Presentation is loading. Please wait.

Presentation is loading. Please wait.

Cost modeling and Price Regulation in telecommunications: Methods and Experiences Sandra Cohen Lecturer of Accounting Athens University of Economics and.

Similar presentations


Presentation on theme: "Cost modeling and Price Regulation in telecommunications: Methods and Experiences Sandra Cohen Lecturer of Accounting Athens University of Economics and."— Presentation transcript:

1 Cost modeling and Price Regulation in telecommunications: Methods and Experiences Sandra Cohen Lecturer of Accounting Athens University of Economics and Business

2 1/7/2004Sandra Cohen2 Presentation overview zGoals of EU directives zCosting and pricing principles for regulated services zPresentation of the basic steps in costing methodology zAsset valuation alternatives (HC- CC) zCost standard alternatives (FDC- LRAIC) zCost accounting systems used by the incumbents in member states zCommon deviations from cost orientation

3 1/7/2004Sandra Cohen3 EU objectives pursued zLiberalisation of the telecoms market yRestriction of the monopolistic power of the incumbent yProtection of the newcomers yImprovement of the quality of services offered, decrease of prices, increase of consumers options and introduction of new innovative services

4 1/7/2004Sandra Cohen4 EU directives zFixed Telephony directive 98/10 (previous 95/62) zLeased lines directive 92/44 zInterconnection directive 97/33 Recommendation 98/322/EC, 8/4/1998 (costing) xProposed amendments included in a new ERG Document Recommendation 98/195/EC, 8/1/1998 (pricing) zAssess directive 2002/19 zFramework directive 2002/21 zUSO directive 2002/22

5 1/7/2004Sandra Cohen5 Basic pricing goals (non competitive services) zEncouragement of the effective competition yAvoidance of: xprice squeeze xpredatory pricing and xexcessive pricing practices zTransmission of the «correct» economic signals zCoverage of the incumbent's accounting cost and allowance for a reasonable rate of return

6 1/7/2004Sandra Cohen6 Basic pricing principles zThe prices have to be: yAdequately unbundled yPubliced yCompetition oriented yNon descriminatory yCost orientated

7 1/7/2004Sandra Cohen7 Why cost orientated? zCost is an adequate benchmark when competition doesnt exist zAs soon as three factors are taken into consideration yIncumbents efficiency xBottom -up models can be used as benchmarks yNetwork technology yCost of capital (Reasonable profit margin) zIn case cost orientation cannot be obtained: Then use best practice

8 1/7/2004Sandra Cohen8 Basic costing principles (for regulatory purposes) zCost causation principle yActivity based costing yNetwork costing zObjectivity principle zConsistency principle zTransparency principle yAuditability yAccounting Separation Access Network Retail Other services

9 1/7/2004Sandra Cohen9 Accounting Separation - Access Access Network Retail Other services OLOs Customers Revenues for Access Cost for Retail Transfer prices

10 1/7/2004Sandra Cohen10 Accounting Separation - Network Access Network Retail Other services Customers OLOs Revenues for Network Cost for Retail Transfer prices

11 1/7/2004Sandra Cohen11 Accounting Separation Reports

12 1/7/2004Sandra Cohen12 Basic cost elements zSalaries of personnel zDepreciation of network elements zDepreciation of buildings and vehicles zTransport costs zMarketing cost zOverhead zetc.

13 1/7/2004Sandra Cohen13 Depreciation zDepreciation is the yearly recognition of the cost of assets usage and corresponds to the decrease of asset value zHistorical cost - cumulative depreciation = Net book value

14 1/7/2004Sandra Cohen14 Depreciation - Example Linear method z Historical cost = zDepreciation rate = 20% yuseful life = 5 years zDepreciation year 1 = ( x 20%) zDepreciation year 2 = ( x 20%) zNet book value year 2 = y( )

15 1/7/2004Sandra Cohen15 Cost objects zCommercial services yLocal calls ylong distance calls yInternational calls yLeased lines yMonthly rentals zWholesale products yInterconnection services yLocal Loop unbundling zNon regulated Services yE.g. telex, internet The regulator does not care about them

16 1/7/2004Sandra Cohen16 From cost elements to cost of services Cost elements Cost of services Cause causality principle application Asset valuation method Cost standard selection

17 1/7/2004Sandra Cohen17 Methods of cost causation principle application zLinking cost elements with cost objects yActivity based costing yNetwork costing

18 1/7/2004Sandra Cohen18 Activity based costing Personnel cost Business processes - departments Activities Cost drivers SERVICECOSTSERVICECOST General Ledger and Salary database Questionnaires- Time spend to activities What is the reason for the activity to be performed Allocation to services Overheads Allocation to services

19 1/7/2004Sandra Cohen19 Activity based costing Personnel cost Customer service Activities related to customer service- access Number of lines ACCESSSERVICECOSTACCESSSERVICECOST General Ledger and Salary database Allocation to services Overheads Already allocated cost

20 1/7/2004Sandra Cohen20 Activity based costing Personnel cost Customer service 30%, Activities related to customer service- access 50%, Number of lines ,75 /line ACCESSSERVICECOSTACCESSSERVICECOST General Ledger and Salary database Allocation to services Overheads Assume 5%, or 0,05/line Already allocated cost

21 1/7/2004Sandra Cohen21 Network costing Cost of assets Physical network elements Cost drivers Network entities Routing factors SERVICECOSTSERVICECOST General Ledger and Fixed Assets Register What is consuming the capacity of the element: Minutes, calls, subscribers? Grouping of elements based on cost driver analysis Service recipes, volume per service and total volume

22 1/7/2004Sandra Cohen22 Routing Factors min of local call Telephone Sub. Local Switch Telephone Sub. Tandem Switch RSU - Local Link Tandem Local Link

23 1/7/2004Sandra Cohen23 Routing Factors - 1 min of local call Telephone Sub. Local Switch Telephone Sub. Tandem Switch RSU - Local Link Tandem Local Link RSU- Local Link- 2 min. Tandem - local link - 2min Local switch - 2min Tandem switch - 1min

24 1/7/2004Sandra Cohen24 Network costing- example switches Cost of local switches Local switch components access and local switch components traffic Cost driver = minutes local switch traffic (actual min. x routing factors per service) local switch traffic minutes used for local calls LOCALCALLSERVICELOCALCALLSERVICE Depreciation, Air condition Buildings, power, network management, etc. RSU - traffic cost Tandem switch cost RSU-local transmission link Local - Local transmission link Local -Tandem transmission link Tandem - Tandem transmission link

25 1/7/2004Sandra Cohen25 Network costing- example switches Cost of local switches Local switch components access and local switch components traffic - 70% Cost driver = minutes local switch traffic = actual x 1,8 = cost per minute = 0,195/min. local switch traffic minutes used for local calls assume x 1,1 x 0,195 = LOCALCALLSERVICELOCALCALLSERVICE Depreciation, Air condition Buildings, power, network management, etc. RSU - traffic cost Tandem switch cost RSU-local transmission link Local - Local transmission link Local -Tandem transmission link Tandem - Tandem transmission link Assume 0,215 (1.1x 0.195) + 0,10 +…+ 0,05 =

26 1/7/2004Sandra Cohen26 Cost of capital zThe total cost of a service also includes a rational rate of return (profit margin) zThis rate of return is based on the cost of capital of the incumbent (WACC) zThe cost of capital that corresponds to each service equals the capital employed for this service multiplied by the rate of return (WACC)

27 1/7/2004Sandra Cohen27 Balance Sheet Total AssetsTotal liabilities TOTAL ASSETSTOTAL LIABILITIES EQUITY LONG TERM LIABILITIES = Accounting Equation SHORT TERM LIABILITIES FIXED ASSETS CURRENT ASSETS Capital employed

28 1/7/2004Sandra Cohen28 WACC (Weighted Average Cost of Capital) WACC = Cost of debtdebt Χ Cost of equtiy equity Χ + Debt +Equity Example: Cost of debt =7%, debt , cost of equity 15%, Equity (Market Value or Book value) 7% Χ % Χ = = 12,34%

29 1/7/2004Sandra Cohen29 Cost Model Structure Cost element 1Cost element 2Cost element n Activity 1Activity 2 Activity n Network element 1Network element n Service Α Service Β Capital employed Service Α x WACC Capital employed Service B x WACC

30 1/7/2004Sandra Cohen30 Asset valuation zAsset valuation influences cost in two ways: yDepreciation cost (directly influences the cost of service) yNet book value (indirectly influences the cost of service via working capital) zTwo alternatives: yHistorical cost yCurrent cost

31 1/7/2004Sandra Cohen31 Historical prices zThe cost of asset acquisition when the asset was bought or constructed zThe cost of the asset corresponds to a past decision that may be obsolete due to technology changes or other reasons

32 1/7/2004Sandra Cohen32 Current prices zThere are a lot of alternative ways in order to calculate current cost yModern equivalent asset: An asset that has the same functionality as the existing one and uses the most efficient and economic technology established in the market place (forward looking) yReplacement cost ySecondary market yCost adjusted to inflation zThe usage of current prices sends the correct signals to the market

33 1/7/2004Sandra Cohen33 Cost calculation zThere are two main approaches in service costing (cost standards) yFully distributed cost (FDC) yLong Run Average Incremental cost (LRAIC) zEU is in favour of LRAIC because it is theoretically suitable for efficient pricing zBoth cost standards permit incumbents cost coverage

34 1/7/2004Sandra Cohen34 Fully distributed cost zAccording to the FDC standard the cost of a service derives from the usage of a set of algorithms that allocate both direct and indirect costs to it zSome of the indirect allocations are arbitrary and may cause cost distortion

35 1/7/2004Sandra Cohen35 Long run average incremental cost (1) zThe long run average incremental cost (LRAIC) of a service equals to the total cost of the company minus the cost of the total company if it continues to provide all the other currenty provided services but the specific one zThe sum of LRAIC of all services is less than the total cost of the company due to the existance of common costs

36 1/7/2004Sandra Cohen36 Long run average incremental cost (2) zThe cost of a service on the basis of LRAIC is: ylower than the SAC (Stand Alone Cost) of the service and yhigher than the IC (Incremental Cost) of the service zThis is because the common cost has to be allocated to services yMark - ups yLRAIC+

37 1/7/2004Sandra Cohen37 Total cost 2 services Total cost Total volume

38 1/7/2004Sandra Cohen38 Total cost - 2 services FDC - Cost per service Total cost Total volume Α Β

39 1/7/2004Sandra Cohen39 Total cost - 2 services Average ΙC- Cost per service Common Cost Total volume Α Β Average IC - A Average IC - B Incremental cost

40 1/7/2004Sandra Cohen40 Floors and Ceilings Ceiling Floor SAC LRAIC LRAIC +

41 1/7/2004Sandra Cohen41 Total cost - 2 services SAC Service A & IC Service Β Total volume Α Β SAC A IC - B

42 1/7/2004Sandra Cohen42 Fixed vs. Variable costs zFixed are the costs that remain unchanged for a relevant range of activity yDepreciation yManagement remuneration zVariable are the costs that fluctuate relatively to the level of activity yLinear or no linear relationships (economies of scale) yPower yDirect labour

43 1/7/2004Sandra Cohen43 Cost accounting systems currently used for interconnection LRAIC zGreece zAustria zDenmark zFrance zGermany zIreland zLuxembourg zSpain (FDC mix) zSwitzerland (FDC mix) zGreat Britain FDC z Belgium (CC) z Italy (CC) z Norway z Portugal Source: Cullen International February 2004

44 1/7/2004Sandra Cohen44 WACC rates currently used zAustria 9.34% zBelgium12.46% zDenmark12% zFrance12.1% zGermany10.6 % zIreland 12 % zItaly 13.5% zHolland 10.7%-12.3% z Norway 13% z Spain12.6% z Sweden15% z Swetzerland 11.75% z Great Britain 12.5% z Greece 12.1% Source: Cullen International November 2001

45 1/7/2004Sandra Cohen45 Common deviations from cost orientation zCross subsidisation of services zUnbalanced tariffs zGeographically averaged tariffs zUniversal service (affordability)

46 1/7/2004Sandra Cohen46 Bibliography zBT, LRIC Methodology, 6 May 1997, p. 13/52 zOfficial Journal, 98/195/EC: Commission Recommendation of 8 January 1998 on interconnection in a liberalised telecommunications market (Part-1- Interconnection Pricing), L 141, 13/05/1998, p zOfficial Journal, 98/322/EC: Commission Recommendation of 8 April 1998 on interconnection in a liberalised telecommunications market (Part-2- Accounting Separation and cost accounting), L 073, 12/03/1998, p zOFTEL, Draft guidelines on the application of the competition act in the telecommunication sector – Consultation, January zWIK, Network Interconnection in the Domain of ONP Study for DG XIII of the European Commission, Final report, November 1994 zTelecom Reform: Principles, Policies and Regulatory Practices, Editor W. Melody, Technical University of Denmark, zHilton, R., M. Maher and F. Selto, Cost management: Strategies for Business Decisions, International Edition, second version, Mc Graw Hill, 2002.


Download ppt "Cost modeling and Price Regulation in telecommunications: Methods and Experiences Sandra Cohen Lecturer of Accounting Athens University of Economics and."

Similar presentations


Ads by Google