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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