Transcript NBED Title of the document

Introducing Analysys Mason: expertise in price squeeze
Q1 2008
For more information please contact:
Bram Moerman
Email: [email protected]
Web: www.analysysmason.com
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Price squeeze analysis verifies whether there is enough economic space
for alternative operators to compete effectively
NRAs need to balance two opposing goals when regulating wholesale
tariffs:

guarantee that margins for alternative operators (OLOs) are not
squeezed by an excessively reduced margin between the
incumbent’s retail and wholesale tariffs
ensure that low tariffs for a particular wholesale service do not
squeeze another wholesale alternative
–
for instance, local loop unbundling may be squeezed by
low wholesale tariffs for bitstream, resulting in underinvestment by OLOs
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Illustration of outcome of a static price squeeze model
100%
90%
80%
70%
60%
50%
40%
30%
20%
10%
0%
10
50
40
30
5
20
10
0
0
-10
2004
2005
Interconnection costs
Own network costs
Margin
Equally efficient
operator test
Interconnect link costs
Average costs OH and retail
2007
2008
2009
-20
-30
-5
Revenues
Reasonably efficient
operator test
2006
Cumulative units (GBP millions)

Illustration of outcome of a dynamic price squeeze model
Annual units (GBP millions)

Opex + capex
FCF
Cumulative FCF

Reaching a satisfactory compromise between these two goals requires a
very good understanding of the economics of the services under
examination and their likely evolution over the future years

Depending on the nature of the service and the status of the market, a
static or a dynamic price squeeze test may be a more appropriate choice:


static models are in general appropriate for mature markets

dynamic models (cashflow) are appropriate for early-stage
markets or markets under significant change
It is also essential to determine whose costs need to be taken into
consideration: those of the incumbent (leading to the ‘equally efficient
operator test’) or those that an alternative operator can realistically
achieve (the ‘reasonably efficient operator test’)
Source: Analysys Mason
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A price squeeze analysis often needs to be undertaken rapidly
in response to a formal complaint from a competing operator

Disputes can concern either predatory pricing of outputs or excessive
pricing of wholesale inputs


Possible impact of price changes
EUR
Effect of price change?
To be able to accurately assess the available margin, a detailed
understanding is required of the costs of the competing operators
(wholesale inputs and own network costs)

This is further complicated by the fact that often more than one wholesale
product can or has to be used to be able to provide an equivalent retail
service – which is often the case for broadband services
Potential for price squeeze in the supply of DSL services
Excessive pricing?
DSLAM
Output
price
End user

too high a margin, if imposed by regulation, can lead to undesired
effects just as much as too low a margin

Predatory pricing?
Wholesale
input price
With margins for most telecoms services being low, price squeeze
models need to have a high level of accuracy if used for setting margins –
a difference in margin of 1cent could potentially be significant:
ATM
BAS
networ
k
ATM parent
ATM distant
switch
switch
Custome
r
services
IP
networ
k
ISP
Squeeze disputes can arise at different levels:

route – e.g. between City A and City B

service – e.g. national calls

customer type – e.g. residential

geography – e.g. rural customers

company level
DSLAM access
ATM parent
switch access
ATM bitstream
ATM distant
switch access
IP access
IP bitstream
Potential broadband price squeezes
Resale
Retail
Retail
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Our approach ensures that both the technical and commercial requirements
of the services under consideration are properly addressed
From the commercial side, the price squeeze test demands full
understanding of all retail costs
The price squeeze test requires comprehensive modelling
of the technical requirements of the service
• Accurate modelling of the efficient
usage of the wholesale services
on a forward-looking basis
• Understanding alternative
technical architectures that may
be employed
• Capex and opex requirements
associated to each alternative
• Potential economies of scope
associated to the provision of
complementary services
Whol
Own
esale
infra
Costs along the value chain to be considered
in a price squeeze model*
prod
struc
ucts
ture
(provi
and
Retail costs
ded
other
by
tech
incu
nical
• COGS on mben
• Switching cost
• Advertising
consumptiont)basis
• Transmissions
• Acquisition
(per subscriber, per
minute)
• Backhaul
• Commissions
• COGS on capacity
basis (per port, per
point of presence)
• Activation fees
• Complementary
wholesale products
• O&M
• Software updates
• International
connectivity
• Roaming
• We provide relevant benchmarks and support on the determination of key
variables for the design of the price squeeze test:

us in a excellent position to complement and cross-check cost information
provided by operators
(including discounts and
subsidies) need to consider the
competitive environment of the
specific retail market
• Start-up costs may be of relevance
in the case of recently liberalised
markets or markets that require
demand building actions on the
side of operators
• Distribution
• Billing
• Post-sale service
• Customer care
• Bad debt
• Our models generate a number of critical outputs, including:

appropriate time horizon and cost of capital for OLOs
• Our experience in business planning and international benchmarking places
• Advertising and acquisition costs

overall profitability and profitability split by service and customer
segment for greater visibility of results
minimum gross margin required to achieve economic break-even
(including return on capital employed)
*Source: Analysys Mason
Some of our high-profile price squeeze assignments
are presented in the following slides
Case studies
Client type
Summary
Case study 1
Incumbent operator
Design of new broadband access offers that meet regulatory
conditions, including price squeeze test
Case study 2
France Telecom
Impact of pricing proposals by France Telecom on the business
case of alternative operators at all positions in the value chain
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Case study 1: Design of new broadband access offers that meet
regulatory conditions, including price squeeze test
Business challenge
• Our client was intending to lower its Internet access service prices. As such, it sought to develop robust economic and regulatory documentation to preempt potential complaints from its competitors, which were trying to demonstrate that its offers were squeezing them
• Analysys Mason was asked to provide economic elements to demonstrate that the offers from the incumbent were not anti-competitive
Approach
• Provided advice and cost inputs related to the development of a margin
squeeze test, which aimed to show that our client's offers could be
replicated by an alternative operator in a profitable way
• Carried out a detailed international benchmark of broadband offers to
assess the position of incumbent Internet service providers (ISPs) in
comparison to their main competitors:

this benchmark was used to demonstrate that in other European
countries the prices of the incumbent operators were close to the
prices of alternative operators for similar services
List of cost inputs provided for squeeze test
Network costs
Other costs
DSLAM
Service platforms
Customer care
ATM routers
Leased lines
Billing and
debt collection
ATM switches
Co-location
Bad debt
Ethernet switches
IP transit
Sales and marketing
GBIC modules
Dark fibre
G&A
IP routers
Broadband
access server
Subscriber acquisition
Benefits and results
• The results of our work were used by our client to design its offers as well as prepare the dossier to be used in front of the regulator and other competition
bodies
• Our inputs allowed our client to gain regulatory approval for its offers
Case study 2: Impact of pricing proposals by France Telecom
on the business case of alternative operators at all positions in the value chain
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Business challenge
• The French regulator was in the process of reviewing and validating the evolution of wholesale tariffs. As such, the members of the AFORST* wished to
obtain a robust and objective reference tool for modelling the various tariff options for France Telecom’s broadband DSL products. This tool was intended
to form the basis for a healthy and uncontestable discussion of these tariff options
• Analysys Mason was commissioned to help alternative operators and the regulator appreciate the impact that the evolution of the incumbent’s retail and
wholesale DSL prices was having on the DSL market
Approach
• Given the AFORST members’ different positions, a broad approach
was required: for some members, the ‘squeeze effect’ of changes in
certain specific tariffs was of critical importance; others were more
interested in an analysis of France Telecom’s costs with the
consequent possibility of a general reduction in tariffs
Output from economic models developed (extract)
• To reflect these varying concerns and priorities, we developed
a set of robust economic models, for use by the operators and the
regulator, to: a) analyse the business case of operators at all positions
in the value chain (such as infrastructure-based operators, retail ISPs
and vertically integrated operators); b) investigate the possibility of
the existence of a margin squeeze; and c) calculate the long-run
incremental costs incurred by France Telecom in offering
wholesale DSL services
Benefits and results
• Our methodology made it possible to respond to the needs and concerns of all AFORST members. The results of this study were presented to the French
regulator, which took them into account when evaluating the price evolution requested by France Telecom
• We
developed a parametric model that could easily be set up to represent the business model of various OLOs/ISPs (infrastructure based, simple
reseller etc.). Our models have been used by several operators in their responses to regulatory consultations on broadband markets
*Association of French Service and Telecoms Network Operators
Other recent examples of our price squeeze projects [1]
Country
Client type
Project scope
Our achievements
Cyprus
NRA
To inform the regulator on the cost orientation of
the regulated retail and wholesale services
provided by the fixed and mobile incumbent
• We audited a fully-allocated cost model using
historical costs and a LRIC model using current
costs of the fixed and mobile incumbent
• We helped the regulator to determine regulated
tariffs
Greece
South East Asia
Western Europe
Australasia
NRA
NRA
New entrant
Alternative
operator
To review the costs of the different actors in the
Greek retail and wholesale market. The goal was
to determine the margins in order to see if the
regulated IX and retail tariffs needed adjustment
• We developed a calibrated model based on a
Evaluation of price squeeze between retail and
wholesale DSL and cable access products in
order to determine whether anti-competitive
pricing was occurring
• The outcome of our study was a report and Excel
Market and competitor analysis in assistance of
the Product Manager of a new entrant in the
residential telephony market
• The project involved market and competitor
An international benchmarking study of
wholesale price structures and price levels
for a range of services, including leased lines
and DSL
• The study discussed the economic principles of
theoretical OLO and used costing and network data
from the OLO and the incumbent. The results were
used to set remedies for ensuring proper
competition in accordance with the country's law
model which are being used by the NRA to inform
its thinking on future regulation to be imposed in the
broadband markets
analysis of offers and prices, pricing and margin
analysis, advice on regulation and interconnection,
as well as ad-hoc advice on developments in the
European market
wholesaling and evaluated the merits of retailminus and cost-plus methodologies. The final report
was used by the client to respond to government
proposals for wholesaling
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Other recent examples of our price squeeze projects [2]
Country
Client type
Project scope
Our achievements
Western Europe
Incumbent
For a major Western Europe incumbent, we
provided regulatory assistance to the launch of
new voice packages for the residential market
• We conducted an international benchmark of
Alternative
carrier’s carrier
Assessment of a marginal cost and pricing model
to identify product profitability across various panEuropean routes
• The project identified the critical value drivers and
Local loop
provider
Development of a retail price and margin analysis
tool and advice on innovative pricing strategies
Europe
Europe
similar offers and prepared pricing and margin
squeeze tests to present to the regulator. We also
assisted in preparing meetings with the regulator.
Our client appreciated our responsiveness during
the process, which contributed to get the offers
approved
recommended a sales channel strategy to optimise
short-term value. On the basis of our advice, the
client’s performance prospects have been
materially improved
• The tool analysed every level of aggregation, from
the price of an individual call right through to the
total bill paid by a class of customers for a bundle
of services. The tool was extended into a
comprehensive bottom-up market forecasting
system
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Industry commentary [1]
Price squeeze analysis: the need for deeper understanding and greater consensus
Price squeeze is a well-known problem that can affect sustainable
competition in telecoms markets. The EC states that “where the
operator is dominant in the product or services market, a price squeeze
could constitute an abuse.” Price squeeze analysis has therefore
become an important tool in the hands of regulators seeking to
understand the competitive landscape of their markets and to produce
effective regulatory decisions. A deeper understanding will help create
telecoms markets (narrowband and broadband) that function more
efficiently
Exhibit 1: Issues and options for intervention for the regulator,
according to the outcomes of price squeeze analyses for dominant
and alternative operators
There are two perspectives to analysing price squeeze. From the
perspective of a dominant operator, price squeeze is demonstrated by
showing that the dominant company's own retail operations could not
trade profitably on the basis of the wholesale price that it charges its
competitors. From an alternative operator’s perspective, price squeeze
exists where it can be demonstrated that the margin between the retail
price which the alternative service provider charges and the wholesale
price charged by the dominant operator is insufficient to allow a
reasonably efficient service provider to obtain an acceptable profit.
Both perspectives can co-exist, however they produce different
outcomes. Regulatory conclusions on price squeeze will therefore need
to take into account both points of view
As shown in Figure 1, there are five basic scenarios that can be
presented. The situation that we have described as “effective
competition” is one which does not represent significant imbalances in
price squeeze between the dominant operator and alternative
operators. However, in many of the cases price squeeze will exist,
either for alternative operators or the incumbent. The possible
regulatory actions and risks will depend on the particular price squeeze
scenario
*Source: Analysys Mason
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Industry commentary [2]
Price squeeze analysis: the need for deeper understanding and greater consensus (contd.)
Whatever approach is taken, the conclusions of price squeeze
analyses will depend on exactly how the revenues and costs of the
dominant and the alternative operators are modelled (and separated
between services). Consequently, differences in modelling
methodologies and/or modelling assumptions might lead to different
outcomes. It is therefore in the interest of the regulator to understand
the revenue and cost models used, how they should be interpreted and
what assumptions or methodological and quantitative aspects could be
debated or corrected. Some of the most relevant issues which need to
be examined include:
• Should
the dominant operator’s costs be long-run, short-run,
incremental, or forward-looking?
• How should mark-ups be considered? Is incremental costing used?
• Has cost accounting and separation been carried out correctly? Has it
been verified from a methodological perspective? Has it been
audited?
• What is a ‘reasonably efficient’ operator or service provider? What is
its size and its market share?
• What is ‘normal’ or ‘acceptable’ profit? Should the rate of return of the
dominant operator be the same as that for an alternative operator?
• Is
the alternative operator’s perspective sufficiently dynamic and
forward-looking to grasp the evolution of the scale of its business?
• How is terminal value taken into account in estimating the costs of the
alternative operator in the long term?
The more closely these issues are analysed and corrected, the better
the regulator will be able to understand the situation. However, in some
circumstances finding an objective solution will be difficult – for
example, regarding certain specific assumptions on the evolution of
service take-up. Industry players and regulators will then need to find
consensus in order to create stable and properly functioning markets
Analysys Mason has performed narrowband and broadband price
squeeze analyses for regulators, and for regulatory departments within
incumbents and new entrants. Our analyses have assisted
organisations, to understand the competitive forces and build to
consensus on the way forward