The presentation made at dubai at a conference organized by IIR describes the variable and fixed cost allocation methods to workout mobile termination rates using FAC and LRIC methods.

1. The Most Effective Tools For
Allocating Costs To Meet
Regulatory Requirements
Implementing Regulatory Economics &
Cost Accounting For Telecoms
IIR’s Conference at Dubai
Nov. 05-08, 2006
Ahmad Nadeem Syed
Director Interconnect & Regulatory Economics
Mobilink, Pakistan
Ahmad.n@mobilink.net

2. 2
Discussion Points
● Evaluating Accuracy Of Different
Interconnect Cost Allocation Models
● The Data Collection, Input Requirements
and Resource friendliness of Different
Models
● Justifying Use Of Different Tools and The
Results Gained to Regulatory Authorities

3. 3
Stakeholder’s Varying Interests
Incumbent
Best Possible
New Entrant
As Low As Possible
(Payable to Rival Networks)
Regulator
Reasonable
(Cost based is preferred to ensure fair competition)

4. 4
Types of Costing Models
FAC (Fully Allocated Cost)
All costs of the operator including direct, indirect and common costs
are allocated to all services. Effectively each service is cost at an
average level
LRIC (Long Run Average Incremental Cost)
● Long Run - A period where all inputs may vary as a function of
change in demand
● Incremental cost – the extra cost added to an existing base of cost,
required to provide a defined additional increment of a given service
● Average – Cost of a given Network element being same for all the
services included

5. 5
Characteristics of Costing Models
FAC LRIC
Incumbent/Regulator
(short term)
Operator RegulatorPreference
Given Time Forward LookingTime Horizon
Historical
Cost
Current
Cost
Top Down Bottom Up
(Efficient operator)
Types
Models
Actual
● Actual +
● Assumptions
● Actual +
● Assumptions AssumptionsBasis
Existing Existing Existing HypotheticalNetwork

6. 6
Steps for FAC Model
1. Group costs into cost categories
o Operating Costs
o Depreciation (Network, Non-network )
o Assets ((Network, Non-network)
2. Identify relevant network element and Activities
o Core, Access (in case of Fixed) or Transmission (Mobile) Elements
o Retail and other activities
3. Revaluation of fixed assets (in case of CCA)
o Develop replacement cost using independently or combination of MEA, absolute valuation or historic costs
methods
o Calculate CCA depreciation
4. Workout Financial Capital Maintenance
5. Apply cost of capital using WACC
o Workout WACC (Cost of Equity, Cost of Debt)
o Workout capital employed
6. Derive per-minute costs
o Allocate costs to network elements
o Apply routing factors
o Apply traffic volume (Minutes)
7. Apply Checksum to verify the accuracy
o Multiply cost per minute with the Minutes of each increment
o Sum up the above cost and subtract from sum of cost arrived above. The difference should be zero

7. 7
Steps for Top Down Model
1. Group costs into cost categories
o Operating Costs (Direct, Indirect and Common)
o Depreciation (Network, Non-network – Direct, Indirect & Common)
o Assets ((Network, Non-network – Direct, Indirect & Common)
2. Identify relevant network element and Activities
o Core, Access (in case of Fixed) or Transmission (Mobile) Elements
o Retail and other activities
3. Introduce efficiency factor
o Network (trimming on idle capacity)
o Operating cost
4. Revalue fixed assets (if required) & Apply Cost of Capital
o Develop replacement cost using independently or combination of MEA, absolute valuation or historic costs methods
o Calculate CCA depreciation (Straight line or Economic etc.)
5. Cost of Capital and Financial capital maintenance
o Workout Financial Capital Maintenance
o Apply cost of capital using WACC
6. Develop Cost Volume Relationship to
o Determine variation in individual costs with cost drivers
o Identify variable, fixed and common costs
o Allocation of cost categories to each service (activity) and network elements
o Estimate incremental volume and cost
7. Derive per-minute costs
o Allocate costs to network elements
o Apply routing factors
o Apply traffic volume (Minutes)
8. Apply common costs as mark-up
o Equal Proportionate Mark-up (EPMU) – Commonly used or
o Ramsey Pricing
9. Apply Checksum to verify the accuracy
o Multiply cost per minute with the Minutes of each increment
o Sum up the above cost and subtract from sum of cost arrived above. The difference should be zero

8. 8
Steps for Bottom Up Model
1. Measure demand and equipment cost
o Establish end user demand using SMP benchmarks
o Decide the technology
o Obtain equipment cost
2. Design Hypothetical network of efficient operator
o Apply routing factors to design the network including core and access/Transmission networks
o Determine cost of network
3. Determination of Operating costs
o Drive Direct and Indirect costs using parameters (SMP)
o Determine common costs
o Workout Depreciation (Straight line or Economic etc.)
4. Apply cost of capital using WACC
5. Identify network elements and activities
o Core, Access/Transmission Elements
o Retail and other activities
6. Determine cost of network elements and identify activities
o Combine capital and operating costs into network element costs
o Allocate cost to network elements
7. Derive per-minute costs
o Allocate costs to network elements
o Apply routing factors
o Apply traffic volume (Minutes)
8. Apply common costs as mark-up
o Equal Proportionate Mark-up (EPMU) – Commonly used
o Ramsey Pricing
9. Apply Checksum to verify the accuracy
o Multiply cost per minute with the Minutes of each increment
o Sum up the above cost and subtract from sum of cost arrived above. The difference should be zero

9. 9
Comparative Analyses
Models + Ves - Ves
FAC
● Auditable objectively – Actual data used
● Lower chance of errors
● Full recovery of costs
● Average costs inefficient allocation of
resources
● Lack long run view
● Not useful for price pricing analyses
LRIC – Top Down ● Auditable objectively – Actual data used
● model credibility – Actual data used
● Efficiency adjustments questionable
● Cost forecasting difficult
● High data intensive exercise
LRIC - Bottom Up ● Less data intensive
● built-in demand and cost forecast
mechanism
● efficiency is implicit
● Network design difficult to authenticate
● Prone to errors on cost estimation

10. 10
Evaluating Accuracy of Different
Cost Allocation Models

11. 11
Can Accuracy Be Defined?
There is no single, correct answer to the cost
of an interconnect product or service!
Because
● The number of variables is too numerous
● the value for variables is too uncertain
Which is
● Generally dependent on the specific view point of various players
Because:
● The stakes are too high
“Writes Peter Cartwrite in his book “Interconnect Costing”

12. 12
How Do You See This?
Half Empty
or
Half Full
The decision depends on who's eye is this, how
is it viewed and in what perspective

13. 13
Accuracy From Various Perspectives
● Model Development & Inputs
o Actual data; verifiable results
o More assumptions; more questions
● Applicability
o Short term
o Futuristic
● Stakeholders
o Incumbent Operator
o Regulator
(FAC & LRIC Top down)
(LRIC Bottom up)
(FAC)
(LRIC)
(FAC)
(LRIC) & their mindset

14. 14
The Data Collection and Input
Requirements of Different
Models

15. 15
Input Data
● Operating Cost Data
o Direct (Example: Billing cost for retail services)
o Indirect (Examples: circuits, switching, Transmission equipment cost)
o common (Example: Corporate office costs)
● Depreciation - (economic, straight line or other method)
o Asset life
o Depreciation rate
● Cost Drivers
o No. of customers
o Amount of Traffic
o Quality of Service
o No. of call handovers and Level of coverage required (In mobile case)
● Activities
o Retail services
o Wholesale services
o Interconnect services
● Capital Cost
o Fixed assets (Direct, Indirect, Common)
o Asset Revaluation Parameters

16. 16
Input Data Contd…
● Network Design Parameters
o Demand forecast
o Traffic Erlangs
o Network capacity
o routing factors
o Geography
● Network Elements and Cost
o Core network
o Access/Transmission network
o Cost of network items
● Traffic Routing Factors
o Call scenarios
o Number of nodes
● Financial Capital Maintenance
o Inflation rate
o Replacement cost
● WACC Parameters
o Cost of equity (Beta, Market risk, etc)
o Cost of debt
o Tax rate

17. 17
Major Variations of the Models
Factors FAC
LRIC
Top-down Bottom-up
Network Existing Existing Hypothetical
Source of Operating Cost Accounts Accounts Derived
Efficiency Factor N.A Applied Implied
Common Costs Application
Fully
Allocated
As Mark-up As Mark-up

18. 18
Input & Data Collection Requirements
Compared
Data Collection FAC
LRIC
Top-down Bottom-up
Input Requirements Medium High Low
Data Collection High High Low
Assumptions/Variables Almost None Some Quite many

19. 19
Data Collection
Factors FAC
LRIC
Top-down Bottom-up
Data Source Accounts Accounts Derived
Data Accuracy
Good Good Questionable
Data Availability
(Resource Friendliness)
Difficult
Generally data is not
available in the detail
and the format as per
requirement of the
model
Difficult
Generally data is not
available in the detail
and the format as per
requirement of the
model
Easy
Self generated

20. 20
Justifying Use of Different Tools
and the Results Gained to
Regulatory Authorities

21. 21
Regulator’s Testing Parameters
Causation
● Attribution of costs and assets is based on:
o The existence or avoidance of costs being a direct result of
providing or not providing any service or group of services;
o Establishing and using the driver (that caused each item to arise)
to allocate each item to individual business unit or activity
Objectivity
● The allocation process is objective and not intended to
benefit the SMP/a specific operator, product, service,
component, business unit or disaggregated activity.

22. 22
Regulator’s Testing Parameters Contd..
Consistency
● The basis of allocations remains the same (preferably) from year to
year
● The variation is explained and substantiated by restatement of
separated accounts
Transparency
● Cost allocation methodology is well defined and documented
● Accounts are duly separated
● The see through models are helpful
● What tools are used and why? Examples:
o Revaluation if done: What basis?
o EMPU and not Rumsey Pricing for common cost allocation
o Depreciation method

23. 23
Conclusion
● Accuracy is a relative term
● LRIC method (although handicapped in certain respects) is more
appropriate because of
o Being futuristic
o Avoidance of inefficiencies
o Win-Win Case (after Top-down : Bottom-up reconciliation)
● Justification is achieved by adhering to Regulator’s
parameters
● Rates are agreed (generally) by reconciling Top-down
and Bottom-up models

24. 24
Thank You !