Pricing domestic telecommunication services to reflect costs

Dr Tim Kelly, ITU Seminar on Cost-based Tariffing, Delhi, 16-18 February 1999

The views expressed in this paper are those of the author and do not necessarily reflect the opinions of the ITU or its Membership. Dr Kelly can be contacted by e-mail at Tim.Kelly@itu.int

Pricing domestic telecom services to reflects costs

Agenda
lSupply and demand
Approaches to pricing Approaches to costing TRAI tariff study

lTariff rebalancing lTariff comparisons lPrice regulation lStructure of presentations and background reading

Pricing domestic telecom services to reflects costs

The functions of pricing

lTo forge a link between supply and demand lTo generate revenues and cover costs of providing service lTo convey information to customers concerning the service lTo provide a platform for competition

Demand is a function of price

Teledensity and monthly residential telephone rental (US$)
Monthly subscription charge (US$)
$ 15

Paying more. Demand met.

$ 10

Supply
Paying more. Demand not met.

$5 Paying less. Demand not met. Paying less. Demand met.

Price / Demand
$0 10 20 30 40 50 60

Main lines per 100 inhabitants

Source: ITU World Telecommunication Development Report, 1998: Universal Access

Pricing strategies, selected countries

Teledensity and monthly residential telephone rental (US$)
Monthly subscription charge (US$)
$ 15

Barbados

$ 10

Supply
Australia

India
$5

Price / Demand
Ghana
$0 10 20 30 40 50 60

Main lines per 100 inhabitants

Source: ITU World Telecommunication Development Report, 1998 (forthcoming).

Pricing domestic telecom services to reflects costs

Approaches to pricing
lDemand-based pricing
Pricing according to what the customer is able to pay May be required by politicians (monopoly environment)

lCost-based pricing
Pricing according to what the service costs to supply May be required by regulators (regulated environment)

lMarket-based pricing
Pricing in order to compete with other suppliers in the marketplace May be required by shareholders (competitive market)

Pricing domestic telecom services to reflects costs

Reasons for cost-based pricing

lTo cover the full costs of providing the service lTo recognise cross-subsidies between services and between users
to eliminate them to make them explicit, e.g., for Universal Service

lTo prepare for competition lTo prevent abuses of competitive position

Pricing domestic telecom services to reflects costs

Approaches to costing
lFully-allocated pricing models (e.g., TAS cost model)
total costs for providing service (including historical, depreciated investment costs) divided by the volume of service provided (e.g., minutes of use, number of subscribers)

lIncremental pricing models (e.g., LRIC)

marginal cost of providing an additional unit of service (e.g., next minute of traffic, next subscriber)

l1001 different flavours of the above

Pricing domestic telecom services to reflects costs

TRAI tariff study: Objectives

lEncourage access to and use of the network lCater to social objectives (e.g., targeted subsidies) lCost-based prices
as preparation for competition so that benefits are shared by all users

lMaintain profitability for all operators

Pricing domestic telecom services to reflects costs

Traditional pricing structures

lCross-subsidies to network access
Connection charges cover only a fraction of costs Low-cost monthly rental

lCross-subsidies to local loop

High-cost international and long-distance charges Free, unmetered or low cost local calls

lGeographical and social averaging of costs

Uniform charges for connection & rental One price fits all

Pricing domestic telecom services to reflects costs

Market-oriented pricing structures

l Cost-oriented
Connection charges reflect real underlying costs Monthly rental includes only a small element of usage

l Reflecting technology trends

moving towards distance-independent tariffs biggest price cuts in international call charges

l Market-driven
Tariff options for different user groups Discounts, special offers, promotional prices .

Tariff rebalancing trends, in US$

12 10 8 6 4 2 0 1990 1991 1992 1993 1994 1995 1996 1997
Source: ITU World Telecommunication Indicators Database.

Average of 39 major economies

300 minutes, local calls 3 mins Int'l call to US Monthly line rental

Tariff rebalancing trends, in US$

For India
12 10 8 6 4 2 0 1990 1991 1992 1993 1994 1995 1996 1997
Source: ITU World Telecommunication Indicators Database.

300 minutes, local calls 3 mins Int'l call to US Monthly line rental

Pricing domestic telecom services to reflects costs

Typical evolution in monthly subscription charge

lMonthly fee kept well below cost Social lMonthly fee includes free local calls plus rental of handset plus services lUnbundling of monthly subscription
handset rental; local calls extra services, e.g., Directory inquiry

lSplit between residential and business subscriptions Costbased lProgressive rise towards costs

Monthly residential subscription, in US$:

Selected countries plus World average
Thailand Russia Turkey Venezuela India Malaysia Indonesia Philippines Hongkong Brazil Average Mexico
Source: ITU World S. Africa Telecommunication Indicators Database. Argentina

$3.19 $3.43 $4.12 $4.16 $5.15 $7.11 $7.22 $8.53 $8.91 $8.94 $9.39 $9.75 $12.05 $12.83

Pricing domestic telecom services to reflects costs

Typical evolution in local call charges

Social

lFree local call charges included in monthly subscription lLimited number of free calls included in subscription, others charged lLocal calls timed and metered lSize of pulse unit shortens lSize of local call zone shrinks

Costbased

Existing and proposed local call charges, India

No. of bimonthly calls Up to 120 121-150 151-250 251-450 451-500 501-1 000 1 000-2 000 2 001 plus Existing per call charge, rural areas Free Free Free 0.60 0.80 1.00 1.25 1.40 Existing per call charge, urban areas Free Free 0.80 0.80 0.80 1.00 1.25 1.40 Proposed per call charge, all areas Free 1.30 1.30 1.30 1.30 1.30 1.30 1.30

Source: TRAI Consultation Paper on telecom pricing, September 1998.

Pricing domestic telecom services to reflects costs

Typical evolution in long distance prices

lHighly distance sensitive charges. Social Long distance call >100 times cost of local call lIntroduction of off-peak rates lReduction in number of bands lReduction of distance and duration elements Cost- lLong-distance call <3 times cost of based local call

Long distance m arket share % share of long distance calls 35% 30% 25% 20% 15% 10% 5% 0% 1991 1992 1993 1994

NCCs (Japan) Clear (NZ) Optus (Aust.)

As competitors gain market share ...

Long distance prices Index, 1993=100 100 Japan New Zealand Australia

1995

1996

95 90

Long distance prices come down ...

Source: ITU Asia-Pacific Telecommunication Indicators, 1999.

85 80 75 1993

1994

1995

1996

Pricing domestic telecom services to reflects costs

Tariff comparisons: What for?

lTo carry out benchmarking between operators in similar countries lTo track effects of tariff rebalancing over time lTo provide comparative information for managers, regulators, users lTo create baskets of different services to compare like with like

Pricing domestic telecom services to reflects costs

Different types of tariff comparison

lIndividual rate comparisons (e.g., installation charge, local call rate) lComposite basket with fixed components (e.g., Siemens basket) lComposite basket with variable components (e.g., OECD Tariff Comparison basket) lVariations over time in same indicator

OECD tariff baskets: Then and now ...

Six baskets defined: lBusiness telephony lResidential telephony lInternational telephony lMobile communications lX.25 data communications lLeased lines at 9.6 kbit/s, 56/64 kbit/s and 1.5/2.0 Mbit/s Comparisons between countries lAdditional telephony baskets to take account of usage discounts (e.g. small businesses, multinationals, elderly) lCombined national and international telephony basket lAdditional baskets needed for Internet, ISDN, digital mobile (roaming), PCS, ATM etc Comparisons between operators within countries

Pricing domestic telecom services to reflects costs

Price regulation: Why?

lTo ensure that the benefits of competition and technological change are shared by all users lTo protect the interests of specific user groups (e.g., low volume users, rural areas) lTo ensure that incumbent operator does not abuse its dominant position lTo regulate specific services
e.g., Interconnect price for competitive operators e.g., Leased line charges for Internet Services

Price regulation of BT, 1984-92

10.0% 8.0% 6.0% 4.0% 2.0% 0.0% -2.0% 1984 85 86 87 88 89 90 91 92 Retail Price Index (RPI) RPI - "X" BT price changes

Pricing domestic telecom services to reflects costs

TRAI proposed price s regulation regime

Service Rental Local calls Longdistance International Other Price cap principle Below cost price Cost without margin Cost-plus Comment Cost-based rental would reduce access

Upper limit of estimated cost taken as price To provide cross-subsidy for rentals, local calls Cost plus To provide cross-subsidy for rentals, local calls Mainly cost-based Depending on service and or reporting degree of competition requirement only

Pricing domestic telecom services to reflects costs

Structure of presentations and background reading

lPricing domestic services to reflect costs lPricing strategies to achieve Universal Service / Universal Access
Chapter 2 from WTDR98: Pricing Access

lPricing int services towards costs l

Chapter 6 from DoT96: Future pricing

lImpact of the Internet on pricing

Chapter 6 from Challenges99: Internet for PTOs

lIndia Country Case Study

ITU/Phillips Tarifica/IIM case study of India