Cost Issues in International Settlements

1. Cost Issues inInternational Settlements March 1998 DNTADavid N. Townsend & Associates DNTA@dntownsend.comhttp://www.dntownsend.com/dnta/

2. Cost component definition: the ITU framework ITU-T Recommendation D.140 defines three basic operational components (network elements) of international telephone termination service: 1. International transmission facilities 2. International switching facilities 3. National extension

3. Cost component definition: the ITU framework 1. International transmission • Earth station • Submarine/terrestrial cable system • Cable landing station • International terrestrial radio links • National links between these facilities and the International Exchange

4. Cost component definition: the ITU framework 2. International switching • International telecommunications maintenance and operations center • Telephone exchange • Associated transmission and signaling equipment

5. Cost component definition: the ITU framework 3. National extension ITU definition: The national extension, used for international telephone traffic, consists of national exchanges, national transmission facilities and, if appropriate and identified under a bilateral or multilateral agreement, the local loop.

6. Cost component definition: the ITU framework 3. National extension A. For combined international and national administrations: • Trunk switches/national exchanges • National transmission facilities • Local loop, “if appropriate and identified under bi-lateral/multilateral agreement”

7. Cost component definition: the ITU framework 3. National extension B. For separate international and national administrations: Payment by international administration to national administration on the basis of: • Per minute • Annual lump sum • Revenue/Cost sharing (e.g. percentage of international collections), or • Combination of any of above three

8. The FCC methodology: Tariffs as surrogate for costs Two basic components to the FCC’s “Benchmark Order” (Docket 97280) on international settlement rates to be paid by U.S. carriers: 1. Development of cost estimates using a “Tariffed Components Price” (TCP) methodology; and 2. Development of “benchmark” settlement rates, based upon worldwide averages of TCP costs.

9. The FCC methodology: Tariffs as surrogate for costs 1. International transmission • The FCC uses tariff prices for international leased circuits. • Formula = price for 2.048 Mbps circuit  (120 lines x 8,000 mins per line) • Results range from 0.7¢ per minute (Mexico) to 25.5¢ per minute (Kenya), with most countries’ results falling below 10¢ per minute.

10. The FCC methodology: Tariffs as surrogate for costs 2. International switching • The FCC utilizes the published switching component of TEUREM (European) country settlement charges. • Countries are divided according to three categories of economic development. • Results range from 1.9¢ to 4.8¢ per minute.

11. The FCC methodology: Tariffs as surrogate for costs 3. National extension • The FCC uses a complicated formula of weighted averages of local and in-country long distance tariffs. • Based upon a sample of incoming traffic to each country from the U.S. • The results range from a high of $25.2¢ per minute to a low of zero, for three countries that don’t charge for domestic calls on a per-minute basis.

12. Problems with the benchmark approach • The term “benchmarks” is meant to describe average or target cost or price levels for an entire industry. • Benchmark prices do not necessarily reflect the actual cost experience of any given operator. • The goal is to establish an approximate industry-average cost, as an objective for all operators to move toward.

13. Problems with the benchmark approach • Benchmarks assume that costs are, or should be, the same across widely different countries and economies. This is clearly not true. • Under the FCC policy, countries with above average costs must lose money on international settlements, while countries below can make a profit.

14. Problems with the benchmark approach Examples: Russia TCP = 35¢ per minute Thailand TCP = 17¢ per minute Benchmark for both = 19¢ per minute

15. Problems with the FCC “TCP” for national extension costs • Improper use of non-discrimination principle • Below-cost national tariffs • Ignores fixed charges • Rebalancing effects

16. Problems with the FCC “TCP” for national extension costs • No accounting for domestic access charges • Miscalculation of local tariffs • Incorrect assumptions about commercial costs • Rejecting Universal Service contributions

17. Toward a theoretical basis for national extension costs Three components to economically “appropriate” national extension costs: 1. Incremental cost of national usage 2. Proportionate share of joint and common costs 3. Support for infrastructure development

18. Toward a theoretical basis for national extension costs 1. Incremental national usage cost • National trunks • Tandem switches • Local switches Total recurring capital + operating costs, divided by combined total minutes of use in network.

19. Toward a theoretical basis for national extension costs 2. Share of joint and common costs • Administration and commercial overhead expenses (excluding marketing costs) • Local loop recurring capital and operating costs (existing loops only) • Subtract monthly subscription revenues Divide result by total minutes of use in network.

20. Toward a theoretical basis for national extension costs 3. Contribution to infrastructure (Universal Service) • Projected near-term annual network investment • Subtract projected annual connection charge revenues Divide result by total minutes of use in network. Yields an upper ceiling for contribution element.