HIPSSA Cost Model Training Workshop: Session 5 Cost Standards & Application
Dive into the world of telecom network cost modeling through an expert-level training workshop focusing on HIPSSA regions. The workshop, led by ITU Expert David Rogerson, will cover the essential aspects of cost standards and their practical application. Join us in Arusha from July 15-19, 2013, to enhance your knowledge and skills in this critical field.
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HIPSSA Cost model training workshop: Session 5: Cost Standards and their Application EXPERT LEVEL TRAINING ON TELECOM NETWORK COST MODELLING FOR THE HIPSSA REGIONS Arusha 15-19 July, 2013 David Rogerson, ITU Expert International Telecommunication Union 1
HIPSSA Cost model training workshop: Session 5: Cost Standards and their Application Session 5 Cost standards and their application International Telecommunication Union 2
HIPSSA Cost model training workshop: Session 5: Cost Standards and their Application Agenda Aims and objectives for this session Identifying types of cost Understanding cost standards Knowing when to apply them Effective regulation 3
HIPSSA Cost model training workshop: Session 5: Cost Standards and their Application Identifying types of cost International Telecommunication Union 4
HIPSSA Cost model training workshop: Session 5: Cost Standards and their Application How much does a pint of milk cost? List as many types of cost as you can think of that might affect the cost (or cost-based price) of milk http://i.telegraph.co.uk/multimedia/archive/01854/DO_NOT_USE_1854325a.jpg 5
HIPSSA Cost model training workshop: Session 5: Cost Standards and their Application Examples of cost categories Distribution costs: Transport, packaging, refrigeration, logistics Production costs: Land, cows, feed, fertilisers, labour Processing costs: Equipment and labour for milking, pasteurising, skimming Retail costs: Shops, staffing, marketing, branding, billing 6
HIPSSA Cost model training workshop: Session 5: Cost Standards and their Application Four key types of cost Fixed costs Cost which must be incurred if any non-zero quantity is supplied Variable costs Cost whose magnitude changes when output changes Capital costs Assets purchased for use in more than one year Operating expenditure Costs consumed entirely within the current year 7
HIPSSA Cost model training workshop: Session 5: Cost Standards and their Application Categorisation of costs Fill in examples of each cost type relevant to the cost of milk Fixed capital costs Variable capital costs Fixed operating expenditure Variable operating expenditure Production Processing Distribution Retail 8
HIPSSA Cost model training workshop: Session 5: Cost Standards and their Application Categorisation of costs Possible categorisation of the costs of milk supply Fixed capital costs Land Buildings Logistics Shop Variable capital costs Cows Equipment Vehicles Display shelving Fixed operating expenditure Fertilisers Rates Insurance Billing Variable operating expenditure Labour Labour Staff and fuel Marketing Production Processing Distribution Retail The extent to which costs are fixed or variable depends on the time horizon. Economists define the long run as the shortest period of time necessary for all the fixed costs to become variable. 9
HIPSSA Cost model training workshop: Session 5: Cost Standards and their Application How each cost type is treated in cost models Fixed costs Excluded from marginal and incremental cost calculations Variable costs Part of all cost standards, but may be treated differently Capital costs Need to be annualised for pricing: different approaches apply Operating expenditure May be direct or joint/common. The latter may be excluded depending on the mark-up regime. 10
HIPSSA Cost model training workshop: Session 5: Cost Standards and their Application Understanding cost standards International Telecommunication Union 11
HIPSSA Cost model training workshop: Session 5: Cost Standards and their Application Four key cost standards Fully Allocated Costs (FAC) An accounting method to distribute all costs among a firm's various products and services Long Run Incremental Costs (LRIC) An accounting method to calculate the cost caused by the provisioning additional units (the increment ) or by an extension of the service portfolio Stand Alone Costs The costs of supply assuming a firm only provides one service Marginal Costs Cost caused by the provisioning of one additional unit of service 12
HIPSSA Cost model training workshop: Session 5: Cost Standards and their Application Fully Allocated Costs (FAC) All costs have to be taken into account and allocated to the products and services of a company The concept is neutral with regard to valuation principles, depreciation and cost of capital calculation methods The art of fully allocated costs is to identify direct cost, joint (service family) cost and common cost and to find ways to properly allocate the latter two categories to services. Can be used with either historic costs (actual costs incurred) or current costs (revalue assets at their replacement costs) 13
HIPSSA Cost model training workshop: Session 5: Cost Standards and their Application Long Run Incremental Costs (LRIC) Estimates the incremental cost of providing the service under consideration Defined as the total cost when the service is provided less the cost when the service is not provided By measuring over the long run, infrastructure investment is variable rather than fixed and can be matched to capacity If common costs are to be recovered, then a mark-up is required LRIC typically uses current or forward looking costs (cost of an efficient firm using new infrastructure) 14
HIPSSA Cost model training workshop: Session 5: Cost Standards and their Application FAC v LRIC: a two product example T T Cost Cost This point T represents all costs / volumes of the network LRIC of A FAC of A Stand- alone cost of B FAC of B B A B A Volume Volume Long Run Incremental Costs Fully Allocated Costs 15
HIPSSA Cost model training workshop: Session 5: Cost Standards and their Application LRIC variations TSLRIC Total Service LRIC LRAIC Average LRIC LRAIC+ LRAIC plus mark-up for joint and common costs Pure LRIC LRIC of a specific service (usually call termination) http://www.di-arezzo.co.uk/multimedia/images/novello/couv/nov100042r.jpg 16
HIPSSA Cost model training workshop: Session 5: Cost Standards and their Application The difference between Pure LRIC and LRAIC+ Source: RTR by end of /2003 Source: BIPT 17
HIPSSA Cost model training workshop: Session 5: Cost Standards and their Application More costing definitions Direct cost or directly attributable cost costs are incurred as a direct result of the provision of a particular service. can be fixed or variable. Joint or shared cost (indirectly attributable cost) The cost of inputs that contribute to the production of two (or more) different increments. For example the costs of mobile towers contribute to 2G and 3G services (and maybe others) Costs can be allocated on the basis of identifiable cost drivers (e.g. tower space) Common cost inputs necessary to produce several services, which cannot be directly assigned to specific services. 18
HIPSSA Cost model training workshop: Session 5: Cost Standards and their Application Cost categories for Pure LRIC or Marginal Costs Marginal costs (MC) Directly attributable costs Volume sensitive costs Fixed costs Joint costs Common costs Source: RTR In Pure LRIC the increment is a full service (e.g. terminating calls), whereas in Marginal Costs it is the smallest possible unit (e.g. a single call) 19
HIPSSA Cost model training workshop: Session 5: Cost Standards and their Application Cost categories for Incremental Costs Incremental cost Directly attributable costs Volume sensitive costs Fixed costs Joint costs Common costs Source: RTR 20
HIPSSA Cost model training workshop: Session 5: Cost Standards and their Application Cost categories for Stand Alone Costs Stand alone costs (SAC) Volume sensitive costs Direct and attributable costs Fixed costs Joint costs Common costs Source: RTR 21
HIPSSA Cost model training workshop: Session 5: Cost Standards and their Application Cost categories for Fully Allocated Costs Fully allocated cost (FDC or FAC) of service A Direct and attributable costs Volume sensitive costs Fixed costs Joint costs Common costs Source: RTR 22
HIPSSA Cost model training workshop: Session 5: Cost Standards and their Application Another view of cost accounting concepts Cost accounting concepts Source: DTAG 23
HIPSSA Cost model training workshop: Session 5: Cost Standards and their Application With LRIC the definition of the increment matters (1) Possible increments in a mobile network service traffic low bandwidth data traffic high bandwidth data traffic voice traffic send receive GPRS/UMTS /HSDPA data GPRS/UMTS /HSDPA data call check voicemail leave voicemail SMS SMS call origination origination termination termination Source: Europe Economics 24
HIPSSA Cost model training workshop: Session 5: Cost Standards and their Application With LRIC the definition of the increment matters (2) Difference between LRAIC+ and pure LRIC in Belgium Source: RTR by end of /2003 Source: BIPT The larger the increment the higher the LRIC 25
HIPSSA Cost model training workshop: Session 5: Cost Standards and their Application With LRIC the definition of the increment matters (3) Analysys Mobile Model UK LRIC+ vs. Pure LRIC Source: RTR by end of /2003 Source: OFCOM 26
HIPSSA Cost model training workshop: Session 5: Cost Standards and their Application Applying the different cost standards to regulation International Telecommunication Union 27
HIPSSA Cost model training workshop: Session 5: Cost Standards and their Application The questions regulators face Return on capital employed? Which interconnect pricing standard? Equal mark-up? Efficient component pricing rule? Fully allocated costs? Incremental costs? + Mark-up Ramsey pricing? Constrained mark-up? Forward looking? Historic? Historic? Actual best practice? Theoretical best practice? 28
HIPSSA Cost model training workshop: Session 5: Cost Standards and their Application Emerging best practice Constant mark-up same percentage to all services Efficient Component Pricing Rule (ECPR) based on opportunity cost - considers retail prices only works well if retail prices already competitively priced Ramsey Pricing sets mark-ups inversely proportional to the price elasticity of demand theoretically works well, but very difficult to implement Floors and Ceilings allows the operator flexibility of assigning mark-ups within limits (generally defined as between MC and SAC) 29
HIPSSA Cost model training workshop: Session 5: Cost Standards and their Application The aim of cost based regulation Aim is to encourage economically efficient investment to promote the long term interests of end users Balance between: efficient use of existing infrastructure investment in new infrastructure by incumbents and new entrants Regulation of interconnect services is required where there is potential market failure Without infrastructure based competition - ongoing regulation will be necessary 30
HIPSSA Cost model training workshop: Session 5: Cost Standards and their Application LRIC balances competing interests LRIC is an economic cost concept designed to: Encourage use of existing facilities where desirable Encourage investment in new facilities where justified Increasing desire for entrants to build rather than buy Neutral benefits Interconnect tariff Decreasing desire for incumbent to sell LRIC 31
HIPSSA Cost model training workshop: Session 5: Cost Standards and their Application Deviating either side of LRIC has its dangers Encourages greater investment in infrastructure Protects the incumbent versus potential competitors Economic cost Economic Cost Encourages greater efficiency in use of existing infrastructure May deter otherwise appropriate market entry by facility based competitors 32
HIPSSA Cost model training workshop: Session 5: Cost Standards and their Application Emerging best practice FAC (or benchmarks) until LRIC models in place TSLRIC+ or LRAIC+ (for all services initially) Pure LRIC (for call termination only) 33
