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Draft TSO cost calculations

Telecommunications Act: Commerce Commission
releases draft TSO cost calculation

The Commerce Commission has released its draft determination on the calculation of Telecom New Zealand Limited’s net cost of complying with its telecommunication service obligations (TSO) for the period 20 December 2001 (the commencement date of the Act) to 30 June 2002 (the end of Telecom’s financial year). The Commission considers the cost for that period to be $38.84 million.

The cost will be apportioned between Telecom, TelstraClear Limited, WorldxChange Communications Limited, Vodafone New Zealand Limited, CallPlus Limited, Compass Communications Limited, Teamtalk Limited, The Internet Group Limited (ihug) and Global One Communications (recently merged with Equant New Zealand Limited), in proportion to their retail revenues.

Telecommunications Commissioner Douglas Webb emphasised this is a draft determination, and interested parties are invited to make submissions on the determination. The closing date for submissions is Friday 25 July. A conference on the draft determination will be held on 11, 13-15 August, with the final determination expected to be issued as soon as possible after the conference.

“The TSO is an area that produces a sharper divergence of opinions than almost any other I can think of in the telecommunications arena,” said Mr Webb.

“Opinion on the net cost of the TSO varies between the views that there is no cost at all to the TSO while others say it has a very high cost.

“The Commission’s approach has been to consult widely in a number of areas that feed into the overall net cost decision. It has been our aim to get as much information and analysis in front of industry to encourage debate and model development. It is important we receive submissions from all interested parties on this draft determination.”

Mr Webb said there were two key factors in the Commission’s calculation of the TSO net cost.

“First, the Commission determined that the number of commercially non-viable customers was approximately 51,000. This compares to 1.3 million residential customer lines currently operating in New Zealand.

“Second, the net cost includes a reasonable return on capital to service the non-viable customers. The Commission concluded this is a low risk business, and an after tax return of 6 percent was reasonable.”

The Commission’s consultation process has included the release of two models to be used in the calculation of the TSO net cost and reports on the intangible benefits that flow from the TSO and the appropriate weighted average cost of capital (WACC). The Commission has also published three papers and has held two conferences and a workshop with industry participants.

The Commission used two models to calculate the net cost: Hybrid Cost Proxy Model (HCPM) developed by the US Federal Communications Commission and modified by the Commission to calculate the incremental cost of providing the service to commercially non-viable customers. CostPro New Zealand model used to calculate the incremental switching, transport and concentration costs of servicing commercially non-viable customers.

A copy of the Commission’s draft determination is available on the website,, select Telecommunications Regulation. Friday 27 June 2003

Telecommunications Act - Telecommunication Service Obligations

Release of draft Determination - Questions and Answers

What do the numbers actually mean? The cost calculated by the Commerce Commission is the cost to Telecom of serving residential customers whose cost of service exceeds the revenue they produce. There are approximately 51,000 of these customers.

The cost is calculated for the period of 20 December 2001 (the date on which the Telecommunications Act was passed) to 30 June 2002 (the end of Telecom’s financial year).
On an annualised basis, the net cost is $73,450,000.

How much will the TSO cost each carrier? TSO cost per liable person:
Telecom $31,131,873

Vodafone $3,859,564

TelstraClear $3,411,672

CallPlus $191,286

WorldxChange $166,859

Ihug $38,387

Teamtalk $18,821

Compass $17,624

Equant $3,910

Total $38,840,000.00
Why are there differences between the Commerce Commission’s cost calculation and Telecom’s calculation? The major reasons for the differences are: the Commission assumed a more extensive reconfiguration of Telecom’s network would be required to measure efficient costs; Telecom counted unused capacity in its network. The Commission only recognised capacity for growth, and disregarded other excess capacity; and differing approaches to the cost of capital, reflecting different views of the risks faced by Telecom as the TSO provider.

What is the Telecommunications Service Obligation? Under the Telecommunications Act 2001, the Kiwi Share Obligation was updated to become the Telecommunications Service Obligations (TSO). The Kiwi Share was essentially a contractual agreement between the Crown and Telecom that enabled the Government to meet its social objectives in telecommunications. The Kiwi Share was established when Telecom was privatised in 1990.

The TSO requires Telecom to meet detailed service quality measures and report to the Crown and the Telecommunications Commissioner.

The Commission is required annually to determine the net cost to Telecom of providing TSO services to residential customers in compliance with the TSO Deed. The TSO services are detailed in the TSO Deed, and include basic telephone access, free local calling and low speed internet access.

The cost of the TSO arises from the possibility that the revenues from some residential telephone customers do not cover the costs of providing the TSO services. Such customers may be, for example, remote rural customers who are served using expensive equipment.

To estimate the total net cost of the TSO it is, therefore, necessary to identify commercially non-viable areas and to calculate the incremental costs of serving these areas. This requires modelling of the costs and revenues of customers and groups of customers in the New Zealand telecommunications environment.

What is covered by free local calls? Free local calls include: standard voice calls; single standard listing in The Telephone Book; one residential line; free genuine calls to emergency service centres; fax calls; and standard calls to the Internet.

Who must share the TSO cost? Once the TSO net cost has been determined, the Telecommunications Act requires it to be shared between Telecom and other “liable persons”. To achieve this, the Commission is required to determine who the liable persons are and how the cost is allocated.

The definition of liable persons is complex. It includes those carriers who directly, or indirectly, interconnect with Telecom’s telephone network. The Commission does not consider internet service providers (ISPs), who only provide internet services, to be liable.

Liability is calculated based on the gross retail revenue from providing services to end users through a telephone network. On this basis, a liable person’s share of the TSO cost would be in proportion to its share of the industry’s total pool of appropriate revenues.

What is the impact of today’s draft determination on the industry? Liable persons, which in this case means TelstraClear, WorldxChange Communications, Vodafone, CallPlus, Compass Communications, Teamtalk, The Internet Group (ihug) and Global One Communications (recently merged with Equant New Zealand), will be obliged to pay Telecom the amounts assessed by the Commission as their contribution to the cost of TSO. Telecom itself bears the bulk of the cost, as its revenues are the largest proportion of industry revenues.

Why should other carriers contribute to the cost of TSO? All carriers benefit from national fixed line coverage. The Commission independently oversees the process, using a robust costing process set out in the Telecommunications Act. The process under the Act is transparent and competitively neutral.

The legislation gives the Commission the final decision over the calculation of costs and cost contributions. It is also linked to the enforcement mechanism, as the Commission can reduce the industry contribution should Telecom fail to meet its telecommunications service obligations.

The net cost of TSO to whom? The Commission has previously said that the existence of the TSO will impact on all carriers, and therefore ultimately all telecommunications users to at least some degree. TSO costs could therefore be measured from any number of different perspectives. However the net cost referred to in the Act is clearly defined as “…costs to an efficient service provider of providing the service required…”

Will the costs of TSO be passed on to consumers? The Act envisages that TSO costs can be passed on, but each company will make their own decision.

What is the Commission’s role under the Telecommunications Act? The regulatory regime applies to the supply of telecommunications services by carriers within New Zealand, and its overriding purpose is to promote competition for the benefit of end-users in New Zealand.

The Commission’s three principal functions under the Telecommunications Act are to: resolve access disputes between carriers; oversee the TSO regime and apportion the annual net cost between Telecom and liable carriers; and monitor the regulatory regime and recommend to the Minister of Communications changes to the list of regulated services.

What period of time does today’s cost apply to? This determination applies for the period between 20 December 2001 and 30 June 2002. There will be further determinations made for each subsequent 12 month period.

How many cost calculations did Telecom provide the Commission as part of the TSO calculations? Under the Telecommunications Act, Telecom must, not later than 60 days after the end of each financial year (30 June), provide to the Commission calculations of the net cost of complying with the TSO instrument during the financial year.

Telecom provided three separate cost calculations to the Commission: On 20 September 2002, Telecom advised the Commission that the net cost of providing the services required by the TSO Deed over the 20 December 2001 to 30 June 2002 period was $226.5 million. On 8 November 2002, Telecom provided the results of its revised TSO net cost calculation, incorporating requirements set out by the Commission, including a WACC of 8.2%, of $112 million for the period. Telecom also estimated that at 13.2% return on capital the cost for the period was $218 million. The most recent calculation of these cost provided by Telecom to the Commission on 4 April 2003 concluded that the cost for the full year was $357 million (roughly $178 million for the period) at 13.2% return on capital. However, Telecom also estimated that at 8.2% return on capital the cost for the full year is estimated at around $170 million (roughly $85 million for the 20 December 2001 to 30 June 2002 period).

Internet service providers (ISPs) are major drivers of traffic on a network. Should they be contributors to the TSO costs? The Commission does not consider that ISPs fit the description of liable persons in the Telecommunications Act because ISPs generally do not operate components of a network.

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