Preliminary analysis of Telecom's TSO model

Telecommunications Act: Preliminary analysis of Telecom's TSO model and Commission's own proposed model

The Commerce Commission today released the access network model that it proposes to use in estimating the annual cost to Telecom New Zealand Limited of complying with its telecommunications service obligations (TSO). The Commission's modelling forms part of its preparatory work for the publication of its draft and final TSO determination.

The Commission is using the Hybrid Cost Proxy Model (HCPM) model developed by the US Federal Communications Commission to calculate the key parts of the incremental cost of serving commercially non-viable customers.

In addition, the Commission released its preliminary analysis of Telecom's model for calculating the cost. Osmond Borthwick, Manager of the Commission's Network Access Group, said the Commission's preliminary view, to be tested through the consultative process, was that the Telecom model has a number of drawbacks and is of limited value to the Commission in calculating net TSO costs.

The Commission invites industry parties to make submissions on the HCPM model and the Commission's paper on the Telecom model, which will be the subject of an industry conference in Wellington from 15 to 16 May 2003.

The transport and switching network costs will be calculated by the Commission using a separate model developed by CostQuest Associates of the United States. This model will be released as soon as it is available. Comments may be made on the model at the May conference, and later written submissions will also be accepted.

Under the Telecommunications Act, the Commission is responsible for overseeing the TSO regime and apportioning the annual net cost between Telecom and other liable carriers. The Commission is currently working on setting the TSO cost 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).

Current timeframe for TSO determination process: Date Activity 23 April Release of models the Commission will use to estimate the net TSO cost, together with supporting documentation Release of analysis of Telecom's TSO cost model 8 May Submissions due on material released 23 April 15, 16 May Conference in Wellington on Commission's modelling and inputs 30 May Release of TSO draft determination 30 June Submissions due on TSO draft determination 8, 9, 10 July Conference in Wellington on TSO draft determination

The TSO final determination will be released as soon as practicable after the completion of the conference on the draft determination.

The Commission's analysis of Telecom's model, plus documentation of the Commission's own proposed model will shortly be available on its website at: http://www.comcom.govt.nz/telecommunications/Obligations.cfm

Background Section 86 of the Telecommunications Act 2001 states: The Commission must make reasonable efforts to do the following things not later than 120 working days after the end of each financial year of a TSP under a TSO instrument: (a) prepare a draft determination of the matters set out in section 88: (b) give public notice of the draft determination: (c) include in the public notice the closing date for submissions, which must not be later than 20 working days after the date of giving public notice.

Section 90 of Telecommunications Act states: The Commission must make reasonable efforts to do the following things not later than 40 working days after the closing date for submissions under section 86(c): (a) prepare a final determination of the matters set out in section 92: (b) give public notice of the final determination: (c) give a copy of the determination to all liable persons in relation to the TSO instrument.

Media contact: Osmond Borthwick, Manager, Network Access Group Phone work (04) 924 3667

Gail Kernohan, Communications Adviser Phone work (04) 924 3709, mobile 029 924 3709

Commission media releases can be viewed on its web site www.comcom.govt.nz Analysis of Telecom's Cost Model - Executive Summary

Under the Telecommunications Act 2001, the Commission is required to determine the net cost to Telecom of complying with the Telecommunications Service Obligations (TSO) Deed for Local Residential Telephone Service. To assist with that determination, Telecom must, not later than 60 days after the end of each financial year (June 30), provide to the Commission calculations of the net cost of complying with the TSO instrument during the financial year.

On 20 September 2002, Telecom provided the Commission with its calculation of the net cost from 20 December 2001 to 30 June 2002, in accordance with s83 of the Act. Telecom advised that the net cost of providing the service required by the TSO Deed over that period was $226.5 million.

The Commission wrote to Telecom on 14 August, 2 September and 25 October 2002, setting out requirements relating to Telecom's calculation under s83 of the Act.

On 8 November 2002, Telecom provided the results of Telecom's TSO net cost calculation, incorporating the Commission's requirements. The result was a TSO calculation of $112 million.

On 4 April 2003, Telecom provided a fresh calculation of the TSO net cost through rerunning its TSO model with some improvements. Telecom noted that it had identified and highlighted a number of minor errors in the modelling. The revised annualised cost at 8.2% return on capital was estimated at around $170 million.

On 30 September 2002, the Commission released its Position Paper on the TSO which stated that the Commission considered that a bottom-up approach should be adopted for the modelling of TSO costs. This was because it more directly estimated the cost of an efficient service provider and was likely to be better at identifying and estimating the unavoidable incremental costs of providing services to groups of customers within a service area.

On 25 October 2002, the Commission announced that it had decided to use the public domain FCC Hybrid Cost Proxy Model (HCPM) as a bottom-up model. However, the Commission also noted that the net cost calculations produced by Telecom's model would provide helpful input into the Commission's net cost calculation, even though the model was not a bottom-up model as envisaged by the Commission.

The degree to which the Telecom model will prove helpful depends on its consistency with the provisions and purpose of the Act. Therefore, the Commission has undertaken an assessment of whether the Telecom calculation is consistent with the provisions and purpose of the Act. To enable the assessment, the Commission has sought, and Telecom has provided, information on the Telecom model. The Commission has explored the assumptions underlying the calculation, and the operation of the cost model that produced the calculations.

The Commission has formed a preliminary view, to be tested through the consultative process, that the Telecom model has the following disadvantages, which limit its utility in calculating net TSO costs: * the reliance on Telecom's historic network configuration to estimate infrastructure requirements; * placement of "modern equivalent assets" [new, best-in-use technology] in the historic network configuration to calculate capital costs; * the calculation of an efficiency factor by benchmarking Telecom performance against similar firms in the United States; * including the cost of lines and infrastructure not serving current customers in the capital cost modelled; * treating the cost of serving business customers as incremental to the cost of serving residential customers; * the calculation of core switching costs on a fully allocated rather than incremental basis; and * taking all residential customers as the increment when calculating the cost of directory listings and emergency calls.

Given these features, the Commission's preliminary view is that the initial results are not suitable for use by the Commission in determining the net TSO cost. The Commission is seeking feedback on these preliminary views before the release of its Draft Determination on the TSO.

The Commission has also released its model, based on HCPM, with the associated documentation, for comment by the industry. The Commission is using the HCPM model to calculate the key parts of the incremental cost of serving commercially non-viable customers.

The HCPM model and the Commission's paper on the Telecom model will be the subject of an industry conference from 15 to 16 May 2003.

The transport and switching network costs will be calculated using a model developed by CostQuest Associates of the United States. This model will be released as soon as it is available. Comments may be made on the model at the May conference, and later written submissions will also be accepted.

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