CELLULAR PRICING: Greener or Leaner

Aspate of activities has taken place in the cellular industry
over the past few years. However, the issue that has taken prominence among the
cellular operators, subscribers and policy makers, is that of pricing. The
competition among the players in the industry has also aggravated this issue.
Each and every player is coming out with his or her tariff plans and tries to
attract more number of cellular subscribers.

Is the issue of pricing peculiar to India? Can we not
benchmark against some other country’s practices? In order to answer these and
a set of other questions that may arise regarding the issue of pricing, we need
to have a clear understanding of the cellular tariff rates prevailing across
some of our neighbors. The table gives a bird’s eye view of the scenario
across some of our neighboring countries. A cursory look at the table would
reveal that the tariff in our country is far higher. Can this higher price be
attributed to poor telecommunications infrastructure in our country, or to the
lack of clear understanding of the interconnection issues, or to our practice of
Receiving Party Pays (RPP) scheme as against some of our neighbors Calling Party
Pays (CPP) scheme or due to any other reason(s)? Let us analyze the pricing
structure of our country and answer the issues of concern.

Pricing: Towards Greener or Leaner

Pricing of the telecommunications services is the mechanism
that provides the linkage between supply and demand, and it also sets the
threshold level for being able to afford sustainable service. There is a
tradeoff between affordability and sustainability i.e. the desire to reduce the
cost of services to make it affordable for a broader segment and the funds
generated for sustainable investment.

There are two possible alternatives for any
telecommunications service–socially-desirable pricing and the cost-based
pricing, which we call as the leaner and the greener pricing, respectively. The
principle of leaner pricing which forms the basis for most traditional pricing
strategies is to charge customers only as much as they are able to pay. Such a
strategy dictates that the price of telephone connection would be low, usually
not related to the cost of provisioning of service i.e. subsidized subscription
charges and negligible usage charges for basic services and in contrast, very
expensive business services, long distance services and premium services. The
argument against such a philosophy is that initially the subscribers of these
services belong to a well versed category because of their clustering in
commercial and political centers of large cities. Further, the leaner pricing is
often a failure to generate desirable revenue to break-even the initial
infrastructure costs and to sustain further growth. The service provider
(generally, the public operator) may be forced to borrow to cover the subsidy,
resulting in raising his cost structure in order to pay interest charges and
repayment of loan. Ultimately, the operator can slip into a vicious trap. This
will affect the economy as well as the new infrastructure investment
opportunities, adversely.

The cost-based pricing is another extreme in the
price-strategy continuum. Such a strategy emphasizes on two-part tariff
structure–fixed and variable charges. Fixed charges include part of
installation and recovery of initial infrastructure costs. On the other hand,
variable charge also known as usage charges include operation, maintenance and
administrative charges. The infrastructure costs include transmission or
receiver, base units, network management systems, signaling network, and test
center, among others. Operating costs include leased line fee, and promotion and
interconnection charges. For a detailed comparison of the pricing approaches,
refer to the table on the previous page.

Cost-based Approach

In a cost-based approach, the two major cost drivers are the
fixed costs comprising of installation and infrastructure costs, and the
variable costs comprising of mainly license fee and interconnection charges. We
consider that estimating interconnection charge is the primary issue in the
determination of pricing for cellular services in the near future.

Interconnection charges are the charges which one service
provider pays to the other service provider for transporting or terminating the
calls in his area. Interconnection between fixed and mobile network is critical
for mobile operation, as a large portion of total cellular traffic either
originates or terminates on the fixed network (93 percent in metro regions and
85 percent in the telecom circles).

The two major issues that need to be addressed in
interconnection are: interconnection charges and multiple points of
interconnection.

Currently, there is no interconnection agreement between the
fixed and mobile service operators. For calls between fixed and mobile networks,
the revenue-sharing arrangement is same as set out in the original license. As
per the arrangement, there is no revenue sharing for the calls from fixed to
mobile. However, in the Chinese case, each three minute fixed-mobile or
mobile-fixed call, incurs an interconnection charge.

The arrangement in India is expected to change with the
implementation of the CPP regime. And the mobile operators should continue to
stress for a share of long-distance and international call charges on the
grounds of parity with basic service operators. This will benefit the operators
as well as the mobile users. The operators will be able to target at cost-based
pricing in the near future.

Further, the interconnection methods followed in some of the
other countries are depicted in table below. It is clear from the table that
many countries have started following the cost-based interconnection charges.
Moreover, in Mexico, the interconnection charges are benchmarked against
international practices. All these factors should give India enough motivation
to go ahead with the cost-based approach. The pricing models followed by the
other countries can be tailored to our Indian conditions, so that both the
mobile operators as well as the customers benefit.

In the case of multiple point of interconnection, operators
stand to gain from access to multiple points within their circle(s) of
operation. This would enable them to carry calls on their own network to a
maximum extent and would minimize the fixed-line charges they would pass on to
the fixed operators. However, the fixed operators preferred to provide only a
single point of interconnection. So, TRAI intervened and made multiple points of
interconnection possible. This would eliminate the basis of charging
fixed-to-mobile calls at STD rates. However, the mobile operators continue to
complain that the TRAI order is not being implemented.

Under the original license agreements, the fixed operators
were not paying mobile operators for terminating traffic on their network.
However, the mobile operators have to compensate the state-owned incumbent for
terminating traffic. It is known as the Mobile Party Pays (MPP) scheme. It is
also being used as part of compensation to fixed service providers for loss of
revenue due to the existing or potential fixed line traffic migrating to the
cellular networks.

The other approach that is currently considered for adoption
is the CPP scheme. Under CPP, the person making the call pays the entire cost of
the call. The subscriber will benefit with greater flexibility in pricing
options, control over billing and publication of a cellular directory. While
operator will benefit with larger subscriber base, greater revenue, flexible
pricing options and level-playing field with WiLL.

From some of the OECD countries experience, it has been
established that growth in mobile subscribers in the countries with CPP scheme
is much faster. For instance, in 1998, in the countries following CPP and RPP,
the number of mobile subscribers per 100 fixed access lines was fifty-one and
thirty-eight, respectively. By 1999, the ratio changed to sixty-one and
forty-two, respectively. This signifies that the growth rate of mobile
subscribers with RPP have much slower growth rate than those of CPP.

Hence, the tariffs need to be re-balanced or rationalized in
order to promote efficiencies. Re-balancing would reduce tariffs that are above
cost and increase tariffs which are below cost. The primary gains that can be
achieved via cost-based approach would be:

• Reduction
  in cross-subsidization and ensuring that transparency is maintained

• Facilitate
  widening of the subscriber base and at the same time restricts cream skimming by
  the operators

• Provides
  efficiency-oriented incentives for consumption

• Help
  in linking costs to technology and market changes

• Enhance
  the value of service to the customer

• Cost-based
  pricing coupled with the CPP regime would increase the mobile subscriber base

Future Challenges and Recommendations

BSNL earlier preferred to provide only a single point of
interconnection, and to charge STD rates for originating and terminating calls
on the mobile network in a circle. TRAI had intervened and issued an order in
April 1997 directing the then DoT/DTS to provide both-way connectivity at points
of interconnect, and also any number of points of interconnect and multiple
gateway mobile switching centers, to the mobile network operators subject to
technical integrity of the network and technical feasibility. Now with the
finalization of the fourth cellular licenses, some of the operators will have
their bases in adjacent circles. The issue of providing inter-circle
connectivity to mobile operators will be a challenge that needs to be addressed.

One of the reasons cited for not embracing the cost-based
approach is the inherent difficulty in estimating the price. The cost structure
submitted by the license-awarded cellular operators during the introduction
phase, can prove to be a great guidance in this process.

Further, TRAI can outsource the activity to the research or
educational institutes, so that a more acceptable and elaborate
mathematical-modeling approach can be applied to structure the tariffs. Other
alternative would be to benchmark against the international standards as
followed by Mexico.

With the emergence of newer services like Short Messaging
Services (SMS) and WAP-enabled services, the interconnection charges need to be
arrived at seperately. Currently, the charges for the mobile services are based
on the duration of the call. However, as the domain of mobile services extends
to data, a different system of charging will need to be developed. One viable
alternative would be to charge on the basis of pay-per-click, as currently done
by Bharti.

Lok Sabha secretariat in its March 2001 issue published the
seventeenth report of the standing committee on IT-2001. The report emphasizes
that TRAI accepts that the convergence of mobile pricing to that of fixed line
pricing is possible, without hampering the operators’ sustainability. This
statement is based on the information provided by different agencies during the
tariff-revision dialog. Further, there has been a rapid fall in per line cost
for cellular services due to the change in the policy, maturity of technology
and economies of scale. Per cellular line cost has come down to Rs 4,100 as
against TRAI’s previous estimate of Rs 40,000, which shows that revised
cellular tariffs will be comparable with landline tariffs (per landline cost of
Rs 30,000).

This reduction in pricing of the cellular services is
feasible only if it is backed by the improvement in capacity as well as quality
of service to cater the potential customers. So it is always advisable to reduce
mobile charges in a planned manner to cope up with the demand for new services
and maintenance of service quality. It is a prime task of the regulatory
authority to keep a check over service providers like MTNL who can offer very low
tariffs, creating a sudden imbalance in the competitive cellular market due to their advantageous position, in terms
of license fee and interconnection charges.

With the newer challenges emerging in the cellular industry,
the question of pricing based on leaner pricing may not be viable. So, the
transformation to the greener or cost-based pricing is a pre-requisite and with
continued reductions in mobile prices to that of landline costs, the customers
stand to gain a lot.

The article is written under the guidance of Prof V Sridhar,
by
Srikumar K, Piyush Jain, Ashish Sanghavi, Tarun Tripathi, Santosh Ramji, and Jateen Waghdhare,
all MBA students at IIM Lucknow.