-based. Universal service charges

should be dealt with by means of a separate charge,not a revenue-sharing formula. Issues related touniversal service and universal access charges arediscussed in detail in Module 6.

Table 3-3 does not provide an exhaustive list of theapproaches to calculating interconnection charges.Other approaches exist. One example is the EfficientComponent Pricing Rule (ECPR), which basesinterconnection charges on the net incrementalcosts of interconnection, plus the “opportunity costs”or margin lost by the incumbent as a result of traffic“taken” by the new entrant. This approach has beendiscussed among academics and consultants, buthas generally not been accepted by regulators as areasonable option.

Finally, interconnection charges are sometimesindexed or “price capped” to determine futureincreases (e.g. for a five or ten year period). Suchapproaches provide certainty to interconnectingparties regarding their level of future costs orrevenues.

3.3.4 Specific Interconnection Costs

3.3.4.1 Start-up Costs

The network infrastructure of most incumbentoperators was designed to function on a monopolybasis. In the transition to a competitive telecommu-nications market, some modifications are usuallyrequired to the operator’s switching and transmis-sion facilities and related software to permit efficientinterconnection among multiple operators. Forexample, switches must be programmed torecognize and route traffic to telephone numbers onthe network of interconnection operators. Additionalnumbers must often be allocated and equipmentmodified to deal with them. These modifications areoften referred to as “start-up costs”, since they arerequired at the outset to permit interconnection.

Regulators in different countries have treated start-up costs in different ways. Some take the view thatnew operators are the beneficiaries of interconnec-tion, so they should pay all start-up costs. In theextreme, this approach is applied not only tointerconnecting transmission circuits, but to allmodifications and upgrades to an incumbent’snetwork required to facilitate interconnection. Some


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new operators accept this approach as the only onethat will provide them with interconnection,particularly in countries with state-owned PTTs.However, this approach has disadvantages. It canimpose a heavy financial burden on a new entrant,shift costs of network upgrades from incumbents tocompetitors, and ultimately lessen the chances ofviable competitive entry.

A different approach that is more pro-competitive innature has been adopted by a number of countriessuch as Canada. The approach is based on theassumption that competition is introduced to benefitall telecommunications users and the economy ingeneral. Interconnection start-up costs are seen as adirect result of the policy decision to open a marketto competition. It is also recognized that the costsincurred by all operators will, market conditionspermitting, generally be borne by telecommunica-tions users.

Therefore, some basis is developed to apportioncosts among established and new operators on theassumption that they will generally pass these onthrough user rates. A specific surcharge may beconsidered, but may not be adopted for politicalreasons. One method of apportioning costs is on thebasis of the projected use of telecommunicationsservices (including interconnected services) in thefuture. A formula can be established to adjustcompensation between operators in case actual usediffers from projected use of telecommunications orinterconnected services.

Under this approach, the incumbent will generallybear a large share of start-up costs. Someregulators regard this approach as necessary orappropriate to facilitate competition. Understandably,this approach is generally opposed by incumbents.

3.3.4.2 Interconnection Links

Different approaches have been adopted toapportion the costs of the physical links betweeninterconnecting operators. Such links includetransmission lines or radio links that carry the inter-connecting circuits. They also include the ducts,towers, manholes and other support infrastructure,as well as the modifications that are required to thetransmission-related facilities (e.g. cross-connects

and distribution frames) in order to accommodatethe interconnected circuits.

One approach is to require the new operator to paythe entire cost of the transmission links and relatedfacilities. This approach is based on the theory thattransmission facilities are being added and themodifications made solely for the benefit of the newoperator and its customers. If this approach isadopted, incumbents should not be able to recoverany more than the actual costs of the transmissionlinks and related facilities. Sophisticated costingapproaches are not required. Normally, these costsare easily tracked through expense invoices, relatedlabour costs and overhead. As a general principle,the costs should not exceed fair market costs forinstalling the links. Incumbents may have anincentive to inflate charges for such links, and regu-latory oversight may be required to ensure chargesare based on market costs.

One method of ensuring charges for interconnectionlinks are not inflated is to give the new operator theoption of installing the links itself, including work onthe premises of the incumbent. Specifications forsuch work can be subject to discussion at a jointtechnical committee with a dispute resolutionmechanism. Work on its premises can be monitoredby the incumbent to avoid arguments aboutimproper work or sabotage.

As with start-up costs (see discussion in previousSection), interconnection links are a necessaryprerequisite for the development of a competitivemarket. Taking this view, regulators may consider itappropriate to apportion the costs of such linksbetween incumbents and new entrants, based onthe assumption that end users of all operators willultimately benefit.

The simplest, and probably most common methodof apportioning costs of interconnection links is tohave each operator pay the costs of its interconnec-tion links up to the Point of Interconnection (POI).Since POIs are often located in or near theexchange of the incumbent, this method can imposesignificant costs on a new operator. However, underthis approach, the new operator can decide how toconfigure its network to limit its costs.


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Interconnection

3.3.5 Structure of Interconnection Charges

The structure of charges for interconnection oftenvaries from country to country. These variationsreflect a number of factors, including differences inthe telecommunications infrastructure, policydifferences and varying levels of effort on developingcost and price structures. Price structures need notbe complex to be efficient and fair. In many cases,simplicity is best. However, with some effort, a pricestructure can be developed that levels the playingfield for all operators and facilitates more efficientinterconnection.

Box 3-4 sets out some basic principles for an effi-cient interconnection price structure.

Operators, regulators and telecommunicationsexperts have long discussed how best to refine tele-communications pricing structures to improveefficiency. Many of the principles applicable to othertelecommunications prices also apply to the struc-

ture of interconnection charges. Several examplesare given below.

3.3.5.1 Fixed and Variable Charges

As a general principle, interconnection chargesshould reflect the difference between fixed andvariable costs of interconnection. For example, thefixed costs of providing a dedicated network accessline (loop) are best recovered through a fixedcharge. On the other hand, where the costs ofnetwork components, such as telecommunicationsswitches, are traffic sensitive, they are bestrecovered through usage charges. Usage chargesare usually based on time (minutes). In the case ofinterconnection of Internet backbone operators andInternet Service Providers, charges are often basedon capacity (bits of traffic).

While it is not always practical to implement thisprinciple, doing so is consistent with efficient pricingtheory. Distinguishing between fixed and variablecosts in the charges for interconnection components

Box 3-4: Principles for Efficient Interconnection Price Structures

➢ Interconnection charges should be cost-based (ideally based on long-run average incrementalcosts, including cost of capital, plus a reasonable markup to cover forward-looking joint andcommon costs)

➢ Where information is available, costs should be based on the current replacement costs of assets(discounted to their remaining service life); in the absence of such costs, depreciated book value ofassets is sometimes used

➢ Interconnection charges should be sufficiently unbundled so that an operator seekinginterconnection need only pay for the components or services it actually requests

➢ Where the costs of a particular component vary significantly in different locations, theinterconnection charges should be disaggregated (e.g. costs of access lines may be higher in ruralareas (where they are typically longer) than in cities)

➢ Charges should not include hidden cross-subsidies, particularly of an anti-competitive nature (e.g.charges for monopoly-supplied network components should not be inflated to a level well abovecosts in order to fund below-cost provision of competitive components). This principle is adopted inthe WTO Regulation Reference Paper.

➢ The structure of interconnection charges should reflect underlying costs. Thus, fixed costs shouldbe covered by fixed charges, variable costs by variable charges. Peak and off-peak charges shouldbe set where there is a significant difference in costs.


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will send the right price signals. For example, therewill be less incentive to overuse usage-sensitivenetwork components if they are priced based onusage, rather than on a flat monthly charge.Establishing a price structure that reflects underlyingfixed and variable costs should lead to a moreefficient use of those components.

3.3.5.2 Peak and Off-Peak Charges

Peak and off-peak pricing differentials have beenused for retail pricing of telecommunicationsservices for many decades. Charging higher ratesfor usage in peak hours provides users with anincentive to call in off-peak hours. Advantages of apeak/off peak pricing structure include:

➢ reduced peak-hour congestion;

➢ reduced demand to build new infrastructure tomeet peak traffic loads;

➢ increased overall network utilization; and

➢ improved quality of service.

The same principles of peak and off-peak pricing areoften incorporated in interconnection charges. If theyare not, then interconnecting operators will have noincentive to charge higher rates to their end-usersduring peak hours. The result can be a migration ofpeak-hour traffic to new entrants, who will thenimpose higher costs on incumbent’s that must buildthe infrastructure to support the higher peak-hourloads.

Good regulatory policies, such as those adopted inHong Kong, China specifically provide that thestructure of interconnection charges must reflect thebehaviour of underlying costs. Thus, the “carrier-to-carrier” charging principles in Hong Kong encourageinterconnection charges to reflect both fixed/variableand peak/off peak cost differences.

3.3.5.3 Unbundled Charges

In an increasing number of countries, telecommuni-cations policies require incumbent operators toprovide competitors with access to unbundlednetwork components. This approach is supported bythe WTO Regulation Reference Paper, which states

that major suppliers must provide interconnection ona basis that is sufficiently unbundled so that asupplier need not pay for network components orfacilities that it does not require for the service to beprovided.

In keeping with their WTO commitments, or gener-ally because it is good policy, many regulators haveissued directives requiring unbundled charges. Forexample, in India, a regulation was issued in 1999by the Telecommunications Regulatory Authority ofIndia (TRAI) that states that “No service providershall be charged for any interconnection facility itdoes not seek or require”. (TRAI (1998a))

3.3.5.4 Universal Service and ADC Charges

In many countries, incumbent operators incurdeficits in carrying out uneconomic universal serviceobligations (USO) or universal access obligations.Beneficiaries of these social obligations generallyinclude high-cost service areas, such as remotevillages or low-income customers. In somecountries, however, deficits are not incurred by theincumbents to perform specific universality. Rather,the deficits are incurred as part of a policy ofmaintaining low access charges for all customers.These are usually referred to as Access DeficitContributions (ADCs) to distinguish them fromUniversal Services Obligation (USO) payments thatgenerate revenues for more targeted socialpurposes.

In a monopoly environment, ADCs are often paidfrom services priced above costs (e.g. internationalrates or business services) to access costs that arepriced below cost. In the case of the incumbent,ADCs may be explicit, or implicit in unbalancedrates. Traditional telecommunications policies oftenprevent “rebalancing” of the prices to more closelyreflect their costs. New interconnecting operatorsoften do not have similar universal service obliga-tions or access deficits. Accordingly, they are oftenasked to contribute to USO payments or ADCs ofthe incumbent.

There are a number of ways of dealing with thisissue. These are discussed in detail in Module 6. Asindicated in that Module, the best practice for regu-lators is to levy any USO or ADC charges separatelyfrom interconnection charges. As demonstrated in


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Interconnection

this Module, the underlying concepts and calcula-tions for interconnection charges are very differentfrom those underlying USO and ADC charges.

If USO or ADC charges are established, it is clearlya good practice to identify them as separate frominterconnection charges. Blending the two chargesremoves transparency from the interconnectionprocess. Separate charges permit regulators tocomply with the requirement of the WTO RegulationReference Paper that USO charges beadministered in a transparent, non-discriminatoryand competitively neutral manner. Please seeModule 6 for a more comprehensive discussion ofUSO and ADC issues.

3.3.6 Internet Interconnection Charges

Over the past decade, the Internet has changedfrom a co-operative to a commercial communica-tions medium. It has also changed from a relativelysmall education and research-based data network toa network that accounts for more traffic than voicetelephony in several countries today. Thistransformation of the Internet has changed the basisfor interconnection charges among ISPs and be-tween ISPs and the operators of the large capacitybackbone telecommunications networks that carryInternet traffic.

Originally, many ISPs regarded themselves asequals or “peers”. They generally entered into Billand Keep interconnection arrangements. Underthese ‘peering’ arrangements Internet networksexchanged traffic without levying charges or payingfees to each other. The underlying premise forpeering arrangements was that Internet networks ofsubstantially similar size and traffic volumesbenefited more-or-less equally from interconnection,and incurred generally similar costs.

Over time, some Internet Protocol (IP) networksexpanded their coverage to national and global lev-els. Some network operators developed intospecialized IP backbone operators, carrying largevolumes of Internet traffic for long distancesbetween ISPs and Internet hosting services. Thesebackbone network operators generally provide ‘tran-sit’ services. Transit services involve thetransmission of Internet traffic between two or moreISPs and Internet hosts. Providers of Internet transit

services may or may not provide any Internetcontent or access services themselves. Some ISPswith larger networks also provide transit services, inaddition to standard Internet interconnectionarrangements.

ISPs generally interconnect with each other and withInternet backbone providers at Internet ExchangePoints (IXPs). These are sometimes referred to asNetwork Access Points (NAPs), although that termis becoming less common. IXPs have switchingequipment and routers that permit interconnection ofthe various Internet networks using the IXP. As withthe Internet generally, IXPs are evolving intoincreasingly multifunctional, and commercial opera-tions, that charge fees for an increasingly widerange of services, rather than just facilitating ‘free’interconnection of ISPs. Many IXPs now providecollocation services, providing space as well asequipment for Internet routing, transmission, web-hosting and other services. Separate, market-basedcharges are usually levied for such services. As withmost Internet-related services, these charges aregenerally unregulated, except where they areprovided by a dominant incumbent operator.

The transition of the Internet to a more commercialmedium, with large disparities between the sizesand functions of Internet networks, has changed thestructure of Internet interconnection charges. Insome cases, interconnecting ISPs still exchangetraffic with each other as ‘peers’ on a Bill and Keepbasis. Under this arrangement, each ISP typicallypays its own costs of transmission, routing and otherequipment, or shares the costs on a negotiatedbasis.

However, such peering arrangements are becomingless common, particularly where different types orsizes of Internet operators interconnect. There,asymmetrical charges have become the norm. Thebackbone network operator, or the larger ISP,usually charges the smaller ISP or local accessprovider for interconnection and transit services. Thebasis for such interconnection charges is oftensimilar to those found in other parts of the telecom-munications industry. Charges are typically basedon one or more of the following variables:


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➢ traffic flow or usage, based on the increasingcapacity of Internet routers and other equipmentto measure traffic;

➢ imbalance of traffic flows between ISPs;

➢ distance or geographical coverage;

➢ number of points of interconnection; and

➢ other cost-based interconnection charges.

All of these charging variables are related to costsincurred by the ISP providing the service, or at leastproxies for such costs. This trend toward cost-basedinterconnection charges is consistent with develop-ments in other telecommunications services.

One anomaly in the trend toward cost-based Inter-net charges has been related to the traditionallyheavy reliance on US-based ISPs and Internetbackbone providers by ISPs in other countries. Dueto the early lead of the US-based Internet industry,and the heavy concentration of attractive Internetweb sites in the US, many ISPs in other countrieshave paid US ISPs for transportation to and from theUS to their home country. There have often been noreciprocal charges paid by US ISPs for traffic to theinterconnecting ISPs in other countries. Thisimbalance has become a hot policy issue within theITU and other international organizations. WithinAPEC, for example, Australia and various Asiancountries have complained that current costs ofinterconnecting with North America are too high andthat it is inequitable that Asian networks are notcompensated for their costs in carrying trafficgenerated by North Americans.

In April 2000, ITU Study Group 3 adopted Recom-mendation D.iii on International InternetInterconnections:

“Noting the rapid growth of Internet and Internetprotocol-based international services: It is rec-ommended that administrations involved in theprovision of international Internet connectionnegotiate and agree bilateral commercial ar-rangements applying to direct internationalInternet connections where each administrationwill be compensated for the cost that it incurs in

carrying traffic that is generated by the otheradministration.”

The US and Canada have opposed this recommen-dation. They argue that the North American bias ofInternet routing will decrease over time, ascompetition and market developments reduce costsand increase Internet facilities in other regions. TheUS, in particular, has long argued that the Internetshould remain unregulated in most respects. Theproposed resolution was considered at the ITU’sWorld Telecommunications StandardizationAssembly in Montreal in October 2000. After muchdiscussion, the Assembly adopted arecommendation that calls for arrangements to benegotiated and agreed upon on a commercial basiswhen direct Internet links are establishedinternationally. The new recommendation does notprescribe any particular costing approach; thusoperators are free to determine the approach to beused in implementing it. This recommendation hasbeen referred to as a framework for futurediscussions. The US and Greece stated that theywould not apply this recommendation in theirinternational charging arrangements.

Local interconnection charges are also important tothe viability of ISPs. Local Internet access providerswill be principal beneficiaries of the move to unbun-dling of local loops, which is discussed in Section3.4.6 of this Module. Unbundled local loops can beused by ISPs to provide DSL-based high speedInternet services on more favourable terms thanthose currently available in most markets.

In a number of countries, cable television networksprovide an efficient and highly successful form ofhigh-speed local Internet access. These ‘cablemodem’ services have generally been provided onlyby the serving cable TV operator. This has given thecable operator a strong position in ISP marketscompared to other ISPs without high-speed capabili-ties. Several countries have considered whether torequire cable operators to interconnect with otherISPs to provide them access to high-speed cablenetworks.

In Canada, the CRTC has ordered major cableoperators to grant other ISPs access to their highspeed networks at a discount from retail ISP rates.In the US, the FCC has not, to date, taken similar


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Interconnection

action. Some US cable operators have entered intoagreements with ISPs to access their high-speednetworks on an exclusive basis, thus making accessunavailable to competitors. This appropriateness ofsuch exclusive arrangements is under considerationby the FCC.

3.3.7 Interconnection with Mobile Networks

As indicated in various places in this Module, mobileoperators must obtain interconnection with incum-bent operators of the PSTN in order to ensure theviability of their services. In general the interconnec-tion principles and practices described in thisModule apply to interconnection by mobile operatorsto the PSTN. However, certain differences apply tointerconnection with mobile operators.

Historically, regulators devoted much less attentionto mobile services than fixed services. Mobileservice was priced at a substantial premium to wire-line service. As a result, mobile service was viewedas a discretionary or even a luxury service whereconsumers did not need much in the way of regula-tory protection. As well, mobile service was offeredcompetitively in many countries, with the expectationthat market forces rather than regulators would bethe prime force in setting prices. Mobile operatorswere not perceived as possessing market power inthe same way as fixed operators.

However, the role of mobile services has changed inrecent years, leading to increased regulatory interestand attention:

➢ The consumer rates for mobile service havedeclined in both developed and developingcountries. The combination of rate decreases,the fact that consumers like the flexibility of mo-bile service, and improvements in mobiletechnology (such as longer battery life) havecontributed to an enormous increase in thenumber of mobile users. Indeed, in some coun-tries, the number of mobile users now exceedsthe number of fixed users. Thus, for many,mobile service is no longer a luxury – it is theprime way in which they access the PSTN.

➢ Some less developed countries have begun todevote much more attention to fostering thegrowth of mobile service, as they realize that

implementing mobile infrastructure can bequicker and less capital intensive than buildingthe type of ubiquitous wireline networks that arefound in most developed countries.

➢ All countries have come to appreciate therevenues that can be realized by auctioningmobile wireless spectrum. Bidders will take thedesign of the regulatory environment intoaccount as they assess how much to bid.

When mobile service was first introduced, mostcountries adopted Calling Party Pays (CPP)arrangements. Under CPP, the person that origi-nates a call is the one that pays for it, whether itoriginates on a mobile or fixed-line telephone. Aperson who makes a mobile-to-fixed call pays themobile operator at the retail rate. The mobileoperator, in turn, pays the fixed operator aninterconnection charge that is relatively small whencompared to the retail rate. Usually, theinterconnection charge is invisible to the mobilecaller. However, the situation is quite different for afixed-to-mobile call. Because the interconnectioncharge paid by the fixed operator to the mobileoperator is relatively large, the fixed operator willwant to recover it from the caller who makes the call.Accordingly, the fixed operator will charge asubstantial surcharge for fixed-to-mobile calls, withthe surcharge (less an administrative charge) beingpassed on to the mobile operator. The mobileoperator does not charge its customers for callsreceived from the PSTN.

CPP has not been adopted in countries such as theUS and Canada, where most local calls on thePSTN are not metered, but charged at a flat monthlyrate. These are referred to as Receiving Party Pays(RPP) or Mobile Party Pays (MPP) environments. Ina RPP country, the mobile customer pays both formobile-to-fixed calls and for fixed-to-mobile calls.However, the customer on the fixed network paysthe same amount to call someone whether on thefixed network or on a mobile network. Interconnec-tion between the fixed and mobile operators isgenerally on a reciprocal basis, either bill-and-keep(also referred to as sender-keep-all) or mutual com-pensation at the same interconnection rates that arefound in fixed-fixed interconnection arrangements.


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A number of countries that do not have CPP areconsidering a switch to it, or have done so. Forexample, Mexico introduced CPP in April 1999. Thismove is partly motivated by evidence of highermobile subscriber growth rates in CPP countries. SriLanka has announced its intention to change toCPP. The transition to CPP affects subscribers of allnetworks in a market, including PSTN subscribers.Their bills will be increased since they will becharged for calls to mobile subscribers. Accordingly,the transition normally involves regulatory supervi-sion to ensure, among other things, that PSTNsubscribers are adequately notified of increasedcharges that will appear on their bills.

Because fixed-to-mobile calls are so much moreexpensive than fixed-to-fixed calls in a CPP country,many countries have distinct dialling prefixes forfixed-to-mobile calls. In that way, consumers under-stand that they will be charged a premium for fixed-to-mobile calls, and it is obvious when such chargingtakes place.

In recent years, some observers have expressedconcern about the level of CPP charges for fixed-to-mobile calls. The ITU’s Trends 2000 Report, whichfocuses on interconnection, points out that inEurope, where CPP arrangements prevail, the aver-age fixed-to-mobile interconnection rate was USD0.21 per minute for a three minute call. Thiscontrasts with mobile-to-fixed interconnection ratesof USD 0.01 per minute for local interconnection,0.014 for single transit interconnection and 0.02 fordouble transit interconnection. The ratios of fixed-to-mobile and local mobile-to-fixed rates range from alow of 8.7 in Norway to a high of 34 in France. Thereport suggests that asymmetrical regulation offixed-line and mobile operators may have resulted ininflated mobile termination charges under CPP.

Some observers believe that the high level of CPPcharges for fixed-to-mobile calls is due to a combi-nation of two factors, market failure and regulatoryinattention:

➢ The market failure arises because there is littlecompetition in fixed-to-mobile rates. Mobileoperators often compete vigourously onsubscription and mobile-to-fixed rates, servicelevels and coverage, but they rarely compete onfixed-to-mobile rates. Such competition does

sometimes arise, for example in Finland, wheremobile operators have reduced fixed-to-mobilerates in line with mobile-to-fixed rates. Incountries where there is a monopoly fixedoperator, the fixed operator has little incentive toreduce fixed-to-mobile rates. Even in countrieswith competing fixed operators, there seems tobe little evidence of competition to reduce fixed-to-mobile rates.

➢ The regulatory inattention arises because, asexplained earlier, mobile service was historicallyviewed as a discretionary or even a luxuryservice that appealed to a narrow segment ofusers. In many countries, mobile service wasoffered competitively, and rates were set bymarket forces. Unlike the fixed networks, regu-lators did not have good cost data for mobilenetworks. Without cost data, the regulators werenot in a position to determine if fixed-to-mobilerates might be higher than necessary.

The result of these two factors is that fixed-to-mobilerates in some countries have remained at high levelseven as mobile-to-fixed rates have declined sub-stantially due to reduced costs and vigourouscompetition.

An examination of the fixed-to-mobile rates that arecharged to the customers of a fixed operator leadsto an examination of the interconnection chargeslevied by the mobile operator to the fixed operatorfor the termination of a call on the mobile network.Few countries have examined the costs of mobiletermination and applied these costs in setting inter-connection charges. One country that has recentlymade such an attempt is the United Kingdom. In a1998 report, the Competition Commissiondetermined that fixed-to-mobile termination rateswere substantially above cost. In 1999, OFTELordered that rates be substantially reduced to aceiling of 11.7 pence per minute, and that the ceilingbe further reduced by 9% per year (after inflation) fortwo years thereafter. OFTEL will be considering iffurther pricing action is needed following this period.

High mobile interconnection rates may be reducedby competition over time. However, as mobile serv-ices catch up with and overtake fixed networks,there is likely to be more regulatory scrutiny of highmobile termination rates, particularly where they are


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Interconnection

thought to be set at levels that are significantlyabove cost.

3.4 Technical and OperationalConditions

While financial arrangements are important to thedevelopment of interconnection arrangements, thetechnical and operational conditions determine howefficient and “seamless” interconnection is from theusers’ perspective. These conditions can alsodetermine whether competition in a particular marketwill succeed or fail.

The most important technical and operationalconditions are neither complex nor difficult to under-stand. At a minimum, regulators should develop anoverview of the key technical and operationalconditions in order to resolve disputes that may arisein interconnection negotiations.

3.4.1 Provision of Information byIncumbents

3.4.1.1 Availability of Agreements or Offers

The advantages of transparent interconnectionarrangements are discussed in Section 3.1.5.4. Thesimplest way to encourage transparency is torequire publication of interconnection agreements oroffers of incumbents. In this regard, the WTORegulation Reference Paper requires signatories toensure that a major supplier will make publiclyavailable either its interconnection agreements or areference interconnection offer.

The advantages of publication of interconnectionagreements or standard offers include:

➢ Publication facilitates interconnection by existingand potential new entrants. It allows them toobtain basic interconnection terms andconditions without lengthy negotiations orregulatory orders;

➢ It discourages undue discrimination by adominant operator (or by both parties to anagreement) that may not be readily detectableby regulators if filed in confidence;

➢ It facilitates comparisons of interconnectionrates, terms and conditions among major op-erators; and

➢ It assists in developing industry standards,benchmarks and best practices.

The disadvantage of mandatory publication of inter-connection agreements is that it breaches thenormal confidentiality of commercial agreements.However, this disadvantage can be mitigated inseveral ways. One is to permit deletion ofcommercially sensitive information from filed agree-ments. This can include proprietary network orservice information and related costs. In such cases,a confidential filing with the regulator is normallyrequired. Another approach is to require only thefiling of standard agreements or offers (“referenceoffers”), rather than all executed agreements.

For the reasons discussed in Section 3.1.5.2, thefiling of interconnection agreements between non-dominant operators is not generally required. TheWTO Regulation Reference Paper requirespublication of agreements with major suppliers, or areference interconnection offer with them. A numberof countries with well-developed regulatory regimes,for example Denmark and the UK, only require thepublication of interconnection agreements ofincumbents.

There is often no telecommunications regulatoryrequirement for publication of interconnectionagreements between smaller operators. However,these are increasingly being made public to complywith the securities laws of some countries. In thesecountries, securities regulators require companiesthat issue shares to the public to disclose their mate-rial contracts. Examples of such agreements can befound on the EDGAR Web Site in the US.Agreements between new entrants can provideinsight into interconnection arrangements in lessregulated markets.

3.4.1.2 Network Specifications

Interconnected networks must be technicallycompatible. A new entrant must, therefore, haveaccess to technical specifications of the network ofthe incumbent with which it will interconnect. Simi-larly, the incumbent requires information on the


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technical characteristics of an interconnectingoperator’s network. For example, it will be importantfor both operators to know the types of switching,routing and transmission equipment used by theother, signalling protocols, number of circuits and theprojected volume of traffic to be exchanged.

Sufficient information is required to permit the inter-connecting operators to design their own networksto provide efficient connectivity between eachother’s customers. Regulators should ensure thatincumbents and new entrants do not withhold infor-mation necessary to ensure efficient interconnectionarrangements for both sides.

Operators should not be permitted, for example, towithhold necessary information on the grounds thattheir standards and specifications are proprietary. Ifnecessary, some technical information could beexchanged under non-disclosure agreements. Inpractice, however, this is impractical and canfrustrate interconnection of future networks. Thetelecommunications sector is evolving towards moreopen standards, and this is a trend that regulatorsshould encourage. Open standards are oftendeveloped through industry committees with regu-latory observers or mediators. In keeping with thispractice, regulators should encourage interconnec-tion operators to establish technical committees todevelop specifications, protocols, and procedures forthe interconnection of their networks.

In many cases, incumbent operator networks havenot been designed to anticipate interconnection withother operators. Accordingly, some network modifi-cations are often required to permit interconnection.Treatment of such network modifications or “start-upcosts” is discussed in Section 3.3.4.1.

3.4.1.3 Network Changes

Telecommunications networks are dynamic. In mostcountries, networks are constantly changing as newswitching and transmission facilities are added, newsoftware and features are installed, and newprotocols adopted. The most obvious example is thecurrent transition from circuit-switched to packet-switched networks, such as Internet Protocolnetworks, to carry both data and voice traffic.However, the network plans of operators change

regularly in response to technological development,market and budget considerations.

Over time, as the networks are modified, it is goodpractice for regulators to require that networks ofdominant incumbents evolve into more opennetworks.

3.4.2 Treatment of Competitor Information

Monopoly or dominant providers of local telephoneservices, and certain other monopoly services, are ina position to collect competitively valuable informa-tion on their interconnecting competitors. A typicalsituation might involve a local monopoly operatorthat receives orders from a long distance competitorto install leased local lines to interconnect with thecompetitor’s POP. The monopolist would know thatthe competitor had located a relatively heavy longdistance user (probably a business or governmentuser) that had sufficient traffic to require a leasedlocal line. In the absence of competitive restrictions,the monopoly could send a salesperson from its ownlong distance division to offer a discount or otherincentive to the customer to persuade it not to use itscompetitor’s services.

Abuse of such competitive information is subject toregulatory restrictions in many countries. The Refer-ence Paper on Regulation that forms part of theWTO’s Agreement on Basic Telecommunicationsattempts to prohibit such activities. The ReferencePaper requires signatories to maintain “appropriatemeasures” for the purpose of preventing major sup-pliers from engaging in anti-competitive practices.One of the practices identified is using informationobtained from competitors with anti-competitiveresults.

A national example of a prohibition against competi-tive misuse of information can be found in theGeneral Licence issued by the Irish regulator.Condition 20 of that licence deals with misuse ofdata in the following terms:

“The Licensee shall not make use of network ortraffic data, traffic profiles or any other data ofany nature, and which are not otherwise publiclyavailable and which become available to theLicensee directly or indirectly either as a result ofentering into interconnection arrangements or


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Interconnection

otherwise as a result of carrying telecommunica-tions messages, in such a way which, in thereasonable opinion of the Director, would undulyprefer the interests of any business carried on bythe Licensee or an Affiliate or place personscompeting with that business at an unfairdisadvantage.” (OTDR (1998))

A good approach to preventing abuse of competitiveinformation is the establishment of an Interconnec-tion Services Group (ISG). This is sometimes calleda Carrier Services Group. The idea is to establish aseparate organization within the incumbent operator,whose role it is to handle interconnection-relateddealings between that operator and interconnectingoperators. For example, all orders by interconnect-ing carriers for interconnection links, additionalcapacity and customer access lines would besubmitted to the ISG. The ISG will process theorders.

Safeguards will be put in place to ensure that infor-mation obtained by the ISG is not used for improperpurposes. For example, where a new entrant ordersan access line from the incumbent operator to servea new customer, the ISG should not pass thatinformation on to the marketing department of theoperator to try to “snare” or “win-back” the customerbefore the access line is installed. Confidentialitysafeguards should include codes of conduct withmandatory suspension or termination of employeeswho “leak information”. Separate office space,locked filing cabinets, audits and other measurescan help ensure confidentiality of ISG information.

3.4.3 Treatment of Customer Information

Monopoly providers of local telephone services arein a position to collect information on their custom-ers. Such information may include names,addresses and telephone numbers, as well asinformation on monthly billing levels, calling patterns,percentage of calls unanswered, etc. Customerinformation of this type can be very valuable in mar-keting new services. For example, customers withvery long calls may be heavy Internet users to whomInternet services can be successfully marketed.Users with many missed calls make good customersfor voice-messaging services. Customers with highinternational calling would be good targets to tie up

in long-term contracts if a competitive internationalservice operator is about to be licensed.

In some countries, including the US and Canada,regulatory restrictions are imposed on the use ofcustomer information. Some of these rules areaimed at protecting the privacy of customers. Forexample, customers typically do not want the worldto know what phone numbers they call.

Another example of a regulatory restriction is foundin the European Union data protection directives andin related laws of EU Member States. These lawsimpose specific obligations on telecommunicationsservice providers regarding the use that can bemade of billing and other customer data, including aprohibition against using such information to markettelecommunications services to customers unlessthe customer has consented to that use of its data.Other countries have implemented, or are consider-ing similar consumer protection rules.

Other restrictions are aimed at preventing anti-competitive use of customer information gathered bymonopoly operators that have competitive opera-tions or affiliates. Such rules may require amonopoly local operator, for example, to share anycustomer information that it provides to itscompetitive operations or affiliates with intercon-necting operators or other direct competitors in thesame business line. For example, if a local monop-oly operator’s long distance services division collectsinformation to identify heavy Internet users to help itsInternet division sell services, it would be required toprovide the same information to competitive InternetService Providers.

These restrictions are based on the assumption thatthe local monopoly service provider is in a position tocollect the information solely due to its monopolyposition. Distribution of this type of information canbe handled through an Interconnection ServiceGroup (see Section 3.4.2).

3.4.4 Points of Interconnection

The interconnection policies of many countriesrequire incumbent operators to permit interconnec-tion with their networks at any technically feasiblepoint. This policy is reinforced by the WTORegulation Reference Paper, which requires


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signatory countries to ensure interconnection at anytechnically feasible point with their major suppliers.

Interconnection agreements and regulatory ordershave established different interconnection points indifferent countries. Box 3-5 provides examples oftechnically feasible interconnection points that havebeen prescribed by regulators or established in in-terconnection agreements.

The definition of technically feasible interconnectionpoints is not static. Telecommunications networkscontinue to evolve. As new technologies, such asthose based on the Internet Protocol and digitalsubscriber loops, are rolled out, it is becoming tech-nically feasible to interconnect networks at differentpoints. Therefore, interconnection agreements andregulatory directives should not prescribe limitationson the points of interconnection that will be permit-ted. It should be open to interconnecting operatorsto propose interconnection at different points asnetworks evolve.

The costs of interconnection incurred by bothoperators will vary depending on the points of inter-connection. Incumbents will sometimes proposestandard points of interconnection of their networkswith other operators. These standard points of inter-connection may be set out in the “reference

interconnection offers” major suppliers are requiredto make available pursuant to the WTO RegulationReference Paper.

In some cases, new entrants may wish to intercon-nect at points other than the standard points. In suchcases, the Reference Paper provides that suchinterconnection should be made available uponrequest. However, the requesting party may berequired to pay charges that reflect the cost of con-struction of necessary additional facilities.

A variation on the theme of interconnection at non-standard points can be found in a recent regulatorydecision in the United Kingdom on Third Generationcellular services. The UK regulators have recentlyruled that new Third Generation cellular networksshould have access to earlier generation cellularnetworks at points around the country, by means ofa compulsory roaming arrangement. This example isset out at Box 3-6.

3.4.5 Access to Unbundled NetworkComponents

In an increasing number of countries, telecommu-nications policies require incumbent operators toprovide competitors with access to unbundled

Box 3-5: Examples of Technically Feasible Interconnection Points

➢ The trunk interconnection points of local and national tandem exchanges (most common point ofinterconnection or POI)

➢ The national or international circuit interconnection points of international gateway exchanges➢ The trunk side of local exchanges➢ The line side of local exchanges (e.g. at the main distribution frame (MDF) or Digital Distribution Frame

(DDF)➢ Cross-connect points of any exchange➢ “Meet points” at which operators agree to interconnect➢ Signaling transfer points (STF) and other points outside of the communications channel or band, where

interconnection is required for CCS7 or other signaling to exchange traffic efficiently and to access call-related databases (e.g. a Local Number Portability (LNP) database).

➢ Access points for unbundled network components➢ Cable landing stations


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Interconnection

network components. Unbundling generally refers tothe provision of network components on a stand-alone basis. Unbundling permits interconnectingoperators to access a single unbundled componentwithout an obligation to buy other components aspart of an “interconnection service”.

There are many possible types of unbundlednetwork components. The policies of some countriesrequire provision of certain features, functions andservices on an unbundled basis – as well as certainphysical facilities. These features, functions andservices may be associated with transmission orswitching facilities. They may also be associatedwith software facilities, such as databases that

support the efficient provision of telecommunicationsservices. Examples include access to directoryinformation databases, operator services andsubscriber listings in telephone directories.

In this Module, we will use the term “networkcomponents” to refer to both physical networkfacilities and these “non-physical” features, functionsand services. Box 3-7 lists examples of unbundlednetwork components.

Unbundling of the local loop is a special case ofunbundling that is currently being addressed byregulators in many countries. It is dealt with in moredetail in the next Section.

Box 3-6: Compulsory National Roaming in the UK

Background:

As part of the process leading to the licensing of “Third Generation” cellular wireless networks in the UK,Oftel and the Department of Trade and Industry ("DTI") dealt with the issue of compulsory roaming. Theregulators determined that any existing wireless network operator which participated in the auction toobtain spectrum for Third Generation network services would be required to accept a licence modificationobligating the operator to negotiate an interconnection agreement to provide national roaming access tonew entrants. The aim was to prevent incumbent operators from using their existing wireless networks toan unfair competitive advantage while new entrants built up their networks and territorial coverage. Ineffect, DTI and Oftel determined that access to earlier generation networks was an essential facility to bemade available to new entrant competitors. (The concept of essential facilities is discussed in the nextSection.)

The Nature of Roaming:

Roaming is typically an arrangement between wireless network operators or services providers to allowaccess by one service provider's customers to the network or services of another service provider locatedoutside the service area of the first service provider. Roaming arrangements require the implementation ofsubscriber authorization and billing systems. They also require appropriate technical and spectrumcapacity arrangements to be at all points of access by customers of roaming operators.

The Requirements of National Roaming:

DTI and Oftel intend to make what was previously a system of negotiated interconnection among non-competing wireless operators a compulsory arrangement between incumbents and a new entrant. Nationalroaming is to be made available on a non-discriminatory basis. Oftel will deem the incumbent to have costsof roaming services equal to the rates for roaming services charged to competitors. Oftel will then includesuch deemed costs in determining whether the service charges of incumbents are sufficient to cover costsand make an adequate return. National roaming services will not be available to a competitor before thecompetitor has achieved network roll-out covering at least 20% of the UK population, and may expire anytime after 31 December 2009. Roaming charges are to be determined on a “retail minus” rather than “costplus” basis (meaning that roaming charges will be derived from end user charges, less a discountreflecting elements of cost not incurred in providing the roaming service rather than an end user service).


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Decisions as to what components to unbundle andhow to unbundle them are sometimes left to nego-tiations between operators. According to theJapanese interconnection policy, for example,unbundling should be promoted as much aspossible through a process which takes intoconsideration the opinions of carriers other than theincumbent. However, the Japanese policy alsoindicates that the regulator should be involved ifnegotiations fail. In practice, for the reasonsdiscussed below, negotiated unbundling arrange-ments are generally unsatisfactory in the long run.The incumbent has little incentive to unbundle itsnetwork sufficiently to permit competitors to operatevery effectively.

Rationale for Unbundling

The purpose of unbundling policies is to lowereconomic and technical barriers to competitive entry.The large capital costs of building duplicatenetworks raise a significant barrier to entry.Competitors may not be willing or able to finance theconstruction of complete networks. However, theymay be willing to build parts of such networks. Forexample, they may build certain switches, inter-exchange transmission facilities, and access lines ina limited number of locations. If the regulatory

framework permits, competitors can then obtainother network components, such as switchingcapability and access lines in other locations, fromthe incumbent. This permits new entrants to mixtheir self-built network components with those of theincumbent in an efficient manner.

The ability to mix self-built network components andthose of the incumbent will increase the viability ofthe business case for competitive entry in manycountries. Thus, competition will emerge where itotherwise would not. The use of the incumbentoperator’s network components by competitors willoften be transitional. Over time, the competitor willbuild more of its own facilities and become a full-fledged facilities-based operator.

Many incumbents are unwilling to provide competi-tors with access to unbundled network componentsunless they are required to do so by regulation.While the issue is still controversial in somecountries, and among some experts, mandatorynetwork unbundling is becoming more common.

Unbundling Policies

The trend to unbundling was given a strong impetusin the WTO Regulation Reference Paper. The

Box 3-7: Some Possible Unbundled Network Components and Services

➢ Network access lines (local loops and related functions)

➢ Local switching functions

➢ Tandem switching functions

➢ Inter-exchange transmission (e.g. between local and tandem switches)

➢ Access to signaling links and signal transfer points (STPs)

➢ Access to call-related databases (e.g. line information, toll-free calling and number portability databases)

➢ Central office codes (NNXs)

➢ Subscriber listings (in telephone directories and directory databases)

➢ Operator services

➢ Directory assistance functions

➢ Operations support systems (OSS) functions


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Interconnection

Reference Paper states that major suppliers mustprovide interconnection on a basis that is sufficientlyunbundled so that a supplier need not pay fornetwork components or facilities that it does notrequire for the service to be provided. While thisstatement is supportive of unbundling policies, it isquite general. It provides little guidance for thedevelopment of national unbundling policies.Unbundling policies are still in the early stages ofdevelopment in many countries.

Unbundling policies have developed in the US,Canada, Australia, Singapore, Hong Kong and othercountries, including, more recently, the EU. The newregulatory framework for electronic communicationsservices proposed by the European Commission on12 July 2000 provides a strong new impetus forimplementation of national unbundling policies.Particularly significant in this regard, is the EU’s newregulation on local loop unbundling, which will comeinto force on 31 December 2000.

Unbundling has also been required in other EUregulatory documents. Article 7(4) of the EUInterconnection Directive provides that interconnec-tion charges must be sufficiently unbundled so thatan applicant for interconnection is not required to

pay for anything that is not strictly related to theservice requested. Similarly, Article 7(4) of theRevised Voice Telephony Directive (Directive98/10/EC) states that:

“Tariffs for facilities additional to the provision ofconnection to the fixed public telephone networkand fixed public telephone services shall, inaccordance with Community law, be sufficientlyunbundled so that the user is not required to payfor facilities which are not necessary for theservice requested."

Advantages and Disadvantages of Unbundling

There are some disadvantages to a full-scale man-datory unbundling policy. In particular, it can act as adisincentive to the construction of competitivenetwork components, and the development of truefacilities-based competition. However, thedisadvantages appear to be outweighed by theadvantages. Moreover, the potential disadvantagescan generally be avoided if the pricing and otherterms of the unbundling guidelines are properly set.The main advantages and disadvantages of amandatory unbundling policy are summarized inTable 3-4.

Table 3-4: Advantages and Disadvantages of Unbundling

Advantages➢ Reduces economic barriers to entry, by

allowing new entrants to construct somecomponents of their networks and obtain othercomponents from the incumbent operator

➢ Encourages innovation, since new entrants cancombine new technologies (e.g. ADSL and IPdata/voice switches) with components ofexisting networks (e.g. access lines)

➢ Avoids unnecessary duplication of components(e.g. access lines in remote areas,transmission tower space)

➢ Facilitates access to rights of way, towers, etc.by new entrants (in many countries it can bevery time consuming and expensive to obtainsuch rights)

Disadvantages➢ Reduces incentive for construction of

competitive network facilities (depending onthe availability and price of unbundledcomponents)

➢ Can enrich the new entrant at the expense ofthe incumbent operator (if unbundledcomponent prices are set below costs)

➢ Requires detailed regulatory intervention andtechnical co-ordination


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Regulatory Approaches to Unbundling

Given the potential disadvantages of a mandatoryunbundling policy, some regulators have adoptedmodified approaches to such a policy. Theseapproaches are intended to achieve someadvantages and avoid some disadvantages of poli-cies that require unbundling of all networkcomponents. Some of these approaches may besummarized as follows.

➢ Transitional Unbundling Requirements -Access to certain types of unbundledcomponents may be required for a limited periodof time. This approach can apply, for example,to access lines (loops) in urban areas.Unbundling of access lines might be required forthe first five years after a market opening. Thus,competitors can use the incumbent’s accesslines to “jumpstart” competition. However, theywill have to construct their own access lines byyear five, in order to maintain networkconnections with their customers. In theory, thisapproach will encourage the development ofcompetition in the short term. At the same time itshould promote development of completefacilities-based competition over the mid tolonger term. Local loop unbundling is describedfurther in the following Section of this Module.

➢ Selective Unbundling Requirements - Someunbundling policies distinguish between networkcomponents. They require unbundling of someand not others. Unbundled access may berequired only for certain types of components.For example, unbundled access may berequired for network components in caseswhere construction of duplicate componentswould cause environmental damage or publicinconvenience. Thus, incumbents might berequired to provide access to towers, poles,conduits, ducts, aerial access lines and insidewiring, where a proliferation of such facilitieswould degrade the environment, disrupt publicroads, and/or otherwise inconvenience thepublic. The same may be true of access lines orswitching facilities in architecturally or culturallyimportant areas. Such access might be requiredover the long term as well as the short term.

Many countries are still developing policies onnetwork unbundling. Unbundling policies vary fromcountry to country, depending on the conditions oflocal telecommunications markets. It is arguable thatmandatory unbundling is less desirable in countrieswith very limited telecommunications networkinfrastructure and large pent-up demand. In suchless developed countries, mandatory unbundlingmay reduce the incentive to build much-needed newinfrastructure. On the other hand, in some lessdeveloped countries, the business case for newentry may not be viable without mandatoryunbundling. Each telecommunications marketshould be carefully assessed to determine the roleunbundling policies should play in sector develop-ment.

3.4.6 Local Loop Unbundling

Mandatory unbundling of local loops is increasinglybeing used as a regulatory tool to accelerate com-petition in local access markets. Around the world,telecommunications network competition hasdeveloped most rapidly in the long-distance andinternational markets. Local access markets aregenerally less competitive. Wireless services cur-rently provide an alternative means of localnarrowband access in many markets, andbroadband competition is starting. However, wirelineservices still provide the main means of local accessaround the world. There, high entry costs and lowmargins have discouraged competition.

Competition in local access is increasingly seen asan important policy objective. One reason is theperceived need to provide more competition in high-speed access markets in order to accelerate the rollout of Internet, e-commerce and video services.Many regulators and policy makers see such com-petition as necessary to maintain or increase thecompetitiveness of their national economies.

Regulators have now mandated unbundled accessto local loops in a range of different economies. Atone end of the income spectrum, these countriesinclude the US, Australia, Canada, Singapore andthe EU members. Unbundled loop access has alsobeen mandated in a number of middle incomecountries, such as Mexico and the Slovak Republic,as well as in lower income countries, such asAlbania, Guatemala, Kyrgistan and Pakistan.


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Interconnection

Types of Local Loop Unbundling

Local loop unbundling regimes typically requireincumbent operators to provide access to their localloops to competitors. Other third parties, such ascustomers, may sometimes also obtain unbundledaccess. Access to local loops is provided at a pointof interconnection somewhere between the networktermination point on the customer premises and theline-side of the access network operator's localswitch. From this point of interconnection, the com-petitor will obtain dedicated or shared access to thelocal loop. The competitor will thus be able to usethe loop as a direct transmission medium betweenits network and the customer's premises.

Various technical options are available for local loopunbundling. In its proceedings on unbundled accessto the local loop in early 2000, the EuropeanCommission’s DGIS focussed on three main optionsfor access to local loops:

➢ Full unbundling of the local loop (unbundledaccess to the copper pair for competitiveprovision of advanced services by third parties);

➢ Shared use of the copper line (unbundledaccess to the high frequency spectrum of the

local loop for the competitive provision of DigitalSubscriber Loop (DSL) systems and services bythird parties); and

➢ High speed bit stream access (provision ofxDSL services by the incumbent).

Although different approaches are possible, thesethree are the main ones in use today. Each of themis described in greater detail below.

Full Unbundling (Copper Loop Rental)

Full unbundling can provide new entrants withaccess to raw copper local loops (copper terminatingat the local switch) and sub-loops (copper terminat-ing at the remote concentrator or equivalent facility).In the case of unbundling at the local switch, the linkbetween the main distribution frame (MDF) and thelocal switching equipment on the incumbent’spremises is re-routed and connected to the newentrant’s switch. The new entrant takes over theoperation of the local loop.

Figure 3-1 illustrates this type of full unbundling of alocal loop. The illustrated case assumes that the

Figure 3-1: Full Unbundling – Local Loop

L o c a l lo o p

L in k re - ro u te d fro m in c u m b e n t’ss w itc h to n e w e n tra n t ’s

MDF

In c u m b e n t’slo c a l s w itc h

T o n e we n tra n t ’s

s w itc h

P S T N

P S T N

Source: Adapted from CEC (2000b)


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customer has decided to change telecommunica-tions service suppliers. The local loop that previouslyconnected the customer to the incumbent’s switchhas been re-routed to connect it to the new entrant’sswitch. The new entrant will then use the unbundledlocal loop to provide an alternative local accessservice to that previously provided by the incumbent.

Figure 3-2 illustrates full unbundling in a case wherethere are two local loops to a customer’s premises.One loop is unbundled by the incumbent and re-configured to connect the customer to the newentrant’s network. The other loop continues toconnect the customer to the incumbent’s network. Asimilar approach would apply where there are threeor more loops to a customer’s premises. In eachcase, the customer could decide how many loops itwanted connected to different operators. Theapproach illustrated in Figure 3-2 would be usedwhere a customer wants to retain its basic telephoneservice with the incumbent. It can do so and, forexample, at the same time have a dedicated con-nection to a new entrant’s xDSL services to accesshigh-speed data services (e.g. Internet or videoservices).

Full unbundling of the type illustrated in Figure 3-1and Figure 3-2 essentially involves rental of adedicated copper loop by the incumbent to a newentrant. Such copper loop rental provides the newentrant with direct access to and use of the copperloop. This allows new entrants to operate their ownend-to-end transmission systems. Such operationalcontrol can be important to ensure the integrity andquality of high-speed services.

Although Figure 3-1 and Figure 3-2 indicate that thepoint of interconnection is at the distribution framewhere the copper loop terminates, it is also possibleto locate the point of interconnection at a remoteconcentrator unit (remote line unit).

Shared Use of the Copper Loop

An alternative means of providing access to the localloop involves shared access rather than exclusiveaccess by a new entrant. In this form of unbundling,the incumbent and the new entrant provide servicesover the same loop.

Figure 3-3 illustrates one form of sharing the localloop. In this case, the customer will continue to

Figure 3-2: Full Unbundling – Two Local Loops

S eco ndL oca l loo p

M

D

F

In cum bent’slo ca l sw itch

P S T N

X D S Lm od em

N e w en tran t’sD S L accessm ultip lexe r

(D S L A M )

N ew en tran tP C or o ther

cu s tom er eq u ip m e nt

F irst loca l loo p



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Interconnection

Figure 3-3: Shared Use of Copper Loop Using Splitter

sp litte r

te lLoca l loop

A D S Lm odem

N ewe ntran t

Incum be nt’slo cal sw itch P S TN

M

D

Fdata

P C or other custom erequ ipm ent

D S L accessm ultip lexer(D S LAM )


receive basic PSTN services from the incumbent,and at the same time, receive DSL access servicesfrom a new entrant. As illustrated, a splitter is locatedbetween the MDF and the incumbent’s local switch.The splitter is connected to both the incumbent’sswitch and to a DSL access multiplexer (DSLAM)connected to the new entrant’s high-speed network.

As indicated, the splitter separates telephone anddata traffic. Thus, the voice frequencies of the loopcontinue to be used by the incumbent. The non-voice frequencies are made available to the newentrant to provide high-speed services. In effect, thisarrangement provides unbundled access to the highfrequency spectrum of the local loop for the com-petitive provision of Digital Subscriber Loop (DSL)services by new entrants.

Shared use of copper line can provide a cost-effective solution for some customers. For example,it permits a customer to retain the incumbent as itstelephone service provider, and at the same time,select a new entrant to provide high-speed Internetservice over the same loop.

High-speed Bit Stream Access

A third approach to providing access to the localloop involves provision by an incumbent of a high-

speed bit stream to new entrants. To do this, theincumbent would install a high-speed access link tothe customers’ premises and then make it availableto other operators to enable them to provide high-speed services. Provision of bit stream accessservices requires provision of both the transmissionmedium (e.g. copper cables, coaxial cables andoptical fibre cables) and the transmission system(e.g. synchronous digital hierarchy transmission onoptical fibres and xDSL transmission on coppercables).

In the case of high-speed bit stream access, thepoint of interconnection will usually be at the incum-bent’s local switch, but circuits could be back-hauledto points of interconnection further up the switchinghierarchy. Technically, bit stream access can beprovided to any transmission system, since it onlyrequires reservation of a specified bandwidth, ratherthan dedicated use of a physical loop. This accessarrangement does not entail any unbundling of acopper pair. Rather it uses the higher frequencies ofthe copper local loop, as in the case of shared useof the copper line.

Providing high-speed bit stream service can beattractive for incumbent operators as it does notinvolve physical access to copper pairs. As a result,for example, it would not hinder the progressive


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modernization of the local access network byreplacing copper with fibre.

Figure 3-4 illustrates the provision of high-speed bitstream access by an incumbent. In this example,two customers obtain high-speed data services fromtwo different service providers, the incumbent and anew entrant. At the same time, the incumbentcontinues to provide basic PSTN services to bothcustomers.

The three means of access to the local loop referredto above are not necessarily mutually exclusive.Where regulators mandate local loop access, theymay require or permit incumbent operators toprovide one or more alternative forms of access.

Advantages and Disadvantages of Unbundlingthe Local Loop

The main reason regulators have required incum-bents to unbundle their local loops is to promotecompetition and innovation in access and advancedhigh-speed services. However, there continues to bean active debate on the merits of mandatory loopunbundling. There remain arguments against it, aswell as for it. Table 3-5 summarizes the pros andcons of mandatory loop unbundling.

Implementation of Local Loop Unbundling

Different approaches may be used in mandating andregulating local loop unbundling. The appropriateapproach will often depend on the state of competi-tion in the relevant market for local access. Possibleapproaches include:

➢ Mandatory loop access without specification ofthe type of access arrangement. In this case, itis likely many incumbents will choose to offer bitstream access, which enables them to retaingreater management control and possibly obtainhigher access charges from competitors. Thedisadvantage of this approach is thatcompetition may be delayed. Incumbentoperators will have little incentive to accelerateimplementation of bit stream accessarrangements, at least until they are positionedto provide competitive services.

➢ Requiring bit stream access only (see previouspoint – same considerations apply).

➢ Requiring all three forms of access describedabove, except where the incumbent can

Figure 3-4: Provision of High-Speed Bit Stream Access

Custom er ofincum bent’s

dataservices

Loca l loop

Local loop

P STN

H igh speed bits tream serv iceprovided to oneor m ore newentran ts

splittersMDF

DS LAMopera ted

byincum bent

C ustom er ofnew entrant’sdata serv ices



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Interconnection

demonstrate significant problems with dedicatedloop rentals.

➢ Requiring all three forms of access in some orall national markets.

Various other regulatory approaches to unbundlingmay be developed.

Local loop unbundling may be a transitionalphenomenon in some areas. Unbundling of loopsmay be required, for example, to facilitate competi-tion in the short term. This will enable new entrantsto roll out service rapidly, while they are constructingalternative access networks in the areas where thereis sufficient demand.

Implementation of local loop unbundling continues tobe a novel issue for regulators in many countries. Amajor source of experience to date is the United

States. In the US, the 1996 TelecommunicationsAct requires incumbents to offer access to unbun-dled network elements and to making retail servicesavailable at wholesale prices. The US regulator hasstated that “[p]reventing access to unbundled localloops would either discourage a potential competitorfrom entering the market in that area, therebydenying those consumers the benefits of competi-tion, or cause the competitor to constructunnecessarily duplicative facilities, therebymisallocating societal resources” (FCC, First Reportand Order in the Matter of the Implementation ofthe Local Competition Provisions in theTelecommunications Act of 1996). The FCC andUS state regulators have subsequently taken furthersteps to facilitate loop unbundling.

As of June 1999, approximately 685,000 loops hadbeen provided to competitors in the US as unbun-dled network elements. This represented an

Table 3-5: Arguments For and Against Local Loop Unbundling

Pros Cons

➢ Accelerates introduction of local accesscompetition, including xDSL access

➢ Reduces incentive to build alternative accessnetworks and more sustainable facilities-basedcompetition

➢ Accelerates competition, service innovationand roll out for high speed services, including:

➢ Internet services

➢ Video services (including interactive ones)

➢ E-commerce

➢ other data services

➢ May undermine investment in alternativeaccess networks (wireline and wireless)

➢ May complicate modernization of incumbentoperators’ networks (e.g. if some access loopsare dedicated to competitors use)

➢ Requires prolonged and detailed regulatoryintervention compared to facilities-based accesscompetition

➢ Avoids duplication of access networks, andincreases network operating efficiencies

➢ Requires more technical co-ordination betweenoperators compared to facilities-based accesscompetition

➢ Provides new revenue streams to incumbent(which may or may not exceed existingrevenues from loops, depending on tariffs)

➢ Reduces disruption of streets andenvironment due to construction of newaccess networks


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increase of 180 percent over the previous year. Inaddition, competitors had collocation arrangementsin exchanges covering 60 percent of all lines in theUS (compared with 32 percent of all lines theprevious year). By the end of 1999, competitors hadprovided 117,000 xDSL lines, up from 1,500 lines in1997, while incumbents provided 386,000 DSL lines,up from 32,000 at the end of 1998. Competitors hadinstalled over 1,400 data switches, a fivefoldincrease over 1997. Recent estimates suggest thatabout 60% of the US population had access to DSLat the beginning of 2000, with 25% located in citieswith four or more DSL providers.

In July 2000, the European Union adopted aRegulation on Unbundled Access to the LocalLoop. The regulation will be binding on dominantoperators in EU Member States, as of 31 December2000. Issuance of the regulation is based on theassumption that providing access to the local loop toall new entrants will increase the level of competitionand technological innovation in the local accessnetwork, and in turn stimulate the competitive provi-sion of a full range of telecommunications servicesfrom simple voice telephony to broadband services.The regulation is aimed, in part, at ensuring that theEU does not fall further behind the US in thedeployment of high speed access and the advancedservices it enables.

The European regulation requires dominantoperators to provide physical access to third partiesat any technically feasible point of the copper localloop or sub-loop. The third party can locate andconnect its own network equipment and facilities atsuch points (i.e. at the local switch, concentrator orequivalent facility) in order to deliver services to itscustomers. Dominant operators are required tomake unbundled loop access available to thirdparties under transparent, fair and non-discriminatory conditions. In addition, the regulationprovides that the dominant operators must providecompetitors with the same facilities as they provideto themselves or their associated companies, andwith the same conditions and times. Regulators aregiven authority to intervene in pricing issues andresolve disputes in connection with the regulation.

Experience in other jurisdictions suggests thatregulatory guidance is required in determining thepricing (and costing) of unbundled local loops.

Operator negotiations, or unilateral price setting byincumbents can result in anti-competitive pricing.Where advance regulatory guidelines are notestablished, ex post regulatory intervention will oftenbe required. A recent Australian case illustrates thepoint. In early August 2000, the Australian regulator,the ACCC, found that prices imposed by thedominant operator (Telstra) on competitors for localloop access were too high.

3.4.7 Sharing of Infrastructure andCollocation

Extensive infrastructure is required to build tele-communications networks. Key supportinginfrastructure includes poles, ducts, conduits,trenches, manholes, street pedestals, and towers.Sharing of such infrastructure can significantlyincrease the efficiency of telecommunications supplyin an economy. The same is true in the case ofsharing building space in exchanges to permit two ormore operators to “co-locate” their cable and radiotransmission facilities and related equipment.Collocation permits direct (or near-direct) access toexchange switches and local access lines.

Availability of infrastructure sharing and collocationcan significantly decrease barriers to competitiveentry. The acquisition of rights of way and otherpermits required to build pole lines or towers, digtrenches or install ducts and conduits can be verytime consuming and expensive. In some countries,only government entities, such as the incumbentoperator, have clear legal authority to obtain rights ofway, occupy public property or expropriate privateproperty. Sharing of infrastructure and collocationcan reduce costs for the new entrant, and at thesame, time provide additional revenues to incum-bents.

An added benefit is reduced environmental impactand public inconvenience. Competitive entry intotelecommunications markets has led to a prolifera-tion of cellular and microwave towers, aerial polelines and road trenches in many countries. Thisresult has become an increasing concern for manymunicipalities and other local administrations.

Some regulators require incumbents to permit infra-structure sharing and collocation of a new operator’stransmission facilities in their exchanges. Other


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Interconnection

operators, including new entrants, are frequentlyrequired to cooperate as well, at least in the sharingof infrastructure that is seen to be environmentallydegrading, such as towers. In some countries, thirdparties that own support infrastructure, such aselectrical power utilities, are also encouraged toparticipate in sharing arrangements.

In some jurisdictions, sharing of infrastructure occurswithout regulatory intervention. Both sharing partiescan benefit from the arrangements. In these jurisdic-tions, sharing of infrastructure is often seen as amatter to be freely negotiated between operators.However, as with other interconnection issues, thereis often an asymmetrical market situation. In somecases, incumbents resist sharing their infrastructure.In these markets, regulatory intervention will berequired to implement efficient sharing and colloca-tion arrangements.

Table 3-6 lists steps regulators can take to promotesharing of infrastructure and collocation.

Once there is clear regulatory direction that infra-structure sharing and collocation must be permitted,operators are sometimes able to negotiate mutuallyacceptable sharing arrangements. In many othercases, however, regulatory direction or disputeresolution has been required to finalize sharingarrangements. Regulators seeking to expeditesharing arrangements may want to provide advanceguidelines on such arrangements, after taking intoaccount the views of incumbents and new entrants.

Some of the main issues that have arisen in relationto infrastructure sharing and collocation are:

➢ Rationing of space between incumbents’ futurerequirements and current and futurerequirements of various new entrants;reservation of future expansion space for eachoperator.

➢ Pricing of facilities, and costing basis for thesame.

➢ Access and security arrangements for variousoperators’ equipment. Collocation premises ofdifferent operators are usually separatedphysically (e.g. by wire mesh) and locked.

➢ Appointment and supervision process for mutualcut-overs and work affecting more than oneoperator’s facilities. Payment and rates for thesame.

➢ Provision and pricing of ancillary services suchas electrical power and back-up power, lighting,heating and air conditioning, security and alarmsystems, maintenance and janitorial services,etc.

➢ Negotiation of other lease and/or licencearrangements, including issues of sub-licenceson property of third parties (e.g. building owners,right of way owners, municipal and other publicproperty owners), insurance and indemnificationfor damages.

3.4.8 Equal Access

On a level competitive playing field, telecommunica-tions users should be able to access the services ofnew entrants as easily as those of incumbentoperators. Without equal ease of access, newentrants will find it difficult to attract customers. Whileaccess need not be exactly equal, accessing acompetitor should not be significantly more difficult.

In the early days of long-distance competition inCanada and the US, for example, customers wereoften required to dial up to 20 or more extra digits toroute calls to new entrants’ networks. This significantdifference in access was due to the historical designof the PSTN. The operators’ switches had beenprogrammed for a monopoly environment. The addi-tional digits were required to permit the operators’switching software to identify the new entrant towhich the call should be routed as well as to providebilling details for the customer. It is not surprisingthat the new entrants initially found it difficult to en-courage customers to switch services from theincumbents.

Over time, many incumbents and telecommunica-tions equipment manufacturers redesigned theirswitches and related software. These facilities arenow far more adaptable to the requirements of amulti-operator environment. Dialling parity is easy toachieve with the right software package. This hasmade it much easier to implement equal access.


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However, changes in incumbent procedures and theregulatory environment are also required to facilitate

equal access in a previously monopoly environment.

Table 3-6: Steps to Promote Infrastructure Sharing and Collocation

DevelopRegulatory Policy

➢ Publish a regulatory policy encouraging infrastructure sharing and collocation

➢ Encourage local authorities, such as municipal governments to support andfacilitate infrastructure sharing

➢ Encourage reciprocity of infrastructure sharing (i.e. new entrants should berequired to size and build their facilities to permit sharing with incumbents andother operators)

➢ Require incumbent operator to publish a standard offer and price list for accessto key infrastructure components: poles, ducts, conduits, tower space, etc.

➢ Incumbents should be required to provide information on the location ofinfrastructure, and capacity available for sharing (e.g. excess capacity in ducts,towers, etc.)

➢ A joint committee of operators should be established to plan infrastructurecapacity, co-ordinate permits from local authorities and improve the mutualefficiency of the infrastructure provisioning process

➢ Operators should be able to reserve capacity in advance on reasonable terms

Price of Sharedand InfrastructureCollocation

Regulators should encourage development of clear pricing guidelines (the followingguidelines are illustrative only)

➢ Normally, incumbents and other operators should be able to recover at leasttheir direct incremental costs of sharing, plus reasonable overheads

➢ Additional price components may be subject to negotiation and regulatorydispute resolution

➢ Prices for collocation and infrastructure sharing should generally be unbundledso that the operator requesting access is only required to pay for the services ituses

➢ Cost of new infrastructure should be shared among 2 or more operators inproportion to their use of the infrastructure (e.g. number of antennae locatedon a microwave tower)

➢ Costs of increased capacity and re-location of infrastructure should be sharedamong those that benefit from such works. Where an incumbent operatorreceives no benefit from works required to accommodate a new entrant, itshould normally not pay, unless and until it benefits from such works. Analternative approach is to allocate the costs among sharing operators based onuse, with a surcharge for the operator that requests the work.

➢ Future sharers of infrastructure should reimburse early entrants forexpenditures that benefit them

RegulatorySafeguards

➢ Shared infrastructures should be made available to all operators on a non-discriminatory basis. This includes the owner of the infrastructure. Capacityshould normally be provided on a first come, first served basis. The regulatorshould approve rationing schemes for scarce capacity.


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Interconnection

Table 3-6: Steps to Promote Infrastructure Sharing and Collocation (cont’d)

➢ New entrants (or other operators) that do not use ordered infrastructurecapacity within a set time period should be required to return it. A penalty forexcessive orders may also be appropriate

➢ Operators that provide shared infrastructure should record and have availablefor regulatory review: provisioning times for their own operations andcompetitors

➢ Physical separation of infrastructure (e.g. by walls or fences) may bewarranted where necessary to prevent sabotage, but operators should beencouraged to share in the most efficient manner

There are basically two approaches to providingequal access:

➢ Call-by-call customer selection – Customersselect the operator of their choice for each call.They usually do this by dialing a short code orprefix for their selected operator. For example, inColombia, customers dial 09 to route nationalcalls through TELCOM’s network, 05 to routethem through Orbitel’s network, and 07 forETB’s network. The main requirements toprovide this type of equal access on an efficientbasis are:

➢ Trunk-side interconnection by new entrantsto incumbent switches.

➢ A numbering plan that allocates equivalentnumbers to the incumbent operators andnew entrants (For example similar accesscodes for long distance and internationalcompetitors; and equivalent blocks of accessnumbers for local and mobile operators).

➢ Provision of basic signalling services by in-cumbents to new entrants including CallingLine Identification (CLI); answer anddisconnect supervision.

➢ Appropriate billing and audit arrangements topermit direct billing by each operator or bill-ing by one and remission to the others. Forexample, the local operator might do allbilling and remit long distance charges to theother operators.

➢ Operator pre-selection – Under this approach,customers select a operator for some or all oftheir calling. For example, an operator otherthan the incumbent might be selected for alllong distance and international calling. After theselection is made, all calls from these customerswill be routed to the operator of choice until theirselection is changed. The main requirements forthis type of equal access are:

➢ Trunk-side interconnection by new entrantsto incumbent switches.

➢ Switch software features to identify customerselections and to route and bill callsappropriately to the selected operator.

➢ Appropriate billing and audit arrangements topermit direct billing by each operator or bill-ing by one and remission to the others. Aswith the call-by-call approach, the localoperator might do all billing and remit longdistance charges to the other operators.

The implementation of equal access has beenuneven around the world to date. It is available, forexample in Argentina, Australia, Canada, Chile,Hong Kong, and the US, but unavailable to date inmany other countries. Equal access is morecommon for international and local services but lessso for long distance services. In some countries,equal access is unavailable due to limitations ininstalled switching and software facilities. In others, itis due to delays in implementing a numbering planthat allocates equivalent numbers to competitors. In


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some, regulators have simply not seen equal accessas a priority.

Market experience in more open markets has dem-onstrated that there is considerable inertia amongtelecommunications customers. Regulators thatwish to expedite the development of fully competitivemarkets will, therefore, want to consider equalaccess as a useful approach.

3.4.9 Quality of Service to InterconnectingOperators

It is good regulatory policy to require incumbentoperators to provide a reasonable quality of inter-connection services and facilities. Without such apolicy, it would be possible for an incumbent tofrustrate a competitor’s ability to provide competi-tively attractive services. For example, if anincumbent connected its own new customers’circuits within days, but delayed connection of acompetitor’s customers’ circuits for months,customers in a hurry would likely choose theincumbent’s services.

The WTO Regulation Reference Paper deals withquality of interconnection with major suppliers insignatory countries. It requires interconnection to beensured under terms and conditions that are no lessfavourable than those provided for their own similarservices. Interconnection must also be no lessfavourable than that provided to a major supplier’ssubsidiaries, its other affiliates or to non-affiliatedservice suppliers.

Similar types of policies in many countries require“non-discriminatory” interconnection by anincumbent. In practice, it is very difficult to ensurethe implementation of such policies. Many intercon-nection complaints of new entrants deal withunequal quality of interconnection as between theincumbent’s services and their own.

The practical tools available to a regulator topromote high quality interconnection are:

➢ Establishing interconnection quality of servicemonitoring requirements;

➢ Monitoring complaints seriously, and estab-lishing significant penalties for clearly unequalservice quality; and

➢ Establishing an independent InterconnectionServices Group within the incumbent’sorganization.

Quality of interconnection services can be monitoredby an Interconnection Services Group (ISG) (seeSection 3.4.2). The ISG should measure quality ofservice to interconnecting operators, and compare itto the incumbent’s self-provisioning. For example, itshould ensure that new circuits ordered byinterconnecting operators are provisioned, onaverage, within the same number of days as internalorders.

Table 3-7 provides examples of interconnectionquality of service measures. Where interconnectionservice problems are serious enough to warrantregulatory supervision, regulators can monitor thesemeasures. Regulators may also establish amonitoring regime in advance, to prevent problems.A monitoring regime may require reports fromincumbents on two types of quality of serviceperformance:

1. Absolute performance based on establishedstandards or international benchmarks, and

2. Relative performance by the incumbent in pro-viding interconnection facilities to itself and tointerconnecting operators.

Interconnection policy in some countries may requirean incumbent to provide superior interconnectionservices to interconnecting operators under somecircumstances. For example, it may be useful torequire an incumbent to provide interconnectingoperators with higher quality service than it normallyprovides for its own services – if the interconnectingoperator is willing to pay for the difference. Such anapproach has applications in industrialized countriesseeking to promote the provision of advancedtelecommunications services.


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Interconnection

Table 3-7: Some Key Interconnection Quality of Service Measures

Provisioning Measures ➢ Average time for provisioning interconnection circuits and otherinterconnection facilities and services (including unbundledcomponents)

➢ Percentage of installation appointments met for competitors’ serviceinstallations

➢ Average time for processing changes in customers from incumbentoperator to competitor (in an equal access regime)

➢ Percentage of repair appointments met for competitors

➢ Comparative provisioning performance for (1) competitors, (2)affiliates, and (3) self-provisioning (including measures such as thoseset out in the previous points)

Switching and TransmissionQuality Measures

➢ Probability of blockage in peak hour on interconnecting circuits

➢ Transmission delay (ref: ITU-T recommendation G114)

➢ Transmission loss (loudness – ref: ITU-T recommendation P76)

➢ Noise and distortion (ref: ITU-T recommendations, including Q551-554, G123, G232, G712, P11)

➢ Other transmission quality standards (e.g. for digital services ref: ITU-T recommendations G821 re: bit errors and timing, and G113 re voicecoding problems, and for both analogue and digital services ref: ITU-T recommendations G122 re: echo and loss of stability; and P16 et.al re crosstalk).

This type of policy can also be useful in lessdeveloped countries. In many less developedcountries, the quality of service provided by anincumbent is below international standards. This lowquality of service is often due to financial constraintson the incumbent. In such cases, regulators shouldbe willing to promote improvement of the quality ofservice provided to a new entrant, provided the newentrants pays for it. For example, a new entrant maybe willing to pay for new trunk circuits between thepoint of interconnection at a congested customerservice exchange and a tandem exchange.

Such payments can be a win-win situation for theincumbent and new entrants. Arrangements of thistype are best negotiated between incumbents andinterconnecting operators. However, someregulatory supervision may be required to ensurenew entrants do not have to pay excessive charges.Similarly, the regulator may need to ensure that the

incumbent does not require payments from newentrants to construct facilities to improve theincumbent’s competitive advantage, as a conditionof providing an adequate quality of service.

3.4.10 Quality of Interconnected Services

The previous Section discussed the provision ofservices by incumbents to interconnecting operators.Regulators in most countries are also concernedwith the broader issue of the quality of service to thepublic. Many regulators established quality ofservice reporting systems during the time serviceswere provided in their countries on a monopolybasis.

To deal with the emergence of competition, somecountries have apportioned responsibility forproviding a prescribed quality of service amonginterconnecting operators. For example, in the UK,


3 - 54

the regulator prescribed maximum delays forinterconnecting operators. The purpose of thesemaximum delay standards was to ensure callsbetween operators met national transmission speedstandards. Customer PBX equipment at each end ofa call was allocated 5 milliseconds (ms); originatingand terminating local network operators 3 ms each;and the long distance network operator 7 ms, for atotal maximum delay of 23 ms.

Other countries have taken a more deregulatoryapproach. They have not imposed quality of servicereporting requirements on new entrants. This

approach is based on the assumption that newentrants will not be able to attract and retaincustomers if their quality of service does not matchor exceed that of the incumbent operator. Based onthe same approach, it should be possible to removeregulatory quality of service requirements fromincumbents once competition is well established andthey lose their market power.

As competition develops, it should be possible formore and more regulators to take the latterapproach. Regulation of service quality can then beleft to the market, rather than to regulators.

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4 - 1

MODULE 4

PRICE REGULATION

4.1 Introduction

This Module discusses price regulation in the tele-communications sector. Before reading the Module,readers may want to review the section on theeconomic rationale for price regulation in the tele-communications sector that is found in Appendix Bof the Handbook. As indicated in Section 1.1 ofAppendix B, price regulation is normally justifiedwhen telecommunications markets fail to producecompetitive prices.

In this Module, we look more closely at the specificobjectives of price regulation and at the regulatoryapproaches used to achieve those objectives. Thebasic approaches to price regulation have evolvedwith the transformation of the telecommunicationssector from monopoly to competition. As regulatorshave increasingly recognized the benefits of compe-tition, they have adapted price regulation to takeadvantage of those benefits.

Today, price cap regulation is the most widelyaccepted form of price regulation in the sector.Because of its pre-eminence, a substantial part ofthis Module is devoted to price cap regulation.Before dealing with it, however, we discuss the ob-jectives of price regulation and review otherapproaches to price regulation, particularly Rate ofReturn (ROR) regulation and its variations.

4.1.1 Objectives of Price Regulation

Good price regulation mimics the results of efficientcompetition. However, price regulation may haveadditional objectives. The objectives of price regula-tion may be grouped into three broad categories:

➢ Financing objectives;

➢ Efficiency objectives; and

➢ Equity objectives.

Financing Objectives

An important objective of price regulation is toensure that regulated operators are permitted toearn sufficient revenue to finance on-goingoperations and future investments. The minimumamount of revenue associated with the financialobjective is often referred to as the operator’s“revenue requirement”. To mimic the effect of acompetitive market, the revenue requirement shouldideally match the amount required by an efficientoperator to finance its operations and investments.This aspect of the financial objective may beconsidered as setting a revenue “floor” for efficientoperators.


4 - 2

Some traditional forms of price regulation, includingRate of Return regulation, do not allow operators toearn revenues in excess of their revenue require-ments. This aspect of the financial objective isassociated with preventing excessive revenuesassociated with monopoly or dominant marketpositions. It is discussed in greater detail in Sections1.1 and 1.2 of Appendix B of the Handbook. Thisaspect of the financing objective, which may be con-sidered a revenue “ceiling”, has been relaxed undersome specific conditions in other forms of priceregulation, particularly price cap regulation.

Efficiency Objectives

It is generally accepted that price regulation shouldpromote efficiency in the supply of telecommunica-tions services. However, efficiency can be measuredin different ways. Three main aspects of efficiencyare discussed below.

Allocative efficiency is achieved when theprices of services reflect their relative scarcity. Inan efficient market, prices will equal the marginalcost of producing each service. In the telecom-munications sector, prices of international andlong-distance services have traditionally been setsignificantly above their costs while local calls arepriced below theirs. This is viewed as anexample of allocative inefficiency. The above-cost pricing of international services discouragesconsumption of such services. On the otherhand, pricing local calls below cost encouragesconsumption beyond the level at which local callscan be economically provided. A more detaileddiscussion of allocative efficiency is presented inSection 1.2 of Appendix B of the Handbook.

Productive efficiency has two related aspects.One aspect relates to the most efficient mix ofinputs (capital, labour, etc.) for a given level ofoutput. Some forms of price regulation canreduce productive efficiency. Rate of Return(ROR) regulation, for example, is generallyviewed as encouraging operators to use an inef-ficiently high level of capital for its level of output.A second aspect of productive efficiency requiresthat the services be produced as efficiently aspossible, that is by minimizing all inputs. Therelated concept of x-efficiency describes a situa-tion in which an operator’s costs are not

minimized because the actual output from thegiven inputs is less than what could be achieved.

Dynamic efficiency is achieved when resourcesmove over time to their highest value uses. Suchuses include efficient investment, improvedproductivity, research and development, and thediffusion of new ideas and technologies.Dynamic efficiency involves the movement fromone type of efficient use of resources to anothertype of efficient use of resources.

Equity Objectives

Equity objectives motivate many regulatory deci-sions on telecommunications prices. Equityobjectives generally relate to the fair distribution ofwelfare benefits among members of society. Tele-communications regulators are primarily concernedwith two different aspects of equity in the regulationof prices:

Operator-consumer equity relates to thedistribution of benefits between consumers andthe regulated operator. For instance, manypeople would not consider it equitable thatmonopoly operators be allowed to earn highprofits for an extended period of time without im-proving or extending service. In this regard, theaim of many regulators is to ensure that thesavings that result from improved technologicalinnovations are shared equitably between theoperator and consumers. Price cap regulationincludes a mechanism for consumers to share inthese productivity gains.

Consumer-consumer equity relates to thedistribution of benefits between different classesof telecommunications consumers. For example,in Colombia, consumers in lower socio-economicbrackets pay less for the same local telephonesubscription services than consumers in higherbrackets. This approach implements a govern-ment policy aimed at improving consumer-consumer equity.

Balancing the Objectives of Price Regulation

The main challenges of price regulation involve thedesign and implementation of low-cost and effectiveregulatory approaches that induce the regulated

Module 4 – Price Regulation

4 - 3

Price Regulation

operator to achieve the socially desirable objectivesdiscussed above. Regulation imposes a burden onthe economy in the form of direct costs totelecommunications operators for enforcement andcompliance. It may also place indirect burdens onconsumers in the form of loss of choice of operatorsand/or services. A practical objective in the design ofprice regulation approaches should be to impose theleast burden necessary to achieve their purposes. Ata minimum, benefits of price regulation should justifyits costs.

In practice, there is often disagreement over tele-communications price regulation because the threebroad regulatory objectives, financial, efficiency andequity, can conflict with one another. Some peoplewill place more importance on one objective thanothers. This means that the regulator will often haveto make trade-offs between these objectives in thecourse of implementing price regulation.

4.1.2 Rate Rebalancing

This Section contains a brief discussion of pricerebalancing, or rate rebalancing, as it is morefrequently called. This important topic is dealt with ingreater detail in Appendix 4-1 of this Module.

The term “rebalancing” refers to moving the pricesfor different telecommunications services moreclosely in line with the costs of providing eachservice. Currently, telecommunications price struc-tures in many countries are highly unbalanced, withsome services priced well above costs and othersbelow costs. Telecommunications costing isdiscussed in detail in Section 1.4 of Appendix B ofthe Handbook

Prices of telephone connections, monthly subscrip-tions, and local calls have traditionally been setbelow costs in many countries. Resulting deficitshave been subsidized by higher-than-cost longdistance and international calling prices. Some ofthe historical reasons for these traditional pricingstructures are discussed in Section 4.2.2.

Unbalanced price structures are not sustainable in acompetitive environment. New competitors willgenerally enter those market segments where profitmargins are highest, such as long distance and in-ternational calling. Incumbent operators will

therefore be under pressure to reduce subsidies orrisk losing customers in the more profitable marketsegments. Traditional unbalanced price structuresare also inefficient in that higher-than-cost pricesencourage uneconomic entry by high-cost opera-tors. Lower-than-cost prices discourage economicentry, even by low-cost operators.

Costs of different telecommunications services havebeen decreasing at different rates as a result oftechnological developments. This has furtherunbalanced telecommunications prices. Where tele-communication markets are open to competition,prices of different services will tend to move towardstheir costs. However, in monopoly or non-competitive environments they may not, and theregulator may be required to take steps to ensurethat prices are more closely aligned with costs.Efficient monopoly pricing, and related matters, suchas Ramsey Pricing, are discussed in Sections 1.1and 1.2 of Appendix B of the Handbook.

A significant amount of rate rebalancing hasoccurred in many industrialized countries in recentyears. Comprehensive price comparisons havebeen conducted by the OECD for its 29 membercountries since 1990. The effects of rebalancingcalls in member countries is presented in Figure 4-1.As this figure illustrates, since 1990, the averageprice of local calls in OECD countries has risen bymore than 30%. In contrast, the average price oflong distance calls (110 km and 490 km calls) hasdecreased by about 30% over the same period.

Figure 4-2 shows the effect of rebalancing on pricesfor business services. Over the 1990-1998 period,fixed charges (connection and subscription)increased by over 20% and usage chargesdecreased by over 20%, for an overall weightedreduction of about 12%. Note that overall teledensityin the OECD countries has increased steadily,despite rebalancing. The relationship betweenrebalancing and consumer welfare is discussedfurther in Module 6.

These two figures and those contained in Appendix4-1 indicate that rate rebalancing has producedlower overall prices for most consumers in a majorityof the countries surveyed. However, this is not theonly benefit of rebalancing. Rate rebalancing willalso increase social welfare by moving prices closer


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Figure 4-1: Index of OECD Tariff Rebalancing by Distance, including Local Calling

50

60

70

80

90

100

110

120

130

140

150

1990 1991 1992 1993 1994 1995 1996 1997 199850

60

70

80

90

100

110

120

130

140

150

27 km 110 km 490 km Local Calling

Notes: All indices set to 100 in 1990 Average weighted by number of access lines Calculation based on PPP’s expressed in USD

Source OECD (1999)

Figure 4-2: Index of OECD Business Charges and Teledensity

6 0

7 0

8 0

9 0

1 0 0

1 1 0

1 2 0

1 3 0

1 9 9 0 1 9 9 1 1 9 9 2 1 9 9 3 1 9 9 4 1 9 9 5 1 9 9 6 1 9 9 7 1 9 9 8

T o ta l C h a r g e s U s a g e C h a rg e s F ixe d C h a rg e s T e le d e n s ity

Notes: All indices set to 100 in 1990 Average weighted by number of access lines. Calculation based on PPPs expressed in USDSource: OECD (1999)


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Price Regulation

to costs. This is illustrated in more detail in Appendix4-1, and in other studies that have examined rebal-ancing in different countries. Rate rebalancing willprovide benefits to the economy in addition toproducing lower overall prices. Therefore, there is astrong case to be made for rate rebalancing, withour without the introduction of competition.

4.2 Approaches to Price Regulation

4.2.1 Introduction

Different approaches have been developed over theyears to regulate telecommunications prices. Some,involving rules-based approaches, are designed toprovide stability and certainty, as well as achievingregulatory objectives. Others have been more adhoc and discretionary.

This Section begins with a discussion of twocommon pricing approaches: traditional discretion-ary price setting and Rate of Return regulation. ThisSection is followed by a discussion on incentiveregulation. In our analysis we consider how well thethree approaches achieve the broad objectives ofprice regulation: namely the financing, efficiency,and equity objectives.

4.2.2 Discretionary Price Setting

Traditionally, in many countries, price regulation wasfocussed heavily on social objectives as well asfinancial or economic ones. This was particularlytrue where the government operated the telecom-munications network. Under such circumstances,prices were usually set to promote consumer-to-consumer equity objectives. In many countries, therewas little or no analysis of the economic impacts ofsuch policies.

Where discretionary price regulation existed, orcontinues to exist, it is usually characterized bybelow-cost prices for connection, subscription andlocal calls. The shortfall is made up by higher-than-cost international call prices, and sometimes alsohigh long-distance prices.

The frequently-stated objective of this type of pricingis to promote affordability of basic telephone serv-ices. This type of pricing may also incorporate thevalue of service principle. Simply stated, this

principle assumes that a prospective buyer will pay aprice that is related to the value derived from theservice and that telephone services are morevaluable to some classes of customers than toothers. Accordingly, businesses are often chargedmore than residential customers for the sameconnection and subscription services. It is assumedthat businesses are major users of international andlong-distance services, and that they value suchservices highly. Accordingly, higher rates arecharged for such services.

Discretionary price regulation approaches in manycountries were interventionist. Often the governmentor the Minister in charge would micro-manage thePTT’s pricing structure, severely reducing its abilityto function as a normal business enterprise. In somecases, telephone prices were increased to make upgovernment budget deficits, without extensive con-sideration of the economic or social impacts of suchincreases.

In some countries, traditional discretionary priceregulation failed to generate enough revenue to paythe operating costs of the incumbent operator or tosupport network upgrades and expansion. As aresult, the operator’s revenue requirement and thefinancial objective of regulation were sometimes notmet.

In some jurisdictions, telephone revenues of state-owned operators were treated as part of generalgovernment revenues. Expenditures of the state-owned operator, including those for investments, areincluded in the general government budget. Poorgovernment fiscal management made it impossibleto meet a PTT’s revenue requirement. Such anarrangement deprives the operator of the capitalrequired to upgrade its network. It can also reducethe incentive for the operator to innovate and reducecosts, which hurts the dynamic efficiency objective.In practice, such operators often have poor perform-ance and over-staffing, which means that theproductive efficiency objective is not met either.

Long-term capital investments should make up alarge part of the costs of a telecommunicationsoperator. However, cash-strapped governmentssometimes extract cash from state-owned operatorsto finance other government priorities. This has beenmore common where there was no explicit rules-


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based regulatory regime that requires prices to beset to meet a revenue requirement calculated to in-clude long-term capital investments. Enough cashmay be left for the operator to meet its day-to-dayoperating requirements, but not enough to upgradeor expand the network.

Where this has happened, the result has been anundersupply of telecommunications services andwaiting lists for service. In some countries, telecom-munications prices have been increased solely tomeet general government revenue requirements,without regard to the specific revenue requirement ofthe telecommunications operator. Instead ofimproving telecommunications service, the proceedsof telephone rate increases have sometimes beenused to meet a wide range of other governmentpriorities, from subsidizing postal services to payingthe armed forces.

In some cases, it is said that local telephone ratesare kept at low levels to maintain affordability ofservices for low-income subscribers (i.e. to meetconsumer-consumer equity objectives). In reality,however, the initial telephone users in most emerg-ing economies are not the poor. With low prices, therelatively privileged group of telephone users end uppaying much less than it can afford. At the sametime, the operator cannot expand the network toprovide service to other users. This undermines theoperator-consumer equity and consumer-consumerequity objectives. As a result, most of the poorhouseholds, especially in rural areas, receive nosubsidy at all because they have no access. Insummary, experience has shown that discretionaryprice setting approaches have seldom achievedtheir social or economic goals, at least on a long-term basis.

Traditional discretionary price setting approacheshave usually resulted in inefficient price structures.Table 4-1 summarizes the main differences betweenprices that typically result from discretionary pricesetting and the types of cost-oriented prices thatwould result from competition.

A detailed discussion of telecommunications costs isprovided in Section 1.4 of Appendix B.

4.2.3 Rate-of-Return Regulation

Rate of Return (ROR) regulation is a rules-basedform of price regulation. Unlike discretionary pricesetting, ROR regulation provides an operator withrelative certainty that it can meet its revenuerequirement on an ongoing basis. The essence ofROR regulation is simple. First, the regulatedoperator’s revenue requirement is calculated. Thenthe operator’s individual service prices are adjustedso that its aggregate service revenues cover itsrevenue requirement.

In calculating the revenue requirement, the regulatorfirst reviews the operating costs and financing (e.g.debt service) costs. Typically there is some regula-tory scrutiny to ensure that the costs werenecessarily and prudently incurred in order toprovide the regulated services. If not, they may bedisallowed from the “rate base”. The operator will notbe entitled to increase its prices or rates to recoversuch disallowed costs.

The next step in calculating an operator’s revenuerequirement is to determine its rate of return. Inorder to allow the operator to remain financiallyviable, and to attract new capital for its operations,ROR regulation permits the operator to recover notonly its direct operation and financing costs, but alsoa fair return on its rate base. The regulator deter-mines an appropriate rate of return on capital for agiven time period (typically one to three years). Thisreturn is generally based on a review of financialmarket conditions, plus any additional operator orindustry-specific issues (industry or operator risk,operator specific taxation issues, etc.).

Based on the approved rate of return, a revenuerequirement is calculated (i.e. total revenues thatmay be generated in a given period). The revenuerequirement is to be recovered from the sum of allservices provided. If an operator earns more than itsallowable rate of return, the regulator will requireprice reductions to bring the operator’s rate of returndown to the allowable level. Conversely, if theoperator does not meet its allowable rate of return, itwill request price increases to raise its revenues.


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Price Regulation

Table 4-1: Typical Result of Discretionary Price Setting

Service Discretionary Price Setting Efficient Cost-oriented Pricing

Connection Very low price: typically below $50.Waiting list used to ration demand.

Related to the incremental costs of providing the line.

Subscription Relatively low price: typically below$3/month. Network congestionused to ration demand.

Related to the incremental costs of local service,including the local exchange switch and the "localloop" portion of the network. Local service costs varysignificantly across different service areas, based ondensity and other factors. Higher charges levied onbusinesses due to their higher demands for main-tenance and service quality.

Local Calling Very low, unmetered or non-existent local call charges.

Calls charged per minute and in some cases withadditional call set-up surcharge. Discounts for off-peak calling and special promotions.

DomesticLong-distanceCalling

High charges with multiple callzones. Longest distance typicallycharged at a multiple of 20 or moretimes local call rate.

Calls charged per minute with possible reductions forduration of call. Discounting during off-peak periods.Ratio between longest-distance call and local call inrange of five to one or less. Tendency to distance-insensitive or “postalized” prices.

InternationalCalling

Generally very high, especially todistant countries. Accounting rateskept high and number of outgoingcircuits kept low to generate netsettlement payments.

Calls charged per minute with possible reductions forduration of call. Discounting during off-peak periods.Ratio between international and national callstypically in excess of 3 to 1, but coming down due toaccounting rate reform.

Source: Adapted from ITU (1998a)

ROR regulation is designed to equate an operator’stotal revenues with its total costs. It is generally notdesigned to equate revenue for any particularservice to the cost of that service. As a result, it doesnot specifically address the structure of prices. Inpractice, where ROR regulation is applied, thestructure of prices generally tends to fall somewherebetween cost-oriented prices and the prices thatresult from discretionary price setting.

Weaknesses of ROR Regulation

The weaknesses of ROR regulation are summarizedin Box 4-1. The main weakness is that it does notprovide operators with a strong incentive to operateefficiently by reducing their operating costs. Theycan usually recover most if not all of their coststhrough rate increases, and they are not permitted toretain additional profits earned by reducing theircosts. As a result, ROR regulation does not promote

the efficiency objectives of price regulation as wellas other forms of regulation.

The perceived inefficiencies of ROR regulation mustbe put into perspective. The reality is that operatorsin some industrialized countries performed relativelywell under ROR regulation for nearly a century, tak-ing advantage of gains in technology and sharingthe benefits with their customers in the form of lowerprices. Nevertheless, because of the identifiedweaknesses, many regulators in industrializedcountries have been introducing forms of incentiveregulation instead of ROR regulation.

Concerns about the inefficiencies of ROR regulationarose in industrialized countries after extensivenetworks had been constructed. The most importantobjective in many developing countries is to buildnetwork infrastructure to meet unsatisfied demand.


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Box 4-1: Weaknesses of Rate of Return Regulation

Lack of Incentive to Minimize Costs

➢ In ROR regulation, the operator’s prices are set at a level sufficient to cover its costs. This is whyROR regulation is often referred to as “cost plus regulation”. From a dynamic perspective,therefore, the operator has little incentive to reduce its rate base or its operating costs. Incompetitive markets, where the market determines price levels, an increase in costs will reduceprofits. Therefore cost containment is a major objective of operators in a competitive market.

Lack of Innovation/Productivity Improvement

➢ Over time, ROR regulation of a monopoly operator will lead to a lower rate of productivity improve-ment than would occur under effective competition. ROR regulation does not provide the operatorwith a strong incentive to increase its productivity.

Capital Bias – The Aversch-Johnson Effect

➢ ROR regulation provides incentives to increase the amount of capital that the operator invests. Thehigher the capital expenditure, the higher the rate base, and the greater the total return theoperator can earn. It therefore encourages the operator to use an inefficient input mix. Theoperator will have an incentive to use an inefficiently high capital/labour ratio for its level of output.This result is often referred to as the Aversch-Johnson effect, named after two economists whodescribed it. The effect is an indication that productive efficiency is not being maximized.

Cost of Regulation

➢ ROR regulation requires the operator and the regulator to spend significant amounts of time andmoney. The rate base must be repeatedly calculated by the operator and reviewed by theregulator, the cost of capital must be recalculated, and so on. Rate reviews or hearings must beheld on a regular basis, incurring costs to the regulator, the operator, and other participants in theprocess.

Interventionist Nature of ROR Regulation

➢ The regulator is required to review many aspects of the operation and management of the firm in adetailed manner. This includes scrutiny to prevent rate base “padding”. Over time, this type ofdetailed regulation may place a regulatory burden on the firm that impedes its ability to function asa normal business enterprise.

Inadequacy for Transition to Competition

➢ ROR regulation operates relatively slowly, and generally does not allow operators the pricingflexibility they need to respond to competitors’ actions.

➢ The introduction of competition in some parts of the telecommunications sector, combined withcontinuing ROR regulation in monopoly segments, means that vertically-integrated operators havean incentive to engage in anti-competitive practices (e.g. anti-competitive cross-subsidization).

This will typically require a very large capital invest-ment. As a result, the concern about ROR regulationemphasizing capital investment is not as significanta concern in developing countries. The political andeconomic environment in many developing countries

minimizes the differences between ROR and incen-tive regulation. In fact, any economically sustainableform of rules-based price regulation would bepreferable to the ad hoc forms of discretionary price


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Price Regulation

setting currently practised in some developingcountries.

4.2.4 ROR-Incentive Regulation

The term ROR-incentive regulation is generally usedto describe variations on ROR regulation that weredeveloped in different US states to respond toperceived weaknesses in traditional ROR regulation.ROR-incentive regulation has enjoyed limitedpopularity in other parts of the world.

Incentive regulation provides inducements and pen-alties that encourage an operator to meet regulatorygoals.

The different types of incentive regulation generallyshare the following elements:

➢ The operator often participates in setting goalsor performance targets.

➢ The operator is given more flexibility than undertraditional ROR regulation. The regulatortypically does not prescribe specific manage-ment actions. For example, the operator may berewarded for reducing its operating costs but nottold exactly how to reduce these costs.

➢ The regulator restricts some activities of theoperator.

➢ Rewards and penalties established by theregulator motivate the operator to performefficiently.

4.2.5 Types of ROR-Incentive Regulation

In this Section, we summarize some of the incentive-based regulatory schemes that have beenimplemented in the US telecommunications industry.These forms of regulation typically replace traditionalROR regulation.

Banded Rate-of-Return

Under this form of incentive regulation, regulatorsestablish a range (or band) of authorized earnings.Prices are set to generate earnings that fall withinthe authorized range. When only a narrow band ofearnings is permitted, the operator’s incentives are

similar to those created by traditional ROR regula-tion. A broad band of earnings can create strongerincentives for the operator to reduce operating costsand improve operations. For instance, rather thanset the rate of return at 12%, the operator might beallowed a return of between 10% and 14%.

Rate Case Moratoria

Rate case moratoria can be implemented byagreements between a regulator and an operator tosuspend regulatory scrutiny of the operator’searnings for a fixed period. This form of incentiveregulation is often used at the beginning of a transi-tion to price cap regulation. It gives the regulatedoperator an incentive to lower operating costs, sinceit may retain higher earnings during the transitionperiod.

Earnings-Sharing

Under an earnings-sharing plan, the operator mayretain higher earnings. However, earnings in aspecified range are shared with consumers.Typically, these plans are set up with differentsharing ranges based on a prescribed ROR. Thesesharing ranges can differ substantially from plan toplan. In one example of this type of plan, theregulated operator keeps 100% of the earnings upto 10%, the operator and consumers split earningsbetween 10% and 14%. The operator’s earnings arecapped at 14%.

4.3 Price Cap Regulation

4.3.1 Overview

This Section provides an overview of price capregulation, which is the preferred form of rules-based price regulation around the world today.

Price cap regulation uses a formula to determine themaximum allowable price increases for a regulatedoperator’s services for a specified number of years.The formula is designed to permit an operator torecover its unavoidable cost increases (e.g. inflation,tax increases, etc.) through price increases.However, unlike ROR regulation, the formula doesnot permit the operator to increase rates to recoverall costs. The formula also requires the operator tolower its prices regularly to reflect productivity


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increases that an efficient operator would beexpected to experience.

Price cap regulation has several advantages overROR regulation:

➢ It provides incentives for greater efficiency;

➢ It streamlines the regulatory process;

➢ It provides greater pricing flexibility;

➢ It reduces the possibility of regulatory interven-tion and micro-management;

➢ It allows consumers and operators to share inexpected productivity gains;

➢ It protects consumers and competitors by limit-ing price increases; and

➢ It limits the opportunity for cross-subsidization.

For these advantages to materialize, price capregulation must be implemented in an effective andinternally consistent manner. We discuss some ofthese implementation challenges in the Sectionsbelow.

Price cap regulation is meant to provide incentivesthat are similar to competitive market forces. Com-petitive forces require operators to improveproductivity and, after accounting for unavoidableincreases in their input costs, pass these gains on totheir customers in the form of lower prices. The pricecap formula has a similar effect.

Price cap regulation is a means to regulate pricesover time. The price cap formula determines the rateof change in prices from an initial level. The initiallevel of prices may be set by the regulator (see Sec-tion 4.1.2). Alternatively, the regulator may establisha transition period at the end of which the regulatedoperator must reach target price levels or ranges(see Section 4.4.5). Future financial performance fora price cap regulated operator formulae is highlydependent on the initial price levels. Therefore, it iscritical for the regulator to ensure that the initial levelof prices are consistent with the operator’s revenuerequirement.

4.3.2 The Basic Price Cap Formula

There are a number of ways to express the pricecap formula. In its simplest form, a price cap formulaallows an operator to increase its rates annually byan amount equal to an inflation measure, less anamount equal to the assumed rate of productivityincrease. A simplified very basic price cap formula isset out in Box 4-2.

It can be seen from this simple example that opera-tors may increase their prices to include the effectsof inflation, but no more. Inflationary cost increasesof 5% may be passed on because it is assumed thatthe operator cannot control them. However, theexample also assumes that telecommunicationsindustry productivity will increase by 3%. Such pro-ductivity increases result from technologicalimprovements, lower switching and transmissioncosts, and many other factors. Therefore, in theabove example, the operator must pass on aproductivity benefit to its customers by lowering itsyear 2001 prices by 3%.

In this example, the operator may reap the benefitsof any measures it takes to reduce its costs below3%. If the operator has been very efficient, it may

Box 4-2: Simplified Basic Price CapFormula

Allowable price increase for a year = StartingPrice + I – X

Notes:

(1) I = Inflation Factor for the year

(2) X = Productivity Factor

(3) These factors are discussed in greater detail in later Sections of this Module

Example:

In year 2000, the price is 100

I = 5

X = 3

Therefore, the allowable price increase for2001 equals 100 + 5 – 3 = 102


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Price Regulation

have reduced its actual costs by 10%. In such acase, the operator may retain the benefits oflowering its costs from the assumed 3% productivityfactor to 10%. The additional earnings which resultfrom such efficient operations may be retained asprofits to shareholders or used for other purposes,such as new investment. The earnings could also beused to reduce prices further, for example to meetcompetition. However, such additional reductionswill not be required by the regulator. The price capformula determines the maximum required pricedecreases.

4.3.2.1 Price Indices and Weights

The sample price cap formula in Box 4-2 is highlysimplified. In practice, telecommunications operatorsdo not offer a single service at a single price. Theyoffer a range of different services at different prices.A typical price cap formula will, therefore, generallyuse an index of the prices charged by an operatorand not a single price. In such cases, the operatorwill be required to keep its actual prices below aPrice Cap Index (PCI).

In developing indices for a price cap formula, pricesof different services are weighted so that the pricesfor major services receive a proportionately greaterweight. Consider a simple example, where anoperator provides only two services, local serviceand international service. An index of the operator’sactual prices (Actual Price Index or API) can bedeveloped for this operator using service revenuesas weights. For example, assume that local serviceaccounts for 75% of the operator’s revenues, andinternational service accounts for 25%. The sameproportions (“weights”) will be used to determinewhether the operator’s API exceeded the price cap,or PCI.

Let us use the same price increase assumptions asdescribed in Box 4-2. In the year 2001, prices will beallowed to increase from 100 to 102. Therefore, letus assume that 102 is the PCI. To determinewhether the operator’s actual prices in 2001 exceedthe PCI of 102, we must compare that PCI to theAPI. Box 4-3 contains examples comparing theoperator’s API for 2001 to its PCI of 102.

These simple examples illustrate the following basicfeatures of price cap formulae that are based onindices:

➢ The actual prices of the operator (as measuredby the API) may not exceed the price cap for theyear (as measured by the PCI).

➢ The operator has pricing flexibility; some pricesmay be increased above the weighted averageof the change in prices, as long as others arenot.

➢ Prices for services with heavier weightings in anindex will affect the index more. Therefore,prices for major services (measured byrevenues) may not be increased as much asprices for less significant services.

4.3.2.2 Basic Indexed Price Cap Formula

Box 4-4 restates the basic price cap formula usingthe concept of price indices described above. Theformula assumes that prices will be calculated foreach year. The symbol “t” is used in the formula torepresent the appropriate time period (e.g. a year).In practice, different time periods can be used in-stead of years.

The factors I and X which are used in the formulaset out in Box 4-4 are discussed in greater detail inlater Sections of this Module.

4.3.2.3 Service Baskets

Under price cap regulation, services are usuallygrouped into one or more service baskets. Differentservice baskets may be subject to different price capindices.

For example, a residential service basket might bedeveloped to limit price increases affecting residen-tial consumers. This basket might include localresidential connection charges, monthly subscriptionfees, and local and international usage charges. Aseparate basket might include services used by typi-cal business customers.


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Box 4-3: Using Price Indices - Simplified Calculation of API

Basic Price Cap Rule: API @ PCIi.e. the Actual Price Index (API) for the year 2001 must be equal to or less than the Price Cap Index (PCI)for 2001. The objective of this example is to calculate the API for year 2001 and determine whether theproposed price changes comply with the Basic Price Cap Rule. The API for year 2001 is the product of theAPI for year 2000 and the weighted average of the change in prices from 2000 to 2001.Notes:(1) Set the API, the PCI and all prices equal to 100 in year 2000(2) Year 2001 PCI = 102 (i.e. a 2% increase over year 2000)(3) Indices are weighted by revenues(4) The operator provides only 2 services:

(a) Local Services = 75% of revenues(b) International Services = 25% of revenues

(5) The weighted average of the change in prices is the sum of the following calculation for each service:the change in prices (expressed as the division of year 2001 price by year 2000 price) multiplied by therespective revenue weight (expressed as the division of service revenue by total revenue).

Example A:Proposed price changes: Local price increases by 1% from year 2000 to 2001 (100 to 101)

International price increases by 4% from year 2000 to 2001 (100 to 104)

Weighted average of thechange in prices:

Local service: 1.01 x 0.75International service: 1.04 x 0.25Total:

= 0.7575= 0.2600= 1.0175

Since the API for 2000 was 100, the API for 2001 is the product of 100 and the weighted average of thechange in prices, i.e. 100 x 1.0175 = 101.75. Therefore API < PCI (i.e. 101.75 is less than 102). Since theproposed year 2001 prices are less than the PCI, no additional price reductions would be required by theregulator.Example B:Proposed price changes: Local price increases by 4% from year 2000 to 2001 (100 to 104)

International price increases by 1% from year 2000 to 2001 (100 to 101)

Weighted average of thechange in prices:

Local service: 1.04 x 0.75International service: 1.01 x 0.25Total:

= 0.7800= 0.2525= 1.0325

Since the API for 2000 was 100, the API for 2001 is the product of 100 and the weighted average of thechange in prices, i.e. 100 x 1.0325 = 103.25. Therefore API > PCI (i.e. 103.25 is greater than 102). Sincethe proposed year 2001 prices are higher than the PCI, the proposed prices would not be approved by theregulator. The regulator would require that prices must be reduced further.


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Price Regulation

Box 4-4: Basic Price Cap Formula Using Indices

Price cap regulation requires:

APIt @ PCIt for all t

That is, the API for a particular time period must always be less than or equal to the PCI for that period. Fromyear to year, the PCI is adjusted according to the following formula:

PCIt = PCIt-1 x (1 + It - X)

i.e. the PCI for a given year (t) will be equal to the PCI for the previous year (t-1) multiplied by 1 plus the Infla-tion Factor for year t (It ) minus the Productivity Factor (X).

Notes:

(1) APIt means the Actual Price Index at year t. The API is a weighted average of the change in pricesactually charged by the operator.

(2) PCIt means the price cap index at year t. The PCI is a weighted average of the change in themaximum allowable prices of the operator.

(3) It is the inflation factor at time t.

(4) X is the productivity factor.

(5) It is common to express It and X in percentage terms especially when referring to them outside thecontext of actual price cap calculations. Note, however, that in the price cap formulae these variables areexpressed in decimal, not percentage terms.

Example

Using the same PCI assumptions as described in Box 4-2 and Box 4-3, in a period where the inflationfactor is 5% and the productivity factor is 3%, the maximum amount that the weighted average of thechange in prices would be permitted to increase would be by 2%.

i.e. The formula PCIt = PCIt-1 x (1 + It - X) produces the following result: 102 = 100 x (1+.05 -.03)

There may also be restrictions on the absolute orrelative movement of prices for services subject toprice cap regulation. Operators may change pricesfor individual services within the baskets as long asthe API for the services in the basket complies withthe price cap formula, and as long as no individualservice pricing restrictions are breached.

An example of an individual service pricing restric-tion is a rule that no price for an individual servicemay increase by more than 10% per year. Suchrestrictions may be applied, for example, to limit theimpact on residential consumers of rate rebalancing.The concepts of service baskets and individualrestrictions are discussed further in Sections 4.3.7and 4.3.8 of this Module. Service baskets may alsobe used to restrict or prevent the cross-subsidization

of service open to competition (e.g. domestic andinternational long distance) by monopoly services(e.g. access and local calling).

4.3.3 Calculating Price Cap Variables:Looking Ahead or Back

The basic price cap formula contains a number ofvariables that must be calculated. To mimic theworkings of competitive markets, the price capformula should ideally be forward-looking. Variablessuch as the inflation (I) and productivity (X) factors,and the weights used to calculate the indices shouldideally be determined based on expected futurevalues.


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In practice, however, the majority of regulators onlyset the productivity factor based on future values.The inflation factor and index weights aredetermined based on the most recent availablehistorical data.

There are a number of practical reasons for settingthe inflation factor and index weights based onhistorical data:

➢ In many economies, past inflation performanceis a good predictor of future inflation.

➢ The process of forecasting inflation and the de-mand and revenue variables needed to forecastweights is complex, time consuming, andsubject to controversy and possiblymanipulation.

➢ A forecasting approach may necessitatecorrections to offset the effect of forecastingerrors, thus adding complexity and regulatoryuncertainty.

Basing the inflation factor and weights on historicaldata also has disadvantages. For instance, futureinflation may vary significantly from past inflation.This disadvantage may be mitigated by increasingthe frequency of adjustments to the inflation factor,or by establishing trigger mechanisms as discussedbelow.

In principle, index weights may be based on costs orrevenues. Cost weights are generally considered tobe the more theoretically correct choice, but reliableforward-looking costing data is often not available. Inpractice, therefore, most regulators have chosenrevenue weights to calculate the aggregate indicesin the price cap formula. Regulators should be espe-cially vigilant in the choice of weights when pricesare not balanced and heavy cross-subsidizationexists. In this type of scenario there may besignificant differences in the cost and revenueweights and use of the latter may bias thecalculation of the API.

Another approach is to set fixed weights that do notvary from period to period. This approach isadministratively simpler and limits any possibility forthe operator to manipulate the price cap formula bysetting prices strategically. Setting weights based onforward-looking cost benchmarks is one possiblealternative under this approach.

4.3.4 The Inflation Factor

The price cap formula includes an inflation factor toaccount for changes in input costs of the operator.For example, holding all the other variablesconstant, a 5% inflation factor would allow aregulated operator to increase its average prices by5%.

4.3.4.1 Selection Criteria

In most economies, a number of different indices areused to measure inflation. For example, a consumerprice index or retail price index (CPI or RPI) meas-ures changes in the prices of goods and servicespurchased by typical consumers (e.g. food,passenger transportation, residential electricalpower, etc.). A Producer Price Index (PPI) measureschanges in the prices of goods and servicespurchased by different types of production industries(e.g. prices for labour, freight transport, industrialelectrical power, etc.).

In developing a price cap formula, regulators mustselect an appropriate inflation factor (I). A choicemay be made from among existing inflation indices,or a new inflation factor may be calculated.Regulators that have implemented price cap regula-tion have identified a number of criteria for selectingan inflation index to be used as the inflation factor.Frequently used criteria are set out in Box 4-5.

Particular national circumstances may dictate thatother criteria should be considered. It is unlikely thatany one potential inflation measure will rank highestin all of the selection criteria. Ultimately, the selectionmust be based on the informed judgment of theregulator.


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Price Regulation

Box 4-5: Selection Criteria for an Inflation Factor

Reflective of changes in the operator’s costs

➢ For the inflation factor to be a useful variable, it must reflect changes in the operator’s input costs.This is particularly critical in situations of economic instability, when the inflation factor will have tocapture sudden and large changes in the country’s exchange rate. This is particularly important foroperators that typically purchase a large proportion of their equipment in foreign currency.

Availability from a credible, published, independent source

➢ This is important if price cap regulation is to have credibility with all parties involved. Private sectorparticipants as well as international investors in the sector must be able to trust the source of thedata.

Availability on a timely basis

➢ In order for the price cap formula to respond quickly to any changes in input costs, the inflationfactor should ideally be available with a lag of less than 6 months and preferably 2 to 4 months.

Understandability

➢ There is significant benefit in including an inflation factor that is easily understood not only by allthe players in the telecommunications sector, but by the public at large.

Stability

➢ The values of some statistical indices are subject to revision after their initial release. For example,in March 2001, the January 2001 CPI may be announced at 123.47; however, that value may berevised to 123.58 in June 2001. If possible, an inflation factor should be chosen that is not subjectto large frequent revisions.

Consistency with total factor productivity of the economy

➢ The choice of price index will have a direct impact on the manner of calculating the productivityfactor (X) because efficiency gains in the rest of the economy affect the operator through thisindex. As we discuss below, the inclusion of specific variables in the price cap formula will dependon whether an economy-wide price index or a price index for the operator's principal inputs isused. This aspect is discussed in greater detail in Section 4.3.5.

4.3.4.2 Potentially Useful Inflation Indices

With these selection criteria in mind, the next step isto examine existing inflation measures available inthe country. A number of indices are normally pub-lished by or available from the government statisticaloffice (if one exists), and/or the country’s centralbank. In some countries, these statistics areproduced by government ministries, such as theMinistries of Finance, Statistics, Planning orEconomic Development.

Potentially useful inflation measures may be classi-fied as either economy-wide indices or non-economy wide price indices. Some inflationmeasures are designed to reflect national ordomestic output price changes. For example, theGross Domestic Product (GDP) price indexmeasures the cost of a fixed basket of goods andservices that make up the GDP in a particular baseyear. This is updated at periodic intervals. Similarly,the price index for the Gross National Product (GNP)gives economy-wide coverage.


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A related index is the GDP or GNP deflator. Tradi-tionally, the deflator is determined by dividing thecost of the basket of goods and services that makeup the GDP (or GNP) at current prices by the cost ofthe same basket at constant prices. Hence, thedeflator reflects not only pure price changes, butalso changes, if any, in the weights attached to theGDP (or GNP) components.

The GDP (and GNP) indices and deflators arebroadly based. They reflect changes in the pricesaffecting a large basket of goods and services. Manyregulators in the U.S. and Canada have chosen oneof these economy-wide indices as the inflation factorto be included in their price cap formula.

Other indices are narrower in scope. For example,the Consumer Price Index (CPI) or the Retail PriceIndex (RPI) measures the changes in prices paid byconsumers. They typically measure the cost of afixed basket of goods and services that are boughtby consumers in a particular base year, and updateit at periodic intervals. This narrow scope is theirgreatest disadvantage because telecommunicationsoperators incur only a portion of their costs in retailconsumer markets. Hence, the CPI or RPI may berelatively poor indicators of inflation affecting theoperator’s cost structure.

Another set of inflation measures that is narrower inscope are the producer, industrial or wholesale priceindices. Generally, they measure changes in pricespaid by companies economy-wide, or in particularsectors of the economy.

A number of regulators in the United Kingdom andEurope have selected retail price indices as theinflation factor to be included in their price capformula. In fact, price cap regulation is sometimesreferred to as “RPI-X” regulation, referring to theinitiative of the United Kingdom in first implementingthis type of regulation in the early 1980s, whenBritish Telecom was privatized.

4.3.4.3 Other Inflation Factors

Based on the general criteria set out above and on asurvey of existing indices, the regulator should con-

sider the advantages and disadvantages of eachavailable index as a potential inflation factor. It ispossible that the regulator will decide that none ofthe existing national indices is appropriate. Box 4-6presents some possible alternative inflation factors.

4.3.4.4 Period of Adjustment

The regulator must decide how often changes in thechosen inflation index will be used to adjust the pricecap formula, and how often the operator will beallowed to adjust its rates. This is referred to as theperiodicity of adjustment to the price cap formula. Inindustrialized countries, the period of adjustment isusually once a year. This is a feasible option be-cause inflation rates tend to be relatively low andstable in such countries.

Many developing countries, however, are subject togreater economic instability. Hence, the ideal perio-dicity may be less than a year, say 3 or 6 months. Arelatively short period between updates lessens theimpact that an acceleration or deceleration ofinflation can have on the operator’s expenses. Theregulator should weigh the benefits of frequentadjustment against the administrative costs ofchanging and publishing new prices on a regular,short-term basis.

4.3.4.5 I-Factor Adjustment Mechanism

One approach developed to deal with economicinstability is to include a trigger mechanism in theadjustment of the price cap formula. Under thisapproach, the regulator may select a standardnational inflation index as its inflation factor with arelatively long period of adjustment. However, as a“fall back”, an immediate adjustment may be madeto the inflation factor in the event of certain large andunexpected economic developments.

As an example, an adjustment might take placewhen the selected national inflation index increasesor decreases by a significant amount. In countrieswith a history of relatively low and stable inflation,this amount could be in the order of 10% to 20%.


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Price Regulation

Box 4-6: Alternative Inflation Factors

➢ One option is to use an inflation index from another country (or inflation measures produced byUnited Nations organizations and/or international financial institutions, regional development banks,The World Bank, the IMF, etc.).

➢ In Argentina, for instance, some regulated utilities use the producer price index for the UnitedStates. This is then converted into the national currency. This choice was designed to reassureforeign investors by relating their revenues to a hard currency.

➢ Another option is to construct a new measure of inflation that more accurately reflects the coststructure of the operators. This new “composite” index may be a weighted combination of severalexisting indices.

➢ In Colombia, for instance, the interconnection access rates paid by wireless and long distance op-erators to local telephone operators is indexed on a monthly basis to a composite index made upof the following:

➢ An index of the US/Colombia exchange rate and the average customs duty; weight: 0.38

➢ An index of the minimum industrial wage in Colombia; weight: 0.29

➢ The Producer Price Index of Colombia; weight: 0.33

➢ Similarly, in Chile, the access rates paid by mobile operators to terminate calls on the networks ofPSTN operators is indexed on a monthly basis to a weighted aggregate index made up of thefollowing:

➢ An index of the imported goods and services component of the Chilean wholesale priceindex; weight 0.263

➢ The Chilean wholesale price index; weight: 0.542

➢ The Chilean consumer price index; weight: 0.195

Source for Argentina example: Green and Pardina (1999)

An I-Factor adjustment mechanism can also be tiedto other key changes that would seriously impact onthe cost of operating a telecommunications system.In many countries, the most serious potentialchange is a devaluation of the national currency.While this may reduce labour costs, it can signifi-cantly increase the costs of equipment, foreignconsulting services, financing charges, etc. Anadjustment mechanism to deal with this type ofchange is presented in Box 4-7.

4.3.5 The Productivity Factor

The price cap formula includes a productivity factor,which is based on an estimate of the operator’s ex-pected productivity increases over the relevantperiod. This variable, commonly referred to as the“X-factor” or the “productivity offset”, ensures that

consumers receive partly or fully the benefits of theoperator’s expected productivity gains in the form oflower prices. For example, if all other variables areheld constant, a 3% X-factor will result in annualreductions of 3% in average consumer prices.

The proper choice of an X-factor is critical for thelong-term viability of any price cap plan. Selectingthe X-factor is often the most contentious aspect ofimplementing price cap regulation. The X-factorshould be set so that it poses a challenge to theoperator. It should promise consumers higher gainsrelative to alternative regulatory regimes. If the X-factor is set too low, the operator will earn excessiveprofits and the regulatory regime could fall intodisrepute. If too large an X-factor is selected, theoperator may not be permitted to meet its revenuerequirement.


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Box 4-7: Inflation Factor for Foreign Exchange Rate Changes

A mechanism to adjust the inflation factor in a price cap formula can be triggered by large foreignexchange (FX) rate changes. It is possible that national inflation measures will not adjust rapidly enough toreflect the real impact of large FX changes. For example, this occurred in Indonesia in 1997, when theAsian economic crises caused the Indonesian rupiah to drop rapidly from approximately 2400 rupiah perUS dollar to 14,000 per dollar. In comparison, the Indonesian inflation indices remained relatively stable.Since telecommunications operators paid for equipment purchase, financing charges, etc. in foreigncurrencies, the drop in the rupiah translated into a massive increase in operating costs, which was notreflected in the national inflation indices.

To account for such large FX changes, a pre-established mechanism could provide for an adjustment tothe inflation factor – for example, if the percentage change in the average monthly exchange rate is higherthan the corresponding percentage change in the inflation factor by a specified amount (perhaps 20 to30%) within any specified period.

By way of illustration, let us assume a 25% threshold. If the Indonesian rupiah depreciated by 35% duringthe relevant period (hence, increasing by 35% the number of rupiah required to purchase a US dollar), butthe national inflation measure increased by 30%, the trigger mechanism would not apply. However, if theinflation measure only increased by 5%, an adjustment would be triggered.

4.3.5.1 X-Factor Determination

The X-factor may be divided into the “basic offset”and adjustment factors. The basic offset shouldreflect the regulated operator’s historical achieve-ment of productivity growth. If the operator has hada history of lower input price inflation than other firmsin the economy, that should be reflected in the basicoffset. Adjustment factors are included to take intoaccount changes in the operating environment of theregulated operator. For example, an adjustmentfactor might reflect the introduction of price capregulation, the introduction of competition or the pri-vatization of the operator.

There are two major approaches to determination ofthe X-factor. One approach, which we will refer to asthe historical productivity method, relies on historicinformation about the productivity performance ofthe regulated firm to set the basic offset. Once thebasic offset is calculated, certain adjustment factorsmay be added or subtracted to take into accountchanges in the operating environment of theoperator. These adjustment factors are based onregulatory benchmarking or other predictivemethodologies. This approach is based on theunderstanding that past productivity, withadjustments, is a good indicator of future productiv-

ity. The implementation of this approach is subject tothe availability of specific data. The calculation maybe very data-intensive and requires reliable andconsistent data of a very specific nature at anadequate level of detail for an adequate period oftime.

The other approach, which we will refer to as theregulatory benchmarking method, recognizes that insome instances, past productivity performance maynot be a good indicator of future expected perform-ance. This may be the case where the sector waspreviously regulated by discretionary price setting (ornot regulated at all). It may also be the case wherethe sector has been inefficiently operated underpublic ownership or is subject to very significantstructural change, for instance, divestiture. In thesecases, the adjustment factors may be much moresignificant than the calculated basic offset. Abenchmarked productivity factor is likely the onlypractical alternative in many developing countries.There the regulator is not likely have access toreliable and consistent historical productivity data todetermine the historical productivity factor.


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Price Regulation

4.3.5.2 Historical Productivity Method

A number of empirical methods can be used to helpthe regulator set the X-factor. Most of these methodswere developed in the countries that first imple-mented price cap regulation (United Kingdom,United States, Canada, etc.). The preferred methodto determine an X-factor is to carry out a total factorproductivity (TFP) study using historical data on theregulated operator and/or on the sector. Box 4-8

provides an overview of TFP and how it may beapplied to the telecommunications sector.

Historical Productivity - Basic Offset

Price cap regulation is intended to replicate thediscipline of competitive market forces. These forcesrequire operators to improve productivity and passtheir gains on to their customers in the form of lowerprices, after accounting for increases in input prices.If all sectors in the economy were fully competitive,

Box 4-8: Total Factor Productivity

Productivity is the measure of how effectively an entity employs inputs to produce outputs. It is a measure ofoperational efficiency. A typical, although partial, measure of productivity in the telecommunications industryis lines (one output) per employee (one input). Lines per employee is obviously only a partial measure,given that one could increase the number of lines by increasing capital investment or materials.Simultaneously, a telecommunications operator produces many more outputs than just the number of lines.

TFP (also known as multi-factor productivity) measures how effectively an operator, an industry or aneconomy employs all inputs to produce all outputs. TFP can be said to have increased if the operatorproduces more outputs with the same amount of inputs, or if it produces the same outputs with fewer inputs.TFP is equal to the ratio of output volume to input volume. Algebraically the TFP index may be expressedas:

TFP = Q/Z

Where Q is an index of aggregate output volume and Z is an index of aggregate input volume. Note that forprice cap regulation we are primarily interested in the changes in the TFP index, rather than its level. If werefer to changes by the symbol ∆, the change in the TFP index may be expressed in the following manner:

∆ TFP = ∆Q/∆Z

Example:

If the output volume index has increased by 5% (i.e. ∆ Q=1.05) and the input volume index has increasedby 2% (i.e. ∆ Z= 1.02), the change in the TFP index is 2.94%:

∆ TFP = 1.05/1.02 = 1.0294

Note that for the sake of simplification regulators and analysts often approximate the multiplicativerelationship between TFP, Q and Z by an additive relationship. In this instance, if output has increased by5% and inputs by 2%, it can be said that TFP has approximately increased by 3%:

Approximation: ∆ TFP ´ ∆Q – ∆Z´ 5% - 2%´ 3%

It should be stressed that while this type of approximation is fairly common, it is not always accurate. Whilein the example above the approximation (2.94%) was quite close to the actual number (3.00%), this will notalways be the case. Generally, the larger the change in TFP the larger the inaccuracy of the approximation.


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output prices in the economy would grow at a rateequal to the difference between the growth rate ofinput prices and the rate of productivity growth.

As described in Bernstein and Sappington (1998), ifregulated telecommunications operators were like atypical company, the telecommunications regulatorcould replicate market discipline by restricting in-creases in the operator’s prices to the economy-wide rate of price inflation. This restriction wouldrequire the regulated operator to achieve the sameproductivity gains as that of the typical company,and to pass these gains on to its customers, afteradjusting for the typical input price inflation rate. Ifthe regulated operator faces the same input priceinflation rate as other companies in the economy,the X-factor should be set at zero.

Generally, therefore, the X-factor should reflect theextent to which:

➢ the regulated operator is capable of increasingits productivity more rapidly than othercompanies in the economy; and

➢ the prices of inputs used by the regulatedoperator grow more slowly than the input pricesfaced by other companies in the economy (thisis often referred to as the input price differentialor IPD).

Telecommunications operators should normallyenjoy faster productivity growth than othercompanies due to the more rapid rate oftechnological change in the telecommunicationsindustry. Telecommunications operators may alsohave lower input price inflation due to the decreasingunit costs of processing, switching and transmission.

If the regulated operator can achieve faster produc-tivity growth or enjoy lower input price inflation thanother companies in the economy, then the regulatedoperator should be required to pass the associatedbenefits on to customers in the form of lower prices.

For example, assume the expected annual rate ofproductivity growth of the regulated operator is 3%.The corresponding growth rate elsewhere in theeconomy is 1%. Input prices in the regulated

industry are expected to increase 0.5% annually,and the corresponding growth rate of input priceselsewhere in the economy is 2.5%. In this setting,the X-factor should be set at approximately 4% (= [3- 1] + [2.5 - 0.5]). Note that for simplicity we haveapproximated the X-factor by adding and subtractingthe different variables. As pointed out in Box 4-8, forsmall numbers this is generally a fair approximationto the mathematically-correct multiplicativecalculation.

Table 4-2 presents the results of some studies ofTFP for the US communications industry andcorresponding TFP performance of the US economyas a whole. Based on Table 4-2 and other studies(including those of the Canadian telecommunica-tions industry), it appears that in the long-termproductivity growth of the communications industryin North America has been about 2% to 2.5% higherthan productivity growth of the respectiveeconomies. Some of these studies are dated andthe productivity differential may have changedrecently.

The choice of the inflation factor will have an impacton the choice of variables to calculate the basicoffset. If a general inflation index is selected for the I-factor (e.g. GDP-PI or CPI or RPI, etc.), the basicproductivity offset should be calculated as in theexample presented two paragraphs above. This isreferred to as the differential approach. Based onthis approach, the figures in Table 4-2 suggest abasic offset between 2.0% and 2.5%. If a sector oroperator-specific index is constructed, however, theappropriate basic offset is simply thetelecommunications TFP estimate. This is referredto as the direct approach. Based on his approach,the figures in Table 4-2 suggest a basic offsetbetween 3.0% and 3.5%.

Historical Productivity Adjustments

Many regulators have adjusted the basic offset byother factors to take into account significant changesin the operating environment of the regulatedoperator. We review some of the key adjustmentfactors below. These adjustment factors are oftendetermined based on benchmarking or predictivemethods, such as time-series, cross-sectionaleconometric studies.


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Price Regulation

Table 4-2: Selected Estimates of TFP for the US.

Study Period COM US DIFF

Nadiri-Schankerman

1947-76 4.1 2.0 2.1

Jorgenson 1948-79 2.9 0.8 2.1

Christensen 1947-79 3.2 1.9 1.4

AT&T 1948-79 3.8 1.8 2.0

A.P.C. 1948-87 4.0 1.7 2.3

Christensen 1951-87 3.2 1.2 1.9

Crandall 1960-87 3.4 1.3 2.1

DRI 1963-91 3.0 0.2 2.8

Christensen 1984-93 2.4 0.3 2.1

Note: US Communications Industry (COM); US Economy and Differential (DIFF %)

Source: Taylor (1997)

Incentive Regulation Factor

After price cap regulation replaces ROR regulationor, more likely, when it becomes the first form ofrules-based price regulation adopted, operators inthe industry can be expected to achieve a higherproductivity growth rate than they have in the past.

In such circumstances, some regulators have sup-plemented the basic offset with what is sometimescalled a customer productivity dividend (CPD). Anumber of econometric studies have examined theimpact of incentive regulation plans on productivityof telecommunications operators. On the whole,these studies have concluded that incentive regula-tion has a positive impact on productivity growth.

In principle, the CPD should reflect the best estimateof the increase in the productivity growth rate in theregulated sector that will be brought about by theimproved incentives inherent in the new regulatoryregime. This variable, also referred to as the stretchfactor, could be allowed to vary over the life of theprice cap plan. For example, the variable may behigher at the beginning of the plan and reduced nearits end. CPDs adopted in the US and Canada havegenerally been below 1% per year.

Competition Adjustment

The rise of strong competition is another structuralchange that can affect the value of the X-factorunder price cap regulation. The effect of increasedcompetition, however, is unclear.

On the one hand, increased competition, like achange in regulatory regime, can force the regulatedoperator to operate more efficiently, and therebyachieve a higher productivity growth rate. This wouldseem to favour a higher X-factor, particularly if aCPD has not been imposed.

On the other hand, increased competitive forces canshift market share from incumbent operators to newentrants. The result can be an unavoidable reductionin the growth rate of the incumbent’s outputs. Par-ticularly in the short run, this lowering of the growthrate of the incumbent’s outputs can be higher thanany associated lowering of the growth rate of itsinputs. This leads to a lower productivity growth ratefor the incumbent, arguing for a lower X-factor. Theempirical evidence on the effect of competition onproductivity growth is mixed. A number of recenttime-series, cross-sectional econometric studieshave found no relationship between competition and


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productivity growth, after taking into account otherfactors.

Privatization Factor

The theoretical literature suggests that privatizationshould increase productivity growth. The theory issubstantiated by recent econometric studies thathave found privatization to increase productivity byat least 0.5% to 1.0% per year.

4.3.5.3 Regulatory Benchmarking Method

In some instances, past productivity performancemay not be a good indicator of future expectedperformance. This may be the case where thesector was not price regulated, was not operatedefficiently or is the subject to very significant struc-tural change.

In these circumstances, or when the operator and/orits operating environment are undergoing drasticchange, the X-factor may have to be developedbased on the informed judgement of the regulatorand its advisors. International experience with pricecap regulation can provide a useful benchmark insuch cases. This is why we refer to this method asregulatory benchmarking.

Furthermore, this approach may be the only practi-cal alternative in many developing countriesbecause of lack of the very specific detailedhistorical data over an adequate period of time tocalculate TFP. More generally, the historical methodmay be less applicable to developing economies forthe following reasons:

➢ Low teledensity levels, and privatization offormer government telecommunications opera-tors, can be expected to lead to significantproductivity improvements;

➢ Significant political and economic instability, andthe lack of a clear legal and regulatoryframework may affect productivity levels, and;

➢ Recent evidence suggests that technologicalcatch-up and the possibilities for greater sectorgrowth in developing countries mean thatproductivity growth should be higher than inindustrialized economies. This would suggest

that the X-factor should be set at relatively highlevels. On the other hand, there are some veryefficient telecommunications sectors in thedeveloping world that may not be subject tosuch “catch-up” phenomenon.

Countries that have had a number of price cap planshave generally increased the X-factor over time.One example is that of British Telecom (BT) in theUnited Kingdom (UK), where the X-factor has beenincreased from 3% in the 1984-1989 period to muchhigher factors in recent years (see Table 4-3). Thisregulatory “tightening” has been a result of better-than-expected performance by the regulatedoperator. The major increases in the X-factor from amodest initial figure also reflects a degree ofregulatory caution, with an initial bias towardsensuring the regulated operator's revenuerequirement is met.

No price cap plan, no matter how carefully designed,will be perfect or permanent. It is in the nature ofgood regulation to evolve with market and policydevelopments. The evolving nature of price capregulation is perhaps best illustrated by the changesin the various price cap plans that have been appliedto British Telecom. BT was the first telecommunica-tions operator subject to price cap regulation. Itremains subject to this form of regulation, but asillustrated in Table 4-3, there have been significantchanges over the years. Regulators that areconsidering introducing price cap regulation shouldtake comfort from the British experience. The mostsignificant decision at the time of the privatization ofBT was to adopt price cap regulation – not to specifyits particular X-factor, and other details. The actualform of regulation was not cast in stone. As in othercountries where price cap regulation has since beenadopted, adjustments continue to be made as theregulator’s experience with this form of regulationincreases, particularly with respect to the determina-tion of the X-factor.

Table 4-4 and Table 4-5 provide examples of currentX-factors adopted by regulators around the world.Although there is some variation in the actual X-factors set by regulators, based on this selectedsample, when a majority of the operator’s servicesare included in price cap regulation, many regulatorshave selected an X-factor in the range of 3.5% to4.5% as the initial X-factor. This range is generally


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Price Regulation

Table 4-3: A Summary of British Telecom' s Price Cap Plans

Duration X Services Subject to PriceCaps

Other Main PricingConstraints

Main Services NotSubject to Price Caps

1984-89 3.0 Subscription; local andnational calling

Residential subscription(RPI+2)

Rental, international calls,operator services , con-nection charges, publictelephone calls

1989-91 4.5 Subscription; local andnational calling

Subscription (RPI+2);connections (RPI+2);private circuits (RPI+0).

Rental; international callsand public phone calls.

1991-93 6.25 Subscription; local andnational call charges;international calls; volumediscounts.

Residential and single linesubscription (RPI+2):multi-line subs. (RPI+5);connection (RPI+2);private circuits (RPI);median res.bill (RPI)

Telephone rental; publictelephone calling.

1993-97 7.5 Subscription; local andnational calling; interna-tional calls; connectioncharges.

All subscriptions (RPI+2);all individual prices inbasket limited to RPIincluding connectioncharges; private circuitbasket (RPI).

Public telephone calling.

1998-2001 4.5 Retail charges: residentialconnection subscription;local, national and inter-national calls. Based onexpenditure patterns oflowest spending 80% ofresidential customers.

Business assurancepackage, includingsubscription (RPI),analogue private circuits(RPI).

Public telephone calling.

8.0 Network charges: non-competitive accessservices (call originationand termination, singletransit, local conveyance)and interconnectionspecific service.

Services divided into threebaskets, each basketsubject to RPI-8 cap.

Source: Adapted from OECD (1995) and Oftel (2000a)

consistent with the differential approach to calculat-ing the X-factor. The more detailed guidelines

discussed below may assist in regulatoryjudgements to set the X-factor.


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Table 4-4: X-Factors of Selected NationalPrice Cap Regulation Plans

Table 4-5: X-Factors of Selected State PriceCap Regulation Plans in US

Country X-Factor State X-Factor

Argentina 5.5 Connecticut 5.0

Australia 7.5 Delaware 3.0

Canada 4.5 Georgia 3.0

Chile 1.1 Illinois 4.3

Colombia 2.0 Maine 4.5

Denmark 4.0 Massachusetts 4.1

France 4.5 Michigan 1.0

Ireland 6.0 New York 4.0

Mexico 3.0 North Carolina 2.0

Portugal 4.0 Ohio 3.0

UK 4.5 Rhode Island 4.0

US 6.5 Wisconsin 3.0

Regulatory Benchmarking

➢ Differential Approach

The long-term historical productivity differentialbetween the telecommunications sector and theeconomy is generally accepted to be 2% to 2.5%or higher. We discussed this range in theprevious section. This benchmark can be higherwhere the telecommunications sector isexpected to grow at a rate significantly higherthan that of the economy.

The long-term historical input price differential(IPD) between the telecommunications sectorand the economy is generally accepted to bepositive, but smaller than 1%. The IPD could belowered if, for example, a telecommunicationsworker’s wages grew faster than that of theaverage worker. Conversely, the IPD should beraised if the rate of productivity-improving tech-nological development in the telecommunicationsindustry increases.

➢ Direct Approach

The long-term historical productivity performanceof the telecommunications sector is generallyaccepted to be 3% to 3.5% or higher. Wediscussed this range in the previous section. Thisbenchmark could be higher where productivity inthe telecommunications sector is expected togrow at a rate significantly higher than that of theeconomy.

Regulatory Benchmarking – Adjustments

Adjustments can be made for the effects of theintroduction of incentive price regulation, competi-tion, and privatization, where these conditions apply.These factors and their effects are discussed above.Table 4-6 provides a numerical summary of thebenchmark estimates discussed in this Section.These are of a general nature. It is recommendedthat each country carry out an appropriate TFP orbenchmarking study based on specific nationalconditions.


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Price Regulation

Table 4-6: Summary of Benchmark Estimates for Setting X-Factor (%)

Differential Approach Direct Approach

Basic Offset 2.0 to 2.5 3.0 to 3.5

Adjustment Factors

Incentive Regulation 0.5 to 1.0

Competition 0.0*

Privatization 0.5 to 1.0

Note: * Could be increased to up to 0.5 if competition is combined with privatization.

Source: Based on McCarthy Tétrault review of the literature and experience with price cap regulation inindustrialized countries. Estimates may be less applicable to developing countries. These estimates are of ageneral nature. It is recommended that each country carry out an appropriate TFP or benchmarking studybased on specific national conditions.

4.3.6 Capped and Non-Capped Services

A basic decisions to be taken in price cap regulationis the selection of which services to regulate. Ingeneral, regulators apply price cap regulation toservices that are provided on a monopoly or domi-nant provider basis. The rationale for price regulationis discussed in Appendix B of the Handbook.

In many markets, the distinction is made between“basic services” which are price-capped, and otherservices which are not. Services provided in fullycompetitive markets are normally excluded fromprice cap plans. There is sometimes a grey linebetween the categories, and regulators have treatedthe same types of services differently. Table 4-7 andTable 4-8 describe the types of services covered byprice cap plans in the same jurisdictions as in Table4-4 and Table 4-5 around the world.

Services are sometimes included in price capbaskets to promote competition and to protect con-sumers. An example is the case of interconnectioncharges. Interconnection access charges can beincluded under a global price cap that couldincorporate consumer “retail” and access“wholesale” services. This would make it possible forexpected productivity gains in the provision of ac-cess services to be passed on to competitors and be

ultimately reflected in retail prices. Access servicescan also be placed in a separate basket from retailservices to prevent the dominant supplier from “pricesqueezing” its competitors through its control of bothretail and wholesale pricing.

4.3.7 Service Baskets

Having selected the services to be included in pricecap regulation, the structure of the price cap planshould be determined. One of the features of pricecap regulation is that the regulated operatormaintains some pricing flexibility. This flexibility isparticularly important when significant rate rebal-ancing is required within the price cap plan. It is alsoimportant when the operator is facing competitionand must respond quickly to competitive pricechallenges. Nevertheless, there are a number ofreasons for the regulator to restrict pricing flexibility.

One reason is to restrict the operator’s ability toengage in inappropriate cross-subsidization. Such arestriction can be implemented through the creationof groups of services, or service baskets, within theprice cap plan. An example of how service basketsconstrain flexibility is provided in Box 4-9.

It is common practice to place capped services inmore than one basket. For example, Figure 4-3 and


4 - 26

Table 4-7: Service Coverage of SelectedNational Price Cap Regulation Plans

Table 4-8: Service Coverage of SelectedPrice Cap Regulation Schemes in US

Country Service Coverage State Service Coverage

Argentina Basic services Connecticut Basic and non-competitiveservices

Australia Basic and mobile services Delaware Basic services

Canada Basic local services Georgia Basic and other services

Chile Local and access services Illinois Non-competitive services*

Colombia Local services Maine All services

Denmark Basic and ISDN services Massachusetts Non-competitive services*

France Basic services Michigan Non-competitive services

Ireland Basic and ISDN Services New York Basic services

Mexico Basic services North Carolina Basic services

Portugal Basic and leased line services Ohio Basic Services*

UK Basic residential services Rhode Island Basic services

US Interstate access services Wisconsin Basic and other services

Note: * excludes basic residential services

Figure 4-4 illustrate the service baskets for theTelecom Australia price cap plan. Different types ofservices are grouped in different baskets, and serv-ices with common characteristics are grouped withina single basket.

Many regulators have established different “sub-caps” on different baskets. In effect, these basket-pricing restrictions are used by regulators to furtherconstrain the pricing flexibility of the operator. Forinstance, in Figure 4-4, subscription services wouldbe subject to the CPI-2% sub-cap of its servicebasket and also to the overall price cap of CPI-5.5%.

The assignment to baskets is intended to replicatethe effects of competition. The following are generalcriteria for assigning capped services into servicebaskets:

➢ degree of competition in each service basket;

➢ homogeneity of services (including similarity indemand price elasticities); and

➢ degree of substitutability of each service.

4.3.8 Individual Service Pricing Restrictions

Restrictions can be placed on the relative and/orabsolute movement of prices of individual services,as well as on service baskets. This may be done, forexample, if the regulator is concerned that the resi-dential subscription rate may rise too quickly as aresult of rate rebalancing.

The maximum allowable price increase for individualservices will be inversely proportional to the weightof the individual service within the services basket.As a result, the price for services with relatively smallweights could increase significantly if the allowedincrease were channelled towards one of theseservices and there were smaller compensatingdecreases in charges for services with relativelylarger weights. Conversely, a service with arelatively heavy weight within the proposed servicesbasket would be subject to only moderate priceincreases if the allowed increase were channelled to


4 - 27

Price Regulation

this service, even though compensating decreaseswere made in services with relatively smallerweights.

There are two alternatives to individual restrictions,each of which may be applied to restrict thedecreases and/or increases in prices.

One of these methods, commonly referred to as“banding”, limits the price movement of specificservices relative to another variable, usually theinflation factor. For instance, if the regulator isconcerned about increases in the residentialsubscription price, an upper restriction could providethat the price could not increase at a rate greaterthan the inflation factor plus 5% (CPI + 5). If the X-factor has been set at 4% and the corresponding I-factor was 7%, the weighted average of prices couldincrease by approximately 3% (7% - 4%). Theresidential subscription price, however, couldincrease up to a maximum of approximately 12%(7% + 5%). This is an example of a relative restric-tion. In the case of Telecom Australia provided inFigure 4-3, the residential subscription and localcalls are subject to an individual restriction of CPI.

The other type of restriction is absolute. Forexample, if the regulator is concerned that nationallong-distance rates may decline too quickly, adownwards restriction could provide that the aver-age price of these calls should not decrease bymore than 20% per year.

It is generally considered that relative restrictions arepreferable to absolute ones because they providethe regulator with greater certainty as to themovement of the real (inflation-adjusted) prices ofthe services.

Restrictions may be upwards or downwards, but donot necessarily have to be symmetrical. Forexample, if access prices are included in the pricecap, they could be subject to relative restrictions withupward and downward bounds (e.g. inflation factor±5%).

Restrictions on the regulated operator’s pricing flexi-bility have been implemented by most regulators.Care must be taken to design restrictions that areinternally consistent and do not unduly constrain theoperator. Judgment is required to set restrictions that

provide sufficient flexibility to permit necessary raterebalancing, while protecting consumers fromexcessive rate increases and competitors from anti-competitive subsidization. Too many restrictions onprices will eliminate pricing flexibility, one of the mainbenefits of price cap regulations.

4.3.9 Duration and Review of Price CapPlans

The longer the term of a price cap plan, the strongerthe incentive for the operator to improve itsperformance. In theory, the duration of a price capplan should be indefinite, so that the regulator wouldnot intervene in the setting of future prices.

In practice, however, this type of price cap regime isneither feasible nor desirable. A regulator cannotestimate future productivity growth with certainty; norcan it set the X-factor at the right level for anindefinite period. With the X-factor set imperfectly,

Box 4-9: How Service Baskets ConstrainPrice Flexibility - Example

Assume a one-basket price cap plan. Itincludes international services and residentialsubscription services. Assume both have thesame weight in the price cap index. Holdingall other prices constant, a decrease indomestic long distance prices (say 30%) canbe offset by a significant increase (also 30%,assuming the same revenue weights) in theresidential subscription rates.

To constrain this type of offsetting raterebalancing, residential subscription servicesand international services can be placed inseparate baskets. If this were done, pricedecreases in one service cannot be offset byequivalent increases in the price of otherservices.

In practice, of course, regulators should notconstrain operators from implementingnecessary rate rebalancing. Individual priceconstraints or bands can be used to limitprice increases to particularly sensitiveservices, with less impact on the overallpricing flexibility of operators.


4 - 28

Figure 4-3: Price Cap Plan for Telecom Australiafrom 1989 to 1992

Figure 4-4: Price Cap Plan for TelecomAustralia from 1992 to 1995

• International Calls

International Cap:CPI-4 %

• Subscription• Local Calls• Domestic LD Calls

Domestic Cap:CPI-4 %

• Subscription• Residential• Local Calls

Individual Restrictions: CPI

• Connections• Subscription• Local calls

Sub Cap:CPI-2 %

• International Calls

Sub Cap:CPI-5.5 %

• Domestic LDCalls

Sub Cap:CPI-5.5 %

• Domestic DedicatedLines

• International DedicatedLines

• Mobile TelephoneService

Charges Subject toOverall Cap Only

• Connections• Rentals• Local Calls• Trunk Calls

Individual Restrictions: CPI(in any one year)

Overall Price Cap: CPI-5.5 %

the operator would either earn insufficient revenuesor unacceptably high profits. Both outcomes areinefficient and unsustainable. As a result, in a real-world price cap plan, the regulator generally sets aminimum period during which the X-factor will not berevised. At the end of the duration period, a review isundertaken. Regulators have typically chosenperiods of three to five years.

The duration of the plan should be sufficiently long toallow efficiency incentives to be acted on. However,it should not be so long that market developmentsundermine the regime. In the Regulatory Bench-marking Section, above, it was suggested that aprudent approach would be to set an initial X-factorconservatively. In such as case, the plan should bereviewed reasonably soon, to minimize the negativeimpact of miscalculations or errors of judgement insetting the X-factor.

The price cap plan review process should becarefully designed. The key variable that will have tobe reviewed, and perhaps reset, is the X-factor. Thiswill be a primary focus of the review. It involvessome complex incentive issues for the regulator tograpple with.

If productivity improvements achieved by theoperator exceed the X-factor by a substantialamount, the operator will make significant profits.There may be pressure on the regulator to adjust thevalue of the X-factor upwards. Rate of return orother profit indicators are generally used to reset theX-factor. This review mechanism will reduce theregulated operator’s incentive to continue toincrease its productivity. The incentives for furtherefficiency improvements will tend to fall as thereview approaches, particularly if the operator knowsthat any additional cost savings will result in a higherX-factor resulting from the review process. In this


4 - 29

Price Regulation

instance, price cap regulation will approximate RORregulation during the review period. The optimalselection of incentives/disincentives will ultimately bebased on regulatory judgement.

The approach to resetting the X-factor will dependon how the regulator evaluates the need for the op-erator to earn higher profits to increase its ability toattract investment, compared to the consumerbenefits of lower prices (operator-consumer equityobjective). It will also depend on the relativeimportance placed on productive and dynamicefficiency. The higher the weight placed onconsumer benefits relative to profits in the shortterm, the more the regulator will tend to reducefuture profits by setting a higher X-factor at the timeof the review.

4.4 Price Cap Variations

4.4.1 Introduction

This Section considers some of the variations thathave been applied to the basic price cap formula.Depending on national telecommunications marketconditions, regulators may include some of thesevariations in their price cap plan.

4.4.2 The Exogenous Factor

As discussed above, the inflation factor is a proxy forthe changes in the regulated operator’s input prices.There may be instances, however, when theoperator faces a significant change in input pricesthat are outside its control and not captured by theinflation factor. An example is provided in Box 4-10.Regulators must decide whether to include in theprice cap formula a cost pass-through variable (alsoreferred to as an “exogenous” variable or “Z-factor”)to address this possibility.

The inclusion of a Z-Factor in a price cap formula isnot always warranted. Many US state regulatorshave not included a Z-factor in their price cap plans.They may consider that there are very few trulyexogenous events that are not captured in the

Box 4-10: Examples of Unexpected InputPrice Change Outside Control ofRegulated Operator

An increase in customs duty from 20% to40% is imposed on imported capitalequipment, including telecommunicationsequipment. The telecommunications operatorfaces a significant input price increase.Assuming new equipment purchases accountfor 20% of the annual costs of the operator,the customs increase could increase totalcosts by 4%. This change may not be fullyreflected in the inflation factor. Assuming thatnew foreign equipment purchases account for5% of economy-wide costs, an economy-wideinflation index would increase by only 1%. Asa result, the operator would have to absorbthe remaining 3% increase in its costs.

inflation factor. Most developing country price capplans do not include a Z-factor. However, the situa-tion may be quite different in emerging marketswhere significant exogenous events are morecommon.

If the regulator decides to include a Z-factor adjust-ment, the amended price cap formula would be asfollows:

PCIt = PCIt-1 x (1 + It – X ± Zt)

It should be recognized that the practical applicationof a Z-factor adjustment could be administrativelychallenging and a source of controversy. Some ofthe uncertainty can be eliminated by carefullydefining the types of cost changes covered by the Z-factor.

Based on the considerations outlined in Box 4-11,the regulator should define the exogenous factor topromote certainty in price regulation of the sector. Inpreparing this definition, the criteria should begeneral enough to capture the impact of certainevents without diminishing the operator’s incentiveto control its costs.


4 - 30

Box 4-11: What are Exogenous Cost Changes?

The following considerations are relevant in determining which cost increases may be covered by a Z-factor:

➢ Generally, legislative, judicial or administrative actions that have a significant impact on the regu-lated operator should be considered. Such actions are usually beyond the control of theoperator. With respect to “significant”, there may be an advantage to setting a threshold belowwhich adjustments would not be considered. A threshold in the range of 1% to 2% of revenuesmay be reasonable.

➢ Regulators should only consider events that do not represent normal business risk. In assessingwhether costs should be included in a Z-factor, the regulator should consider whether theoperator can take reasonable measures to mitigate the consequences of the cost-producingevents.

➢ The Z-factor costs should not otherwise be reflected in the price cap formula and must be suchthat they have specific or disproportionate impact on the operator. The burden of proof should beon the operator to show that the proposed event is not already accounted for in the inflationfactor and would be reflected in prices charged by operators operating in competitive markets.

➢ Events, such as an economic downturn, that affect the whole economy would generally not beconsidered to produce exogenous cost increases eligible for Z-factor treatment. While suchevents may have a negative impact on the demand for the operator’s services, and decrease itsability to recover costs, the purpose of the Z-factor is not to guarantee a rate of return for theoperator. Such a guarantee would not be consistent with the objective of using price capregulation as a proxy for competitive market conditions.

➢ Z-factor costs should be quantifiable and known. The operator must be able to estimate the spe-cific costs in monetary terms.

In theory, the impact of the exogenous event shouldbe allocated across capped and uncapped services,with only the impact allocated to capped servicesbeing included in the price cap formula. In practice,the regulator could use revenue shares or otherweights to allocate the impact to capped servicesonly.

Generally, the regulator will design the exogenousfactor so that the regulated operator must requestthe inclusion of exogenous cost changes in the pricecap formula. The onus is placed on the operator totake action in the matter. The regulator only has todecide on the issue if and when there is an applica-tion before it.

An exogenous event may increase or decrease thecosts of the operator. It will be in the interest of the

operator to request the consideration of an eventthat has increased its costs. Where an event hasdecreased the operator’s costs, however, theoperator has no incentive to request consideration. Ifa Z-factor exists, the regulator will likely have toensure that savings are passed on to consumers.

4.4.3 Quality of Service

Like other services, telecommunications serviceshave a quality component and a price component. Intheory, a telecommunications operator subject toprice cap regulation could increase profit by loweringthe quality of its service. This prospect is of mostconcern when the operator is a monopolist, or isdominant so that it’s service levels are not subject toeffective competitive pressure from other operators.


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Price Regulation

Table 4-9: Q-Factor Example –Rhode Island Scheme

The price regulation plan for the incumbent operator in Rhode Island, NYNEX, includes a Service QualityAdjustment Factor "SQAF". It was added to the basic price cap formula in the following manner

PCIt = PCIt-1 x (1 + It – X ? SQAFt)

Each month, NYNEX provides reports to the regulator on QoS performance. As illustrated in the tablebelow, the maximum value for the Service Quality Index (SQI) is 42. The regulator has determined that apassing monthly score is 25. The price cap formula is adjusted once a year. At that time, for each of the 12most recently measured months that NYNEX has not achieved a passing score in the SQI, the SQAF willbe increased by .0417%. Hence, if NYNEX does not receive a passing score in 6 months, the SQAF willtake the value of 0.25%, and prices must be decreased by that amount in the next period to compensatefor poor QoS performance.

Nynex Performance Points

New Installations orders not completedwithin 5 working days (%)

<1212.0-13.99

A14.0

210

Installation appointments missed (%) < 2.52.5 – 3.49

A3.5

210

Line out of service > 24 hours (%) < 4040 – 44.99

A45

420

Repeat repair reports (%) < 1111.0 – 13.99

A14

210

Repair service answer time (sec.) < 14.014.0 – 16.99

A17

420

Directory assistance answer time (sec.) < 4.04.0 – 5.99

A6.0

210

Average duration time – special access1.5 Mbps Circuits (hours)

< 2.52.5 – 4.49A4.49

210

Sub-total (maximum available) 22

Customer trouble reports per 100 linesper central office (CO)

< 4.04.0 – 4.99

A5

210

Sub-total (maximum available assuming10 CO’s reviewed)

20

TOTAL POSSIBLE POINTS/MONTH 42


4 - 32

Telecommunications Quality of Service (QoS) hasmany aspects. It has traditionally been measured bya number of QoS indicators, such as:

➢ Call Completion Rate

➢ Dial Tone Delay

➢ Delivery Precision

➢ Call Failure Rate

➢ Fault Clearance

➢ Complaints

➢ Billing Accuracy.

If a regulator decides to regulate QoS of an operatorsubject to price cap regulation, it can adopt severalapproaches. The traditional approach is to set a se-ries of QoS targets or standards for each indicator.Sub-standard performance can be dealt with on acase-by-case basis, or by pre-set sanctions (e.g.monetary fines or penalties payable by theoperator).

An innovative approach is to integrate a QoSvariable, often referred to as a Q-factor, in the pricecap formula. This is a relatively new approach. It isbeing implemented in a few states of the US. Table4-9 provides a summary of such an approach in theUS State of Rhode Island. A similar approach hasalso been recently adopted in Colombia at thenational level. This approach is consistent with theobjectives of incentive regulation. In addition, it hasthe advantage of directly linking QoS with the pricemechanism, thus mimicking the quality/price trade-off in competitive markets. The following formulaillustrates how a Q-factor fits into the basic price capformula:

PCIt = PCIt-1 x (1 + It – X � Qt)

The objective of including a Q-factor is that a reduc-tion in quality should result in lower prices forconsumers. Conversely, increased quality may leadto higher prices. If there is concern that quality maydrop to unacceptable levels, the regulator may set

minimum quality standards similar to minimum pricefloors. It should be recognized that the incorporationof a Q-factor can be complex and administrativelychallenging. Few regulators have integrated QoSand price cap regulation in this manner.

4.4.4 New Services

A key objective of telecommunications sector reformis to promote innovation, particularly in the introduc-tion of new services. The regulator must determinewhether or not to subject new services to priceregulation. If the decision is affirmative, price capregulation is sufficiently flexible to accommodatemost new services.

In markets that are subject to competition, manyregulators have concluded that it is not in the publicinterest to regulate most new services. Suchdecisions provide an additional incentive for opera-tors to introduce innovative services; mobile servicesare a common example.

Where such a decision is taken, it is important forthe regulator to ensure that a regulated operator’s“new” service is truly new. Operators will have anincentive to try to repackage existing services as“new” services in order to avoid price regulation. Toavoid confusion in the industry, the regulator maywant to consider publishing a definition of a newservice based on the criteria, such as the following:

➢ Does the new service include a new technologyor functional capability?

➢ Does the new service replace an existingservice and consequently not expand the rangeof services available?

4.4.5 Rate Rebalancing and Price Caps

Rate or price rebalancing is discussed in Section4.1.2 and in Appendix 4.2. It refers to the adjustmentof price levels for different services to more closelyreflect the costs of providing each service. Rebal-ancing can be achieved under most forms of priceregulation.


4 - 33

Price Regulation

A regulator that implements a price cap plan shouldconsider including a transitional period for raterebalancing, either before the plan comes into effector as part of the plan. The transition period shouldbe kept as short as possible and, depending on thelevel of price-cost imbalances, should not last morethan 5 to 7 years. This will ensure that prices at thebeginning of a price cap plan are more in line withcosts than they would be without a transition period.In a number of countries, regulators have allowedthe regulated operators a period of several years to

achieve limited rebalancing. This decision is basedon the conviction that the benefits of price capregulation are greater when prices are balanced.Rebalanced prices are clearly closer to those foundin a competitive market.

A new regulator will likely be confronted with thenecessity to rebalance prices and to introduce aform of price regulation for the first time. Given thebenefits of rebalancing and price cap regulation,neither should be delayed. Hence, there may be noopportunity to attain any significant rebalancing priorto the implementation of price cap regulation. It willhave to be done as part of a price cap plan. Theregulator may prescribe the specific targets or targetranges for some or all prices for regulated services.Some regulators have only specified end-of-periodtargets while others have also specified intermediatetargets. In this manner the regulator may be surethat over the transition period the operator will moveprices in the desired direction. If this is done, theoperator should be given sufficient pricing flexibilityto achieve rebalancing.

Establishing a transition period for rebalancingbefore a price cap plan is implemented is only apractical option when there is another form of priceregulation in place. In Canada, the incumbentoperators were subject to ROR regulation during thetransition period. Clearly, where the operator is aprivately-owned monopoly or dominant operator,some form of price regulation is preferable to noneat all. In countries where price cap regulation is thefirst form of price regulation to be introduced, themore desirable option will be to undertake raterebalancing within a price regulation regime.

4.4.6 International Accounting Rates

Technological developments and the liberalization oftelecommunications markets have put downwardpressure on international accounting rates.Accounting rates are the charges payable to inter-connecting international operators under traditionalsettlement arrangements for mutual termination oftraffic between their networks. In most countries,during the last few decades of the 20th Century, thelevel of accounting rates was well above the cost ofproviding international service termination.

Profits from high accounting rates provided a signifi-cant source of cross-subsidies, particularly todeveloping countries. It also led to a majorimbalance in payment of accounting rates fromcountries that originated more calls than theyterminated. There has been strong pressure fromthe US and other countries with outbound account-ing rate imbalances to reduce accounting rates. Thispressure, the ITU response, international servicecompetition and technological developments haveall led to significant decreases in accounting rates.

One recent technological development that under-mines the accounting rate regime is Internettelephony, also referred to as “Voice over theInternet”, or “voice over IP” (VoIP) technology.Internet telephony generally bypasses the account-ing rate regime, and hence allows VoIP providers toprice their services below those of operators ofconventional PSTN networks.

The downward trend in international accountingrates can be seen as an international form of raterebalancing - between international and nationalservice. Operators in a large number of countries willneed to increase revenues from national services tooffset potential losses from international settlements.

The demand for international calling is generallyconsidered to be price elastic, especially at higherprices. Reductions in international rates will there-fore usually lead to increases in international calling.Local access and calling, on the other hand, aregenerally less price elastic. The result of thisrebalancing could therefore be higher overallrevenues for operators providing both services.


4 - 34

The need to rebalance international and nationalrates has important implications for price cap regula-tion. For many countries, a significant amount of raterebalancing may be both desirable and necessary.Accordingly, pricing restrictions should not deprivethe operator of sufficient pricing flexibility to

implement rebalancing. The potential volatility ofinternational prices and uncertainty of customerresponse, may make it beneficial for the regulator toimplement a fixed-weights scheme for the price capformula, at least until the majority of the rebalancinghas occurred.


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Price Regulation

Appendix 4-1: OECD Rate Rebalancing

This appendix provides an overview of the OECDtariff comparison methodology and recent analysisof rate rebalancing trends in the OECD membercountries.

Figure 4-5 and Figure 4-6 show the most recentBusiness and Residential Tariff basket comparisonsfor OECD member countries. Note that thesebaskets are based on standard listed prices ratherthan the myriad of discount schemes generallyavailable in competitive markets.

In its 1999 publication, Communications Outlook, theOECD noted significant rate rebalancing in its 29member countries. For instance, it noted a majortrend towards postalized rates at the national level.Postalization is the term given for the trend towardsflat rates for long distance services regardless of thedistance. In other words, long distance service isheading for a world where, like postal services, it isusually priced the same irrespective of distance.This has been referred to in the industry as “thedeath of distance.”

For instance, Figure 4-7 shows the differencebetween the cost of long distance calls and a localcall (3 km) between 1990 and 1998. In 1990, theaverage price of a call at 490 km was 20 times

greater than a local call at 3 km. In 1998, the marginwas reduced to about seven times.

There are a number of reasons for postalized rates.Incumbent operators typically tend to reduce thenumber of long-distance bands in response to com-petitive entry. Another reason is the prevalence ofdiscount plans that require consumers to sign up toa specific operator, often having to pay a fee. Inreturn, loyal consumers receive significant savingsover standard listed prices. Figure 4-1 in the maintext of this Module indicates that rate rebalancing isalso evident in the price trends of calls at differentdistances.

Rebalancing has been slower for the residentialbasket, as shown in Figure 4-8, than the businessbasket, which is illustrated in Figure 4-2 in the maintext of this Module. When rate rebalancing occurredin 1994, however, significant cost savings for bothresidential and business consumers were realized.Fixed charges are now slightly lower than in 1990.Combined with usage charge reductions in the orderof 25%, the overall price of the basket has beenreduced by nearly 15%. Note that overall teledensityin the OECD countries has increased steadily,despite rebalancing.

Box 4-12: OECD Tariff Comparison Methodology

In 1990, the OECD established a harmonized methodology that enables international comparisons ofnational telecommunications prices, using a basket of the different elements for a particular service. Thiscomparison can be made across countries and across time.

In recognition of the calling patterns and different prices faced by residential and business consumers, theOECD constructed a Residential basket and a Business basket. Each basket is made up of two elements,a fixed charge and a usage charge. The fixed charge covers a one year’s subscription with the installationcharge discounted over 5 years.

Once the fixed charge is calculated, the usage charge is based on OECD averages for the overallallocation of fixed charges to usage charges. Based on telephone usage patterns, the usage charge canbe allocated to national calls. These calls are then priced out for each of the countries to arrive at themonetary amount, which is either expressed in US dollars at prevailing exchange rates or based onpurchasing power parity (PPP).


4 - 36

Figure 4-5: OECD Business Tariff Basket

0

500

1000

1500

2000

2500

Luxem

bourg

Denmark

Swede

nNorw

ayKo

rea

Finlan

d

Netherl

ands

Canada

Japan

United K

ingdo

nBe

lgium

Turke

y

Irelan

d

Switze

rland

OECD av

erage

France

Germany

United S

tates Ital

y

Greece

Austri

a

New Ze

aland

Austra

lia

Hungary

Czech R

epub

licPo

rtugal Sp

ainPo

land

Mexico

Fixed Charges Usage Charges

Source: OECD (1999)

Note: Calculated based on PPPs, expressed in USD

Figure 4-6: OECD Residential Tariff Basket

0

100

200

300

400

500

600

700

800

900

Icelan

dKo

rea

Luxem

bourgSw

eden

Denmark

Norway

Turke

y

Canada

United S

tates

Japan

United K

ingdo

n

Netherl

andsFin

land

Germany

France

New Ze

aland

Austra

lia

OECD avera

geIre

land Ital

y

Switzerla

nd

Belgiu

m

Czech R

epublicAu

striaGree

ce

Hungary

Portu

gal Spain

Poland

Fixed Charges Usage Charges

Source: OECD (1999)

Note: Calculated Based on PPPs, expressed in USD


4 - 37

Price Regulation

Figure 4-7: Index of OECD Tariff Rebalancing, by year- The "Death of Distance"

0

500

1000

1500

2000

2500

3 km 7 km 12 km 17 km 22 km 27 km 40 km 75 km 110 km 135 km 175 km 250 km 350 km 490 km0

500

1000

1500

2000

2500

1998 1990

Note: 3km call charge = 100

Source: OECD (1999)

Figure 4-8: Index of OECD Residential Charges and Teledensity

6 0

7 0

8 0

9 0

1 0 0

1 1 0

1 2 0

1 3 0

1 9 9 0 1 9 9 1 1 9 9 2 1 9 9 3 1 9 9 4 1 9 9 5 1 9 9 6 1 9 9 7 1 9 9 8

T o ta l C h a r g e s U s a g e C h a r g e s F ixe d C h a r g e s T e le d e n s it y

Notes: All indices set to 100 in 1990 Average weighted by number of access lines. Calculation based on PPPs expressed in US$Source: OECD (1999)


4 - 38

Appendix 4-2: Welfare Benefits of Rate Rebalancing

This Appendix provides an overview of the potentialbenefits to public welfare that may be expected fromrate rebalancing.

The OECD study of telecommunications price trends(Appendix 4-1) indicates that rate rebalancing pro-vided most consumers with lower prices in a majorityof the countries surveyed. This is not the only benefitof rebalancing. Rate rebalancing will also increasesocial welfare by moving prices closer to costs. Thiswill provide benefits to the economy in addition tothose that result in lower overall prices. Rate rebal-ancing, therefore, should be undertaken whethercompetition is being considered or not.

Regulators may be requested to justify raterebalancing. The recent modelling of raterebalancing that carried out in Australia may beuseful in this regard. The model was prepared forAustralia’s incumbent operator, Telstra, to estimatethe potential efficiency gains from differentrebalancing scenarios. Similar analyses have beencarried out in other countries. This example uses anumber of concepts, including long run incrementalcosts (LRIC), demand elasticities, revenuerequirement, and Ramsey Pricing, which arediscussed in Appendix B of the Handbook.

Table 4-10 provides a summary of the main esti-mates used in the model. By way of explanation, theunit of measurement for access is connections. Forlocal calling, it is number of calls, for long distanceand international calling, it is minutes. Net revenue isthe difference between price and cost (LRIC) timesthe quantity. For instance, the net revenue loss forresidential access of $614 million is equal to thedifference between price $139.80 and LRIC$235.00, times 6.45 million connections. Note thatthe sum of the net revenue is $2,909 million, whichwe later assume to be its net revenue requirement.

The price elasticity of demand was based on areview of available estimates that were consideredappropriate for national conditions. With theexception of local calling elasticity, the estimates arewithin the intervals discussed in the Appendix B ofthe Handbook.

The concept of efficiency loss requires some expla-nation. It is based on the theory that marginal costpricing is optimal, that is, it maximizes the sum ofconsumer and producer surplus. (This concept isdiscussed in Appendix B of the Handbook.) Whenprices do not equal marginal costs, there are effi-ciency losses because either consumer or producer

Table 4-10: Estimates Used in the Telstra Rate Rebalancing Model – Base Scenario

Markets Price($ per unit)

LRIC($ per unit) Quantity

NetRevenue($m)

EfficiencyLoss ($m)

PriceElasticity ofDemand

Res. Access 139.80 235.00 6.45 m -614 8 -0.04

Bus. Access 240.00 235.00 2.76 m 14 0 -0.00

Local calls 0.232 0.099 11.20 b 1492 26 -0.006

Dom. LD calls 0.311 0.124 9.51 b 1782 322 -0.60

Intntnl. Calls 1.129 0.759 638.00 m 236 46 -1.20

Total 2909 402

Source: Australia Productivity Centre (1997)


4 - 39

Price Regulation

surplus are reduced. Figure 4-9 provides a graphicalpresentation of the main estimates used in theanalysis. The black shaded areas are the efficiencylosses associated with each instance of non-marginal cost pricing. Note that efficiency lossesincrease when the price-cost disparity is greater andwhen demand is more elastic. (Note the light shadedareas represent net revenues for each service).

The price-cost gap at initial conditions (the basescenario) imposes a loss in economic efficiency of

$402 million, or nearly 15% of total operatorrevenues. Note, however, that while marginal costpricing will eliminate this loss in economic efficiency,it will not meet Telstra’s net revenue requirement,which is assumed to be equal to $2,909 million. Asdiscussed in Appendix B of the Handbook, the solu-tion to this dilemma is to calculate the correspondingRamsey prices, that is, the set of prices thatminimize efficiency losses and meet the revenuerequirement.

Figure 4-9: Rate Rebalancing - Base Scenario

$

P = 0.232

LRIC = 0.099

11.2b

Local Calling (calls)

$

LRIC = 235

2.76m

Business access (connections)

P = 240

$

LRIC = 0.124

9.51m

Domestic LD Calling (minutes)

P = 0.311

$

P = 1.129

LRIC = 0.759

638m

International Calling (minutes)

$

LRIC = 235

P = 139.80

6.45m

Residential access (connections)

Note: Figures are not to scale.

Source: Australia Productivity Centre (1997)


4 - 40

Table 4-11 presents the results of five rebalancingscenarios, with the corresponding net revenue con-tribution and efficiency losses, and contrasts theseto the base scenario.

Scenario #1, which totally eliminates the efficiencyloss, would appear to be an extreme case. Ramseyprices call for the highest price over cost mark-up forthe least price-sensitive service. In this instance,business access price is raised to $1,287 andcontributes the entire net revenue of $2,909 millionbecause it has an estimated zero price elasticity.

Scenario #2 holds the business access price to$350 and calculates the constrained Ramsey prices.Scenarios #3, #4, and #5 are other permutationsthat put further constraints on prices. Note that themore constraints that are placed on Ramsey prices,the smaller the efficiency gains. Note also, however,that even modest price movements towards LRICcan result in significant efficiency gains. These gainsare likely to be greater in developing countriesbecause of the generally greater disparity betweenprices and costs.

Table 4-11: Results of Rate Rebalancing Scenarios

Variable ResidentialAccess

BusinessAccess

LocalCalls

DomesticLD Calls

InternationalCalls

Total

Scenarios LRIC $ 235.00 235.00 0.099 0.124 0.759

Price ($) 139.80 240.00 0.232 0.311 1.129

Net. rev ($m) -614 14 1492 1782 236 2909

Base Scenario

Eff. Loss ($m) 8 0 26 322 46 402

Price ($) 235.00 1287.00 0.099 0.124 0.759

Net. rev ($m) 0 2909 0 0 0 2909

Scenario 1:UnconstrainedRamsey Pricing

Eff. Loss ($m) 0 0 0 0 0 0

Price ($) 354.00 350.00 0.235 0.148 0.804

Net. rev ($m) 723 318 1529 301 38 2909

Scenario 2:ConstrainedRamsey Prices

Eff. Loss ($m) 13 0 27 5 0 45

Price ($) 235.00 350.00 0.291 0.158 0.822

Net. rev ($m) 0 318 2120 418 53 2909


Eff. Loss ($m) 0 0 54 10 1 65

Price ($) 235.00 350.00 0.232 0.209 0.919

Net. rev ($m) 0 318 1492 975 124 2909


Eff. Loss ($m) 0 0 26 67 8 101

Price ($) 140.00 350.00 0.232 0.272 1.036

Net. rev ($m) -614 318 1492 1520 194 2909

Scenario 5:ConstrainedRamsey prices

Eff. Loss ($m) 8 0 26 203 25 262

Source: Australian Productivity Centre (1997)

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5 - 1

MODULE 5

COMPETITION POLICY

5.1 General Principles

5.1.1 The Rationale for Competition Policy

When competition exists in market-based econo-mies, two or more different suppliers contend witheach other to sell their goods or services tocustomers. Competitive suppliers may offer lowerprices, more or better quantities, and packages orqualities of service to attract customers. Competitionserves the public interest by inducing suppliers tobecome more efficient and to offer a greater choiceof products and services at lower prices.

In a competitive market, individual suppliers lack“market power”. They cannot dictate market terms,but must respond to the rivalry of their competitors inorder to stay in business. Market power is generallydefined as the power to unilaterally set and maintainprices or other key terms and conditions of sales;that is without reference to the market or to theactions of competitors.

Imperfect Competition

In a perfectly competitive market, there would belittle or no reason for government intervention toimplement competition policy. Such a market wouldideally consist of a large number of suppliers ofproducts or services, as well as a large number ofconsumers. Consumers would have completeinformation and freedom to deal with any chosen

supplier. There would be no negative external fac-tors associated with supplier or consumer behaviour.No single supplier would be able to distort theefficient operation of the market, or the setting ofprices or supply conditions.

However, no markets are perfectly competitive.Many markets are not truly competitive, but aredominated by a small number of large or well-established firms. Producers or suppliers in suchmarkets often have market power that can be exer-cised to the detriment of consumer welfare andoverall industry performance.

Imperfect competition gives rise to an inefficientallocation of resources. Imperfect competition is animportant source of “market failure”. Market failureoccurs when resources are misallocated or allocatedinefficiently. The result is waste or lost value.

Monopoly

Monopoly can be the result of market failure. Amonopolistic market is often associated with exces-sively high product prices, reduced supply levels orother behaviour that reduces consumer welfare.Collusive agreements among suppliers are anotherexample of market failure. Supplier collusion can bedirected to increasing prices or restricting output,behaviour that is similar to the exercise of monopolypower.


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Telecommunications has, in most jurisdictions,developed in a monopoly environment. As competi-tion is introduced into telecommunications markets,there are typically concerns about the continuingexercise of market power by the incumbent opera-tor. This exercise of market power constitutes aspecial form of market failure that must beaddressed by regulators and competition authoritiesin many countries.

5.1.2 Government Intervention to ImplementCompetition Policy

Objectives

Governments intervene in the operation of a market-based economy for a variety of different reasons. Inthe case of competition law and policy, the mainobjectives of government intervention are to respondto market failures, to limit abuses of market powerand to improve economic efficiency. This Module willfocus on competition laws and policies that areaimed at achieving those objectives.

Public intervention can have other objectives. Forexample, a government may adopt rules andpolicies that limit the participation of foreign capital orcompanies in order to create or cultivate a domesticindustry. Such intervention may deliberately limitcompetition and compromise economic efficiency infavour of other public interests.

There is a long history of government intervention topreserve and stimulate the operations of competitivemarkets. Many useful precedents for competitionpolicy have developed in the US, where the term“antitrust policy” is used to refer to what is oftencalled “competition policy” in other countries. Thisterm “antitrust” comes from an old form of anti-competitive conduct once engaged in by the ownersof different companies that had the power to jointlydominate a market (e.g. steel or rail transport).These owners delivered the majority of their sharesto a central body, which would hold the shares “intrust” for the owners. The trust’s control of theshares was then used to direct the actions of thedifferent companies. The objectives of such jointdirection included raising prices across the industry,restricting supply and otherwise acting to reducecompetition.

Types of Government Intervention

Competition policy is generally applied through twodifferent types of government intervention.

The first type is behavioural. In this type of interven-tion, a public authority attempts to modify thebehaviour of a particular firm or group of firmsthrough regulation of their behaviour. Price regula-tion is an example of behavioural intervention. Otherexamples are orders prohibiting collusive practicesor agreements, and orders requiring interconnectionof competitors’ networks.

A second form of intervention is structural. Suchintervention affects the market structure of theindustry. For example, governments may interveneto prevent a merger of the two major telecom net-work operators in a market. Similarly, a dominantsupplier might be required to separate its operationsinto distinct corporate entities, or to divest itself oflines of business entirely. The 1984 AT&T divestiturein the United States provides a well-known exampleof the latter.

Flexibility

Government intervention in markets generallyrequires flexibility and an ability to tailor rules andprinciples to specific circumstances. In someinstances, competition rules can be formulated asoutright prohibitions (for example, against price fixingagreements). In many situations, however, pro-competitive rules are formulated so that there is dis-cretion in their application. For example, pricediscrimination is not always inappropriate; only anti-competitive or otherwise harmful forms of price dis-crimination are generally prohibited.

Competition policy is applied to curb abuses ofmarket power and to prevent a powerful firm fromforcing competitors out of the market. However,there is a tension between the objective of protectingcompetition and the more problematic practice ofprotecting individual competitors. This tension isparticularly evident in the regulation of the telecom-munications industry during the transition periodfrom the introduction of competition to the time com-petition becomes self-sustaining.

Module 5 – Competition Policy

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Com

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ompetition Policy

Competition policies generally have no iron-cladrules that must be rigourously applied in all circum-stances. The policies must be applied flexibly to suitthe circumstances of different markets.

5.1.3 The Interplay of Competition andTelecommunications Policies

Some countries have both a general competitionauthority and a sector-specific telecommunicationsregulator. Where two or more authorities exist, it isimportant that they not subject an industry to dupli-cative or inconsistent intervention.

Not all countries have separate telecommunicationsregulators and competition authorities. For example,New Zealand has long had economy-wide competi-tion law, but no sector-specific regulator. While NewZealand is an anomaly in this regard, other countrieshave telecommunications sector regulators, but noeconomy-wide competition law or authority. Somecountries have neither. In any case, it is importantfor those involved in the regulation or supervision ofthe telecommunications sector to understand andhave access to the basic tools provided by competi-tion law and policy.

Sector-Specific Regulators and CompetitionAuthorities

The roles of a sector-specific telecommunicationsregulator and a general competition law authoritycan be compared and contrasted in several ways.

Sector-specific regulation typically involves bothprospective and retrospective activities. A telecom-munications regulator, for example, will often renderdecisions that establish conditions for firmsparticipating in telecommunications service markets,such as the approval of prices or the terms and con-ditions for interconnection between operators. Suchconditions have forward-looking application. Tele-communications regulators are also typicallyauthorized to respond to particular complaints, or toremedy existing or past behaviour which contra-venes telecommunications policies or laws.Competition authorities, by contrast, tend to exercisetheir powers on a retrospective basis and with aview to correcting problems which result fromactions by particular firms that harm competition.

The types of policies typically adopted by sector-specific regulators can also be contrasted with thoseof competition authorities. Sector-specific regulationis often unrelated to (and even inconsistent with) thekey competition policy goals of facilitating competi-tion and improving economic efficiency. Competitionpolicy is typically directed at preventing marketparticipants from interfering with the operation ofcompetitive markets. Traditional telecommunicationsregulation, on the other hand, often manipulatedcompetitive market circumstances to achieve otherpublic goals.

An example is the prices approved by telecommuni-cations regulators. Most regulators traditionallysupported price structures that were very differentfrom prices that would prevail in a competitivemarket. Telecommunications regulators oftensupported such price structures in an effort toincrease availability of basic telecommunicationsservices. Examples include various types of cross-subsidization: local service by long distance serv-ices, residential subscribers by business subscribersand rural subscribers by urban subscribers. Theseprice structures were typically developed in a periodof public monopoly supply. These structures are notsustainable in a competitive market. They requireadjustment as competition develops. (See Module 4for a further discussion of telecommunicationspricing.) Table 5-1 sets out the typical differencebetween a competition authority and sector-specificregulator.

Rationale for a Telecommunications SectorRegulator

An industry-wide competition authority may play auseful role in overseeing the telecommunicationsindustry. However, there are good reasons to estab-lish and retain telecommunications sector-specificregulation, at least until the relevant markets arereasonably competitive. These reasons include:

➢ the need for sector-specific technical expertise todeal with some key issues in the transition frommonopoly to competition (e.g. network intercon-nection, anti-competitive cross-subsidization);

➢ the need for advance rules to clearly define anenvironment conducive to the emergence ofcompetition, and not just retrospectively apply


5 - 4

remedies to “punish” anti-competitive behaviouror restructure the industry;

➢ the need to apply policies, other than competi-tion-related policies, that are perceived importantby national governments (e.g. universal servicepolicies, national security and control policies);and

➢ the need for ongoing supervision and decisionson issues such as interconnection, quality ofservice, and the establishment and enforcementof licence conditions, particularly for dominantoperators.

These factors, among others, suggest that, evenwhere an economy-wide competition authorityexists, a telecommunications regulator can play animportant role.

➢ As a separate matter, it may be efficient tocombine, in a single entity, the regulation of thetelecommunications sector and other sectors,such as pipelines, electrical power, commercialwater supply, etc. The advantages anddisadvantages of such a multi-sectoral regulatorare discussed in Module 1.

Implementation of Competition Policy byTelecommunications Regulators

Telecommunications sector regulators often applycompetition law or policy in carrying out their man-dates. Four examples from the UK, Malaysia,Canada and Australia are set out below.

Table 5-1: Typical Differences Between a Competition Authority and a Sector-Specific Regulator

Feature Competition Authority Sector-Specific Regulation

Timing/Process ➢ Typically applies remedies retro-spectively (i.e. after the fact)

➢ Specific complaint or investigationdriven

➢ Formal investigative, other proce-dures

➢ Narrow scope for public intervention

➢ Prospective as well as retrospective➢ Decisions or other processes of

general application, as well as spe-cific issue proceedings

➢ Mix of formal and less formalprocedures

➢ Typically broader scope for publicintervention

Policy Focus ➢ Objective to reduce conduct whichimpedes competition

➢ Focus on allocative efficiency/preventing abuse of market power orother misconduct

➢ Typically applies multiple policyobjectives

➢ Traditional (monopoly) regulationlikely to pursue social objectivesother than allocative efficiency(universal service for example)

➢ Transitional regulation may focus onpreventing anti-competitive behaviouras market becomes competitive;(ultimately, forbearing from regulationmay be a policy objective ascompetition becomes sufficient toprotect public)

Scope ➢ Economy wide, multiple industries➢ Powers of intervention and remedies

tend to be narrowly defined.

➢ Usually industry-specific (usuallydevelops greater sectoral expertise)

➢ Powers tend to be more broadlydefined (correspond to breadth ofpolicy objectives and procedures).


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United Kingdom

In the UK, Oftel has concurrent authority to deal withmatters arising under the Competition Act. Oftelmust co-ordinate its efforts with the Director Generalof Fair Trading, who is primarily responsible for en-forcing the Competition Act. Oftel has also beenresponsible for enforcing the Fair Trading Conditionsof U.K. telecommunications licensees, including BT.

Oftel has published Guidelines on the Application ofthe Competition Act in the TelecommunicationsSector. The guidelines address subjects such asmarket definition, measures of market power andthe assessment of individual agreements andconduct. The guidelines reference conventionalapproaches to competition rules from a number ofsources and jurisdictions, and anticipate how thesestandard tools will be applied in the tele-communications sector.

Malaysia

The Malaysian Communications and MultimediaCommission has prepared similar guidelines. Theseindicate how the Commission will apply competitionlaw concepts such as “substantial lessening of com-petition” and “dominant position” in exercising itsauthority under the Malaysian Communications andMultimedia Act 1998. The guidelines identify theconcepts and analytical processes that the Commis-sion will use in evaluating certain conduct. Theguidelines borrow conventional tools and conceptsfrom competition theory and indicate how they willbe applied in the context of the domestic telecom-munications industry.

Box 5-1 sets out the Malaysian Commission’sproposed analytical process for evaluating whetherparticular conduct constitutes a substantial lesseningof competition.

Canada

Canadian law provides for changes in the extent ofsector-specific telecommunications regulation de-pending on the level of competition in specific tele-communications markets.

Under the Canadian Telecommunications Act, thesector-specific regulator, the CRTC, has a duty toforbear (refrain) from regulation where telecommuni-cations services are subject to sufficient competitionto protect the interests of users. Forbearance is alsopermissible in certain other circumstances. Aforbearance order may not be made by the CRTCwhere such an order would likely impair the estab-lishment or continuance of a competitive market fora service. The Canadian approach to forbearance isdescribed in Box 5-2.

Australia

A more general example of the interplay of com-petition policy and telecommunications sectorregulation can be found in Australia. In July,1997,the Australian government implemented a packageof statutory reforms to both its competition andtelecommunications laws. These reforms changedthe Trade Practices Act 1974 (the primarycompetition law) and introduced a new Telecom-munications Act.

As a result of these reforms, the Australian Com-petition and Consumer Commission (ACCC) wasgiven a significantly expanded role in telecommu-nications regulation. It became responsible for both(1) implementation of competition rules and policiesin the telecommunications sector; and (2) economicregulation of telecommunications operators,including the incumbent operator, Telstra.

Box 5-3 provides details on the scope and per-formance of the telecommunications regulatoryresponsibilities of the ACCC.

These four examples from the experience of differ-ent countries illustrate the overlap of telecommuni-cations and competition policy. The examplesindicate how some telecommunications regulatorsapply standard competition policy and analysis, andhow competition authorities must understand sector-specific telecommunications regulation. Thecompetition policy concepts used in these examplesare discussed in greater detail below (in Section5.2).


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Box 5-1: Substantial Lessening of Competition: Proposed Malaysia Approach

Objective Ensure that the Commissionhas appropriate powers toact.

Define the boundaries of therelevant market

Determine whether there is(or may be) a substantiallessening of competitionwithin the relevant market.

Process Consider which section ofthe Act the assessment isbeing made under.

Identify the circumstanceswhich initiated the assess-ment.

Identify the key stakeholdersin the process.

Identify all demand substi-tutes for the service.

Identify all supply substitutesfor the service.

Determine the relevant prod-uct market.

Determine the relevant geo-graphical market.

Determine the relevant tem-poral market.

Assess the likely changes inthe degree of competitiverivalry in the absence ofCommission intervention inthe light of test criteria.

Assess the likely changes inthe degree of competitiverivalry in the case of Com-mission intervention in thelight of test criteria.

Assess the difference in thelevel of rivalry between thetwo cases.

Assess whether thedifference is substantial inthe light of the objects of theAct and national policyobjectives.

The Regulated Conduct Defence

A final point to consider in the interplay of telecom-munications sector regulators and industry-widecompetition authorities is the regulated conductdefence. A number of jurisdictions recognize such adefence. The defence can shield regulated firmsfrom the application of competition laws in certaincircumstances.

The essence of the defence is that activities that areauthorized under a valid scheme of regulation are

deemed to be in the public interest. Where thedefence applies, a telecommunications operator thatcarries on activities authorized by a telecommunica-tions regulator will generally not attract liability undercompetition laws for those activities. Questions canarise, however, as to whether particular anti-competitive activities were subject to active regula-tion. For example, competition laws that aregenerally inapplicable to the activities of regulatedtelecommunications operators may becomeapplicable where a regulator decides to forbear fromregulation.

Define the MarketDefine the Context Assessment of Conduct


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Box 5-2: Case Study: Canadian (CRTC) Forbearance Analysis

The CRTC may withdraw (“forbear”) from regulation of telecommunications markets or services when thereis sufficient competition. In Telecom Decision CRTC 94-19, the CRTC set out the criteria for decisions toforbear from regulation pursuant to Section 34. The criteria for forbearance reflect standard competitionpolicy concepts and principles. They can be summarized as follows:

➢ The CRTC should forbear from regulation when a market becomes “workably competitive”.

➢ A market cannot be workably competitive if a dominant firm possesses substantial market power.

➢ Market power is assessed in terms of three factors:(i) the market share held by the dominant firm;(ii) demand conditions affecting responses by customers to a change in price of the product or service

in question; and(iii) supply conditions affecting the ability of other firms in the market to respond to a change in the price

of the product or service.

➢ High market share is a necessary but not a sufficient condition for market power. Other factors mustbe present to enable a dominant firm to act anti-competitively.

The CRTC’s method of assessing market competitiveness begins with a definition of the “relevant market”.The CRTC defines the relevant market as “the smallest group of products and geographic area in which afirm with market power can profitably impose a sustainable price increase”

The CRTC then proceeds to an assessment of the market share held by the largest and other firms in therelevant market. In addition to an assessment of market share, the CRTC assesses other aspects of marketpower, including the availability of substitutes, whether a particular product or service is an essential input orbottleneck and the extent of barriers to entry. Among the other indicators of competition highlighted by theCRTC is evidence of rivalrous behaviour (price competition and effective marketing activities for example).

The CRTC decided in Decision 94-19 to refrain from regulating the sale, lease and maintenance of certainforms of customer premises equipment. The CRTC subsequently applied Section 34 to forbear from theregulation of a number of other services, including wireless services, services provided by non-dominantlong distance operators and certain of the long distance services provided by the incumbent telephonecompanies. The CRTC has also forborne from the regulation of other services, including retail servicesprovided by competitive local exchange operators and the supply of retail Internet services.

5.1.4 The Transition from Monopoly toCompetition in Telecommunications

An effective competition policy must take intoaccount the specific characteristics of the marketto which it is applied. Telecommunications networkservice markets raise unique challenges for theapplication of competition policy. These challengesarise from the specific manner in which someincumbent network operators are able to continueto dominate their markets after the introduction ofcompetition.

It is generally desirable to minimize governmentintervention in competitive markets. However,there is a general consensus that regulatoryintervention is required to implement a successfultransition from monopoly to competitivetelecommunications markets. The introduction ofeffective competition into telecommunicationsmarkets around the world has generally beenmore difficult and intrusive than in the case of mostother markets.


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Box 5-3: Case Study: The Telecommunications Mandate of the Australian Competition andConsumer Commission

The ACCC’s telecommunications mandate is performed by the Telecommunications Group, which isconsidered a part of both the ACCC’s Regulatory Affairs Division (for economic regulation) and theCompliance Division (for competition enforcement).

The revised Trade Practices Act 1974 (TPA) includes two parts which address telecommunications mattersspecifically. Part XIB gives the ACCC authority to issue competition notices in cases of anti-competitive con-duct. Competition notices are enforceable in the Federal Court. Part XIB also governs tariff filing and recordkeeping requirements (the latter reinforce the ACCC’s implementation of accounting separation in appropriatecases).

Part XIC of the TPA establishes a framework for access to the networks of competing operators. The ACCChas power to declare a body to be a recognized “telecommunications access forum” or “TAF” (a facilitator ofaccess arrangements); to approve any “access code” prepared by the TAF; to approve “access undertakings”or model terms and conditions submitted by individual operators; and to arbitrate access disputes.

The ACCC has complementary authority under the Telecommunications Act, the Radiocommunication Act1992 and the Telstra Act 1991. Specifically, the ACCC has regulatory authority:

➢ to oversee the conduct of international telecommunications operators;.

➢ to issue directions on technical issues such as the implementation of number portability and intercon-nection:

➢ to arbitrate a range of operator disputes (i.e., in addition to interconnection disputes);

➢ to administer price regulation, such as price caps, for those services of Telstra which remain subject toprice regulation; and

➢ to assess the acquisition of radio-frequency spectrum by incumbent operators to determine whethersuch acquisition is likely to have anti-competitive effects.

The ACCC also has authority to monitor telecommunications markets and activity in order to determinewhether the general provisions of the TPA should be applied to promote competition and fair trading

Advantages of Incumbent Operators

The nature of telecommunications networksprovides strong advantages to well-established net-work operators. These advantages often call for pro-competitive measures that are relatively unique tothe telecommunications sector. Such measures arediscussed throughout this Module and in Module 3 –Interconnection. Without such measures, newentrants may never overcome the “incumbencyadvantages” of established operators. Incumbents inother types of markets (e.g. steel, chemicals, andfood products) generally do not enjoy similaradvantages and, therefore, those types of marketstypically require less detailed sector-specific regula-tion.

Some major advantages of incumbent operators arelisted below. Technical terms used in this list arediscussed in greater detail in the following sectionsof this Module.

Control of Essential Facilities – Incumbentoperators often own “essential facilities” that werebuilt and paid for under a regime of governmentownership or guaranteed rate-of-return regulation.The concept of essential facilities is discussed indetail in Section 5.2.4 below. In telecommunicationsnetwork markets, essential facilities may includepublic rights-of-ways, support structures such aspoles and conduits, local loops, telephone numbersand frequency spectrum. New entrants typically re-quire access to these facilities in order forcompetition to be feasible. Duplication of these


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facilities may be either technically difficult, or moreoften, economically inefficient.

Control of essential facilities can give an incumbentnumerous advantages over new entrants, particu-larly in the absence of strong pro-competitiveregulation. For example, an incumbent can use itscontrol over essential facilities to increase acompetitor’s costs, and make its services lessattractive to customers. The competitors' costs canbe increased by increased prices of essential facili-ties. The incumbent may be able to shield its owncustomers from the impacts of such higher essentialfacility prices, either by not “charging itself” thoseprice increases, or offsetting them with cross-subsidies from its monopoly or less-competitiveservices.

An incumbent can also discriminate in the provisionof essential facilities to make its competitors’services less attractive to end-customers. In the ex-treme case, it can simply refuse to supply essentialfacilities to competitors. It can also discriminate byproviding inferior quality essential facilities tocompetitors, as compared to itself. For example, itcan provision local loops to its own customers withina week, but delay provisioning of local loops to cus-tomers of competitors for months. Anti-competitivediscrimination in the provisioning of essentialfacilities can take many forms, some of which aredifficult to detect.

Economies of Established National Networks –As a related matter, incumbent network operatorsmight enjoy “economies of scale and scope” thatcannot be matched by new entrants for many years(or decades). For some network elements (e.g. anational local access (loop) network), the cost ofduplicating an incumbent’s facility may be prohibi-tively high. At the same time, the facility may have alarge enough capacity that one or more competitorsmay be able to share use of the facility with theincumbent without imposing any congestion costs.

In addition, many established telecommunicationsoperators have a long history of providing localaccess service at subsidized rates. This provides theincumbent with advantages in terms of economies ofdensity, scale and scope. In competing for a newcustomer, an incumbent can often set a relativelylow price, which reflects a lower long-run “total-

service” incremental cost than new entrants, andspreads its “joint and common costs” across a largeestablished customer base. A new entrant mustoften cover a much higher long-run total-service in-cremental cost, since this must be recovered from asmaller customer base.

Vertical Economies – Many incumbents have“vertically integrated” upstream and downstreamproduction facilities. For example, they may operatelocal access networks, national long-distance net-works and international networks. These incumbentswould usually enjoy vertical economies. For exam-ple, it is less expensive to co-ordinate local, longdistance and international telecommunications withina single firm than through arm’s-length negotiationsand transactions with different (often competing)operators. Incumbents may also enjoy verticaleconomies related to integrated network planning,construction, operations (e.g. traffic aggregation)and maintenance.

Control Over Network Standards andDevelopment – An incumbent usually has a signifi-cant advantage in that its existing technologies andnetwork architecture have become de facto networkstandards to which all competitors must adapt theirnetworks. Unless competitors are notified well inadvance, the incumbent may obtain a substantialhead-start in the deployment of new networkservices or features that rely on switching, transmis-sion or software upgrades installed by theincumbents.

Cross-subsidies – Incumbent operators are oftenable to cross-subsidize some services from others.Many different forms of cross-subsidy are possible.In most countries, local access services have tradi-tionally been cross-subsidized by internationalservices. Profits from the latter were used tomaintain below-cost tariffs in the former. Newentrants typically do not have a similar range ofservices to cross-subsidize. Some incumbents haveengaged in anti-competitive practices by whichcompetitive services (e.g. mobile telephone servicesor Internet access services) are priced below costsand effectively subsidized by monopoly or less-competitive services, such as international services.

Customer Inertia – Telecommunications networkmarkets are often characterized by a high degree of


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customer inertia. New entrants may find it very diffi-cult to persuade customers to switch from anincumbent that has served them for many years.This is particularly true for lower-volume users (e.g.residential customers) when marketing costs andcustomer-switching costs and inconveniences canbe high (e.g. dialing extra digits to reach a newentrant’s network, dealing with two telephone bills,changing telephone numbers, etc.). In some cases,incumbents may intentionally take actions to “lock in”their customers, and to make switching to competi-tors more difficult and costly.

The “natural” advantages of incumbent operators(e.g. economies of scale and scope and customerinertia) can be augmented by anti-competitiveconduct on the part of such operators. This is wheretelecommunications regulators (and competitionauthorities) often face difficult challenges. Their goalis to promote competition without unfairly “handicap-ping” incumbents.

Before dealing with specific types of anti-competitiveconduct, we will describe some of the basic con-cepts that are widely used in competition law andpolicy.

5.2 Basic Concepts of CompetitionPolicy

5.2.1 Market Definition

The definition of a market is a key issue in competi-tion policy and analysis. It is necessary to define a“relevant market” in order to establish whether a firmhas a dominant position in that market. Similarly, inanalyzing whether a restrictive agreement amongfirms has an appreciable effect on reducing compe-tition in a market, it is necessary to define therelevant market and then to evaluate the impact ofthe agreement in that market. Market definition is aninitial step in competition analysis. It provides thecontext in which to evaluate the level of competitionand the impact of anti-competitive conduct.

There are two aspects to the definition of a market –the product, including a service, and the geographicarea in which the product is sold. In defining theproduct, close substitutes are normally included. Theanalysis of substitutability is generally conducted

from the demand side, that is from the perspective ofbuyers of the product.

For example, the definition of the market for interna-tional telephone service in a country could include IPTelephony services that are available through thePSTN, by dialing a specific access number or code.However, the definition would generally exclude“computer-to-computer” IP Telephony services thatrequire special software, computers at both ends ofa call, and pre-arranged calling times, etc. to theaverage buyer of international telephone services,such “computer to computer” services would not bea close substitute for international telephone service.

The Product Market

A widely accepted approach to market definitionbegins with the assumption that there is a monopo-list in the relevant product market. The question isthen asked: could the hypothetical monopolist raisethe price of the product by a small but significantamount and for a non-transitory period? If a suffi-cient number of buyers would switch to otherproducts so as to make the price increaseunprofitable for the monopolist, those substituteswould be included in a new definition of the market.This analysis will be repeated until the boundariesare set so that substitution does not make the priceincrease an unprofitable strategy.

The Geographic Market

The second dimension is the definition of the geo-graphic scope of the market. In defining thegeographic boundaries of a product market, the aimis to identify the extent to which the proximity of rivalsuppliers can impose competitive constraints on thehypothetical monopolist or actual market participant.Again, the definition of the geographic scope of themarket is based on an assessment of substitutabilityin response to product price changes.

Geographic areas are more important in definingsome telecommunications markets than others. Forexample, the market for local access in Mumbai isnot affected by the degree of competition in theJohannesburg local access market. These areclearly separate markets. However, geography isincreasingly less important in defining the level ofcompetition in markets for Internet Service Providers


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(ISPs), E-mail providers or even international longdistance services. The markets for these productsare rapidly becoming global markets. Consider thesubstitution test described earlier in this Section. Itwould be difficult, if not impossible, for an E-mailservice provider in Mumbai to raise the price of its E-mail service if customers in Mumbai have localaccess to substitute E-mail service providers (e.g.Hotmail) that are based in other geographic areas.

Having said that, the definition of product and geo-graphic markets remains very relevant for theservices that remain most subject to marketdominance, particularly local and national long-distance services.

5.2.2 Barriers to Entry

The evaluation of competitive markets and marketbehaviour often focuses on the extent to which oneor more firms can introduce and sustain priceincreases. If it is easy for a new supplier to enter amarket and provide a substitute product, then estab-lished suppliers will be reluctant to implementsignificant long-term price increases. Such priceincreases would invite market entry, which willincrease competition.

The existence of barriers to market entry will limitthis competitive response. There are many types ofbarriers to entry in different markets. Among themost commonly recognized barriers are:

➢ government restrictions such as monopoly fran-chises or restrictive licensing practices;

➢ economies of scale (i.e., where per unit produc-tion costs fall as output increases, a largeestablished supplier can produce at a lower perunit cost than new entrants);

➢ high fixed/capital costs; and

➢ intellectual property rights such as copyright andpatent protection (which may affect the availabil-ity to a competing supplier of key inputs oroutputs).

Multiple barriers to entry may exist in a single tele-communications market. For example, localnetworks are typically regarded as being

characterized by economies of scale. Theestablishment of a local facilities-based network alsorequires a large investment in fixed costs. Localtelecommunications operators often requiregovernment licences, which may be granted on anexclusive or otherwise restrictive basis. Entry intowireless local networks is also restricted byspectrum scarcity. Certain local telecommunicationsservices may operate on network platforms whichhave patent or copyright protection (complicating orpreventing the launch of a competing service).

In addition to these barriers to entry, it is also possi-ble for a dominant firm to engage in conduct thatestablishes additional barriers to entry. Refusal tosupply essential facilities and refusal to interconnectnetworks are two classic examples of anti-competi-tive conduct that an incumbent operator mayengage in to discourage or prevent new entry.These and other examples of anti-competitiveconduct are discussed in Section 5.3.

5.2.3 Market Power and Dominance

As a practical matter, most of the concern of compe-tition authorities (and telecommunications regulatorspromoting competitive markets) is focussed onestablished telecommunications operators that havemarket power. Firms without market power are sim-ply not able to cause serious problems in theeconomy or in the sector. If they raise their pricesabove market levels, for example, they will simplylose customers and profits.

This Section discusses the related concepts ofmarket power, significant market power and marketdominance.

Market Power Defined

In general, market power is defined as the ability of afirm to independently raise prices above marketlevels for a non-transitory period without losing salesto such a degree as to make this behaviour unprofit-able.

Factors frequently considered in determiningwhether a firm has market power include:

➢ market share;


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➢ barriers to market entry;

➢ pricing behaviour;

➢ profitability; and

➢ vertical integration.

Market share can be measured in several ways,including monetary value, units of sales, units ofproduction and production capacity. Market sharealone can be an inaccurate measure of marketpower. However, it is unlikely that a firm without sig-nificant market share will have sufficient marketpower to behave anti-competitively on its own.Therefore, market share is usually a starting point indetermining market power.

Assessment of barriers to entry is also important.The extent to which established suppliers are con-strained by the prospect of new market entry is akey factor in whether the established suppliers havemarket power.

Pricing and profitability are other factors relevant to adetermination of market power. The existence oftrue price rivalry is inconsistent with a finding of mar-ket power. Price competition, which consists of“follow the leader” behaviour is consistent with theexercise of market power by the price leader.

The profitability of existing suppliers in a market canalso be indicative of the extent of true price competi-tion. Excessive profitability typically indicatesinsufficient price competition and the exercise ofmarket power in setting prices.

Finally, vertical integration is relevant to an assess-ment of whether a firm which enjoys market powerin one market is able to extend its power intoupstream or downstream markets. In telecommuni-cations, incumbent operators that are verticallyintegrated (e.g. that provide local access as well aslong distance or international services) can often usetheir market power in the local access market tocompetitive advantage in the long distance andinternational markets. They may abuse their marketpower, for example, by inflating local access prices(including interconnection prices) and using thesurplus revenues to subsidize rate cuts to theircompetitive long distance or international services.

Significant Market Power

A related concept is that of “Significant MarketPower” (or SMP). This is a relatively arbitrary meas-ure of market power utilized in EuropeanCommission competition analysis. A number of theEuropean Commission’s Open Network Provision(ONP) directives permit the imposition of additionalobligations on operators that have SMP. In its July2000 package of proposed policy reforms, theCommission proposed to change its approach, andto focus more on traditional measures of marketdominance. Nevertheless, since the SMP approachis frequently referred to, we will discuss it here.

Article 4 of the European Commission’sInterconnection Directive states that “an organizationshall be presumed to have significant market powerwhen it has a share of more than 25% of a particulartelecommunications market”. The article imposes anobligation on organizations with SMP to “meet allreasonable requests for access to the networkincluding access at points other than the networktermination points offered to the majority of end-users”.

The 25% SMP threshold is not fixed in stone. TheDirective permits national regulatory authorities todetermine that organizations with less than 25%market share have significant market power; and todetermine that organizations with market sharegreater than 25% do not have significant marketpower. In making such determinations, regulatorsare directed to take into account factors such as:

➢ the organization’s ability to influence marketconditions;

➢ turnover relative to the size of the market;

➢ control of means of access to end-users;

➢ access to financial resources; and

➢ experience in providing products and services inthe market.

Characterization of an organization as having SMPdoes not necessarily lead to a finding of marketpower or dominance on the part of that organization.The SMP designation is simply a trigger for the ap-


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plication of additional obligations under the variousONP Directives.

Market Dominance

Market dominance is a more extreme form of marketpower. The definition of market dominance variessignificantly in the laws and jurisprudence of differentcountries. In general, however, two factors are keyin the determination of market dominance. Firstthere must usually be a relatively high market share(usually no less than 35%, often 50% or more).Second, there must normally be significant barriersto entry into the relevant markets occupied by thedominant firm.

Some definitions are more qualitative than quantita-tive. Consider Box 5-4, which sets out the definitionestablished in European Commission jurisprudence.

Other definitions exist. The U.K. Office of FairTrading has said that describing an operator asdominant raises the implication that it possessesmore market power than any of its competitors. TheEuropean Court of Justice has found that there is apresumption of market dominance, in the absence ofevidence to the contrary, if a firm has a market shareconsistently above 50%. As is the case for marketpower generally, market dominance is not a matterof market share alone. However, some commenta-tors have suggested that a market share in excessof 65% is likely to support a finding of dominance.

5.2.4 Essential Facilities

The concept of essential facilities is important to theapplication of competition law in the telecommunica-tions sector. In the sector, an essential facility isgenerally defined as one which has the followingcharacteristics:

➢ it is supplied on a monopoly basis or is subjectto some degree of monopoly control;

➢ it is required by competitors (e.g. interconnect-ing operators) in order to compete; and

➢ it cannot be practically duplicated by competitorsfor technical or economic reasons.

Box 5-4: Market Dominance: A EuropeanCommission Definition

“A position of economic strength enjoyed by anundertaking which enables it to preventeffective competition being maintained in therelevant market by affording it the power tobehave, to an appreciable extent,independently of its competitors, customersand ultimately consumers.”

(United Brands v. Commission, ECR 207).

Definitions of essential facilities have been devel-oped by a number of national regulations andmultilateral agencies. Box 5-5 includes a benchmarkdefinition of essential facilities was included in theWTO Regulation Reference Paper:

The complete WTO Regulation Reference Paper isreproduced in Appendix A. The Reference Paperindicates when and how signatory countries mustensure essential facilities are provided to competi-tors.

The phrase “bottleneck facility” is sometimes usedas a synonym for “essential facility”. However, theterm “bottleneck” puts the emphasis on the facilitybeing a necessary part of a communications link, thesupply of which is restricted, rather than on theability of competitors to replicate the facility.

Box 5-5: Essential Facilities - WTODefinition

Essential facilities mean facilities of a publictelecommunications transport network orservice that:

(a) are exclusively or predominantly providedby a single or limited number of suppliers;and

(b) cannot feasibly be economically ortechnically substituted in order to providea service


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Common examples of essential facilities are networkaccess lines (local loops) and local exchangeswitching. Local loops are the circuits between acustomer’s premises and the first “node” orexchange which connects the customer with thePSTN. It can be seen that in many countries, localloops fall within the definition of essential facilitiesbecause they are:

(1) required by competitors in order to compete forthe business of end customers;

(2) predominantly supplied by the incumbent, and

(3) technically or economically difficult to substitute,at least on a widespread basis.

Accordingly, regulators in the US, Canada, Europeand elsewhere have required incumbents to facilitatecompetition by providing local loops to competitors.If alternative sources of fixed and wireless localloops become available, they may no longer bedesignated as essential facilities.

More examples of essential facilities, and a moredetailed discussion of the concept are set out inSection 3.4.5 of Module 3 under the heading“Access to Unbundled Network Components”.

A telecommunications operator that controls an es-sential facility often has both the incentive and themeans to limit access to the facility by competitors. Itbecomes a matter of public interest to ensure thatessential facilities are available to competitors onreasonable terms. Without such access, competitionwill suffer, and the sector will operate less efficientlythan it could.

Consider, for example, how much more efficient it isto have a variety of different ISPs, internationaloperators and other telecommunications serviceproviders use the same network access lines andlocal switches to reach subscribers in a locality. Thisis far more efficient than having each operatorconstruct network access lines to serve the samelocality.

The determination of which telecommunicationsnetwork resources constitute essential facilities hasgreat practical importance. Too narrow a definitioncan impede competition by preventing competitors

from being able to obtain necessary network com-ponents on appropriate terms. Too broad a definitioncan stimulate uneconomic entry or provideinsufficient incentives for competitors to invest in anddevelop alternative network infrastructure.

Various approaches to defining essential facilitiesare discussed in Section 3.4.5 of Module 3. ThatSection considers which facilities an incumbentoperator should be required to unbundle and provideto competitors, The balance of this Module 5 illus-trates the use of the concept of essential facilities incompetition policy as it applies to the telecommuni-cations sector.

5.3 Remedies for Anti-CompetitiveConduct

5.3.1 Abuse of Dominance

The concept of abuse of dominance includes abroad range of anti-competitive conduct recognizedin the laws and policies of many countries. It issimilar to, but broader than the concept of “monopo-lization” that is found in some laws.

While there are different definitions of abuse ofdominance, there are common themes in the defini-tions. The essential characteristics of abuse ofdominance include:

(i) A firm has a dominant market position in therelevant market; and

(ii) The firm uses that position to engage in“abusive” conduct which is or is likely to beharmful to competition.

The concept of abuse of dominance covers manyspecific types of conduct. New forms of abusiveconduct are being recognized today. Recent exam-ples can be found in the Microsoft litigation in theUS, or in other areas of intellectual propertylicensing. Other actions that were once consideredabusive are considered acceptable today, depend-ing on the circumstances. This Section andsubsequent sections describe some specific types ofconduct that have been considered abuses of domi-nance in the telecommunications industry. Thesedescriptions should not be considered exhaustive.


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Before discussing different types of abusive conduct,we will review the concept of market dominance.

When Does a Firm Dominate a Market?

The concepts of market power and dominance arediscussed earlier in this Module. The first step inevaluating whether a firm dominates a marketinvolves the definition of the relevant market in whichthe possible abuse occurs. As discussed earlier,once the relevant product and geographic marketmust be considered. Then the degree of dominanceexercised by the firm in the relevant market can beevaluated.

A narrow definition of the relevant market will gener-ally suggest a higher market share for a particularfirm, and an appearance of greater dominance.Conversely, a broad definition of the market willsuggest lower market shares and less dominance.The definition of the relevant market will, therefore,often be critical to an assessment of marketdominance.

Once the relevant market has been defined, theevaluation of whether a firm occupies a dominantposition will typically depend on two main factors: (i)the market share of the particular firm; and (ii) theextent of barriers to market.

A finding of dominance must be based on thecontext and circumstances of the relevant market. Itis difficult to provide general guidelines to determinethe particular measure of market share which willsupport a finding of dominance. Many commentatorssuggest that a market share of less than 35% isunlikely to be associated with a dominant position;while a market share of greater than 65% is likely tobe. It is widely observed that even a very largemarket share may not result in market dominance.This is particularly the case when barriers to entryare so low that price increases or output decreasesby a firm with a large market share will stimulate newentry and additional competition.

When is a Firm Abusing its Dominant Position?

If it is determined that a firm has a dominant positionin a relevant market, the next question is: Is the firmabusing this position? In telecommunicationsmarkets, abuse of dominance can occur in many

ways. Box 5-6 sets out common examples of thetypes of behaviour that are seen as abusive, ifcarried out by a dominant telecommunicationsoperator.

Different approaches are used to define conduct thatamounts to an abuse of dominance. Theseapproaches all focus on conduct that is harmful tocompetition in a market.

Abusive conduct is sometimes divided into “exploita-tive abuses” and “exclusionary abuses”. Conductsuch as charging excessive prices or offering poorservice to subscribers can be characterized as ex-ploitative abuses. This type of conduct exploits thedominant position a firm enjoys in a market andreduces consumer welfare. Predatory pricing orrefusal to supply essential facilities, on the otherhand, can be characterized as exclusionary abuses.These forms of conduct are aimed at foreclosingmarket entry or forcing market exit. Other ap-proaches to classifying abuses of dominance exist invarious laws as well as in the legal and economicliterature.

The main types of abuse of dominance encounteredin the telecommunications industry are discussed ingreater detail below. They include refusal to supplyessential facilities, anti-competitive cross-subsidiza-tion, vertical price squeezing, predatory pricing, tiedsales and bundling.

Legal Prohibitions Against Abuse of Dominance

National and international laws and treaties includeprohibitions against abuse of dominance. Someprohibitions are broad and general; others morespecific.

A good example of a broad prohibition againstabuse of dominance is found in Article 82 of the ECTreaty (formerly Article 86). It provides a generalprohibition at the level of European Union law.Article 82 states that:

“Any abuse by one or more undertakings of adominant position within the common market orany substantial part of it shall be prohibited asincompatible with the common market insofar asit may affect trade between member states.”


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The broad prohibitions of the EC Treaty have beenincorporated into the laws of member countries ofthe European Union. In addition to being bound bythe requirements of the EC Treaty, public telecom-munications operators in EC member countries aregenerally subject to additional and more specificnational legal prohibitions against abuse of domi-nance.

Abuse of Dominance – Remedies

Different approaches are taken to prevent, correct orpunish abuse of dominance. To properly investigateand remedy abuse of dominance complaints, aregulator or competition authority must havesufficient powers to conduct a proper investigation.At a minimum, investigative powers typically includethe ability to compel the dominant entity to discloseinformation and documents.

If an investigation indicates that abusive conduct hasoccurred, an effective legal framework generallyprovides powers to remedy the situation. Examplesof the types of powers that are granted to remedyabuse of dominance are set out in Box 5-7. Some ofthese powers may be granted to a telecommunications regulator, some to a general competitionauthority, and some to the courts.

Box 5-6: Abuse of Dominance by aTelecommunications Operator: CommonExamples

➢ Refusal or delay in providing essentialfacilities to competitors;

➢ Providing services or facilities tocompetitors at excessive prices or ondiscriminatory terms;

➢ Predatory pricing and/or cross-subsidization of competitive serviceswith revenues obtained from serviceswhich are subject to less competition;

➢ Bundling of services designed to providethe dominant firm with exclusiveadvantages in subscriber markets orrequire a competitor to obtain services orfacilities which it does not truly need.

Box 5-7: Some Powers to Remedy Abuseof Dominance

➢ Power to issue enforceable ordersagainst the dominant entity,

(a) to cease abusive behaviour; or

(b) to prescribe specific changes in itsbehaviour to limit the abusive aspects

➢ Power to revoke the licence of thedominant entity (NB. In practice, this haslimited applications since no regulatorwants to deny service to the public)

➢ Power to fine the dominant entity andthe individual persons responsible forthe abusive conduct

➢ Power to order compensation(damages) to be paid to subscribers orcompetitors injured by the abusiveconduct

➢ Power to restructure the dominant entity(such as the divestiture of some lines ofbusiness or structural separation ofthose lines into a separate but affiliatedcompany)

➢ Power to facilitate and approve informalsettlements in cases of abuse ofdominance (e.g. to pay compensation,restructure, voluntarily cease or changeconduct)

The question of establishing an effective regulatoryframework, including investigative and remedialpowers, is discussed in Module 1 – Overview ofTelecommunications Regulation. Specific remediesfor different types of abuse of dominance and otherforms of anti-competitive conduct are set out in thefollowing sections.

5.3.2 Refusal to Supply Essential Facilities

The concept of “essential facilities” is introduced inSection 5.2.4. above, and discussed in greater detailin Section 3.4.5. of Module 3. We will only deal withthe matter briefly here.


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The competition policies of a number of countriesrequire dominant firms to provide competitors withaccess to essential facilities controlled by dominantfirms. The so-called “essential facilities doctrine” isclosely related to the concept of “refusing to deal”with competitors, which is an offence under compe-tition law in some, but not all circumstances.

Some experts have discouraged telecommunica-tions regulators and competition authorities fromdeveloping excessively broad principles requiringincumbent operators to provide network facilities totheir competitors. They point out that such principleswould discourage competitors from building theirown competitive facilities.

However, most telecommunications experts agreethat the introduction of competition can be greatlyaccelerated by requiring incumbents to provideaccess to a broadly defined range of essentialfacilities to new entrants. For the provision oftelecommunications services to the general public,for example, interconnection to the incumbents’PSTN and related switching, signaling, OperationalSupport Systems (OSS) and database systems cansignificantly speed up the introduction of competitivenew services.

Most of the debate about essential facilities in thetelecommunications context relates to interconnec-tion facilities. The issues related to the supply andunbundling of essential facilities are discussed inmore detail in Module 3 – Interconnection.

Abuse of Dominance and Essential LocalNetwork Facilities – The EU Example

The European Commission’s 1998 “Access Notice”provides a good example of the treatment of essen-tial network facilities in current competition andtelecommunications law and policy (Notice on theApplication of the Competition Rules to AccessAgreements in the Telecommunications Sector).

The Access Notice illustrates how an establishedtelecommunications network operator can abuse itsdominant position in controlling network accessfacilities. The Notice sets out how competition rulesare to be applied to telecommunications networkaccess agreements in the context of: i) specific tele-communications market liberalization directives; and

ii) overlapping authority between national and EUinstitutions, and between competition and sector-specific regulatory authorities. The Access Noticebuilds on earlier Commission guidelines on theapplication of competition rules in the telecommuni-cations sector.

The Notice adopts a conventional approach tomarket definition. It uses the concepts of demandsubstitutability and non-transitory price increases asthe main tools for defining separate product markets.Based on its analysis, the Commission concludesthat telecommunications network access constitutesa distinct market from the market for end user serv-ices.

Much of the Notice is directed toward an evaluationof market dominance and the application ofprinciples of abuse of dominance to the networkaccess market. The first principle is that a companycontrolling access to an essential network facility isin a dominant position within the meaning of EU lawon abuse of dominance (specifically, Article 82 of theEC Treaty – formerly Article 86).

The Commission concludes that abuse of domi-nance can be made out where a network operatorrefuses access to its network, withdraws access orprovides access subject to unjustifiable delays orexcessive prices. The Commission identifies otherconduct which may be abusive, including tying orbundling network elements without adequate justifi-cation, configuring a network so that access bycompetitors becomes more difficult, unjustlydiscriminating in the terms of access offered tocompeting operators or pricing access so as to“squeeze” competitors’ profit margins. These con-cepts are discussed later in this Module.

5.3.3 Cross-Subsidization

In some key telecommunications markets, there is aconcern that incumbent telecommunications opera-tors will abuse their dominant position by engagingin anti-competitive cross-subsidization. The concernis that an operator that dominates one market mayincrease or maintain its prices above costs in thatmarket. It can then use its excess revenues from thedominant market to subsidize lower prices in othermore competitive markets. As a result, a dispropor-tionately large share of the costs of the operator’s


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entire business can be recovered from the marketsthe operator dominates.

This results in a “cross-subsidy” between servicesand subscriber groups. The more competitiveservices are subsidized by the less competitiveservices. Such cross-subsidies can be significantbarriers to competition.

Without the ability to cross-subsidize its own com-petitive services, a new entrant may not be able tomatch the incumbent’s low prices in competitivemarkets. This may prevent new entry into theincumbent’s less competitive markets. Alternatively,it may drive new entrants out of business or preventthem from raising enough capital to expand into theincumbent’s dominant markets.

Regulatory treatment of anti-competitive cross-subsidies in telecommunications markets iscomplicated due to the patterns of “social” cross-subsidies which characterized the monopoly era oftelecommunications services in many jurisdictions.

In the monopoly era, governments typically author-ized the cross-subsidization of local, residential andrural services by other services, such as interna-tional, long distance and business services.Whatever the benefits of social cross-subsidies inthe monopoly era, there is now a widespreadrecognition that they should be abolished. Thesecross-subsidies are gradually being eliminated bythe implementation of rate rebalancing policies. Raterebalancing policies are aimed at aligning prices ofdifferent services more closely with their costs.Rebalanced rates are closer to the types of“efficient” pricing found in competitive markets.

That is not to say that social objectives, such asmaintenance of affordable access for poor or remotesubscribers, are being ignored today. However,most telecommunications policy-makers, regulatorsand sector experts agree that implicit cross-subsidies between services should be replaced byexplicit subsidies aimed at meeting specific socialobjectives. The issues surrounding targeted subsi-dies to meet social objectives are discussed ingreater detail in Module 6.

Prohibitions Against Cross-Subsidies

Prohibitions against anti-competitive cross-subsidyhave been incorporated into the laws and regulatoryframework of many countries. Many countries thatdid not do so before have established such prohibi-tions as part of their obligations under the 1998WTO Agreement on Basic Telecommunications.

The WTO’s Regulation Reference Paper (seeAppendix A) requires signatory countries to maintainappropriate measures to prevent major suppliersfrom engaging in or continuing anti-competitivepractices. The list of anti-competitive practices spe-cifically includes “engaging in anti-competitive cross-subsidization”.

National prohibitions against cross subsidies can befound at various levels, including laws, regulations,regulatory guidelines, rules, orders or licences.

Licence conditions are often used to prohibit cross-subsidy. One example of a licensing prohibition canbe found in the General TelecommunicationsLicence granted by the Office of the Director ofTelecommunications Regulation in Ireland. Condi-tion 14 of the Licence permits the Director to enquireinto complaints of cross-subsidization by thelicensee, and to issue a binding direction requiringthe licensee to cease such cross-subsidization. Thiscondition is found in Part 3 of the Licence, whichincludes the conditions applicable to any licenseewith Significant Market Power (see definition inSection 5.2.1). This licence also requires licenseesto keep appropriate accounting records in order topermit the Director to evaluate whether conductamounts to unfair cross-subsidization.

Another example of a broad prohibition can be foundin the licence issued to the Jordan Telecommunica-tions Corporation by the TelecommunicationsRegulatory Commission of Jordan. The prohibitionreads as follows:

“The Licensee will not, alone or together withothers, engage in or continue or knowinglyacquiesce in any anti-competitive practices and,in particular, the Licensee shall: … not engage inanti-competitive cross-subsidization;”


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Such broad prohibitions are included in licences orin other regulatory conditions imposed on incumbentoperators in many other countries. While thesebroad prohibitions send a strong signal to incum-bents, they are not generally effective unless theyare accompanied by more specific measures toidentify and prevent anti-competitive cross-subsidies. We will now consider several specificmeasures: accounting separations, structural sepa-rations and imputation tests.

Accounting Separations

Accounting separations can be used to determinethe existence of cross-subsidization. Regulatorshave developed accounting separations, or haverequired incumbents to do so, in a number of juris-dictions.

An example is provided by Article 8 of the EU’sInterconnection Directive. It imposes an obligationon EU member states to ensure that public tele-communications network operators that havesignificant market power keep separate accounts fortheir interconnection-related activities and their othercommercial activities. This obligation applies if suchincumbents provide both end user services andinterconnection services to new entrants. In addition,the record of interconnection-related activities mustinclude both interconnection services provided inter-nally and interconnection services provided toothers. The new Interconnection Directive proposedby the European Commission in July 2000 providesthat regulators should have the authority to imposeaccounting separations in relation to specifiedactivities related to interconnection and/or networkaccess (Article 11).

More detailed accounting separation approachesare required by several national regulators. In somecases, accounts must be separated for a range ofdifferent services. The most detailed approacheshave been developed in Canada and the UnitedStates.

The goal of accounting separations is to divide thecosts of an operator between the different services itoffers in order to determine the costs of providingeach service. The costs of each service are thencompared to the revenues generated by that serviceto determine whether the service recovers its costs

or loses money. Services that do not cover theircosts are considered to be subsidized by otherservices with revenues that exceed their costs.

In effect, accounting separations require an operatorto account for different services as if they werestand-alone operations. Since telecommunicationsoperators provide a wide range of services, manyaccounting separations undertaken for regulatorypurposes do not attempt to separate the costs ofeach individual service. Rather, they separate thecosts of broad categories of service.

The focus of regulators is usually on separating thecosts of the categories of services in which anoperator is dominant, from the costs of providing themore competitive services. Such a separation per-mits the regulator to determine whether the monop-oly (or less competitive) services are generatingexcess revenues – and whether these costs arebeing used to subsidize the more competitiveservices. Accounting separations can addtransparency to the costing and pricing process ofthe incumbent operator.

Accounting Separations – Cost & RevenueCategories

Determination of which accounting categoriesshould be established will depend on the state ofcompetition in a national telecommunications mar-ket. In general, the more competitive the market, themore difficult the accounting separation process.

Once all segments of a market become workablycompetitive, it will no longer be necessary to estab-lish accounting separations, or worry about cross-subsidies. At that point, no firm would retain adominant position in any market segment.Accordingly, it could not raise prices abovecompetitive levels and use the excess profits tocross-subsidize more competitive areas.

The following are simplified illustrations of possibleaccounting separations that could be used inemerging markets that are subject to a limiteddegree of competition. Three simplified scenariosare considered in Table 5-2, Table 5-3 and Table 5-4.


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Several observations can be made about these sim-plified scenarios. In Scenario A, the operatorappears to be cross-subsidizing its entry intocompetitive services with revenues from its monop-oly services. Several factors are relevant indetermining the extent of this cross-subsidy. Anyfirm will incur start up costs in the early years of

introducing a new service, and if the deficit forCategory 2 competitive services is short lived, theremay not be a serious anti-competitive problem.However, if the cross-subsidy persists, or increases,that would make it very difficult for new entrants inthe cellular and value-added services markets tocompete. They may be driven out of business.

Table 5-2: Scenario A: No competition in basic telephone services; competition in cellular andvalue-added services (e.g. Internet access, e-commerce services)

Accounting Category 1 – Monopoly Services Accounting Category 2 – Competitive Services

Revenues 5000 Revenues 100

Costs Costs

Local Access Network Services 2500 Cellular Telecommunications Services 300

Long Distance Network Services 1000

International Network Services 400

Value-added Services (including InternetAccess, e-commerce)

200

Total Costs 3900 Total Costs 500

Surplus 1100 Deficit (400)

Table 5-3: Scenario B: No competition in local access services; competition in long distance,international cellular and value-added services (e.g. Internet access, e-commerce services)


Revenues 2500 Revenues 2600

Costs Costs


Value-added Services (including InternetAccess, e-commerce)

200




Surplus/Deficit 0 Surplus 700


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Table 5-4: Scenario C: (same assumptions as Scenario B) No competition in local access services;competition in long distance, international cellular and value-added services (e.g. Internet accessand e-commerce)


Revenues from End Users 1700 Revenues 2600

Local Access Revenues from Competitors 800

Total Revenues 2500

Costs Costs


Cost of Providing Local Access Servicesto Competitors

100 Value-added Services (including InternetAccess, e-commerce)

200




Surplus/Deficit 0 Surplus 700

Scenario B illustrates a hypothetical accountingseparation for an incumbent operator that hasrebalanced its local access prices. Its local accessprices are sufficient to cover associated local accesscosts – and no more. Based on these data, the firmcannot be said to be cross-subsidizing itscompetitive services from its monopoly services.

However, a further degree of accounting separationmay illustrate a form of anti-competitive cross sub-sidization that is potentially damaging to competition.This is illustrated in Scenario C.

The total costs and revenues illustrated in ScenarioC are the same as in Scenario B. However,Scenario C separates out the costs and revenues ofthe incumbent in providing local access services(e.g. call termination) to competitors. In so doing,Scenario C illustrates what appear to be anti-competitive cross-subsidization practices on the partof the operator.

It appears that the operator is charging competitors8 times as much as it costs to provide them withlocal access services (local access revenues from

competitors are 800, costs are 100). This couldincrease the costs of competitors to a level wherethey would find it very difficult to compete with theincumbent. The more detailed level of accountingseparation provided in Scenario C illustrates whatseems to be a large cross-subsidy from one cate-gory of monopoly services, i.e. local access servicesprovided to competitors, to other monopoly services.

Scenario C indicates other potential problems thatmerit further investigation. For example, it is possiblethat the incumbent is implicitly charging its owncompetitive services at lower prices for local accessservices than it is to competitors. This problem isdiscussed later in this Section.

A comparison of Scenarios A, B and C indicates thatit is important to design accounting separation cate-gories to meet different market circumstances, andto take into account the type of cross-subsidy that isbeing investigated or monitored.


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Accounting Separations - Cost Allocation Issues

In practice, it is sometimes difficult to separate thecosts to telecommunications operators. Costaccounting approaches are well developed in somehighly competitive industries, where businessmanagers carefully monitor the financialperformance of different services or “profit centres”.However, the same has not generally been true ofincumbent telecommunications operators.

Identifying the costs of different services was simplynot required in the monopoly era. Telecommunica-tions managers and regulators typically focussed onthe overall profitability of the firm, not on theprofitability of individual services. If some serviceslost money, these losses were covered by profits inother services. Detailed cost separation approacheswere never required or developed.

Some difficult issues of cost separation are rooted inthe nature of telecommunications costs. Many of thecosts of operating a multi-service telecommunica-tions operator can be characterized as joint or com-mon costs. These concepts are defined anddiscussed in detail in Appendix B.

As discussed in Appendix B, it is difficult to assignjoint and common costs directly to a service.Accordingly, such costs are often “allocated” or“distributed” among the different services. Variousapproaches can be used for such cost allocations.Most involve some degree of judgment.

Given the arbitrary nature of some cost allocations,incumbent operators will often have the opportunityto allocate more costs to their less competitive serv-ice offerings. This “shifting” of costs will make themore competitive services appear less costly andmore profitable. For example, an incumbent mightallocate 95% of its head office expenses to its basictelephone services, because those services accountfor 95% of its revenues. However, in reality, over30% of the time of head office staff may be devotedto competition with new entrants in value-added,Internet and e-commerce services, which accountsfor only 5% of its revenues. By shifting its head-quarters’ costs away from the more competitiveservices, the incumbent could justify charging a verylow price for these services. The incumbent mightthus be able to convince the regulator that it was not

pricing the competitive services below cost, andsubsidizing them from excess basic servicerevenues.

There is no simple solution to the accountingseparation problems identified above. If there areserious concerns about anti-competitive cross-subsidies, the regulator will have to “roll up itssleeves”, and work to understand the cost structureof the incumbent. The help of experienced telecom-munications accounting or economic consultants willbe useful, if not essential, in most cases.

International benchmarks can assist in some cases.For example, consider two services: (1) localtermination services provided by an incumbent tointerconnecting competitors, and (2) cellulartelephone services provided to end users in compe-tition with the same competitor. A benchmarkingstudy may show that the incumbent charges twiceas much for service (1) in comparable countries, andonly half as much for service (2). In such a case, theregulator will want to take a closer look at the costsand pricing of the incumbent to ensure it is notengaging in anti-competitive cross-subsidization.

In conclusion, accounting separations can be chal-lenging for both the regulator and regulated opera-tors. However, some simplifying assumptions andbenchmarking can assist in providing “order ofmagnitude” indications of possible cross-subsidies.Whatever techniques are used, accountingseparations remain a valuable tool for regulators.

The accounting separations approach does havedrawbacks. These include the discretionary natureof some cost allocations and the large amount ofresources required for detailed cost separations. Forexample, the Canadian regulator spent the betterpart of a decade to develop its “Phase III” category-wide cost separations process. These drawbackssuggest that detailed accounting separations shouldnot be relied on exclusively as a tool to identify andprevent anti-competitive cross-subsidies. Incountries with limited resources, it may be moreefficient to use a combination of benchmarking andvery high level cost separations.


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Structural Separation and Divestiture

Two other approaches, namely structural separationand divestiture, have been used by competitionauthorities and telecommunications regulators incases of serious anti-competitive cross-subsidization. Both approaches tend to be used onlywhere there is evidence of significant anti-competitive conduct. This usually involves not onlycross-subsidization, but related conduct such aspredatory pricing, anti-competitive use of informationand discriminatory practices.

Structural separation generally refers to the separa-tion of different lines of business of a telecommuni-cations operator into separate corporate entities.

As an example, a cellular business can be operatedby a separate company from a wireline telephonebusiness. Both may be owned by the sameshareholders. However, existence of a separatecellular company makes it easier to ensure that theincumbent operator with which it is affiliated does notdiscriminate unfairly against cellular competitors ascompared to its own cellular operations. Rules canbe established to ensure that both cellularcompanies are treated the same, for example, withrespect to interconnection charges. Other examplesof telecommunications lines of business that arefrequently separated include ISPs and various typesof mobile operators.

When structural separation is mandated by regula-tion, the different companies must typically be run onan “arm’s length” basis. In that case, the companiesmust deal with each other on the same terms andconditions as they deal with third parties, such ascompetitors. The separate companies must normallynot only have separate accounting records, but alsoseparate management, offices, facilities, etc.

Regulatory conditions normally determine thedegree of separation required in the companies’operations. Development of these conditions canpose challenges. Regulators must balance twocompeting objectives. One is to create sufficientseparation to minimize the potential for cross-subsidization, collusion or other anti-competitiveactions between the separated companies. Theother is to minimize the inefficiencies that will almostinevitably be created by structural separation.

For example, there may be efficiencies (economiesof scale and scope) inherent in providing commonadministrative services to both companies. On theother hand, the sharing of administrative services,such as accounting services, provides potential foranti-competitive conduct and for developing covertcross-subsidies. Similarly, sharing head office spacecan lead to efficiencies. On the other hand, itprovides opportunities for collusive conduct betweenmanagers of the two companies. If structuralseparation is to be required, there should be a realseparation of the two lines of business, includingtheir management, premises, customer data bases,accounts and operations. Otherwise, the structuralseparation may be a sham.

The initial question, however, is not whether thereshould be structural separation between the compa-nies, but whether the advantages of separationoutweigh the disadvantages given the realities of aparticular market. Other disadvantages of structuralseparation include high transaction costs (the costsof creating the separate companies) and the distrac-tion for employees and customers as they workthrough the separation. Despite thosedisadvantages, structural separation may be theonly way to ensure a level playing field forcompetition in some markets.

Structurally separate companies can often continueto operate under common ownership. Divestiturerefers to a situation where a company, such as anincumbent, not only runs a particular line of businessthrough a separate company, but divests (i.e. sells)some or all of the ownership of that separatecompany to independent parties.

Some competition advocates argue that only dives-titure of ownership can ensure that a separatecompany is run in the interests of its separateshareholders, rather than merely as an operatingarm of its parent company (e.g. the incumbent).Without divestiture, it is argued, a great deal ofregulatory effort will be expended to detect anti-competitive dealings between affiliated companies.Once there are separate shareholders, the man-agement of the separate companies must act in theinterests of those shareholders. It will be safer toassume that the companies are actually run on anarms-length basis.


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Structural Separation – The EU Cable Directive

An example of a structural separation directive canbe found in the EU’s 1999 Cable OwnershipDirective. This Directive requires dominant tele-communications operators to place their cabletelevision operations in a structurally separatecompany. The Directive builds on the EU’s ONPDirectives and other efforts to implement acompetitive framework for telecommunications. It isintended to address specific problems which the EUCommission has concluded result from the jointoperation of cable television networks and conven-tional telecommunication networks.

The Cable Ownership Directive makes it clear thatthe Commission views structural separation as theminimum corrective measure required at this time,and that it may impose further measures, includingdivestiture of cable interests to third parties, inspecific cases. The Commission also appears to beadopting a practice of requiring dominant companiesto divest their cable interests as a precondition tosecuring Commission approval for new mergersamong telephone companies. (See, for example, thediscussion of the Commission’s approval of themerger of Telia AB of Sweden and Telenor AS ofNorway in Section 5.4.2 below.)

Divestiture – The AT&T Model

The most famous example of a telecommunicationsdivestiture involved the separation of AT&T from theRegional Bell Operating Companies (RBOCs) in theUnited States in 1984. Not only were the localoperations of AT&T structurally separated from itslong distance and international operations, but own-ership of the two groups of companies wasseparated by means of a share swap. Thedivestiture was, by most accounts, a great success.

With their ownership separate from AT&T, theRBOCs no longer had an incentive to favour AT&Tover its long distance competitors, such as MCI andSprint. Therefore, all long distance competitorsobtained access to local telecommunications serv-ices from the RBOCs on similar, non-discriminatoryterms. More relevant to this Section, the divestitureeliminated concerns about anti-competitive cross-subsidies between AT&T’s local and long distanceoperations.

Divestiture is generally viewed as an extremeremedy that is only appropriate in cases of over-whelming dominance by very large operators inlarge economies such as the US. Policy-makers inother countries have been reluctant to considerdismembering incumbents, which are often seen as“national champions”.

However, this view may be changing. The EU CableOwnership Directive indicates a willingness by theEU to consider divestiture of at least some types ofbusiness lines. Consideration of the divestitureoption may increase as more incumbents around theworld become fully privatized. The changing market,economics and financing of the telecommunicationssector suggest that there are advantages as well asdisadvantages in divesting some lines of telecom-munications business from others. For example, it isoften easier to finance an e-commerce or GSMcellular business on a stand-alone basis than as partof a large multi-service operator. Finally, in countrieswith limited competition, divestiture may provide themeans to create other strong players with the criticalmass to become successful telecommunicationsservice providers.

5.3.4 Vertical Price Squeezing

Vertical price squeezing is a particular type of anti-competitive conduct that may be engaged in byincumbent operators. This form of conduct canoccur if the incumbent provides services in two ormore “vertical” markets. Vertical markets are some-times labelled “upstream” and “downstream”markets. For example, the oil production market isupstream of the oil refining market, which in turn isupstream of the gasoline sales market. Instead ofupstream and downstream, the terms “wholesale”and “retail” are often used.

Vertical price squeezing can occur when an operatorwith market power controls certain services that arekey inputs for competitors in downstream markets,and where those same key inputs are used by theoperator or its affiliates to compete in the samedownstream market.

To take an example, in telecommunicationsmarkets, incumbents often control local access andswitching services. Consider one such service – theprovision of dedicated local circuits from customer


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premises to local exchanges. Dedicated localcircuits can be viewed as “upstream” services.These services are used as an input by theincumbents in providing “downstream” services,such as dedicated Internet access services. Dedi-cated local circuits are also a key input forcompetitors who provide dedicated Internet accessservices. In other words, both the incumbent andother suppliers compete in the downstream marketfor dedicated Internet access services.

If the incumbent decided to engage in vertical pricesqueezing, it could increase the price to competitorsfor the upstream input (i.e. dedicated local circuitrates) – while leaving its downstream prices thesame (i.e. prices for its dedicated Internet accessservices). The effect would be to reduce or eliminatethe profits (or “margins”) of competitors. Theirmargins would be “squeezed”. To increase thesqueezing effect, the incumbent could also reduceits downstream prices for Internet access. Thiswould be a “two-way” or margin squeeze.

Put another way, an incumbent can often squeezethe margins of competitors by raising wholesaleprices paid by competitors, while at the same timelowering retail prices on competitive services.

A simplified numerical example of a vertical pricesqueeze is included in Box 5-8.

Box 5-8: Example of Vertical PriceSqueeze by Incumbent Operator

Cost to incumbent of upstreamfacility (e.g. dedicated loop)

$ 90

Price charged by incumbent tocompetitor for loop

$ 120

Cost of providing retail services toend users (e.g. dedicated Internetaccess service) in addition to loopcost (e.g. marketing, billing)

$ 20

Price charged by incumbent toend users for dedicated Internetaccess services

$ 130

In this example, it is evident that there is no marginavailable for the competitor. The competitor mustbuy the upstream service, a dedicated loop, from theincumbent at $120. Assume that it will incur $20 inadditional costs before it can provide retail services.Thus, it must spend $140 to provide the retailservice to end-users. Since the incumbent providesthe same retail service for $130, it is unlikely that thecompetitor could attract any customers away fromthe incumbent.

Wholesale Cost Imputation Requirement

To prevent vertical price squeezing, a telecommuni-cations regulator may impose a wholesale costimputation requirement, along the lines set out inBox 5-9.

Box 5-9: Basic Elements of WholesaleCost Imputation Requirement

Conditions for Application:

1. Applies to a monopoly or dominantprovider of “wholesale services”

2. Where the dominant provider alsocompetes in market for “retail services”that require the wholesale services asinputs.

Basic Rules:

Dominant provider must provide evidence tothe regulator that its retail prices are no lowerthan the sum of the following:A. The price it is charging competitors for the

wholesale services that form part of theretail service (this price is said to be“imputed” in the cost of the dominantprovider whether it actually incurs this costor not); plus

B. The actual incremental costs (above theimputed wholesale costs) that are incurredby the dominant supplier in providing theretail service. For example, marketing,billing, etc. costs.


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Variations on this type of imputation approach havebeen used by various regulators and competitionauthorities. It is relatively simple to use (compared todetailed accounting separations or cost allocations).To return to the margin squeezing example in Box 5-8, it does not matter whether the actual cost of thewholesale service is $90, $120 or some othernumber. What the imputation requirement assures isthat the same cost for essential wholesale servicesis imputed to the dominant operator’s retail servicesas is passed on to its competitors.

Imputation – A Canadian Example

A form of the wholesale cost imputation requirementhas been applied by the Canadian regulator inresponse to complaints of targeted retail price dis-counting by incumbent operators. The CRTC’sapproach was tailored to the rather uniquecircumstances of the Canadian market. In thatmarket, the CRTC established a universal serviceprogram in the form of a subsidy for the accessdeficit incurred by operators in higher-cost areas.

All long distance operators, including new entrants,are required to make “contribution” payments tosubsidize the deficit described above. However, asnoted in our detailed discussion of the Canadianexample in Module 6, incumbent local operatorscontinue to receive the vast majority of contributionpayments. Initially, the CRTC did not specificallyrequire the incumbent operators to account for theirown use of the local access network in providingcompetitive services. That is, it did not requireincumbents to make contribution payments tothemselves. This led to the potential for vertical pricesqueezing by incumbents. The CRTC’s response tothis situation is described in Box 5-10 below.

This imputation test is similar to the one described inBox 5-9. The main difference is that the CRTCimputes “contribution” subsidies, as well aswholesale facilities costs, as costs that must becovered in the incumbents’ retail prices. The CRTCtook the position that so long as a service recoversthese imputed costs, plus the direct causal costs ofthe retail service, targeted pricing would not be anti-competitive.

Box 5-10: Case Study - The CRTC Imputation Test

In 1994 (Decision 94-13), the CRTC described the targeted price cutting responses of incumbent operators tonew entrants as follows:

“Under a scenario of unrestrained targeted pricing by the telephone companies, competitors could be facedwith the situation in which they must compete against telephone company prices that embody a contribu-tion amount that is lower than the competitor contribution cost in that market segment…The Commissionconsiders that, due to their previous status as monopoly toll providers, the telephone companies have anestablished and generally predominant share in all market segments. As a result, their traffic mix, thepresence of barriers to entry and the existence of customer inertia would permit them, on a sustainedbasis, to recover contribution from the most highly contested market segments at a level below thecontribution amount [payable by competitors].”

As a result of these concerns, the CRTC implemented an “imputation test” to ensure that incumbents’ prices incompetitive networks were subject to similar cost recovery requirements as competitors. This imputation test,as modified in a later CRTC decision (Telecom Decision CRTC 94-19), has the following requirements:

Revenues for each service offered by an incumbent must equal or exceed the sum of--

(a) the costs for “bottleneck services” used by the company in the provision of the services in question, usingtariffed rates for those bottleneck services (the “Operator Access Tariff”);

(b) the causal costs specifically attributed to the services, which are additional to the costs covered in (a)above; and

(c) any applicable contribution payments.


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5.3.5 Predatory Pricing

Predatory pricing is the practice of providing servicesat prices that are low enough to drive competitorsout of a market, so as to monopolize the market.There is considerable debate about what prices andwhat conduct constitute predatory pricing. While thecompetition laws of various countries differ, it isgenerally agreed that a number of elements mustexist to constitute predatory pricing. Typical ele-ments for the definition of predatory pricing are setout in Box 5-11.

Predatory pricing is often prohibited under nationalcompetition laws. It may also be prohibited under thelaws or policies applied by a telecommunicationsregulator. Either way, it will be necessary for theregulator to have the means to investigate and stopinstances of predatory pricing and to implementsuitable penalties or remedies.

Remedies vary. Predators may be penalized,competitors which have been the victims ofpredatory pricing may be compensated, or both.Another regulatory approach is to anticipatepredatory pricing by implementing price regulation to

deter predatory behaviour. Wholesale cost imputa-tion requirements, which are discussed in theprevious Section, provide an example of thisapproach.

Predatory pricing is a particularly difficult type ofconduct to prove in the telecommunications industry.As previously discussed, the industry is character-ized by substantial joint and common costs whichare difficult to assign to particular services. Theeconomic cost tests used to determine predatorypricing, such as Average Variable Costs and LongRun Incremental Costs are difficult to apply to manytypes of telecommunications prices. Again, thesetests and related costing issues are discussed inAppendix B.

Predatory Pricing – Example of a Complaint

The case study provided in Box 5-12 summarizesOftel’s investigation into certain of BT’s Internetservices after a competitor raised predatory pricingconcerns. It illustrates some of the problems ofestablishing that low pricing amounts to predatorypricing.

Box 5-11: What is Predatory Pricing?

Generally, the following elements must exist to constitute predatory pricing:

➢ The predator must have market power (power to unilaterally increase its prices, etc.).

➢ The predator must charge prices that fall below a predatory price standard. This standard variessomewhat between countries. Generally, in competition law, prices in this sector must be belowAverage Total Costs, and near or below Average Variable Costs. In the telecommunications sector,prices must usually be below Long Run Incremental Costs (LRIC) or Total Service Long RunIncremental Costs (TSLRIC). (See Appendix B for a discussion of these cost standards).

➢ There must be evidence of a clear policy of selling at predatory prices, not just sporadic or reactiveprice cutting.

➢ Normally, there must be a reasonable expectation that the predator will be able to recoup its lossesafter its predation ends (e.g. after competitors are driven out of the market).


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Box 5-12: Case Study - Oftel Investigation of BT's Internet Services

The complaint:

A competing Internet service provider complained to Oftel that BT was engaging in predatory pricing. Thecomplaint was that BT was offering its BTNet services at a price 9 times less than other comparable BTservices (X.25 packet services). Other elements of the complaint were that BTNet was not recovering anappropriate measure of costs and that BT was offering a free initial period of subscription.

The analysis:

Oftel observed that barriers to entry were low in the Internet services market, and so predatory behaviourwas not feasible (BT would not be able to raise prices and recoup early losses in the longer run). Oftel alsonoted that the BTNet service was distinguishable from the X.25 packet service, which the complainantrelied on to demonstrate unreasonably low pricing. Oftel looked at the business plan for BTNet andperformance against plan, and concluded that early losses were consistent with being a start up businessand that projected results indicated a move into profitability. Finally, Oftel observed that free subscriptionperiods were common in the industry and that BTNet had limited these offers to its initial launch.

The conclusion:

Oftel concluded that BT was not engaged in predatory pricing in its BTNet offers. Oftel did state itsintention to continue to monitor the situation closely (given BT’s potential influence over the market).

5.3.6 Misuse of Information

Dominant providers of local telephone services andcertain other monopoly services are in a position tocollect competitively valuable information on theirinterconnecting competitors. For example, a com-petitor might require a local access circuit from anincumbent operator in order to provide a dedicatedInternet service to a business customer. Thecompetitor would order the circuit from the incum-bent.

An incumbent should not be able to misuse theinformation obtained in its capacity as a supplier ofessential facilities to the competitor. For example,the incumbent should not be permitted to approachthe competitor’s prospective customer to induce thecustomer to switch to (or remain with) theincumbent’s own dedicated Internet services.

Most of the information received by an incumbentwhich is subject to competitive misuse, is received inthe course of interconnection arrangements.Therefore, the types of potential anti-competitiveabuse, and the remedies for such abuse arediscussed in Module 3, Sections 3.4.2 and 3.4.3.

5.3.7 “Locking-in” Customers

Telecommunications network operators may attemptto “capture” particular subscribers through agree-ments that make it difficult or impossible for acustomer to move to another network operator orservice provider. Examples include long termcontracts and discounts for exclusive dealing, aswell as agreements which tie a customer to aparticular technology or hardware platform.

Not all agreements that lock-in customers are anti-competitive. Most do not warrant regulatory interfer-ence. However, there are cases, particularly where adominant competitor locks in customers in advanceof the introduction of competition, that merit regula-tory review. Dominant firms certainly can injure theprospects for competition in a market by lockingcustomers into exclusive arrangements. Thesearrangements can amount to an abuse ofdominance.

One clear form of abuse involves a requirement by amonopoly operator that a customer enter into a long-term exclusive contract in advance of the introduc-tion of competition, as a condition of receivingcontinued service. Regulators should prohibit such


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practices. Clearly, monopoly services should not bediscontinued if customers refuse to enter into long-term contracts that would undermine the introductionof competition. Such a practice clearly involves anabuse of dominance. This is a form of anti-competitive tied sale, as well as a form of locking-incustomers.

Other cases of locking-in customers are less clear.Much will depend on the degree of competition inthe market and the effect of the locking in-arrangements on competition in the market. Themore dominant a telecommunications operator, andthe more injurious to competition the locking-inarrangement is, the stronger the case for interven-tion by the regulator or competition authority. Someregulators and competition authorities will be morevigilant than others regarding the potential harmthrough locking-in arrangements.

A practical example of the approach taken by acompetition authority to a case of locking-in tele-communications customers can be found in the EU’s“SIM Lock” case. The approach taken by the EU’sDirector-General for Competition (DG IV) in thiscase is illustrated in Box 5-13.

5.3.8 Tied Sales and Bundling

A tied sale is the sale of one product or service oncondition that the buyer purchases another productor service. Bundling is the practice of assemblingmultiple products or services (or multiple product /service elements) together in an integrated offer.

Tied or bundled sales are not necessarily abusive oranti-competitive. The sale of one product or servicemay be tied to another for reasons of consumersafety or technical interdependence. Bundled salesmay also be provided to respond to consumer pref-erence or convenience.

Box 5-13: Case Study – DG IV Intervention in "SIM Locking"

The following approach was taken by the Director-General for Competition (DG IV) of the EuropeanCommission in the case of the “SIM Lock” feature on mobile phone handsets. This feature was, at one time,common on European handsets.

The SIM Lock feature had at least two characteristics:

(i) It could be used as a theft deterrent (since the “subscriber identification module” – or “SIM” –integrated circuit card was uniquely associated with a particular handset); and

(ii) It effectively locked a particular handset and subscriber to a single mobile telephone serviceoperator. The SIM card authorized a particular handset and subscriber to use a particular serviceprovider’s network. Locking the SIM card and preventing its replacement in the handset preventedsubscribers from changing their service provider. The SIM Lock feature could be “unlocked”.However, service providers tended to impose significant charges for overriding the SIM Lock feature.

On 30 May 1996, DG IV wrote a letter to the manufacturers of the handsets and to network operatorsnotifying them that it considered the SIM Lock feature as having anti-competitive effects. Further consultationsand correspondence ensued. As a result, manufacturers agreed to modify their handsets and include theability for subscribers to unlock the SIM Lock feature.

DG IV also set out a number of additional restrictions on the use of the SIM Lock feature. These included fulldisclosure to consumers that they could unlock the handsets. Where service providers had subsidizedhandset prices, the amount of the subsidy and specific commercial terms for recovering that subsidy had tobe disclosed. Providers also had to disclose any effect that this subsidy might have on the subscriber’s abilityto unlock the feature. DG IV permitted service providers to keep the handsets locked until such time as thesubsidy had been recovered.


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Anti-competitive Aspects

Tied sales can be abusive when they have signifi-cant adverse effects on consumers or competitors.An example of an abusive form of tied sales is tyinga product or service offered in a highly competitivemarket to another product in a monopolistic or lesscompetitive market. The first product would typicallyhave low prices and profit margins; the latter, higherprices and profit margins. Another example is tying arequirement to buy a maintenance service contractwith the sale of the product itself, where the servicemarket is highly competitive but the product marketis not.

Bundling has become a popular marketing approachin the telecommunications industry. Many incumbentoperators and competitors are offering bundledpackages of services. A popular bundle in Canada,for example, includes wireless telephone service,Internet access service and cable TV service, soldtogether for a price which is 10% lower than thecombined price of the individual services. Like tiedsales, bundling can be convenient to customers.Among other things, it cuts down on the number ofbills to pay. However, regulators have been asked todeal with anti-competitive aspects of bundling invarious countries.

Regulatory Intervention

Regulatory intervention is usually focussed on a fewtypes of bundling activity. One type occurs where anincumbent offers bundles of products or services onterms which cannot possibly be met by competitors.This concern is particularly serious where theoperator includes a service in the bundle, such asbasic local telephone service, of which it is themonopoly or dominant supplier.

Another area where regulatory intervention may berequired occurs where a dominant operator suppliesservices to a competitor which the competitor needsas an input to its own services in order to competewith the incumbent. In other words, the dominantoperator provides both the upstream and down-stream services, but the competitor only providesdownstream services. Some concerns about this

situation are discussed above under the title VerticalPrice Squeezing.

A related concern arises where the dominantoperator chooses to provide the upstream service tocompetitors on a bundled basis. In other words, thedominant operator may require competitors toacquire not only the minimum upstream serviceelements they require, but also other services. Suchbundling would impair the competitors’ efficiency. Itwould also inflate revenue flows from competitors tothe dominant operators.

The issues related to the bundling of services pro-vided by incumbents to their competitors arediscussed in detail in Section 3.4.5 of Module 3,under the title Access to Unbundled Network Com-ponents.

Unbundling Conditions

Dealing more generally with the issue of bundling ofretail packages by incumbents, a number of regula-tory approaches are possible to prevent anti-competitive conduct. Outright prohibition shouldgenerally be seen as a last resort. Other approachescan often be used.

Steps can often be taken to level the playing fieldbetween dominant operators and new entrants,even when monopoly services are part of a bundle.Where this is the case, regulators can impose resalerequirements on the dominant operator. In otherwords, the dominant operator may be permitted tosell monopoly services as part of a service bundle,but only if it makes the monopoly services availableto competitors on reasonable terms to resell as partof their own competing bundles.

Box 5-14 provides an example of conditions im-posed by one regulator on dominant operators thatwant to provide bundles of services that includemonopoly service elements. The conditions estab-lished in this example include a resale requirement,a cost imputation test and a general requirementthat competitors must be able to offer similarbundles in competition with the dominant operators.


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Box 5-14: Case Study - CRTC Bundled Service Conditions

In 1994, when local services were offered on a monopoly basis in the Canadian market, the CRTCestablished the following bundling conditions (in Telecom Decision CRTC 94-19). These conditions appliedto dominant operators that proposed to offer a bundled service, including monopoly service elements andcompetitive service elements:

➢ The bundled service must cover all applicable costs including:

(a) Tariffed rates for bottleneck network components;

(b) Bundled service start-up costs; and

(c) Contribution payments (access deficit subsidies similar to those paid by competitors);

➢ Competitors must be able to offer their own service bundles by combining network or service elementsacquired from the dominant operator at tariffed rates and the competitor’s own network or serviceelements; and

The dominant operator must permit resale of the bundled service by its competitors.

Regulatory conditions of this type can beincorporated into the regulatory framework to permitprovision of bundled services, while safeguardingagainst anti-competitive conduct. Such conditionscan be included in licences or specific guidelines,decisions or directions of regulators.

5.3.9 Other Abuses of Dominance

When the concept was introduced in Section 5.3, itwas indicated that abuse of dominance involved twofactors: (1) existence of market dominance, and (2)conduct by the dominant firm that is harmful to com-petition. The most common types of abuse ofdominance in the telecommunications industry havealready been reviewed.

However, various other abuses of dominance arepossible. If conduct by a dominant firm exploitsconsumers, excludes competitors, or otherwiseharms competition, it should be reviewed by tele-communications regulators or competition authori-ties. Box 5-15 lists some other types of abuses ofdominance that are found in telecommunicationsand other industries.

5.3.10 Restrictive Agreements

Types of Restrictive Agreements

Most telecommunications regulators and virtually allcompetition authorities are called upon, from time totime, to review potentially anti-competitive agree-ments involving telecommunications operators.Some types of regulatory review are ex ante, suchas where laws or licence conditions require priorapproval of some types of agreements entered intoby regulated operators. Other reviews are ex post,such as in cases where a competitor complainsabout the anti-competitive effect of an existingcontract.

Some types of telecommunications agreements,such as interconnection agreements, are routinelyreviewed by regulators. Interconnection agreementsare discussed in Module 3. The following discussionfocuses on other types of agreements between tele-communications operators.

Two categories of agreements may raise concernsof anti-competitive conduct. “Horizontal agree-ments” are agreements among competitors. Theywill cause concern to the extent that they restrict thecompetitors’ ability to compete independently.


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Box 5-15: Some Other Forms of Abuse of Dominant Position

The following list includes common types of abuses not discussed in detail elsewhere in this Module. Thislist is not exhaustive.

➢ Excessive Prices – This is perhaps the most common form of “exploitative” abuse of a dominant ormonopoly position in the telecommunications sector. It is not an anti-competitive abuse but anexploitation of consumers. (It is discussed in Module 4 and Appendix B.)

➢ Restriction of Supply - A monopolist or dominant firm may refuse to invest in network infrastructureand supply new customers, preferring to serve a limited range of customers. This limited range ofcustomers may provide a secure stream of profits, and requires less additional capital.

➢ Refusal to Deal – Refusal by a telecommunications operator to deal with a competitor is not alwaysanti-competitive. Refusal by a dominant operator to do so may be anti-competitive, where the effect isinjurious to competition. The most common example involves refusal by an incumbent operator toprovide essential facilities, such as local loops required by competitors to compete (see discussion inthis Module and in Module 3). However, other forms of anti-competitive refusal to deal occur intelecommunications markets.

➢ Unjust Discrimination – A dominant firm may discriminate unjustly or unfairly between customers, orbetween competitors (including itself). Discrimination may involve prices or other conditions ofservice. Regulators have traditionally prohibited such discrimination where it is exploitative,exclusionary of competition or otherwise harms competition or consumer welfare. Regulatorsgenerally do not prohibit all forms of discrimination, particularly those that have no harmful effects.Rules on which forms of discrimination are “unjust” vary from country to country.

➢ Abuses Involving Intellectual Property – Anti-competitive abuses of dominance may occur, forexample in exclusionary IP licensing arrangements, and in attempts to monopolize adjacent markets.

“Vertical agreements” are agreements betweenupstream and downstream participants in the sameor related markets. These agreements can excludeor restrict competition or harm consumer welfare.Problematic vertical agreements include someagreements that fix retail prices or grant exclusivedistribution rights in a given geographic market.

Only horizontal or vertical agreements that haveanti-competitive effects should be prohibited. Thereare many useful forms of horizontal agreements.These include some agreements to adopt commonstandards, or other product specifications or designfeatures. Such industry standardization may result ingreater production efficiency. It can also promotecompetitive entry by establishing an “open” marketwith increased product interoperability.

Certain vertical agreements can also benefit thepublic, such as exclusive marketing agreements thatinduce a distributor to invest in the development of a

difficult new market. Exclusive arrangements canalso be used to maintain high levels of customersupport.

Box 5-16 deals with three types of problematicagreements found in telecommunications and otherindustries: price-fixing, bid-rigging and marketallocation agreements. The first two are generallyhorizontal agreements. Market allocationagreements can be horizontal or vertical.

Other types of agreements can have anti-competitive effects, depending on the circum-stances. Some are subject to legal prohibitions andremedies in different countries. Remedies and sanc-tions for restrictive agreements are generally similarto those for abuse of dominance. They can includefines, awards of damages or other compensation,orders rescinding agreements and other correctiveorders.


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Box 5-16: Examples of Restrictive Agreements

➢ Price Fixing price fixing agreements among competitors are designed to manipulate pricing. Thesimplest example is an agreement on the prices to be charged to consumers. Variations includeagreements to jointly implement price increases, resist price decreases, establish a formula togenerate uniform prices, or remove lower price products from the market in order to shift demand tohigher price products.

➢ Bid-rigging - is collusion among bidders in order to determine who will win or what the winning priceor conditions will be. Various forms of bid-rigging can occur. Some bidders may agree not to submit abid in response to a particular tender. They may agree to submit tenders at higher prices orincorporate conditions that are deliberately inferior. Another variation involves competitors agreeing totake turns as to which of them is to succeed in a particular tender, a practice often referred to as “bidrotation”. This can inflate prices for all bidders.

➢ Market Allocation – can be implemented by horizontal or vertical agreements. Market allocationreduces competitive entry. In horizontal agreements, competitors allocate geographic or productmarkets amongst themselves. They will agree not to compete in each other’s markets. Suchagreements are anti-competitive, and should almost always be prohibited. In vertical marketallocation agreements, it may be acceptable to support a period of territorial exclusivity. This may berequired to induce investment to develop a market properly. Competition from suppliers of substituteproducts or services may also reduce the anti-competitive impact of such agreements.

Evidence of Anti-competitive Effect

Legal and regulatory approaches to restrictiveagreements vary. In some countries, some forms ofrestrictive agreements are prohibited outright. Inother jurisdictions, prohibitions incorporate areasonableness test.

In the US, for example, collusive arrangementsamong competitors, such as price-fixing and marketallocation, are illegal regardless of whether theagreed restrictions are considered reasonable ornot. Participants to a restrictive agreement can bepunished if it is proven that: (1) such an agreementexists, and (2) it could have anti-competitive conse-quences.

Similarly, Article 81 (formerly Article 85) of the ECTreaty prohibits all agreements between undertak-ings “which may affect trade between MemberStates and which have as their object or effect theprevention, restriction or distortion of competitionwithin the common market”. Article 81 specificallyprohibits price-fixing and production allocationagreements which prevent, restrict or distortcompetition.

A different approach is taken in Canada. There, onlyagreements among competitors that lessen compe-tition “unduly” are prohibited. Accordingly, inCanada, it is necessary to prove: (1) the existence ofa prohibited agreement; and (2) that the agreementlessens competition unduly. This additional require-ment is a major reason why there have been fewsuccessful prosecutions in Canada for agreementsthat would be recognized as anti-competitive in otherjurisdictions.

5.4 Mergers, Acquisitions and OtherCorporate Combinations

5.4.1 Concerns About Mergers

The review and approval of mergers, acquisitionsand other corporate combinations (all referred to as“mergers” for convenience here) is normallyentrusted to competition authorities or otherbranches of government rather than to telecommu-nications regulators. However, there has been ahigh level of merger and acquisition activity in theglobal telecommunications industry in recent years.Consequently, the analysis of mergers andacquisitions can be expected to become a more


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important part of competition policy in the telecom-munications sector.

Many mergers will have little or no negative impacton competition. Some mergers may be pro-competitive, for example, by enhancing productionefficiencies resulting from economies of scale orscope. Mergers may also create new synergies,lead to innovation by combining talents of differentfirms, and provide additional resources to developnew products and services.

Concerns about mergers, acquisitions and othercorporate combinations are generally based on thesame concerns about anti-competitive behaviour asdiscussed earlier in this Module. The main concernis that a larger merged firm may increase its marketpower. To the extent a merged firm becomes moredominant in a market, there is a greater potential toabuse this dominance. Merger controls aim toprevent the accumulation and exercise of marketpower to the detriment of competitors and consum-ers.

The basic rationale for merger control is that it isbetter to prevent firms from gaining excessivemarket power than to attempt to regulate abuses oftheir market power once such power exists. Inpractice, merger reviews and the exercise of relatedpowers by competition authorities are usually basedon an evaluation of the impact of a specific mergeron competition in the relevant markets.

Types of Mergers and Acquisitions

Mergers can be characterized according to threecategories: horizontal mergers, which take placebetween firms that are actual or potential competi-tors occupying similar positions in the chain ofproduction; vertical mergers, which take placebetween firms at different levels in the chain ofproduction (such as between manufacturers andretailers); and other mergers, such as those whichtake place between unrelated businesses orconglomerates with different types of businesses.

Merger reviews typically focus on horizontal mergerssince, by definition, they reduce the number of com-petitors in the relevant markets. Also of concern aremergers between a firm which is active in a

particular market and another which is a potentialcompetitor.

In the telecommunications industry, vertical mergerscan also be of concern. The merger of a firm thatprovides essential inputs to other firms can beproblematic if the supply of those inputs to otherfirms is threatened. For example, the merger of adominant local access provider with a major InternetService Provider can raise concerns about whetherother ISPs will obtain local access services on fairand non-discriminatory terms. Such a merger mightbe reviewed in order to ensure that adequate safe-guards are in place to protect competing ISPs.

5.4.2 Merger Analysis

Large mergers, acquisitions and some othercorporate combinations require prior review andapproval in some jurisdictions. As part of theirreview, competition authorities may prohibit mergersor approve them subject to conditions. Mergers areusually only prohibited or subjected to conditions ifthe authority concludes that the merger will substan-tially harm competition. Given the discretion inherentin the interpretation of this threshold, variouscompetition authorities have published mergerguidelines. These are intended to assist firms andtheir advisers to anticipate the procedures and crite-ria which will be applied in assessing a merger.

An example of such guidelines is contained in theHorizontal Merger Guidelines published in 1997 bythe US Department of Justice and the Federal TradeCommission. The Guidelines set out a five-stageanalysis of the following subject areas:

➢ market definition;

➢ identification of firms participating in the relevantmarket and their market shares;

➢ identification of potential adverse effects of themerger;

➢ analysis of barriers to market entry; and

➢ evaluation of any efficiencies arising from themerger.


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The importance of market definition was discussedin Section 5.2.1. In the context of a merger review,market definition is often the key factor in determin-ing whether a merger is anti-competitive. If a marketis defined broadly, the merging firms may beconsidered to be competitors. A more narrow marketdefinition may result in a determination that the firmsoperate in different markets. On the other hand, abroad market definition could lead to a conclusionthat the merged entity will face sufficient competitionfrom other firms in the market. A narrower definitioncould lead to a conclusion that the merged entitywould have excessive market power in a smallermarket.

The second stage of the analysis is the identificationof firms competing in the relevant market and theirmarket shares. The determination of market sharewill have a direct bearing on an assessment ofmarket power and the potential for abuse of marketpower by the merged entity. The evaluation ofmarket participants includes not only firms whichactually participate in the relevant market, but alsofirms which could be expected to enter it.

In assessing the potential adverse effects of aproposed merger, attention will typically focus on theestablishment or increase of the dominant positionby the merged entity. There may also be concernsthat the merger, by reducing the number of firmsparticipating in a market, will create conditions whichmake anti-competitive agreements among themmore likely.

The evaluation of barriers to entry is an importantaspect of merger review. A finding that there are lowbarriers to entry can help justify a merger.

Finally, the five-stage analysis concludes with anassessment of any efficiencies to be realized as aresult of the merger. In this stage, the objective is toassess efficiency or other welfare gains which canbe projected to result from the merger. These will bebalanced against any anti-competitive effects whichhave been identified in the earlier stages of thereview.

Theoretically, substantial efficiency gains or otherpublic welfare gains could support approval of amerger even where anti-competitive risks are identi-fied. In practice, it is difficult for a competition author-

ity to quantify the positive and negative aspects ofthe transaction and arrive at any verifiable net effect.It may also prove difficult to determine how any effi-ciency or other welfare gains will be distributedbetween the producing firm and its customers.Similarly difficult is the development of any means toensure redistribution of efficiency gains to broaderpublic advantage.

In exceptional circumstances, a merger which wouldhave anti-competitive effects may be permittedwhere one of the merging entities is in severefinancial distress. The competition authority may bepersuaded that the public interest is better served bya merger than by the failure of one of the mergingentities. However, transactions of this sort should becarefully evaluated. Sometimes the merger is not thebest solution. For instance, it may be that anotherfirm could expand productive capacity using theassets of the failing firm and that public welfarewould be better served by this alternative solution.Bankruptcy is painful for shareholders, but does notalways have a long-term negative effect on theeconomy.

Information in Merger Reviews

As part of the merger review process, the mergingfirms must normally provide information to thereviewing authority. It is standard practice in jurisdic-tions which impose merger review to require partiesto the merger to submit advance notice of theproposed transaction. The information disclosed inthe pre-merger notification will normally be used bya competition authority in the first stage of mergerreview (i.e., to determine if any anti-competitiveconcerns are present and whether to proceed with amore detailed review of the proposed transaction).

The contents of pre-merger notifications aregenerally defined by law or regulation. Required in-formation typically includes:

➢ the identity of the firms involved in the proposedtransaction;

➢ a description of the nature and commercialterms of the transaction;

➢ the timing of the transaction;


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➢ financial information on the firms involved(including revenue, assets and copies of annualor other financial reports);

➢ identification of related ownership interests andthe organizational structure of the firms involved,and

➢ a description of the relevant product and servicemarkets in which the firms operate.

The initial information filing typically triggers awaiting period, during which the reviewing authoritywill be entitled to request further information. Thisprocess concludes with a determination by thereviewing authority whether to proceed with a moredetailed investigation.

If the competition authority decides to proceed with afurther investigation, it will obtain more informationfrom the merger participants. Additional informationis usually gathered from third parties such as com-petitors and customers. Commercially sensitiveinformation is also generally protected from publicdisclosure.

During a more detailed review, a competitionauthority will normally seek information aboutmatters such as the following:

➢ products, customers, suppliers, market shares,financial performance;

➢ activity of competitors and competitors’ marketshares;

➢ availability of substitute products;

➢ influence of potential competition (includingforeign competition);

➢ pace of technological or other change in therelevant markets, and its impact on competition;and

➢ nature and degree of regulation in the relevantmarkets.

The quality of a merger review will depend heavilyon the quality and range of information available tothe reviewing authority.

5.4.3 Merger Remedies

The goal of merger control laws is to prevent orremove anti-competitive effects of mergers. Threetypes of remedies are typically used to achieve thisgoal:

➢ Prohibition or Dissolution - The first remedyinvolves preventing the merger in its entirety, orif the merger has been previouslyconsummated, requiring dissolution of themerged entity.

➢ Partial Divestiture – A second remedy is partialdivestiture. The merged firm might be requiredto divest assets or operations sufficient to elimi-nate identified anti-competitive effects, withpermission to proceed with the merger in otherrespects.

➢ Regulation/Conditional Approval - A thirdremedy is regulation or modification of thebehaviour of the merged firm in order to preventor reduce anti-competitive effects. This can beachieved through a variety of one-time condi-tions and on-going requirements.

The first two remedies are structural, and the thirdremedy is behavioural. Behavioural remediesrequire ongoing regulatory oversight and interven-tion. Structural remedies are often more likely to beeffective in the long run and require less ongoinggovernment intervention.

Partial divestiture or behavioural constraints are lessintrusive in the operation of markets than preventinga merger from proceeding or requiring dissolution ofa previously completed merger. Partial divestiturecan reduce or eliminate anti-competitive effectswhile preserving some of the commercialadvantages of a merger. Partial divestiture isemerging as a preferred remedy in many jurisdic-tions. Although it has since been abandoned, theproposed Telia/Telenor merger, which is describedin Box 5-17 provides a good illustration of the use ofthis remedy.


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Box 5-17: Case Study - The Telia / Telenor Merger

On 13 October 1999, the European Commission approved the merger of Swedish telecommunicationsoperator, Telia AB and Norwegian operator, Telenor AS into a new company to be jointly controlled by theSwedish and the Norwegian governments.

On its initial review, the Commission identified a number of concerns due to the breadth of operations andmarket presence of Telia and Telenor, in their respective domestic markets. In addition, the Commissionexpressed concern with certain overlapping interests, such as the interest of each operator in competingmobile companies in Ireland. In addition, a significant concern was raised about Telia and Telenor’sownership of cable TV networks in each of their domestic markets.

To secure Commission approval of the proposed merger, Telia and Telenor volunteered the followingcommitments:

➢ each of Telia and Telenor would divest its cable television operations;

➢ each company would divest overlapping operations in the Swedish and Norwegian markets;

➢ one of Telia or Telenor would divest its Irish mobile telephone interests; and

➢ each of Telia and Telenor would implement local loop unbundling in its domestic market to facilitatethe development of local competition.

The divestiture of cable assets is consistent with the Commission’s Cable Ownership Directive. The commit-ments made to secure Commission approval for the merger represent a mix of structural and behaviouralremedies to address identified anti-competitive effects. The commitments to divest operations are structuralremedies. The commitment to implement local loop unbundling is a behavioural remedy requiring ongoingregulatory oversight.

Note: Although the merger was conditionally approved, it was later abandoned due to inability to agree oncertain implementation matters.

We will now move to behavioural remedies. Someproposed mergers raise concerns about the poten-tial for ongoing anti-competitive behaviour by themerged firm. Remedial orders issued in response tothese concerns are generally similar to the remediesfor abuse of dominance discussed earlier in thisModule. Box 5-18 describes the US FCC’s decisionsin recent Bell Operating Company mergers in theUS. It illustrates the types of behavioural remediesthat may be imposed in telecommunications industrymergers. These orders are likely to focus on thesupply of products or services to competitors and

the prevention of anti-competitive pricing practicesby the merged entity.

A merger may impact existing regulatory treatmentof one or more of the merged firms in a number ofways. For example, if a merger significantlyincreases a firm’s market share or market power, theregulator may review earlier decisions to forbearfrom regulation. Similarly, it may review an earlierdetermination that an entity involved in the mergerwas not dominant in its market, and was thus enti-tled to a lighter degree of regulation.


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Box 5-18: Case Study - FCC Review of Bell Atlantic/Nynex and SBC/Ameritech Mergers

The Bell Atlantic/Nynex Merger

On 14 August 1997, the FCC approved the merger of Nynex Corporation into Bell Atlantic Corporation.The FCC’s review was conducted pursuant to sections of the Communications Act of 1934, which requiresFCC approval for transfers of operating licences and other authorizations. These sections required ademonstration that the merger is in the public interest. Accordingly, the parties to a proposed merger havethe onus of proving that the transaction will enhance competition or that it will otherwise be in the publicinterest. The merger was also subject to approval of the US Department of Justice (DOJ).

In this and other merger reviews, the FCC applied the 1997 DOJ/FTC Horizontal Merger Guidelines. TheFCC also evaluated the proposed merger on the assumption that the market opening initiatives introducedby the Telecommunications Act of 1996 had been implemented. Applying this framework, the FCCconcluded that the merger would have significant anti-competitive effects.

The first concern was that the merger would remove Bell Atlantic as a potential Nynex competitor in theNew York market. The second concern was that continuing Bell Operating Company consolidationincreased the likelihood of co-ordinated action among the remaining market participants.

The FCC reviewed claims of merger-related efficiencies put forward by the parties (including cost savings,accelerated broadband deployment and service quality improvements), and concluded that these fell farshort of overcoming anti-competitive effects and of demonstrating a net public benefit. The FCC concludedthat substantial barriers to entry would remain and that, without the benefit of additional measures, marketentry could not be relied upon to constrain the exercise of market power.

Ultimately, the FCC decided to approve the proposed merger based on the following market openingcommitments volunteered by Bell Atlantic. These commitments were to be made enforceable conditions forapproval of the merger:

➢ the provision of detailed performance monitoring reports to competitors and regulators regardingperformance of Bell Atlantic’s networks and operational support systems (OSS);

➢ negotiated performance standards and enforcement mechanisms covering all major aspects of OSSoperation and network performance;

➢ development and implementation of uniform OSS interfaces for the combined Bell Atlantic / Nynexregion;

➢ operator-to-operator OSS testing in response to competitor requests, with a further obligation ofproviding evidence to the FCC that OSS functions could meet demand for resold services andunbundled network elements;

➢ offering interconnection, unbundled network elements and transport and termination services atrates based on forward-looking economic cost;

➢ offering unbundled switching and shared transport services priced on a per minute of use basis,routed in the same manner as Bell Atlantic’s phone traffic and without the imposition of accesscharges; and

➢ optional payment plans permitting new entrants to pay recurring charges for what would otherwisebe non-recurring charges, an installment payment plan for co-location and other large non-recurringcharges and alternative payment mechanisms for common construction costs and competitor-specific construction and equipment costs (with cost apportionment consistent with earlier FCCorders).

These conditions were subject to a sunset limitation. They were due to expire 48 months following therelease of the merger approval order.


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Box 5-18: Case Study - FCC Review of Bell Atlantic/Nynex and SBC/Ameritech Mergers (cont’d)

The SBC / Ameritech Merger

On 6 October 1999, the FCC approved the merger of Ameritech Corp. into SBC Communications Inc. FCCapproval was required and proceeded under the same statutory framework as the Nynex / Bell Atlanticmerger. As a result of the merger, SBC will control three of the original seven Regional Bell OperatingCompanies (Southwestern Bell Telephone, Pacific Telesis and Ameritech). Perhaps because of thisgreater degree of consolidation, the FCC appears to have required a more onerous set of conditions inorder to approve the merger.

In its review, the FCC was primarily concerned about the effects of the merger in removing a significantpotential competitor from each of the participating firms’ local markets. Concerns were also expressedabout impeding the implementation of the market-opening requirements of the Telecommunications Act of1996. Again, the FCC concluded that claimed efficiencies and other merger benefits were insufficient toovercome the identified anti-competitive effects.

Both the DOJ and FCC reviews of the SBC / Ameritech merger concluded that the merged entity wouldhave to divest itself of cellular telephone licences in identified service markets (14 in all). This wouldeliminate overlapping operations by the two merged firms in those markets. The FCC concluded that thetransfer of Ameritech’s international authorizations to SBC would be approved subject to the SBCsubsidiaries being classified as dominant international operators on US-South Africa and US-Denmarkroutes.

The most striking aspect of the FCC Decision is the range of conditions to be imposed on the mergedentity. The conditions (30 in all) include:

➢ establishing a separate affiliate for the deployment of advanced services (which must obtain facilitiesand services from SBC companies on the same terms as competitors and be subject to a“comprehensive” annual audit);

➢ enhanced OSS loop information and loop conditioning to facilitate competition in advance services;

➢ enhanced OSS and performance measurement data to improve and monitor interconnection andother competitor provisioning (with identified “incentive payments” to be made by SBC ifperformance measures are not met);

➢ interconnection agreements to be made available on a multiple state and “most-favoured-nation”basis;

➢ identified operator-to-operator “promotions”, including a loop discount of 25% off the otherwiselowest monthly loop charge (subject to “state-specific quantity limits”);

➢ a commitment to enter at least 30 out of territory, major markets as a facilities-based competitivelocal service provider (to business and residential customers) within 30 months of the merger closing(and subject to an “incentive payment” of up to $1.2 billion U.S if the entry requirements are not metin all 30 markets); and

➢ a number of residential service enhancements, including “life line plans” for low-income subscribersand additional quality of service and network reliability reporting requirements.

These conditions are of limited duration. SBC undertook that each of the conditions would remain in effectfor a period of 36 months from first implementation.


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5.4.4 Joint Ventures

In some cases, telecommunications competitorsmay enter into joint ventures. The competitionanalysis of joint ventures generally raises similarissues to those discussed under the title RestrictiveAgreements earlier in this Module. The process andinformation requirements for review of a joint venturewill resemble those discussed earlier under the titleMerger Analysis and Remedies.

Questions will be raised about whether a jointventure will bring about a significant reduction in

competition or result in the exercise of market powerto the detriment of competitors or consumers. Jointventures can become vehicles for anti-competitivecollusion between firms that would otherwise becompetitors. Such ventures can also result in thecreation or reinforcement of a dominant position.

Box 5-19 illustrates some of the considerationstaken into account in a large-scale telecommunica-tions joint venture recently reviewed by theEuropean Commission.

Box 5-19: Case Study - The BT/AT&T Joint Venture

On 30 March 1999, the European Commission approved the creation of a joint venture between BritishTelecommunications plc and AT&T Corp. to create a global telecommunications services company. Thefinal decision marked the conclusion of an in-depth inquiry commenced in December 1998. This inquiry wasprompted by concerns that:

➢ The joint venture would create or reinforce a dominant position in the supply of internationaltelecommunications services to large corporations and other telecommunications operators;

➢ the joint venture would create or reinforce a dominant position for certain telecommunicationsservices in the U.K.; and

➢ the joint venture would result in anti-competitive co-ordination in the U.K. market given AT&T’sownership interests in competitors to BT (ACC and Telewest).

The joint venture was assessed with a view to determine whether it would create or strengthen a dominantposition and significantly impede competition contrary to Article 2 of the European Community MergerRegulation and Article 85 (now 81) of the EC Treaty.

The Commission concluded that the presence of substantial competition in the international servicesmarkets, as well as “plentiful additional capacity” supported the conclusion that the joint venture did notcreate or strengthen a dominant position. Although the Commission found that AT&T and BT had about halfthe traffic volume on the U.K./US route, it also found that the parties controlled only about 20% of capacitywith planned additional capacity and falling prices for new capacity supporting competitive entry.

However, the Commission expressed a number of “co-ordination concerns” regarding U.K. markets. Theseincluded concerns about AT&T’s interests in BT competitors ACC and Telewest (the former a competitivelong distance telephone services provider, the latter a major operator of telephony enabled cable TVsystems). The Commission was also concerned about the distribution of AT&T /Unisource internationaltelecommunications services in the U.K. To overcome these concerns, AT&T volunteered undertakings to:

➢ divest its interests in ACC U.K.,

➢ reinforce the structural separation between AT&T and its Telewest holdings, and

➢ facilitate the appointment of another Unisource services distributor in the U.K. (since the existing U.K.distributor, AT&T U.K., would be wound up).

The Commission granted approval for the joint venture subject to compliance with these undertakings.

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6 - 1

MODULE 6

UNIVERSAL SERVICE

6.1 Universal Service and UniversalAccess

6.1.1 Introduction

This Module deals with the concepts of universalservice (US) and universal access (UA) in the tele-communications sector. These concepts can bedescribed as follows:

Universal Service policies generally focus onpromoting or maintaining “universal” availabilityof connections by individual households topublic telecommunications networks. The objec-tive of connecting all, or most, households topublic telecommunications networks is generallyreferred to as the “Universal Service Obligation”(USO). US is a practical policy objective in manyindustrialized countries. However it is noteconomically feasible in most developingcountries, where universal access is a morepractical objective.

Universal Access generally refers to a situationwhere every person has a reasonable means ofaccess to a publicly available telephone. UAmay be provided through pay telephones,community telephone centres, teleboutiques,community Internet access terminals and similarmeans.

While US and UA policies can be quite different, theconcepts are closely related. In some cases, theterms US, USO and UA are used interchangeably.In this Module, we use the term universality to referto both US and UA.

The overriding objectives of universality policies areto expand and maintain availability of affordabletelecommunications services to the public. Inparticular, US and UA policies are aimed at provid-ing or maintaining service to those who would notnormally be served. This population includes thosein high cost service areas, such as rural and remoteregions, as well as lower income groups.

This Module reviews the key issues in the develop-ment and implementation of universality policies andprograms.

Section 6.1 provides background information ontelecommunications universality. It lists the mainobjectives for introducing universality programs, anddescribes the economics of universality.

Section 6.2 deals with the definition of US, UA andthe USO. The definitions vary among countries. Theunderlying economics of universality suggest thatricher industrialized countries will focus on providinga range of increasingly sophisticated services to


6 - 2

every household, while developing countries willfocus on providing public access.

Innovative programs in countries such as SouthAfrica, Chile and Peru demonstrate that it is possibleto make advanced telecommunications services,including Internet access, available to the public at areasonably low cost. Good universality policies cango a long way to bridging the “digital divide” between“online” and unserved populations in developing aswell as industrialized countries.

Section 6.3 addresses the question: How to funduniversality programs? That section reviews themain approaches used in different countries. Theseapproaches include:

➢ Market-Based Reforms: especially privatiza-tion, competition and cost-based pricing;

➢ Mandatory Service Obligations: imposed bylicence conditions or other regulatory measures;

➢ Cross-subsidies: between or within servicesprovided by incumbent operators;

➢ Access Deficit Charges (ADCs): paid bytelecommunications operators to subsidize theaccess deficit of incumbents; and

➢ Universality Funds: independently adminis-tered funds that collect revenue from varioussources and provide targeted subsidies toimplement universality programs.

These approaches are not mutually exclusive. Mostcountries use more than one approach.

Industrialized countries have gradually introducedmarket-based reforms, such as privatization,competition and cost-based pricing over the last twodecades. Despite concerns to the contrary, theevidence suggests that teledensity levels increased,and did not decrease, after these reforms were im-plemented. Many other countries around the world,with historically lower telecommunications penetra-tion levels, have also introduced similar reforms inrecent years. In these countries, well-designedsector reforms have led to large gains intelecommunications service penetration levels.

Traditionally, most countries have relied to someextent on the second and third approaches listedabove: that is, mandatory service obligations andcross subsidies. These mechanisms were intendedto subsidize unserved or high cost subscribers fromrevenues earned from other subscribers or services.Such transfers are often implicit rather than explicit.International and long distance services, for exam-ple, have traditionally been priced well above cost.Surplus revenues from these high-priced serviceswere intended to be used to subsidize higher cost orlower margin services, particularly residential localaccess lines.

Today, cross-subsidies between services areincreasingly viewed as impractical and anti-competitive. With the onset of competition ininternational and long distance services, rates havefallen. This has left smaller subsidies available tosupport the universality objective.

Economists and other telecommunications expertshave long criticized inter-service cross-subsidies.Cross subsidies can promote inefficiency and de-press demand for services (e.g. Internet services)that must pay artificially high international rates.They also constitute a form of hidden taxation, whichmay be regressive. For example, a cross-subsidyregime may require poor migrant workers, who willnever be able to afford a personal telephone, to payhigh long distance rates to subsidize individual lineservices to their wealthier fellow citizens.

Finally, large cross-subsidies have fallen out offavour with telecommunications experts todaybecause they simply have not been effective as atool to promote universality. Some of the countrieswith the highest international, business and longdistance service rates in the world have retainedsome of the lowest telephone penetration orteledensity rates. Other countries with similar orlower levels of GDP have often increased theirteledensity levels significantly after implementingalternative approaches to promoting universality.

Access Deficit Charges are used to promote univer-sality in some countries. An ADC regime is like atraditional cross-subsidy regime, but modified to fit acompetitive market. In an ADC regime, otheroperators pay subsidies to finance the total localaccess deficit incurred by the incumbent in providing

Module 6 – Universal Service

6 - 3

Universal Service

local services that are priced below cost. Like cross-subsidies that are internal to the incumbent, ADCshave been criticized for their reliance on inefficientand potentially anti-competitive subsidies. A numberof regulators, including those in Australia andCanada, have reformed their ADC regimes by tar-geting subsidies to finance only the access deficitincurred in providing service to high-cost areasand/or low-income subscribers. Others, such as theUK’s Oftel, have abolished ADCs altogether.

The final approach discussed in this Module is theuniversality fund. This approach is seen as the bestoption in an increasing number of industrialized anddeveloping countries. The approach has manyvariations. These are sometimes called USO funds,US funds or UA funds.

Universality funds collect revenues from a variety ofsources. These include government revenues,charges on interconnecting services and levies onall telecommunications service operators. The reve-nues collected in these funds are then used in avariety of ways to promote universality objectives. Incontrast to ADCs, universality funds are generallyused to finance specific and targeted high cost areasand/or low income subscribers. In practice, the mostefficient funds provide relatively small subsidies toincent private sector telecommunications operatorsto expand their networks to serve specificallytargeted service areas. These are typically areaswhere service would otherwise be uneconomic (i.e.where costs cannot be recovered from availablesubscriber revenues).

Section 6.4 addresses the main issues involved indesigning an effective universality fund.

The last half of this Module is devoted to casestudies of universality policies and programs in arange of different countries. The case studies arereferred to throughout the Module to illustrate vari-ous approaches and issues.

6.1.2 Objectives of Universality Policies

Governments and regulators pursue universalitypolicies for different reasons. In many countriesthere is strong political support for extending US orat least UA to unserved members of the public.

The following are some of the major objectives forimplementing universality policies:

➢ To permit full participation in 21st Centurysociety. Access to telecommunications is in-creasingly being viewed by policy makers as abasic right of all citizens, essential to fullmembership in the community. The objective ofensuring access is gaining momentum due tothe increased reliance on the Internet and re-lated new media by all sectors of society. It iswidely recognized today that telecommunica-tions services are necessary for far more thanpersonal and business communications. Today,telecommunications delivers all types ofinformation, goods and services to the public;including essential government, social, educa-tional and medical services, and a wide range ofe-commerce services. Those without access totelecommunications services risk becomingincreasingly marginalized members of 21stCentury society.

➢ To promote national political, economic andcultural cohesion. These nation-building consid-erations call for the widespread availability oftelecommunications throughout a country'sterritory. Creating a single market, and even asingle nation-state, requires effective telecom-munications.

➢ To promote economic development. While therelationship between economic and telecom-munications development is a complex one, anincreasing amount of research suggests thattelecommunications leads to economic growth.With the increasing ubiquity of the Internet ande-commerce, countries or regions withoutadequate telecommunications infrastructure willnot be able to reap the benefits of the “neweconomy”.

➢ To encourage more balanced distribution of thepopulation. Telecommunications can encouragedevelopment outside congested metropolitanareas. This objective is often cited in industrial-ized countries, where “telecommuting” can easetraffic and pollution in urban areas.

➢ To eliminate disparity between rural and urbanareas. This objective is particularly apt in lower


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income countries. Figure 6-1 illustrates thedisparity between urban and rural access totelecommunications in various regions. Only inhigh-income countries is the ratio of urban to ru-ral teledensity close to being balanced. Theratios of urban to rural teledensities indeveloping regions is considerably higher,ranging from a high of about 7:1 in South Asia,to a low of the about 2.5:1 in Eastern Europe,Central Asia, Latin America and the Caribbean.

6.1.3 The Economics of Universality

Universality and Economic Development

➢ The most important determinant oftelecommunications universality is economicdevelopment. There is a strong relationship

between the national telephone penetration rate,and a nation’s per capita Gross DomesticProduct (GDP). Figure 6-2 illustrates therelationship between teledensity and per capitaGDP.

➢ The strong relationship between teledensity andGDP per capita provides explanations for majordifferences in teledensity in different countries. Itis not surprising that countries such as the USA,Canada, Japan, France and Germany rank highin teledensity levels, compared to mostcountries in Africa, for example. A sample ofteledensity levels reported by the ITU is includedin Table 6-1.

Figure 6-1: Ratios of Urban to Rural Telephone Density by Region

0 1 2 3 4 5 6 7

S o u t h A s i a

E a s t A s i a a n dP a c i f i c

M i d d l e E a s ta n d N . A f r i c a

S u b - S a h a r a nA f r i c a

L a t i n A m e r i c aa n d C a r i b b e a n

E . E u r o p e a n dC e n t r a l A s i a

H i g h - i n c o m ee c o n o m i e s

N o t e : T h e r a t i o i s t h e n u m b e r o f m a in l i n e s p e r 1 0 0 p e o p le i n t h e l a r g e s t c i t i e s d i v i d e db y t h e n u m b e r p e r 1 0 0 p e o p le o u t s i d e t h e l a r g e s t c i t i e s .S o u r c e : T h e W o r l d B a n k ( 1 9 9 8 )


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Universal Service

Figure 6-2: Teledensity and GDP per capita

0102030405060708090

100

0 5000 10000 15000 20000 25000 30000 35000 40000

GDP/capita (USD)

Tele

dens

ity (l

ines

/100

pop

.)

Source: ITU (1999)

In general the maximum amount of revenue avail-able to fund telecommunications networks andservices depends on per capita income levels withina country. It is clear, from Table 6-1, however, thatper capita income levels do not absolutely determineteledensity levels. Table 6-1 illustrates that there aremany variations in the relationship between GDPper capita and teledensity. For instance, the distribu-tion of income within a country will determine thenumber of households that can actually afford tohave access to telecommunications services. Thetable also makes it clear that penetration of publictelephone lines and cell phones varies considerablyacross the range of countries illustrated.

In some of the least developed countries, aid fromforeign governments and multilateral institutions,such as The World Bank, has provided supplemen-tary resources to expand teledensity levels. Cross-subsidies from international telephone accountingrates, and other external sources have also

increased teledensity levels in some countries.However, such sources of external revenues aredeclining. This decline is due, in part, to the wide-spread perception that scarce public developmentfunds should be devoted to other purposes sinceprivate capital is generally available to fund tele-communications network development.

Expenditures on Telecommunications

Although national per capita income levels impose aconstraint on universality, there are significant differ-ences in the percentage of income that is spent ontelecommunications in different countries. Forexample, in some countries with a relatively lowGDP per capita, less than 1% of GDP is spent ontelecommunications. In other countries with similarGDP per capita, as much as 4% or 5% of GDP isspent on telecommunications. These differencesand the general trend in telecommunicationsspending are illustrated in Figure 6-3.


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Table 6-1: Teledensity in Selected Countries

Country GDP per capita (in1997 USD)

Teledensity(Telephone lines per

100 people 1998)

Public teledensity(Public telephone

lines per 1000people 1998)

Mobile cellularphones (per 100

people 1998)

Angola 1,684 1.0 0.0 0.1

Argentina 8,214 20.0 2.7 7.9

Bangladesh 262 0.3 0.0 0.1

Cameroon 617 0.5 0.0 0.0

Canada 20,608 63.4 6.1 17.6

Colombia 2,424 17.3 1.4 5.0

Czech Republic 5,052 36.4 3.6 9.4

Egypt 1,195 6.0 0.1 0.1

Germany 25,625 56.7 1.9 17.0

Haiti 447 1.0 - -

India 451 2.0 0.4 0.1

Indonesia 1,068 3.0 1.1 0.5

Japan 33,231 50.3 6.2 37.4

Mexico 4,216 10.4 3.3 3.5

Morocco 1,218 5.4 1.1 0.4

Nepal 220 0.9 0.0 -

Peru 2,676 6.7 2.0 3.0

Russia 3,030 20.0 1.3 1.0

South Africa 2,979 11.5 3.5 5.6

Thailand 2,478 8.4 2.0 3.3

Ukraine 974 19.1 1.1 0.3

USA 30,173 66.1 6.5 25.6

“-“means zero or a quantity less than half the unit shown.

Source: ITU (1999)

The international experience provides a good rule ofthumb for testing the effectiveness of universalitypolicies. There are differences in national telecom-munications expenditures. However, on average,

around the world, people spend about 2% to 3% oftheir incomes on telecommunications. This relationgenerally holds true for whole countries, regions,cities, and on average to households.


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Universal Service

Figure 6-3: Telecommunications Revenues as % of GDP

01234567

0 10000 20000 30000 40000GDP/capita (USD)

Tele

com

s R

even

ue a

s %

of

GD

P

Source: ITU (1999)

This rule of thumb that an average of about 2.5% ofper capita income is spent on telecommunicationsworldwide is useful in a number of ways. Forexample:

➢ Where the costs of providing telecommunica-tions access is greater than 2.5% of localincomes, external subsidies may be required topromote UA. Funding mechanisms, such as auniversal access fund, can be designed with thisrule of thumb in mind. Local residents will gen-erally be willing and able to pay about 2.5% oftheir incomes on telecommunications services,and the fund may be required to subsidize therest of the costs.

➢ Where it would cost less than about 2.5% oflocal income to provide telecommunicationsservices, but no service is available an area,there is often a sector policy problem. In manycases, one or more of the following problemsexists:

➢ Poor telecommunications sector governance

➢ No priority given to telecommunicationsdevelopment

➢ No reliance on private sector funding to ex-pand networks

➢ No competition in relevant telecommunica-tions markets

➢ No effective universality policies

In many countries, lack of supply and not lack ofdemand is the principal reason for low teledensity.Problems, such as those listed above, have resultedin long waiting lists for telephone service in manydeveloping countries. As illustrated in Figure 6-3,consumers around the world are willing spend areasonable percentage of their income ontelecommunications, if service is provided to them.

A review of international experience makes it clearthat the actions of governments and regulatorsdetermine the level of universality that is achieved ina specific country. While national incomes placeconstraints on the upper level of universality, it isclear that some countries have been far more suc-cessful than others in providing their citizens withaccess to telecommunications.

Specific examples of experience with universalitypolicies are found in the case studies in theAppendix to this Module. The case studies of coun-tries such as Peru and Chile demonstrate that gooduniversal access policies can significantly expandservice without large government expenditures,even in remote areas with low income levels.


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It is clear that low teledensity levels in many devel-oping countries have two distinct causes: (1) under-supply of telecommunications services due toinadequate sector policies, and (2) low demand dueto low incomes. The first cause should be addressedfirst. The most effective and lowest-cost means toincrease teledensity in countries that have notalready done so, is to implement telecommunica-tions sector reforms such as competition,privatization and pricing reform (e.g. pricerebalancing). Evidence around the worlddemonstrates that reforms of this type will removemany supply constraints on the sector.

However, such sector reforms will generally not besufficient to address the second cause of universal-ity problems – insufficient local incomes to supportthe rollout of telecommunications networks. Most ofthis Module is devoted to regulatory approaches thataddress that second cause of universality problems.The main approaches are mandatory service obliga-tions, cross-subsidies, ADCs and universality funds.

Before reviewing these approaches, however, wewill consider the definitions of US, UA and the USO.

6.2 Defining Universality: What toFund?

6.2.1 Different Countries: DifferentApproaches

Reasons to Define US and UA

Countries have defined universal service (“US”)and/or universal access (“UA”) for a number ofreasons. In some cases, universality definitions havebeen established as a part of national telecommuni-cations development plans. Such definitionssometimes include specific target dates and servicelevels.

In some countries, state planners or policymakersprescribed certain levels of universality. Suchprescribed levels were often included in telecommu-nications policies or national plans. This wasparticularly true in some centrally plannedeconomies with state-owned operators, or econo-

mies with former state-owned operators that are intransition to market economies. Such definitions ofuniversality were sometimes unrealistic, and manyuniversality targets have been missed in developingor transitional economies. “Planned” levels ofuniversality will only be effective where they arelinked to realistic implementation measures,including funding mechanisms.

More care should be taken in defining US or UAwhen specific universality implementation measuresare introduced. Such definitions are generally devel-oped to define the mandatory service obligations ofan operator that is designated as a “UniversalService Provider”. A definition may be included inthe licence conditions of the US provider at the timeof its privatization. Definitions are also required aspart of specific USO funding mechanisms, such asADCs and universality funds.

Matching Universality Definitions to LocalConditions

The definitions of telecommunications universalityare very different, for example, in Switzerland than inPakistan. Realistic universality definitions reflectlocal economic and sector conditions. The level anddistribution of national income are important factors.Another key factor is the distribution of a country’spopulation. The resources required to provide tele-communications services to the same number ofpeople will vary depending on whether the majorityof the population is concentrated in metropolitanareas, or is widely dispersed in rural areas. Nationalgeography, topology and security matters may alsobe important factors.

Two distinct aspects can be noted in the definition ofuniversality in all countries:

Types of access – At the most general level,the difference between US and UA is that theformer generally refers to individual or private(exclusive) access, while the latter refers tocommunity or public (shared) access. Univer-sality definitions sometimes includerequirements for a certain level of both privateand public access.


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Universal Service

Types of services - Basic access is typicallydefined to include voice-grade fixed access tothe PSTN. However, many universality defini-tions amplify this requirement. Some countriesinclude enhanced or value-added services,including Internet access, within the scope oftheir universality regimes.

As a general rule, developing and transitionalcountries place greater emphasis on basic publicaccess. Industrialized countries can afford to defineuniversal service more broadly to include advancedfeatures. Details of different types of universalitydefinitions are included in the following sections.

6.2.2 Universal Service in IndustrializedEconomies

Table 6-2 provides a summary of the types ofservice contained in the definitions of universalservice in selected OECD member countries. Thetable provides a good sense of the scope of univer-sality as currently defined in those countries. Itshould be kept in mind that the definitions are notstatic. They are evolving with market conditions andpublic demand.

A review of the definitions in Table 6-2 makes it clearthat most of the listed OECD countries have defineduniversal service to include much more than basicpublic access to voice telephony. In most cases, theprescribed level of universal service must beprovided to individual subscribers on demand atregulated rates. In some cases, these regulatedrates are fixed below cost and subsidized throughcross-subsidies, ADCs or universality funds. Detailsof funding approaches are provided in Section 6.3and in the case studies in the Appendix.

6.2.3 Universal Access in Developing andTransitional Economies

Many different universality definitions and objectivesare used in developing and transitional economies.

Table 6-3 provides a selected list of universalaccess policies and operator obligations establishedby various developing and transitional economies.

In all but the richest of the developing and transi-tional economies, it is unrealistic to set a universalservice objective of providing fixed telecommunica-tions service to each household, at least in the nearterm. In such economies, the regulatory focus tendsto be expansion of access services. Effective uni-versality policies in these countries generallyconcentrate on:

➢ Expansion of new access services, rather thansupport of existing services

➢ Expansion of services to remote or high costareas and low income subscriber groups, whereit is currently uneconomic to provide service

➢ Priority on public access services, rather thanprivate household access

Table 6-3 provides examples of some “disconnects”between the definition of universal access and themechanism to implement such access. Forexample, in a number of countries where the UAdefinition calls for a phone in every village, no obli-gations are imposed on the incumbent operator tosupply such phones. More significantly, in manycountries, no funding mechanism is defined toimplement the universality objectives.

Modelling the Viability of Universality Programs

A number of analytical tools are available to regula-tors and policy makers to develop realisticuniversality definitions and implementation policies.Financial models have been developed to determinethe cost and feasibility of expanding service tounserved areas. In general, these models calculatethe difference between the cost of providing servicein specific regions and the projected telecommuni-cations revenues available in those regions.


6 - 10

Table 6-2: Universality in Selected Industrialized Countries

Summary of Definitions of Universal Service in Selected OECD Countries

Australia Standard telephone services, including voice telephony and, if voice telephony isnot practicable due to a disability, another form of communication equivalent tovoice telephony (e.g. a teletypewriter); payphones; prescribed carriage services.

Canada Individual line local service with touch-tone dialing, provided by a digital switch withcapability to connect via low speed data transmission to the Internet at local rates;enhanced calling features, including access to emergency services, VoiceMessage Relay service, and privacy protection features; access to operator anddirectory assistance services; access to the long distance network; a copy of acurrent local telephone directory.

USA Voice-grade access to the PSTN, with the ability to place and receive calls; DualTone Multi-frequency (touch-tone) signaling or its functional equivalent; single partyservice; access to emergency services; access to operator services; access todirectory services; access to long distance services.

Austria Access to the PSTN via a fixed network connection, through which a fax machinealso can be operated, including the transfer of data at rates compatible withtransmission paths for voice communication; free access to emergency services;access to directories of subscribers, as well as directory enquiry services; publicpay telephones.

Denmark A telephony network and an associated telephony service; an ISDN network andthe associated ISDN services; leased lines (excluding broadband lines); specialservices and tariffs for disabled subscribers; public radio-based maritime distressand safety services; directory enquiry services.

Italy Voice telephony (also capable of providing fax G3 and data transmission);provision of directory for local area users; provision of customer informationservice; payphones; special services for the disabled; connection to emergencyservices.

Norway Public voice telephony; operator assistance; emergency and directory inquiryservices; public payphones.

Spain Basic telephone service including local, national and international access; freedirectory services; public phones; special services for disabled people.

Switzerland Real time voice transmission or voice band and digital data transmission, keypadtone dialing and main entry in telephone directory; additional services such as callforwarding, privacy protection, itemized billing and outgoing call barring;emergency services; directory services; public telephones; text service; operatorassistance.

United Kingdom Connection to the fixed network able to support voice telephony and with speeddata and fax transmission (and the option of a more restricted service package at alower cost); public telephones; free access to emergency services; itemized billing;selective call barring; access to operator assistance and directory assistance.

Source: Adapted from OECD (1999)


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Universal Service

Table 6-3: Universality in Selected Developing and Transitional Economies

Summary of Universality Access Definitions and Obligations

Country Universal Access policy Operator Obligations

Bhutan A phone booth in every village. No obligations.

Comoros A phone in every locality. No obligations.

Costa Rica Within 1 km of both public and privateaccess.

No obligations.

Cuba Access to all villages and to communitiesof more than 500 inhabitants.

Licence conditions stipulate by theend of the first 8-year programmeall villages of more than 500inhabitants must have access.

Ethiopia A phone booth in every town. Obligations under preparation.

Guinea A telephone box for every locality; a tele-phone exchange for every administration.

Service and interconnectionexpected; no specified obligations.

Iran Telephone facilities to all villages of morethan 100 people.

Expansion, service quality, inter-connection and service to theelderly as part of licenceconditions.

Kenya A phone within walking distance. A performance contract entailsobligations on service quality andexpansion.

Kyrgyzstan A phone booth in every town; a phone inevery home.

Expansion, service quality andinterconnection contracted withthe government.

Lesotho A public telephone within 10 km of anycommunity.

Voluntary objective to be achievedby 2002.

Madagascar A public phone in every village. No obligations.

Maldives At least one telephone booth per 500inhabitants; a phone on every island.

Operator’s licence condition is toprovide access to basic telecom-munications services to the wholecountry by the year 2000.

Mozambique A public telephone within distance of lessthan 5 km. At least one public telephone ineach of the 144 district centres.

Expansion, service quality andinterconnection contracted withthe government.

Pakistan A phone in every village. No obligations.

Togo A telephone within a 5 km radius by 2010;a telephone in every administrative andeconomic centre of importance

Contract with the state todetermine the objectives fordevelopment and plurality ofservice.

Zambia Telephone booths in public places(schools, clinics, etc) countrywide.

No obligations.

Source: Adapted from ITU (1998a)


6 - 12

Cost projections may be based on specific networkconstruction studies, or on local or internationalbenchmark costs for building new lines. Revenueprojections can be developed in different ways. Oneapproach is to start with per capita income estimatesfor residents of the target region, and then to multiplythose estimates by the number of inhabitants in anarea. The results can then be used to determinewhether the provision of new telecommunicationsservices is financially viable.

For example, we know that, on average, people arewilling and able to spend about 2.5% of their incomeon telecommunications services (see Figure 6-3). Avery rough estimate of the viability of providing aspecified level of service (e.g. one payphone pervillage) can be made by determining whether it willcost more to provide that level of service than about2.5% of the village’s estimated income (per-capitaincome multiplied by the number of inhabitants). Thesame type of study can be conducted for clusters ofvillages or regions.

If it is determined that a specified level of universalaccess is not financially viable, the same type ofmodel can be used to estimate the shortfall betweenthe projected costs and revenues of providing newaccess lines. This type of approach is used in thesuccessful Chilean and Peruvian universality funds(See Appendix.) It can then be determined whethera source of revenues will be available to subsidizethe shortfall between costs and revenues. Thefinancial model can project the amount of subsidiesrequired to make the service financially viable.

Similar types of models have been used to projectthe number of rural pay phones that can be finan-cially viable in different countries. An example of theresults of such a model is presented in Table 6-4. Ifa country’s universal service policy requires agreater number of payphones than the market cansupport, a subsidy mechanism must generally bedeveloped to implement the policy successfully.

6.3 Implementing Universality: Howto Fund It?

6.3.1 Criteria for Selecting UniversalityMechanisms

This section considers the five main mechanisms inuse around the world today to implement universalitypolicies. These mechanisms are:

➢ Market-Based Reforms: especially privatiza-tion, competition and cost-based pricing.

➢ Mandatory Service Obligations: imposed bylicence conditions or other regulatory measures.

➢ Cross Subsidies: between or within servicesprovided by incumbent operators.

➢ Access Deficit Charges (ADCs): paid by tele-communications operators to subsidize theaccess deficit of incumbents; and

➢ Universality Funds: independently adminis-tered funds that collect revenue from varioussources and provide targeted subsidies toimplement universality programs.

This list is not exhaustive and the mechanisms arenot mutually exclusive. One (or more) of thesemechanisms constitutes the main regulatory tool topromote US and UA in most countries. There aremany variations on the five mechanisms. Specificexamples of the application of these mechanismsare included in the case studies in the Appendix tothis Module.

The following sections of this Module describe thefive mechanisms. The strengths and weaknesses ofeach are reviewed. In considering the differentapproaches, a number of criteria should be kept inmind. The following are particularly relevant:


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Universal Service

Table 6-4: Modelling of Financial Viability of Rural Payphones

Rural Population Required to Support One Rural Public Phone in Different Countries

Country Rural GDP/Capita (USD) Investment/Line (USD) Rural Population toSupport One Public

Phone

Argentina 2,327 3,000 28

Bangladesh 171 1,000 187

Bolivia 299 9,000 535

Botswana 1,315 7,000 97

Brazil 843 9,000 190

Colombia 321 8,000 449

Ecuador 446 6,000 251

India 220 2,000 219

Indonesia 444 5,000 216

Kenya 140 5,000 687

Malaysia 1,152 2,000 42

Mexico 1,108 10,000 159

Nepal 139 7,000 574

Pakistan 275 2,000 175

Paraguay 812 7,000 158

Peru 295 10,000 597

Philippines 386 3,000 166

Thailand 1,212 4,000 66

Uganda 134 8,000 1,077

Zimbabwe 236 6,000 474

Source: Dymond and Kayami (1997)

Note: GDP/capita and cost numbers are based on data from mid-1990’s

➢ Compliance with International Trade Rules:The WTO Regulation Reference Paper whichforms part of the WTO Agreement on BasicTelecommunications deals with universality andsubsidy issues. The Reference Paper isreproduced in the Appendix A of the Handbook

and contains the following provision regardingUS:

Universal Service - Any Member has theright to define the kind of universal serviceobligation it wishes to maintain. Such obliga-


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tions will not be regarded as anti-competitiveper se, provided they are administered in atransparent, non-discriminatory andcompetitively neutral manner and are notmore burdensome than necessary for thekind of universal service defined by theMember.

In addition to this specific section on US, theReference Paper has a number of otherprovisions that could impact upon the choice ofuniversality mechanism, and particularly amechanism that uses cross-subsidies. Forexample, the Paper provides that:

Appropriate measures shall be maintainedfor the purpose of preventing suppliers who,alone or together, are a major supplier fromengaging in or continuing anti-competitivepractices [including…] engaging in anti-competitive cross-subsidization.

If a country that has committed to the regulatoryrules in the WTO Agreement on BasicTelecommunications maintains a universalservice mechanism that infringes theAgreement, it will be open to a trade complaintto the WTO from other signatory countries.

➢ Economic Efficiency: Some universal servicemechanisms are more efficient than others. Thedegree of economic efficiency will depend,among other things, on which services receiveand provide the subsidies, and on the size of thesubsidy. Among the least efficient mechanismsare implicit cross subsidies between services ofan incumbent that are neither quantified nortargeted. Such cross-subsidies are maintainedin many countries, particularly those that retainstate-owned incumbents. It is generally as-sumed in such countries that high internationaland long distance rates are being used tosubsidize low local access rates and to promoteuniversality objectives.

In reality, such implicit cross subsidies are oftenmisdirected and wasteful of resources. Forexample, under such an approach, low-incomeinternational callers subsidize low access ratesfor high income local service subscribers. Manyof the local access subscribers who benefit from

such cross-subsidies would continue to pay forlocal access even if their rates were rebalancedto cover underlying costs.

Such cross-subsidies also depress demand forhigher cost services that provide the subsidies(e.g. international, long distance, Internet andvalue-added services). This effect not onlyreduces operator revenues but can reduceoverall economic activity. Similar inefficienciesare associated with other universality mecha-nisms that distort prices. This applies, forexample, to ADCs which inflate long distancerates to provide subsidy to the access servicesof the incumbent.

In contrast, the most efficient mechanisms arethose that provide small targeted subsidies topromote specific universal service initiatives. Onthe revenue side, the more efficientmechanisms will collect revenues from govern-ment sources or from a widely-based range oftelecommunications services, rather than onlyfrom specific “high margin” services, like inter-national or long distance services. Broadlybased collection mechanisms with uniformcharges will also reduce the inefficienciesassociated with operators “gaming” the systemby by-passing highly-taxed services ofattempting to have their services classified aslow-taxed or untaxed.

➢ Political Considerations: These are undoubt-edly important to any regulator that is appointedby, or accountable to, government or a legisla-ture. Public relations and political considerationsare often cited as reasons not to introducemarket-based reforms, such as rebalancingrates, elimination of cross-subsidies, and, insome countries, privatization. Political consid-erations can also be used to argue against in-creased taxes or levies on telecommunicationsrevenues to finance a universality fund.

In many cases, hindsight proves that the politicalrisks of introducing telecommunications sectorreforms are exaggerated. For example, whencost-based rate rebalancing was first proposedin countries in North America a decade or moreago, there were dire predictions of decreasedteledensity levels or network “drop off”. Looking


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Universal Service

back, it is clear that teledensity levels actuallyincreased in most countries as local accessrates went up. (See Table 6-5.) The same istrue in many countries where privatization wasintroduced. Initially, political and labour reactionwas often strong. In retrospect, most telecom-munications privatizations in the last decade arenow seen as successful initiatives to expandnetwork infrastructure while maintaining reason-able rate levels.

Many proactive regulators realize that they canplay an important role in shaping political andpublic opinion about telecommunications sectorreforms. Some political opposition to sectoralreform is based on ignorance or blatant self-interest by established players. Regulators canoften play an essential role in analyzing andpublishing the real costs and benefits of differentuniversality options for politicians and the public.

6.3.2 Promoting Universality: Comparing theOptions

Table 6-5 lists the main options for promoting uni-versality dealt with in this Module. Major advantagesand disadvantages are noted for each option. Theseadvantages and disadvantages are dealt with inmore detail in the following sections. Note that inour detailed discussion of universality funds insection 6.4 we provide a set of criteria for theselection of the most appropriate revenue collectionmechanism for that specific universality approach.Some of those criteria may also be applicable to therevenue collection aspects of some of the otheruniversality approaches discussed below.

6.3.3 Sector Reform and Universality

In many countries, particularly those with developingand transitional economies, outdated sector policiesare a principal cause of universality problems.

Many of these countries have low income levels,and undoubtedly have many poor people who couldbenefit from domestic or international programs topromote universal access. However, in many cases,these countries also have large unserved popula-tions that are willing and able to pay for personal orcommunity telecommunications access. Theseinclude businesses that could increase economic

activity if they had the telecommunications servicesto do so.

Experience in a growing number of countries aroundthe world indicates that the introduction of market-based reforms can significantly increase the supplyof telecommunications services. This experience issupported by an increasing body of statisticalevidence, including multiple regression studies. Inmany countries, a few key telecommunicationssector reforms would eliminate most supply con-straints. Three key reforms will be considered here:

➢ Privatization

➢ Competition

➢ Cost-based pricing

Privatization

There is a growing amount of data available to dem-onstrate that privatization increases the supply oftelecommunications services. Privatization hassignificantly increased teledensity and publictelephone penetration in a variety of different typesof countries.

Privatization promotes universality for a number ofreasons. First, network expansion targets are oftenincluded in contracts or licences that form part of theprivatization process. However, that is only one rea-son. Privatized operators have surpassed manymandatory network expansion targets. Investors inthe privatized operators have demonstrated theirwillingness to meet or exceed rollout targets, notsimply to comply with legal obligations, but as aprofit-maximizing strategy. There are other reasonswhy privatization promotes universality. Theseinclude:

➢ Availability of private capital to fund network ex-pansion;

➢ Commercial incentives to supply service to meetdemand;

➢ Improved management; and

➢ Reduced political and bureaucratic constraintson extending service.


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Table 6-5: Options for Promoting Universality

Main Options for Increasing Universality – Advantages and Disadvantages

Option Advantages Disadvantages

1. Market-BasedReforms:(Privatization,Competition & Cost-Based Pricing)

➢ Proven effectiveness in ex-panding service in economieswith state-run telephone mo-nopolies

➢ Privatization tied to specific net-work roll-out obligations (some-times including non-economicareas)

➢ Combination of 3 reforms shouldprovide incentives forcontinuous service to all areasthat are economic to serve

➢ Reforms are consistent withsector development in all areas(i.e. not just uneconomic areas)

➢ Privatization, competition andcost-based pricing will not ex-pand service to uneconomicareas (however these reformscan be supplemented by tar-geted subsidies to achieveuniversality objectives inuneconomic areas)

➢ Some conflict between these 3reforms. Direct competition andrebalancing may be limited im-mediately after privatization tomaximize network rolloutobligations. Exclusivity periodsare often granted in order tomaximize privatization proceedsto the government

2. Mandatory ServiceObligations: (imposedby licence conditionsor other regulatorymeasures)

➢ Can be effective, if realistic andnot anti-competitive

➢ Most effective for newly licensedor newly privatized operators

➢ Places burden of financinguniversality on specific opera-tors; with potentially anti-competitive effects (if USOburden outweighs benefits)

➢ Sometimes used as a rationaleto limit other sector reforms:rebalancing & competition

3. Cross Subsidies:(between or withinservices provided byincumbent operators)

➢ Traditional approach in place inmany countries; often combinedwith mandatory service obliga-tions

➢ Promotes inefficiency; demandis depressed for higher costservices that provide subsidies,and entry is foreclosed insubsidized markets

➢ In most cases, only existingusers receive the subsidy.

➢ Anti-competitive effects aredifficult to detect and prevent

4. ADCs: (AccessDeficit Charges paidby telecommunicationsoperators to subsidizehe access deficit ofincumbent operator)

➢ Spreads burden of financing un-economic access servicesacross all operators (includingcompetitors)

➢ Difficult to calculate accesscosts; difficult to implement andadminister in a transparent andefficient manner

➢ Inefficient (as with cross-subsidies)


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Universal Service

Table 6-5 Options for Promoting Universality (cont’d)

➢ Difficult to calculate benefits ofUSO provider; can lead toexcessive access charges tocompetitors

5. UniversalityFunds: (e.g. USO, USor UA funds that collectrevenue from varioussources and providetargeted subsidies topromote universalityprograms)

➢ Most effective means of provid-ing targeted subsidies to expandor support uneconomic service

➢ Potentially most efficient

➢ Most transparent

➢ Work best in expansion of serv-ice to new areas if combinedwith competitive bids for privateoperators

➢ Some administrative complexityand transaction expenses inestablishing fund; some poten-tial for bad governance; difficultto forecast associated costs andrevenues

Competition

Competition generally has positive universalityeffects. These include increased teledensity andpublic payphone penetration and reduced waitinglists. Competition has also resulted in significantlyincreased penetration of wireless service, which isbecoming a substitute for wireline services in manycountries. The relationship between competition andteledensity has been demonstrated in studies ofboth developing and industrialized country markets.

Cost Based Pricing

As discussed in other Modules, “rate rebalancing”refers to initiatives to align prices for individualtelecommunications services more closely withcosts. In most countries, this means increasing localsubscription and usage rates and decreasinginternational, long distance and Internet accessrates. When rate rebalancing was first proposed inmost countries, some predicted that higher localaccess rates would lead to lower teledensity levels.

Ten years later, the evidence indicates that suchconcerns were exaggerated. Penetration levels ac-tually increased after rate rebalancing, at least inOECD countries, where most research has beendone.

This result is not surprising since, in most OECDcountries, the evidence indicates that rate rebalanc-ing resulted in lower overall prices of telecommuni-cations service for most consumers. Other reforms,such as privatization and introduction of competition,also stimulated price decreases in these countries.

In addition, the evidence indicates that the priceelasticity of access services is very low. In otherwords, relatively few people will give up telephoneaccess due to an increase in access rates. Theresearch is consistent with the conclusion that localaccess services and telephone calling services arecomplementary. Therefore a decrease in the price ofusage will result in an increase in demand foraccess services. In other words, demand for accessservice is influenced at least as much by the level ofusage rates as by the access charge.

Figure 6-4 and Figure 6-5 demonstrate that therehas been significant price rebalancing over the lastdecade in business and residential telecommunica-tions markets in OECD countries. While fixedcharges, such as those for local access, have in-creased significantly, prices have declined overall.During this period, teledensity increased every yeardespite the increase in fixed charges. As Figure 6-4demonstrates, this trend continued even in 1991 and1996, when fixed business charges increasedaround 10% each year.


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Figure 6-4: Index of OECD Business Charges and Teledensity

6 0

7 0

8 0

9 0

1 0 0

1 1 0

1 2 0

1 3 0

1 9 9 0 1 9 9 1 1 9 9 2 1 9 9 3 1 9 9 4 1 9 9 5 1 9 9 6 1 9 9 7 1 9 9 8

T o t a l C h a r g e s U s a g e C h a r g e s F ix e d C h a r g e s T e le d e n s i t y

Notes: All indices set to 100 in 1990 Average weighted by num ber of access lines. Calculation based on PPPs expressed in USDSource: OECD (1999)

Figure 6-5: Index of OECD Residential Charges and Teledensity

6 0

7 0

8 0

9 0

1 0 0

1 1 0

1 2 0

1 3 0

1 9 9 0 1 9 9 1 1 9 9 2 1 9 9 3 1 9 9 4 1 9 9 5 1 9 9 6 1 9 9 7 1 9 9 8

T o ta l C h a r g e s U s a g e C h a r g e s F ixe d C h a r g e s T e le d e n s it y

Notes: All indices set to 100 in 1990 Average weighted by number of access lines. Calculation based on PPPs expressed in US$Source: OECD (1999)


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Universal Service

The positive relationship between rebalancing andteledensity also seems to apply to developingcountries. For instance, as Ros and Banerjee (2000)have shown, higher subscription prices result inhigher telephone penetration rates and in reducedwaiting lists. While this relationship seems counter-intuitive, there are good explanations. The mainreason is that residential subscription rates tend tobe set below economic costs. As operators arepermitted to raise these rates, they are able toreduce their access deficits. It becomes profitable,rather than unprofitable, to construct more networkaccess lines. Thus, higher prices lead to increasedsupply.

The experience with rate rebalancing in OECDcountries is discussed further in Appendix 4-1 ofModule 4.

6.3.4 Mandatory Service Obligations

Perhaps the most commonly used mechanism forpromoting universality is the mandatory service obli-gation. In some countries, this obligation isdescribed as a “duty to serve” all customers willingto pay the prescribed rates.

Geographic limits are sometimes prescribed forareas where service is mandatory. For example,such areas include urban areas but not remote ruralareas where no telecommunications infrastructure isinstalled. In most cases, new services must beinstalled within a prescribed time after an applicationfor service is received. Compliance is monitoredthrough quality of service indicators.

The operator with a general obligation to serve allcustomers is usually referred to as the universalservice provider. In most cases, it is the incumbentoperator.

In some countries, governments and regulatorshave imposed mandatory service obligations onnewly licensed or newly privatized operators. Thesemay include obligations to provide service through-out certain areas (especially for wireless operators)or to install a specific number of lines within a certainperiod (coverage and rollout obligations).

Such mandatory service obligations are currently themost common mechanisms used to expand tele-

communications networks in developing economies.They are used in the case of most privatizations andnew licence grants. A major benefit of implementingsuch mandatory service obligations is that the fund-ing is generally provided by the private sector.

There are disadvantages to imposing excessivelyhigh roll-out obligations. A privatized operatornormally has a commercial incentive to roll out serv-ice to previously unserved customers that are ableto pay for its service. If privatized operators aresubjected to uneconomic service obligations theywill have to finance such obligations through mo-nopoly profits, cross-subsidies or futureconsiderations. In other cases, an operator maysimply fail to meet its roll-out obligations.

Table 6-6 presents a sample of recent licence obli-gations in developing and transitional economies.

6.3.5 Cross-Subsidies

For decades, in most countries, internal cross-subsidization by the incumbent operator has beenthe main mechanism used to promote universality inthe telecommunications sector. Such cross-subsidi-zation involves the use of surplus revenues earnedfrom profitable services to cover losses from provid-ing non-profitable services. In the context ofuniversality, we are primarily concerned with the useof such cross-subsidies to maintain low accessrates, particularly in high cost areas.

Theodore Vail, the driving force behind the earlysuccess of AT&T in the USA at the turn of the lastcentury, promoted universal service through cross-subsidization. This was a means of expanding thereach of the telephone, and thus the value of AT&T’sservice to the public. While the public interest wasundoubtedly a concern, this policy was also veryvaluable to the company, which soon became one ofthe largest business corporations in the world.

Incumbents have often been encouraged by regu-lators to maintain a policy of internal cross-subsidization in order to extend telephone accessservices, and to maintain low access rates. Similarpolicies were adopted by both state-owned andprivately-owned operators during the monopoly eraof telephony which lasted for most of the 20thCentury.


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Several types of internal cross-subsidies werecommonly used by incumbents:

➢ Inter-service cross-subsidization. Connectionand access services are usually priced belowcost and long distance and international callingare priced above cost. In this instance, the sub-sidy flows from long-distance and internationalcalling to access and local calling. Otherservices may also provide or receive subsidies.

➢ Intra-service cross-subsidization. A com-mon example is geographic tariff averaging,where access prices in rural or other higher-costareas are set at the same level as in urban andother lower-cost areas. Another example in-volves the pricing of business access services,which were often set much higher than residen-tial access services.

A number of countries maintain more complextargeted cross-subsidy regimes. One example isColombia, where residential households in low-

income “strata” pay lower access rates than house-holds in high income “strata”.

While internal cross-subsidization has been the mostcommonly used mechanism to promote universality;it is being phased out in many countries. The cross-subsidy approach has a number of weaknesses thatmake it undesirable and probably unsustainable inthe long run. These weaknesses include:

Competitive unsustainability: Cross subsidies areincreasingly unsustainable in a competitiveenvironment. New entrants typically target profitablemarket segments or classes of service (i.e. theservices or areas that provide subsidies, rather thanthose that receive it.) This reduces or eliminatessubsidies.

International accounting rate reform: Internationalaccounting rates are being significantly reduced inthe near to mid-term, hence reducing or eliminatinga major source of funding for cross-subsidization inmany countries.

Table 6-6: Selected Licence Network Expansion Obligations

Country Company Obligation

Ghana Ghana Telecom 225,000 new telephone lines within 5 years, starting in 1996.

Mexico Telmex Starting in 1990, average annual line growth of 12% p.a. to1994. Public payphone density of 2 per 1,000 inhabitants by1994 and 5 per 1,000 inhabitants by 1998.

Panama Cable and Wireless From 1997, increase teledensity to 25% by 2002. Install 600rural payphones within 2 years.

Peru CPT and Entel Starting in 1994, add 978,000 telephone lines by 1998. Install19,000 public telephones by 1998.

Venezuela CANTV Increase telephone lines by 355,000 p.a. from 1992 to 2000.

SouthAfrica

Telkom Starting in 1997, install 2.69 million new lines by 2002. Install120,000 new public pay phones by 2002.

9 International Licensees Each install 300,000 new access lines within 3 years ofobtaining licences.

Philippines

5 Cellular Licensees Each install 400,000 access lines within 5 years of obtaininglicences.

Sources: Various, including ITU (1998a)


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Universal Service

➢ Inefficiency of untargeted subsidies: Allexisting access users generally receive the sub-sidy, whether they can afford to pay the fulleconomic price or not.

➢ Subsidies promote inefficient consumption:Demand is depressed for higher cost servicesthat provide subsidies, and entry is foreclosed insubsidized markets (competitors cannot matchlow prices).

➢ Anti-competitive use of subsidies: Subsidiesfrom profitable services are intended to supportuniversality. However, in many cases the cross-subsidy regimes are not quantified or carefullymonitored by regulators. As a result, the incum-bent may engage in anti-competitivesubsidization as well. For example, surplusrevenues from monopoly international or longdistance services may be used to providebelow-cost Internet access services, therebydriving competitive ISPs out of the market.

➢ In most cases, only existing users receivethe subsidy. While access rates may be low inmany urban areas, those without telephoneservice, in rural areas or on waiting lists, do notbenefit from the subsidy.

These problems have initiated an international trendaway from reliance on internal cross-subsidies.While such cross-subsidies remain important inmany countries, including most industrializednations, they are increasingly being phased out orsupplemented by more efficient targeted mecha-nisms to promote universality.

An exception to the trend away from cross subsidiesinvolves services to physically handicapped andother disadvantaged subscribers. A number ofcountries maintain subsidized services to the hear-ing impaired and the blind, among others.

6.3.6 Access Deficit Charges

Access Deficit Charges (ADCs) are a variation ontraditional cross-subsidy mechanisms. Traditionalcross-subsidies are internal to the incumbent. Thatis, the incumbent uses subsidies from some of itsown services to subsidize below-cost prices, usuallyfor local access services.

With the onset of competition, regulators in somemarkets, including the USA, Canada, and Australia,initially established ADC systems to replace or sup-plement internal cross-subsidies. The difference isthat in an ADC regime, all providers of subsidizingservices (e.g. long distance services) must contrib-ute payments to subsidize access services. In otherwords, in the example above, the subsidy “tax” isexpanded beyond the incumbent and spread acrossall competitors in the long distance market.

Like cross-subsidies that are internal to the incum-bent, ADCs have been criticized as being inefficientand anti-competitive. Some regulators, notablyincluding those in the UK, Australia and Canada,have recently rejected or reformed ADC regimes.Other regulators, including those in the USA arereviewing their ADC regimes. ADCs are referred toas “supplementary charges” in some countries. Adetailed description of the approach to ADCs isincluded in the USA case study in the Appendix.

ADCs are imposed on designated operators as ameans of financing the local access deficit that re-sults from local services of the incumbent beinggenerally priced below cost. More specifically, ADCsmay be used to subsidize either broad service cate-gories (for instance, all access services) or narrowercategories (such as only residential accessservices).

ADCs are often collected in a similar manner to in-terconnection charges. In most cases, this meansthey are collected on a per-minute basis. In othercases they are collected on a per trunk basis, or onsome other basis. They may also be collected bymeans of a levy on telecommunications servicerevenues earned by contributing operators. In thelatter case, they resemble a tax.

Whatever means is used to collect ADCs, theyshould not be bundled or confused with standardinterconnection charges. International trade law andbest practice require ADCs and other payments thatpromote universality to be collected in a transparent,non-discriminatory and competitively neutralmanner. Interconnection charges should be sepa-rate from ADCs, and should be cost-based andunbundled. (See discussion of WTO Agreement onBasic Telecommunications in Section 6.3.1 above,and in Module 4, Price Regulation).


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ADCs were traditionally collected and administeredby the universal service provider in many countries.However, regulatory reform, and the impetus of theWTO Agreement on Basic Telecommunications, hascaused most regulators to establish an independentadministrator to collect and disburse ADCs.

If an ADC regime is to be maintained, ADCs shouldbe calculated based on detailed estimates of theaccess deficits (i.e. access revenues minus costs ofthe universal service provider). Such calculationsform the basis of the ADC regimes in several coun-tries, including the USA. In other countries, suchcalculations have led to the conclusion that ADCsshould be abolished (as in Australia and the UK), orthat there is no need for an ADC regime (as in someEuropean countries). The European Commissionhas established criteria to be applied by its memberstates in determining whether an ADC regime orsimilar USO charges should be established. Theseand other examples are described in the casestudies in the Appendix.

The move by several industrialized countries toeliminate or replace ADCs is based on a growingperception that ADCs are a problematic and ineffi-cient mechanism for promoting universality.Perceived problems with ADCs include:

➢ ADCs inflate the prices of the subsidizingservices and, therefore, reduce the demand forthem. (e.g. long distance or international serv-ices). ADCs are an economically inefficientmeans to collect the required subsidy. Thedemand for long distance calling, for example, isrelatively price elastic compared to other tele-communications services, such as accessservice. Therefore, ADCs can reduce demandfor these services in a disproportionate manner,hence contributing to economic inefficiency.

➢ ADCs encourage bypass of the PSTN. In coun-tries where ADCs are charged forinterconnected services (e.g. the USA),competitors have a strong incentive to terminateservices to customers by means other than thePSTN. Such bypass may be uneconomic, in thesense that the competitors could terminate callsmore cheaply on the PSTN if they did not haveto pay the ADCs for PSTN termination. There-fore, ADCs can promote inefficient duplication of

network facilities and deprive the incumbents ofinterconnection revenues they would earn,except for the bypass.

➢ Technological and market developments arestarting to reduce the distinction between localminutes of traffic and minutes of traffic that payADCs (e.g. international or long distance). IPTelephony and “refiling” of long distance trafficby CLECs are two developments thatundermine the viability of ADC regimes. Thesedevelopments make it difficult to detect andmeasure minutes of traffic that should contributeto ADCs. As a result, the collection of ADCs willbecome increasingly problematic.

➢ Finally, many of the problems with ADCs are thesame as those of traditional cross-subsidies thatare internal to the incumbent. These problemsare listed in the previous Section 6.3.5.

6.3.7 Universality Funds

Universality funds, sometimes called US funds, USOfunds or UA funds, are generally seen as the bestoption for promoting universality objectives. Thisview is shared in an increasing number of countries,including those with industrialized, transitional ordeveloping economies.

Universality funds collect revenues from varioussources and disburse them in a fairly targeted man-ner to achieve specific universality objectives.Depending on the country, the source of revenuesmay include government budgets, charges on inter-connecting services, levies on subscribers (e.g. onaccess lines) or levies on all telecommunicationsservice operators.

In contrast to ADCs, universality funds are generallyused to finance specific and targeted high cost areasand/or low income subscribers. The most efficientfunds provide relatively small subsidies to incentprivate sector telecommunications operators toserve targeted service areas. These are typicallyareas where service would otherwise beuneconomic (i.e. where costs cannot be covered byavailable subscriber revenues). Good examples ofthe universality funds are included in the casestudies of Chile and Peru, set out in the Appendix.


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Universal Service

The design and operation of universality funds isconsidered in detail in the next Section of thisModule.

6.4 Universality Funds

6.4.1 Introduction

International experience is demonstrating the bene-fits of universality funds. These funds are designedto meet universality goals by subsidizing specificinitiatives to extend or maintain service or access.Such funds have most of the benefits and few of thedisadvantages of the other universality fundingmechanisms discussed in this Module.

Universality funds (USO, US or UA funds) arespecial-purpose mechanisms designed to achieveuniversality objectives. These funds are generallyadministered independently from the incumbent op-erator. Subsidies from universality funds are typicallyused to provide financial support to fund specificprograms. Examples include network expansionprojects and installation of public payphones or call-ing centres. While they come in different forms, goodfunds have a number of features in common. Someof these features are summarized in Box 6-1.

As noted above, two of the most successful univer-sality funds in the world today have beenestablished in Chile and Peru. There are manypossible variations on such funds. Some of the mainconsiderations in designing funds are discussed inthe remaining sections of this Module.

Universality funds can be used to subsidize existinglevels of universal service, or to provide newuniversal access or service through new networkrollouts. Both purposes are discussed below. How-ever, it is clear that universality funds are an idealmechanism for subsidizing new network rollouts toexpand universal access to uneconomic areas.Much of the discussion below relates to funds usedfor that purpose.

6.4.2 Sources of Fund Revenues

Unlike cross-subsidies and mandatory serviceobligations, universality funds involve the collection

Box 6-1: Features of a Good UniversalityFund

➢ Independent administration – not relatedto telecommunications operators

➢ Transparent financing

➢ Market-neutral – does not favourincumbent operators or new entrants

➢ Funding targeted to specificbeneficiaries (e.g. high cost regions,unserved rural areas, low incomepopulations, educational & healthsectors)

➢ Subsidies should be relatively small;should only subsidize the uneconomicportion of service; private sectoroperators should finance the rest

➢ Competitive bidding process forimplementation of universality projects:i.e. lowest bidder should be awardedsubsidy and right to build and operatenetworks to expand service

and disbursement of funds by an independent or-ganization. There are various possible sources ofsuch funds. These “collection mechanisms” include:

➢ Direct funding from general government reve-nues (e.g. Chile);

➢ Contributions from telecommunications opera-tors (e.g. in proportion to their revenues fromspecified services);

➢ Proceeds from telecommunications privat-izations, spectrum auctions and/or licence/concession payments;

➢ A subscriber levy (e.g. on a per access line ba-sis) collected by telecommunications operators;and

➢ Funding from international development agen-cies.


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If funds are collected from telecommunicationsoperators, or through them from subscribers, therules of the WTO Agreement on Basic Telecommu-nications should be kept in mind (see Section 6.3.1above). Specifically, the collection andadministration of such funds should be transparent,non-discriminatory, competitively neutral and notmore burdensome than necessary for the kind ofuniversal service defined by the country’s laws orpolicies. Below we discuss some of the principalcriteria used by regulators for selecting amongstthese collection mechanisms. Most regulators haveselected contributions from telecommunicationsoperators (i.e. a proportion of operational revenuesfor universality funding.)

Criteria for Collection Mechanisms

Regulators have established different criteria todetermine the best way to collect revenues for uni-versality funds. These criteria include:

➢ Economic Efficiency: All collectionmechanisms result in some degree of economicinefficiency. The goal, therefore, should be tocollect universality fund revenues in a mannerthat minimizes economic efficiency losses. Forinstance, as discussed in Appendix B of theHandbook, Ramsey pricing principles suggestthat services with relatively inelastic demandshould pay higher universality charges thanthose with more elastic demand. In practice, foradministrative and equity considerations, mostregulators have opted for widely-based uniformuniversality charges rather than Ramsey-basedcharges. As discussed in section 6.3.1, auniform widely-based charge will reduce theinefficiencies associated with operators trying toavoid or by-pass highly-taxed services in favourof low-tax or untaxed services. Other analystshave suggested that collecting universality fundrevenues from the government budget is themost efficient option. This conclusion is basedon the observation that only the government hasan overall economic vision and mandate to taxall sectors of the economy, and can, therefore,choose the optimal level and mix of taxation.However, many governments are in the processof implementing fiscal reforms and hence directgovernment funding is often not a feasible orreliable option.

➢ Administrative Efficiency: Universality reve-nues should be collected in an efficient andtransparent manner. It may be that the existinggovernment revenue collection process is themost administratively efficient because theinfrastructure to collect taxes and otherrevenues already exists. On the other hand,experience suggests that the administrativecosts of setting up a universality fund to collectrevenues are reasonably low. The collectionmechanism should be designed so that thecalculation of the amount that each operator isrequired to pay is relatively simple and not sub-ject to interpretation and controversy. Thisconsideration supports relatively simple andbroad collection mechanisms, such as onapplied to all telecommunications revenues(basic and non-basic services).

➢ Sustainability: Collection mechanisms must bedesigned so as to access a relatively stablerevenue base. Collection mechanisms based ona specific service or based on minutes may notbe sustainable in the long term. Universalityfunding based on one-off events such asspectrum auctions, may also not be sustainable.The advent of distance-insensitive long-distancecalling and the significant growth of mobilewireless telephony is blurring the distinctionbetween local and long-distance calling.Developments in digital and IP technology arealso leading to doubts about whether minuteswill continue to be the basic unit ofmeasurement for telecommunications. Rather, itmay be the bit or the IP packet. Therefore, itmay be prudent to select a constant measure,such as revenues, rather than a technology orservice specific measure, such as minutes oflong distance traffic.

➢ Equity: The collection mechanism should befair. Many regulators have rejected the eco-nomically-efficient option of collectinguniversality revenues through a levy on accesscharges due to equity considerations. Suchlevies would increase local access rates for all,including low-income subscribers. Manyobservers have argued that telecommunicationsuniversality objectives are an aspect of govern-ment social policy and that they should,therefore, be funded from the government


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Universal Service

budget rather than exclusively from the tele-communications sector. However, as a practicalmatter, few governments have made fundingavailable for universality funds.

6.4.3 Determining the Amount of Subsidy

Funds can be used to finance various types of uni-versality objectives. However, they are ideal vehiclesfor financing the expansion of service to specifichigh-cost areas or populations. The funds in Chileand Peru were used for this purpose, and eachcountry’s fund has succeeded in extending newtelecommunications access to thousands of rurallocalities.

Where a subsidy is used to fund specific networkextension targets, such as in Chile and Peru, someestimate should be made of the amount of financingthat will be required to reach that target. The fundshould not pay too much for a network extensionproject.

There are generally two ways to determine thesubsidy required for a network expansion project.They are complementary, and both should generallybe used. The first is to estimate the cost of thesubsidy using a financial model along the lines dis-cussed in the next section. The second approach isto let the market determine the final amount of therequired subsidy, through a competitive biddingprocess.

It is recommended that the competitive biddingapproach should always be used. However, the fi-nancial study can be useful for a number ofpurposes. It can assist in fund budgeting, and assistthe fund administrator in determining the maximumsubsidies that will be available for the projects. It canalso act as a safeguard against possible bid riggingor other attempts to undermine the competitivebidding process.

Cost Models for New Universal Access

A financial model can be used to determine the sub-sidy required to expand new service to rural andother high cost areas. In general, these financialmodels calculate the difference between the capitaland operating costs of providing service in specificregions and the projected telecommunications reve-

nues available in those regions. Cost projectionsmay be based on network construction estimates oron national or international benchmark costs for newaccess lines. Revenue projections can be developedin different ways.

The fund should only pay for the uneconomic part ofthe project. For example, it may cost USD 10 millionto provide one or two public telephones per village to500 very remote villages. However, the financialmodel may indicate that telecommunications servicerevenues from those villages can be expected tofinance USD 6 million of the cost of the networkexpansion, plus cover ongoing operating revenues.In this case, the required subsidy from the fundshould be no greater than USD 4 million. It may beless once ancillary benefits to the operator are takeninto account.

Cost Models for Maintaining Universal Service

Estimating subsidies required to maintain existinglevels of universal service is somewhat more difficultand controversial than estimating subsidies requiredfor new network extension projects. This difficulty isdue, among other things, to the larger and morediverse scope of the services to be costed and dueto the embedded nature of the costs of existingservices.

Universality funds in industrialized countries havegenerally focussed on providing subsidies to existingservices or to maintaining below-cost rates for sub-scribers already on the network. Under thesecircumstances, a detailed cost model incorporatinginstallation and ongoing costs appears to be the onlypractical option for estimating the required subsidy.International best practice suggests that the calcula-tion of the net costs of providing the required level ofuniversal service should be based on the long runincremental costing (LRIC) method.

At best, an LRIC cost model only provides a generalestimate of the subsidy costs, not a precise calcula-tion. Models incorporate a series of choices abouthow to assign costs in the network. These choicesare made using expert judgement; the choices arenot black and white. Disagreements may arise aboutwhat geographic areas should be used as net costareas, how to assess which technologies could havebeen used to deliver the designated services most


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efficiently, whether and how to account for deprecia-tion, how to calculate the cost of capital, how toaccount for the benefits to the operator of being theuniversal service provider (see discussion below)and how to judge which network and access costsare truly avoidable, as opposed to costs that wouldhave been incurred in any event.

As a result, there have been significant controver-sies about regulatory decisions on the level offunding to maintain existing levels of universalservices in industrialized countries. In the end, thelevel of funding is based, in large part, on regulatoryjudgement. The same controversies will generallyexist whether universality initiatives are fundedthrough ADCs administered by an incumbent orthrough an independent universality fund.

A number of regulators have found innovative solu-tions to address universal service costing. Forinstance, the FCC in the USA has made publiclyavailable its Hybrid Proxy Cost Model. As part of aregulatory proceeding, the FCC developed thismodel based on three other cost models that differ-ent parties had submitted. The FCC selected itspreferred modules from each of the models andcreated its own hybrid version.

The FCC model is referred to as a “proxy” because itdoes not model the network of any specific operator.Rather it may be used with the particular costs ofdifferent operators to estimate or “proxy” its TELRIC.The FCC has made the model publicly available(free on the FCC’s website and at a nominal cost onCD-ROM) for interested parties. Parties are able toinput their own data to run the model and to carryout sensitivity analyses.

Competitive Bidding to Implement UniversalityProjects

Even the best regulators or universality fund admin-istrators will generally have less information thantelecommunications operators about the real costsand benefits of implementing universality initiatives.Therefore, a competitive bidding process is a betterapproach than cost modelling to determine the finalsubsidy amount, if any, required to implement auniversality initiative.

Competitive bidding is more practical and is adminis-tratively simpler in cases where new universalaccess is to be provided, for example, in anunserved rural area. As previously discussed, theprocess is more difficult where an incumbent isalready providing the designated universal services.Most of the discussion in this section relates tosubsidies for new services and not existing ones.However, in principle, competitive bidding processescould be equally effective in determining the amountof subsidy required to maintain existing services.

For example, an auction could be held to determinethe amount of subsidy required to maintain or up-grade service in a region where an incumbentcurrently operates network facilities at a loss. Auniversality fund administrator might require theincumbent to submit to a competitive tender processas a condition of receiving a continued subsidy forthe region. If another financially and technicallyqualified operator makes a firm bid to operate thenetwork in that region for a lower subsidy, then theincumbent’s subsidy might be limited to the loweramount. If dissatisfied, the incumbent could negoti-ate with the alternative operator to have it take overnetwork operations. Alternatively the incumbentcould sell the network facilities to the other operator,which would then be required to upgrade them tomeet the required universality objectives. A variety ofmanagement contracts, joint ventures, build-operate-transfer arrangements, and asset purchasecontracts could be used to implement the transfer ofnetwork operations to the lower cost bidder.

The case studies for Chile and Peru provide gooddescriptions of competitive bidding processes forlicences to serve rural areas. In these countries,licences were granted to the bidders that offered toprovide the designated services at the lowest sub-sidy. As a result of the competitive bidding processin those countries, many licences were granted witha zero-subsidy, meaning that there was no need tosubsidize the winning bidder at all.

Use of competitive bidding processes means thatthe fund administrators need not determine theactual net cost of fulfilling the universal access re-quirements, but rather only the subsidy that the fundmust provide to UA providers. It does not absolutelyrequire the use of economic or financial costingmodels by regulators, although such models are


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Universal Service

useful to determine the maximum subsidy amountthat may be required. Bidders will use their ownmodels and projections to determine their proposedsubsidy bid. It is clear from the results in Chile andPeru that competitive bidding has the advantage ofreducing the total funding required to meet univer-sality objectives.

The Peruvian case study illustrates another advan-tage of the competitive bidding process. There mayoften be synergies in providing service to differentlocalities or across various regions. An operator’swillingness to serve a market at a given subsidy willdepend on whether the operator can also serveother areas. When tendering more than one desig-nated service area, fund administrators can capturescale economies by allowing applicants to bid toserve different combinations of areas at differentsubsidy amounts. The methods and effectiveness ofsuch a multiple bidding approach are discussed inthe Peruvian case study.

Intangible Benefits

Another advantage of a competitive bidding processis that it can transfer the value of the intangiblebenefits of being a US or UA provider from theoperator to the universality fund. In this sense,intangible benefits refer to financial or other benefitsaccruing to US or UA providers that are not takeninto account in traditional costing or revenue models.The United Kingdom case study in the Appendixdescribes some of the benefits of being a universalservice provider.

In theory, a bidder that wants to become a US or UAprovider would include intangible benefits in itscalculation of the subsidy required to serve a new

area. The larger the benefits, the lower the subsidy abidder would require. Until recently, there were noreal-world examples to test this theory. However, thecompetitive bidding processes in Chile and Peruprovide such evidence. As described in the casestudies for those countries, the actual winning bidamounts were generally well below the maximumsubsidy that was calculated to be required to provideeconomic service in the tendered regions. In somecases, the proposed subsidy was zero, although thesubsidy estimated by the fund was much higher.

In Chile, over the 1995-1999 period, the averagewinning subsidy was about 50% of the maximumsubsidy offered. Similarly, in Peru, in the last twoyears, the average winning subsidy has been about25% of the maximum subsidy offered. Thesemarket-based results suggest that operators areprepared to become a UA provider for a compensa-tion which is significantly less than the net financialcost of the activity. The evidence suggests that thedifference between the net financial cost and thecompensation must be equal to the intangible bene-fit that the UA provider expects to receive.

In the absence of a competitive auction, subsidyvaluations should include a value for such intangiblebenefits. A degree of judgement will be required toestimate such values. However, it should be possi-ble to establish benchmark estimates for certaincategories of benefits. Perhaps the best practicalexample of the valuation of intangible benefits is theUK. As described in the UK case study, in 1997,Oftel determined that such benefits offset any netcosts involved in the provision of universal serviceby British Telecom. As a result of this determination,BT does not receive any funding from other opera-tors or the government to subsidize its USO.


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Universal Service

APPENDIX: UNIVERSALITY CASE STUDIES

1 CHILEThe Chilean model of extending public telecommu-nications service to low income and rural areas wasone of the first to utilize market-based mechanismsto implement a successful universal access policy.

1.1 Universal Access Policy

The Chilean telecommunications sector was the firstin Latin America to be privatized and opened tocompetition. The introduction of market-openingpolicies succeeded in reducing telecommunicationsprices and increasing teledensity. Despite thissuccess, however, many low income and rurallocalities continued to be unserved. This lack ofaccess to telecommunications services wasidentified as a market failure.

The Chilean government developed an effective andeconomically efficient approach to address thismarket failure. The approach relies on public fundingin the form of targeted financial subsidies to providepublic telephone access to low income and rurallocalities.

The Chilean program focuses on providing commu-nity access (i.e. universal access) rather thanindividual access (i.e. universal service). Theprogram provides one-time subsidies for theinstallation of public telephones. It does not provideongoing funding.

1.2 Legislation

In March 1994, the General TelecommunicationsLaw was revised to establish the Telecommunica-tions Development Fund. The fund is referred to asthe “FDT” (Fondo de Desarrollo de lasTelecomunicaciones). The FDT providesgovernment funds to private operators to subsidizethe installation of public telephones in unserved, lowincome and rural areas. The private operators whoreceive the subsidies are selected by means of acompetitive bidding process.

The FDT is administered by a special MinisterialCouncil presided over by the Minister responsible forTelecommunications. The FDT’s ExecutiveSecretary is the head of the telecommunicationsregulator, SubTel (Subsecretaría de Telecomunica-ciones).

The FDT is financed from the Chilean nationalgovernment budget. Each year, a specific allocationis approved for FDT purposes. This type of fundingwas selected for several reasons. First, it avoidedthe economic inefficiencies that result from cross-subsidies between telecommunications services.Providing tax-based funding was also consistentwith the government’s view that universal access isa social policy issue. As such, subsidizing universalaccess is primarily seen as a governmentresponsibility, and not that of telecommunicationsoperators or telecommunications subscribers.

1.3 FDT Project Selection Process

A Regulation to implement the FDT was approved inDecember 1994. The Regulation established therules for the operation and administration of theFDT.

The process for the selection of projects eligible forFDT subsidies is detailed in the Regulation. Themain features of the process are:

➢ Focus on Public Telephone Services: Ingeneral, only public telephone services are fi-nanced by the FDT. These services may beprovided by individual public telephones ortelecentres.

➢ Publicity: SubTel has undertaken publicitycampaigns to raise awareness of the FDT andto promote participation from unserved localitiesaround the country.

➢ Application Process: Any person, communityor municipal organization may submit a publictelephone application to SubTel by 30September of each year. After the annual


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closing date, SubTel compiles a list of localitiesrequiring public telephony service. (In 1998,1,963 rural applications were received, and atotal of 1,951 localities were accepted.)

➢ Development of FDT Projects: With the as-sistance of external consultants, SubTelundertakes a technical analysis of theapplications. SubTel then develops specific ruralpublic telephony projects. Each project is de-signed to cover a number of adjacent localities.(In 1998, 80 projects were designed toincorporate all 1,951 eligible applications.)

➢ Financial Evaluation: SubTel evaluates eachof the projects based on general government-approved methods of cost-benefit analysis. Foreach project, two measures of net present value(NPV) are calculated: private and social.Projects that have a positive private NPV areexcluded from the list. Projects with a positiveprivate NPV are those capable of being financedsolely from project revenues, without a govern-ment subsidy. SubTel then ranks the remainingprojects (those with a negative private NPV)based on the relationship between social andprivate NPV, among other factors. Thisformulation aims to maximize the social returnsper dollar of private investment. For thesesubsidizable projects, the maximum subsidy iscalculated as the private NPV (always negative).The NPV’s are calculated based on the tariffregime established for rural public telephones.The tariff regime in Chile is based on maximumrates that are adjusted on an annual basis withreference to an aggregate price index andproductivity offset. Operators are allowed to settheir rates lower than the designated maximum.The maximum rates for local calls from ruralpublic telephones are approximately USD$0.07/minute based on a 5-minute local call. Incomparison, local calls from urban public tele-phones are priced at approximately USD$0.05/minute, also based on a 5-minute call.Higher rates are allowed for shorter calls fromrural public telephones. Interconnection accesscharges for all telecommunications services,including rural public telephones, are set bySubTel.

➢ Selection of Projects: A list of projects that areeligible for subsidies is then developed bySubTel. The projects are ranked based on thefinancial evaluation. The list is submitted to theFDT Ministerial Council, which selects theprojects that will be opened to competitive bid-ding, based on the available FDT budget. In1998, 80 projects were eligible for subsidy, and31 were selected. These 31 projects covered1,023 localities.

➢ Competitive Bidding Process: Once theMinisterial Council selects projects eligible forsubsidy, SubTel prepares tender documents fora competitive bidding process. These are pub-lished in the country’s Official Digest. Tenderdocuments for each project include the followinginformation:

➢ the localities to be served by the project;

➢ the minimum quality of service to beprovided;

➢ the applicable tariff regime (see furtherdiscussion above);

➢ the time period allowed for the installation ofthe public phones;

➢ the maximum subsidy available for theproject;

➢ available spectrum frequency bands; and

➢ any other conditions.

➢ Selection of Successful Bidders: For eachproject, the bidder that proposes the lowestsubsidy is declared the winner by SubTel. In1998, firms bid for 27 of the 31 eligible projects.In total, the successful bidders proposedsubsidies of USD 5.5 million, well below themaximum subsidy of USD 8.9 million availablefor the 27 projects. In some cases, no (zero)subsidy was required by the successful bidder.

➢ Concessions: The winning bidders must applyfor a public telephone concession. Concessionsare issued by the Ministry responsible for Tele-communications, based on the recommendation


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Universal Service

of SubTel. The concessions are non-exclusive.The decree granting the concession includesthe following information:

➢ name and details of the holder of theconcession (the “concessionaire”);

➢ type of service to be offered;

➢ duration of the concession;

➢ geographic zone covered by the concession;

➢ technical specifications of the infrastructureto be installed;

➢ deadlines for commencement and termina-tion of installation;

➢ technical specifications of radio stations, ifany;

➢ amount of subsidy awarded, if any; and

➢ other conditions.

➢ Implementation: Concessionaires must gener-ally install the required public telephones withinabout 20 months. These public telephones mustbe capable of sending and receiving calls fromother subscribers, including local and longdistance calls from both fixed and mobile termi-nals. Once the infrastructure has been installed

and verified by SubTel, the concessionairereceives the subsidy it is eligible for.

1.4 Results of the Bidding Process

Table 6-7 summarizes the results of the FDT biddingprocess to 1999. At the start of the FTD program,around 6,000 localities were identified as unserved.Between 1995 to 1999, a total of 183 projects wereapproved under the program. These projectscovered 5,916 localities with a served population ofover two million people. Therefore, it is evident thatthe original target of providing telephone service tounserved areas was met over a five-year period.

Table 6-7 demonstrates that competition betweenbidders significantly reduced the actual subsidiespaid, as compared with the maximum subsidies thathad been projected to be required to provideservice. Over the five-year period, only about 50% ofthe estimated maximum subsidies were actuallypaid. In 1996, only 21% of the estimated maximumwas paid. In 1999, 80% of the maximum was paid.

In practice, some delays have been experienced inthe installation of public telephones under the FDTprogram. For instance, at the end of 1998 about1159 or just over 50% of committed telephones hadbeen delivered. As a result of these delays, SubTelhas issued warnings and imposed fines inaccordance with the terms of the concessions. Thefines are calculated separately for different localities.

Table 6-7: Summary of FDT Results

Year Projects Localities Inhabitants inLocalities (000)

MaximumSubsidy (USD m)

Subsidy Granted(USD m)

1995 34 726 240 3.1 2.1

1996 18 1632 762 4.2 0.9

1997 70 2146 772 20.4 8.1

1998 27 858 229 8.9 5.5

1999 34 554 154 5.5 4.4

Total 183 5916 2157 42.1 21.0


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Fines increase for longer delays. By the end of1999, an additional 3,264 public telephones wereinstalled under the programme, for a cumulative totalof 4,424 to that date.

1.5 Regional Funding Differences

Chile is divided into 12 regions plus a capital region(R.M.). The Regions range from Region I at thenorthern end of Chile to Region XII at the southernend. The central Regions IV to X are the mostdensely populated areas. Figure 6-6 provides a re-gional analysis of the 1995-98 results.

Figure 6-6 indicates that most localities that receivedsubsidies were located in the densely populatedcentral areas of the country. Not surprisingly, thefigure also indicates that the average subsidy perlocality is significantly higher in outlying regions ascompared to the central regions. It clearly cost more

to provide service in more remote regions. Forinstance, the subsidy was 33 times greater perlocality in Region I than in Region VII. Therefore,while the more remote Regions I, II, XI and XII,accounted for 25% of the total amount of subsidiesfor the country as a whole, they represent only about2% of the newly served population.

1.6 Access to the Internet

The original FDT target of providing public telephoneservice to approximately six thousand unserved lo-calities was met over the 5 years between 1995-1999. Having met this target, the President of Chileproposed revisions to the FDT in November of 1999.Under these changes, FDT funds may be used tofinance community Telecentres with access to theInternet and to other new information and communi-cations technologies.

Figure 6-6: Regional Analysis of FDT Subsidies Awarded (1995-98)

0

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I II III IV V R.M. VI VII VIII IX X XI XII

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Universal Service

2 PERUPeru’s experience with universality programs bearssimilarities to that of Chile’s. Peru’s policy, likeChile’s, promotes universal access by means of arural telecommunications fund. However, thePeruvian program is more recent, and includessome notable differences and innovations.

2.1 Universal Access Policy

In the mid 1990s, Peru’s government joined agrowing number of others in deciding that the tradi-tional policy of financing universal access by internalcross-subsidies was no longer feasible or desirable.This decision was consistent with its policy torebalance rates and to eliminate all inter-servicecross-subsidies over a five-year period after theprivatization of its monopoly operator.

The Peruvian government distinguished betweenthe universal service emphasis of maintainingaccess in industrialized countries, and the emphasisin developing countries on extending basic access inthe first place. Peru clearly fit into the latter situation,particularly in rural areas. Accordingly, the Peruviangovernment established a universal access fundwith targeted subsidies to finance new public accesstelephones in rural areas.

2.2 Legislation

A new regulatory framework for the Peruvian tele-communications sector was introduced by revisionsto Peru’s telecommunications laws in 1993 and1994. The revisions promoted private sector partici-pation in telecommunications, and among otherthings, authorized the privatization of the mainwireline operators.

The legislative changes also created OSIPTEL asthe new sector regulator. In addition, they estab-lished the universal access telecommunicationsfund, FITEL, which is administered by OSIPTEL.Under the law, OSIPTEL collects 1% of gross reve-nues from the telecommunications sector to financeFITEL. Collection started in mid-1994. By mid-1998,when FITEL undertook its first pilot project, overUSD 30 million had been collected.

2.3 Sector Policy

The Peruvian Full Competition Guidelines, publishedin August 1998, opened the sector to competition.These Guidelines placed renewed emphasis on ru-ral telecommunications. Although the privatizedincumbent operator had met the rollout obligationsimposed as part of its privatization, many rurallocalities in Peru remained without telecommunica-tions service.

In the 1998 guidelines, the government set a targetof extending service to five thousand unservedlocalities by the year 2003. The government defineduniversal access as access to a set of essentialservices provided by public operators and availableto the majority of users. Specifically, these servicesincluded voice telephony, low-speed fax and data,and free emergency calls.

2.4 Regulation

To implement its universal access policy, thegovernment issued the FITEL Regulation in Sep-tember 1998. The regulation establishesadministrative and technical terms for FITEL’soperations.

The FITEL Regulation establishes criteria to selectthe localities that will receive funding for service ex-pansion. Such localities include:

➢ rural towns (with a population of more than 400inhabitants and less than 3,000 inhabitants);

➢ district capitals; and

➢ towns in high social interest areas (as definedby the Government).

FITEL will not finance past or future networkexpansion or coverage obligations imposed by theGovernment on telecommunications operators.Therefore, the incumbent operator is excluded fromaccessing FITEL funds to finance its rollout obliga-tions. The Regulation also stipulates that FITEL willnot provide direct subsidies to subscribers or providefunding for localities that already have access totelecommunications services.


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FITEL refines the list of possible projects bydetermining which projects have the highest socialbenefit for FITEL’s investment, among other things.According to the regulation, FITEL must establish alist of projects eligible for subsidy, and forward it forapproval by the Ministry responsible for Telecom-munications. Once the list has been approved by theMinistry, OSIPTEL prepares tender documents for apublic bidding process to select operators toimplement the projects.

The competition is public and international. Notice ofthe tender is published in the country’s OfficialDigest, and in at least one newspaper with nationalcirculation. The tender may also be published ininternational media.

The bidder with the minimum subsidy bid is selectedas the winning bidder. The winner is eligible toreceive the concession to provide the designatedservices. The winner is required to enter into a fi-

nancing contract that stipulates the conditions underwhich FITEL will provide the subsidy.

The maximum subsidy is set at the “private NPV” ofeach project. Tariffs for rural public telecommunica-tions services are regulated by OSIPTEL, based ona maximum rate regime. Operators are allowed toset lower rates if they wish. The maximum rate forlocal calls from rural public telephones isapproximately USD $0.057/minute. In comparison,the price for local calls from urban public telephonesis about USD $0.048/minute (based on a three-minute call), with each additional minute at aboutUSD $0.029. Domestic long distance charges areset at the same regulated rate as that of thedominant long distance provider.

Interconnection charges are negotiated by theoperators. If there is no agreement, the generalinterconnection regime established by OSIPTELapplies. This regime includes provisions for defaultcost-based rates.

Box 6-2: Key Information in Fitel Tender Documents

FITEL tender documents include the following information for each project:

➢ the localities to be served;

➢ technical description of the service to be offered;

➢ timetable for the project, including expected installation dates;

➢ the maximum subsidy offered by FITEL;

➢ the applicable tariff regime (see below for further discussion);

➢ a technical, financial and economic profile of the project (i.e. business plan);

➢ a description of the socio-economic situation of the area to be served;

➢ information relating to a guarantee bond;

➢ information relating to a performance bond for the proper operation of the infrastructure;

➢ timetable and procedures for the tender process;

➢ the evaluation process for the offers;

➢ draft financing contract;

➢ draft concession contract (for 20 years, non-exclusive); and

➢ other conditions and requirements.


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Universal Service

2.5 Project Results

FITEL’s program began with the Northern Frontierpilot project, which was awarded in May 1998. Thisproject was a test case used to verify the design ofthe program. The project included 213 localities in 4departments, with a total of about 59,000 inhabi-tants. The project required the installation of onenew public telephone per locality.

The maximum FITEL subsidy for the pilot projectwas calculated at USD 4 million. The public biddingprocess was won by a subsidy bid of USD 1.66million to serve the designated communities. Thissum was equal to 41% of the maximum availablesubsidy.

The winning bidder completed installation of allrequired public telephones in December 1999. Weunderstand that in this instance the winning bidderused VSAT technology to implement the project.The public telephones in the project can send andreceive calls to and from other subscribers, includinglocal and long distance calls from fixed and mobileterminals.

After the pilot project, a number of changes weremade to the program. These changes applied toprojects awarded in December 1999. One changerequired the winning operator to install and maintaina public Internet telecentre in all district capitals inthe areas covered by the three projects. The threeprojects tendered in December 1999 included a re-quirement to install 1,937 public telephones and 236public Internet telecentres.

2.6 Bidding Procedure

Another innovation introduced after the pilot projectencouraged bidders to bid simultaneously on morethan one project. OSIPTEL’s objective was to pro-vide the lowest total subsidy for all three projects.Therefore, OSIPTEL adopted bidding proceduresdesigned to capture possible economies of scale(i.e. to pay a lower subsidy if a single operator couldserve two or three projects at a lower total cost thanone project).

OSIPTEL designed a bidding process that permittedbidders to bid on any combination of the threeprojects. Table 6-8 and Box 6-3 use a specificexample to illustrate this process. This exampleassumes there are three projects (1, 2 and 3) andthree bidders (A, B and C).

In the example in Table 6-8 and Box 6-3, the combi-nation of bids that minimizes the total subsidy is (iv)with a total of 170. Hence the winners would beBidder A for Project 3 with a bid of 50 and Bidder Bfor projects 1 and 2 together (1&2) with a bid of 120.

In fact, for the bidding process undertaken by FITELin December 1999, the winning firm made acombined bid for all three projects for a total of USD10.99 million. This bid was well below the maximumavailable subsidy of USD 50 million. Details areprovided Table 6-9. Projects to be tendered in 2000and afterwards will include the requirement to installcommunity Internet telecentres and will incorporatethe multiple project bidding process describedabove.

Table 6-8: Example of Multiple Project Procedure

Project 1 Project 2 Project 3Projects

1 & 2Projects

1 & 3Projects

2 & 3Projects1, 2 & 3

BidderA’s bids:

100 50 130

BidderB’s bids:

80 50 60 120 130 100 180

BidderC’s bids:

90 45 130


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In September 2000 OSIPTEL modified the FITELRegulation to among other things, formally introducethe possibility of funding access to the Internet andother advanced services. The new Regulation alsoexpanded the geographic and operational coverageof the Fund. Indeed, FITEL can now provide funding

for areas that, while having limited telecommunica-tions access, are not expected to fully benefit fromcompetition in the near future. In addition, FITEL isnow permitted to provide funding for the operationand maintenance of the designated services, ratherthan just installation as was previously the case.

Box 6-3: Evaluation Process for Bids

Example of Evaluation Process (Multiple Bids):Step 1: Determine the minimum subsidy amounts requested for each project or combination of projects:Min(Project 1) = 80;Min(Project 2) = 45;Min(Project 3) = 50;Min(Projects 1&2) = 120;Min(Projects 1&3) = 130;Min(Projects 2&3) = 100;Min(Projects 1&2&3) = 180Step 2: Compare the minimum amounts requested, this time for all three projects based on the followingpossible combinations:(i) Sum (Min(Project 1) + Min(Project 2) + Min(Project 3)) = 175(ii) Sum (Min(Project 1) + Min(Projects 2&3)) = 180(iii) Sum (Min(Project 2) + Min(Projects 1&3)) = 175(iv) Sum (Min(Project 3) + Min(Projects 1&2)) = 170(v) Sum (Projects 1&2&3) = 180

Table 6-9: Projects Tendered in December 1999

Project Localities Inhabitants inLocalities (k)

MaximumSubsidy (USD m)

Subsidy Granted(USD m)

South 534 136 14.0

Centre South 1029 303 27.0

Jungle North 374 141 9.0

Total 1937 580 50.0 10.99


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Universal Service

3 EUROPEAN COMMISSIONIn developing new policies for the telecommunica-tions sector, the European Commission issued aCommunication in November 1993 on developinguniversal service in a competitive environment. ThisCommunication initiated a process that establisheda consensus within the European Union on keyissues related to universality. These issues includethe scope of universal service, the choice of costingmethods to determine the actual costs of universalservice (if any), and possible universal service fund-ing mechanisms. Each of these issues is discussedbelow.

The European Commission has declared that itsmember states are free to select their approach touniversal service from three options. The decisionon the appropriate national option must be based onthe costing method stipulated by the Commission.The options are:

➢ Universal service financing is not required (i.e.universal service obligations do not represent anunfair burden to the designated operators pro-viding universal service);

➢ Universal service obligations do represent anunfair burden on the designated operators;however the State chooses to finance it directlyor indirectly; or

➢ Universal service is considered to be an unfairburden on the designated operators and aspecific universal service financing mechanismscheme is required. In this case the nationalscheme must comply with EuropeanCommunity Law.

3.1 Scope of Universal Service

The European Commission has defined universalservice in its Interconnection Directive. Universalservice is defined as a minimum set of services ofspecified quality which is available to all users inde-pendent of their geographical location and, in light ofspecific national conditions, at an affordable price.

In the most recent version of the ONP VoiceDirective, the Commission defined universal serviceto include:

➢ voice telephony service via a fixed connectionwhich will also allow a fax and a modem tooperate;

➢ operator assistance;

➢ emergency and directory inquiry services(including the provision of subscriber directo-ries); and

➢ the provision of public payphones.

The European Commission has recognized that theconcept of universal service may evolve as technol-ogy develops, and as the needs and expectations ofcitizens in its member states change. Accordingly,the scope of universal service may need to beredefined in the future. (See further discussionbelow.)

3.2 Costing Method

The Interconnection Directive states that universalservice regimes must be based on the net cost ofuniversal service obligations. The net cost must beaudited by the NRA of the member state. The cal-culation of the net cost and the structure of themechanism adopted by the NRA must be based onobjective, transparent, non-discriminatory and pro-portionate criteria and objectives.

According to the directive, the costs of universalservice should, in principle, be calculated based ona long-run average incremental cost (LRAIC) meth-odology. Universal service funding mechanisms areonly justified when the net cost of the USO isconsidered to represent an unfair burden on theoperator(s) subject to the obligation by the NRA.

The European Commission considers that theassessment of the net costs of universal servicemust be rigourous. The calculation of net costsshould take into account all of the benefits derivedby an operator from the provision of universal serv-ice.


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3.3 USO Funding Mechanisms

The Interconnection Directive stipulates that nationaluniversal service regimes may take the form of:

➢ a universal service fund established at a na-tional level,

➢ a system of supplementary charges collecteddirectly by the operators who have the respon-sibility of providing the service, or

➢ a combination of elements of both mechanisms.

Universal Service Fund: Such a fund pools contri-butions from operators and service providersrequired to contribute. The funds are thentransferred to operators that are entitled to receiveuniversal service payments. The fund must beadministered by a body that is independent of theparties who contribute to and benefit from the fund.The NRA is responsible for verifying the net cost ofthe USO.

Supplementary Charges: A supplementary univer-sal service charge may be added to interconnectioncharges to recover the net cost of the USO. Suchcharges must be distinct from interconnectioncharges. The NRA must ensure that such contribu-tions:

➢ are made in a transparent, non-discriminatoryand proportionate manner, and

➢ that there is no conflict of interest between anoperator’s commercial activities, and its role incollecting such supplementary charges fromcompetitors.

The Interconnection Directive states that only or-ganizations providing public telecommunicationsnetworks and/or public voice telephony servicesmay be required to contribute to a Universal ServiceFund or to pay Supplementary Charges. Thisdetermination was based on a number of factors.First, contributions should be apportioned amongstmarket players according to their activity in therelevant market. In addition, the collection mecha-nism must be designed to prevent doublecontributions. Note that the European Commissionconsidered the use of Supplementary Charges only

as a transitional measure and required them to bephased out.

Only service obligations that flow from the Commis-sion’s definition of universal service may be financedby universal service schemes. European Unionmember states may impose other obligations ontelecommunications companies and finance suchobligations in accordance with Commission law(including fair competition principles). However,member states may not require other market playersto contribute to the resulting costs.

In November 1996, the Commission issued aCommunication on the assessment criteria for uni-versal service schemes. This document providesmore detailed guidance on various aspects of uni-versal service, including some of the mattersdiscussed in this section.

3.4 Current Status of USO in theEuropean Union

In February 1998, the European Commission com-pleted its First Monitoring Report on UniversalService in Telecommunications in the EuropeanUnion. The report concluded, among other things,that it would be premature to propose an expansionof the scope of universal service obligations at thisstage. In the most recent European Commissioncommunication pertaining to universal service, theCommission reports that the provision of universalservice does not appear to be creating an undueburden on the designated operators in the memberstates.

In practice, the vast majority of European Unionmember states have not established specific USOmechanisms. Some have decided that any burdenassociated with universal service is so low that itdoes not constitute an unfair burden for the desig-nated operator. Others have determined that anyUSO burden does not justify the administrativeoverheads of a specific mechanism.


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Universal Service

4 UNITED KINGDOMThe United Kingdom (UK) provides an interestingspecific case study of the European Union’s generalapproach to USO issues. Oftel, the UKtelecommunications regulator, has determined thatspecific universal service financing is not required forthe designated universal service provider, BritishTelecom (BT). This determination was based on theconclusion that its USO does not represent an unfairburden on BT.

4.1 Background

In December 1994, Oftel published a consultativepaper which examined the evolution of the tele-communications regulatory framework in the UnitedKingdom. The paper examined the interconnectionregime and the Access Deficit Contributions (ADCs)which provided universal service funding in the UKat that time. ADCs were made by interconnectingoperators to pay for the deficit incurred by BT in pro-viding access services. The consultative paper setout a number of options to address concerns aboutADCs. The options included elimination of ADCsand their replacement, if necessary, with otheruniversal service funding mechanism(s).

In July 1995, Oftel decided to eliminate ADCs from1997 onwards. In coming to this decision, Oftelidentified what it considered to be critical problemsof ADCs in the UK. First, the net costs of universalservice in the UK were calculated based on fully-allocated, historical costs and not the preferred LRICmethod. In addition, the ADC regime was complexand difficult to administer. Oftel also concluded thatADCs provided a major source of uncertainty forpotential market entrants, since the calculation ofADCs was in the hands of the incumbent, BT.Finally, Oftel expressed concerns that maintenanceof ADCs would institutionalize a significant distortionof the market.

4.2 Benefits of Providing UniversalService

Once Oftel decided that ADCs were to be eliminatedby 1997, it had to determine whether BT’s USO

constituted an unfair burden. If so, based on ECpractice, such a burden could justify theestablishment of a specific funding mechanism.

In February 1997, Oftel reached a preliminaryconclusion that, taking into account the benefits toBT of providing universal service, there was noproven net cost of the USO. Accordingly, Ofteldecided that there was no justification for setting upa USO funding mechanism, at least in the shortterm. Oftel confirmed this preliminary conclusion inJuly 1997.

Early in its process of determining the cost ofuniversal service, Oftel identified some of thebenefits to operators of being a universal serviceprovider. These benefits are summarized in Box 6-4.

4.3 Calculation of Net Cost of USO

Table 6-10 below presents two estimates developedby Oftel of the net cost and benefits of being theUSO provider. The net cost estimates were basedon standard costing and revenue calculation meth-odologies, consistent with European Commissionguidelines. Of the various possible types of benefits,Oftel estimated the value of the following: life cycleeffects; ubiquity; corporate reputation (brandenhancement); marketing from Public Call Boxes.

The original estimates were released by Oftel inFebruary 1997. In this instance, the total intangiblebenefits (£102m to £151m) were estimated to ex-ceed the total net cost (£45m – £65m). Theseestimates are presented in Table 6-10.

In July 1999, Oftel released a consultative paper toreview universal service issues. The paper includedrevised estimates of net cost and benefits of theUSO. The revised estimates are also presented inTable 6-10. Oftel noted that the balance between thecosts and the benefits is closer than previouslyestimated. However, Oftel maintained its view thatthe case has not been made for the establishment ofa universal service fund to share the USO costs withother operators. In September 2000 Oftel againstated its belief that the USO is not an unfair burdenon BT. Oftel expects to be able to issue a definitestatement on the issue in Spring 2001.


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Box 6-4: Benefits of Being a Universal Service Provider

➢ Enhanced corporate reputation;

➢ Marketing and brand recognition;

➢ Access to customers’ telephone usage and demand data;

➢ Benefits associated with customer life cycle. The life cycle effect refers to the effect of basing a deci-sion on the net present value (NPV) of the business proposition in question, instead of on the currentdifference between costs and revenues;

➢ Ubiquity provides a marketing benefit to an operator within its traditional serving territory. Allcustomers know they can order telephone services from that operator no matter where they are inthe serving territory;

➢ Avoidance of loss of business through poor image and loss of trust due to disconnecting ordiscouraging subscribers;

➢ Avoidance of disconnection costs; and

➢ Reduced planning costs.

Table 6-10: Annual Net Cost and Benefits of Universal Service Provision

Original Estimates(February 1997)

(₤m)

Revised Estimates(July 1999)

(₤m)Benefits

Life cycle 1 – 10 0

Ubiquity 40 – 80 0

Corporate Reputation 50 50

Call Boxes 11 11

Total Benefits 102-151 61

Total Net Cost(conventional)

45-65 53-73


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Universal Service

5 SPAINSpain is one of the member states of the EuropeanUnion that has introduced legal provisions relating tothe creation of a universal service fundingmechanism. However, as most other memberstates, Spain has not yet put the mechanism intooperation.

5.1 Legislation

Spain’s General Telecommunications Law/1998 (the“Law”) implemented a comprehensive revision of thelegal framework for the telecommunications sector inSpain. The main objective of these revisions was tofacilitate full liberalization of the sector. It also trans-posed several European Commission directives intoSpanish law. Title III of the Law created the legalframework for the regulation and financing ofuniversal service in Spain.

Title III states that operators that provide telecom-munications services to the public and operators oftelecommunications networks whose operationrequires an individual licence are subject to publicservice obligations. Three categories of publicservice obligations are established: Universal Tele-communications Services (UTS); obligatorytelecommunications services; and other publicservice obligations. Obligatory telecommunicationsservices include telex, leased lines, and advancedservices. The Law provides for the possibility ofexternal financing only for UTS.

Universal Telecommunications Services (“UTS”) aredefined as a set of telecommunications services of adetermined quality that should be accessible to allusers independent of their geographic location at anaffordable price. This definition is similar to theEuropean Commission’s definition. The Lawprovides that the services included in the UTSconcept may be enlarged or revised to take intoaccount technological developments.

Initially, UTS should include the following elements:

➢ the right of all citizens to be connected to thepublic fixed network and have access to fixedpublic telephone service available to the public;

➢ the right of telephone subscribers to receive,free of charge, a printed and updated telephonedirectory;

➢ supply of sufficient public telephones; and

➢ rights of subscribers who are handicapped, orhave special social needs, to have access tofixed telephone service available to the publicunder equivalent conditions as other subscrib-ers.

The Law provides that any dominant operator in adetermined geographic zone may be designated toprovide any of the services included in the definitionof UTS. The telecommunications regulator, theCMT, is empowered to determine whether the USOfor designated operators results in a competitivedisadvantage. If the CMT so determines, a universalservice funding mechanism (the National UniversalService Fund) will be established to distributeamong telecommunications operators the net cost ofuniversal service provision. The Fund will be admin-istered and managed by the CMT.

The Law establishes a method for the calculation ofthe net cost of universal service. The Law’sapproach is in line with the European Commission’sguidelines. If implemented, the specific contributionscheme will be determined by the CMT. As previ-ously indicated, only operators providing telecom-munications services available to the public andoperators of public telecommunications networkswould be liable to contribute to the universal servicefunding mechanism. However, the Law allows theCMT to exempt certain operators from the contribu-tion requirement, to promote the introduction of newtechnologies or the development of effectivecompetition.

5.2 Regulation

In July 1998 a regulation was approved to imple-ment Title III of the Law. The regulation defines inmore detail the initial set of services to be included inUTS. It also sets out UTS quality and technicalspecifications and establishes the framework fordetermining UTS affordability.

The regulation authorizes the Ministry responsiblefor telecommunications to undertake a public


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consultation process to determine whether there areoperators interested in providing some or all of theservices included in UTS in determined geographicareas. This process should be carried out at leastonce a year before the finalization of the term estab-lished to provide universal service. Under thisprovision, the Ministry could open a competitivetender process to determine the US provider for thatzone. The universal service licence will be given tothe operator that offers service under the mostadvantageous conditions, including its offer with re-spect of the net cost of providing universal service.

The regulation establishes a detailed method forcalculating the net cost of universal serviceprovision. Procedures are to be established by theCMT to quantify the non-monetary benefits expectedto accrue to the designated operator of being of theuniversal service provider. The regulation also setsout detailed provisions for the financing of universal

service including the distribution of any contributionpayments and the administration of the Fund.

On 3 June 1999, the CMT issued a resolution des-ignating dominant operators in three nationalmarkets (fixed telephony, leased lines, and mobiletelephony). In the first two markets, CMT designatedTelefonica as dominant (having over 95% marketshare in both markets). For the third market, theCMT designated Telefonica Movil and Airtel asdominant operators.

Since its designation as dominant in relevant UTSmarkets, Telefonica may now calculate its net USOcosts and petition the CMT to rule that its USOplaces the company at a competitive disadvantage.This move could lead to the establishment of adetailed universal service regime in accordance withthe Law.


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Universal Service

6 CEE AND CIS COUNTRIESThis Section provides a high-level overview ofuniversality policies in the countries of CEE (Centraland Eastern Europe) and the CIS (Confederation ofIndependent States).

In summary, in these countries, USO and universalaccess concepts are not currently defined in a man-ner that would allow the specific implementation ofuniversality funding mechanisms. There are plans toimplement universal service funds in some countriesin the region. However, the most common universal-ity funding mechanisms in the regions are:

➢ inter-service cross-subsidies by the USOoperator; and

➢ (in countries that have recently privatized theirincumbent operators) service performance androllout obligations.

6.1 Introduction

There are significant variations in the level of eco-nomic and telecommunications development amongcountries in this region. Until the last decade, allcountries in the region had state-owned monopolies.Since then, some have privatized, using differentmodels, and others have not. Some have relativelyopen telecommunications markets. Other marketsremain closed, particularly in the key wirelinemarkets.

The policies and practices of the European Unionare increasingly becoming the model for telecom-munications policy development in the region. Theprocess of accession to the European Unionrequires countries to adopt European Commissiondirectives on policy, regulations and legislation, in-cluding directives on universal service. The followingsections review universal service policies in variousCEE and CIS sub-regions.

6.2 CEE Countries - EU AccessionTier 1 Countries

The five Tier 1 countries, the Czech Republic,Hungary, Estonia, Poland and Slovenia have signed

EU Accession Partnership Documents. TheEuropean Commission considers these countries asthe most similar to itself in terms of economic andpolicy development. This group of countries will,therefore, be the first in the region to join the EU.

The telecommunications sector is relatively well de-veloped in these countries. National telecommunica-tions and sector policies generally promotecompetition and private sector participation. Thesecountries have generally relied on internal operatorcross-subsidies to promote universality objectives.Countries that have privatized their incumbentoperators have imposed rollout obligations topromote universality.

New universal service schemes in these countries,when established, should be consistent with those ofthe European Commission. In Poland, for example,the government currently plans to replace the exist-ing posts and telecommunications law with separatelaws for each industry. The two new laws will comeinto force by the end of 2000. The new Telecommu-nications Law will establish a new universal serviceregime. The regime will implement a universalservice fund called the Fundusz UslugPowszechnych. The goal of the universal servicefund will be to increase access to universal tele-communications services in less developed areas ofPoland, especially rural areas.

Similarly, in the Czech Republic, the current legisla-tion does not specifically deal with the concept ofuniversal service. The concept will be defined in anew Telecommunications Act, which is currently inpreparation. A new universal service regime is alsobeing prepared in Hungary.

6.3 CEE Countries – EU AccessionTier 2 Countries

The Tier 2 Accession countries are Bulgaria, Latvia,Lithuania, Romania, and the Slovak Republic. Thesefive countries have also signed EU Accession Part-nership Documents and are likely to becomemembers of the European Union some time after theTier 1 countries. The European Commissionconsiders that more preparation is required to alignthe policies and regulatory framework of the Tier 2countries with those of the EU.


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Like those countries in Tier 1, Tier 2 countries havegenerally relied on inter-service cross-subsidies byincumbent operators to promote universality.Countries that have privatized have also imposedservice rollout obligations. For example, networkrollout obligations were imposed on Lattlelecom, themain operator in Latvia when it was privatized.

Some of the Tier 2 countries have started to definemore specific universal service regimes. In Bulgaria,for instance, the telecommunications sector policyincorporates universal service principles that areconsistent with those of the European Union.Specific universal service policies are currentlyunder preparation, and the interim Bulgarianuniversal service definition is similar to the EUdefinition. At present, the USO is imposed on themain telecommunications operator, the BulgarianTelecommunications Company.

6.4 CEE Countries – Non EUAccession Countries

Other CEE countries, such as Albania, Bosnia,Croatia, Macedonia, and Turkey have not yet signedEU Accession Partnership Documents, but plan todo so. Turkey has made a commitment under the

WTO Agreement on Basic Telecommunications andis preparing for the privatization of its established na-tional operator. The other countries in this grouphave been affected by war and civil unrest whichhas destroyed significant parts of their telecommuni-cations infrastructure. Generally, countries in thisgroup do not have specific definitions of universalservice. They generally require their incumbentoperators to cross-subsidize from higher marginservices, such as international services, to maintainaffordable service.

6.5 CIS Countries

The CIS countries are Armenia, Azerbaijan, Belarus,Kazakhstan, Kyrgyz Republic, Moldova, Russia,Tajikistan, Turkmenistan, Ukraine and Uzbekistan.In general, these countries do not yet have detailedpolicies on universal service or universal access.Universal service is generally not specificallydefined, or is not defined in a manner that imple-ments a specific funding mechanism for universalservice or universal access. The traditional model ofinter-service cross-subsidization by the incumbentoperator is typically still used in CIS countries.Where privatization has occurred, some networkrollout obligations have been imposed on theprivatized operator.


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Universal Service

7 CANADACanada’s main universal service program wasintroduced in 1992. It was established by the federaltelecommunications regulator, the CRTC, as part ofits decision to authorize infrastructure-based long-distance competition.

Under Canada’s original universal service regime,long distance operators paid “contribution charges”to support the USO of the incumbent operators. Thenet cost of the USO is the access deficit incurred bythe USO operators as a result of charging theprescribed “affordable” rates for local service inhigher-cost areas. In other words, regulatory con-straints require USO operators to maintain ratelevels in high cost areas below associated costs.

Contribution payments are based on the “contribu-tion-eligible” minutes of long distance traffic of eachoperator. All long distance providers, incumbents aswell as entrants, are required to contribute. The flowof contribution funds is administered by anindependent Central Funds Administrator (CFA).

The current contribution payments regime is underreview by the CRTC. As part of this review, theCRTC is considering whether to replace contributioncharges with a revenue-based contribution regime.Another option under consideration is a levy onsubscribers, similar to the subscriber line charge inthe USA. (See discussion of the SLC in USA casestudy below.)

7.1 Background

The CRTC established contribution charges in 1992in order to provide a subsidy to support local accessservices. Despite rebalancing initiatives in the1990s, Canadian local access services are stillpriced below their associated costs in a number ofhigher-cost areas. The CRTC policy is intended topromote and retain Canada’s high teledensity levels.

The rationale for the 1992 CRTC policy was partlybased on the assumption that new entrants in longdistance markets would reduce long distance reve-nues of the vertically-integrated incumbents. Thus, itwas assumed that the new entrants would reduce

the total amount of subsidy available to fund thoseoperators’ access services.

In 1998, the CRTC authorized competition in localaccess markets. At that time, it modified thecontribution regime. For instance, it decided to makethe contribution regime portable. Therefore, LocalExchange Carriers (LECs), whether incumbents ornew entrants, are entitled to use contributionrevenues to subsidize residential access services indesignated higher-cost areas. Note that to date,given the relatively slow entry of competitors in thoseareas, incumbents continue to receive the vastmajority of contribution payments.

The CRTC also modified the contribution chargeregime to establish an independent administrator tocollect contribution charges from long distanceoperators. These funds are disbursed to LECsbased on the number of residential customers theyserve. Since competitive LECs (CLECs) have madefew inroads into residential markets in Canada, thevast majority of contribution funds are still presentlypaid to incumbent LECs (ILECs).

7.2 Rate Rebalancing

Since 1992, the CRTC has implemented a programof tariff rebalancing to raise access rates to a levelcloser to costs. This rebalancing program was com-pleted prior to the introduction of a price cap tariffregime in 1998. The rate rebalancing resulted in areduction of contribution charges from a range ofabout CD 0.05 to CD 0.08 per minute per end to thecurrent range of about CD 0.006 to CD 0.023 perminute per end for average (includes peak and off-peak) rates. This has resulted in the elimination ofthe access deficit in lower-cost areas; however, asignificant access deficit is still incurred in higher-cost areas by the ILECs.

As in many countries, social and political concernshave prevailed in Canada to prevent the completionof full rate rebalancing in higher-cost areas. Newentrants in long distance markets have beenvociferous opponents of the contribution regime,arguing, among other things, that the regime doesnot take into account the significant benefits thataccrue to incumbents in providing universal service.Early in 2000, the Canadian government requesteda Senate Committee to study a variety of issues


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related to the regulatory framework for the telecom-munications sector, including the contributionregime.

The CRTC has frozen the current level of contribu-tion charges until the end of 2002. This move haseliminated the requirement for annual regulatoryproceedings to set contribution rates. It has alsoprovided more certainty to competitive suppliersregarding the cost of the contribution regime.

7.3 Cost Classification

As in other countries, the territories of the majorCanadian ILECs are subdivided into exchanges (thegeographic areas served by a switching centre orcluster of switches). In order to better identify higher-cost areas, the CRTC has classified exchanges intoseveral bands, largely based on the cost to providetelephone service in the exchanges. Only certainhigher-cost bands are eligible for subsidy. LECs re-ceive a subsidy based on the number of residentiallines they serve in those bands. Bands in higher costareas generally receive higher subsidies persubscriber line.

The CRTC has recently initiated a regulatory pro-ceeding to revise the banding classification. Theoverall objective of banding is to de-average thecosts to provide services across the territory of thedesignated operator. The costs of providing service

will be significantly lower in the urban core of a citythan in isolated rural areas. Universal serviceprogrammes should incorporate these cost differ-ences, where practical. The aim of the CRTC in thecurrent proceeding is to have the greatest amount ofintra-band exchange cost homogeneity whilemaintaining an administratively practical programme.

In a recent decision, the CRTC decided that in thefuture, only residential services in high-cost areaswould be eligible for subsidies. This means thatrates in all but the defined high-cost areas will haveto increase in order to eliminate any remainingaccess deficit. This decision was based on severalconsiderations. A major consideration was the factthat despite concerns to the contrary, telephonepenetration had increased through the period duringwhich rate rebalancing was implemented. TheCRTC also considered that contribution subsidiesshould be better targeted to reduce the overallsubsidy and the resulting economic efficiencylosses.

The CRTC has defined a high-cost area as:

A clearly defined geographical area where theincumbent local exchange carrier’s monthlycosts to provide basic service are greater thanthe associated revenues generated by an ap-proved affordable rate. Costs are estimatedusing long-run, incremental costs plus anappropriate mark-up.

Box 6-5: CRTC Basic Service Objective

This objective defines the level of service which should be extended to as many Canadians as feasible in allregions of the country. This level of service includes;

➢ individual local service with touch-tone dialing, provided by a digital switch with capability to connectvia low speed data transmission to the Internet at local rates;

➢ enhanced calling features, including access to emergency services, Voice Message Relay service (forthe hearing impaired) and privacy protection features;

➢ access to operator and directory assistance services;

➢ access to the long distance network (the capability to make and receive long distance calls); and

➢ a copy of a current local telephone directory.

The basic service objective is independent of the technology used to provide service, and may change overtime as service expectations evolve.


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Universal Service

The CRTC-approved mark-up is intended to coversome of the joint and common costs of the ILECs’operations which are not captured under the LRICapproach.

7.4 Basic Service Objective

The CRTC has recently defined a “basic serviceobjective”, which is similar in concept to the defini-tions of universal service adopted in the EuropeanUnion and elsewhere. The CRTC’s basic serviceobjective is described in Box 6-5.


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Universal Service

8 UNITED STATES8.1 Introduction

The administration of universal service policies isrelatively complex in the USA. This complexity ispartly the result of the two-tier state and federalregulatory system in that country. In summary, theUSA Telecommunications Act of 1996, confirmedthat the authority for implementation of universalservice support programs was shared between thefederal government (through the federal regulator,the FCC) and the states. The state regulatoryagencies have authority to impose universal supportprogrammes consistent with FCC principles. Theimplementation of the universal service reformprovisions of the 1996 Act were delayed and havebeen the subject of various regulatory and judicialappeals.

At the federal level, the USA has two distinct fundingschemes. One is aimed at the financing of accessdeficits (i.e. the difference between access costsand access revenues). The objective of the secondis the promotion of universal service in higher costareas.

8.2 Access Deficit Charges

A portion of the access deficit of incumbent localexchange carriers (ILECs) has been allocated to thefederal (interstate) jurisdiction. This portion has tra-ditionally been about 25%. This amount is collectedthrough a combination of access charges oninterstate carriers and direct subscriber charges.This regime was introduced in 1984 at the time ofthe AT&T divestiture. The access charge regime hasbeen modified extensively since. Historically, themain access charges have been:

➢ the Subscriber Line Charge (SLC) which islevied monthly by LECs directly on subscribers;

➢ the Common Carrier Line Charge (CCLC) whichis a per minute charge on interstate longdistance calls levied by LECs on interstate long-distance providers; and

➢ the Pre-subscribed Interexchange CarrierCharge (PICC) which is levied by the LEC on

the long distance provider which has prescribedto each access line.

As part of the most recent access charge reformpackage that went into effect in July 2000 the FCCcombined the PICC and the SLC into a new SLC.For the first year the new single charge will be lowerthan the existing two charges combined. By July2003, however, the cap for the new SLC is expectedto increase significantly, to USD $6.50 per monthper residential and single-line business lines.Consequently, the CCLC is expected to decrease tobelow USD $0.005 per minute of interstate longdistance traffic (from about USD $0.06 per minute in1996). Another component of the reform packagewas to remove about USD $650m in implicituniversal service support from access charges, andreplace that amount with an equivalent amount to becollected through the existing federal high-costservice fund.

8.3 Universal Service Support -Federal

As in the case of the access deficit, about 25% ofthe cost of subsidizing high-cost areas is currentlycollected at the federal level. A central high-costservice fund has been established towards which allcarriers contribute in proportion to their share ofinterstate revenues. The contributions are paid intothe Universal Service Administration Company(USAC), an independent fund administrator.

This fund supports three principal Federal programs:High-Cost Support, Local Switching Support andLong Term Support.

➢ High-Cost Support provides funds to rural car-riers in high-cost areas to finance their accessdeficit.

➢ Local Switching Support provides additionalsupport to LECs with fewer than 50,000 lines fortraffic sensitive switching costs.

➢ Long Term Support allows high cost providersto have the same CCLC rate level as other carri-ers.


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As part of the July 2000 reform package discussedabove, an additional and separate program for high-cost rural support was created. The new programsupport is provided on a portable, per-line basis. Thecentral high cost service fund also finances FCClow-income support programs for eligiblesubscribers. Under a different and separate fundingmechanism, schools, libraries, and health careproviders are eligible for discounted telecommunica-tions services.

All telecommunications carriers that provide inter-state telecommunications services must contributeto the cost of universal service. This includes carri-ers that provide service on a non-common carrierbasis, as well as payphone aggregators. However,the FCC has determined that carriers that provideonly international telecommunications services arenot required to contribute to universal service. Thisdecision was made, in part, so that foreigners wouldnot be required to cross-subsidize the national USAnetwork and its universal service regime.

Contributions for high-cost and low-cost incomesupport mechanisms are assessed againstinterstate and end-user revenues. Recently, thecontribution rate has been approximately 3% ofdesignated revenues.

To date, the FCC has calculated access costs forthe purpose of its universal service charges basedon historic, embedded costs. As part of the reformsinitiated by the 1996 Telecommunications Act, theFCC announced that it would introduce a forward-

looking cost model to be used from 2001. After thisdate, federal payments are to be shifted gradually to25% of the difference between forward-looking costsof high-cost facilities and a benchmark level ofdesignated telecommunications revenues. This newapproach is intended to replace the existingprograms described above.

8.4 Universal Service Support –States

The remaining 75% of universal service subsidies iscollected at the state level. Collection of thesesubsidies falls under the jurisdiction of state regula-tors. Each state may allow carriers to use a differentmechanism. Historically, most states have relied oninter-service cross-subsidies by the ILECs topromote their universal service plans. Many stateregulators are now moving to replace internal cross-subsidies with a central high-cost fund at the statelevel. These funds will collect contributions fromcarriers operating in each state in proportion to eachcarrier’s share of revenues.

For example, the State of Arizona has implementedthe Arizona Universal Service Fund (AUSF). TheAUSF receives its funding equally from longdistance customers (based on the total intrastatelong distance revenue for a particular carrier) andlocal customers (based on the number of accesslines and interconnecting trunks) of telecommunica-tions carriers operating in the state that areconnected to the PSTN.


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Universal Service

9 SOUTH AFRICASouth Africa provides an interesting case studybecause of the high profile that country has given tothe development of the telecommunications sectorin general and to universality objectives in particular.Telecommunications is high on the Government’seconomic and social policy agenda.

9.1 Background

In South Africa, universal service is considered along-term goal, and universal access a short-termgoal. A 1995 consultative document (the GreenPaper) and the subsequent 1996 White Paper onTelecommunications Policy placed considerableemphasis on these issues. The TelecommunicationsAct of 1996 also emphasized universality objectives.

More recently, the newly created Universal ServiceAgency (see discussion below) undertook a consul-tation process in 1998 to establish specificuniversality definitions, mechanisms and targets.

Telkom, South Africa’s incumbent operator waspartially privatized in 1997 (30% of its equity wassold to a foreign strategic partner). As part of thereform package, Telkom was granted five years ofexclusivity for PSTN services, ending in 2002.During this period of exclusivity, Telkom has theprimary role in universal service/universal accessprovision in South Africa. The company is expectedto use its monopoly revenues to cross subsidize itsnetwork rollout. At the same time, government policyprovides that Telkom must rebalance its rates by theend of the exclusivity period.

9.2 Network Rollout Obligations

According to its licence, Telkom must also install2.69 million new lines by 2002. Of these lines, 1.67million must be installed in under-served areas.Telkom must also convert 1.25 million existinganalogue lines to digital, as well as installing120,000 payphones in the same time period.

Other telecommunications providers also have obli-gations related to universal service and universalaccess. Cellular network operators, for example,have rollout obligations imposed as conditions of

their licences. The two cellular operators licensed in1993, MTN and Vodacom, were required to install7,500 and 22,000 cellular payphones (communityservice telephones) in under-served areas over aperiod of five years.

9.3 Universal Service Fund

Telecommunications licensees must pay an annualcontribution to the Universal Service Fund (USF),which was created by the Telecommunications Actof 1996. The USF was allocated R3,000,000 asstart-up funding when it was established in 1997.The USF may be used for:

➢ providing direct subsidies to targeted priority(needy) persons to defray the higher cost oftelecommunications services due to raterebalancing; and

➢ subsidizing the cost of network rollout to under-served areas by operators, including Telkom,whose licences impose such rollout obligations(until such time as Telkom has completedrebalancing its rates).

The USF is administered jointly by SATRA, thenational telecommunications regulator, and the Uni-versal Services Agency (USA). SATRA monitorscompliance with network rollout and service qualitytargets and pricing. It also establishes the basis forUSF contributions. The USA defines, investigatesand recommends ways to achieve universal serviceand universal access.

The establishment of telecentres has been a priorityfor USF financing. Generally, the USA is responsiblefor establishing telecentres in partnership withcommunities and donor agencies. NGO’s, individualentrepreneurs, women and disabled people in ruralareas and townships are particularly encouraged toapply to run community telecentres. Telecentrestypically contain a number of telephones, fax andphotocopy machines, PCs and access to theInternet.

Over the last three years, 150 telecentres have beenestablished or are in the process of being estab-lished. In the 1997/98 financial year, six standardtelecentres were established. In 1998/99 anadditional 12 standard telecentres were set up. In


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1999/2000 ten mini-telecentres, 10 standardtelecentres and 90 larger multipurpose communitytelecentres (MCT) will be established. Thirty of theMCT’s will be specifically targeted to disabledpeople.

All telecommunications licensees are required to payannual contributions to the USF. In the most recentfinancial year, operators licensed to provide publicswitched services (including access, local and longdistance services) and mobile cellular services wererequired to contribute 0.16% of their annual revenuefrom the provision of the corresponding telecommu-nications services. Value-added network serviceslicensees were required to contribute R1500annually to the USF, while private network licenseeswere required to contribute R1000 annually.

9.4 Human Resources Fund

The Telecommunications Act of 1996 also created aHuman Resources Fund (HRF) which is adminis-

tered by the Ministry of Posts, Telecommunicationsand Broadcasting, in consultation with SATRA. TheHRF is utilized to promote the provision ofadequately skilled human resources at all levels ofthe telecommunications sector. The HRF will financetraining and educational programs at theartisan/technician, undergraduate, and post-graduate levels. It includes support for science andtechnology education at schools.

All licensees are required to pay annualcontributions to the HRF. In the most recent financialyear, operators licensed to provide public switchedservices (including access, local and long distanceservices) and mobile cellular services were requiredto contribute 0.08% of their annual revenues fromthe provision of the telecommunications services.Value-added network services licensees were re-quired to contribute R750 annually to the HRF, whileprivate network licensees were required tocontribute R500 annually.


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Universal Service

10 AUSTRALIA10.1 Background and Legislation

The universal service regime in Australia is set out inPart 2 of the Telecommunications Act of 1999. TheAct establishes a USO, which is the obligationplaced on the universal service provider(s). Suchproviders must ensure that standard telephoneservices and payphone services are reasonablyaccessible to all people in Australia on an equitablebasis, wherever they reside or carry on business.

The rates of standard telephone services are regu-lated. As a result, in high-cost areas, the universalservice provider cannot always recover the full costof its service from the customer. Losses from theprovision of such USO services are shared amongall telecommunications operators. All operators,including Telstra (the incumbent and USO provider)are required to contribute to the costs of providingthe USO in proportion to their overall share of thetelecommunications market. Contribution shares arecalculated using an eligible revenue formula(discussed below).

10.2 Net Cost of USO

“Net cost areas” are determined by the Australianregulator, the ACA. These are geographic areas forwhich universal service providers may claimcompensation for their losses. They are primarilyrural areas. Within 90 days after the end of thefinancial year, each universal service provider mayfile a claim to the ACA for a credit, based on itsclaimed net universal service cost for the financialyear.

The net universal service cost is calculated as“avoidable cost” minus “revenue forgone”. Inessence, avoidable cost is the cost incurred by auniversal service provider that it would not haveincurred if it had not supplied services to net costareas. Revenue forgone is the revenue a universalservice provider would not have earned if it had notsupplied service to net cost areas.

10.3 Eligible Revenue

Within 90 days after the end of a financial year, allparticipating carriers (including universal serviceproviders) may file returns with the ACA setting outtheir designated “eligible revenue” for that financialyear.

Eligible revenue is calculated as follows. First, thecarrier’s gross telecommunications revenue is de-termined, based on all sales revenue earned fromtelecommunications industry activities. The carriermay then make certain deductions to calculate itsnet telecommunications revenue. Deductionsinclude revenue earned entirely in overseasmarkets, sale of customer equipment, USO levycredit receipts, supply of content services andterrestrial radiocommunications broadcastingactivities.

Eligible revenue is then calculated as net telecom-munications revenue minus “input payments” toother carriers. Input payments are payments to othercarriers for services required to provide the firstcarrier’s telecommunications services (e.g. intercon-nection charges). The carrier’s share of the totaleligible revenue of all participating carriers is itscontribution factor. This factor can be seen as aproxy for its market share in the markets from whicha contribution is required.

10.4 Payment Mechanism

The ACA may choose either to accept the net costclaims and the eligible revenue returns as correct, ormake further inquiries. After any such inquiries, theACA publishes a written assessment for the financialyear. The ACA assessment sets out a “levy debit”for each participating carrier, which is its contributionfactor multiplied by the total net universal servicecost.

Each participating carrier must pay its levy debit tothe Commonwealth’s Universal Service Reservewithin one month after receiving the ACA assess-ment. The total of a participating carrier’s levy debitis equal to total net universal service cost. Eachparticipating carrier that is a universal serviceprovider also has a levy credit, which is equal to itsnet universal service cost. When all carriers who


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owe money to the Reserve have paid into theReserve, universal service providers are paid anynet amount to which they are entitled.

10.5 Recent Developments

For the 1996/97 fiscal year, the net universal servicecost levied on the industry was agreed betweencarriers to be USD 153.4 million. For 1997/98,Telstra claimed a net cost of USD 1,115.1 million, asubstantial increase over the previous year. ACA’spreliminary review of the Telstra claim suggested itwould be substantially decreased (to around USD580M).

The Australian government recognized the potentialfor Telstra’s large universal service claims to gener-ate uncertainty in the industry and serve as a

disincentive to investment. Accordingly, thegovernment enacted legislation that capped the1997/98 net universal service cost at USD154.5 mand at USD154.5 m plus CPI for 1998/99 and1999/2000. This cap is an interim measure only.These capped amounts represent approximately1.4% of gross carrier revenue.

The scale of the Telstra claim and the potentialuncertainty it generated has called into question thecurrent USO funding arrangements. It has promptedthe Australian government to undertake a publicconsultation process to review the USO fundingarrangements, including the desirability andpracticality of direct government funding.


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Universal Service

11 ASIA11.1 Introduction

This section provides a very high-level overview ofthe status of universal service and universal accesspolicies in selected Asian countries. In general,universal service is not currently defined in Asiancountries in a manner that would allow for theimplementation of a targeted funding mechanism.The most common funding mechanism in the coun-tries we reviewed remains inter-service cross-subsidy by the incumbents.

In a number of countries, network expansion obliga-tions are used to supplement cross subsidies as amethod of promoting universality. Such obligationsmay be imposed on existing state-ownedincumbents, on newly privatized operators, oncompetitive new operators or on jointventure/consortia–type entities, for example, as partof BOT-type arrangements.

There are other variations on the continent. HongKong has implemented transparent per-minutecharges to promote universal service in competitiveconditions. Malaysia is considering the establish-ment of a Universal Service Fund. In the followingsections, we highlight a few notable countryexamples and provide a summary of developmentsin other countries.

11.2 Highlights: Selected Countries

In Japan, the NTT Corporation Law of 1997 reor-ganized the incumbent, NTT into two regionalcompanies for eastern and western Japan, and onelong-distance company. All three operatingcompanies are owned by a single holding company.The 1997 Law specifies that NTT has the responsi-bility to contribute to securing appropriate, fair andstable provision of nation-wide telephone services.Although universal service is not specifically defined,universality objectives have been implemented byrequiring uniform geographically-averaged rates forboth access and local calling. In high-cost areas,these charges are cross-subsidized by accesscharges from more densely-populated, less costlyareas, and by long-distance charges.

In New Zealand, the government maintained somerestrictions on the incumbent, TCNZ, when it wasprivatized in 1990. These restrictions are enforcedthrough the so-called Kiwi Share provisions in theTCNZ Articles of Association. For example, the KiwiShare provisions oblige TCNZ to maintain ruralcustomer access charges at rates no higher than thestandard urban residential rate. New Zealand doesnot have a telecommunications regulator or specificregulations for the telecommunications sector.Recovery by TCNZ of the costs of serving high-costareas is left to commercial negotiations and generalcompetition policy. Accordingly, TCNZ seeks torecover costs through commercially negotiatedinterconnection prices. As of late 1999,interconnection negotiations resulted in an impassewhich the New Zealand government has tried sinceto sort out.

Hong Kong has established a cost-based universalservice regime funded through charges on external(i.e. international) traffic. The designated universalservice provider (CWHKTC) has an obligation toprovide PSTN access services in Hong Kong. Theuniversal service provider may receive fair contribu-tions from other licensees towards the net costs ofserving customers and providing public telephones.Customers and payphones for which compensationis requested by the USP are referred to as “uneco-nomic”. The total net cost of CWHKTC (the universalservice contribution or USC) was calculated at HKD510.5 million for the 1997/98 financial year. Of thisamount, HKD 398.2 million was incurred in servinguneconomic customers and HKD 112.3 million inserving uneconomic payphones. The USC for the1997/98 year was equivalent to HKD 0.136 perminute external of traffic. The USC accounted forabout one percent of total sector revenues. TheUSC regime has been maintained after the externalmarket liberalization of January 1999. However, anindependent intermediary was appointed to collectand administer the USC.

11.3 Other Asian Countries

Internal cross-subsidization is widely used in otherAsian countries to promote universality. This ap-proach is used, for example, in China, Bangladesh,Bhutan, Indonesia, Iran, South Korea, Sri Lanka,Mongolia, Nepal, Philippines and Thailand.


6 - 56

Network expansion obligations are also widely usedto promote universality. Some examples follow.

In India, new and existing telecommunicationsoperators are required to install a certain number oflines in rural areas within specified periods. As anexample, in category A concessions, in the mostdesirable areas, the tender conditions for India’sbasic service operators stipulated that at the end of12 months, a minimum of 10% of installed linesmust be in rural areas. A similar condition applied tothe less desirable category B concession areas, butthe timetable was extended to 24 months. For cate-gory C concession areas, the timetable was 36months.

In the Philippines, all nine international serviceproviders were required to install 300,000 local lineswithin 3 years of obtaining their licences. Cellular

mobile operators were required to install 400,000local lines within a period of five years. In somecases, licences were awarded to companies for bothcellular and international services, resulting in arequirement to put in 700,000 lines in 5 years.

Thailand and Indonesia have adopted joint-venture/consortia models with Build OperateTransfer (BOT) type arrangements. Under thesearrangements, foreign strategic investors enteredinto agreements with local partners (often includingthe incumbent operators) to operate telecommuni-cations networks in designated areas. In bothThailand and Indonesia, the licence and contractualarrangements included requirements to install acertain number of lines within specified period. InIndonesia, the new operators were also required toextend service to rural municipal districts in theirserving territories within specified periods.

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A - 1

APPENDIX A – WTO REGULATION REFERENCE PAPERAnnex to the Fourth Protocol to the GATS Agreement, the “Agreement on Basic Telecommunications”

negotiated under the auspices of the World Trade Organization (WTO) in February 1997, which came intoeffect on 1 January 1998.

This Reference Paper forms part of the commitments of most of the original 69 signatories to the Agreementon Basic Telecommunications. Several signatories committed to somewhat different wording. Others have

subsequently committed to implement the regulatory framework set out in the Reference Paper.

REFERENCE PAPER

Scope

The following are definitions and principles on the regulatory framework for the basictelecommunications services.

Definitions

Users mean service consumers and service suppliers.

Essential facilities mean facilities of a public telecommunications transport network or service that:

(a) are exclusively or predominantly provided by a single or limited number of suppliers;and

(b) cannot feasibly be economically or technically substituted in order to provide aservice.

A major supplier is a supplier which has the ability to materially affect the terms of participation (having regardto price and supply) in the relevant market for basic telecommunications services as a result of:

(a) control over essential facilities; or

(b) user of its position in the market.

1. Competitive safeguards

1.1 Prevention of anti-competitive practices in telecommunications

Appropriate measures shall be maintained for the purpose of preventing suppliers who, alone ortogether, are a major supplier from engaging in or continuing anti-competitive practices.

1.2 Safeguards

The anti-competitive practices referred to above shall include in particular:

(a) engaging in anti-competitive cross-subsidization;


A - 2

(b) using information obtained from competitors with anti-competitive results; and

(c) not making available to other services suppliers on a timely basis technicalinformation about essential facilities and commercially relevant information which arenecessary for them to provide services.

2 Interconnection

2.1 This section applies to linking with suppliers providing public telecommunications transport networksor services in order to allow the users of one supplier to communicate with users of another supplier and toaccess services provided by another supplier, where specific commitments are undertaken.

2.2 Interconnection to Be Ensured

Interconnection with a major supplier will be ensured at any technically feasible point in the network.Such interconnection is provided.

(a) under non-discriminatory terms, conditions (including technical standards andspecifications) and rates and of a quality no less favourable than that provided for itsown like services or for like services of non-affiliated service suppliers or for itssubsidiaries or other affiliates;

(b) in a timely fashion on terms, conditions (including technical standards andspecifications) and cost-oriented rates that are transparent, reasonable, havingregard to economic feasibility, and sufficiently unbundled so that the supplier neednot pay for network components or facilities that it does not require for the service tobe provided; and

(c) upon request, at points in addition to the network termination points offered to themajority of users, subject to charges that reflect the cost of construction of necessaryadditional facilities.

2.3 Public Availability of the Procedures for Interconnection Negotiations

The procedures applicable for interconnection to a major supplier will be made publicly available.

2.4 Transparency of Interconnection Arrangements

It is ensured that a major supplier will make publicly available either its interconnection agreements ora reference interconnection offer.

2.5 Interconnection: Dispute Settlement

A service supplier requesting interconnection with a major supplier will have recourse, either:

(a) at any time or

(b) after a reasonable period of time which has been made publicly known to anindependent domestic body, which may be a regulatory body as referred to inparagraph 5 below, to resolve disputes regarding appropriate terms, conditions and

Appendix A

A - 3

Appendix A

rates for Interconnection within a reasonable period of time, to the extent that thesehave not been established previously.

3 Universal Service

Any Member has the right to define the kind of universal service obligation it wishes to maintain. Suchobligations will not be regarded as anti-competitive per se, provided they are administered in a transparent,non-discriminatory and competitively neutral manner and are not more burdensome than necessary for thekind of universal service defined by the Member.

4 Public Availability of Licensing Criteria

Where a licence is required, the following will be made publicly available:

(a) all the licensing criteria and the period of time normally required to reach a decisionconcerning an application for a licence; and

(b) the terms and conditions of individual licences.

The reasons for the denial of a licence will be made known to the applicant upon request.

5 Independent Regulators

The regulatory body is separate from, and not accountable to, any supplier of basictelecommunications services. The decisions of and the procedures used by regulators shall be impartial withrespect to all market participants.

6 Allocation and Use of Scarce Resources

Any procedures for the allocation and use of scarce resources, including frequencies, numbers andrights of way, will be carried out in an objective, timely, transparent and non-discriminatory manner. Thecurrent state of allocated frequency bands will be made publicly available, but detailed identification offrequencies allocated for specific government uses is not required.

B - i

APPENDIX B – THE ECONOMICS OF TELECOMMUNICATIONSPRICES AND COST

Table of Contents

1.1 The Economic Rationale for Price Regulation 11.1.1 Benefits of Competition 11.1.2 When Markets Fail 3

1.1.2.1 Economies of Scale 31.1.2.2 Economies of Scope 4

1.1.3 The Monopoly Problem 51.1.4 Regulated Monopoly 51.1.5 Public Enterprise 5

1.2 Monopoly Pricing 51.2.1 Single Product Monopoly 51.2.2 Ramsey Pricing 61.2.3 Regulation under Increasing Competition 8

1.3 Elasticity of Demand 91.3.1 Survey of Elasticity Estimates 9

1.4 Telecommunications Costs 101.4.1 Costing Perspectives 101.4.2 Costing Terms and Concepts 101.4.3 Costing Methods 10

1.4.3.1 Costing Method Comparison 121.4.3.2 Historical Cost Approaches 131.4.3.3 Forward-Looking Cost Approaches 14

1.4.4 Interconnection Costing Example 151.4.4.1 Determining the Size of the Increment 161.4.4.2 LRIC Approach 171.4.4.3 TSLRIC/LRAIC Approaches 171.4.4.4 Allocation of Joint and Shared Costs: Mark-ups 171.4.4.5 Structure of Interconnection Prices 18

B - ii

List of Boxes, Figures and Tables

List of Boxes

Box B-1: Price and Income Elasticities of Demand 8Box B-2: Application of Industrialized Country Elasticity Estaimtes to Less Developed Markets 9Box B-3: Three Principal Costing Perspectives 11Box B-4: Principal Costing Terms and Concepts (in alphabetical order) 12

List of Figures

Figure B-1: Market Demand Curve 2Figure B-2: Market Supply Curve 2Figure B-3: Market Supply and Demand 3Figure B-4: Social Welfare of Marginal Cost Pricing 3Figure B-5: Average Cost under Economies of Scale 4Figure B-6: Firm Loses Money at "First Best" Pricing under Economies of Scale 6Figure B-7: Example of Application of Ramsey Prices 7Figure B-8: The Relationship Between Costs, Costing Methods and Allocations 14Figure B-9: Interconnection Costing Example: Analysis of Access and Local Calling Networks 16

List of Tables

Table B-1: Point and Interval Estimates of Price and Income Elasticities of Demand for Selected Telephone Services 10

B - 1

APPENDIX B – THE ECONOMICS OF TELECOMMUNICATIONSPRICES AND COSTSThis Appendix provides an overview of theeconomic theory and practice of price regulation(tariff setting) and costing in telecommunications. Itcontains background information relevant to severalof the modules in this Handbook. It is particularlyrelevant to Module 4, which focuses on priceregulation.

The concepts addressed in this Appendix are alsorelevant to other Modules. In particular,telecommunications costing and pricing conceptsunderlie many of the issues related toInterconnection (Module 3), Competition Policy(Module 5), and Universal Service (Module 6).Having said that, the world of economic theory andpractice is not for everyone. We have concentrateda discussion of these concepts in this Appendix tobe read by those with a particular interest in thesubject.

We start this Appendix with a discussion of thebenefits of competition and the alternatives availablewhen markets fail to produce socially-optimal results.We then review the theoretical and practicalapplications of monopoly pricing, including Ramseypricing. We provide a survey of telecommunicationselasticity estimates. The last half of this Appendix isdevoted to a survey of telecommunications costs,including different costing perspectives, terms anddefinitions. We discuss some of the costingmethodologies adopted by regulators around theworld, including the FCC’s TELRIC and theEuropean Commission’s LRAIC. We conclude with aspecific interconnection costing example.

This Appendix covers a range of topics, fromgeneral economic theory to very specific economicapplications of the theory in the telecommunicationssector. We have only provided a summary treatmentof the principal topics, and we have simplified thediscussion of certain issues. Readers interested in amore detailed and technically specific treatment aredirected to the selected sources listed in AppendixD.

1.1 The Economic Rationale forPrice Regulation

In the following Section, we review the economictheory relating to the benefits of competition. Wealso review the cost characteristics of telecommuni-cations networks that constrain competition and thatprovide a rationale for continued price regulation ofdominant operators in the telecommunications sec-tor.

1.1.1 Benefits of Competition

According to economic theory, price regulation isjustified when markets fail to produce competitiveprices. If markets are competitive and functionsmoothly, theory predicts that they will lead to“efficient” prices that maximize society’s welfare.Specifically, efficient prices will equate the amount ofa service that sellers want to supply to the amount ofa service that buyers demand. Efficient prices willequal the benefit that buyers get from the last unitconsumed and the cost of producing the last unitsupplied (the marginal cost).

The general economic theory of efficient competitivemarkets is illustrated below. Figure B-1 shows themarket demand curve, D, for a particular service.The demand curve is plotted on a graph with theprice of the service (the “own-price”), P, on thevertical axis (the “y-axis”) and the quantity of theservice, Q, on the horizontal axis (the “x-axis”).Because consumers will want more of the servicewhen the price is lower, the demand curve is drawnsloping downwards from left to right, to show thatmarket demand increases as price decreases, andvice-versa. Total market demand is determined byadding together the demand curves of individualconsumers.

Figure B-2 shows the market supply curve, S, for theservice. This curve slopes upward to the right,showing that more services will be provided by firmsas the price of the service increases. In this exampleof a perfectly competitive firm, we assume constantor decreasing returns to scale (see discussion ofthese and other cost concepts below). Under thisassumption, the supply curve of a perfectly


B - 2

Figure B-1: Market Demand Curve Figure B-2: Market Supply Curve

P

Q0

D

P

Q0

S

competitive firm is that portion of the marginal cost(MC) that lies above the average variable costcurve. Total market supply is determined by addingtogether the supply curves of individual firms.

Figure B-3 shows the market equilibrium when firms(suppliers) and consumers interact. At marketequilibrium, the demand and supply curves intersectat the market price P* and market output Q*. Insummary, competitive markets will lead to anefficient price P*, at which the amount suppliers wantto provide, Q*, equals the amount buyers demand.Given that for each firm the supply curve is themarginal cost curve, at market equilibrium the firmwill produce up to the point where the price is equalto marginal cost – that is, the level of output at whichP* equals marginal cost.

Figure B-4 shows that social welfare is maximized atthe competitive equilibrium (price P*, output Q*).Assuming that the area under the demand curverepresents consumers’ total willingness-to-pay andthe area under the supply curve representssuppliers’ total cost, the difference between thesetwo concepts is area ABC. This is often referred toas “social surplus” or “total surplus”.

Total surplus may be divided into consumer surplusof AP*B (the difference between total willingness topay 0Q*BA less what consumers must actually pay0Q*BP*), and producer surplus of P*CB (the totaldifference (profit) between the revenues 0Q*BP* andthe costs incurred 0Q*BC). It can be shown that noother combination of prices will result in as muchtotal surplus. In short, equating price and marginalcost at output Q* maximizes total surplus and,hence, social welfare. This is why economists referto marginal-cost pricing as “efficient”.

This, then, is the situation in this ideal competitivemarketplace. For this efficient ideal to be realized,the market must meet a number of conditions. Forinstance, the market must have several sellers(suppliers) and buyers (consumers), with none solarge that it can affect prices: no one can bedominant in the marketplace. In addition, there mustbe no significant externalities, loosely defined asspillover benefits or negative effects to/from othermarkets. There should also be free entry to and exitfrom the market. Finally, as mentioned above, thismarket should not be characterised by economies ofscale.

Appendix B

B - 3

Appendix B

Figure B-3: Market Supply and Demand Figure B-4: Social Welfare of Marginal CostPricing

P

Q0

S

D

Q*

P*

P

Q0

S

D

Q*

P*

ConsumerSurplus

ProducerSurplus

A

B

C

This conventional description of competitive marketsgenerally will not be applicable to thetelecommunications sector because of the specificcost characteristics of telecommunications networks.We discuss these cost issues in the sections below.

1.1.2 When Markets Fail

Where all the conditions mentioned above are notpresent, the market will not generally producesocially-optimal results. Economists call this “marketfailure”. Market failure occurs when resources aremisallocated, or allocated inefficiently. The result iswaste or lost value. In such a situation, there isjustification for government intervention to improvesocial welfare. Clearly, the impetus for regulationmust be weighed against its economic andbureaucratic costs, in order to avoid or minimize“regulatory failure”. Module 1 of this Handbookprovides guidelines for effective and efficientregulation in the telecommunication sector.

In traditional economic theory, natural monopoly iscited as a prime example of market failure. Looselydefined, a natural monopoly exists when the costs of

production are such that it is less expensive formarket demand to be supplied by one operator thanby several. A natural monopoly arises from twosources: economies of scale and economies ofscope. Economists use the concept of “subadditivity”to describe and test for natural monopoly.

1.1.2.1 Economies of Scale

Economies of scale exist when the average (total)cost of the firm decreases with the volume ofproduction. Figure B-5 illustrates how a supplier’slong-run average cost (AC) declines as a result ofeconomies of scale. Economies of scale are alsoreferred to as increasing returns to scale.Conversely, diseconomies of scale, or decreasingreturns to scale, exist when average costs increasewith the volume of production. Constant returns toscale exist when average costs are constant with thevolume of output.

Economies of scale can arise from a number oftechnological and managerial factors. One commonsource of economies of scale, especially in the tele-communications sector, is fixed costs (i.e. costs that


B - 4

are incurred regardless of how many units of outputare produced). Fixed costs are significant in tele-communications and in other industries that requirenetworks. When output expands, average fixedcosts will decline. This phenomenon will exert adownward pressure on average cost that may resultin economies of scale. Note that the existence offixed costs does not necessarily mean that the firmwill have economies of scale. As noted above,economies of scale can be due to factors other thanfixed costs.

Economies of scale can exist over some ranges ofoutputs, but not others. For instance, at high levelsof output, management might not be able to overseeclosely all the operations of the firm, giving rise toinefficiencies that can dominate any technologicalcost advantages of large-scale operation.

The existence of economies of scale depends onwhether average (total) cost increases or decreasesin the long run. Average total cost is made up of twocomponents: average fixed cost and averagevariable cost. As discussed above, average fixedcost decreases with output. However, averagevariable cost may increase more or less rapidly thanoutput. Economies of scale depends on the

Figure B-5: Average Cost under Economiesof Scale

P

Q0

AC

combined behaviour of these two components asoutput increases.

For a single service firm, a natural monopoly exists ifeconomies of scale arise over the relevant range ofoutput relative to actual and future demand. Whenthe firm produces more than one service, averagecosts are not clearly defined. In this instance,economists have developed a number of criteria torepresent and test for economies of scale. The gen-eral idea remains the same as in the single serviceexample: a multi-service firm with economies ofscale can increase all of its services in proportionwith a less than proportional increase in its totalcosts.

1.1.2.2 Economies of Scope

When more than one good is being produced, anatural monopoly can arise from economies ofscope as well as from economies of scale. Withseveral goods, there are sometimes sharedequipment or common facilities that make producingthem together less expensive than producing themseparately. Economies of scope exist if a givenquantity of each of two or more goods can be pro-duced by one operator at a lower total cost than ifeach good were produced separately by differentoperators.

Economies of scope refers to the cost advantage ofone operator supplying two or more products orservices compared to different operators each pro-viding one. A local PSTN operator, for example,already has a network for local subscribers. Withappropriate interconnection to long distancefacilities, the local network can also be used toprovide long-distance service to customers. Usingthe local network for long distance service willprovide the local operator with economies of scopethat would be unavailable to a new operator thataimed to provide just long-distance services. Thelatter would have to replicate the local network toaccess subscribers.

A somewhat similar curve to that in Figure B-5 wouldrepresent the effect of economies of scope onaggregate average costs of an operator providingseveral products or services, recognizing that differ-ent curves would appear for each individual output.

Appendix B

B - 5

Appendix B

As with economies of scale, it is possible for econo-mies of scope to exist at some levels of output andnot at others. Economies of scope can exist with orwithout economies of scale.

1.1.3 The Monopoly Problem

The traditional view was that the entire telecommu-nications sector had natural monopoly characteris-tics. This implied that key telecommunicationsmarkets would fail to meet the competitive conditionthat there be many sellers in the market. In effect,the traditional industry structure was that ofmonopoly.

The problem is that the monopolist may exploit itsposition by charging excessive prices or restrictingoutput. This leads to losses of social welfare (marketfailure) and sets the scene for governmentintervention to ensure that consumers and potentialcompetitors are not exploited by the power of themonopolist.

1.1.4 Regulated Monopoly

Governments have addressed the monopolyproblem in a number of ways. The main one isregulation. Government policy makers that believedthe telecommunications industry to be a naturalmonopoly decided that citizens would best beserved by a single monopolist that can exploiteconomies of scale and scope. However, traditionaltelecommunications policies imposed regulations toprevent the monopolists from exercising monopolypower and charging excessive prices. This compro-mise was aimed at capturing the benefits ofproductive efficiency without permitting anunrestrained monopolist to earn excessive profits orrestrict supply of its services.

In some cases, this view that monopoly was thesocially optimal market structure provided a rationalefor creating regulatory or legislative barriers to entryin monopoly markets. This transforms a naturalmonopoly into a legal monopoly. In practice, theregulated monopoly model was implementedthrough privately owned operators in a number ofcountries, including the US and Canada.

1.1.5 Public Enterprise

The most common alternative model to regulatedprivate monopoly is public ownership of the operatorin a monopoly environment. This model is based onthe belief that sector objectives are more likely to beachieved through direct public control and ownershipof the enterprise actually providing the services. Insuch a model, therefore, regulation is often thoughtto be unnecessary. Until recently, monopoly publicownership was the prevalent sector model in manycountries in Europe, Africa, Asia, Latin America andthe Caribbean.

In practice, however, public enterprises are used fora variety of tasks of which handling the natural mo-nopoly problem is just one. Given these conflictingtasks and historically poor performance, manygovernments have abandoned or are abandoningthe unregulated public enterprise model. In somejurisdictions, there was a recognition that the ration-ale for economic regulation was strong whether theoperating firm was private or public. State-ownedoperators were sometimes established as separate“commercialized” or “corporatized” entities, subjectto regulation by a different government body.

1.2 Monopoly Pricing

1.2.1 Single Product Monopoly

There is a substantial body of economic theory andpractice on the regulation of prices charged by amonopoly. A sample of this literature is included inthe Selected Sources to this Appendix.

As seen in the foregoing discussion of the socialwelfare in an ideal competitive marketplace,economic theory states that “first-best” pricing setsprices equal to marginal cost. For a firm witheconomies of scale, such as a natural monopoly,however, this efficient pricing prescription isproblematic. For such a firm, marginal cost isgenerally below average costs in the relevant rangeof output. This situation is illustrated in Figure B-6,where the demand curve and the marginal costcurve intersect below the average cost curve. In thisinstance, setting a regulated price equal to marginalcost, P1, will not allow the firm to recoup all of itscosts. In such a case, the firm will lose money and


B - 6

go out of business. Accordingly, regulators must findviable solutions to avoid this result.

In practical terms, this means that price will have tobe set above marginal cost. But at what level? Tomaximize social welfare, departures from marginalcosts should be set to minimize total surplus losseswhile allowing the supplier to break even. This isreferred to as the second-best price; in the case of asingle-product monopoly, it is the average cost. Thisprice, P2, is set at the intersection of the averagecost curve and the demand curve in Figure B-6.

Notice that the quantity associated with second-bestpricing, Q2, is less than that related to first-bestpricing, Q1. This reduction in quantity is an indicationof the welfare losses due to economies of scale.These welfare losses, however, are small comparedto those that would result if the monopolist were notprice regulated. An unregulated monopolist wouldequate its marginal cost with its marginal revenue(MR curve in Figure B-6 and set a monopoly price,PM, higher than its average cost. This pricing wouldresult in monopoly profits for the firm, a reduction inthe quantity supplied, QM, and additional welfarelosses.

Figure B-6: Firm Loses Money at "First Best"Pricing under Economies of Scale

P

Q0

D

Q1

AC

MCP1=MC

P2=AC

MR

QM

PM

Q2Notes: P1 = First-best Pricing

P2 = Second-best Pricing PM = Monopoly Pricing

Note that unlike the perfectly competitive firm thathas a well-defined supply curve (the marginal costcurve that lies above the average variable costcurve), the natural monopolist has no supply curvethat is independent of the demand curve. Theamount that an unregulated monopoly producesdepends on its marginal cost curve and on theshape of the demand curve.

1.2.2 Ramsey Pricing

Telecommunications operators produce more thanone service. The problem that first-best pricing is notcommercially viable also applies to a multi-servicetelecommunications monopoly. Marginal cost pricingwill not cover all the monopoly operator’s costs, soprices must be raised until the operator can breakeven. With more than one service, however, thereare an infinite number of price combinations that willproduce this result.

Economic theory provides a recommendation as tohow to deal with this issue. Out of all the these pricecombinations, the second-best prices (i.e. the onesthat result in the smallest loss of social welfarecompared to marginal-cost pricing) are those thatequate the amount by which price exceeds marginalcost in inverse relation to the elasticity of demand foreach service. In other words, prices are raisedabove marginal costs more for services with a lowerelasticity of demand and less for services with higherelasticity.

These second-best prices are often referred to asRamsey prices named after the British researcherwho originally studied the issue. This is also referredto as the “inverse elasticity rule.” Ramsey pricesminimize the changes in quantity purchased com-pared to the quantities that would be bought atprices equal to marginal cost. The general principleis that the products with the least price-sensitivedemand should have the highest prices relative totheir marginal costs.

Figure B-7 shows a simplified example of the appli-cation of Ramsey pricing principles when theoperator provides two services. Ramsey principlesare general enough to account for differences incost; however, for simplicity, our example shows thatthe two services have the same marginal cost (MC)and that these costs are constant. Under this

Appendix B

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Appendix B

assumption, both services have the same “first best”prices, P1, set at their marginal cost. In order to raiseadditional revenue, for instance, to cover all of itscosts or to pay for regulatory levies (such asuniversal service, etc.) prices have to be raisedabove marginal cost. The application of Ramseyprinciples would mean that the price of the servicewith the relatively inelastic price demand would beraised proportionately more than the price of theservice with relatively elastic demand. The resultantsecond-best Ramsey prices, P2, are higher for therelatively inelastic than for the elastic service.

To apply Ramsey prices in an exact manner,regulators face two challenges. One is to determinethe elasticity of demand for various telecommunica-tions services. The other is to identify, as accuratelyas possible, the costs of providing these services.While the perfect application of Ramsey principlesrequires a great deal of information and hencepresents implementation challenges, this does notmean that the basic Ramsey lesson (that relativedemand elasticities of telecommunications servicesaffect social welfare) should be ignored. Reasonablemeasures that approximate Ramsey principles willresult in welfare improvements relative to alternatemeasures. A numerical example of these welfare

improvements is presented in the Appendix toModule 4.

The informational requirements to implement Ram-sey pricing are less onerous for operators, who maybe presumed to have a much better sense of theelasticities and costs involved than the regulator(another example of the “asymmetry of information”regulatory problem). Fortunately, recent researchsuggests that under certain conditions price capsregulation provides the operator with the correctincentives for it to set prices in a manner consistentwith Ramsey prices. That is, an operator subject toprice caps will tend to set economically efficientprices as a result of trying to maximize its profit – anexample of incentive-compatible regulation.

Ramsey prices may also be referred to as Ramseymark-ups. As explained in more detail in the nextSection, a mark-up is a percentage or a fixedmonetary amount that is used to take into accountjoint and common costs, to supplement certain in-cremental costing methodologies. Mark-ups may beuniform or non-uniform. While regulators havegenerally set uniform mark-ups to promote competi-tion, the application of Ramsey principles suggeststhat a non-uniform mark-up may be moreeconomically efficient.

Figure B-7: Example of Application of Ramsey Prices

0

D

P

MCP1=MC

P2

Q

P

Q

MC

D

P2

0

P1=MC

Service with Elastic Demand Service with InelasticDemandNote: P1 = First-best pricing

P2 = Second-best (Ramsey) pricing


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1.2.3 Regulation under IncreasingCompetition

Policy-makers and regulators are quickly eliminatinglegal monopolies around the world. However, theend of legal monopoly does not mean the end ofmonopoly power or of natural monopoly. Hence, theend of legal monopoly does not mean the end ofprice regulation.

Economists now generally agree that manysegments of the telecommunications sector are notcharacterised by natural monopoly. Infrastructure-based competition between multiple operators inlong distance and mobile cellular service, forinstance, has proven to be durable and sustainable.There is no economic consensus, however, onwhether the access network remains a naturalmonopoly and, if so, to what extent.

The existence or not of natural monopolycharacteristics in the access network may not matter

much. Given the historically poor performance ofmost legal monopolies, especially in developingcountries, most policy-makers do not believe that thetheoretical benefits of natural monopoly can berealized in a legal monopoly environment. Hence,there is a growing consensus that there is afavourable trade-off for the sector as a whole fromthe introduction of competition. There may be someloss of economies of scale, for instance, but theselosses are more than offset by the gains in improvedefficiency and responsiveness due to competition.

After the introduction of competition, many formermonopoly (incumbent) operators will retain residualmonopoly power (or “market power”’) for extendedperiods of time. This will especially be the case incertain market segments, for instance the accessnetwork. Market power exists when incumbentoperators are still able to unilaterally (or incombination with other operators) influence marketconditions, especially prices. Firms with marketpower are therefore generally price regulated in

Box B-1: Price and Income Elasticities of Demand

The effects of many demand factors are typically measured by elasticities:

➢ Price elasticities measure the percentage by which the quantity demanded for a telecommunicationservice changes in response to a small percentage change in price.

➢ For example, if a 1% decrease in the price of national long distance service leads to a 0.5%increase in national long distance calling, the price elasticity is –0.50.

➢ Elasticities with a value between 0.0 and –1.0 reflect inelastic demand.

➢ Elasticities with a value smaller than –1.0 reflect elastic demand.

➢ Elasticities with a value of –1.0 are said to be of unitary elasticity.

➢ One of the critical characteristics of elastic demand is that a reduction of prices will result insufficient increased demand – stimulation – that revenues will in fact increase after the pricedecrease. On the other hand, revenues will decrease after a decrease in the price of an inelasticservice.

➢ The elasticity of demand may be deduced from the slope of the demand curve. Generally, thesteeper the demand curve, the more inelastic the demand. At one extreme, a vertical demandcurve shows zero elasticity. In this instance of totally inelastic demand, the quantity demandeddoes not vary by price at all. For example, research suggests that business demand fortelecommunications access can be almost totally inelastic.

➢ Income elasticities measure the percentage by which the quantity demanded for a telecommunica-tion service changes in response to a small percentage change in income.

Appendix B

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Appendix B

order to constrain their ability to charge excessiveprices. The subject of market power and its impacton pricing is discussed further in Module 5 -Competition Policy.

1.3 Elasticity of Demand

In this section, we discuss the responsiveness ofdemand for telecommunications services to changesin prices. This is referred to as the (own-price) elas-ticity of demand and is of critical importance in anumber of applications, including in the determina-tion of Ramsey prices and the calculation of thewelfare benefits of rate rebalancing. Box B-1provides an overview of demand elasticities.

As for most other products, the demand for tele-communications services depends on factors suchas consumers’ demographic characteristics, theirincomes, the prices of the services, and theavailability and price of other communicationsoptions.

In considering price elasticities, it should be notedthat telecommunications demand generally has twointerrelated parts — access and usage. Local, longdistance and international calls depend on havingaccess, and access is of value only if using the net-work (calling) has value. Whereas most economicgoods are substitutes, access and usage arecomplements. That is, if the price of accessincreases, the demand for access and usage bothdecrease. If the price of usage increases, demandfor calls and access decreases.

1.3.1 Survey of Elasticity Estimates

Most studies of telecommunications demand haveconcentrated on voice telephony services. They aredivided into studies of residential and business de-mand for access, local, long distance andinternational calls.

Estimates of elasticities are usually based on histori-cal consumption patterns and are calculated usingcomplex statistical techniques. As a result,determining the magnitude of elasticities is anempirical matter. Most of the elasticity studies todate have been done in industrialized countries. Asignificant and consistent body of literature nowexists to provide point and/or interval estimates of

most price and income elasticities for importantclasses of telecommunications services.

Table B-1 summarizes the subjective estimates fromthe classic 1980 study conducted by Lester Taylor.(The results from this study are used as benchmarksby many consulting economists in industrialized anddeveloping countries.) A second edition of the Taylorstudy was published in 1994.

The elasticity studies show that there is a range ofprice elasticities among telecommunicationsservices. Access service is very price inelastic. De-mand for access is more inelastic at higher rates ofpenetration. Domestic long distance andinternational calls are the most elastic services..Demand for calling is more elastic the longer thedistance of the call. Demand for any given service isless elastic for business users than for residentialusers.

Box B-2: Application of IndustrializedCountry Elasticity Estaimtes to LessDeveloped Markets

Care must be taken in interpreting elasticity es-timates for industrialized telecommunicationsmarkets in developing countries. One of theprincipal reasons for low penetration rates insuch countries is not lack of demand, but ratherunder-supply, shown by the long and ever-present waiting lists.

A change in price in capacity-constrained tele-communications markets is not likely to affectdemand as much as is suggested by the elas-ticity estimates presented in this section (whichwere calculated in environments where supplyis not constrained). It could be, therefore, thatconsumers in many developing countries arenot on the same demand curve as their coun-terparts in mature telecommunications markets.

Recent research has confirmed this hypothesis.For instance, in studying the recent raterebalancing initiatives in many Latin Americancountries, Ros and Banerjee (2000) found thatan increase in monthly subscription pricesactually lead to increases in penetration rates –that is, the quantity demanded.


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Table B-1: Point and Interval Estimates of Price and Income Elasticities of Demand for SelectedTelephone Services

Price ElasticityType of Demand Connection Subscription Long Distance

Income

Elasticity

Access -0.03 (±0.03) -0.10 (±0.09) 0.50 (±0.10)

Local Calls -0.20 (±0.05) 1.00 (±0.40)

Domestic LD Calls

Shorter distance -0.375 (±0.125) 1.15 (±0.25)

Medium distance -0.65 (±0.15) 1.25 (±0.25)

Longer distance -0.75 (±0.20) 1.50 (±0.40)

International Calls -0.90 (±0.30) 1.70 (±0.40)

Notes:

In each cell, the first figure indicates the point estimate of the elasticity – that is the one best estimate ofthe variable. The second figure, preceded by ±, indicates the subjective interval estimate for the elasticity –that is, the possible range of the variable. For example, medium distance domestic LD calling the priceelasticity is estimated at about –0.65 with a possible range of –0.50 to –0.80.

LD refers to long distance

Source: Adopted from Taylor (1980) and supplemented by Taylor (1994) and other elasticity studies.

1.4 Telecommunications Costs

Determining or verifying the costs for telecommuni-cations services are among the most difficultchallenges facing regulators. Nevertheless, costanalysis can be of crucial importance. In particular,regulators use cost analysis in setting or approvingprices, including “retail” prices for consumers and“wholesale” prices for competitors (e.g. interconnec-tion and unbundled network elements, etc.), and inenforcing competition policy.

The practice of determining costs in thetelecommunications industry is often complex andcontroversial. Different cost approaches, concepts,definitions, interpretations and data sources lead tothis complexity. Generally, the nature of the problembeing addressed and the purpose of the costing ex-ercise will determine which is the most appropriateapproach to use.

1.4.1 Costing Perspectives

Most telecommunications cost analyses use one ormore of the main perspectives outlined in Box B-3.Each is associated with the perspectives of aparticular profession.

1.4.2 Costing Terms and Concepts

Box B-4 provides descriptions and some examplesof the principal terms and concepts used in tele-communications cost analysis. These are the basicbuilding blocks of cost analysis.

1.4.3 Costing Methods

In this section, we briefly review and compare someof the main costing methods used by telecommuni-cations regulators over the years.

Most costing methods are based on the principle ofcost “causality” (also referred to as cost causation).Simply stated, cost causality means that costs

Appendix B

B - 11

Appendix B

Box B-3: Three Principal Costing Perspectives

Accounting Costs

➢ This perspective focuses on the recording of the actual incurred costs by the operator. The focus ison the historically recorded costs (i.e. it is backward-looking). Data sources include corporatefinancial accounting and more detailed management accounting measures. In the past, regulatorsrelied almost exclusively on accounting data as their source of information for cost studies.

Engineering Costs

➢ This perspective is primarily concerned with forward-looking management decisions. Engineeringcost analyses assess different ways of meeting a specified objective, such as provisioning a certainamount of capacity. The goal of engineering cost analysis is generally to determine the optimalmethod of building telecommunications facilities.

Economic Costs

➢ The objective of this costing perspective is to determine the structure of efficient prices, that is,prices that maximize consumer and producer surplus. Economic costing uses a forward-lookingapproach that emphasizes concepts of cost variability, incremental costs and opportunity costs.These concepts are discussed below.

should be recovered (e.g. through prices, etc.) fromthe source that caused the costs to be borne. Whilethis principle is relatively easy to implement in manyinstances (variable or incremental costs), it is morecomplex to apply in the presence of fixed, joint andshared costs. We discuss this issue in more detailbelow in the section containing the interconnectionpricing example.

One of the most important distinctions betweencosting methods is between methods that usehistorical data and ones that use a forward-lookingapproach. We adopt this distinction in our detaileddiscussion of costing methods in the followingsection. Generally, forward-looking costs arepreferred because they better reflect the workings ofcompetitive markets. In such markets, from the mo-ment an investment is made, the asset’s value to theoperator depends more on what use can be made ofit than what it cost. If a competitor is more efficient,the operator will need to respond by adjusting itsprices, rather than to continue pricing on the basis ofits historical costs. In other words, competitiveoperators are compelled to look forward to setprices, and hence be able to compete, rather than tolook backward to prices based on their originalinvestments.

Costing methods and models can be “top-down” or“bottom-up”. Top-down approaches are generallyassociated with historic costs, while bottom-upmodels are generally associated with forward-looking costs.

One matter that we have not dealt with so far is thecost of capital. The required return on investment inthe network and other related assets is the cost ofcapital. It should reflect the opportunity cost toinvestors, so that the return earned on networkassets and other related assets would be broadlyequal to the likely return on alternative comparableinvestments.

Because the telecommunications industry is capital-intensive, the cost of capital is a critical issue indetermining telecommunications costs, regardless ofthe costing methodology used. The main point torecall is that the regulator has to incorporate thecorrect measure of the cost of capital in its costingmethodology in order for the regulated operator torecover all of its efficient capital costs, including itsequity and debt costs.


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1.4.3.1 Costing Method Comparison

This introductory section provides a graphicalcomparison of the main costing methods that arediscussed in greater detail in the following sections.

Much of the controversy associated with costanalysis relates to the allocation of indirect costs todifferent telecommunications elements or services.The allocation issue is highlighted in Figure B-8which provides a simplified comparison betweenLRIC, TSLRIC/LRAIC, TELRIC, FDC/FAC andstand-alone cost for a specific telecommunicationselement or service.

Recall from Box B-4 that LRIC, TSLRIC/LRAIC andTELRIC are generally required to be supplementedby mark-ups to recover a portion of joint and sharedcosts. Hence, mark-ups are included in Figure C-15for those cost methods. This is in contrast toFDC/FAC approaches that generally allocate all jointand common costs to the services, based on alloca-tion formulae. In this instance, there is norequirement for mark-ups. Recall that if all joint andshared costs are included, the resultant cost conceptis stand-alone cost. We discuss the allocation issuefurther in the section that contains theinterconnection cost analysis example.

Box B-4: Principal Costing Terms and Concepts (in alphabetical order)

Allocated Cost - A joint or common cost that has been divided among services in accordance with a setformula or by judgement. This is also known as a distributed cost.

Average Cost - A specified cost divided by the quantity of output. [By default, usually refers to the averageof total cost, which is total cost divided by the specified volume of output.]

Avoidable Cost - A cost that would not be incurred if output volume was reduced.

Common Cost - A cost incurred when a production process yields two or more services. This is also re-ferred to as shared cost if it applies to all of the operations of the operator. For example, the cost of thebuilding to house a telecommunications exchange may be described as a common cost of serving bothbusiness and residential customers. The salary of the operator’s president may be considered a sharedcost of all services (this type of cost is often also referred to as an “overhead” cost).

Direct Cost – A cost that can be attributed solely to the production of a specific item. A direct cost does notrequire a cost allocation (or distribution) to separate it from the costs incurred in the production of otheritems. An indirect cost, however, does require such an allocation. An operator that produces a singleproduct sold in a single market incurs only direct costs. When an operator is engaged in producing multipleproducts or serving multiple markets, however, it will normally also incur indirect costs such as joint and/orcommon costs.

Fixed Cost – A cost that does not vary by volume of production. A specific type of fixed cost is sunk costs,costs that cannot be changed or avoided even by ceasing production entirely. For instance, head officespace is a fixed cost, but the labour component of the installation of the copper wire in the local loop is asunk cost. Neither fixed nor sunk costs enter into marginal-cost pricing decisions because neither varieswith output.

Increment - A specific non-minimal increase or decrease in volume of production.

Incremental Cost – The change in total cost resulting from an increment. Incremental cost equals totalcost assuming the increment is produced, minus total cost assuming the increment is not produced.Because a wide variety of different increments can be specified, incremental cost can conceptually rangeall the way from total cost per unit (entire output as the increment) to marginal cost (one unit as theincrement). The size of the increment used in any specific cost analysis will be a matter of judgement. Themost common practice is to use the entire service or element as the increment, in which case the serviceor element specific fixed costs of the service or element would be included in the increment

Appendix B

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Appendix B

Box B-4: Principal Costing Terms and Concepts (in alphabetical order) (cont’d)

Joint Cost – A specific kind of common cost incurred when a production process yields two or moreoutputs in fixed proportion. Joint costs vary in proportion to the total output of the joint production process,not to the output of the individual joint products.

Long Run – A period over which all factors of production, including capital, are variable. In practice, aperiod of 10 to 15 years is sometimes selected by regulators for the purpose of LRIC analysis, forexample.

Long Run Incremental Cost (LRIC) – The incremental costs that arise in the long run with a specificincrement in volume of production. LRIC is generally calculated by estimating costs using currenttechnology and best available performance standards. When a cost study is based on the “costs of anefficient firm”, it usually refers to LRIC-type methodology. In the presence of joint or common costs, thesum of the LRIC for all of the operator’s services will be less than the total costs of the operator. Hence, theoperator will not be able to recoup all of its costs. Regulators will generally allow a mark-up to be added toLRIC or LRIC-type costs for the firm to help recover all of its costs.

Marginal Cost - The change in total cost resulting from a very small change in the volume of outputproduced. Due to a number of practical issues, including the lumpiness of capital increments (i.e. theinability of telecommunications plant to be divided into very small parts, or scaled to provide an exact fitwith the actual requirements of the network), marginal cost is difficult to estimate. Accordingly, mostestimates of marginal cost are based on incremental cost.

Mark-Up – A percentage or a fixed monetary amount that is used to take into account joint and commoncosts, for example, to supplement certain costing methodologies. Cost concepts that do not fully allocate(or distribute) all indirect costs generally require mark-ups. These cost concepts include incrementalcosting methodologies, including LRIC (and TSLRIC/LRAIC and TELRIC as discussed in detail in the costmethods section below). The mark-up may be uniform or non-uniform. While regulators have generally setuniform mark-ups to promote competition, the application of Ramsey principles suggests that a non-uniform mark-up may be economically efficient.

Stand-alone Cost – The total cost to provide a particular product or service in a separate productionprocess (i.e. without benefit of scope economies).

Total Cost – The aggregate amount of all costs incurred in producing a specified volume of output. Thesum of fixed and variable costs equals total cost.

Variable Cost - A cost that varies with increased volume of production.

Source: Adapted from Johnson (1999) and other sources.

1.4.3.2 Historical Cost Approaches

These approaches generally involve the compilationand analysis of accounting and other historical data.One of the advantages of these approaches is thatthey reflect the real-world workings of the actualtelecommunications operator under study.

Fully Distributed Cost (FDC)

➢ This method, also referred to as fully allocatedcost (FAC), is generally based on a historicalaccounting of costs. Typically, an FDC study

focuses on broad categories of service ratherthan on individual services. For instance, thestudy might show the cost of local exchangeservice, different lengths of long distance andmiscellaneous services.

➢ The challenge (and inherent weakness) of thistype of study is how to allocate joint and com-mon costs to the specific classes of services.The joint and common costs are often allocatedto the various categories of service usingformulas that reflect relative usage or otherfactors.


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Figure B-8: The Relationship Between Costs, Costing Methods and Allocations

Allocation ofResidual of Joint& Common Cost

TELRIC

Incrementalcost

+

+

Notes: 1. For TSLRIC/LRAIC the increment is defined as the total service. Hence, indirect cost elements are shaded while direct cost elements are not shaded.2. In this example, FDC/FAC is assumed to be calculated based on forward-looking economic cost methodology.3. The total costs of the 3 cost concepts identified by an asterisk, *, do not necessarily have to be equal, as shown in this example.4. Note the relative sizes of the costing concepts are indicative only and should not be taken as an approximation of actual costs.

IncrementalCost

IncrementalCost

IncrementalCost

IncrementalCost

IncrementalCost

IncrementalCost

FDC/FAC*

Stand-alone Costs

TSLRIC/LRAIC

LRIC

Service-specificFixed Cost

+

+

+

+

+Service-specificFixed Cost





+

+

+

+

+

TSLRIC/LRAIC+ uniform mark-up*

TELRIC+ uniform mark-up*

Allocation of Partof Joint &

Common Cost

Allocation of Partof Joint &

Common Cost

Allocation of allJoint & Common Cost

FAC-based allocation ofall Joint & Common Cost

All Joint and Common Cost

Source: Adapted from ODTR (1999) and other sources.

➢ For instance, if network access lines in anexchange are used 70% for local calls, 20%for national long distance calls and 10% forinternational calls, an FDC study mayallocate the joint costs of these lines basedon the same percentages. These allocationsare arbitrary.

➢ FDC/FAC methods do not require a mark-upto recover a portion of joint and commoncosts. The FDC/FAC allocation may or maynot be the same as the one that would resultfrom the use of a mark-up.

➢ Another criticism of this type of study is that thehistoric costs may reflect certain operational ortechnological inefficiencies of the incumbent op-erator. Using historic costs, for example tocalculate interconnection costs, leads toconcerns that incumbent operators are “passingon their inefficiencies” to the interconnectingoperators. The reason for this is that theservices in question could likely be provided at a

lower cost using current technology or efficientlabour and/or management practices.

Embedded Direct Analysis (EDA)

➢ This is also a type of study based on historicalaccounting of costs, but it differs from FDC. AnEDA study will only assign those costs that canbe directly traced to a particular servicecategory. Joint and common costs will be leftunassigned, typically as one or more lump sumamounts.

1.4.3.3 Forward-Looking Cost Approaches

These approaches typically involve the developmentof engineering-economics models that are used tocalculate the costs of network elements and, in turn,services provided using those elements. Thesemodels estimate the costs of rebuilding specificelements of the network using current technology.Generally, this modelling approach assumes

Appendix B

B - 15

Appendix B

operating and capital costs will be incurred efficiently.The LRIC approach is discussed in Box B-4.

Total Service Long Run Incremental Cost(TSLRIC)

➢ TSLRIC measures the difference in costbetween producing a service and not producingit. TSLRIC is LRIC in which the increment is thetotal service. Hence, mark-ups are required torecoup a portion of joint and common costs,which are not included in TSLRIC.

➢ The European Commission has adopted aTSLRIC-type approach, called, Long RunAverage Incremental Cost (LRAIC) as itspreferred costing methodology. The term“average” is intended to capture the policydecision that defines the increment as the totalservice. LRAIC, hence, includes the fixed costsspecific to the service concerned: “service-specific fixed costs.”

➢ TSLRIC can be useful in public policy andpricing decisions. For example, TSLRICestimates can highlight the presence or absenceof subsidies for a service. Similarly, incrementalcosts can be useful in developing or examiningthe regulatory or pricing policies that apply to aparticular service or group of customers.

➢ One of the weaknesses of this method, and ofall forward-looking studies, is that the results areestimations that may or may not occur inpractice.

Total Element Long-Run Incremental Cost(TELRIC)

➢ TELRIC is a term coined by the FCC to describea specific approach to costing. TELRIC includesthe incremental cost resulting from adding orsubtracting a specific network element in thelong run, plus an allocated portion of part of thejoint and common costs. Hence, mark-ups mayalso be necessary to recoup a portion of the“residual” joint and common costs not alreadyincluded in TELRIC.

➢ The FCC developed TELRIC to implement the1996 Telecommunications Act. In the FCC’swords:

…prices for interconnection and unbundledelements…should be set at forward-lookinglong-run economic cost. In practice, this willmean that prices are based on the TSLRICof the network element, which we will call…TELRIC, and will include a reasonableallocation of forward-looking joint andcommon costs...

➢ In coming up with its own costing method, theFCC distinguished between its approach tocosting network elements and TSLRIC.

➢ The FCC required that certain joint and commoncosts be included in TELRIC, even if they do notvary with the presence or absence of theelement in question. This is not consistent withthe standard definition of TSLRIC.

1.4.4 Interconnection Costing Example

This section provides a numerical example of aforward-looking costing analysis to determine aninterconnection price. This example incorporatesmany of the concepts introduced in this Appendix.Note, however, that it deals only with the on-goingcosts of interconnection. It does not include the“start-up” costs associated with actually inter-connecting the two operators (transmission links,etc.). These “start-up” costs, which can be relativelysmall compared to the “ongoing” or “recurrent” costsdiscussed in this example, are discussed in Module4.

Figure B-9 provides a simplified graphical repre-sentation of the costs of an incumbent operator thatprovides access services and local calling services.The specific division between access and callingservice costs varies depending on the purpose ofthe cost analysis. Generally, access service costsinclude costs of the local loop and some associatedfixed costs. Calling service costs generally includethose associated with the rest of the network,including switching and transmission. Note that“calling” services are referred to as conveyance inthe UK and other countries.


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1.4.4.1 Determining the Size of the Increment

In this example, we generally assume that the sizeof the increment is the entire service. This assump-tion is consistent with the principle of cost causationas it has been interpreted by many regulators. Thisassumption means that the service-specific fixedcosts of each service are included in calculation ofthe respective incremental costs. In practice, thisassumption will mean that the entrant makes acontribution to the incumbent operator’s service-specific fixed cost.

As shown in Figure B-9, the incremental costs foraccess, transmission, tandem switching and localswitching are 50, 40, 15 and 15. Local switchingmay be further disaggregated into fixed costs of 10and variable costs of 5.

Total incremental costs are 120. These costsconstitute the incumbent operator’s direct costs. Theindirect costs total 30 and include joint cost of 10(e.g. carrier services or network division, etc.) andshared cost of 20 (e.g. president’s salary, etc.).

In this example, we assume that a long-distanceoperator requests interconnection with theincumbent (access and local) operator at the localswitch. Let us assume that the parties do not agreeon interconnection price, or that the regulator wishesto provide interconnection pricing guidelines inadvance. What is the appropriate interconnectionamount? This question is addressed in the followingsections.

Figure B-9: Interconnection Costing Example: Analysis of Access and Local Calling Networks

In c re m e n ta lC o s t ( IC ) = 5 0

In c re m e n ta lC o s t ( IC ) = 4 0

T ra n s m is s io n

S w itc h in g

A c c e s s C a llin g

S h a re d C o s t = 2 0

J o in t C o s t = 1 0

In d ire c t C o s ts

D ire c t C o s ts

T an d e m L o ca l

Fixe

d Co

st =

10

Varia

ble

Cos

t = 5

IC=

15

IC=

15

N o te: In th e c a lc u la t ion o f IC , th e s ize o f th e in c re m e n t is a s su m e d to b e th e e n tire s e rv ice

Appendix B

B - 17

Appendix B

1.4.4.2 LRIC Approach

Based on a narrow application of the principle ofcost causation, the entrant should pay theincumbent operator only for the additional costs thatresult from the entrant terminating and originatingtraffic on the latter’s network. Based on the LRICmethodology, therefore, the entrant should pay theincumbent operator only a proportion of the variablecost of the local switch. That proportion may bebased on market share or other criteria. For in-stance, the proportion could be the percentage ofentrant minutes routed on the incumbent operator’snetwork. For this example, we assume the entranthas a 10% market share. Using this methodology,the regulator would set an interconnection amount of0.5. This amount is based on the proportion (10%) ofthe variable cost of local switching (5).

Based on this perspective, the entrant does notcause the incumbent operators to bear any otheradditional costs, and should therefore pay only theamount indicated above. The LRIC approach doesnot include service-specific fixed cost or joint andshared costs. These cost concepts are discussed inthe sections below.

Note that the entrant is not required to pay for theuse of the incumbent operator’s access services.This is because these are traditionally considered asfixed with respect to the volume of traffic. Hence theentrant does not cause any additional access cost tothe incumbent operator. Most telecommunicationseconomists suggest that the costs of access serv-ices (including the local loop) should generally berecovered from the incumbent operator’ssubscribers through connection and subscriptionprices.

Given that the entrant is requesting interconnectionat the local switch, it is not using the incumbentoperator’s transmission or tandem switchingservices and hence should not have to pay for them.

Regulators have not generally set the interconnec-tion amount charges solely on LRIC. Interconnectionprices based only on LRIC will generally be lowerthan those based on other costing methodologies.Such low prices may promote market entry. Pricesbased solely on LRIC are generally considered to betoo low, and to not adequately compensate the

incumbent operator for the use of its network. Suchrates will generally not provide sufficient compensa-tion for the incumbent operator to properly maintainits network and to build additional neededinfrastructure.

1.4.4.3 TSLRIC/LRAIC Approaches

The LRIC approach discussed above does notinclude service-specific fixed costs. The fixed costsof the local-switching services (10) are being bornewholly by the incumbent operator. Most regulatorshave established that the size of the incrementshould be set as the entire service. This issue wasdiscussed in section 1.4.4.1.

Under the TSLRIC/LRAIC approaches, the regulatorwould set an interconnection charge of 1.5. Asindicated in Figure C-15, this charge is made up ofLRIC plus a proportion (for example 10%, equal tothe entrant’s market share) of the service-specificfixed cost of the local switch (10).

1.4.4.4 Allocation of Joint and Shared Costs:Mark-ups

The TSLRIC/LRAIC approach does not include anyof the joint and shared costs of the incumbentoperator. Generally, most regulators have deter-mined that the interconnection amount shouldinclude a component that accounts for an allocatedpart of joint and shared costs. This has traditionallybeen implemented by including a mark-up tosupplement TSLRIC/LRAIC.

This situation is analogous to that discussed in thenatural monopoly pricing section. In that section wefound that marginal cost is below average costs, andsetting a regulated price equal to marginal cost willnot allow the operator to recoup all of its costs. Inorder for the operator not to lose money and go outof business, the regulator had to set at least someprices above marginal costs. The sum of all the“mark-ups” over marginal should be set so that theoperator could break even.

Similarly, in our example, the regulator should beconcerned that the incumbent operator is able torecoup all of its forward-looking costs, including jointand shared costs. The issue is one of overall costrecovery. If no mark-up is included in the


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interconnection amount, the incumbent operator willhave to recoup all of its joint and shared cost from itsown customers and/or other entrants. Manyregulators have determined that this would not be afair and equitable distribution of these indirect costs.

The mark-up may be uniform or non-uniform.Regulators have generally set uniform mark-ups. Inour example, a uniform percentage mark-up wouldbe 20%. This is calculated as the percentage of indi-rect cost (30) to the total costs (150) of the firm.Applying the 20% mark-up on the TSLRIC/LRAICamount would result in an interconnection amount of1.8.

As noted in Box B-4, Ramsey principles wouldsuggest that a non-uniform mark-up, based on theinverse-elasticity rule, may be more economicallyefficient than a uniform mark-up. Regulators havenot generally adopted such an approach.

1.4.4.5 Structure of Interconnection Prices

Note that in our example we have referred to inter-connection amounts. These amounts are similar tothe revenue requirement concept introduced inModule 4. That is, the interconnection amountconstitutes the total monetary sum to be paid over acertain period. This is not the same asinterconnection prices or rates. These relate to themanner in which the interconnection amount isrecovered. We also refer to this issue as the struc-ture of interconnection prices. The structure ofinterconnection prices is an important matter that willhave an impact on the economic and administrativeefficiency of the entire interconnection regime.

For any specific interconnection amount, there are anumber of alternate pricing structures. For example,interconnection prices may be set based on one or acombination of the following:

➢ Usage-based (e.g. minutes, calls, etc.);

➢ Fat–rated (fixed amount per period, independentof usage);

➢ Time-of-day (peak and off-peak, etc.);

➢ Network functionality (call set-up and callduration, etc.); and

➢ Capacity-based (fixed available capacity,measured in bandwidth, E1’s, T1’s, etc.).

Generally, the structure of interconnection pricesshould reflect the underlying cost structure, if this isknown. The price structure should also be relativelyeasy to implement and administer and shouldensure adequate cost recovery.

For instance, in the TSLRIC/LRAIC plus uniformmark-up discussion above, the total interconnectionamount was determined at 1.8. Recall that the localswitch had a fixed cost of 10 and a variable cost of5, a 2:1 relation between fixed and variable costs.Hence, one option is to have flat-rated pricing to re-coup the fixed cost component of the interconnec-tion amount, 1.2 and usage-based pricing to recoupthe variable cost component, 0.6. Flat-rated pricescould include fixed monthly charges for the numberof ports used by the entrant in the incumbent’s localswitch or other alternatives. Usage-based pricescould include per minute or per call charges for theentrant’s calls.

Note that in practice most regulators have adoptedusage-based pricing only. In our example the entireinterconnection amount of 1.8 would be collected byper minute or per call charges. This decision hasgenerally been based on a number of factors,including administrative efficiency. Pricing based onusage only is also recommended when the regulatoris uncertain of the relation between fixed andvariable costs.

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APPENDIX C - GLOSSARYNote: This glossary includes terms commonly used in telecommunications regulation and thetelecommunications business generally. Definitions are adapted from non-definitive referencesources, including ITU reports (see sources note). The definitions have no official status.Terms in italics are defined elsewhere in the Glossary.

Abuse of Dominance - Conduct by a firm, madepossible by its dominant position in a market (seeDominance and Market Power), that is or may beharmful to competition in that market. The concept ofabuse of dominance is a broad and evolving onethat covers different types of conduct. Examplesinclude anti-competitive cross-subsidization, andvertical price squeezing. (See Module 5.)

Access charge – A form of interconnection pay-ment, usually consisting of an amount per minute,charged by network operators for the use of theirnetwork by other network operators. (See Module 3)

Access Deficit Charge (ADC) – Mechanism usedto finance universal service in competitive markets.New operators typically pay ADCs to subsidizeincumbent operators for the deficit they incur inproviding local access services that are priced belowcost. (See Module 6.)

Agreement on Basic Telecommunications (ABT)– This World Trade Organization (WTO) agreementcame into effect on 1 January 1998. Properly citedas the Fourth Protocol to the General Agreement onTrade in Services, this agreement is discussed inModule 1. See also the entry below for the WTORegulation Reference Paper, which is reproduced inAppendix A.

Advanced Mobile Phone System (AMPS) - Ananalogue cellular telephone service standardutilizing the 800 to 900 MHz band (and recently alsothe 1800-2000 MHz band).

Air time - The minutes of calls a subscriber makesfrom a mobile phone. Also referred to as talk time.

Allocated Cost - A joint or common cost that hasbeen divided among services in accordance with aset formula or by judgement. This is also known as adistributed cost. (See Appendix B: The Economicsof Telecommunications Prices and Costs)

Amplifier - Device used to boost the strength of anelectronic signal over an analogue transmissionfacility.

Analogue - Analogue signals carry information incontinuous, varying electrical waves. Analogue wasthe original recording and transmission technology(preceding digital technology). It is still used in manycommunications applications.

Asynchronous Transfer Mode (ATM) - A methodto send data packets at irregular intervals bypreceding each packet with a starter bit and follow-ing the data packet with a stop bit. It isasynchronous in the sense that time betweenpackets varies.

Asynchronous Transmission - Transmission ofdata over a network in which each character ofinformation is individually synchronized by means ofa start and stop bit to provide character framing. Thetime between characters may vary (see ATM).

Automatic Number Identification (ANI) –Application able to transmit and display the tele-phone number of the calling party to the partyanswering the call. (See also Calling LineIdentification)

Average Cost - A specified cost divided by thequantity of output. [By default, usually refers to theaverage of total cost, which is total cost divided bythe specified volume of output.] (See Appendix B:The Economics of Telecommunications Prices andCosts)

Avoidable Cost - A cost that would not be incurredif output volume was reduced. (See Appendix B:The Economics of Telecommunications Prices andCosts)

Backbone Network - A network that links smaller orlower-speed networks.


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Bandwidth - The range of frequencies that can passalong a transmission line or other medium. In ana-logue systems it is measured in terms of Hertz (Hz)and in digital systems in bit/s per second (bit/s). Thehigher the bandwidth, the greater the amount ofinformation that can be transmitted at the same time.High bandwidth channels are referred to asbroadband which typically means 1.5/2.0 Mbit/s orhigher.

Bandwidth on demand - Capability of an end useror network device to access available networkcapacity at a rate as required by the application be-ing utilised for a specified period.

Base station - A radio transmitter/receiver andantenna used in the mobile cellular network. Itmaintains communications with cellular telephoneswithin a given cell and transfers mobile traffic toother base stations and the fixed telephone network.

Basic telecommunications service – Generallyrefers to voice telephony service, though somedefinitions also include telex and telegraph services.

BDT – ITU Telecommunication DevelopmentBureau. (See Module 1 for description of the ITU)

Best effort - The service model for standard Internetservice. In the face of congestion of a network inter-face, packets are discarded without regard to user orapplication until traffic is reduced.

Bill and Keep – Interconnection arrangement whereno charges are payable between interconnectingoperators for termination of each other’s traffic.(Another term for Sender Keep All; See Module 3).

Bit (“Binary Digit”) - A bit is the primary unit ofelectronic, digital data. Written in base-2, binarylanguage as a “1” or a “0”.

Blocking - The inability to complete a call becauseall possible paths between the calling station and thedestination are already in use. Users are alerted tothis condition through a busy signal.

Bps - Bits per second is a measure of the rate ofdata communications representing the number ofbits transmitted every second. (10 Mbps (Megabits)

= 10 million bits per second; 10 Gbps (Gigabits) =10 billion; 1 Tbps (Terabits) = 1 trillion)

Broadband -. Broadband communications usetransmission media with a large bandwidth such aswireless, coaxial or fibre-optic cable. This allowstransmission at higher speeds (bps). Broadbandtransmission techniques can permit more than onedevice to transmit at the same time using differentfrequencies. Services provided include video, voiceand additional data channels.

Build-Operate-Transfer (BOT) - A project wherebya private company is awarded a concession to builda telecommunications network or service and oper-ates it for a certain period of time before handingover ownership to the national telecommunicationadministration or PTO. (See Module 2)

Build-Transfer-Operate (BTO) - A project wherebya private company is awarded a concession to builda telecommunications network or service, handsover ownership to the national telecommunicationadministration or PTO, and operates it for a certainperiod of time. (See Module 2)

Byte - (1) A set of bits that represent a single char-acter. A byte is composed of 8 bits. (2) A bit stringthat is operated upon as a unit and the site of whichis independent of redundancy or framing techniques.

Calling Line Identification (CLI) - Relies on ANI tocapture and use the telephone number of a callingparty for various purposes (e.g. calling lineidentification display, or call blocking).

Calling Party Pays (CPP) – The billing optionwhereby the person making the call is charged. Thisis in contrast to billing the recipient of the call. Callingparty pays is the norm on fixed telephone networksand is used for an increasing number of mobilenetworks.

Carrier – See Common Carrier. This term is alsoused to describe the presence or absence (“nocarrier”) of information on a cable or other transmis-sion medium.

CCITT - Comité Consultatif Internationale deTélégraphique et Téléphonique (InternationalConsultative Committee on Telephones and

Appendix C

C - 3

Appendix C

Telegraphs). The former name of ITU-T, CCITT wasthe primary international standards body for tele-communications. (See description of ITU in Module1).

CCSS7 - See Signalling System Number 7.

Cell - The geographic area covered by a single basestation in a cellular mobile network.

Cellular - A mobile telephone service provided by anetwork of base stations, each of which covers onegeographic cell within the total cellular systemservice area.

Central Office - Location where local subscriberloops are controlled, connected and switched toother destinations in the public switched networksystem. Central Office is the term used in NorthAmerica for a local telephone Exchange (seebelow). In addition, the term “Central Office” isfrequently used as a synonym for the switchingequipment itself.

CEPT - Committee of European Post and Telephone(See Table of International Organizations, Module1).

Channel – (1) A path for electrical transmission.Also called a circuit, line, link or path. (2) A specificand discrete bandwidth allocation in the radiofrequency spectrum.

Circuit - A telecommunications channel establishedbetween two or more points, allowing the exchangeof sources information between these points.

Circuit Switched Connection - A temporaryconnection that is established on request betweentwo or more terminals (stations) in order to allow theexclusive use of that connection until it is released.

Coaxial Cable – A type of electrical communicationscable used to provide cable television and also usedin the LAN environment in other networks. Coaxialcable consists of an outer conductor and an innerconductor, separated from each other by insulatingmaterial, and covered by some protective outermaterial. This medium offers large bandwidth, sup-porting high data rates with relatively high immunityto electrical interference and a low incidence of

errors. Coaxial cable is subject to distance limitationsand is relatively expensive and difficult to install.

Code Division Multiple Access (CDMA) - Atechnology for digital transmission of radio signalsbased on spread spectrum techniques where eachvoice or data call uses the whole radio band and isassigned a unique code. Used in cellular and otherwireless mobile services.

Collocation - Facility-sharing in which an operator,often an incumbent operator, provides space in itsswitching exchanges or other premises for commu-nications equipment, such as transmission cables, ofcompetitive operators to facilitate interconnectivity toend-users. (See Module 3.)

Common Carrier - A North American term for atelecommunications operator that provides publictelecommunications services, including access tothe public switched telecommunications network andtelecommunications transport services.

Common Cost - A cost incurred when a productionprocess yields two or more services. This is also re-ferred to as shared cost if it applies to all of theoperations of the operator. For example, the cost ofthe building to house a telecommunicationsexchange may be described as a common cost ofserving both business and residential customers.The salary of the operator’s president may beconsidered a shared cost of all services (this type ofcost is often also referred to as an “overhead” cost)(See Appendix B: The Economics ofTelecommunications Prices and Costs.)

Competitive Local Exchange Carrier (CLEC) -Term originating in North America to identify a newentrant in the local exchange network servicesmarket. It generally competes with an ILEC.

Connectivity - The capability to provide, to endusers, connections to the Internet or other communi-cations networks.

Corporatization - Corporatization involves legalchanges to grant a government-ownedtelecommunications operator administrative andfinancial autonomy from the central government.


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Cross-subsidy – Covering the cost of offering someservices through excess revenues earned fromother services. In telecommunications, the term“anti-competitive cross-subsidy” normally refers to apractice by a dominant firm of offering services incompetitive markets at low (e.g. below-cost) prices,while maintaining overall firm profitability by chargingabove-cost prices in monopoly markets, or in othermarkets where the firm enjoys Market Power. (SeeModule 5).

Customer Premises Equipment (CPE) - A termdeveloped in North America to describe anyapparatus from PBX switching systems to telephonehandsets that are located on the customer's prem-ises, rather than on the telephone company’spremises. The term CPE is commonly used to referto equipment that is owned by the customer (enduser).

Dedicated Access Lines – Telecommunicationslines dedicated to or reserved for use by particularusers along predetermined routes. They intercon-nect a switching system to a dedicated customerand may be connected to specific telephone, keytelephone system or PBX. Also referred to simply as“dedicated lines”.

Dial Tone - A signal heard when the telephonehandset is off-hook, indicating that the exchange orPBX is ready to accept and process a diallednumber.

Dial Tone Delay - Refers to the time it takes toobtain a dial tone after a telephone handset is takenoff hook. Average dial tone delay is a commonmeasure of service performance quality.

Digital - A communications technique in whichsound is represented as discrete Bits. The digits aretransmitted as a series of pulses. Digital transmis-sion differs from analogue transmission in that digitaltechnology converts analogue sounds or electricalsignals into the Bits, which can be transmittedwithout distortion or need of amplification. Digitalnetworks allow for higher capacity, greaterfunctionality and improved quality. GSM, CDMA andTDMA networks are all digital. The Internet is also adigital network.

Digital Network - A telecommunication network inwhich information is converted into a series of dis-tinct electronic pulses and then transmitted as adigital bit stream (see also Digital and Analoguenetwork).

Digital Signal Level 1 (DS1) - Digital Signal level 1refers to a digital hierarchy of circuits or channelsoperating at 1.544. This corresponds with the NorthAmerican and Japanese T1 designation.

Direct Cost - A cost that can be attributed solely tothe production of a specific item. A direct cost doesnot require a cost allocation (or distribution) toseparate it from the costs incurred in the productionof other items. An indirect cost, however, doesrequire such an allocation. An operator thatproduces a single product sold in a single marketincurs only direct costs. When an operator isengaged in producing multiple products or servingmultiple markets, however, it will normally also incurindirect costs such as joint and/or common costs.(See Appendix B: The Economics ofTelecommunications Prices and Costs.)

Domain Name - The registered name of an individ-ual or organization eligible to use the Internet.Domain names have at least two parts and eachpart is separated by dot. The name to the left of thedot is unique for each top-level domain name, whichis the name that appears to the right of the dot. Forinstance, The International TelecommunicationUnion’s domain name is itu.int. “ITU” is a uniquename within the gTLD “int”.

Dominance – An extreme form of Market Power.(See below) While the definition of market domi-nance varies with the laws of different countries, afinding of dominance usually requires proof of arelatively high market share and the existence ofsignificant barriers to entry into the markets in whicha firm is dominant. (See Module 5.)

Download - The process of loading software or filesfrom one device to another across a network.

Dual Tone Multi-Frequency (DTMF) - A method ofsignalling initiated from the pushbutton touch-tonekeys of the telephone. The exchange recognizeseach digit dialled by the caller by means of a uniquefrequency generated by the touch-tone keys. DTMF

Appendix C

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Appendix C

is used for many value-added features, such asvoice-mail, tele-ordering and automated responsesoftware.

E-1 - A European and international digital standardreferring to any transmission line or connectionoperating at the rate of 2.048 Mbps. (See also T-1for a description of the comparable North Americanstandard.)

Electromagnetic Interference (EMI) - Interferencecaused to telecommunications signals by electro-magnetic radiation.

Electronic Data Interchange (EDI) - EDI is thecomputer-to-computer exchange of businessdocuments between companies, using a publicstandard format. Rather than preparing paper andsending it through the mail, or using othercommunications methods such as fax, EDI usersexchange business data directly between theirrespective computer systems.

Electronic Mail (E-Mail) - Host computer or LAN-based electronic mail systems employ software-defined "mail boxes." Other computer terminals canaccess the E-mail program to view, answer,broadcast, delete, forward, or file E-mail messagetext and images.

Encryption - The translation of data into a secretcode. Encryption is the most effective way toachieve data security. To read an encrypted file, onemust have access to a secret key or password thatenables it to be decrypted.

End User - The individual or organization thatoriginates or is the final recipient of telecommunica-tions messages or information (i.e. the consumer).

Enhanced services – Telecommunications servicesprovided over public or private networks which, insome way, add value to the basic carriage, usuallythrough the application of computerized intelligence,for instance, reservation systems, bulletin boards,information services. Also known as Value AddedServices.

Equal Access – The ability of telecommunicationsusers to access the services offered by new entrants

as easily as to those of incumbent operators. (SeeModule 3.)

Essential Facilities - In telecommunications regula-tion, this term generally refers to facilities associatedwith a telecommunications network or service thatare exclusively or predominantly provided by amonopolist or a small number of suppliers, and thatcannot feasibly be substituted by competitors foreconomic or technical reasons. The concept ofEssential Facilities is discussed in detail in Modules3 and 5.

Exchange - The term Exchange is generally used torefer to Switches that are connected to the PSTN.Local exchanges connect local loops from end usersto trunks which are connected to other exchanges,including tandem exchanges and internationalgateway exchanges, all of which are different typesof switches. In North America, the term CentralOffice is usually used to refer to a local Exchange. Insome countries, including those in North America,the term Exchange or Exchange Area refers to thelocal area served by one or more local Exchanges.(See also definition of Switch.)

Exchange Point - Points within a network at whichIP packets are exchanged between ISPs.

Extranet - An Extranet is an Intranet that is partiallyaccessible to authorized outsiders through the useof passwords.

Facilities-based Operator - A PTO that operates itsown network transmission facilities (wires, cables,microwave routes, radio transmitters and receivers,satellite transponders, etc.). A facilities-basedoperator is usually contrasted with a “Reseller” (seedefinition below).

Fibre Optics - A technology that uses pulses of lightas a digital information carrier, transmitted throughthin strands of glass. Fibre Optic Cable is a trans-mission medium composed of such glass strands.Fibre optic cable provides higher transmission ratesthan wire or co-axial cable and is immune fromelectrical interference.

Fixed Cost - A cost that does not vary by volume ofproduction. A specific type of fixed cost is sunkcosts, costs that cannot be changed or avoided even


C - 6

by ceasing production entirely. For instance, headoffice space is a fixed cost, but the labourcomponent of the installation of the copper wire inthe local loop is a sunk cost. Neither fixed nor sunkcosts enter into marginal-cost pricing decisionsbecause neither varies with output. (See AppendixB: The Economics of Telecommunications Pricesand Costs.)

Fixed Line - A physical line connecting thesubscriber to the telephone exchange. Typically,fixed-line network is used to refer to the PSTN (seebelow) to distinguish it from mobile networks.

Frame Relay - A fast packet switching technologythat eliminates much of the processing and delay oftraditional X.25 packet switching.

Frequency - The number of cycles per second atwhich an analogue signal electrical current alter-nates, usually measured in Hertz (Hz). One Hertz isone cycle per second. It is also used to refer to alocation on the radio frequency spectrum, such as800, 900 or 1800 Mhz.

Fully Distributed Costs (FDC) – Approach forallocating telecommunications costs to different tele-communications services (also referred to as “fullyallocated costs”). This approach is usually based onan allocation of historical accounting of costs tovarious broad service categories. After assigningdirect costs to each category, the Joint and CommonCosts are allocated to applicable service categoriesbased on formulas that reflect relative usage orother factors. (See Appendix B: The Economics ofTelecommunications Prices and Costs.)

Gateway - Any mechanism for providing access toanother network. This function may or may notinclude protocol conversion.

GATS - General Agreement on Trade-In Services(See Module 1 and WTO)

Gbps - Billion bits per second.

General Packet Radio Service (GPRS) - Anenhancement for GSM, based on packet-switchedtechnology enabling high-speed data transmission(115 kbit/s per second).

Gigabit - One billion bits.

Global System for Mobile communications(GSM) - European-developed digital mobile cellularstandard. For more information, see the GSMAssociation website athttp://www.gsmworld.com/index.html.

Graphic User Interface (GUI) - A computer terminalinterface that employs a bit-mapped screen.Graphical interfaces typically have Windows, Icons,Mice, Menus and Pointers. The GUI permits mixedgraphics and text, and incorporates easy-to-usevisual representations of system functions. The GUIwas popularized in personal computing, with theintroduction of the Apple Macintosh computer, andlater with Microsoft’s Windows operating system.

Half-Circuit - A component of an international circuitbetween two countries that originates in one countryand terminates at a theoretical midpoint between thecountries.

Hand-off - A central concept of cellular technology,enabling mobility for subscribers. It is a process bywhich the Mobile Telephone Switching Office passesa mobile phone conversation from one radio fre-quency in one cell to another radio frequency inanother as a subscriber crosses the boundary of acell.

Head-End – The point in a broadband network thatreceives signals on one set of frequency bands andretransmits them on another set. The head end of acable TV network generally receives satellite, off-airand wireline TV and multimedia signals, andretransmits them to end users through a fibre opticor co-axial cable distribution network.

Hertz (Hz) - The frequency measurement unit equalto one cycle per second.

High Speed Circuit Switched Data (HSCSD) - Anintermediary upgrade technology for GSM based oncircuit-switched technology and enabling dataservice speed of 57 kbps.

Host - Any computer that can function as thebeginning and end point of data transfers. EachInternet host has a unique Internet address (IPaddress) associated with a domain name. A host

Appendix C

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Appendix C

computer provides services such as databaseaccess, computation or other processing, and spe-cial programs or other content. A host computer isthe primary or controlling computer in a multiplecomputer installation.

HTTP - HyperText Transport Protocol (see WWW).

IEEE - Institute of Electrical and ElectronicEngineers. An international standards-settingorganization.

IETF - Internet Engineering Task Force. Anorganization responsible for updating and maintain-ing TCP/IP standards.

IMT-2000 - International Mobile Telecommunica-tions. The ITU third generation mobile cellularstandard. For more information see the website athttp://www.itu.int/imt.

In-Band Signalling - A communications techniqueused between switches and communicationsequipment in which the control signals areexchanged within the standard bandwidth of thetelecommunications signal.

Increment - A specific non-minimal increase ordecrease in volume of production. (See Appendix B:The Economics of Telecommunications Prices andCosts.)

Incremental Cost - The change in total costresulting from an increment. Incremental cost equalstotal cost assuming the increment is produced,minus total cost assuming the increment is notproduced. Because a wide variety of differentincrements can be specified, incremental cost canconceptually range all the way from total cost perunit (entire output as the increment) to marginal cost(one unit as the increment). The size of theincrement used in any specific cost analysis will be amatter of judgement. The most common practice isto use the entire service or element as theincrement, in which case the service or elementspecific fixed costs of the service or element wouldbe included in the increment. (See Appendix B: TheEconomics of Telecommunications Prices andCosts.)

Incumbent Operator - The establishedtelecommunications network operator(s) in acountry. Normally the entity that operates all or mostof the PSTN infrastructure in a country. In manycountries this was the Posts, Telephone and Tele-graph (PTT) administration of the nationalgovernment. In some countries it was or now is aprivate sector operator. In both cases, incumbentPTOs generally operated as monopolies. (See alsodefinition of PTO).

Incumbent Local Exchange Carrier (ILEC) - Termoriginating in North America to identify theincumbent operator that runs the local exchangenetwork. It is or was typically the dominant providerof local PSTN services. See also Competitive LocalExchange Carrier.

Inflation Factor – Variable included in a price capformula to reflect or represent changes in the inputcosts of telecommunications operators. (See alsoPrice Cap.) (See Module 4.)

Information infrastructures, Informationsuperhighway - High-speed communication net-works capable of carrying voice, data, text imageand video (Multimedia) information in an interactivemode.

Integrated Services Digital Network (ISDN) - A setof CCITT standards that provides for the transport ofdigital voice, data, image and video services.

Interactive Voice Response (IVR) - A voiceprocessing system that allows the storage and re-trieval of digital data, including data in the form of thehuman voice, through user interaction with thetouch-tone keys of the telephone. The IVR's pre-recorded voice commands guide the caller through amenu, and the caller responds by touching theappropriate numbered or lettered key(s).

Interconnection - The physical connection of tele-phone networks owned by two different operators inorder to allow customers connected to differentnetworks to communicate, to ensure theinteroperability of services. (See Module 3)

Interexchange Carriers (IXC) - A term originating inNorth America to describe long-distance telecom-


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munications operators that provide service betweencities or other local exchange areas.

Interface - The logical or physical connectionbetween two networks, systems or devices; thepoint of interconnection of two components and thebasis on which they exchange signals according tosome hardware or software protocol.

Internet - The collection of interconnected networksthat use the Internet Protocols (IP).

Internet Backbone - The high-speed, high capacitylines or series of connections that form a majorpathway and carry aggregated traffic within theInternet.

Internet Content Provider - A person or organiza-tion, that provides information via the Internet eitherwith a price or free of charge.

Internet Exchange Point (IXP) – Refers to aNetwork Access Point (NAP) where connections aremade to dedicated Internet backbone networks orwhere ISPs connect with one another. NAPs serveas data interchange points for backbone serviceproviders. NAPs and Metropolitan Area Exchanges(MAEs) are generally referred to as public InternetExchange Points (IXPs).

Internet Protocol (IP) Numbers - An IP number(also referred to as Internet address number) is theaddress of a host or other intelligent devices on theInternet. All servers and users connected to theInternet have an IP number.

Internet Service Provider (ISP) - ISPs provide end-users and other ISP access to the Internet. ISPsmay also offer their own proprietary content andaccess to online services such as e-mail.

Intranet - An Intranet is a network, based on TCP/IPprotocols, accessible only by an organization’semployees, or other authorized users. Intranetwebsites are similar to other websites, but aresurrounded by firewalls that prevent unauthorisedaccess.

ISO - International Standards Organization - ISOpromotes the development of standards for

computers and other products. It developed the OSImodel for data communication.

ITU - International Telecommunication Union. (SeeModule 1 for a description of the ITU and its variouscomponents, including ITU-R, ITU-T and ITU-D.)

ITU-D - Telecommunication Development Sector ofthe ITU. (See Module 1 for description of the ITU.)

ITU-R - Radiocommunication Sector of the ITU.(See Module 1 for description of the ITU.)

ITU-T - Telecommunication Standardization Sectorof the ITU. (See Module 1 for description of the ITU.)

Joint Cost - A specific kind of common cost incurredwhen a production process yields two or moreoutputs in fixed proportion. Joint costs vary inproportion to the total output of the joint productionprocess, not to the output of the individual jointproducts. (See Appendix B: The Economics of Tele-communications Prices and Costs.)

Kbps - Kilobits per second.

Key Telephone System - A multi-line telephonesystem designed to provide shared access toseveral outside lines through buttons on thetelephone set. It typically offers identified accesslines with direct line terminations on a telephone set.The system is located on the user’s premises andcan operate independently or in conjunction with aPBX.

Kilobit - One thousand bits.

Layer - A conceptual level of network processingfunctions. In the OSI model, network processing isthought of as taking place in layers, from thephysical transmission of data up to the issuing of anend-user command. Layers communicate only withthose immediately above or below in the layer proto-col stack, or with peer-level layers on other systems.

Leased Line - A point-to-point communicationchannel or circuit that is committed by the networkoperator to the exclusive use of an individualsubscriber. Depending on the country, leased linesmay or may not be permitted to interconnect with thePSTN.

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Appendix C

Licence – A telecommunications licence generallyrefers to the authorization to providetelecommunications services or operate telecom-munications facilities. A telecommunications licenceusually defines the terms and conditions on whichthe licensee is authorized to operate and sets out itsrights and obligations. (See Module 2.)

Licensing – Term used to refer to the administrativesteps followed by an NRA or other licensing author-ity to issue a licence. (See Module 2.)

Line – It usually refers to the communicationschannel whereby end users connect to the PSTN.Also called a circuit, trunk or facility.

Local Area Network (LAN) - A communicationsnetwork that provides high speed data transmissionand a low error rate in connecting computers andother terminal devices, usually within relatively smallareas. Most LANs are confined to a single buildingor group of buildings. However, one LAN can beconnected to other LANs over any distance via tele-phone lines and radio waves. (See also Wide AreaNetwork.)

Local Exchange Carrier (LEC) – The telecommu-nications operator that provides service to end usersthrough its local exchanges, which are connected tothe PSTN. (See also ILEC and CLEC.)

Local Loop - The transmission path linking endusers (i.e. subscribers) to the nearest exchange. Itgenerally consists of a pair of copper wires, but mayalso employ fibre-optic or wireless technologies. Thelocal loop is sometimes referred to as the "last mile".(See also unbundled local loop.)

Long Run - A period over which all factors ofproduction, including capital, are variable. Inpractice, a period of 10 to 15 years is sometimesselected by regulators for the purpose of LRICanalysis, for example.

Long Run Average Incremental Costs (LRAIC) –A variation on LRIC (See below) in which theincrement is defined as the total service. Thus, itdiffers from LRIC and marginal cost approaches inthat it includes fixed costs that are specific to theservice. (See Appendix B: The Economics of Tele-communications Prices and Costs.)

Long Run Incremental Costs (LRIC) Theincremental costs that arise in the long run with aspecific increment in volume of production. LRIC isgenerally calculated by estimating costs usingcurrent technology and best available performancestandards. When a cost study is based on the “costsof an efficient firm”, it usually refers to LRIC-typemethodology. In the presence of joint or commoncosts, the sum of the LRIC for all of the operator’sservices will be less than the total costs of theoperator. Hence, the operator will not be able torecoup all of its costs. Regulators will generally allowa mark-up to be added to LRIC or LRIC-type costsfor the firm to help recover all of its costs. (SeeAppendix B: The Economics of TelecommunicationsPrices and Costs.)

Main Telephone Line - Telephone line connecting asubscriber to the telephone exchange equipment.This term is synonymous with the terms mainstation, Direct Exchange Line (DEL) and mainaccess line.

Marginal Cost - The change in total cost resultingfrom a very small change in the volume of outputproduced. Due to a number of practical issues,including the lumpiness of capital increments (i.e.the inability of telecommunications plant to bedivided into very small parts, or scaled to provide anexact fit with the actual requirements of the network),marginal cost is difficult to estimate. Accordingly,most estimates of marginal cost are based onincremental cost. (See Appendix B: The Economicsof Telecommunications Prices and Costs.)

Mark-up - A percentage or a fixed monetary amountthat is used to take into account joint and commoncosts, for example, to supplement certain costingmethodologies. Cost concepts that do not fullyallocate (or distribute) all indirect costs generallyrequire mark-ups. These cost concepts includeincremental costing methodologies, including LRIC(and TSLRIC/LRAIC and TELRIC as discussed indetail in the cost methods section below). The mark-up may be uniform or non-uniform. While regulatorshave generally set uniform mark-ups to promotecompetition, the application of Ramsey principlessuggests that a non-uniform mark-up may beeconomically efficient. (See Appendix B: TheEconomics of Telecommunications Prices andCosts)


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Market Power – Generally, a telecommunicationsoperator or other firm is considered to have marketpower when it is able to establish and maintainprices or other key terms and conditions of sales in amarket for a non-transitory period, without regard tothe market or the actions of competitors, withoutlosing sales to such a degree as to make thisbehaviour unprofitable. (See also Dominance, aboveand see Module 5.)

Megabit - One million bits. Mbps - Megabits persecond.

Mobile Cellular Service - A communication servicein which voice or data is transmitted by radiofrequencies. The service area is divided into cells,each served by a transmitter. The cells areconnected to a controlling switching exchange,which is connected to the worldwide telephonenetwork.

Modem - Modulator/Demodulator. A conversiondevice installed in pairs at each end of analoguecommunications lines. The modem at the transmit-ting end modulates digital signals received locallyfrom a computer or terminal. The modem at thereceiving end demodulates the incoming analoguesignal, converts it back to its original digital formatand passes it to the destination device.

Multimedia - The presentation of more than onemedium, typically images (moving or still), soundand text in an interactive environment. Multimediarequires a significant amount of data transfer andinvariably requires computational facilities.

Multiplexer - A device that combines severalcommunications channels onto a single circuit. Thechannels are combined by paralleling the channelsin real time on the single circuit and distributing themin frequency (Frequency Division Multiplexing--FDM)or by time-sharing the channel (Time DivisionMultiplexing--TDM).

Multiplexing - (1) To combine the signals of two ormore channels into one single channel fortransmission over the telecommunications network.(2) Division of a transmission facility into two or morechannels.

National Regulatory Authority (NRA) – Seedefinition of Regulator below.

Network - A public and/or private communicationstransmission system that provides interconnectivityamong a number of local or remote devices (e.g.telephones, exchanges, computers, television sets).The PSTN is operated by local PTOs. Like thePSTN, other private and public networks cancomprise many point-to-point transmission media,including wire, cable and radio-based ones.

Network Access Point (NAP) - Point at whichdedicated Internet backbone lines are reached or atwhich ISPs connect with one another. NAPs serveas data interchange points for backbone serviceproviders. NAPs and Metropolitan Area Exchanges(MAEs) are increasingly referred to as public Internetexchange points (IXPs).

Network Redundancy - A telecommunications paththat has backups connecting various points in caseone path fails (e.g. if a cable is cut).

New Entrant - A new telecommunications serviceprovider, including a new PTO.

Node - A computer, switch or other device when it isconsidered as part of a network.

Number Portability - The ability of a customer totransfer its service account from one operator toanother without requiring a change in the customer’snumber.

Online Service and Software Companies -Companies which operate Internet sites whoseprincipal function is to provide services in electronicform, including transactions with third parties, salesand support for its products and software which canbe downloaded by end users for a fee or withoutcharge.

Open System - A computing system that usespublicly available standards so that it can communi-cate with other systems using the same standards.

Open Systems Interconnection (OSI) - The overallname for ISO's classification of standards for globalconnectivity. ISO has developed a seven-layermodel for standards-based networking and is in the

Appendix C

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Appendix C

process of developing protocols that comply with thismodel.

Operating System - Software that provides the linkbetween a computer's application programs and itshardware.

Out-of-Band Signalling - A communicationstechnique used between switches and other tele-communications equipment in which the controlsignals are exchanged through a control channelthat is separate from the channel(s) carrying theinformation.

Packet - A unit of information identified by a label atlayer 3 of the OSI reference model. The term is usedto describe a collection of bits that contain bothcontrol information and content. Control informationis carried in the packet to provide for addressing,sequencing, flow control and error control at each ofseveral protocol levels. A packet can be fixed orvariable in length, but generally has a specifiedmaximum length.

Packet Switching - A data telecommunicationstechnique in which information is grouped intopackets for ease of handling, routing, supervisingand controlling on telecommunications networks.Packets are sent to their destination by the fastestroute. The transmission channel is occupied onlywhile the packet is being transmitted and thechannel is then available to transfer other packetsbetween other data terminal equipment. Individualpackets may reach the destination by differentroutes and in the wrong order. The destination nodeis responsible for reassembling the packets into theproper sequence. Packet switching is used in mostdata networks, including those that use the olderX.25 protocol, and the Internet, which uses TCP/IPProtocols.

Paging - A mobile radiocommunication serviceoffering - usually one-way - of numeric or textualinformation to small pocket terminals.

PCM - Pulse Code Modulation. The technique mostfrequently used to sample and convert analoguesignals to a digital format. In telephony, PCM is usedto convert analogue voice signals to an 8-bit digitalformat at an 8 Khz rate, producing a serial bit streamof 64 kbps.

Peak rate - Term used for calls made during thebusy part of the working day, at full tariff. Off-peakrefers to calls made at other times, often withdiscounted tariffs.

Peering - The exchange of routing announcementsbetween two Internet Service Providers for thepurpose of ensuring that traffic from the first canreach customers of the second, and vice-versa.Peering takes place predominantly at IXPs andusually is offered either without charge or subject tomutually agreed commercial arrangements.

Penetration - A measurement of access to tele-communications, normally calculated by dividing thenumber of subscribers to a particular service by thepopulation and multiplying by 100. Also referred toas teledensity (for fixed-line networks) or mobiledensity (for cellular ones).

Personal Communication Services (PCS) - In theUnited States and Canada, refers to digital mobilenetworks using the 1900 Mhz frequency. In othercountries, refers to digital mobile networks using the1800 Mhz frequency (See DCS-1800). The termPersonal Communications Network (PCN) is alsoused.

Point of Interconnection (POI) - The physicallocation at which two networks interconnect.

Point of Presence (PoP) - A Point of Presence is aswitch, node or other facility offering users access ina particular market (e.g. dial-up access to theInternet via a specific telephone number). Thegreater the number of PoPs, the higher thelikelihood that users can connect using a localtelephone call.

Port - The physical access point to a computer,switch, device, or network where signals may besupplied, extracted or measured.

Portal - Although an evolving concept, the term“portal” commonly refers to the starting point, or agateway through which users navigate the WorldWide Web, gaining access to a wide range ofresources and services, such as e-mail, forums,search engines, and shopping malls. A mobile portalimplies a starting point, which is accessible from amobile phone.


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Post Telephone and Telegraph Administration(PTT) - Term used to designate governmentdepartments or agencies that traditionally ownedoperated the PSTN as monopolies mainly in Europe,Asia and Africa.

Post, Telegraph and Telephone Administration(PTT) - The traditional organization of the communi-cation sector in many countries was the PTT (thePost, Telegraph and Telephone Administration)wherein the government owns and operates bothtelecommunication and postal services.

Predatory Pricing – Anti-competitive practice ofproviding services at prices that are low enough todrive competitors out of a market, or prevent newentry by them, so as to monopolize the market. (SeeModule 5.)

Price Cap – Is a rules-based form of price regulationthat uses a formula to determine the maximumallowable price increases for a regulated operator’sservices for a specified year or number of years. Theformula typically allows an operator to increase itsrates annually for a service or basket of services byan amount equal to inflation, less an amount equalto the assumed rate of productivity increases. Othervariables may be taken into account in the price capformula such as ‘exogenous factors’ outside of theoperator’s control and the quality of service providedby the operator. (See Module 4.)

Primary Rate Interface - Also called Primary RateAccess. A term used to designate an integratedservices digital network (ISDN) interface standardthat is designated in North America as having23B+D channels, in which all circuit-switched Bchannels operating at 64 kb/s and in which the Dchannel also operates at 64 kb/s. The PRIcombination of channels results in a digital signallevel 1 (or T1) interface at the network boundary.

Private Branch Exchange (PBX) - Equipment thatis located on a customer’s premises that controlsand switches information between local terminalequipment, such as telephones or data terminals,and provides access to the PSTN. Sometimes PBXsare referred to as Private Automatic BranchExchanges (PABXs). (See also Key TelephoneSystem.)

Private Network - A network based on leased linesor other facilities which are used to providetelecommunication services within an organizationor within a closed user group as a complement or asubstitute to the public network.

Private Ownership/Privatization - The transfer ofcontrol of ownership of a state enterprise to privateparties generally by organizing the enterprise as ashare company and selling shares to investors.More generally, the term is sometimes used to referto a wide range of modalities whereby business isopened to private enterprise and investment.

Proprietary Standard - A standard that is owned orcontrolled by a single person or legal entity. Aproprietary standard can be used for interoperabilityif the company that controls it is willing to license itand publish its specifications.

Protocol - A set of formal rules and specificationsdescribing how to transmit data, especially across anetwork or between devices.

Public Switched Telephone Network (PSTN) -The infrastructure of physical switching and trans-mission facilities that is used to provide the majorityof telephone and other telecommunications servicesto the public. In a monopoly environment, one PTOowns and operates the PSTN. In a competitiveenvironment, the PSTN typically comprises theinterconnected networks of two or more PTOs.

Public Telecommunications Operator (PTO) -normally a “facilities-based operator” such as atelephone company, which provides telecommuni-cations services to the public for compensation. Theterm “public” relates to the consumer rather than theownership of the PTO. In some countries the terms“telecommunications common carrier”, “commoncarrier” or simply “carrier” are used instead of PTO.

RAG - Radiocommunication Advisory Group of theITU. (See Module 1 for description of the ITU.)

Rate of Return Regulation (ROR) - Is a rules-based form of price regulation designed to providethe regulated operator with relative certainty that itcan meet its revenue requirements and that priceswill be adjusted, as required to meet that objective.Under this scheme, the regulated operator’s

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Appendix C

revenue requirement is calculated and then serviceprices are adjusted so that its overall servicerevenues cover such revenue requirement. (SeeModule 4.)

Rate Rebalancing - It refers to the adjustment ofrates charged for different services to more closelyreflect their costs. In most countries, this meansincreasing local access rates and decreasinginternational, long distance, local usage rates andInternet access. (See Appendix B, Module 4 andAppendices to Module 6.)

Regulator - This term is used to refer to governmentagency, institution or official responsible forregulation of all or part of the telecommunicationssector in a country. In some countries it is a NationalRegulatory Authority (NRA), an independentregulatory authority, or a Ministry of the Government.Sometimes, one entity is the regulator for somepurposes and another entity for other purposes.Different institutional approaches to regulation arediscussed in Module 1.

Reseller - A public telecommunications serviceprovider that does not own network transmissionfacilities but obtains transmission facilities orservices from others (usually from a PTO) for resaleto its customers. These facilities or services may beresold with other services (e.g. value-addedservices) or without (“simple resale”). Some resellersoperate their own switches, routers and processingequipment. Others do not.

Roaming - A service allowing cellular subscribers touse their handsets on networks of other operators.

Router - Specialized computers that receivetransmissions of packets and compare theirdestination addresses to internal routing tables and,depending on routing policy, send the packets out tothe appropriate interface. This process may berepeated many times until the packets reach theirintended destination.

Routing Policy - An expression of how an ISP willchoose to direct traffic on or off network. Forexample, ISPs may choose to route traffic withpreference to certain paths or through other ISPsdepending on the commercial relationships betweenthe parties.

RRB - Radio Regulations Board of the ITU. (SeeModule 1 for description of the ITU.)

Sender Keep All - Another term for Bill and Keep.(See Module 3.)

Server - (1) A host computer on a network thatsends stored information in response to requests orqueries. (2) The term “server” is also used to refer tothe software that makes the process of servinginformation possible.

Short Message Service (SMS) - A service availableon digital networks, typically enabling messages withup to 160 characters to be sent or received via themessage centre of a network operator to asubscriber’s mobile phone.

Signalling System Number 7 - AN ITU-T commonchannel signalling protocol providing enhanced con-trol functions such as look-ahead routing for high-speed digital communications services betweenintelligent network nodes. Signalling information issent at 64 kbps. Also referred to as CommonChannel Signalling System Number 7 (CCSS7), orCCITT Number 7 Signalling.

Significant Market Power – Test set out in severalEuropean Directives to identify operators that havegreater than a 25% share of a particular telecommu-nications market and that are required to meetcertain obligations (e.g. Article 4 of theInterconnection Directive mandates operators withsignificant market power to “meet all reasonablerequests for access to the network, including accessat points other than the network termination pointsoffered to the majority of end-users”). (See Module5.)

Spectrum - The radio frequency spectrum ofHertzian waves used as a transmission medium forcellular radio, radiopaging, satellite communication,over-the-air broadcasting and other wirelessservices.

Splitter - A device used in a cable system or wirenetwork to divide the power of a single input into twoor more outputs of lesser power. It can also be usedwhen two or more inputs are combined into a singleoutput.


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SS7 - See Signalling System Number 7.

Stand-alone Cost - The total cost to provide aparticular product or service in a separate productionprocess (i.e. without benefit of scope economies).(See Appendix B: The Economics ofTelecommunications Prices and Costs.)

Standards - Recommendation for the protocol,interface, type of wiring or some other aspect of anetwork. Recommendations range from aconceptual definition for a general framework ormodel for communications architecture to specificinterfaces. Standards are developed byinternationally or nationally recognized bodies suchas ITU-T or telecommunications equipment vendors.

Subscriber Identity Module (SIM) Card - A smallprinted circuit board inserted into a GSM-basedmobile phone when signing on as a subscriber. Itincludes subscriber details, security information anda memory for a personal directory of numbers.

Switch - Telecommunications equipment that estab-lishes and routes communications paths betweendifferent lines, trunks or other circuits. Switchesestablish circuits or paths between different endusers or between other devices attached totelecommunications networks. A PBX is a form ofswitch located on customer premises. The termExchange is generally used to refer to switches thatare connected to the PSTN.

Synchronization - Timing pulses to maintain theproper identity between the transmitted and receivedpulses.

T-1 - A North American digital standard referring toany transmission line or connection operating at theDS1 rate of 1.544 Mbps. (See T-1.)

T-3 - Refers to transmission at 44.736 Mbps, etc.(See E-1)

Telecommunications Facility Provider - An entitythat supplies underlying transmission capacity forsale or lease and either uses it to provide services oroffers it to others to provide services.

Teledensity - Number of main telephone lines per100 inhabitants.

Total Cost - The aggregate amount of all costsincurred in producing a specified volume of output.The sum of fixed and variable costs equals totalcost. (See Appendix B: The Economics ofTelecommunications Prices and Costs).

Transmission Control Protocol/Internet Protocol(TCP/IP) - The suite of protocols that defines theInternet and enables information to be transmittedfrom one network to another.

TSB - Telecommunication Standardization Bureau ofthe ITU. (See Module 1 for description of the ITU).

Type Approval - An administrative procedure oftechnical tests and vetting applied to items oftelecommunication equipment before they can besold or interconnected with the public network. Alsoknown as homologation.

UMTS Terrestrial Radio Access (UTRA) - TheEuropean third-generation mobile standard ETSIhas agreed on which draws upon both W-CDMAand TDMA-CDMA proposals.

Unbundled Local Loop - Access to the full andexclusive use of the copper pair connected to thecustomer and/or some form of shared access to thelocal loop. Full unbundling refers to access to rawcopper local loops (copper terminating at the localswitch) and subloops (copper terminating at theremote concentrator or equivalent facility). Sharedaccess refers to the non-voice frequencies of a localloop and/or access to space within a maindistribution frame (MDF) site of an operator forattachment of DSL access multiplexers (DSLAMS)and similar types of equipment to the local loop ofthe notified operator.

Unbundling - Refers to the provision of componentson a stand-alone basis. Therefore, interconnectingcarriers can obtain access to single unbundledcomponent without an obligation to buy other com-ponents as part of an “interconnection package”(See Module 3.)

Uniform Resource Locator (URL) - The standardway to give the address or domain name of anyInternet site that is part of the World Wide Web(WWW). The URL indicates both the application

Appendix C

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Appendix C

protocol and the Internet address, e.g.http://www.itu.int.

Universal Access – A term generally used to referto a situation where every person has a reasonablemeans of access to a publicly available telephone.Universal Access may be provided through paytelephones, community telephone centres,teleboutiques, community Internet access terminalsor similar means. (See also Universal Service; seeModule 6.)

Universal Mobile Telecommunications System(UMTS) - The European term for third generationmobile cellular systems. For more information, seethe UMTS Forum website at http://www.umts-forum.org.

Universal Service – Generally refers to a policyfocused on promoting or maintaining “universal”availability of connections by individual householdsto public telecommunications networks. (See alsoUniversal Access; see Module 6.)

Universal Service Obligation (USO) – Generallyrefers to the obligation imposed on a telecommuni-cations operator to meet the policy objective ofconnecting all, or most, households to publictelecommunications networks. The term is oftenused more generally to refer to operators’ obligationsto take initiatives to promote Universal Access aswell as Universal Service. (See Module 6.)

Universality – Term used in this Handbook to refergenerally to Universal Access and UniversalService. (See Module 6.)

Universality Fund / Universal Service Fund -Such funds typically collect revenues from varioussources and disburse them in a fairly targetedmanner to achieve specific universality objectives.Depending on the country, the source of revenuesmay include government budgets, charges oninterconnecting services or levies on telecommuni-cations services or operators. (See Module 6).

Value Added Services (VAS) - Telecommunicationservices provided over public or private networkswhich, in some way, add value to the basic carriage,usually through the application of computerizedintelligence, for instance, reservation systems,

bulletin boards, and information services. Alsoknown as value added network services (VANS) andenhanced services.

Variable Cost - A cost that varies with increasedvolume of production. (See Appendix B: TheEconomics of Telecommunications Prices andCosts.)

Vertical Price Squeezing - Occurs when anoperator with market power controls certain servicesthat are a key input for competitors in subordinatedor ‘downstream’ markets and where those same keyinputs are used by the operator or its affiliates tocompete in the same downstream markets. Forexample, an incumbent telecommunicationsoperator often controls local access and switchingservices which are key for competitors to competewith the same incumbent operator in a ‘vertical’market. (See Module 5.)

Very Small Aperture Terminal (VSAT) - A satelliteearth station with a small antenna, usually six metresor less. Generally used for point-to-multipoint datanetworks, they have dramatically lowered the cost ofsatellite communications.

Virtual Private Network (VPN) - Uses a telecom-munications operator’s network to provide thefunctions of private lines. Users can design, changeand manage a private network without having toinvest in capital equipment or manage switchingequipment and leased lines. Also known as aSoftware Defined Network.

Voice Mail/Voice Messaging - A technique forsending, storing and handling digitized voiceinformation. Information is stored in "voice mailboxes", one of which is assigned to each end-useron the system. Owners of voice mail boxes, andcallers who access them, interact with the systemthrough a touch-tone telephone key pad. Mailboxowners can retrieve, save, reply to, forward, forwardwith comments and delete voice messages.

Webcasting - A group of emerging services that usethe Internet to deliver content to users in ways thatsometimes closely resemble other traditionalcommunication services such as broadcasting.


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Website/Webpage - A website (also known as aninternet site) generally refers to the entire collectionof HTML files that are accessible through a domainname. Within a website, a webpage refers to asingle HTML file which, when viewed by a browseron the World Wide Web could be several screendimensions long. A “home page” is the webpagelocated at the root of an organization’s URL.

Whole Circuit - A circuit that connects points indifferent countries where a single entity owns thecircuit in its entirety or owns leases, or operates twohalf-circuits in combination.

Wide Area Network (WAN) – A system of two ormore LANs connected over a distance via telephonelines or radio waves.

Wireless Application Protocol (WAP) - A license-free protocol for wireless communication thatenables the creation of mobile telephone servicesand the reading of Internet pages from a mobileterminal, thus being the mobile equivalent of HTTP(Hyper Text Transfer Protocol).

Wireless Local Loop (WLL) - A technique usingradio technology to provide the connection from thetelephone exchange to the subscriber.

World Wide Web (WWW) - (1) Technically refers tothe hypertext servers (HTTP servers) which are the

servers that allow text, graphics and sound files tobe mixed together. (2) Loosely refers to all types ofresources that can be accessed, including - HTTP,Gopher, FTP, Telnet, USENET and WAIS.

WRC - World Radiocommunication Conference ofthe ITU. (See Module 1 for description of the ITU.)

WTAC - World Telecommunication Advisory Councilof the ITU. (See Module 1 for description of the ITU.)

WTO - World Trade Organization. (See Module 1.)

WTO Regulation Reference Paper - A short paperincluding a set of principles for the regulation ofbasic telecommunications services. The paper wasincluded with the commitments of most of thecountries that signed the WTO Agreement on BasicTelecommunications (ABT). The WTO RegulationReference Paper is included as Appendix A.

WTSC - World Telecommunication StandardizationConference of the ITU. (See Module 1 fordescription of the ITU.)

X-Factor – Productivity Factor in Price CapRegulation. (See Module 4.)

3G - Third generation mobile communicationsystem. (See IMT-2000.)

Sources: Various, including ITU, World Telecommunication Development Report, 1999; ITU, Challenge toNetwork, Internet Development, 1999, McCarthy Tétrault and public domain sources.

D - 1

APPENDIX D - SELECTED SOURCESNote: The following list of information sources is selective and not comprehensive. The listhas been provided as a starting point for research, not to provide a balanced source ofinformation on all issues. Most of the laws and regulations of ITU Member States areavailable from the regulatory database of the ITU, at http://www7.itu.int/treg/

Module 1 – Approaches to Regulation

Regulatory Documents

ACA (Australian Communications Authority). 1999. Principles for Decision-Making. Australia.http://www.austel.gov.au/publications/info/decision.htm

CEC (Commission of the European Communities). 1987. Towards a Dynamic European Economy: GreenPaper on the Development of a Common Market for Telecommunication Services and Equipment,

(COM(87) 290 final, 30.06.97).

____. 1996. Full Competition Directive of 28 February amending Commission Directive 90/388/EEC regardingthe implementation of full competition in telecommunications markets, (96/19/EC, OJ L 74/13,22.3.96).http://www.ispo.cec.be/infosoc/legreg/docs/9619ec.html

____. 1998a. Status of voice communications on Internet under Community Law and, in particular, pursuant toDirective 90/388/EEC, (OJ C6, 10.01.98).http://www.europa.eu.int/comm/competition/liberalization/legislation/voice_en.html

____. 1998b. ONP Voice Telephony Directive of the European Parliament and of the Council of 26 February1996 on the application of open network provision (ONP) to voice telephony and on universal servicefor telecommunications in a competitive environment (replacing European Parliament and CouncilDirective 95/62/EC), (98/10/EC OJ L 101/24 1.4.98).http://www.ispo.cec.be/infosoc/telecompolicy/VT/ONPVTEN.pdf

____. 1998c. Council Resolution of 30 June on the development of the common market fortelecommunications services and equipment up to 1992, (88/C 257/01; OJ C 257/1, 04.10.88).http://www.ispo.cec.be/infosoc/legreg/docs/88c25701.html

____. 1999. Directive of the European Parliament and of the Council of 9 March 1999 on radio equipment andtelecommunications terminal equipment and the mutual recognition of their conformity, (1999/5/EC,09.03.1999).http://europa.eu.int/comm/enterprise/rtte/dir99-5.htm

____. 2000. Proposal for a Directive of the European parliament and Council on a common regulatoryframework for electronic communications networks and services, (COM(2000) 393 final 2000/0184(COD) 12.7.2000).http://europa.eu.int/eur-lex/en/com/pdf/2000/en_500PC0393.pdf


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CITEL (Inter-American Telecommunications Commission). 2000. Telecommunication Policies for theAmericas: The Blue Book, 2nd Edition, April, Washington, D.C.http://www.itu.int/itudoc/itu-d/publicat/b_book.html

Communication Authority, Hungary. 2000. Hungarian Telecommunications Regulatory Environment andAuthority, 9th edition. Budapest.http://www.hif.hu/english/bluebookeng.pdf

CRTC (Canadian Radio-television and Telecommunications Commission). 1992. Introduction of Competitionin Public Long Distance Voice Telephone Market, Telecom Decision CRTC 92-12, 12 June, Ottawa.http://www.crtc.gc.ca/archive/Decisions/1992/DT92-12e.htm

____. 1994. Review of Regulatory Framework, Telecom Decision CRTC 94-19, 16 September, Ottawa.http://www.crtc.gc.ca/archive/Decisions/1994/DT94-19.htm

____. 1995a. Implementation of Regulatory Framework - Splitting of the Rate Base and Related Issues,Telecom Decision CRTC 95-21, 31 October, Ottawa.http://www.crtc.gc.ca/archive/Decisions/1995/DT95-21e.htm

____. 1995b. Forbearance - Services Provided by Non-Dominant Canadian Carriers, Telecom Decision CRTC95-19, 8 September, Ottawa.http://www.crtc.gc.ca/archive/Decisions/1995/DT95-19.htm

____. 1998. Regulatory Regime for the Provision of International Telecommunications Services, TelecomDecision CRTC 98-17, 1 October, Ottawa.http://www.crtc.gc.ca/archive/Decisions/1998/DT98-17.htm

Department of Trade and Industry. 1998. A Fair Deal for Consumers: Modernising the Framework for UtilityRegulation. London.http://www.dti.gov.uk/urt/fairdeal/

FCC (Federal Communications Commission). 1976. Regulatory Policies Concerning Resale and Shared Useof Common Carrier Services and Facilities, Report and Order, CC Docket No. 20097, Washington,D.C.

____. 1996a. Local Competition Provisions of the 1996 Act (Non-pricing Issues), CC Docket No. 96-98, 1August, Washington, D.C.http://www.fcc.gov/ccb/local_competition/#docs

____. 1996b. First Report and Order in the Matter of Implementation of the Local Competition Provisions in theTelecommunications Act of 1996, CC Docket No. 96-8, 28 August, Washington, D.C.http://www.fcc.gov/ccb/local_competition/fcc96325.html

____. 1996c. Second Report and Order in the Matter of Forbearance (Tariff) Interexchange Carrier, CC DocketNo. 96-61, 31 October, Washington, D.C.http://www.fcc.gov/Bureaus/Common_Carrier/Orders/1996/fcc96424.txt

____. 1997. Third Report and Order in the Matter of Forbearance (Tariff) Interexchange Carrier, CC DocketNo. 96-61, 18 April, Washington, D.C.

Appendix D

D - 3

Appendix D

____. 1999. Connecting the Globe: A Regulators Guide to Building a Global Information Community. June,Washington, D.C.http://www.fcc.gov/connectglobe/

High Level Group on the Information Society. 1994. Europe and the Global Information Society:Recommendations to the European Council, The Bangemann Report, Brussels.http://www.ispo.cec.be/infosoc/backg/bangeman.html

India, Government of. 1999. National Telecom Policy, New Dehli.http://www.trai.gov.in/npt1999.htm

ITU (International Telecommunication Union). 1993. The Challenge of Change, Report of the High LevelCommittee to Review the Structure and Function of the ITU, Geneva.

____. 1993. Colloquium No. 1: The Changing Role of Government in an Era of Deregulation, Geneva.

____. 1996. Telecommunications Policies in Africa: The African Green Paper. Geneva.http://www.itu.int/treg/reform/Policy_Papers/green/green_eng.htm

____. 1997. Telecommunications Policies for the Arab Region: The Arab Book. Geneva.http://www.itu.int/treg/reform/Policy_Papers/arab/arabbook.htm

____. 1998. General Trends in Telecommunications Reform 1998 “World.” Volume I, 1st. Edition,Telecommunications Development Bureau, Geneva.http://www.itu.int/publications/index.html

____. 1999a. Trends in Telecommunication Reform 1999: Convergence and Regulation. Geneva.http://www7.itu.int/treg/publications/Trends-en.asp

____. 1999b. World Telecommunications Development Report 1999: Mobile Cellular, Geneva.http://www.itu.int/ti/publications/WTDR_99/wtdr99.htm

Ministry of Posts, Telecommunications and Broadcasting [The]. 1996. White Paper on TelecommunicationsPolicy, South Africa.http://www.doc.org.za/docs/policy/telewp.html

OECD (Organization for Economic Cooperation and Development). 1991. The Diffusion of AdvancedTelecommunications in Developing Countries. Paris.

____. 1997. Regulatory Reform in Telecommunications Services. Paris.

____. 1999. Communications Outlook 1999. March, Paris.http://www.oecd.org//dsti/sti/it/cm/prod/com-out99.htm

____. 2000. Telecommunications Regulations: Institutional Structures and Responsibilities. Paris.http://www.olis.oecd.org/olis/1999doc.nsf/LinkTo/DSTI-ICCP-TISP(99)15-FINAL

OFTEL (Office of Telecommunications). 1995. Telecoms: Price Control and Universal Service, London.http://www.oftel.gov.uk/consumer/univserv/contents.htm


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____. 1995. Fair Trading in Telecommunications - A Statement, London.http://www.oftel.gov.uk/fairtrade/fairtrad.htm

____. 1997a. Promoting Competition in Services over Telecommunications Networks, London.http://www.oftel.gov.uk/competition/pcstn.htm

____. 1997b. Network Charges from 1997 - Consultative Document, London.http://www.oftel.gov.uk/pricing/netcha97/contents.htm

____. 1997c. Review of Utility Regulation, Submission by the Director General of Telecommunications,London.http://www.oftel.gov.uk/feedback/utility1.htm

____. 1998a. Improving Accountability: Further Steps, London.http://www.oftel.gov.uk/consumer/impacc.htm

____. 1998b. Regulatory Issues Associated with Multi-Utilities, A Joint Paper by the Directors General ofElectric Supply, Gas Supply, Telecommunications and Water Services, the Director General ofElectricity Supply (Northern Ireland) and the Director General of Gas (Northern Ireland), London.http://www.oftel.gov.uk/feedback/multi598.htm

____. 1999. Management Plan for 1999/2000, London.http://www.oftel.gov.uk/about/plan599.htm

____. 2000. Communications Regulation in the UK: A paper by the Director General of Telecommunications.London.http://www.oftel.gov.uk/about/whit0700.htm [author?]

SADC (Southern Africa Development Community). 1998a. Model Telecommunications Bill, South Africa.http://www.trasa.org/documents/sadcmodeltelecombill_english.doc

____. 1998b. Telecommunications Policy for SADC, South Africa. http://www.trasa.org/documents/sadcmodeltelecompolicy_english.doc

SECOM (Secretaría de Comunicaciones de Argentina). 2000. Decreto No. 764/00. Desregulación delMercado de las Telecomunicaciones, Buenos Aires.http://www.secom.gov.ar

TRAI (Telecommunications Regulatory Commission of India). 1998a. Consultation Paper on Regulations forMeeting the Funding Requirements of the TRAI, New Delhi.

____. 1998b. Quality of Service-Consultation Paper on Benchmarks, Targets, Monitoring and EnforcementMechanism, New Delhi.http://www.trai.gov.in/qos.htm

UNDP (United Nations Development Programme) / ITU (International Telecommunication Union). 1996.Handbook on Telecommunication Reform: Regulatory Organizations (ITU-RAS 93/035), Bangkok:United Nations Development Programme (UNDP) / International Telecommunication Union (ITU).

Appendix D

D - 5

Appendix D

WTO (World Trade Organization. 1997a. Fourth Protocol to the General Agreement on Trade in Services(Agreement on Basic Telecommunications Services), Geneva.http://www.wto.org/english/tratop_e/servte_e/4prot-e.htm

____. 1997b. Reference Paper on Regulatory Principles (attached to the Fourth Protocol to the GeneralAgreement on Trade in Services), Geneva.http://www.wto.org/english/news_e/pres97_e/refpap-e.htm

____. 1998. Schedules of Commitments and Lists of Article II Exemptions annexed to the Fourth Protocol tothe GATS (listed by country), Geneva.http://www.wto.org/english/tratop_e/servte_e/gbtoff_e.htm

Other Documents

Armstrong, M., Cowan, C. and Vickers, J. 1994. Regulatory Reform: Economic Analysis and BritishExperience. London: MOT Press.

Armstrong, M. and Vickers, J. S. 1996. “Regulatory Reform in Telecommunications in Central and EasternEurope.” Economics of Transition Vol. 4: 295-318.

Braga. C.A.P. 1997. “Liberalizing Telecommunications and the Role of the World Trade Organization.” PublicPolicy for the Private Sector Note 120, July 1997. Washington, D.C.: The World Bank Group.http://www.worldbank.org/html/fpd/notes/120/120braga.pdf

Braga, C. A. P. and Fink, Carsten. 1997. “The Private Sector and the Internet.” Public Policy for the PrivateSector Note 122, July 1997. Washington, D.C.: The World Bank Group.http://www.worldbank.org/html/fpd/notes/122/122braga.pdf

Bogdan-Martin, D. 1999. Global Telecom Reforms and BDT Sector Reform Initiatives, Presented at the ITUWorkshop on Telecommunications Reform, (3-5 May) Gaborone, Botswana: ITU.http://www7.itu.int/treg/Events/Seminars/1999/Botswana/papers/Documents/document25.pdf

Bond, J. 1997a. “The Drivers of the Information Revolution – Cost, Computing Power, and Convergence.”Public Policy for the Private Sector Note 118. Washington, D.C.: The World Bank Group.http://www.worldbank.org/html/fpd/notes/118/118bond.pdf

Bond, J. 1997b. “Telecommunications Is Dead, Long Live Networking—The Effect of the InformationRevolution on the Telecom Industry.” Public Policy for the Private Sector Note 119, Washington,D.C.: The World Bank Group.http://www.worldbank.org/html/fpd/notes/119/119bond.pdf

De la Torre, M. 1999. The Changing Role of the Regulator. Presented at the ITU Workshop onTelecommunications Reform, (3-5 May) Gaborone, Botswana.http://www7.itu.int/treg/Events/Seminars/1999/Botswana/papers/Documents/document26.pdf

Izaguirre, A. 1999. “Private Participation in Telecommunications – Recent Trends.” Public Policy for the PrivateSector Note 204. Washington, D.C.: The World Bank Group.http://www.worldbank.org/html/fpd/notes/204/204izagu.pdf

Melody, W.H., editor. 1997. Telecom Reform: Principles, Policies and Regulatory Practices, Denmark: Centerfor Tele-Information, Technical University of Denmark.


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Roger, N. 1999. “Recent Trends in Private Participation in Infrastructure.” Public Policy for the Private SectorNote 196. Washington, D.C.: The World Bank Group.http://www.worldbank.org/html/fpd/notes/196/196roger.pdf

Sallai, G. 1999. Reform and Development of the Hungarian Telecommunications. Presented to the ITU-BDTSub-regional Seminar on “Legal Aspects of Reform and WTO Agreement”, Budapest: CommunicationAuthority.

Satola, D. 1999. Policy Options for Developing Countries Liberalization around the World: The Case for furtherReform. Presented at the Conference “Legal and Regulatory Dimensions of WTO Implementation”.Federal Communications Bar Association (3 March 1999). Washington, D.C.http://www.worldbank.org/html/fpd/telecoms/presentation2/index.htm

Schwarz, T. & Satola, D. 2000. Telecommunications Legislation in Transitional and Developing Economies.World Bank Technical Paper No. 489. Washington, D.C.: The World Bank Group.https://global011.worldbank.org/Site/Products.nsf

Smith, P. 1995. “Subscribing to Monopoly: The Telecom Monopolist's Lexicon—Revisited.” Public Policy forthe Private Sector Note 53. Washington, D.C.: The World Bank Group.http://www.worldbank.org/html/fpd/notes/53/53smith.pdf

____. 1997. “What the Transformation of Telecommunications Markets Means for Regulation.” Public Policyfor the Private Sector Note 121. Washington, D.C.: The World Bank Group.http://www.worldbank.org/html/fpd/notes/121/121smith.pdf

____ & Wellenius, B. 1999. “Mitigating Regulatory Risk in Telecommunications.” Public Policy for the PrivateSector Note 189. Washington, D.C.: The World Bank Group.http://www.worldbank.org/html/fpd/notes/189/189smith.pdf

Wellenius, B. 1997. “Telecommunications Reform How To Succeed.” Public Policy for the Private Sector Note130. Washington, D.C.: The World Bank Group.http://www.worldbank.org/html/fpd/notes/130/130welle.pdf

____ & Stern, P., editors. 1994. Implementing Reforms in the Telecommunications Sector. Lessons FromExperience. Washington, D.C.: The World Bank.

Wong, A. S. K. 1999. Regulatory Framework for Telecommunications in Hong Kong. Presented for the Councilfor Trade in Services at the Special Session on Telecommunications. Geneva.http://www.wto.org/spanish/tratop_s/serv_s/wong-hk/tsld001.htm

Appendix D

D - 7

Appendix D

Module 2 – Licensing


ANATEL (Agencia Nacional de Telecommunicaçoes). 1998. Model Concession Agreements for the Provisionof local, long distance and international telephone services. Brasilia.http://www.anatel.gov.br/biblioteca/contrato/Modelo/modelo.asp

Argentina (República). 2000. Reglamento de Licencias para Servicios de Telecomunicaciones.http://www.secom.gov.ar/normativa/ax1-licencias.htm

CEC (Commission of the European Communities). 1996. Full Competition Directive of 28 February amendingCommission Directive 90/388/EEC regarding the implementation of full competition intelecommunications markets, (96/19/EC, OJ L 74/13, 22.3.96).http://www.ispo.cec.be/infosoc/legreg/docs/9619ec.html

____. 1997. Directive 97/13/EC of the European Parliament and of the Council of 10 April 1997 on a commonframework for general authorizations and individual licences in the field of telecommunicationsservices, (97/13/EC OJ L117, 7.5.1997).http://www.ispo.cec.be/infosoc/telecompolicy/en/licences.htm

____. 2000. Proposal for a Directive of the European parliament and Council on the authorisation of electroniccommunications networks and services, (COM(2000) 386 final 2000/0188 (COD) 12.7.2000).http://europa.eu.int/eur-lex/en/com/pdf/2000/en_500PC0386.pdf

CRTC (Canadian Radio-television and Telecommunications Commission). 1994. Use of Automatic Dialling-Announcing Devices, Telecom Decision CRTC 94-10, 13 June, Ottawa.http://www.crtc.gc.ca/archive/decisions/1994/DT94-10.htm

____. 1998. Regulatory Regime for the Provision of International Telecommunications Services, TelecomDecision CRTC 98-17, 1 October, Ottawa.http://www.crtc.gc.ca/archive/decisions/1998/DT98-17.htm

Department of Trade and Industry, United Kingdom. 1998. Licence Modification Procedure: ProposedChanges to the Telecommunications Act 1984, London.http://www.dti.gov.uk/pip/45teleco.htm

ETO (European Telecommunications Office). 2000. ETO One-Stop-Shopping procedure for EuropeanTelecommunications Services (Licensing Procedure), Copenhagen.http://www.eto.dk/oss.htm

____. 1999a. Final Report to the Commission of the European Union on Categories of Authorisations,October, Copenhagen.http://www.ispo.cec.be/infosoc/telecompolicy/en/categ.pdf

____. 1999b. Study for the Commission of the European Union on Fees for Licensing TelecommunicationsServices and Networks, July, Copenhagen.http://www.ispo.cec.be/infosoc/telecompolicy/en/fees1.doc


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FCC (Federal Communications Commission). 1999. En Banc Hearing on Spectrum Management., 6 April,Washington, D.C.http://www.fcc.gov/enbanc/040699/tr040699.pdf

ITU (International Telecommunication Union). 1999. Trends in Telecommunication Reform 1999: Convergenceand Regulation. Geneva.http://www7.itu.int/treg/publications/Trends-en.asp

Ministry of Industry Canada. 1998. Framework for Spectrum Actions in Canada, Ottawa.http://www.spectrum.ic.gc.ca/auctions/engdoc/frame.pdf

Ministry of Posts and Telecommunications, Japan. 1996. Manual for Entry into Japanese TelecommunicationsBusiness, Japan.http://www.mpt.go.jp/policyreports/english/misc/Entry-Manual/contents.html

ODTR (Office of the Director of Telecommunications Regulation). 1998. Pro Forma GeneralTelecommunications Licence, Dublin.http://www.odtr.ie/docs/odtr/9850r.doc

OFTEL (Office of Telecommunications). 1997. Fair Trading Condition: Incorporation into ExistingTelecommunications Licences, London.http://www.oftel.gov.uk/licensing/ftcinc.htm

____. 1998. A Review of Telecommunication Licence Fees in the UK, London.http://www.oftel.gov.uk/licensing/lfee1198.htm

____. 1999. Statement on the revised licence fee regime, August, London.http://www.oftel.gov.uk/licensing/fees0899.htm

RegTP (Regulatory Authority for Telecommunications and Posts). 2000. Ruling of 18 February 2000 by thePresident’s Chamber on the Determinations and Rules for the Award of Licences for the UniversalMobile Telecommunications System (UMTS)/International Mobile Telecommunications-2000 (IMT-2000); Third Generation Mobile Communications, Bonn.http://www.regtp.de/imperia/md/content/reg_tele/umts/8.pdf

SECOM (Secretaría de Comunicaciones de Argentina). 2000. Reglamento de Licencias para Servicios deTelecomunicaciones, Buenos Aires.http://www.secom.gov.ar

Secretaría de Comunicaciones y Transportes. 1990. Modificación al Título de Concesión de Teléfonos deMéxico, S.A. de C.V., Mexico.http://www.cft.gob.mx/html/9_publica/telmex/Antec.html

Secretary of State for Trade and Industry. 2000. Licence Granted by the Secretary of State for Trade andIndustry to British Telecommunications PLC under section 7 of the Telecommunications Act 1984,Londonhttp://www.dti.gov.uk/cii/docs/psrcp130100.pdf

TRAI (Telecommunications Regulatory Authority of India). 1998. Licence Fee for Radio Paging ServiceProviders in Cities: Consultation Paper on Viability Assessment for Licence Fee Determination, New

Appendix D

D - 9

Appendix D

Delhi.http://www.trai.gov.in/paging.html

____. 1999a. Recommendations of the TRAI on Licence Fee for Radio Paging Service Providers in cities from4th year onwards for the balance licence period of 10 years, New Delhi.http://www.trai.gov.in/recommend.html

____. 1999b. Consultation Paper on Licence Fee and Terms & Conditions of the Licence Agreement for GlobalMobile Personal Communications by Satellite (GMPCS) Service, New Delhi.http://www.trai.gov.in/gmcov.htm

____. 2000a. Regulation on Quality of Service of Basic and Cellular Mobile Telephone Services, New Delhi.http://www.trai.gov.in/qosregln.doc

____. 2000b. Consultation Paper on Licensing Issues Relating to Fixed Service Providers, New Delhi.http://www.trai.gov.in/c1.htm

Other Documents

De la Torre, M. 1999. Licensing. Presented at the ITU Workshop on Telecommunications Reform (3-5 May1999) Gaborone, Botswana.http://www7.itu.int/treg/Events/Seminars/1999/Botswana/papers/Documents/document35.pdf

Montfort, J-Y. 1997. Licensing Issues. Presented at the Conference “UMTS – The Next Generation of Mobile”(28 October 1997) London.http://www.eto.dk/downloads/UMTS-Licensing.doc

Wellenius, B. and Rossotto, C. 1999. “Introducing Telecommunications Competition through a WirelessLicense: Lessons from Morocco”, Public Policy for the Private Sector Note 199, November 1999.Washington, D.C.: The World Bank Group.http://www.worldbank.org/html/fpd/notes/199/199welle.pdf


D - 10

Module 3 – Interconnection


ACCC (Australian Competition & Consumer Commission). 1997. Access Pricing Principles –Telecommunications, as well as several documents on access pricing and related issues, Australia.http://www.accc.gov.au/telco/fs-telecom.htm

APEC (Asia Pacific Economic Cooperation Organization). 1999a. Principles of Interconnection AsImplemented in the United States, Chinese Taipei, Hong Kong SAR, Japan, Singapore and Korea.http://www.apii.or.kr/apec/atwg/pritgtgr.html

____. 1999b. Principles on Interconnection and other related documents.http://www.pecc.org/ptiif/interct.cfm

CEC (Commission of the European Communities). 1992. Directive 92/44/EC of the European Parliament andthe Commission on ONP Leased Lines, (informal consolidated text).http://158.169.51.11/infosoc/legreg/docs/9244ecrev.html

____. 1996. Commission Directive 96/19EC of March 1996 amending Directive 90/388/EEC with regard to theimplementation of full competition in telecommunications markets, (96/19/EC, OJ L 74/13, 22.3.96).http://www.ispo.cec.be/infosoc/legreg/docs/9619ec.html

____. 1997a. Directive 97/33/EC of the European Parliament and of the Council of 30 June 1997 oninterconnection in Telecommunications with regard to ensuring universal service and interoperabilitythrough application of Open Network Provision (ONP) (97/33/EC, OJ L 199, 26.07.1997).http://www.ispo.cec.be/infosoc/telecompolicy/en/dir97-33en.htm

____. 1997b. Leased Lines Directive of 6 October amending Council Directive 92/44/EEC for the purpose ofadaptation to a competitive environment in telecommunications, (97/51/EC OJ L 295, 29.10.97).http://www.ispo.cec.be/infosoc/telecompolicy/en/dir97-51en.pdf

____. 1998a. ONP Voice Telephony Directive of the European Parliament and of the Council of 26 February1996 on the application of open network provision (ONP) to voice telephony and on universal servicefor telecommunications in a competitive environment (replacing European Parliament and CouncilDirective 95/62/EC), (98/10/EC OJ L 101/24 1.4.98).http://www.ispo.cec.be/infosoc/telecompolicy/VT/ONPVTEN.pdf

____. 1998b. Interconnection Recommendation of 8 January 1998 on Interconnection in a liberalisedtelecommunications market. Part 1 - Interconnection Pricing, (98/195/EC; OJ L73/41, 12.03.98).http://www.ispo.cec.be/infosoc/telecompolicy/en/intconen.doc

____. 1998c. Interconnection Recommendation of 8 April on interconnection in a liberalised telecommunicationmarket, Part 2 - Accounting separation and cost accounting, (98/322/EC; OJ L 141/41, 13.05.98).http://www.ispo.cec.be/infosoc/telecompolicy/en/c98160en.doc

____. 1998d. Framework Interconnect Agreement: guidelines for testing, May, Brussels.http://www.ispo.cec.be/infosoc/telecompolicy/en/etp98b.doc

Appendix D

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Appendix D

____. 1998e. Interconnection Recommendation of 29 July amending Commission recommendation98/195/EC of 8 January 1998 on Interconnection in a liberalised telecommunications market. Part I -Interconnection Pricing, (OJ L 228, 15.08.1998).http://www.ispo.cec.be/infosoc/telecompolicy/en/intco2en.doc

____. 1998f. Indicative Reference Interconnection Offer, version 3. Brussels: CEC- DG IV and DG XIII.http://www.ispo.cec.be/infosoc/telecompolicy/en/interconref.doc

____. 1999. Commission Recommendation on leased lines interconnection pricing in a liberalisedtelecommunications market, (C(1999)3863, 1999 (provisional text)).http://www.ispo.cec.be/infosoc/telecompolicy/en/ic-ll-final-en.pdf

____. 2000a. Commission Recommendation amending Commission Recommendation 98/511/EC of 29 July1998 on Interconnection in a liberalised telecommunications market (Part 1 - Interconnection Pricing),(20.03.2000).http://www.ispo.cec.be/infosoc/telecompolicy/en/rec20c0en.pdf

____. 2000b. Commission Recommendation on Unbundled Access to the Local Loop, (C (2000) 1059,26.04.2000).http://www.europa.eu.int/comm/information_society/policy/telecom/localloop/pdf/c20001059_en.pdf

____. 2000c. Proposal for a Directive of the European parliament and Council on access to, andinterconnection of, electronic communications networks and associated facilities, (COM(2000) 384final 2000/0186 (COD) 12.7.2000).http://europa.eu.int/eur-lex/en/com/pdf/2000/en_500PC0384.pdf

____. 2000d. Proposal for a Regulation of the European Parliament and the Council on unbundled access tothe local loop, (COM(2000) 394 final 2000/0185 (COD) 12.7.2000).http://europa.eu.int/eur-lex/en/com/pdf/2000/en_500PC0394.pdf

CRT (Comisión de Regulación de Telecomunicaciones ). 2000. General Policies and Strategies to Establish aUniform Interconnection Regime (in Spanish), July, Bogotá: Colombia.http://www.crt.gov.co/NoticiasYEventos/RUDI/RUDI_Ag15.PDF

CRTC (Canadian Radio-television and Telecommunications Commission). 1997. Co-location, TelecomDecision CRTC 97-15, 16 June, Ottawa.http://www.crtc.gc.ca/archive/Decisions/1997/DT97-15.htm

____. 1998a. Local Competition, Telecom Decision CRTC 97-8, 1 May, Ottawa.http://www.crtc.gc.ca/archive/Decisions/1997/DT97-8.htm

____. 1998b. Final Rates for Unbundled Local Network Components, Telecom Decision CRTC 98-22,30 November, Ottawa.http://www.crtc.gc.ca/archive/decisions/1998/DT98-22.htm

____. 1999. Model interconnection agreements between local exchange carriers, and between competitivelocal exchange and inter-exchange carriers, Ottawahttp://www.crtc.gc.ca/cisc/eng/agreemen.htm

FCC (Federal Communications Commission). 1996a. First Report and Order in the Matter of Implementationof the Local Competition Provisions in the Telecommunications Act of 1996, CC Docket No. 96-8, 1


D - 12

August, Washington, D.C.http://www.fcc.gov/ccb/local_competition/fcc96325.html

____. 1996b. Interconnection Between Local Exchange Carriers and Commercial Mobile Radio ServicesProviders, CC Docket No. 95-185, 28 August, Washington, D.C.http://www.fcc.gov/Bureaus/Common_Carrier/Orders/1996/fcc96325.pdf

____. 1996c. Interconnection Order, 18 December, Washington, D.C.http://www.fcc.gov/Bureaus/Common_Carrier/Orders/1996/fcc96483.txt

IDA (The Infocomm Development Authority of Singapore). 2000. Results of the Consultation on Review ofFixed-Mobile Interconnection, 3 May, Singapore.Under the “Policy and Regulation” section, at http://www.ida.gov.sg

ITU (International Telecommunication Union). Interconnection legislation and policies worldwide (non-comprehensive list prepared by the Sector Reform Unit of the International TelecommunicationUnion). Geneva.http://www7.itu.int/treg/RelatedLinks/LinksAndDocs/interconnectlegisl.htm

____. 2000a. Fixed Mobile Interconnection; Workshop Briefing Paper and Country Case Studies (Finland,India, Mexico, China and Hong Kong SAR), Geneva.http://www.itu.int/osg/sec/spu/ni/fmi/intro.html

____. 2000b. Trends in Telecommunications Reform 2000: Interconnection, Geneva.http://www7.itu.int/treg/publications/Trends-en.asp


OECD (Organization of Economic Cooperation and Development). 1997. Policy approaches in the area ofinterconnection between telecommunication networks of OECD member Countries, September, Paris. http://www.oecd.org/dsti/sti/it/cm/news/INTRCNXN.HTM

____. 2000. Local Access Pricing and E-commerce, July, Paris.http://www.olis.oecd.org/olis/2000doc.nsf/linkto/dsti-iccp-tisp(2000)1-final

OFTEL (Office of Telecommunications). 1995. A Framework for Effective Competition. A ConsultativeDocument on the Future of Interconnection and Related Issues, London.http://www.oftel.gov.uk//consumer/compet.htm

____. 1997a. Interconnection and Interoperability: A Framework for Competing Networks, April, London.http://www.oftel.gov.uk//competition/interop.htm

____. 1997b. Duct and Pole Sharing, A Consultative Document, London.http://www.oftel.gov.uk/competition/ductpole.htm

____. 1997c. Network Charges from 1997, London.http://www.oftel.gov.uk/pricing/nccjul97.htm

Appendix D

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Appendix D

____. 1997d. Network Charges from 1997 - Consultative Document, London.http://www.oftel.gov.uk/pricing/netcha97/anncont.htm

____. 1998a. Interconnection & Interoperability of Services over Telephony Networks, A Statement by theDirector General of Telecommunications, London.http://www.oftel.gov.uk/pricing/ii498.htm

____. 1998b. Statement by the Director General of Telecommunications on Collocation and Facility Sharing,London.http://www.oftel.gov.uk/competition/mast1198.htm

____. 1999a. Rights and Obligations to Interconnect Under the EC Interconnection Directive, Statement issuedby the Director General of Telecommunications, London.http://www.oftel.gov.uk/licensing/an20499.htm

____. 1999b. Statement on Mobile Virtual Network Operators, October, London.http://www.oftel.gov.uk/competition/mvno1099.htm

____. 1999c. Access to second generation mobile networks for new entrant third generation mobile operators,A consultative document issued by the Director General of Telecommunications, May, London.http://www.oftel.gov.uk/licensing/2g3g0599.htm

____. 2000. Access Network Facilities: Oftel Guidelines on Condition 83 of BT’s Licence - Guidelines (LocalLoop Unbundling), September, London.http://www.oftel.gov.uk/competition/llug0900.htm

SADC (Southern African Development Community). 1999. Interconnect: An Overview, June 1999, Botswana.http://www.trasa.org/documents/sadcinterconnectionpaper_english.doc

TRAI (Telecommunications Regulatory Authority of India). 1998. Consultation Paper on Maintenance ofRegister for Interconnection, New Delhi.http://www.trai.gov.in/inter.htm

____. 1999a. The Telecommunication Interconnection (Charges and Revenue Sharing) Regulation 1999 (1 of1999), New Delhi.http://www.trai.gov.in/interregu.html

____. 1999b. The Register of Interconnect Agreements Regulations 1999 (2 of 1999), New Delhi.http://www.trai.gov.in/reguinter.htm

WTO (World Trade Organization). 1999. Council for Trade in Services, Special Session onTelecommunications (includes presentations on the implementation of interconnection regulations inHungary and Peru), 25 June 1999, Geneva.http://www.wto.org/spanish/tratop_s/serv_s/specsess.htm


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Other Documents

Arcome & Smith System. 1998. Equal Access and Interconnection: Study on the issues related to fair andequal access and the provision of harmonised offerings for interconnection to PublicTelecommunications Networks and Services in the context of ONP 21 March 1997, Brussels: CEC-DG XIII.http://www.ispo.cec.be/infosoc/telecompolicy/en/Arcome.doc

Armstrong, M. and Doyle C. 1995. The Economics of Access Pricing. OECD Working Paper, Paris:Organization for Economic Development and Cooperation.

Cave, M. 1997. “From Cost Plus Determinations to a Network Price Cap.” Information Economics and Policy,Volume 9, pp. 151-160, Amsterdam: Elsevier Science B.V.http://www.elsevier.nl/locate/econbase

Diaz, C. and Soto, R. 1999. Open-Access Issues in the Chilean Telecommunications and Electricity Sectors,Washington, D.C.: Inter-American Development Bank

European Interconnect Atlas (created for the European Commission, DG Information Society as a country-specific guide to the status of interconnection in Europe).http://www.analysys.com/atlas/

Eutelis Consult, Horrocks Technology and Tera Consultants. 1999. Collocation Recommended Practices forCollocation and other Facilities Sharing for Telecommunications Infrastructure (main report andcountry studies: Finland, France, Germany, the Netherlands, Spain, the United Kingdom, the USAand Australia), January, Brussels: CEC. http://www.ispo.cec.be/infosoc/telecompolicy/en/main.pdf

Gabel, D. and Weiman, D. F. (eds.). 1997. Opening Networks to Competition: The Regulation and Pricing ofAccess, Topics in Regulatory Economics and Policy Series, Dordrecht: Kluwer Academic Publishers.

Jamison, M. 1998. International Survey of Interconnection Policies. Miami: Utilities Research Centre,University of Florida.http://bear.cba.ufl.edu/centers/purc/PRIMARY/PUBLICAT/interconn.html

Kahn, A. E. and Taylor, W. 1994. “The Pricing of Inputs Sold to Competitors: Comment”, Yale Journal onRegulation, Spring, Volume 4, No. 2: 191-256.

Klinge, M. 1999. Competitive Interconnection in a Liberalized Telecommunications Market. Presented at theSecond CITEL/CC.1 Telecommunications Forum, Interconnection Seminar (March 1999) Foz deIguazu, Brazil.http://www.citel.oas.org/pcc1/iiforum/748a5_i/tsld001.htm.

Laffont, J.-J. and Tirole, J. 2000. Competition in Telecommunications. MIT Press: Cambridge, Massachusetts.

Leive, D. M. 1995. Interconnection: Regulatory Issues. Report of the Fourth Regulatory Colloquium, April,Geneva.http://www.itu.int/itudoc/osg/colloq/

Appendix D

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Appendix D

Sullivan, M. 1999. The Basics of Interconnection. Presented at the ITU/BDT Workshop on TelecommunicationReform (May 1999) Botswana.http://www7.itu.int/treg/Events/Seminars/1999/Botswana/papers/Documents/document19.pdf

Telegeography. 2000. The Internet Exchange Points Directory , Washington, D.C.: TeleGeography Inc.http://www.telegeography.com/ix/

Ungerer, H. 1998. Ensuring efficient access to bottleneck network facilities. Presented at CompetitionWorkshop, (November 1998) Brussels: CEC.http://www.regulate.org/references/ungerer2.doc

Wright, J., Ralph, E., & Kennet, D. 2000. Telecommunications Interconnection: A Literature Survey. APEC.http://www. apii.or.kr/apecdata/telwg/interTG/ATTZ2FG1.htm

Zull, C. 1997. Interconnection Issues in the Multimedia Environment. Presented at the conference“Interconnection Asia ‘97”, (22-24 April 1997) Singapore.http://www.cutlerco.com.au/core/content/speeches/Interconnection%20Issues/Interconnection_Issues.html


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Module 4 - Price Regulation


Argentina (República). 1997. Decreto S.C. No. 92/97 Estructura General de Tarifas del Servicio BásicoTelefónico. Modificaciones. Reglamentos. JHS.http://www.redetel.gov.ar/Normativa/Archivos de Nornas/D_0092_1_97.htm

Australian Productivity Center. 1997. Telecommunications Economics and Policy Issues, Australia.

Bolivia (República de). 1995. Reglamento a la Ley de Telecomunicaciones. La Paz.http://www.sittel.gob.bo/lgsrtl.htm

COFETEL (Comisión Federal de Telecomunicaciones). 1996. Acuerdo por el que se establece elprocedimiento para el registro de tarifas de los servicios de telecomunicaciones, al amparo de lay LeyFederal de Telecomunicaciones. Mexico.http://www.cft.gob.mx/html/9_publica/tarifas/18nov96.html.

CRTC (Canadian Radio-television and Telecommunications Commission). 1997a. Price Cap Regulation andRelated Issues, Telecom Decision CRTC 97-9, 1 May, Ottawa.http://www.crtc.gc.ca/archive/decisions/1997/DT97-9.htm

____. 1997b. Implementation of Price Cap Regulation - Decision Regarding Interim Local Rate Increases andOther Matters, Telecom Decision CRTC 97-18, 18 December, Ottawa.http://www.crtc.gc.ca/archive/decisions/1997/DT97-18.htm

FCC (Federal Communications Commission). 1995a. First Report and Order in the Matter of Local ExchangeCarrier Price Caps, CC Docket No. 94-1, Washington, D.C.http://www.fcc.gov/Bureaus/Common_Carrier/Orders/1995

____. 1995b. Second Further Notice of Proposed Rulemaking in the Matter of Price Cap Performance Reviewfor Local Exchange Carriers, CC Docket No. 94-1; Further Notice of Proposed Rulemaking in theMatter of Treatment of Operator Services Under Price Cap Regulation. CC Docket No. 93-124;Second Further Notice of Proposed Rulemaking in the Matter of Revisions to Price Cap Rules forAT&T, CC Docket No. 93-197, 20 September, Washington, D.C.http://www.fcc.gov/Bureaus/Common_Carrier/Notices/1995/fcc95393.html

ITU (International Telecommunication Union). 1998a. World Telecom Development Report 1998: UniversalAccess, Geneva.http://www.itu.int/ti/publications/WTDR_98/index.htm

____.1998b. “Charging and Accounting in International Telecommunication Services – Accounting RatePrinciples for International Telephone Services.” Recommendation D.140. Geneva.

Ministerio de Transporte y Telecomunicaciones de Chile. 1998. Decreto No. 610 de 1998 – “Fijación de tarifaspor servicios provistos a través de las interconexiones a Chilesat Telefonía Personal S.A., Santiagode Chile.

Appendix D

D - 17

Appendix D

OECD (Organization for Economic Cooperation and Development). 1995. “Price Caps forTelecommunications – Policies and Experiences” in Information Computer Communications Policy.Paris.


Office of the Director of Telecommunications Regulation. 1999. Review of the Price Cap on Telecom Eireann,Consultation Paper, Document No. ODTR 99/34, May, Dublin.http://www.odtr.ie/docs/odtr9934.doc

Office of Utilities Regulation. 1998. Rebalancing Telephone Prices: A Consultative Document, Jamaica.

OFTEL (Office of Telecommunications). 1995. Pricing of Telecommunications Services From 1997 - AConsultative Document on BT Price Controls and Interconnection Charging, Statement, London.http://www.oftel.gov.uk/pricing/pri1997/contents.htm

____. 1996a. Pricing of Telecommunications Services From 1997 - OFTEL’s Proposals for Price Control andFair Trading, Statement, London.http://www.oftel.gov.uk/pricing/pri1997b/chap1.htm

____. 1996b. Pricing of Telecommunications Services From 1997 - Second Consultative Document on BTPrice Controls and Interconnection Charging, London.http://www.oftel.gov.uk/pricing/pri1997a/intro.htm

____. 1998. Statement on Principles of Affordability, Issued by the Director General of Telecommunications,London.http://www.oftel.gov.uk/pricing/rvtd1198.htm

____. 1999. Price Control Review: Future Developments in the Competitiveness of UK TelecommunicationsMarkets, A Consultative Document issued by the Director General of Telecommunications, London.http://www.oftel.gov.uk/pricing/prc799.htm

____. 2000a. Price Control Review: A consultative document issued by the Director General ofTelecommunications on possible approaches for future retail price and network charge controls,March, London.http://www.oftel.gov.uk/pricing/pcr0300.htm

____. 2000b. The Telephone Bill of a “Typical” Residential Customer, London.http://www.oftel.gov.uk/pricing/tycu0500.htm

OSIPTEL. 1996. Tarifas y Price Caps: Estado de la Question, report presented at the conference “PrimerEncuentro Regional de Organos Reguladores de Telecomunicaciones de America Latina y el Caribe”,Lima, Peru.

State of Rhode Island and Providence Plantations. 1995. Price Regulation Plan Applicable to NYNEXCorporation Rhode Island Intrastate Operations, USA: State of Rhode Island and ProvidencePlantations.

TRAI (Telecommunications Regulatory Authority of India). 1997. Telecom Pricing: Consultation Paper onConcepts, Principles and Methodologies, New Delhi.


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____. 1998. Telecom Pricing: Second Consultation Paper: Framework and Proposals, New Delhi.http://www.trai.gov.in/tariff1.htm

____. 1999. Telecommunication Tariff Order 1999 and subsequent amendments. New Delhi.http://www.trai.gov.in/torders.htm

Other Documents

Acton, J. P. and Vogelsang, I. 1989. “Price-Cap Regulation: Introduction.” RAND Journal of EconomicsVol. 20:369-372.

Armstrong, M., Cowan, S. & Vickers, J. 1995. “Nonlinear Pricing and Price-Cap Regulation.” Journal of PublicEconomics Vol. 58, Issue 1:33-55.

Averch, H. and Johnson, L. 1962. “Behavior of the firm under regulatory restraint.” American Economic Reviewat 1050-69.

Ben Johnson Associates. 1999. Price Cap Regulation Compared to Traditional Regulation.http://www.microeconomics.com/essays/p-cap

Berg, S.V. and Foreman, R. D. 1996. “Incentive Regulation and Telco Performance: A Primer.”Telecommunications Policy Vol. 20, No. 9:641-652, Great Britain: Elsevier Science Ltd.http://www.elsevier.com/locate/telepol

Bernstein J.I. and Sappington, D.E.M. 1998. Setting the X-factor in Price Cap Regulation Plans, NationalBureau of Economic Research Working Paper No. 6622

Braeutigam, R. and Panzar, J. 1993. “Effects of the change from rate of return to price-cap regulation.”American Economic Review, AEA Papers and Proceedings.

Braga, C.A.P., Forestier, E. and Stern, P. A. 1999. “Developing Countries and Accounting Rates Reform – ATechnological and Regulatory El Niño?” Public Policy for the Private Sector Note. No. 173.Washington, D.C.: The World Bank Group.http://www.worldbank.org/html/fpd/notes/173/173braga.pdf

Brennan, T.J. 1991. “Regulating by Capping Prices.” Journal of Regulatory Economics Vol. 1:133-148, TheNetherlands: Kluwer Academic Publishers.

Bush, C. A. and Huthoefer, L. 1997. Appendix D: Estimation of TFP Under FCC Rules: FCC Synthesis,FCC.97-159, Washington, D.C.: FCC.

Christensen, L.R., Schoech, P.E. and Meitzen, M.E. 1994. Productivity of the Local Operating TelephoneCompanies Subject to Price Regulation, 3 May.

____. 1995. Productivity of the Local Operating Telephone Companies Subject to Price Regulation: 1993Update, 16 January.

____. 1995. Total Factor Productivity Methods for Local Exchange Carrier Price Cap Plans, 18 December.

Appendix D

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Appendix D

Colombino, U. 1998. “Evaluating the Effects of New Telephone Tariffs on Residential Users’ Demand andWelfare. A Model for Italy.” Information Economics and Policy Vol. 10:283-303, Amsterdam: ElsevierScience B.V.http://www.elsevier.nl/locate/econbase

Cowan, S. 1997. “Price-Cap Regulation and Inefficiency in Relative Pricing.” Journal of Regulatory EconomicsVol. 12:53-70, The Netherlands: Kluwer Academic Publishers.

Edelman S.A. 1997. “The FCC and the Decline in AT&T’s Long distance residential Rates, 1980-1992: Didprice caps do it?” Review of Industrial Organization Volume 12:537-553.

Einhorn, M. A., editor. 1991. Price Caps and Incentive Regulation in Telecommunications, Topics in RegulatoryEconomics and Policy Series. Dordrecht: Kluwer Academic Publishers.

Galal, A. and Nauriyal, B. 1995. Regulation of Telecom in Developing Countries: Outcomes, Incentives andCommitment.” Washington, D.C.: The World Bank.

Green, R. and Pardina, R. 1999. Resetting Price Controls for Privatized Utilities: A Manual for Regulators.Washington, D.C.: The World Bank.

Grupe, H. J.C. 1990. “Regulación ecónomica y teoría del monopolio natural [Economic Regulation and Theoryof Natural Monopoly. With English Summary.]” Economica Vol. 36:71-96.

Heyes, A. G. and C. Liston-Heyes. 1998. “Price-Cap Regulation and Technical Change.” Journal of PublicEconomics Vol. 68, Issue 1:137-151.

King, S. 1998. “Principles of Price Cap Regulation.” In Infrastructure Regulation and Market Reform: Principlesand Practice, Australian Competition and Consumer Commission (ACCC) and the Public UtilityResearch Centre (PURC).

Kridel, D.J., Sappington, D. and Weisman, D. 1996. “The Effects of Incentive Regulation in theTelecommunications Industry: A survey.” Journal of Regulatory Economics Vol. 9:269-306.

Kwoka Jr., J. E. 1996. Privatization, Deregulation, and Competition: A Survey of Effects on EconomicPerformance, PSD Occasional Paper No. 27, Washington, D.C.: The World Bank Private SectorDevelopment Department.

Lewis, T.R. and Sappington, D.E.M. 1989. “Regulatory Options and Price-Cap Regulation.” RAND Journal ofEconomics Vol. 20:405-416.

Liston-Heyes, C. 1993. “Price-Cap Versus Rate-of-Return Regulation.” Journal of Regulatory Economics Vol.5:25-48, The Netherlands: Kluwer Academic Publishers.

Littlechild, S.C. 1983. Regulation of the British Telecommunications’ Profitability, A Report to the Secretary ofState for Trade and Industry. London: Department of Trade and Industry.

Madden, G. and Savage, S.J. 1999. “Telecommunications Productivity, Catch-up and Innovation”Telecommunications Policy Volume 23:65-81, Great Britain: Elsevier Science Ltd.http://www.elsevier.com/locate/telepol


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Majumdar, S. K., “Incentive Regulation and Productive Efficiency in the U.S. Telecommunications Industry.”Journal of Business Vol. 70:547-576.

Mitchell, B. M. and Vogelsang, I. 1991. Telecommunications Pricing: Theory and Practice. Cambridge:Cambridge University Press.

Noll, R.G. 1999. Telecommunications Reform in Developing Countries, Stanford University Department ofEconomics Working Paper.

Pint, E. M. 1991. “Nationalization vs. Regulation of Monopolies: The Effects of Ownership on Efficiency.”Journal of Public Economics Vol. 44:131-164.

Quiggin, J. 1997. “Efficiency Versus Social Optimality: The Case of Telecommunications Pricing.” InformationEconomics and Policy, pp. 291-308, Amsterdam: Elsevier Science B.V.http://www.elsevier.nl/locate/econbase

Resende, M. 1999. “Productivity Growth and Regulation in U.S. Local Telephony.” Information Economics andPolicy 11:23-44, Amsterdam: Elsevier Science B.V.http://www.elsevier.nl/locate/econbase

Rohlfs, J. H. 1996. Regulating Telecommunications: Lessons From the U.S. Price Cap Experience, The WorldBank Group, Viewpoint Note No. 65. Washington, D.C.: The World Bank Group.http://www.worldbank.org/html/fpd/notes/65/65rohlfs.pdf

Roycroft, T. R. 1999. “Alternative Regulation and the Efficiency of Local Exchange Carriers: Evidence fromthe Ameritech States”. Telecommunications Policy 23:469-480. Great Britain: Elsevier Science B.V.http://www.elsevier.com/locate/telepol

Sappington, D. E. M. and Weizman, D.L. 1996. Designing Incentive Regulation for the TelecommunicationsIndustry, The MIT Press: Cambridge, Mass. and the AEI Press: Washington, D.C.

Staranczak, G.A. et al. 1994. “Industry Structure, Productivity and International Competitiveness: The Case ofTelecommunications.” Information Economics and Policy Volume 6:121-142. Amsterdam: ElsevierScience B.V.

Tardiff, T. J. and W. E. Taylor. 1996. Revising Price Caps: The Next Generation of Incentive Regulation Plans,Presentation at the Rutgers University Center for Research in Regulated Industries ResearchSeminar, Cambridge, MA: National Economic Research Associates. NERA.

Taylor, L. 1993. Telecommunications Demand in Theory and Practice, revised edition. Dordrecht, TheNetherlands: Kluwer Academic Publishers.

Taylor, W. E. 1997. Economic Aspects of Canadian Price Cap Regulation, Section 9. Cambridge, MA:National Economic Research Associates Inc.

Wallsten, S. J. . 1999. An Empirical Analysis of Competition, Privatization and Regulation in Africa and LatinAmerica, Washington, D.C.: The World Bank Group.

Appendix D

D - 21

Appendix D

Module 5 – Competition


ACCC (Australian Competition and Consumer Commission). 1999. Anti-competitive Conduct inTelecommunications Markets: An Information Paper, Australia.http://www.accc.gov.au/telco/competition/antdis.html

Australia (Commonwealth of). 1999. Summary of the Trade Practices Act 1974 and additional responsibilitiesof the Australian Competition and Consumer Commission under other legislation, Australia. http://www.accc.gov.au/pubs/tpa_summary/httoc.htm

CEC (Commission of the European Communities). 1990a. Framework Directive of 28 June on theestablishment of the internal market for telecommunication services through the implementation ofopen network provision ONP, (90/387/EEC, OJ L 192/1, 24.07.90).http://www.ispo.cec.be/infosoc/legreg/docs/90387eec.html

____. 1990b. Services Directive of 28 June on Competition in the Markets for Telecommunications,(90/388/EEC, OJ L 192, 24.7.1990).http://www.ispo.cec.be/infosoc/legreg/docs/90388eec.html

____. 1991. Guidelines on the Application of EEC competition rules in the telecommunications sector, (92/C233/02; OJ C233/2, 06.09.91).http://www.ispo.cec.be/infosoc/legreg/docs/91c23302.html

____. 1995. Cable Directive of 18 October amending Directive 90/388/EEC with Regard to the Abolition of therestrictions on the use of cable television networks for the provision of already liberalisedtelecommunications services, (95/51/EC; OJ L 256/49, 26.10.95).http://europa.eu.int/comm/competition/liberalization/legislation/9551_en.html

____. 1996. Full Competition Directive of 28 February amending Commission Directive 90/388/EEC regardingthe implementation of full competition in telecommunications markets, (96/19/EC, OJ L 74/13,22.3.96).http://www.ispo.cec.be/infosoc/legreg/docs/9619ec.html

____. 1997a. Directive 97/33/EC of the European Parliament and of the Council of 30 June 1997 oninterconnection in Telecommunications with regard to ensuring universal service and interoperabilitythrough application of Open Network Provision (ONP) (97/33/EC, OJ L 199, 26.07.1997).http://www.ispo.cec.be/infosoc/telecompolicy/en/dir97-33en.htm

____. 1997b. Treaty Establishing the European Community, (OJ C 340, 10.11.1997).http://europa.eu.int/eur-lex/en/treaties/dat/ec_cons_treaty_en.pdf

____. 1997c. Notice on the definition of the relevant market for the purposes of community competition law,(OJ C 372, 9.12.97).

____. 1998. Commission Notice of 31 March on application of the competition rules to access agreements inthe telecommunications sector, (OJ 98/C 265/02, 22.8.98).http://www.ispo.cec.be/infosoc/telecompolicy/en/ojc265-98en.html


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____. 1999. Directive 99/64/EC of the European Parliament and of the Council of 23 June 1999 amendingDirective 90/388/EEC in order to ensure that telecommunications networks and cable TV networksowned by a single operator are separate legal entities, (OJ L 175/39, 10.07.99).http://www.ispo.cec.be/infosoc/telecompolicy/en/99-64en.pdf

____. 2000a. Proposal for a Directive of the European parliament and Council on access to, andinterconnection of, electronic communications networks and associated facilities, (COM(2000) 384final 2000/0186 (COD) 12.7.2000).http://europa.eu.int/eur-lex/en/com/pdf/2000/en_500PC0384.pdf

____. 2000b. Draft Competition Directive consolidating existing Directives on competition in thetelecommunications markets, (12.07.2000).http://europa.eu.int/comm/competition/liberalization/telecom/draft_directive_2000_07_12_en.pdf

COFETEL (Comisión Federal de Telecomunicaciones). 2000. Resolución Mediante la cual EstableceObligaciones Específicas a Telmex en su Carácter de Operador Dominante en Cinco MercadosRelevantes de Servicios de Telecomunicaciones, 8 September, Mexico.http://www.cft.gob.mx/html/9_publica/resoluciones/resolucion.zip

CRT (Comisión de Regulación de Telecomunicaciones de Colombia). 1997. Resolución No. 087 de 1997 –Por medio de la cual se regula en forma integral los servicios de TPBC en Colombia, Bogotá,Colombia.http://www.crt.gov.co/Normatividad/pdf/Res087Compilada.pdf

CRTC (Canadian Radio-television and Telecommunications Commission). 1992. Introduction of Competitionin Public Long Distance Voice Telephone Market, Telecom Decision CRTC 92-12, 12 June. Ottawa.http://www.crtc.gc.ca/archive/decisions/1992/DT92-12e.htm

____. 1994a. Review of Regulatory Framework –Targeted Pricing, Anti-Competitive Pricing and ImputationTest for Telephone Company Toll Filings, Telecom Decision 94-13, 13 July, Ottawa.http://www.crtc.gc.ca/archive/decisions/1994/DT94-13.htm

____. 1994b. Reduction of Regulation for Cellular and Public Cordless Telephone Services, Telecom DecisionCRTC 94-15, 12 August, Ottawa.http://www.crtc.gc.ca/archive/decisions/1994/DT94-15.htm

____. 1994c. Review of Regulatory Framework, Telecom Decision CRTC 94-19, 16 September, Ottawa.http://www.crtc.gc.ca/archive/decisions/1994/DT94-19.htm

____. 1995. Implementation of Regulatory Framework - Splitting of the Rate Base and Related Issues,Telecom Decision CRTC 95-21, 31 October, Ottawa.http://www.crtc.gc.ca/archive/decisions/1995/DT95-21e.htm

____. 1997. Local Competition, Telecom Decision CRTC 97-8, 1 May, Ottawa.http://www.crtc.gc.ca/archive/decisions/1997/DT97-8.htm

Department of Justice (U.S.). 1997. Horizontal Merger Guidelines, Washington, D.C.http://www.ftc.gov/bc/docs/horizmer.htm

Director of Investigation and Research (Ministry of Industry Canada, Competition Bureau). 1991. MergerEnforcement Guidelines, Ottawa.

Appendix D

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Appendix D

http://strategis.ic.gc.ca/SSG/ct01026e.html

____. 1992. Predatory Pricing Enforcement Guidelines, Ottawa.http://strategis.ic.gc.ca/SSG/ct01139e.html

European Court of Justice. 1978. United Barnds v. Commission of the European Communities, 14 February(case 27/76. ECR 207).http://europa.eu.int/smartapi/cgi/sga_doc?smartapi!celexplus!prod!CELEXnumdoc&lg=EN&numdoc=676J0027

FCC (Federal Communications Commission). 1996a. Second Report and Order in the Matter of Forbearance,Tariff, Interexchange Carrier, CC Docket No. 96-61, 31 October, Washington, D.C.

____. 1996b. First Report and Order in the Matter of Interexchange Services Non-Accounting Safeguards; andRegulatory Treatment of LEC Provision of Interexchange Services Originating in the LEC’s LocalExchange Area: Required by Sections 271 and 271 of the Telecommunications Act, CC Docket No.96-149, 24 December, Washington, D.C.http://www.fcc.gov/Bureaus/Common_Carrier/Orders/1996/fcc96489.txt

____. 1997a. Second Report and Order in the Matter of Interexchange Services Non-Accounting Safeguards;and Regulatory Treatment of LEC Provision of Interexchange Services Originating in the LEC’s LocalExchange Area: Required by Sections 271 and 271 of the Telecommunications Act, CC Docket No.96-149, 18 April, Washington, D.C.

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OECD (Organization for Economic Cooperation and Development). 1996. Competition in Telecommunications,GD.96. 114, Paris.http://www.oecd.org//daf/clp/Roundtables/tel.pdf

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Carsberg, B. 1995. “Need for unitary competition authority”, The Financial Times, 24.

Clark, J. and Chadzynksa, H. 1999. “Recent Developments in National Mergers Laws and Policies”, OECDJournal of Competition Law and Policy Vol. 2, No. 1.

Cronin, F. J. et al. 1993. “Relative demand for telecommunications.” Information Economics and Policy Vol. 5.No. 1.http://www.elsevier.nl/locate/econbase

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Hill, A. and Abdala, M. A. 1994. “Regulation, Institutions and Commitment: Privatization and Regulation in theArgentine Telecommunications Sector”, The World Bank Working Papers. Washington, D.C.: TheWorld Bank.

Kahai, S., Kaserman, D. and Mayo, J. 1996. “Is the Dominant Firm Dominant? An empirical analysis ofAT&T’s Market Powers”, Journal of Law and Economics Vol. 39.

Kwoka, J. 1993. Economic Dominance in Telecommunications, Manuscript.

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Larson, A. C. 1989. “Cost allocations, predation, and cross-subsidies in telecommunications”, The Journal ofCorporation Law Volume 14, No. 2:377-398.


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Liebowitz , S. J. and Margolis, S. E. 1994. “Network externality: An uncommon tragedy”, The Journal ofEconomic Perspectives Spring, at 133-150.

Palm, M. 1998. “The Worldwide Growth of Competition Law: an Empirical Analysis.” Antitrust Bulletin Vol. 43,No. 1, at 105-145.

Philps, L. 1995. Competition Policy: A game-theoretic Perspective, Cambridge University Press: Cambridge,England.

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Rossotto, C., Kerf, M. and Rohlfs, J. 1999. “Competition in Mobile Telecoms”. Public Policy for the PrivateSector Note 184. Washington, D.C.: The World Bank Group.http://www.worldbank.org/html/fpd/notes/184/184rosso.pdf

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Smith, P. 1995. “End of the Line for the Local Loop Monopoly?”. Public Policy for the Private Sector Note 63.Washington, D.C.: The World Bank Group.http://www.worldbank.org/html/fpd/notes/63/63smith.pdf

Styliadou, M. 1997. “Applying EC Competition Law to Alliances in the Telecommunications Sector”,Telecommunications Sector Vol. 21, No. 1, at 47-58.

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Hausman, J. 1997. Taxation by Telecommunications Regulation, Working Paper 6260, NBER Working PaperSeries, National Bureau of Economic Research, November, Cambridge, MA.http://www.nber.org/papers/w6260

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Appendix D

Rosston, G.L. and Wimmer, B.S. 2000. “The ‘state’ of universal service.” Information Economics and PolicyVolume 12:261-283. www.elsevier.nl/locate/econbase

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Wallsten, S.J. 1999. An Empirical Analysis of Competition, Privatization, and Regulation in Africa and LatinAmerica, Stanford University and The World Bank.

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Appendix B – The Economics of Telecommunications Prices and Costs


Australian Productivity Center. 1997. Telecommunications Economics and Policy Issues, Australia.

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Ben Johnson Associates. 1999. Costing Definitions and Concepts.www.microeconomics.com/essays/cost-def.htm).

Bigham, F. 1992. Telecommunications category costing in Canada: accomplishments and emerging issues.Proceedings of the Eight NARUC Biennial Regulatory Information Conference, Volume III,Telecommunications, Columbus, Ohio: National Regulatory Research Institute and Ohio StateUniversity.

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Brown, D. J. and Heal, G. M. 1987. “Ramsey Pricing in Telecommunications Markets with Free Entry.” InRegulating Utilities in an Era of Deregulation, Crew, Michael A. (ed.), pp. 77-83. New York: St. Martin'sPress.

Case, K.E. and Fair, R.C. 1999. Principles of Economics (Fifth Edition), New Jersey: Prentice-Hull

Das, P. and Srinivasan, P.V. 1999. “Demand for Telephone Usage in India.” Information Economics andPolicy, Vol. 11:177-194, Amsterdam: Elsevier Science B.V.http://www.elsevier.nl/locate/econbase

Duncan, Dr. G.M. and Perry, D.M. 1994. “IntraLATA Toll Demand Modelling: A Dynamic Analysis of Revenueand Usage Data”. Information Economics and Policy Volume 6:163-178.http://www.elsevier.nl/locate/econbase

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Appendix D

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Jamison, M.A. 1997. A Further Look at Proper Cost Tests for Natural Monopoly, Public Utility Research CenterWorking Paper.

Jamison, M.A. 1998. “Regulatory Techniques for Addressing Interconnection, Access and Cross-subsidy inTelecommunications.” In Infrastructure Regulation and Market Reform: Principles and Practice,Australian Competition and Consumer Commission (ACCC) and the Public Utility Research Centre(PURC).

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