4.1 The means currently adopted for enforcing the condition providing for action against unfair cross-subsidy is to require the TSPs controlled by the parent companies of the mobile operators Cellnet and Vodafone (and after two years of operation the DSOs of MOTO and Orange) to comply with the Oftel formula referred to in paragraph 2.10. In Section 3 we have put forward the view that the controls on unfair cross-subsidy should continue to apply, but only to operators with significant market power. Oftel considers that two operators at present enjoy such a position, ie Cellnet and Vodafone, which each has around 42-43% of total mobile subscribers. This Document now proceeds to review the application of the monitoring formula to those TSPs to which the controls may be applicable, in the light of the first year's returns made by the respondent companies.
4.2 It is not always appropriate to regard a failure to cover costs in any particular time period as unfair cross-subsidy. Many viable projects may well make losses in their early years while they are building up a customer base and an associated revenue stream, and the loan finance to support the launch phase may be conceptually closer to investment than to cross-subsidy. A temporary failure to cover costs related to the start-up of a new service would not be likely to be thought unfair.
4.3 In the circumstances of the service providers at the time of the Director General's measures of May 1994, accounting losses were to be expected. Because, in all cases, subscribers were attracted to the networks by subsidised handsets, the costs of which were to be recovered through airtime profits, rapid growth in the number of subscribers would inevitably cause losses. Therefore, it seemed most appropriate to measure cross-subsidy by the performance of a subscriber over a relevant period such as the average life of the subscriber.
4.4 Therefore, whilst the investigation of the Talkland complaint involved an analysis of past levels of funding provided by the networks to their TSPs, for the purposes of future compliance cross-subsidy was said to exist where the airtime earnings which it was reasonable to expect from a subscriber did not allow an adequate return on the initial net cost of acquiring that subscriber. This involved a comparison of the economic value of a subscriber with the average cost of acquisition.
4.5 The calculation of the economic value is by means of the following formula:
n n
Monthly Airtime Profit x [(1+I) - 1]/[(1+I) x I]
where n is the life of a subscriber in months and I is the required rate of return per month. This is a forward-looking measure taking account of the expected profits of an additional subscriber over the expected life of that subscriber and the principle of discounting (that the value of the monthly profit from a subscriber diminishes the more remote it is from the date of acquisition). It is a standard actuarial formula for the present value of an earnings stream of finite duration.
where n
is the life of a subscriber in months and I
is the required rate of return per month. This is a forward-looking measure taking account of the expected profits of an additional subscriber over the expected life of that subscriber and the principle of discounting (that the value of the monthly profit from a subscriber diminishes the more remote it is from the date of acquisition). It is a standard actuarial formula for the present value of an earnings stream of finite duration.
4.6 The economic value is then compared to the calculated average net costs of acquisition on the grounds that it is the profits on airtime that allow service providers to recoup the cost of acquisition. The principle underlying the formula is that the net cost of acquisition should not exceed the net present value of the expected future airtime earnings of an average subscriber. If it did so, this would be indicative of cross-subsidy.
4.7 Consideration was given to the idea that amounts paid in Service Provider bulk acquisitions might also indicate a value. This would have been a market value of a portfolio of subscribers, rather than one calculated from returns earned by TSPs. This has the attraction of not requiring the regulator to make assumptions about expected earnings from new subscribers. However it was rejected because it seemed likely that the amounts paid in such cases were distorted. These values could have reflected the expectation of future monopoly profits and may have been connected with attempts to deter entry by new network operators. It is notable that most recent valuations appear to be much lower than those observed several years previously. The relatively small numbers of such transactions also makes it difficult to obtain a reliable contemporaneous value from them.
Oftel believes that the formula given above continues to be the appropriate method of establishing the existence or otherwise of cross-subsidy to TSPs, whether or not individual components are modified (see below). It considers that TSPs linked to Cellnet and Vodafone should continue to submit quarterly returns to enable compliance to be monitored.