Methodologies for computing telecom costs
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Methodologies for Computing Telecom Costs. Rural Task Force Workshop Richard N. Clarke Portland, MaineAT&T - Public Policy 29 September 1999908-221-8685. Presentation overview. Evaluating costing methodologies: Historical embedded costs (HEC) Fully distributed costs (FDC)

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Methodologies for Computing Telecom Costs

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Methodologies for computing telecom costs

Methodologies for Computing Telecom Costs

Rural Task Force Workshop Richard N. Clarke

Portland, MaineAT&T - Public Policy

29 September 1999908-221-8685


Presentation overview

Presentation overview

  • Evaluating costing methodologies:

    • Historical embedded costs (HEC)

    • Fully distributed costs (FDC)

    • Forward-looking economic cost (FLEC)

  • What are the benefits from using FLEC versus other methodologies in terms of:

    • Economic efficiency

    • Competitive neutrality

    • Regulatory efficiency

  • How FLEC can be modeled and computed

  • Role for embedded cost or network information

AT&T


Evaluating costing methodologies

Evaluating costing methodologies

  • Historical embedded costs (HEC)

    • Calculates costs using historical books of account

      • accounting cost categories typically are functional categories

      • these functional categories are used by many services

      • thus, many of these costs are “joint or common”

    • Embodies profile of network designs, efficiency levels, costs and qualities that exist today and in the past

    • Burdensome or unrepresentative for regulators in a multi-carrier market

    • Does not give business managers or regulators correct long run price signals

    • May not be competitively neutral

AT&T


Evaluating costing methodologies1

Evaluating costing methodologies

  • HEC example 1

    • It cost $300/line for end office switching ten years ago

    • Now, it costs $150/line

    • How can an ILEC base its local service prices on a switching HEC of $300/line if a new CLEC competitor is basing its prices on $150/line?

    • A business or a regulatory decision to price based on HEC will invite customers to either:

      • use an alternative vendor’s service, or

      • forgo completely purchasing these services

AT&T


Evaluating costing methodologies2

Evaluating costing methodologies

  • HEC example 2

    • It cost $800/line to install loop OSP ten years ago

    • Because the area is now more developed and paved, it now costs $1200/line

    • Why should an ILEC base its local service prices on a HEC of $800/line if the replacement cost of these loops is $1200/line?

    • A business or a regulatory decision to price based on HEC will:

      • not be competitively or profit-optimal, and will

      • incent customers to buy “too many” of these services

AT&T


Evaluating costing methodologies3

Evaluating costing methodologies

  • Fully distributed costs (FDC)

    • Cost information may be collected by accounting classifications that differ from service classifications, thus these costs must be allocated across services

      • such “overhead” costs are “joint or common”

      • while certain of these allocations may be driven by relative use, many are intrinsically arbitrary

    • Portion of costs that must be allocated arbitrarily depends on how well accounting categories match service categories

    • Because resulting FDCs are arbitrary, they may not give business managers or regulators correct price signals

AT&T


Evaluating costing methodologies4

Evaluating costing methodologies

  • FDC example

    • A conduit is installed that carries:

      • copper and fiber loop feeder cables

      • fiber cables that connect two local switches

      • fiber cables that connect a local switch to a toll switch

    • How should the cost of the conduit be allocated:

      • equally to each cable?

      • equally to each circuit carried on the cables?

      • disproportionately to the cable/circuits that carry high revenue traffic (i.e., more to the toll cable and less to the feeder cable)?

      • in proportion to the relative diameter of each cable?

      • other?

    • Result is possibly arbitrary

AT&T


Evaluating costing methodologies5

Evaluating costing methodologies

  • Forward-looking economic cost (FLEC) is designed to represent the cost level experienced by an efficient competitor that supplies the market with newly constructed facilities and:

    • Operates efficiently using the best currently-available technologies

    • Serves the total demand for the costed item

    • Earns a “normal” return

AT&T


Evaluating costing methodologies6

Evaluating costing methodologies

  • FLEC is the sum of:

    • Forward-looking incremental costs

      • both fixed and variable costs that are specific to the product

      • computed over the complete, long-run life cycle of the product

    • A “reasonable” allocation of forward-looking joint and common costs

      • these costs occur when the costed item is only produced efficiently as part of a family of related items

      • there is no single “correct” way to allocate these costs

      • goal is to calculate the costs of network elements that share minimal joint and common costs

AT&T


Benefits from using flec

Benefits from using FLEC

  • FLEC provides the appropriate cost guide for decision making when:

    • Production decisions have substantial lead times and/or investments are long-lived

    • Markets are competitive -- or are intended to perform competitively (will maximize carrier profits)

  • Business or regulatory decisions based on FLEC:

    • Promote efficient resource use

    • Support efficient multi-carrier competition

AT&T


Benefits from using flec1

Benefits from using FLEC

  • Failing to use FLEC as the cost measure can institutionalize:

    • Inefficient or static production processes

    • Non-competitive supply

  • Examples

    • Preserve efficient use of in-place resources by repricing switching at its FLEC of $150/line, and loops at their FLEC of $1200

    • If fiber-fed broadband networks are the forward-looking technology, would allocate costs equally to each (assumed fiber) cable diameter

AT&T


Methods of computing flec

Methods of computing FLEC

  • Historical accounting methods, possibly projected forward

  • Activity based methods based on currently used combinations of disaggregated component costs

  • Explicit modeling (or “proxying”) of the actual cost-generating processes:

    • Engineering-generated

    • Economics-generated

AT&T


Advantages of proxy modeling

Advantages of proxy modeling

  • Proxy modeling is a more accurate methodology for computing FLEC because:

    • Historical accounting records are often inaccurate

    • In a dynamic industry, historical accounting records cannot capture forward-looking costs

    • Rigid mathematical projections of current cost levels are also inconsistent and inaccurate

    • Proxy modeling is most capable of capturing costs consistently across the life cycles of the company’s capital equipment and the products that it is used to manufacture

AT&T


Advantages of proxy modeling1

Advantages of proxy modeling

  • Proxy modeling is also superior because:

    • It allows costs to be calculated efficiently for families of interrelated products

      • minimizes the need for repetitive data collection

      • ensures that costs that are joint or common across individual products within a family are treated consistently

    • It allows a single model to be used to determine many different firms’ costs of producing the product

      • facilitates market-wide competitive cost analysis

      • helps ensure that all firms receive equal treatment from a regulator

      • the process of cost development is more transparent

AT&T


Advantages of proxy modeling2

Advantages of proxy modeling

  • Carriers and regulators using proxy models to establish costs can avoid the cost of setting up or operating an accounting system for that purpose

    • In the U.S., most new entrant carriers have no established Part 32/USOA accounting system

    • Even established carriers are looking to dispose of these systems

    • Many have adopted proxy models in lieu of setting up, or in order to get rid of accounting-based cost tracking systems

AT&T


Fl embedded costs in fcc synmod

FL/embedded costs in FCC SynMod

Sources: 1997 ARMIS and 6/2/99 release of FCC Synthesis Model

AT&T


Uses for embedded information

Uses for embedded information

  • Even in FLEC models some embedded information remains useful

    • Input prices are assumed to be today’s best price -- can be provided by accurate current data

    • If regulators may not require recipient LECs to provide a network equal in quality to the one modeled

      • Information about the cost and quality of the embedded network may allow regulators to prevent the LEC from receiving an undeserved windfall

      • Embedded costs could be a ceiling, or the model could perhaps be adjusted to suggest the FLEC of the actually provided service quality

AT&T


Summary

Summary

  • FLEC is the appropriate costing methodology to be used by regulators and business managers

    • In dynamic, competitive markets

    • To ensure rational decision-making over the entire life cycle of individual products, and families of products

  • Proxy models can be used reliably and flexibly to estimate the FLECs of complex underlying engineering and economic production processes

  • Embedded information should only be used as an adjunct

AT&T


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