GLOBAL INTERCONNECT: A Divided World

If you thought interconnection was an open and shut case in the more
liberalized telecommunications markets of the US or the UK, you may be in for a
surprise. It’s as contentious an issue in any liberalized telecommunications
market as in India today. The reason: a growing multiplicity of operators and a
not-too-sound regulatory approach.

Regulators and operators agree that any interconnection regime must be
designed to ensure end-to-end interoperability of networks, thus offering
increased calling opportunities for users. It should also provide equality of
access and universality of service. Easier said than done.

Global
Rules of the Game

In most of the countries, incumbents have to publish a reference
interconnect offer (RIO) that has to be approved by the regulator (WTO terms
also require publication of RIO). In many countries, regulators also publish a
model RIO that is supposed to be adhered to by operators while designing their
own RIO. Usually, a model RIO encompasses wider undertakings by incumbents in
terms of meeting technical specifications and an undertaking to meet other
conditions such as delivery times.

In all de-monopolized markets, it is obligatory for incumbents or operators
with significant market power (SMP) to provide interconnection to new market
entrants. Interconnection obligations of incumbents are seen as a way of
neutralizing their significant market power for the benefit of all users. In
markets where all operators lack SMP, interconnection rules are usually set
through a commercial negotiation between operators. While the new operators or
those with no SMP can refuse to interconnect with the incumbent operator or the
one with SMP, the latter cannot do so. Usually, commercial negotiations for
setting up terms of interconnect are preferred in most competitive markets (like
Uganda).

Finland, Canada Earn Applauds

An interconnect regime that has been hailed for its transparency is that of
Finland. There, mobile operators charge the fixed user for calls to mobile via
local fixed operators, who act as invoicing agents for long distance,
international and mobile operators. For fixed-to-mobile calls, mobile operators
set the retail charges for their own call segments, and forward the charging
information to local fixed operators on a call-by-call basis. The local operator
then invoices the subscriber and collects the charge. Also in most cases,
interconnection access and termination rates are not used. Rather, retail
charges are used as the basis of revenue sharing between operators.

The interconnection regime devised by the Canadian Radio-Television and
Telecommunications Commission (CRTC) is interesting, and unique too. Under a
two-tier system, a mobile operator can choose to interconnect as a wireless
service provider (WSP) or as a competitive local exchange carrier (CLEC). As a
WSP, the mobile operator is treated as a large customer, receiving no
compensation for calls it terminates and paying for termination on the fixed
network (on a bulk basis). If the mobile operator interconnects as a CLEC, the
relationship would be as between peers. In this case, the mobile operator
interconnects with a fixed operator for local traffic on a sender-keeps-all
basis. Either party makes no payment to the other for traffic termination within
the same exchange. If there is a large traffic imbalance, sender-keeps-all does
not apply, and specific per-trunk rates apply.

The Prevailing Models

Perhaps the most contentious issue pertaining to interconnection is the
determination of the interconnect charge–what it should be and how it should
be calculated. Regulators and operators are yet to agree on an ideal way out.
And it is not just assessing and setting interconnection prices that remain
highly problematic, the implementation of pricing regimes has offered more
complex challenges. Complex economics apart, the problem of pricing is
complicated by political considerations (like social welfare issues).
Mobile-to-mobile interconnection rates, which are usually set through commercial
negotiations among operators and have not generally formed the basis for any
regulatory intervention, have to be lower than mobile-to-fixed or
fixed-to-mobile rates.

While there is no globally accepted benchmark for determining interconnection
charges, cost-based pricing, based on different forms of long-run incremental
cost (LRIC) models, appears to have gained considerable acceptance with most of
the regulators. LRIC can be defined as forward looking incremental costs that
can arise on account of interconnection. In other words, the total costs are
divided into common costs (common to the interconnection provider and seeker)
and additional costs (that could arise on account of interconnection to a new
operator). It is the additional costs that are termed as incremental costs. But
it has never been easy to measure and assign costs based on this method. Several
methods have been applied to assign and allocate costs associated with the
establishment, maintenance and replacement of network elements and service. The
assignment of underlying infrastructure costs and joint or common costs is
however viewed with suspicion by operators. As the lines between technologies,
markets, services and players blur, historical cost allocation difficulties are
exacerbated.

Which Country Prefers What?

In the UK, the total service LRIC is used to determine prices. A commercial
agreement is the basis of interconnection among operators, though there has been
an industry agreement that there will be reciprocal interconnection charges
based on the incumbent’s charges.

A majority of incumbent fixed network operators in Western Europe (Austria,
Denmark, Germany, France, UK, Ireland) base their interconnect rates on a LRIC
model. Such charges are typically determined or informed using a bottom-up
and/or top-down LRIC modeling approach.

Sometimes it is argued that since incremental cost prices for services are
too small to recover total cost of network, fixed costs must be allocated. Total
Element LRIC (TELRIC) is supposed to solve this problem. TELRIC applies
incremental cost principles to network components rather than services to
minimize common cost allocation problems.

In most of the cases in the US too, rates for local service interconnection
are determined on the basis of TELRIC through commercial negotiations under
pricing guidelines set by the state commissions. Inter-state rates (access
charges) are subject to tariff under an FCC price cap formula. Sate commissions,
under price caps or rate-of-return regulation, set intra-state rates. In the
TELRIC method, each network element is a separate increment (although the
elements were chosen to avoid large common costs among them).

In the US, LRIC is also used in combination with the fully distributed cost (FDC)
methodology to determine interconnection costs. For example, intra-state access
charges use an underlying FDC method and specific switched access rates for the
largest providers, while unbundled network element charges use total service
LRIC. FDC is the total costs of the operator, split or distributed among the
various services that it provides. The distribution of costs depends upon the
accounting attribution and allocation methods adopted.

Countries like Japan and other members of the European Union are also
considering the use of LRIC to determine interconnection charges.

TSLRIC–Modeling Techniques

In all the countries that have charges based on total service LRIC (TSLRIC)
in place, apart from Hong Kong, the interconnection charge includes a mark-up
added to the TSLRIC. Usually, one of these three approaches–top down, bottom
up and international charge comparison–is followed to determine the
quantitative aspects of the above pricing policies. The top-down approach builds
upon a service provider’s accounting information. The results are traced back
to recorded costs and can be audited and verified but include the company’s
inefficiencies; so results are above efficient level of costs. In the bottom-up
approach, an engineering model determines elements of a network required to
supply service using most efficient commercially available technology (e.g.
LECOM and HCPM). This understates the true level of costs and assumes an ideal
network design. Finally, a comparison with charges in other countries is also
done in many cases.

Average charge ranges derived are used to set charges. The advantage is that
it reflects interconnection charges actually in place, and not the hypothetical
costs. The downside is that charges in other countries do not directly reflect
costs in the host nation.

All three approaches are in use around the world. The US uses proxy models
using HCPM and LECOM, while the UK and the Netherlands take a hybrid approach
verifying both top-down and bottom-up models and then reconciling the results.
In Germany and France, international comparisons have been used as the basis to
set interconnection charges.

Towards an Ideal Model

Some of the European regulators (like in Austria) favor what is termed as
‘forward looking long-run average incremental costs (FL-LRAIC)’. FL-LRAIC
basically takes future technological advances into account to determine the cost
of setting up new networks. The interconnection costs arrived at using this
method are lower. This is because the cost of setting up future networks is
supposed to be lower than the existing ones on account of new and more efficient
telecom technologies.

Those regulators that have not been able to apply LRIC, often look at
international benchmarks as standards to determine interconnection charges. For
example, in the EU, the upper limit of the lowest of three fixed domestic
interconnection rates (local, single-transit and double-transit) is used as the
best practice guideline for the 15 member states.

Among other parameters, the success of telecommunications liberalization in
any given market will depend a lot on the nature of the interconnection
regulation that the market follows. Unfortunately, the world is yet to find an
interconnection model that can be termed as ideal. Yet, regulators worldwide
continue working towards a nondiscriminatory and transparent regime.

Ravi Shekhar Pandey