Interconnection Theory & Benchmarking

Transcription

1 Interconnection Theory & Benchmarking Dr. Christoph Stork

2 Termination Rates: Monopoly

3 Termination Rate Monopolies require price regulation Termination rates at cost of efficient operator Incentives to invest in new technologies to reduce costs and expand product offerings Promotes competition Promotes economic efficiency Promote universal service by encouraging rapid uptake through low retail prices There exists no alternative economic concept to cost base for monopoly price regulation

4 Benefit of size: Off-net Price > On-net price = expensive to be called for people of smaller network (Initially, mostly on-net calls, after switching mostly off-net calls) Incumbent New Entrant Mobile Operator New entrant needs to compete with its off-net prices with the on-net prices of incumbent to gain market share

5 Above cost MTR -help dominant to avoid competition pressure Preventing smaller operators to compete with their off-net prices with own on-net price (Namibia MTR >on-net price) High off-net prices of dominant mobile operator makes it expensive to be called for people changing to new entrant or smaller operators Generating club effects with high on-net / off-net price differentials Possible consequences are: traffic imbalance, net termination payment outflow of new entrants and fixed-line networks

6 Termination Rate - Too Low Below cost recovery of terminating network Arbitrage traffic routing may result in undesirable economic outcomes (France: Bill and Keep)

7 Dominant Operators will argue They use termination revenue to subsidise access and usage (Two sided market or waterbed effect argument) If MTRs are lowered: Retail prices will increase There will be less subscribers Operators will invest less However, the opposite is the case Increased competition leads to lower retail prices and more subscribers Operators have to invest more to stay competitive

8 Profit from off-net calls increases with lower MTR (MTR = wholesale cost) Pr ofit offnet = (P own offnet MTR Cost origination )*Q outgoing Q outgoing = f (P own offnet ) Pass on MTR reductions to subscribers = lower off-net prices more traffic Off-net constant = operator makes more money for each outgoing minute, same traffic

9 Profit from termination (MTR = wholesale revenue) Pr ofit ter min ation = (MTR cost ter min ation ) *Q inco min g Q incomin g = f (P other offnet ) Incoming minutes depend on off-net price of other operators MTR limits the off-net price of other operators downwards

10 Cash Flow Issue Net Termination Payment Net ter min ation = MTR *(Q inco min g Q outgoing ) Balanced traffic: MTR reduction revenue neutral However traffic often not balanced hence termination net payments dominant operator can set off-net prices very high eg different user profile use of Please Call MEs

11 Traffic imbalance 2008/09(minutes)

12 High MTR = subsidisation within the sector No funds from outside the sector Why should subscribers of one network subsidise subscribers from other networks? Why should one operator be given a subsidy to role out network infrastructure at the expense of another operators?

13 % of households with a working Fixed-line TELEPHONE at home South Africa Namibia High MTR = Senegal Botswana active contribution to fixed- Ethiopia Côte d'ivoire Burkina Faso Benin mobile substitution Ghana 2.6 Zambia* 2.4 Kenya 2.3 Cameroon 1.8 Mozambique 1.7 Tanzania 0.9 Uganda 0.3 Rwanda 0.1

14 Two sided market Argument Interdependent prices: Price are being determined interdependently, ie changing the price for the one side will change the price of the other side No cost causation: No direct link between incremental cost for a good or service and the price

15 Newspaper - lower price per newspaper = more readers and higher advertising revenue per page However, few high income subscribers could be better than many low income subscribers for advertising revenue (New Yorker eg) Advertisers have a choice where to place an add (competition), while call termination is a monopoly Readers Newspaper Advertisers

16 Two-sided market would predict Onnet Up Down MTR OFF- Net Up Less Subscribers Fixed Up

17 Relationship between wholesale price and retail prices to not constitue a two-sided market Prices are not Interdependent. There exist no unidirectional relationship between termination rates and retail prices Reduction in MTR affects net-payer and net-receivers differently Cost causation is clear for off-net calling prices

18 Argument 1 Wholesale Price: contractually fixed Retail Prices: Many prices varying product by product and change frequently Product 1 MTR On-Net Peak On-Net Off Off Peak OFF- Net Peak On-Net Off Peak Fixed Off Peak Produc t 2 Produc t 3... Fixed Peak OFF-Net Off Peak On-Net SMS Fixed Off Off Peak OFF-Net Off Off Peak OFF-Net SMS

19 Argument 2 Termination rates are mostly symmetrical... contradicts the two-sided market argument If Asymmetry then smaller has higher MTR MTR cannot be increased because of higher market share (newspaper Operator 1 Operat or 2

20 Argument 3 MTRs are wholesale costs and wholesale revenue at the same time Reductions in termination revenues at same time as reductions in termination expenditure Who benefits from termination rate reductions depends on many factors Generally net-payer pay less and net-receiver receive less However, net-receivers may also receive more as shown for Vodacom South Africa

21 Argument 4 Operators have a choice to pass on MTR reductions - no automatism MTR reductions can be passed on to subscribers = lower offnet prices Should it not be passed on, then the operator makes more money for each outgoing minute Concrete choices an operator to maximise profits No automatic response in retail prices to changes in termination rate Retail prices are complex and diverse and pricing strategies are driven by user profiles and market niches, not by revenue replacement

22 Argument 5 Operators can only set their own retail prices but not those of other operators... Cannot control q and p Operator 2 Operator 1 Revenue=x*q p=x+a Off-Net Price q=f(x+a) subject to price elasticity of subscribers of operator 2 Quantity of calls terminated The consequences of own choices depend on the decision of others.

23 Argument 6 Price interdependence has to work both ways If termination rates and retail rates were interdependent, then one would also be able to observe increases in termination rates while retail prices decrease Interdependence of prices has to work in both directions If lower termination rates lead to higher reatil prices, why has no one suggest to increase the arbitrarily set terminations rates MTRs of US 5$ leading to free calling and data?

24 Argument 7 Termination rate payments are payments between operators The industry consists of net-payers and net-receivers of termination rate payments Termination could not be a two-sided market for netreceivers and an ordinary market for net-payers Net payers will benefit directly from lower termination rates and may set their prices in response differently to netreceivers The link between MTR and retail prices could not possible be two sided for some and one-sided for other operators

25 Waterbed Effect Argument Predicted outcome of a Two sided market The waterbed effect describes a situation where if mobile termination rates go down, some other prices need to go up, usually usage and access prices Speculation about the pricing behaviour of mobile operator Assumes that all operators react the same way (even net interconnection payers) Assumes operators base their decisions on revenue replacement rather than profit maximisation

26 OECD countries: Mobile termination rates versus cost of usage (source TMG2010) Cost of OECD basket in US cents Mobile Termination Rates 2009 in US cents

27 OECD countries: Mobile termination rates versus minutes of use (source TMG2010) Minutes of use Mobile Termination Rates 2009 in US cents

28 Interconnection Benchmarking Namibia

29 Interconnection Dispute Consultative workshop on interconnection models... agreement that benchmarking Policies, act (not in place till today) and licence required cost based termination rates The final study benchmarked international best practice, termination rate trends and termination cost to derive at an interconnection model Various interconnection models were discussed with in an iterative process The final consensus solution was only reached after the completion of the study

30 Benchmarking Process of establishing interconnection rates based on cost of termination in other jurisdictions Undertaking full forward-looking cost modelling is challenging, expensive, time-consuming, and often required information is not available Cost benchmarks may need to be adjusted for population density, local area size, extent of urbanisation, traffic patterns and call durations, input prices, scale economies, exchange rates, taxes etc Whatever country or operator seems similar enough, there are always enough factors which are different to expose the selection to criticism

31 Conditions for the selection of countries The billing system needed to be based on Calling Party s Network Pays (CPNP) Countries had already or were in the process of implementing cost based termination rates A pragmatic criteria was the availability of data EU and selected African Countries

32 Step 1: Benchmarking Regulatory best practice Reducing MTR to cost of efficient operator (1-2 Euro cents), EU Recommendation from 7 May 2009 Symmetric termination rates Glide path to allow operators to adjust their business models

33 Termination Rate Trends in Euro cents Cyprus Sweden Finland Austria France UK India

34 Ofcom s Proposed MTRs (April 2010 UK pence) 4.3 Vodafone/ O2/ Orange/ T-Mobile, H3G 4.6 H3G / / / / /15

35 Step 2: Benchmarking Cost of Termination CPNP Countries that had cost data available Adjusting cost benchmarks to Namibia was not possible, incumbent prefered not to provide cost data Common sense check based on annual reports and traffic volume

36 Mobile termination costs Namibia (N$/ZAR): MTC being the most efficient operator Current MTR MTC total expenditure per minute MTC opex per minute MTC direct cost and depreciation per minute MTC direct cost per minute MTC 50% of dircet cost and depriciation per minute 0.24

37 Mobile termination cost per minute in N$/ ZAR 2009: target rate 0.30 (including 25% mark-up) Tanzania LRIC + mark up Australian Efficient Operator (44% market share) Swedish Efficient Operator French Efficient Operator (upper level) MTC s estimated cost of termination Austrian Efficient Operator Telecom Namibia s estimated cost of termination French Efficient Operator (lower level) 0.12

38 Step 3: Namibian Benchmark Model Termination rates = cost of an efficient operator Technologically and service neutral (in line with Namibia s ICT policies and the Act) Facilitate emergence of IP-based NGNs Recommendation should be implemented in terms of the current licence conditions and act

39 Leo Telecom Namibia MTC Model 1: Immediate N$0.30 2nd choice: if accompanied by other regulatory interventions 2nd choice: Removing distortionary factors immediately but request higher transit charge for outgoing international calls No comment Model 2: Symmetric glide path to N$0.30 that started 1 July 2006 Model 3: Symmetric glide path to N$0.30 starting 1 July nd choice: if accompanied by other regulatory interventions Rejected: sees no reason to wait to remove market distorting factors 1st choice: Compensates for market distortions of past years Rejected: only gradually removes market distortions and disadvantage TN and consumers unjustifiably for two years longer No comment No comment Model 4: Asymmetric glide path to N$0.30 starting 1 July st choice: because of current traffic imbalance Rejected: only gradually removes market distortions and disadvantage TN and consumers unjustifiably for two years longer No comment MTC model: reduction to N$0.60 until 2011 Rejected: same as for Model 3 Rejected: same as for Model 3 Otherwise: Drop in EBITDA margin to 37% because of having to compete on a level playing field

40 After several consultations with all operators: Industry consensus Immediate drop of termination rates to N$0.60 to catch up with the region and international developments Glide path to the estimated cost of an efficient operator + 25% mark-up, ie NS0.30 Immediate fixed-mobile convergence of termination rates It gives time to MTC and Leo to conduct LRIC studies and contest the results

41 Mobile and Fixed Termination rates in Namibia MTR FTR Jan 2009 July 2009 Jan 2010 July 2010 Jan 2011

42 Step 4: Evaluating Impact Prices for off-net calls general price development Profitability of incumbent operator (predicted EBITDA margin 36%...)

43 Cheapest product available for Low user OECD basket of incumbent (MTC) in Namibia Sep-05 Dec-08 May-10 Mar-11 Sep-12 Sep-12 in 2005 prices Low User Medium User High User

44 MTC Revenue N$ million ,113 1,232 1,390 1,407 1,453 Shareholders Equity N$ million ,136 1,153 1,166 1,121 Taxation N$ million Net profit after tax N$ million Capital Expenditure in million N$ Total assets N$ million 915 1,169 1,329 1,608 1,632 1,791 1,696 Dividend N$ million Dividend as % of after tax profit 37.5% 23.7% 72.1% 61.7% 95.4% 96.7% 114.2% Return on equity 45.4% 37.3% 34.0% 31.5% 33.6% 34.0% 28.4% Profit Margin 38.1% 36.0% 30.5% 29.0% 27.9% 28.2% 21.9% EBITDA margin 61% 60.2% 52.2% 50.9% 53.8% 55.8% 53.2% Active SIM cards in , , , Full-time Staff Monthly ARPU in N$ Source: MTC Annual Reports

45 Impact of Termination rate reduction in Namibia No waterbed effect Dominant mobile operator More subscribers EBITDA margin 50+% 3rd cheapest dominant operator in Africa

46 Case Study Kenya

47 MTR US cents Mar 2007 Mar 2008 Mar 2009 July 2010 July 2011 July 2012 July 2013 July 2014

48 Monthly cost of OECD Low User basket in US cents, based average exchange rate for 2011 based on OECD 2006 Definition 7.3 Safari Airtel Orange Yu Safaricom increased prices and then dropped them again Jan-10 Sep-10 Jan-11 Sep-11 Oct-11 Sep-12

49 Safaricom s voice traffic in billion minutes Jul-Sep 2010 Oct-Dec 2010 Jan-Mar 2011 Apr-June 2011 Jul-Sep 2011 Oct-Dec 2011 Jan-Mar 2012

50 Safaricom s traffic and subscriber market shares 94% Safaricom share of traffic Safaricom share of subscribers 86% 86% 86% 88% 76% 78% 77% 70% 68% 69% 68% 67% 65% Jul-Sep 2010 Oct-Dec 2010 Jan-Mar 2011 Apr-June 2011 Jul-Sep 2011 Oct-Dec 2011 Jan-Mar 2012

51 Safaricom s key performance indicators for financial years ending in March Revenue After-tax profit Dividend paid Ksh billion USD million ,083 1,222 Ksh billion USD million Ksh billion USD million Subscribers in million EBITDA Margin 51.7% 45.9% 39.6% 43.6% 37.7% 35% Base stations Voice Average Revenue per User (ARPU) Ksh USD Average minutes of use (MoU) Average implied price per minute (ARPU / Average MoU) Ksh US cents Source: Safaricom annual reports Average exchange rate for 2011 used for conversion

52 Impact of Termination rate reduction in Kenya The reaction to the termination rate reduction was immediate, leaving no doubt about the causal relationship Retail prices dropped by 60%, immediately the day after reduction was announced - Opposite effect to the waterbed effect! 9.5% more subscribers in last quarter or 2010 quarter Safaricom is a good example for what happens if a dominant operator does not respond to competitive pressure or tries to increase price after cutting them In both instance Safaricom lost market share and traffic to other operators

53 Case Study South Africa

54 Mobile Termination glide Path in South African cents Since c 89c March c 77c March c 65c March c 52c March c 40c Peak Off Peak Comment political intervention Gazette No , 29 October 2010

55 15 April 2010 Loosing Billions

56 17 May % loss or 10% less revenue? There is a big difference

57 22 July million less revenue in one quarter

58 17 November 2010

59 1 March 2011 Staff retrenchment to offset impact Vodacom: R800 million loss in revenue

60 Vodacom: R1.5 billion loss in revenue R500 million net interconnect loss 17 May 2011

61 17 May 2011 MTN: ZAR 2.5 billion lost in revenues Telkom interconnect revenue dropped 37.4%

62 28 March 2012 I know that it is counter intuitive, but it is what happens, said Knott-Craig.

63

64 January 2012 OECD Low User Basket costs in USD (FX= average 2010) Country Name Cheapest product from Dominant Operator Cheapest product in country Rank US$ Rank US$ % cheaper than dominant Mauritius Dominant is cheapest Ethiopia na Namibia Dominant is cheapest Kenya % Egypt Dominant is cheapest Sudan % Ghana % Libya Dominant is cheapest Rwanda % Guinea % Sierra Leone % Uganda % Congo Brazaville Dominant is cheapest Tanzania % Algeria % Tunisia % Senegal Dominant is cheapest Botswana % Sao Tome &Principe Dominant is cheapest Nigeria % Madagascar Dominant is cheapest Mali Dominant is cheapest Burkina Faso % Benin % Mozambique Dominant is cheapest Chad Dominant is cheapest D.R. Congo % Côte d Ivoire Dominant is cheapest Cameroon % South Africa %

65 8ta MTN South Africa Virgin Mobile Cell C Vodacom South Africa Jan 11 Mar 11 May 11 Jul 11 Sept 11 Nov 11 Jan 12 Mar 12 May 12

66 Ranking of South Africa among 46 African countries - prepaid mobile for OECD low user basket Cheapest prepaid product from Dominant Operator Cheapest prepaid product in country January 2012 May 2012

67 Prices did not go up neither after 1st nor 2nd MTR cut

68 Telkom Fixed-line operating revenues and expenses in ZAR million (Telkom 2011, Telkom 2012, FY ending March) Change Total Revenues 1,679 1, Mobile Domestic Interconnection Mobile International Revenues Fixed International Total Expenditure 5,193 4, Mobile network Interconnection operators 3,704 3, Expenses Fixed International network operators 792 1, Interconnection Loss Total -3,514-3, Interconnection Loss Mobile only -3,206-2, Interconnect revenue up, expenses down, net improved by ZAR432 million Telkom past on MTR cuts 100% to customers

69 Revenue up 7.8%, profits up 27.9%

70 10.2% increase in traffic from Telkom due to pass through of MTR cuts Interconnect revenue down 10.3%, expenses down 13.4%, net interconnect profit up 6.2% in South Africa, additional ZAR 66 million

71 MTN South Africa Revenue up 7.7% EBITDA margin up by 1.2% CAPEX up 5%

72 MTN South Africa: ZAR million Financial year ending December change Revenue 6,568 5, Expense: interconnection and roaming 5,483 5, Net Interconnect 1, Still a net receiver of ZAR 741 million net Overall higher profits in 2011 compared to 2010

73 MTN and Vodacom: profits up Vodacom: R66 million more after cuts Vodacom: net profit from termination R1.14 billion MTN: net profit from termination: R741 million Increase prices? Invest less? Retrench staff?

74 Conclusion Traffic flows are complex and who benefits from termination rate cuts depends on business strategies and the competitive interactions of all operators Cost based termination rates lead to more and fairer competition an thus more subscriber, traffic, investment and a bigger pie of revenues to be shared among operators Quick and steep glide path to lower MTRs to cost of an efficient operator

75 Exercise: Should Pure LRIC be used as a base for the NBC to charge broadcasters that would like to be on digital national backbone?