The Access Deficit Contribution for PSTN Interconnection Pricing

A Submission to the Australian Competition and Consumer Commission

Joshua Gans and Stephen King

26th February, 2003

Executive Summary
This submission evaluates the contention that Telstra ought to receive a contribution from all PSTN users towards a so-called access deficit. That access deficit is the shortfall between the line rental and subscription charges that Telstra may be able to earn under current retail price controls and the costs associated with the customer access network (CAN). From an economic perspective, the construction of an access deficit is rather odd. The CAN is used as an input for a wide variety of telecommunications services including local and long distance calls, calls to mobiles, and internet access. Economically, there is no reason to presume that an input that is used to provide a variety of different services must have its cost recovered from a particular charge. Rather, if one input is used to facilitate a large variety of retail products then any evaluation of any ‘deficit’ or ‘surplus’ associated with that input needs to be made by considering the entire operations of the relevant firm. But the access deficit is calculated only with regards to customer access charges, ignoring any economic profits that might accrue to Telstra from other telecommunications products. As such, it is not clear that the access deficit has any economic meaning. There appear to be two potential arguments are made in favour of an access deficit contribution (ADC). First, it is sometimes argued that the lack of an ADC will not allow Telstra to earn a reasonable market rate-of-return on assets. Second, it is sometimes argued that without an ADC, inefficient entry might occur. That is, entrants may seek opportunities to make profits where Telstra is constrained to meet their price. We evaluate each of these arguments. With regard to investment incentives, the nature and operation of the universal service obligation fund in Australia essentially underwrites any losses that may result from non-recovery of the ADC and effectively guarantees Telstra a market rate of return on PSTN assets. The inefficient entry or ‘cream skimming’ argument neglects the fact that most PSTN dependent service markets (such as long distance and fixed-to-mobile calls) involve competitive provision and, consequently, entry will be efficient regardless of whether there is an ADC in the access price or not. This is because in these markets there are no actual or implicit constraints on Telstra’s ability to meet an entrant’s price. For these reasons, we do not believe there is sound economic basis for the inclusion of the ADC in access arrangements for the PSTN. Finally, even if there was an economic argument for Telstra to receive an ADC, building this ADC into access prices on the basis of calls or call minutes is an inefficient means of recovering the costs of the CAN from access seekers. This is because such pricing will discourage entry and soften price competition in telecommunications markets. A better approach would be to recover the ADC in a manner consistent with that of the USO.

Contents
1. 2. 3. 4. 5.

Page

Background ............................................................................. 3 What is the ‘Access Deficit’? ................................................ 4 Related Telecommunications Policies ............................... 5 The Access Deficit as an Economic Construct.................. 6 Should Telstra Receive an Access Deficit Contribution?9
5.1 5.2 5.3 The Investment Incentives Argument ............................. 9 The Cream Skimming Argument ................................... 12 Conclusion ......................................................................... 14

6.

Methods of Recovering any “Access Deficit” ................ 16
6.1 6.2 6.3 6.4 The Telstra Approach....................................................... 16 The ACCC Approach ....................................................... 17 Evaluation of Call-Based Approaches ........................... 17 An Alternative................................................................... 17

6

Conclusion: Answers to the ACCC’s Questions ............ 19
6.1 6.2 6.3 Should access seekers still be required to make a contribution to the AD? ................................................... 19 If there is to continue to be an AD, how should it be defined and measured?.................................................... 19 If an ADC were to be retained, how should it be spread over calls and minutes?.................................................... 20

Appendix A ....................................................................................... 21
A.1 The Universal Service Obligation Scheme .................... 21

July, 2001

i

Contents
A.2

Page

Regulation of Telstra Prices............................................. 31

July, 2001

ii

Section 1

Background

1.

Background
This submission is a response to the ACCC’s paper “The Need for an ADC for PSTN Access Service Pricing” issued in February, 2003. The ACCC calls for responses to a number of issues that arise in relation to arguments made for an Access Deficit Contribution (ADC). The purpose of this paper is to evaluate the arguments made for an ADC. We begin by reviewing what an “access deficit” actually is. In particular, does the access deficit, as defined by the Commission, have a sensible economic basis? We then turn to consider the various arguments made for an ADC. Finally, we consider how an ADC ought to be made if it is thought it is legitimate to do so. To understand the access deficit, it is important to also understand two related parts of Australian telecommunications policy – the USO scheme and price caps on Telstra. We review these telecommunications policies in the appendix of this submission.

3

Section 2

What is the ‘Access Deficit’?

2.

What is the ‘Access Deficit’?
In its 1999 and 2000 Undertaking Reports, the ACCC recognised the access deficit as a reasonable item that Telstra be allowed to recover as a cost item in PSTN origination and termination. The ‘access deficit’ was defined as the shortfall between the cost of providing basic access and the revenues that Telstra is able to secure under the price control regulations. Telstra’s basic access service is associated with a customer being able to make and receive calls over the customer access network (CAN). The ACCC (July 2000) stated a formulaic definition of the access deficit: AD = Annual Line Costs + Retail Costs – USO funding - Connection Revenues – Line Rental Revenue Notice that, in calculating the access deficit, regard must be had to two other telecommunications policies – retail price controls and universal service obligation funding. We consider the impact of these in the next section.

4

Section 3

Related Telecommunications Policies

3.

Related Telecommunications Policies
Two other telecommunications policies impact on the size of the access deficit:

USO Funding: The USO is the obligation placed on universal service providers (USPs) to ensure that standard telephone services, payphones and prescribed carriage services are reasonably accessible to all people in Australia on an equitable basis, wherever they reside or carry on business.1 Telstra, currently the sole USP, is subsidised for providing this obligation. The subsidy is funded by all licensed telecommunications carriers in the telecommunications industry.2 Note that in the definition of the access deficit, it is recognised that for some customers, the access deficit is covered by USO funding received by Telstra. Hence this is treated as revenue offsetting the difference between line rental and CAN costs.

Retail price controls: The line rental revenue component is the maximum line rental revenue Telstra can secure under the retail price controls. That is, Telstra does not actually charge the maximum line rental to all of its customers. However, the idea of the access deficit is that it is a shortfall caused by retail price controls and hence, an increment over actual revenues is used in calculating the deficit.

The existence and nature of retail price control policies and USO funding impact upon the size and rationale for an access deficit. Appendix A provides a detailed description of these schemes and considers how they impact upon the logic for an access deficit contribution.

See Section 9 of the Telecommunications (Consumer Protection and Service Standards) Act 1999
2

1

See further at http://www.aca.gov.au/consumer/ uso/funding/funding.htm

5

Section 4

The Access Deficit as an Economic Construct

4.

The Access Deficit as an Economic Construct
From an economic perspective, it is far from clear that the access deficit, as defined by the ACCC, has any useful meaning. To see this, note that the services provided by the CAN are used as inputs for other telecommunications services. Few if any customers value basic access in its own right. Rather, customers value basic access because it enables them to consume a variety of telecommunications products, like local and long distance calls, that have the services provided by the CAN as one input. In this sense, the services provided by the CAN are not stand-alone products but rather they are services that, when combined with other services, create valuable telecommunications products. The approach to the access deficit adopted by the ACCC treats basic access as a stand-alone product. It treats basic access as an isolated product and asks whether the direct revenues from that product cover its costs. If the stand-alone product revenues do not exceed the cost then there is a deficit. However, this calculation has no meaning from an economic perspective. It is irrelevant whether there is a surplus or a deficit in terms of direct contributions for one input that is used in combination with other inputs to produce final services. To see this, suppose that two inputs x and y are combined with each other to form a final product z. One unit of final product z requires a consumer to purchase exactly one unit of x and then to purchase one unit of y. The consumer then puts these two components together to form a unit of z. Further, the consumer can only form a working unit of z if they purchase the unit of y from the same manufacturer as the unit of x. For example, x might represent a razor-handle, y might represent a blade, and z might represent a finished razor. The consumer must purchase the razor handle and then purchase the blade that ‘fits’ that handle. The manufacturer might help facilitate this dual purchase by bundling the blade with the razor handle. Assume that consumers only desire the final product z. Having a unit of x by itself provides no benefit to a consumer. Similarly, having a unit of y by itself provides no benefit to a consumer. Also assume that consumers only care what they pay in total for the final product z. Suppose that it costs $1 to produce a unit of x and $1 to produce a unit of y. If z is sold at a competitive price then it will sell for $2. But the seller might ‘break down’ the $2 price of a unit of z in numerous ways. For example, the seller might sell product x for $1.40 and product y for $0.60. From the consumers’ perspective they pay $2 for the final product z. However, if the seller did this, then there would

6

Section 4

The Access Deficit as an Economic Construct

be a ‘product y deficit’ of $0.40 per unit – the ‘revenues’ for y are only $0.60 per unit while the cost is $1 per unit. Alternatively, the seller could hold the price of z fixed at $2 but set a price of x of $1.20 and a price of y of $0.80. If the seller did this, then the ‘product y deficit’ would be $0.20 per unit. In fact, by altering the way they break-down the $2 price of the final product, the seller could create a ‘product y deficit’ anywhere between $1 per unit and -$1 per unit. However, none of these deficit figures would have any economic meaning. They would not alter consumers’ final product demand, the total sales of the final product or the profits that are generated in total from the final product. The economic irrelevance of a ‘deficit’ that relates to one input of a final product for a single producer is even more obvious if the producer bundles the products. Suppose the producer bundled one unit of x together with one unit of y and sold this bundle as one unit of z to customers. Again suppose that the producer sets the competitive price of $2 for the bundle. Then the producer could immediately create any ‘product y deficit’ between $1 and -$1 that they like by ‘breaking down’ the $2 price of the bundle between the two inputs. For example, if the producer stated that of the $2 consumer price, $1.35 was a payment for x and $0.65 was a payment for y, then the producer would create a ‘product y deficit’ of $0.35 per unit. Again, this figure is meaningless as it does not affect the price that consumers pay for the bundle and it does not affect the sales or cost of production for the bundle. From an economic perspective the ‘deficit’ is an artificial figure. There is no reason in economics why the provider of a product that involves a number of inputs needs to receive revenues on each individual input that exactly offset that input’s cost. For example, mobile phone companies regularly ‘sell’ mobile phones below cost. However, this does not reflect irrationality on the part of the sellers. Rather, the sellers expect to make up any ‘phone deficit’ through call charges and customer access revenues. The sellers care about total profit, not the revenues and costs associated with each individual input. Further, there is nothing ‘anti-competitive’ about such pricing. Such pricing could arise even in highly competitive markets and often reflects a benefit to customers. For example, in mobile phones, new mobile phone users might be reluctant to pay a large sum for a phone when they are unsure of how much they will use that phone. By selling the phone at a low price that is below cost the mobile phone company takes the risk away from the customer. If the customer finds that they do not use the mobile phone very much, then they pay little. Conversely, if the customer finds the mobile phone useful, then they pay for the phone through the call charges. By taking the risk away from the customers, more customers will use mobile phone

7

Section 4

The Access Deficit as an Economic Construct

companies that set low phone prices and these companies will be more profitable. From an economic perspective, the correct way to view the CAN is as one of the common fixed costs necessary to provide a variety of telecommunications products, including PSTN access. To evaluate any deficit created for Telstra due to price constraints on the CAN, it is necessary to consider all of Telstra’s costs and revenues from providing services that involve customer access. If providing access to a customer is profitable to Telstra, when all revenues and costs associated with that customer are considered, then there is no meaningful ‘access deficit’ for that customer. A further problem with the access deficit calculation arises due to its relationship with the Telstra price caps. If these price caps do not bind then the access deficit is calculated using the maximum access revenues that Telstra could have received under the price caps rather than the revenues Telstra actually did receive. While this reduces the access deficit, it also highlights that the deficit is an arbitrary construct with little if any economic meaning. If a firm subject to a price cap sets profit maximising prices that fall under the price cap, then that price cap is not a binding constraint on the firm. Under standard economic assumptions that the firm has a well-behaved profit function and seeks to maximise profits, a non-binding price cap is redundant. The price cap could be doubled, tripled, or removed altogether without altering the behaviour of the firm. In this situation, market conditions other than the price cap are constraining the firm’s behaviour so that it is not profit maximising for the firm to price ‘up to’ the cap. In this situation, to define an ‘access deficit’ on the basis of a non-binding price cap has no economic meaning. The deficit could be eliminated by simply raising the (non-binding) price cap. As the cap is not binding, increasing the cap has no effect on any actual market behaviour. But as the cap rises, the maximum ‘allowed’ line rental would rise and the deficit would fall. The access deficit could be arbitrarily raised or lowered by altering the non-binding price cap without changing any actual behaviour. In summary, the access deficit, as calculated by the ACCC, has little if any economic meaning. It does not consider the CAN as an input to a variety of telecommunications products but rather treats the CAN as if it were a stand-alone product. The deficit calculation can be based on fictitious revenues if the price cap for access charges is not binding. A sensible approach to deal with any potential problems that arise for Telstra due to its provision of the CAN and its price regulations is to consider all the revenues and costs borne by Telstra from services that are produced using the CAN. This is the approach used for USO funding.

8

Section 5

Should Telstra Receive an Access Deficit Contribution?

5.

Should Telstra Receive an Access Deficit Contribution?
In section 4 we considered the economic basis for the access deficit, as calculated by the ACCC. For the purpose of the current section we will take that definition as given. In other words, we assume that there is an ‘access deficit’ in the sense that Telstra’s line rental and connection charges do not cover the stand alone costs of providing the CAN. If there is an access deficit, why should Telstra receive a contribution from access seekers to the PSTN for this deficit? From our reading of various documents articulating the case for an ADC, there are two distinct arguments that have been put forward to support an access deficit contribution. The ACCC emphasises issues of investment incentives if an access deficit contribution is not made:
… to the extent that legislation restricts Telstra’s ability to raise line charges to cost, then preventing Telstra from seeking a contribution from charges for call services would lead to under-recovery of fixed line costs, thereby discouraging efficient levels of infrastructure of investment. (July 2000, p.37)

It has also been argued that failure to have an ADC will lead to an under-pricing of access to Telstra’s PSTN and hence, excessive entry in related downstream markets. Thus, there is an investment incentives argument and a cream skimming argument. The investment incentives argument states why Telstra should receive an access deficit contribution. The cream skimming argument is used to justify why the ADC should come from access seekers to the PSTN. Unfortunately, there is little elaboration of these arguments in the Australian debate. Each, when presented, is stated as a contention. In what follows we evaluate investment incentives and cream skimming arguments and identify the facts that would have to be established to give them some validity.

5.1

The Investment Incentives Argument
At a fundamental level, any losses Telstra makes on basic access as a stand-alone business represent a fixed cost of being a ubiquitous

9

Section 5

Should Telstra Receive an Access Deficit Contribution?

provider of telecommunications services. As we noted above, it is existence of related services that make basic access valuable and it is the extent to which profits can be earned on those other services that allows an access deficit to be financed. The access deficit is a fixed cost that is recovered from the profits of other related activities. This is the essence of the investment incentives argument. Suppose that entrants did not have to bear any part of the fixed costs associated with providing basic access. Then it is possible that such entrants could compete away all of Telstra’s business where it was generating profits to pay for the fixed costs of basic access. In this dire scenario, Telstra would go bankrupt and would certainly have no incentive to maintain and renew infrastructure for providing basic access. To see this argument more clearly consider the following example:3 We begin with a single telecommunications carrier who provides three services to three different customers (or types of customers).
Service

Customer 1 2 3
Total Profit

A -10 -4 -1 -15

B -2 2 3 3

C 4 8 10 22

Total Profit -8 6 12 10

In this example, service A is the basic access service. Notice that the firm makes a loss on this service alone. Service B is a less profitable related service such as local calls while service C is more profitable. These figures show the profits on each segment if the provider is a monopolist. However, suppose that the firm is exposed to competition. As services B and C are profitable, entry could occur in those related services if access to service A was mandated. If such competition was strong, the firm would be left with service A alone and an overall loss. For this reason, a provider of access would, at first glance, appear to warrant some contribution to its fixed costs – including the access deficit. Moreover, note that it is precisely because the access service is

3 This example comes from Mark Armstrong and Chris Doyle, “Social Obligations and Access Pricing: Telecommunications and Railways in the U.K,” in Gabel, David and Weiman, David F., eds. Opening networks to competition: The regulation and pricing of access. Topics in Regulatory Economics and Policy Series, Boston; Dordrecht and London: Kluwer Academic, 1998, pages 159-79.

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Section 5

Should Telstra Receive an Access Deficit Contribution?

regulated that a contribution is potentially required. If it were not regulated, the provider would be able to increase its line rentals as related services became more valuable to customers; i.e., as competition improved consumer surplus in those areas. This simple argument is incomplete because Telstra receives a payment from the government for losses in providing basic access. The universal service obligation and its associated industry fund is designed to cover situations where Telstra has a customer (or an exchange area) on which it makes an overall loss -- including what it earns in competition with others. Therefore, under the dire competitive scenario, where Telstra is left with no profits on services B and C, Telstra’s access deficit would be precisely covered. To see this, consider what would happen if there is intense competition faced by the provider in our example on services B and C. Telstra is only left with the economic losses associated with service A. In this case, all three customers would be loss making for the firm and the USO fund would grow to $15.4 Most of the USO would be paid by entrants ensuring that the provider did not make a loss. As such, the existence of the USO rules out the dire scenario of Telstra being made bankrupt and indeed any real possibility of entry causing serious losses for Telstra. Indeed, the USO fund guarantees that if Telstra were to only be a provider of basic access, it would earn a market return on that service. The existence of the USO fund means that Telstra’s fixed costs associated with providing access will always be covered. What, however, does this mean for its incentives to invest in the CAN? Recall, that it has been argued that Telstra would have little if any incentive to invest in the CAN if it did not receive an access deficit contribution. However, Telstra’s universal service obligations require such investments and compensate Telstra for them through the USO fund. Indeed, as that fund is cost-based, if anything it may provide too much rather than too little incentive to maintain and expand the CAN. This is because Telstra is effectively reimbursed for such expenses; subject, of course, to its use of best available technologies. Consequently, the existence of the which it is said to operate mean argument is unlikely to provide an access deficit contribution. For this USO fund and the basis upon that the investment incentives appropriate justification for an to be established would require

4 We can consider customers 1, 2 and 3 as individual customers or as groups of customers such as a local exchange area.

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Section 5

Should Telstra Receive an Access Deficit Contribution?

proof that the USO fund was not performing its stated functions and that this was leading to competitive forces that are not allowing Telstra to cover its fixed costs (including any access deficit).

5.2

The Cream Skimming Argument
The second argument used to justify the access deficit is based on cream skimming. This argument suggests that if no ADC is allowed then entrants will face more favourable conditions than the access provider in related service markets. If this is the case, then it is possible that entry could occur even when an entrant has higher production costs or lower product quality than the access provider in those related service markets. To see this argument, suppose that in, say, long distance markets, Telstra has a cost of C per subscriber and generates gross value of U per subscriber. Suppose also that the price of Telstra’s services is P per subscriber. In this situation, Telstra’s customers receive U – P.5 Now consider a potential entrant who offers a long distance product of value u to subscribers and that costs for the entrant are c per subscriber. Suppose that c includes the costs associated with access to Telstra’s CAN but no ADC. That is, if the cost of the CAN to Telstra is CA, the access charge is t and the long distance cost to the entrant is cL, then c = cL + t = cL + CA. In this case, entry is desirable if total surplus u – c exceeds that generated when the incumbent serves that customer, that is, U – C. In other words, entry is socially efficient if C ≥ c + [U – u]. Given Telstra’s price of P, the entrant can in fact sign up a subscriber so long as the price it charges, p, is such that u – p ≥ U – P. Thus, the maximum price that could be charged by an entrant is p = P – [U – u] and so entry will occur if this price covers the entrant’s costs, c. That is, entry will occur if P ≥ c + [U – u]. Notice that this is different from the condition for socially efficient entry, which occurs whenever P does not equal C. If P exceeds C, there may be too much entry. In this situation, if an additional payment was made by the entrant to the incumbent, a = P – C, then for entry to be privately profitable, P -

This example is based on one from Mark Armstrong, “The Theory of Access Pricing and Interconnection,” M. Cave, S. Majumdar and I. Volgelsang (eds.), Handbook of Telecommunications Economics, Amsterdam: North-Holland, 2002.

5

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Section 5

Should Telstra Receive an Access Deficit Contribution?

a ≥ c + [U – u] or C ≥ c + [U – u], which is the same as condition for socially efficient entry.6 How does this argument relate to the ADC? Suppose that C is decoupled into a CAN, CA, and long distance cost, CL. In this case, the total access payment would be t = a + CA which would equal P – CL. P exceeds CA + CL so that P – CL exceeds CA which exceeds any price earned on basic access if there is an access deficit. Hence, the entrant is implicitly required to make a contribution to that deficit. Note that this is not to fund the provider’s losses on access, but to correct for distortions in the long distance market because the provider’s long distance price deviated from marginal cost. This raises a critical question: why does the provider’s long distance price differ from marginal cost? The above argument is predicated on the assumption that long distance prices are regulated and fixed. In other words, it assumes that Telstra cannot lower its price below P in the presence of competition. However, in Australia, long distance prices are deregulated and indeed, subject to considerable competition. In this situation, the argument that there is a long distance distortion that needs to be ‘cured’ by the use of an ADC does not hold. To see this, suppose that Telstra has a retail price for long distance above a + c (where a is a given ADC). In this case, Telstra will receive a contribution of a per unit from providing access. If, however, Telstra lowers its price in response to entry, it will be able to charge up to P = a + c + [U – u]. In this case, it will earn a profit of a + c + [U – u] – C. This will not be profitable for the incumbent if a ≥ a + c – C + [U – u] or C ≥ c + [U – u]. Hence, regardless of the choice of ADC, a, entry will be socially efficient. As such, no ADC is required to generate efficient entry conditions. In this situation, whether an ADC is allowed or not does not change the efficiency of entry. This occurs so long as the long distance (or related service market) is fairly competitive (notwithstanding product differentiation) and there is no constraint on the provider in terms of lowering price to meet an entrant. What might constrain Telstra’s ability to lower its price in response to entry? At a first glance, Telstra may be unable to simply match a competitor’s price to a customer without lowering prices to all of its customers. This is the infra-marginal problem in pricing, which

6 This argument basically states that the access price should be driven by an ECPR logic.

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Section 5

Should Telstra Receive an Access Deficit Contribution?

reduces Telstra’s incentive to meet small-scale competitive pressure. However, even subject to this constraint, Telstra is choosing not to lower overall prices because it is still able to earn a positive margin on other customers. To be sure, inefficient entry is possible due to Telstra’s exploitation of market power, but equally true is that an ADC is merely another way of deterring entry in general. This is because such a charge reduces competitive pressure from efficient entrants as well inefficient entrants. Because of this, access pricing should include a factor that offsets any ADC.7 However, there are two reasons why this is unlikely to be a strong constraint on price responsiveness. First, the nature of current retail price regulations gives Telstra an additional incentive to respond to entry. Prices for a basket of services are regulated, thus Telstra can lower its price on one service and raise it on services that are not subject to as intense competition. Moreover, to the extent that such entry is with respect to customers in loss making areas (or where entry creates a new loss making area), any profit reduction from the incumbent is compensated for by increased USO payments. In this case, the potential consequences of entry are borne by all non-USO carriers who have increased USO payments as a result. For Telstra, a cost associated with meeting competitive prices is removed and price responsiveness is more likely.

5.3

Conclusion
There are two reasons given why Telstra needs to receive a contribution for the access deficit. The first – based on investment incentives – arises because of a concern that competition based on access to the PSTN will eliminate Telstra’s ability to earn sufficient profits on related telecommunications services to earn a market rate of return on investments in the CAN. However, the existence of a USO fund underwrites that investment to the extent that there is any short-fall caused by competition in related service segments. Hence, Telstra’s return on assets is assured; thereby not leading to a reduction in incentives to investment in the CAN (let alone no incentive as Telstra is contending). The second argument – based on the productive inefficiencies that might result from cream-skimming – is a legitimate concern where competition is in markets where Telstra is unable to lower its price to meet competitive pressure from entrants. When Telstra can compete
7

Armstrong, op.cit.

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Section 5

Should Telstra Receive an Access Deficit Contribution?

effectively on price, entry will occur only if it is efficient, regardless of the existence of an ADC. Consequently, the cream-skimming argument does not provide a rationale for an ADC. Telstra does not face any significant constraints on price responsiveness in related telecommunications service markets and, indeed, has additional incentives to compete resulting from USO funding measures and retail price controls. To be sure, these arguments are contingent upon the effective operation of the USO fund and the continued application of the existing methodology for calculating retail price caps. At present, we have not seen any arguments suggesting that either of these key related policies are operating in a manner significantly different than is intended or are likely to change in the future.

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Section 6

Methods of Recovering any “Access Deficit”

6.

Methods of Recovering any “Access Deficit”
In this section we suppose that there is a legitimate reason that would justify Telstra receiving an access deficit contribution. We consider how they ADC should then be recovered by first looking at the methods proposed in the Australian debate. We consider an alternative approach that is likely to generate more competitive and efficient outcomes.

6.1

The Telstra Approach
It has been contended that the access deficit should be recovered from all PSTN users. For example, Telstra has argued that the AD should be allocated totally on all calls (flagfall) – their 100:0 rule. Telstra argue that this allocation is optimal because the demand for calls is less elastic than that for call minutes (ACCC, July 2000, p.29). This approach has been justified by appealing to work done by Park, Wetzel and Mitchell.8 This is a famous study but in many ways is not applicable to the present day Australian context. In particular, (1) the study looked at calls made in Central Illinois in 1975-77; hardly a model for today’s environment and usage patterns; (2) the specification of their demand model does not appear to be of a form that could give rise to extrapolations that would justify a 100:0 rule; (3) the study was for local calls, whereas the access issues here are for other services whose demand patterns are unlikely to be comparable; and (4) not all of the relevant coefficients in the Park, Wetzel and Mitchell study were statistically significant although this factor may change with a more comprehensive study tailored to a modern telecommunications system.

8 “Price Elasticities for Local Telephone Calls,” Econometrica, 51 (5), 1983, pp.16991730.

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Section 6

Methods of Recovering any “Access Deficit”

6.2

The ACCC Approach
The ACCC has also considered allocating the ADC on the basis of call ends and call minutes. In its initial undertaking reports, the ACCC was concerned that by using call ends this would result “in a greater amount of the access deficit being allocated to the declared PSTN services than when call minutes [are] used to allocate the access deficit.” (ACCC, July 2000, p.25) This is because average call times were lower on declared services as opposed to the PSTN in general. It appears that because of a lack of information upon which to evaluate this distribution the ACCC chose a 50 percent weighting of call ends to call minutes (July, 2000, p.38).

6.3

Evaluation of Call-Based Approaches
Both the Telstra and ACCC methods of allocating the access deficit among access seekers and the provider are based on call volumes (although weights on ends and minutes vary). The difficulty with this approach is that when pricing its services, the marginal cost of an additional call and call minute are increased above Telstra’s costs of supplying PSTN services. This has two effects. First, access seekers face a different marginal cost than does Telstra. This is because the access deficit, as we argued earlier, is a fixed cost of operating a PSTN network for Telstra. Hence, it does not factor into their pricing as it would into the pricing of entrants. As such, entrant’s prices are likely to be too high. Second, this increased marginal cost on access seekers will tend to reduce price competition between entrants and Telstra. As a consequence, Telstra’s call prices will be higher than would be socially desirable. By passing on access deficit costs through unit access charges, rivals face higher costs at the margin than Telstra reducing the pressure on Telstra’s prices. Indeed, it is potentially this impact that motivated the ACCC to structure the weighting of call ends to minutes so as to reduce the overall marginal impact of the ADC.

6.4

An Alternative
As a matter of principle, fixed network costs – like the access deficit – should be recovered through fixed charges. One approach to recovering fixed network costs that is currently used in Australia is

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Methods of Recovering any “Access Deficit”

the approach associated with Telstra’s fixed universal service obligation costs. It seems sensible that, if an access deficit exists that requires a contribution from access seekers, then this deficit should be recovered in a manner similar to the USO costs. That is, the deficit would be recovered according to a weighting based on relative carrier revenues (net of access payments).9 Maintaining consistency between the attribution of the USO costs and any access deficit would add transparency to the regulatory system. This said, the USO funding mechanism is not a true ‘fixed charge’ but may have competitive effects by altering a carrier’s incentives to compete vigorously and raise revenue at the margin. To our knowledge, an economic analysis comparing the competitive effects of the current USO funding mechanism with alternative mechanisms has not been undertaken in Australia. While it seems likely that the de-coupling of marginal costs and payments under the USO funding mechanism will be more pro-competitive than many alternatives, this is an area that requires further economic analysis. The advantage of recovering access deficits in a similar manner to the USO is that it adds transparency and clarity to the system, decouples payments for fixed costs from distortions to marginal prices and potentially avoids distortions on competition that would otherwise result. As the access deficit contribution would be determined in a similar manner to the USO, it would require a minimal additional set of information to implement.

This is the recommendation of the Centre for Research in Network Economics and Communications at the University of Auckland in their paper “Estimating the Cost of the KSO,” 1st June 2001 and also of the Productivity Commission in their draft report.

9

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Conclusion: Answers to the ACCC’s Questions

6

Conclusion: Answers to the ACCC’s Questions
Here we consider answers to the some of the ACCC’s questions in its 2003 issues paper.

6.1

Should access seekers still be required to make a contribution to the AD?
There appear to be no broad efficiency arguments to justify an ADC. We have demonstrated that the absence of an ADC will not undermine Telstra’s investment incentives nor encourage inefficiency entry. This is due to the existence of a USO fund in Australia. It would have to be established that there was an overall concern regarding Telstra’s financial viability coming from imperfections in the USO fund rules. However, that viability would have to be assessed over all markets which may receive a benefit from vertical integration of Telstra with the CAN. If there is no benefit from vertical integration then this would suggest (1) Telstra’s divisions should be structurally separated from the CAN; and (2) that Telstra’s CAN charges reflect an AD from all downstream firms. We are sceptical of claims that Telstra’s internal transfer prices replicate a vertically separated structure.

6.2

If there is to continue to be an AD, how should it be defined and measured?
Even if an access deficit is to continue, the current approach to the access deficit used by the Commission makes little if any economic sense. A sensible measure of any access deficit needs to take into account the revenues and costs Telstra faces over all its operations that use the CAN as a basic input. Such a calculation would, of course, be similar to the current USO approach.

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Conclusion: Answers to the ACCC’s Questions

6.3

If an ADC were to be retained, how should it be spread over calls and minutes?
The answer is that it should not be spread over calls or minutes. Both are distortionary and likely lead to consumer harm. Instead, a fixed charge similar to the USO obligations should be imposed on downstream telecommunications providers.

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Appendix A

Appendix A
This appendix describes in detail the Universal Service Obligation (USO) funding regime and the retail price controls placed on Telstra.

A.1
A.1.1

The Universal Service Obligation Scheme
The Regime The USO regime was introduced in the Telecommunications Act 1991 and subsequently contained in the Telecommunications Act 1997. Regulatory oversight for the USO regime is the responsibility of the Australian Communications Authority (ACA). The current universal service arrangements are specified in the Telecommunications (Consumer Protection and Service Standards) Act 1999 (“the TCPSS Act”). The TCPSS Act allows for the specific regulation of the prices charged for universal service, however by 2002 price regulation had only occurred via the general price controls under the Act.10 The TCPSS Act also allows contestability in delivering the USO. On 21 June 2002 the ACA released guidelines designed to assist carriers and carriage service providers prepare applications to become approved competing USPs. To date, Telstra has been the only declared provider of the Universal Service Obligation.11 USO subsidies are determined by the Minister, based on advice from the ACA. These determinations may be made up to 3 years in advance. Subsidies for 2002/03, 2003/04, 2004/05 have already been set. Before 2000 USPs reclaimed a Net Universal Service Cost (NUSC). Though new legislation (discussed below) does not refer to the

10

For further details see Productivity Commission, Telecommunications Competition Regulation, Final Report, December 2001 at Chapter 18 See further at http://www.aca.gov.au/consumer/uso/index.htm

11

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concept, the NUSC model is still applied by the ACA when formulating its advice for the Minister.12 A.1.2 The Access Deficit and the USO A 1999 ACCC paper on the Access Deficit charges notes that “a proportion of the access deficit will be incurred in Universal Service Obligation (USO) net cost areas. As the funding of the USO is separately determined, this proportion of the access deficit should not be recovered from PSTN services”13. The NUSC is subtracted from the Access Deficit Charge, subject to a reduction for the net loss from payphones and the proportion relating to provision of wholesale PSTN services. In its 2000 PSTN undertaking (originally submitted September 1999) Telstra sought to recover part of its USO costs as part of the access deficit charges. However, this application was rejected by the ACCC which subtracted costs recovered under the USO regime from the access deficit loss. 14 A.1.3 Calculating the Net Universal Service Cost (NUSC) The formula for calculating the overall size of the NUSC is the amount by which the costs attributable to the provision services to net cost areas (avoidable costs) exceed the revenues earned from the provision of the services (revenues foregone). This formula was originally contained in the relevant USO legislation. A model for calculating the NUSC in accordance with the legislation was developed by Bellcore International in 1996.15 The TCPSS Act (the current USO legislation) was amended under the Telecommunications (Consumer Protection and Service Standards) Amendment Act (No. 2) 2000 (commencing July 2000). Under the amendments the avoidable costs minus revenues foregone formula has been removed from the Act and no alternative methodology is prescribed. The ACA Advice to the Minister on New USO arrangements (prepared prior to passage of the legislation) notes that:

Australian Communications Authority, Annual Report 2001-2002, October 2002 at p. 71
12 13

Australian Competition and Consumer Commission, Interconnection Charges and Telstra's Access Deficit, Discussion Paper, September 1999 at p. 5 Australian Competition and Consumer Commission, A report on the assessment of Telstra's undertaking for the Domestic PSTN Originating and Terminating Access services, July 2000 at p. 66 Australian Communications Authority, USO Costing and Assessment Arrangements, May 1999

14

15

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Importantly, the Bill does not refer to NUSC, nor use that concept in any way. In other words, the policy inherent in the Act of enabling USPs to recoup their losses or costs is not replicated in the Bill... Therefore, there will be no inconsistency with policy or proposed legislation if subsidies do or do not recompense USPs for losses incurred.16

Notwithstanding, the Explanatory Memorandum to the Act states that the use of the current methodology is a matter of judgement for the Minister and ACA. In its Advice (prepared September 2000) the ACA recommended the continued use of the avoidable costs, revenues foregone methodology and the NUSC model.17 Advice provided to the Minister on subsidies for the 2002/03, 2003/04 and 2004/05 financial years was derived from the same Bellcore methodology.18 The approach has three major parts: determining the net cost areas (NCAs), determining the avoidable costs and determining the revenues foregone. A.1.4 Net Cost Areas The first step in calculating the NUSC is to determine the regions of Australia where the provision of telecommunications services is loss making. In defining Net Cost Areas the aim is to identify areas where it was possible that a profit-driven carrier may not provide services.19 In doing so, the ACA considers that it is not appropriate to assess the profitability of a single service in isolation, even though there will clearly be loss making services/customers even in urban areas (e.g. a particularly difficult-to-access property). The Bellcore Deliverable # 1 sets out the rationale for costing the USO on a regional rather than per-customer basis. The reasons are twofold:
The first is to ensure that universal service funding is directed only to those areas for which it is intended low density, costly to serve rural and remote areas and customers. … The second … is a practical one. By eliminating the need to study cost structures and revenue sources in urban areas, both the

16

Australian Communications Authority, Advice to the Minister New USO Arrangements, September 2000 at p. 6 Australian Communications Authority (July 2000), op. cit., at p. 7 Australian Communications Authority (October 2002), op. cit., at p. 71.

17 18 19

Australian Communications Authority, Estimate of Net Universal Service Costs for 1998/99 and 1999/2000, January 2000

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development of appropriate cost functions and overall model processing requirement can be significantly reduced.20

Methodology Under the Bellcore methodology, the first step in determining the NCAs is a threshold determination of Potential Net Loss Areas (PNLAs). The Universal Service Provider must lodge proposed Potential Net Loss Areas (PNLAs) with the ACA within 60 days of the beginning of the financial year. Not all PNLA will be loss-making; the PNLA test is a 'first cut’ to identify those types of areas which should be subject to analysis”.21 The ACA evaluates whether the PNLAs provided are NCAs using the avoidable costs - revenues foregone methodology. The analysis of PNLAs begins at the Exchange Service Area (ESA) level. There are several different regions that will be considered a PNLA:
1) Small exchange areas (less than 150 SIOs) 2) ESAs with more than 150 SIOs. These are broken down into two PNLAS: built-up areas (BUAs) (rural townships) and non-built-up areas (NBUAs) (the areas surrounding rural townships). There are a number of rules for determining how to divide an ESA into a BUA and NBUA.22 The aim here has been to capture the loss making areas outside of rural townships that would not be identified as loss-making if the region was taken to be a single area.23 3) Customers receiving radio services 4) From 1998/99, customers receiving satellite services 5) Payphones

Small exchange areas are costed at the full exchange level. NBUAs and BUAs are costed separately but on a regional basis. Customers receiving radio or satellite services and payphone services are costed individually.

20

Bellcore International, Net Loss Area Specifications, Net Universal Service Cost Consultancy Agreement Phase 2, Deliverable #1, November 1996 at p. 1 Bellcore International (1996), op. cit.,, at p. 1 Bellcore International (1996), op. cit., at p. 3 Australian Communications Authority (January 2000), op. cit.

21 22 23

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The PNLA criteria was debated and discussed in 1997 by the participating carriers at the time (Telstra, Vodafone and Optus) during the development of the Bellcore NUSC methodology and is contained in Deliverable #1.24 However, since this time the methodology has been criticised by the other participating carriers. In particular, the carriers have criticised the inclusion of radio services as an independent NCA (Vodafone) and the separation of BUAs and NBUAs (AAPT).25 The ACA continued with the Bellcore approach in its declarations for 1998/99 and 1999/2000. However, while it accepted the validity of separating BUAs and NBUAs it saw problems with the inclusion of radio services as a separate service arguing that:
Including a ‘radio services’ NCA in a NBUA NCA may reduce the NUSC in the few situations where a loss making radio service NCA is included in a profitable NBUA and the NBUA remains profitable after this inclusion.26

A.1.5

Avoidable Costs The NUSC model developed by Bellcore International proposed a methodology for calculation of avoidable costs. This methodology was adopted by the ACA and incorporated by reference into the Net Universal Service Avoidable Costs Determination 1998 (5).27 It continues to be the methodology adopted for calculating avoidable costs and the NUSC. Avoidable costs are calculated according to the long run incremental costs of providing standard telephone service, payphones and prescribed carriage services to customers in net cost areas. Incremental costs are the costs that would be avoided if the services to customers in net cost areas were no longer supplied. These are calculated according to the costs a prospective carrier would incur in providing the service using the most cost efficient technology and production practices, rather than the historical costs actually incurred by the USP.28 The long run cost concept takes into account the cost of replacing fixed assets for the provision of the service.29 The cost of
24 25 26 27

Bellcore International (1996), op. cit Australian Communications Authority (January 2000), op. cit Australian Communications Authority (January 2000), op. cit.

This determination only applied to the 1997/98 but the same methodology has been used for future NUSC assessments. Australian Communications Authority (May 1999), op. cit. Ibid.

28 29

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assets is valued on the basis that a new fully optimised network is supplied each year. To calculate total avoidable costs, first the installed cost of technology, cost of capital and operating costs for a range of different technologies (using best practices) are determined for each NCA. Sampling processes are used in determining the cost for each NCA.30 Once the costs associated with each technology have been determined an optimal mix of technologies for the provision of the USO services is selected whereby each NCA is supplied using least cost technology. Consequently, the major determinants of the size of the NUSC are the:
• • • Technology installation and operating costs Cost of capital Choice of least-cost technologies

Technology Costs Before the costs associated with each technology are calculated a short-list of appropriate technologies is created based upon availability, suitability to Australian conditions, capacity for integration with existing telecommunications network, ability to meet Australian regulations, codes and standards.31 Then the installed cost of technology, depreciation rates and operating expenses are calculated for each of the short-listed technologies.32 Installed Cost of Technology These are the installed costs of switches, junctions, cable, wireless local loop, satellite and any other technologies associated with each type of telecommunications network in an NCA.33 The historical costs of the universal service provider are not used as the basis for deriving these costs. Rather, the costs are those that would be borne by the most cost-efficient operator using best practices.34 A

Australian Communications Authority, Net Universal Service Cost Assessment for 1997-98, October 1999
31 32 33 34

30

Australian Communications Authority (October 1999), op. cit., at p. 52 ibid., p. 67 ibid. ibid., p.12.

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Appendix A

‘greenfields approach’ is adopted for calculating installed costs.35 The installed cost represents:
the fully engineered, furnished, and installed (EF&I) costs of replacement facilities ... including design/engineering time, first level supervision, travel time, commissioning costs.36

The Bellcore NUSC methodology allows for sampling to derive values rather than requiring analysis of a complete greenfields network.37 Depreciation Rates The Avoidable Costs Determination defines depreciation as “the allocation of the initial investment in plant to periods of service provided by the plant”.38 The formula for calculating depreciation factor is:39
Depreciation Factor = (1-Net Salvage)/Asset Life

As the above formula implies, straight-line depreciation rather than an economic rate is adopted.40 Asset lives are determined for each type of asset based on known asset lives. Net Salvage is the proportion of the net investment that is salvageable at the end of its useful life. This is determined at the ESA level. Operating Expenses The Avoidable Costs Determination recommends a methodology for determining avoidable operating expenses. Avoidable operating expenses are defined as “any and all costs which are a direct result of providing telecommunications service and are expensed (or ‘written off’) for tax and/or book purposes in the year in which they occur”.41 Operating expenses are measured using an Activity Based Costing approach. Avoidable operating expenses are categorised as follows:

35 36 37 38 39 40 41

ibid., p.14. ibid., p.14. ibid., p.14. ibid., p.92. ibid., p.92. ibid., p.5. ibid., p.101.

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• • • •

Direct depot costs (resulting from customer demand activity occurring in the depot) Direct central costs (resulting from customer demand activity at a central/regional location) Indirect depot costs (costs occurring at the depot not related to customer demand) Indirect central costs (costs occurring at a central location not directly related to customer demand).42

Opportunity Cost of Capital This is calculated as a pre-tax weighted average cost of capital (WACC). The Capital Asset Pricing Model is used to determine the required rate of return on equity. According to the methodology set out in the Avoidable Costs Determination asset costs are valued on the basis that a new fully optimised network is supplied each year. There is thus a concern that if a standard calculation of asset depreciation were adopted this would overstate actual costs as the rate of depreciation is higher during the first year of the life of an asset.43 Consequently, it was recommended to the ACA by Austel and the Allen Consulting Group that a levelised version of the WACC be used.44 Levelisation works to make annual capital costs the “annuity amount which would make the NPV related to the replacement cost of an asset zero at the WACC over the expected economic life of the replacement technology”.45 Least-Cost Technology Mix Avoidable costs are calculated according to the prospective costs a carrier would incur in providing the service using the most cost efficient technology and production practices.46 The least-cost technology is the one with the lowest annual costs after taking into account capital costs (WACC and depreciation) and operating costs. This approach is favoured to an approach whereby

42 43 44 45 46

ibid., p.101. ibid., p.46. ibid., p.46. ibid., p.46. The levelisation formula can be found at page 49. Australian Communications Authority (May 1999), op. cit.

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Appendix A

the least-cost technology is that with the least cost in year one or with the lowest NPV. 47 A.1.6 Revenues Foregone Under the NUSC methodology, revenue foregone is the amount of revenue earned by the USP during that financial year that the USP would not have earned if it had not supplied NCAs. During the development of the NUSC model Bellcore International derived a basis for calculating revenues foregone that was agreed to by all participating parties. This method has been adopted by the ACA as an appropriate method for calculating revenues foregone.48 Revenues foregone are broken up in a series of categories:
• • • • • • • • • Local call revenue Long distance originating revenue Long distance terminating revenue Long distance between NCAs International Mobile-related Payphones Access Revenue Other (Operator-assistance, white and yellow pages directories, ISP revenue)

Revenues foregone are calculated according to the amount actually earned by the USP rather than the amount it could feasibly earn given price caps in existence. From 1997/98 to 1999/2000 the NUSC was calculated in arrears making it easier for the actual revenues that Telstra earned in NCAs to be ascertained. The amount of revenue foregone in 1998/99 and 1999/2000 was derived from the level of revenue in 1997/98 subject to a revenue variation amount provided by Telstra.49 The revenue variation amount was the variation experienced in its overall operations for each of a series of telecommunications service categories (eg local calls, STD, IDD,

47 48

Australian Communications Authority (October 1999), op. cit., pp. 105-106 ibid.

49 Australian Communications Authority, Estimate of Net Universal Service Costs for 1998/99 and 1999/2000, January 2000

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Fixed to Mobile). Some concern was expressed that the amount of variation would not be constant between NCAs and non-NCAs. Because revenues foregone are calculated using sampling processes there is a statistical error associated with the estimate. From 2000/01, the NUSC was calculated and paid in advance. Consequently, an estimate of the amount of revenues foregone is now used.50 Variances in key inputs, such as revenue, are made based on advice from the Reserve Bank, industry consultants and major industry participants.51 A.1.7 Funding the NUSC Since 1997-98 the Universal Service Levy to be paid by each telecommunications carrier has been calculated according to each participating carrier's share of the total ‘eligible revenue’ earned in the Australian telecommunications industry. Prior to 1997 the universal service levy was shared amongst carriers in proportion to each carrier's share of timed telecommunications traffic. “Eligible revenue” was chosen by the government as the method for apportioning the universal service levy on the basis that it :
Broadly spreads the burden of USO contributions across the telecommunications industry, is transparent, makes use of readily accessible data, is administratively simple and competitively neutral, both between carriers and between carriers and non carriers with whom they compete.52

50 51 52

Australian Communications Authority (September 2000), op. cit., at p. 52 Australian Communications Authority (October 2002), op. cit., at p. 71.

Department for Communications, Information Technology and the Arts, Explanatory Statement to the Telecommunications Universal Service Obligation (Eligible Revenues) Regulations 1998, 1998

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Appendix A

The ACA prepared a new Determination, the Telecommunications Universal Service Obligation (Eligible Revenue) (“the Determination”), on 27 June 2002 regarding the eligible revenue arrangements. In making the Determination, the previous legal instruments that provided for the calculation of eligible revenue were repealed.53 Participating Carriers All licensed carriers are considered “participating persons” in the scheme, unless exempted by regulations under section 20A of the Telecommunications (Consumer Protection and Service Standards) Act 1999. At the date of the Determination, only licensed carriers have been required to pay the Universal Service Levy, however the Minister has been written to allow for the possibility of carriage service providers being made participating persons.54 Eligible Revenues According to the Explanatory Statement accompanying the Determination, “eligible revenue” determines how much each participating person must contribute to the USO subsidy. The Determination defines eligible revenue as gross telecommunications sales revenue less certain deductions.55 A participating person’s sales revenue is taken to be telecommunications revenue as described in its consolidated financial statements. Revenue earned from an activity outside the telecommunications industry may be deducted since the USO is a telecommunications specific scheme. Allowable deductions include “revenue earned for certain acts outside Australia” and “inter-person input payments”.

A.2

Regulation of Telstra Prices
The second set of policies impacting upon decisions regarding access pricing to the PSTN are the regulatory constraints on Telstra’s retail prices. Here we describe those regulations in detail.

53 54 55

See further at http://www.aca.gov.au/consumer/ uso/funding/funding.htm Department for Communications, Information Technology and the Arts, op. cit. ibid.

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A.2.1

Current Regime The majority of the regulation of Telstra's retail prices is found in the Telstra Carrier Charges - Price Control Arrangements, Notification and Disallowance Determination No. 1 of 2002 (“the Determination”) made under the Telecommunications (Consumer Protection and Service Standards) Act 1999 (“the Act”). Other relevant price controls fall under Part XIC of the Trade Practices Act 1974 which regulates the prices Telstra charge to other carriage service providers for access to its telecommunications infrastructure. 56 The Determination specifies a series of price caps on selected baskets of telecommunications services:
• • CPI – 4.5% on a basket of three of Telstra’s services: local, trunk and international calls (this means that the charge for these services as a group must fall, in real terms, by at least 4.5 per cent each year).57 CPI + 4.0% on a basket of line rentals (this means that the charge for these services as a group may rise, in real terms, by up to 4.0 per cent each year),58 CPI - 0% on a basket of connection services.59

It also specifies further price caps of:
• • 22 cents per call on the provision of untimed local calls,60 40 cent per call for local calls made from payphones.61

The revenue weighted average untimed local call price from residential (as well as business) lines in non-metropolitan Australia in 2002/03 is not to exceed the revenue-weighted average local call price in metropolitan Australia in 2001/2002 by more than 0.4 per cent.62 Also, where Telstra proposes to increase a line rental charge for residential customers written consent from the ACCC is required.

56

Australian Competition and Consumer Commission, Review of Price Control Arrangements, Final Report, February 2001., at p. 6. The history of regulation of Telstra’s retail prices can be found at page 7. Sub-clase 9(a) Sub-clause 9(b) Sub-clause 9(c) Sub-clause 13(1) Sub-clause 13(2) Sub-clauses 13(4) to 13(7)

57 58 59 60 61 62

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Charges for directory assistance services are subject to notification to and disallowance by the ACCC (section 158 of the Act). Telstra is able to “carry forward” price changes where it does not increase prices by the maximum allowable in any given year.63 A.2.2 ACCC Review of Price Control Arrangements The ACCC undertook a review of the regulation of Telstra's retail prices with its final report released in February 2001. In the report it recommended that regulation of Telstra's retail prices continue, but recommended a broad price cap applying to all price controlled services and the removal of many of the existing sub-caps on prices.64 This was on the basis that a broad price-cap would more greatly drive Telstra to adopt Ramsey pricing and increase efficiency in the provision of telecommunications services.65 In particular, the ACCC recommended the removal of the sub-cap on the price of line rental.66 There are significant efficiency losses associated with the sub-cap on line rental charges. According to the ACCC, the price cap prevents Telstra from covering the cost of providing line rentals. The average cost of a line rental was estimated to be $346 for 2000-01, but Telstra charged $166.20 per annum to residential customers.67 The efficiency loss from the sub-cap on line rentals alone was measured at between $25 and $45 million dollars per annum.68

63 64 65 66 67 68

Clause 19 ACCC (February 2001), op. cit., at p. vii ACCC (February 2001), op. cit., at p. 32 ACCC (February 2001), op. cit., at p. ix ACCC (February 2001), op. cit., at p. 36 ACCC (February 2001), op. cit., at pp. 37-39

33