Contents

Chapter 1 Introduction

Chapter 2 The structure of the charge controls

Chapter 3 Monitoring compliance with the charge controls

Annex A Standard Services subject to charge controls

Annex B Floors & ceilings

Chapter 1

Introduction

1.1 This is the second issue of the Guidelines on the Operation of the Network Charge Controls. It revises and updates the original Guidelines, which were published in October 1997, and reflects the new Network Charge Control arrangements effective from 1 October 2001.

1.2 The Guidelines are issued to give guidance on the structure and operation of the Network Charge Controls. They explain:

• The structure of the controls on BT’s interconnection charges and classification of services by level of competitiveness;
• The structure of the controls on Concert’s interconnection charges (see paragraphs 2.15 to 2.33);
• Treatment of new services under the controls;
• Movement of services between categories of competitiveness;
• The process for notification of changes to charges by BT; and
• How BT’s performance against the controls is monitored.

1.3 And in separate annexes:

• A full list of BT’s interconnection services that are subject to charge controls; and
• The methodology for deriving floors and ceilings for interconnection services

1.4 These Guidelines should be read in conjunction with the guidelines on The Application of the Competition Act in the Telecommunications Sector, March 2000 (OFT417), which explain how the Competition Act 1998 will be applied and enforced in the telecommunications sector, and Oftel’s Guidelines on interconnection and interoperability, July 1999. How to make complaints about breaches of licence conditions or anti-competitive behaviour is set out in Making a formal complaint to Oftel – guidance for the telecommunications industry, March 2001. On 9 November 2001, Oftel published Requesting the Director General of Telecommunications to resolve an interconnection dispute in which it gave guidance on interconnection dispute resolution that it will publish in November 2001.

1.6 On 16 October 2001, BT announced that it had reached binding agreements to dissolve Concert, its joint venture with AT&T, and return the respective assets to the parent companies. The formal splitting of Concert is not expected to take place before mid-2002. Oftel will consider the implications of this break-up for the Network Charge Control regime and the Guidelines, which will be amended as necessary.

1.7 The European Commission has proposed a new regulatory framework for communications in draft directives including one that covers "access and interconnection". These directives are expected to be agreed and enter into force early in 2002 and implemented within Member States within fifteen months of their coming in to force. Oftel will consider the implications of these directives on the Network Charge Controls in the course of its implementation programme.

Chapter 2

The structure of the charge controls

2.1 The second Network Charge Control regime came into effect on 1 October 2001 and is set to run until 30 September 2005. Under the second regime, as with the first, BT’s and Concert’s interconnection services are subject to charge controls if there is insufficient competition in the relevant markets. In a competitive market, competition would constrain prices for services in that market and, therefore, charge controls would be rendered unnecessary. If the relevant market is not competitive, charges for services in that market would not be subject to the constraint provided by competition. Oftel therefore generally applies charge controls to services in markets in which competition is not effective. Overall, Oftel has identified four categories of competitiveness for services in interconnection markets. These are:

• Competitive Standard Services;
• New Standard Services;
• Prospectively Competitive Standard Services; and
• Non-Competitive Standard Services.

2.2 The charges for the latter two categories of service are subject to charge controls. Services in markets in which competition is prospectively competitive are subject to safeguard controls set at RPI+0%. These controls are disaggregated by time of day, day of week and distance as necessary. Services in non-competitive markets are subject to RPI-X% controls under which the value of ‘X’ is set on the basis of a number of factors and these include the returns made on the relevant services at the end of the preceding charge control period. In addition, BT has to ensure that all interconnection charges meet the generally applicable conditions in its licence and are not contrary to competition law.

2.3 A full list of BT’s of interconnection services that are subject to charge controls is set out at Annex A.

Services in competitive markets: competitive services

2.4 An interconnection service is deemed to be in a competitive market only if the Director General has determined that that is the case following an investigation into competition in the relevant market. Once the Director General has determined that a service is competitive, BT is free to set the charges for the service subject to normal competition provisions.

2.5 BT has to provide one day’s notice before it changes the charge or the structure of the charge for competitive services.

New services

2.6 Oftel makes the general presumption that new services should not be subject to charge controls, although BT has to ensure that it does not breach competition law. Oftel does not automatically place charge controls on new services because it does not wish to impair incentives to innovate. However, Oftel retains the power to introduce charge controls in appropriate circumstances. Indeed, Oftel could introduce charge controls if it found that BT was dominant in the relevant market and it was likely to remain dominant or controls could be introduced if Oftel believed that failure to do so might stifle retail competition.

2.7. BT is required to give twenty-eight days’ notice before the introduction of new services, and the same notice before changing the charge for such services.

Services in markets that are prospectively competitive: prospectively competitive services

2.8 Prospectively competitive services are services in markets in which there is some competitive pressure and that this is likely to increase. These services are subject to safeguard caps set at RPI+0%. However, it is expected that competition – or the threat of it – and not the safeguard caps will act as the binding constraint on the charges for prospectively competitive services. Once the markets for prospectively competitive services become competitive, the Director General will determine that this is the case and withdraw the safeguard caps

2.9 BT is required to give twenty-eight days’ notice before it changes the charges for these services.

Services in markets in which competition is limited: non-competitive services

2.10 Non-competitive services are services in markets in which there is little or no competition. The services are controlled in one of six separate charge control baskets. These baskets are Call Termination; Call Origination; Tandem Layer; Interconnect Specific; Flat Rate Internet Access Call Origination Local Exchange Call Origination Basket; and Flat Rate Internet Access Call Origination Local-Tandem Conveyance Basket. The controls for the baskets are set at RPI-10%; RPI-10%; RPI-13%; RPI-8.25%; RPI-7.5%; and RPI-8.75% respectively. Additionally, Oftel intends to consult on proposed modifications to BT’s licence to give effect to charge controls of RPI-5% for the non-conveyance elements of Portability services. It is Oftel’s intention that these controls should apply from February 2002 (see paragraphs 2.50-2.54).

2.11 BT is required to give ninety days’ notice before it changes the charges for non-competitive services.

Services subject to charge controls

Prospectively competitive services

Inter-Tandem Conveyance; Inter-Tandem Transit; Non-Conveyance elements of Directory Enquiries; Non-Conveyance elements of International Directory Enquiries; Entries onto BT’s Operator Services Information System (OSIS) database; Supply of Phonebooks; and Supply of Customised Phonebooks.

2.12 Prospectively competitive services are services in markets in which competition exists but it not effective. These services are subject to safeguard charge controls until such time as the Director General determines that the markets are competitive or determines that the markets are non-competitive. Each service is subject to individual charge controls set at RPI+0% and these controls are disaggregated by time of day, day of week and distance as necessary.

Inter-tandem conveyance and inter-tandem transit

2.13 Competition is increasing in the provision of inter-tandem conveyance and inter-tandem transit. However, the Director General is of the opinion that, as yet, competition has not increased to the extent that would allow him to lift the safeguard caps. Nevertheless, the Director General believes that competition will become effective in the provision of these services.

Access to the non-conveyance elements of Directory Enquiry services and phonebooks

2.14 Since January 1999, BT has been required to give access to its Operator Services Information System (OSIS) database to service providers for the purposes of providing directory products and services including phonebooks. This increased the prospects for competition in the provision of directory services, the potential for which has been further enhanced as a result of Oftel’s decision (announced in September 2001) to liberalise directory enquiry access codes.

IDD conveyance

2.15 In January 2000, Concert, a joint venture between BT and AT&T, took over all of BT’s international gateway-to-gateway network facilities. In the preceding year Oftel had consulted on, and then implemented, proposed modifications to Concert’s licence so that the international Network Charge Control obligations that applied to BT’s international wholesale services were applied to the same services that were thereafter to be provided by Concert. On 16 October 2001, it was announced that BT and AT&T had agreed to dissolve Concert and return the respective assets to the parent companies. However, until such time as this happens, the guidance given in paragraphs 2.15 to 2.33 applies. Oftel will update the guidance as necessary once it has fuller information about the details and timing of the dissolution of Concert.

2.16 This section sets out Oftel’s view on the application of the Network Charge Control regime to Concert’s interconnect charges for International Direct Dial (IDD) calls. This area requires special consideration because of the way international operators settle charges between themselves for terminating calls mean that an approach based only on network costs would not be sufficient.

2.17 At the start of the first charge controls, Oftel considered that all international routes were prospectively competitive. Safeguard caps were therefore applied to each discrete international route. Since then, Oftel has determined that twenty-six of the routes have become effectively competitive. These competitive routes are no longer subject to safeguard caps.

2.18 Aside from the twenty-six international wholesale conveyance routes found to be effectively competitive, other routes are prospectively competitive and subject to individual safeguard caps by time of day and day of week set at RPI+0%.

2.19 In February 2001, Concert asked Oftel to determine that all wholesale international routes are competitive. In November 2001, Oftel published the consultation document Competition in International Markets in which it set out its initial proposals on competition in the relevant wholesale markets. Its final decision will be published the first half of 2002.

Advance notification

2.20 Concert is required to provide 28 days’ advance notification of all proposed changes to the level of its charges on the prospectively competitive wholesale IDD routes. For routes that are competitive, it has to give one day’s notice. However, as part of the determination request referred to in paragraph 2.19, Concert has asked for its publication requirements for international routes in competitive markets to be withdrawn.

Floors and ceilings

2.21 Whilst Oftel will consider evidence that any charge has an anti-competitive effect, it generally starts with the presumption that charges will not be anti-competitive or excessive if they fall between the floor of the incremental cost and the ceiling of stand alone costs of the service. The levels of the floors and ceilings will be determined as set out below.

Ceiling

2.22 The ceiling for call prices on the prospectively competitive wholesale IDD routes is composed of two elements:

2.23 However, Concert may charge an originating operator an amount that is lower than the gross charge. In these circumstances, the following rules apply in establishing and monitoring the floor.

Floor

2.24 Each outbound traffic minute that Concert sends may produce a degree of return traffic through stimulation of return calls. The floor is considered to be the price at which the cost to Concert of carrying the additional outgoing traffic generated by the reduction in IDD charges is just covered by the additional revenue obtained, including the additional income from new inbound traffic. At any level below this Concert would be pricing below cost and there would be a danger that this would have an anti-competitive effect in the market.

2.25 In order to measure the level of the price floor on any given route, Oftel would ideally be able to isolate and obtain figures for the new (or incremental) traffic caused by a proposed price reduction, both outbound and inbound. A value for the net cost of providing the extra services could then be derived from these figures, after taking account of the relevant transmission costs. If the revenue arising from the incremental traffic was less than this net cost figure then Oftel could assume, in the absence of strong evidence to the contrary, that the pricing was anti-competitive.

Monitoring the Price Floor

2.26 This section explains how these arrangements operate for prospectively competitive wholesale IDD routes.

2.27 In practice, it is likely to be extremely difficult to isolate incremental traffic caused by a price reduction from changes that would have happened anyway. Moreover, the traffic on many international routes is extremely volatile and largely outside Concert’s control. Nevertheless, Oftel will continue to expect Concert to ensure that all of the prospectively competitive wholesale IDD routes are profitable, despite their ability to price down to the "net" floor.

2.28 For these reasons, where Oftel has doubt about a proposed pricing change, it will use a "rule of thumb" when assessing whether or not Concert’s proposed charges are reasonable. Oftel will consider any given price change at a suitable time after its implementation (in the region of 6-8 weeks later) by looking at contemporaneous data on traffic volumes, prices and revenues in both directions and by considering representations from the industry. The "rule of thumb" will be that:

2.29 Where Concert has made a loss, but one which is less than 5% of gross revenues, Oftel will still require it to make immediate adjustments to prices so as to ensure that the route returns to profitability. However, unless there is evidence of anti-competitive intention on Concert’s part, no other action will be taken. Where the loss is above the 5% threshold, an investigation into a possible licence breach will automatically follow.

2.30 The advantage of this "maximum permitted loss" rule is that it puts the onus on Concert to judge in advance the volatility of the route and will encourage caution on their part whilst still allowing customers to benefit from substantial price reductions. The operation of the rule will be reviewed periodically.

2.31 As with these Guidelines, more generally, this "rule of thumb" is not legally binding. The Director General cannot legally fetter his discretion in advance and therefore he retains the ability to depart from these Guidelines where circumstances warrant it. However, he would normally give reasons why he had done so.

2.32 In addition, the Network Charge Control process means that Concert must give notice of price changes and so Oftel will always be ready to begin investigations following complaints received from other operators both before the change comes into effect and afterwards. Oftel will take enforcement action to correct any anti-competitive pricing that is found.

Retail tariff gradient (RTG) for IDD

2.33 The link between interconnection charges and the retail tariff gradient is discussed in detail from paragraph 3.10. It should be noted that, for IDD, the retail tariff gradient to be applied would, in principle, be BT’s retail gradient and that the gradient would be applied in aggregate by the chargebands for international routes. If aggregation by chargeband were found to be unreasonable or to have an anti-competitive effect for a particular route or routes, Concert would be required to apply an appropriate gradient to that route; whether individually or through grouping with another chargeband.

Non-Competitive Services

Call Origination Basket: Call Origination

Call origination: Charge to indirect access operators for use of BT’s non-chargeable Operator Assistance (OA), and emergency services (‘intermediate services’)

2.34 Operators purchasing BT’s call origination service (indirect access operators) pay either a charge for the call origination local exchange segment and a contribution towards OA and emergency intermediate services or they pay a charge for the call origination local exchange segment and contribute to emergency intermediate services only. All indirect access operators have to make a contribution to the running of emergency services. In addition, indirect access operators that do not provide an OA service have to contribute to the running of BT’s non-chargeable OA inland service. It is fair to assume that, if an indirect access operator does not run its own OA services or does not purchase the service from someone other than BT, the retail customer must use BT’s OA service. If, however, the indirect access operator provides an OA service or buys OA from someone other than BT then it should not have to contribute to the running of BT’s OA service.

2.35 Oftel believes that these arrangements are appropriate, taking into account the principle of competitive neutrality and the possibility of free-riding. For reasons of

competitive neutrality, if indirect access operators incur their own costs of non-chargeable OA calls, then they should not also have to contribute to the recovery of BT’s equivalent costs of non-chargeable OA. Otherwise, BT would have a cost advantage over the indirect access operators that would not be justified by greater efficiency. There is a possibility that indirect access operators may in effect free-ride on the operator services that BT provides to its customers, if those customers are also the customers of the indirect access operator. Where the indirect access operator is offering its customers an OA service, Oftel considers that the burden of proof lies with BT to demonstrate that free-riding is occurring in practice to a significant degree and that it can be quantified with reasonable accuracy. In the absence of evidence of the existence and magnitude of free-riding, it is not appropriate for the indirect access operator to pay the OA inland surcharge. If the indirect access operator is offering no OA service to its customers, it seems reasonable for it to pay the surcharge.

Call Termination Basket: Call Termination

2.36 The calling party and not the called party pays for call termination. This confers market power on the provider of call termination services. In addition, BT has a high share of the access market and it therefore terminates a large proportion of calls in the fixed market for call termination. Oftel has therefore concluded that BT is, and is likely to remain, dominant in the call termination market. The calling party pays principle also confers market power on other providers of call termination services.

Reciprocal charges for call termination services

2.37 Charges for call termination on fixed networks (except for Kingston) were based on BT’s costs in terminating calls on its network for the period 1 October 1997 to 30 September 2001. These arrangements were commercially agreed and established in interconnection contracts.

2.38 The Director General supported the establishment of these arrangements. This was because, as explained in paragraph 2.36, the calling party and not the called party pays for call termination. Termination charges based on operators’ own costs have the effect of diminishing the incentives to reduce costs of termination on their own networks. This is because the less efficient operator pays the lower call termination charges of a more efficient operator and, correspondingly, that a more efficient operator would pay the higher termination costs of a less efficient operator. These higher charges are likely to be passed on to retail customers. This distortion can be removed if the charges for call termination on OLOs’ networks are based on the charges paid by OLOs to BT for call termination on BT’s network. The Director General was therefore of the opinion that the arrangements for reciprocal call termination charges reached by the industry met his objective that such arrangements should be competitively neutral.

2.39 In principle, the Director General continues to believe that it is appropriate for call termination charges to be based on BT’s costs. However, if an operator does not believe that its termination charges should be based on BT’s costs, it is open to that operator to seek to negotiate other arrangements with BT and, if negotiations fail to resolve the issue, to refer any resulting dispute to the Director General for resolution. In fact, this has happened. BT and a number of operators have not have not (as at

November 2001) reached a commercial agreement to base charges for termination on BT’s terminating costs. The disputes were therefore referred to Oftel for resolution on 31 August 2001. In line with Oftel’s dispute resolution procedures, Oftel is working to resolve these disputes by 28 February 2002.

Tandem Layer Basket: Local-Tandem Conveyance; and Single Transit

2.40 Local-tandem conveyance is the conveyance service linking BT’s local exchanges with its main exchanges (at the tandem layer). Many operators rely on interconnection at the tandem layer. New entrants, and even in some cases established operators, are likely to connect at the tandem layer. In such cases, it is necessary to purchase local-tandem conveyance. In principle, operators connected at the tandem layer could purchase local to tandem conveyance from an operator connected to BT’s network at the local exchange level and who offered an interconnection service at the tandem level. In practice, no one other than BT is currently offering this service. Therefore, Oftel considers that BT is dominant in its provision. However, other operators are expected to build out data carrying facilities to the local exchange level as growing volumes of traffic make this more economic. This could lead to alternative suppliers of wholesale local-tandem conveyance becoming established and the service becoming increasingly competitive.

2.41 Single Transit is a conveyance service provided by BT to convey calls from one network to another when the networks are not interconnected to each other. Direct interconnection between two networks (not including BT) is normally justified only where there is sufficient traffic flowing between the two networks. An alternative is to use BT as a transit operator: both operators would generally be interconnected with BT, since this is essential in order to be able to access the largest base of customers. BT’s position as the operator with whom all operators are interconnected puts it in a uniquely strong position in providing transit services. No other operator can offer similar services to all operators and other networks often have only the choice of direct interconnection as an alternative to using BT’s transit service. Oftel expects BT to remain dominant in the provision of this service.

Interconnect Specific Basket: Interconnection Extension Circuits; In-Span Interconnection and Customer Sited Interconnection (for connection, rental and rearrangement); Data Management Amendments to allow for the routing of emergency calls to Land Mobile Radio Service Operators; and Product Management, Policy and Planning

2.42 Interconnect specific services include those purchased by other operators to connect to BT’s network. BT is the only operator that can provide services to connect directly to its network. For this reason, and the need to interconnect with BT, these services are non-competitive.

Cost sharing for ISI, CSI, and IECs

2.43 Oftel expects that the costs of establishing these interconnection circuits and their ongoing rental will be shared according to the proportions in which BT and the interconnecting operator will bill customers for originating calls which are to be conveyed over the point of connection (this would mean an OLO would pay the whole

cost for an IEC because IECs carry OLO owned traffic only). The proportions should be derived from forecasts by each party of the capacity required to convey those calls for which the respective parties will bill customers originating them.

2.44 For ISIs, as a result of commercial agreement, the costs are shared in so far as each company pays in full for the capacity that it uses to carry services that it owns. Both the costs and capacity of CSI and IEC links are shared.

Cost sharing for ISI NTS links

2.45 On 28 June 2001, Oftel published the Determination of a dispute between BT and a number of operators regarding a proposal to charge for NTS links from January 1 2001. This determination set out the Director’s decision on BT’s proposals to reverse the ownership of Number Translation Service ("NTS") traffic, originated or carried by BT as transit operator, and terminated onto operators’ networks. BT proposed to charge operators for NTS Links to the operators’ point of interconnection, with effect from 1 January 2001. Oftel agreed that operators should pay for such links but, except for new ISI NTS links, only after they had had the opportunity to optimise their interconnection arrangements so that they pay for links they require and not necessarily those provided additionally by BT for its own network management purposes. BT is entitled to charge for links when BT completes any work required to provide, re-arrange or cancel links for which operators have submitted Advanced Capacity Orders (ACOs) by 13 July 2001 and made firm orders by 24 August 2001. From 25 August 2001 BT will be able to charge operators for the links, where such capacity orders have not been made for capacity orders relating to new ISI NTS links only.

Data Management Amendments for routing emergency calls for mobile operators

2.46 Data Management Amendments (DMA) for interconnecting with BT’s network can be provided only by BT and are therefore not competitive. Most are charged for through a direct pence-per-minute surcharge on all interconnection services using local and tandem switches. DMAs for routing emergency calls for mobile operators are charged for separately and are included in the interconnection specific basket to give BT incentives to reduce costs to an efficient level over the life of the controls.

Flat Rate Internet Access Call Origination Local Exchange Basket

2.47 Flat Rate Internet Access Call Origination at the local exchange (DLE FRIACO) is an unmetered local exchange call origination interconnection service, which has been available from BT since June 2000. It is to be used in the provision of Internet access over the PSTN. The service provides virtual capacity from the customer through the concentrator up to a port on the network side of the local exchange at a fixed fee, which does not vary with the volume of traffic carried up to and through the port. DLE FRIACO is subject to the same level of competition as metered call origination. As set out above, BT is expected to remain dominant in the call origination market over the next charge control period. It follows that DLE FRIACO is non-competitive.

2.48 It would not be appropriate to include the effects of the adjustment ratios in the Network Charge Controls. This is because adjustment ratios are primarily determined by the pattern of traffic and utilisation of FRIACO ports rather than greater or lesser efficiency achieved by BT, which is a secondary factor in setting such ratios. Reappraisal of the values of the adjustment ratios would be better addressed outside of the charge cap controls. The adjustment ratios will be subject to periodic review, which Oftel does not anticipate that these reviews will occur more frequently than annually though circumstances might change in which case the reviews might need to be more often than anticipated, using information on FRIACO traffic patterns. Oftel will consult on the outcome of any of its reviews of the adjustment ratio should any of these reviews result in a proposed change to it. Oftel will advise the industry through the appropriate fora before it commences any such review.

Flat Rate Internet Access Call Origination (FRIACO) Local-Tandem Conveyance Basket

2.49 Flat Rate Internet Access Call Origination at the tandem exchange (ST FRIACO) is an unmetered call origination interconnection service available at the tandem exchange. In conjunction with DLE FRIACO, ST FRIACO allows competitors of BT that interconnect at the tandem layer of its network to offer unmetered retail products to BT’s customers at a fixed fee and this fee does not vary with increases in the volume of traffic. ST FRIACO is subject to the same level of competition as local-tandem conveyance. As set out in paragraph 2.40, BT is expected to remain dominant in the provision of local-tandem conveyance. It follows that ST FRIACO is non-competitive.

Other Services

Number Portability

2.50 On 25 October 2001, Oftel published a document entitled Draft Determination: Proposed Fixed Portability Costs and Charges in which it proposed to set charges for BT’s fixed Portability services on the basis of the long-run incremental costs (LRIC) in providing the services. Oftel proposed to set these charges on the basis of their LRIC so as to align the basis of costs for Portability services with other non-competitive interconnection services. Portability services are similar to call termination services, inasmuch as the Recipient Operator has no choice over the Donor Operator from whom it imports numbers. The Donor Operator could raise its charges for the provision of Portability services without affecting its own business. This makes Portability services non-competitive.

2.51 Oftel proposes to modify BT’s licence to give effect to charge controls for the non-conveyance elements of Portability services. If BT does not object to the modifications to its licence that Oftel intends to propose, the non-conveyance elements of Portability services will be subject to charge controls for four years from February 2002. Oftel proposes to set these controls at RPI-5%. As the controls will not run contemporaneously with other charge controls, the mid-year point (weighted average date) by which all charge changes need to be made is later than the mid-point for other non-competitive services.

2.52 Oftel expects that BT’s charges for the conveyance elements of Portability should – subject to the percentage of calls that originate ‘off-net’ – reflect charges for the equivalent conveyance standard services i.e. single transit and inter-tandem transit short, medium and long.

2.53 Other operators’ licences include provisions that state that their charges for providing Portability services should be based on long-run incremental costs if BT’s charges for such services are based on its long-run incremental costs. Moreover, Oftel believes that charges for the non-conveyance elements of Portability services should be reciprocally applied. In any case, these charges need to be reasonable.

2.54 There are two exceptions to reciprocal charging for Portability. These are the charges applied for the average porting conveyance for geographic and non-geographic Portability, as operators need to calculate their own charges for these services by considering the percentage of calls that originate ‘off-net’ and the amount of their network used in providing these services. However, such charges should be reasonable. Charges for the average porting conveyance that produce a disincentive for an operator to import a number might be considered unreasonable.

Interim Carrier Pre-Selection (ICPS) and Permanent Carrier Pre-Selection (PCPS)

2.55 ICPS/PCPS are non-competitive call origination services for which charges have been determined and may be determined again in future to reflect changing costs. However, Oftel has not proposed to set charge controls for carrier pre-selection services at present.

Local Loop Unbundling

2.56 In December 2000, Oftel published the Determination under Condition 83.16 of the licence of British Telecommunications plc relating to the charges for the provision of metallic path facilities and associated internal tie circuits. In June 2001, Oftel published Local Loop Unbundling – pricing for shared access in which it set out draft shared access charges. Final shared access charges will be published shortly. Oftel intends to reconsider fully unbundled and shared access charges when comprehensive actual cost information is available. After such a review, Oftel proposes to introduce a charge control for unbundled local loop services.

Number translation services

2.57 In December 1999, Oftel published Statement on the Relationship between Interconnection Charges and Retail Prices for Number Translation Services. This established the principles under which terminating payments and retail prices for NTS calls should be set from 1 January 2000. These principles replaced the old NTS Formula and sought to give terminating operators greater control over the revenue they receive for calls to services provided over their networks. Under the "new NTS" arrangements, the terminating operator decides what payment it requires and adds BT’s or another originating operator’s call origination charge (plus any transit charge if applicable) to derive the retail price for calls. BT’s origination charge remains regulated. However, other originating operators can set their own charges for call origination and these may differ from BT’s.

2.58 The retail price for services behind sub-range 0844 can be up to 5 pence per minute or per call (inclusive of VAT); services behind sub-range 0871 can be up to 10 pence per minute or per call. Services operating on traditional NTS numbers, 0845 and 0870, should be charged at the originating operator’s local and national rates respectively.

2.59 In response to the draft Guidelines, comments were received about the following NTS issues:

• The ability of terminating operators to opt-out of BT’s retail discounts for 084X/087X services;
• The suitability of element based charging (INCA EBC) billing for NTS and the lack of transit verification;
• Requirement for a single tandem rate for non-BT originated traffic and why network charge differential billing is not appropriate for this traffic; and
• The need for changes to average discounts for lo-call and national rate services to be subject to rigid dates on which they can change.

2.60 It is not appropriate for Oftel to respond to these concerns here. Oftel is quite separately considering these issues and will consult the industry once it has reached its initial conclusions.

Partial Private Circuits

2.61 On 29 March 2001, Oftel issued a Direction under Condition 45.2 of BT’s licence and under Regulations 6(3) and 6(4) of the Telecommunications (Interconnection) Regulations 1997 in which it required BT to offer partial private circuits (PPCs) on cost-oriented and non-discriminatory terms and conditions. This Direction required BT to conclude commercial negotiations within eight weeks and then implement the outcome of those commercial negotiations within a further six weeks.

2.62 Following commercial negotiations, BT launched its PPC portfolio on the 1 August 2001. Thereafter eight of the negotiating operators advised Oftel that they considered themselves to be in dispute with BT. As part of the request for Determination, the operators have asked Oftel to investigate whether BT’s PPC prices are cost orientated.

2.63 Oftel is currently in the process of examining whether the PPC charges are cost oriented. Once Oftel has resolved this dispute, it will consider whether it needs to place charge controls on PPCs. If Oftel decides to impose charge controls on PPCs, it will consult on the most appropriate way to incorporate these controls within the Network Charge Controls.

Public Payphone Supplementary Conveyance Charges (PPSCC)/Payphone Access Charge

2.64 BT charges other operators the payphone access charge (PAC) on freephone calls from payphones. The purpose of the charge is to ensure that calls from payphones for which no retail payment is made, and hence they do not make a contribution to the costs of providing and maintaining the payphone network, contribute to its upkeep.

2.65 Changes in volumes of calls made from payphones have a major bearing on the unit costs of the payphone business. Volumes of call minutes are currently falling sharply, and it is not clear how they will move in the future. Consequently it is not possible to forecast with any accuracy how the costs of providing access from payphones might change in the future and, accordingly, Oftel has not proposed charge controls for the PAC. However, Oftel will continue to monitor whether the level of the PAC is reasonable relative to cost.

Emergency services

2.66 A safeguard cap of RPI+0% applies to the (unbundled) charge for calls to emergency services provided by BT to other operators’ customers. BT can apply to the Director General for consent to exceed the limit set by the safeguard cap if it demonstrates that failure to increase charges would endanger the quality and security of the emergency service. This control was not set on the basis of the competitiveness of the service, but was set to ensure that provision of this essential service does not disadvantage OLOs, and that its quality is maintained.

Specific charging issues

2.67 Some specific issues arise from the way network components are used in particular types of service. These are dealt with as follows.

DLE as a tandem switch

2.68 In Oftel’s view, the reasonable charge for a DLE when performing a tandem switch function (for example, in conveyance to OA and DQ services) is the charge for a tandem switch. BT will therefore be expected to adjust accordingly the routing factors of services that use a DLE as a tandem switch (i.e. the routing factor for the tandem switch should be the sum of the factors for the use of tandem switches and DLEs as tandem switches). This may affect the charges for services such as local-tandem conveyance, single transit, and inter-tandem conveyance.

BT’s retail ‘sticks’

2.69 BT Retail will purchase services from baskets and safeguard caps like interconnecting operators, but it will also need to purchase "sticks". These are the segments left over when BT end-to-end calls are broken down into interconnection services. The sticks are remote-local conveyance for call termination, remote-local conveyance for call origination, and local-tandem transmission. Since each stick is a sub-set of an interconnection service, BT Retail’s transfer charge for services requiring a stick will be expected to be calculated using the same routing factors and component rates as its corresponding interconnection service (for the components that they share).

The costs and amounts applied to each stick are set out in Financial Statements

Costs of network components and parts which appear in more than one service

2.70 Condition 69.2(d) of BT’s licence requires that the amount applied to any network component or part which is used for more than one service within a Network Charge Control basket be the same for each of those services. Different amounts may be applied to the same component used in services not contained in the same basket.

Charges for new services

2.71 Oftel has made the general presumption that new interconnection services will not be subject to charge controls. The underlying reasoning behind this presumption is that the incentives to innovate could be reduced if the innovator cannot guarantee that it would receive the benefits of its innovation. However, Oftel will consider whether charge controls should be applied to a new service if BT is dominant in the provision of the underlying network components and parts used in provision of that service.

Changes to the competitive status of services during the charge control period

2.72 BT may seek a determination that a particular interconnection market is more competitive than the relevant classification of a service in that market might suggest. If it did so, BT would have to provide Oftel with evidence that the relevant market had become competitive or increasingly competitive. In such a case, Oftel would assess the competitiveness of the market and, if appropriate, remove the charge control or reduce the level of it. Oftel would consult on the outcome of its market assessment before regulation was altered. Similarly, an OLO might argue that a service is less competitive than is indicated by the relative competitive classification of the service. In such circumstances, Oftel would again assess the relative competitiveness of the market before deciding whether charge controls needed to apply.

Definition of markets and assessing the extent of competition

2.73 Oftel’s approach to defining markets is set out in the guidelines The Application of the Competition Act in the Telecommunications Sector, January 2000.

Chapter 3

Monitoring compliance with the charge controls

Ongoing operation and monitoring of the charge controls

3.1 Condition 69.1 of BT’s Licence requires that the charge for each of BT’s Standard Services should be reasonably derived from the forward looking incremental costs of that service, unless the Director General considers that it is appropriate for another cost standard to apply – for example, where incremental cost information is not immediately available. Condition 45.3 requires BT to provide interconnection on terms and conditions that are reasonable. In the event of a complaint that a charge is not reasonable, or is not reasonably derived from the forward looking incremental costs of the service, a first order test will be whether the charge in question falls between its incremental cost floor and stand-alone cost ceiling. The primary focus of an investigation of a complaint under Condition 69.1 will however be the effect or likely effect of the charge on competition and on consumers. The methodology for deriving floors and ceilings is described in detail at Annex B to these Guidelines. Guidance for making complaints about possible licence breaches or anti-competitive behaviour can be found in Oftel’s publication Making a formal complaint to Oftel – guidance for the telecommunications industry, March 2001. Separate guidance on referring interconnection disputes to Oftel was published in the document Requesting the Director General of Telecommunications to resolve an interconnection dispute, which was published in November 2001.

Services in baskets

3.2 BT’s freedom to set charges for the services controlled by the six network baskets will be constrained so that the average charge in each basket cannot be increased by more than RPI less the relevant value of ‘X’ set out in Condition 69.13 (if RPI > the value of ‘X’), or must be reduced by at least the value of ‘X’-RPI (if RPI < the value of ‘X’). RPI (i.e. the controlling value of RPI) is the term used to represent the percentage change in the Retail Prices Index in the 12 months up to June preceding the start of the relevant charge control year (the Relevant Year). With the exception of the two FRICAO baskets, compliance with this constraint will be monitored by calculating a ‘weighted’ average change in charges for each basket, where the weight for each service is BT’s revenue for that service in the previous financial year. The ‘weighted’ average for each basket is then compared with its respective value of RPI less the value of ‘X’. The weights will include revenues from all sales of interconnection services from BT Network, i.e. including sales to BT Retail as well as to other operators. For the two FRIACO baskets, the value of ‘X’ applies to the charge for each component in the relevant FRIACO basket, which must therefore all change by the same percentage.

3.3 BT is required to comply with RPI less the value of ‘X’ by the end of each charge control year, but is subject to a further constraint on how it phases its price changes. This constraint prevents BT from increasing its charges (if RPI > the value of ‘X’) to the

full extent permitted early in the Relevant Year or delaying required reductions in charges until late in the Relevant Year. To ensure that the level of charges is not distorted in this way by the timing of charge changes, an average date of changes in BT’s charges has been calculated for each basket. This will be in the form of a weighted average where the weight applicable to each date is the value of changes to charges implemented on that date. Changes to charges must be implemented in such a way that their effect is equivalent to them all having been made at a specified date close to or at the mid-point of the charge control year. In general, the required Weighted Average Date will be on or after 1 April (if RPI > the value of ‘X’) or on or before 1 April (if RPI < the value of ‘X’). However, for the non-conveyance elements of Portability, Oftel is to propose that the Weighted Average Date should be on or before 1 August (if RPI < the value of ‘X’).

3.4 If BT’s average charge for a basket at the end of the Relevant Year is lower than required by the associated RPI less the value of ‘X’ constraint, it will be able to carryover the difference into the next charge control year. That is, the benchmark for assessing BT’s compliance with the control in the following year will be the level of charges BT was required to achieve, rather than the level it actually achieved. Conversely, if its average charge is higher than the required level, it has to remedy the situation, as the Director General may reasonably require.

Services subject to safeguard caps

3.5 Compliance with safeguard caps will be monitored on the basis of the controlling value of the RPI applied cumulatively to the charge at the beginning of each charge control year such that the charge at 30 September (i.e. at the end of the charge control year) in any year is no greater than the maximum permitted charge at the start of the charge control year increased by the controlling value of RPI. BT may increase the charge during the course of a charge control year, but only to the extent that the charge does not exceed the charge at the year’s beginning plus RPI multiplied by the proportion of the charge control year that has passed i.e. a charge change on 1 October can see a charge increase by no more than RPI x 1/365 plus any proportion of permitted RPI increases which have not been used up in preceding Relevant Years.

Notice period for changes to charges

3.6 BT is required to give ninety days’ notice of a change to a charge or the structure of the charge for non-competitive interconnection services i.e. those in any of the six charge-controlled baskets. For prospectively competitive services, BT is required to give twenty-eight days’ notice of changes to the charges or the structure of the charges. The charges for new services need to be notified twenty-eight days in advance of their implementation. Thereafter changes to the charges for the ‘new’ services can be changed only after giving a further twenty-eight days’ notice. For competitive services, BT is required to give one day’s notice before changing a charge or the structure of it. The Director General may consent to a reduction of the notice period if he considers that there has been a change in the level of competition in the relevant market or that such a change would benefit the development of competition in the long-term.

Special cases: prior consents and extended notice

3.7 Whilst for the majority of BT’s intended changes to interconnection charges Oftel believes that the safeguards against unreasonable and anti-competitive charging explained in these Guidelines will be sufficient, there are four specific situations which Oftel believes warrant particularly close attention when BT proposes changes to interconnection charges. The first of these is the principle established in Condition 71 for BT to seek ‘Prior Consent’ under the conditions set out in paragraph 3.8. The other three are situations where the Director General has chosen not to require BT to seek his ‘Prior Consent’ but for which, nevertheless, the interests of other operators may require Oftel to have the capacity to review proposed charges before they enter into effect. These are situations where it appears that the proposed charge changes may have anti-competitive or unreasonable effect. In such cases, introduction of the new charge may be subject to ‘extended notice’ – i.e. the Director General may direct that the date of introduction of the charge be extended to or from a date specified, or that notice of the charge in question be withdrawn.

Consent under Condition 71

3.8 BT is required by Condition 71 of its licence to obtain the Director General’s prior consent for price changes which reduce certain retail prices below the sum of transfer charges to BT Network and BT’s retail costs. Where a retail price change involves a reduction in the transfer charge levied to BT Retail by BT Network for interconnection services, the equivalent reduction must be made to the charge for all such interconnection services to OLOs. Where a reduction in retail prices results in a reduction of network charges through the application of Condition 71, BT is also required to produce a Network Charge Change Notice (NCCN).

End-use charging

3.9 BT’s ability to vary its network charges according to end-use is subject to the requirements of the Interconnection Directive (Directive 97/33/EC) and the Revised Voice Telephony Directive (Directive 98/10/EC). In particular, Article 17(3) RVTD requires that charges "shall be independent of the type of application which the users implement, except to the extent that they require different services or facilities". Any difference must also be objectively justifiable, proportionate and transparent. Oftel believes that, as a result, the scope for end-use charging is extremely limited. If Oftel considers that a charge is inconsistent with these requirements, the Director General may direct that the date of introduction of the charge be extended to or from a date specified, or that notice of the charge in question be withdrawn. In the latter case, the charge in question may not take effect without publication of a further notice except to the extent that any enforcement action has been taken against it.

Time of day charges and calculation of the network tariff gradient (NTG)

3.10 For prospectively competitive services and those services in the six non-competitive interconnection baskets, Oftel expects that the NTG should be directly coupled to that for retail prices where appropriate. However, BT can propose a decoupled charge provided it is satisfied that it is not unreasonable (ie it has no anti-competitive effect). In general, a decoupled network tariff gradient will be acceptable if it is within +/- 5% of the retail tariff gradient (RTG). If Oftel considers that the proposed charge may be unreasonable, the Director General may direct that the date of introduction of the charge be delayed to a date specified, or that notice of the charge in question be withdrawn. It may be the case that the network tariff gradient will become decoupled from the RTG because retail price changes have changed the RTG, but (as yet) there is no change to the NTG. Again, Oftel would investigate in such circumstances if it appeared to it or if a complaint indicated that an unreasonable or anti-competitive effect might result. However, Oftel is considering whether its treatment of the arrangements for the relationship between the NTG and RTG remain appropriate.

Calculation of the RTG at any point in time

3.11 An estimated RTG needs to be defined at any point in time in order that the implications for interconnection charges of changes in the time of day structure of retail prices may be assessed contemporaneously.

3.12 It is BT’s current practice to derive the RTG at any point in time by using up-to-date information on retail prices (before discounts) and volume weights derived from the volumes by time of day in the latest available financial year. The RTG calculation covers both local and national calls, including non-geographic calls. BT publishes the relevant RTG in both its Price Change Notices (for retail prices) and its NCCNs.

Materiality

3.13 The purpose of the comparison of retail and network tariff gradients is to pick up material differences between the NTG and RTG, which could be unreasonable or have anti-competitive effects. These could arise from structural changes in the retail tariff by time of day; from less substantial but nonetheless significant differences in time of day retail price changes; or from changes in the relative volumes of traffic by time of day. Oftel understands that the RTG could change over time by small amounts, because of the nature of its calculation as a weighted average, without any intention by BT to alter the time of day structure of its retail prices. Oftel would not expect to invoke the extended notice process unless the differences between the network tariff gradient and the estimated contemporaneous RTG were material. The test will be applied both to the averaged charge across all times of day/days of week and the charges at individual times of day/days of week. Oftel will judge the anti-competitive effect and the material degree of divergence between the RTG and NTG on a case-by-case basis. As experience of reviewing potential cases is acquired, Oftel will be able to form a more refined assessment of what should be the threshold for materiality. As explained, Oftel’s initial view is that it would not normally expect to initiate extended notice if the difference in the charge at individual times of day with the estimated contemporaneous RTG applied were less than 5%.

Changes to the structure of charges

3.14 The extended notice process may also be applied if, in Oftel’s judgement, a proposed charge change constitutes a change in the structure of charges. The sorts of changes which Oftel will wish to check for possible damaging effects on competition in this context would include proposals (for instance) to introduce two-part charging (i.e. reflecting call set up costs as well as call duration costs) or charging on the basis of capacity. This sort of change can be generalised as ‘a change in the unit of payment’. Oftel would decide on a case-by-case basis whether these constituted structural changes and should be considered under the extended notice conditions.

Requirement for BT to provide data when it changes charges

3.15 For services in baskets, BT is required to demonstrate that, in each basket, any component (or part) used by more than one service is charged for consistently in all such services. Hence, for these services, BT is required to publish details of amounts applied to network components and parts together with routing factors used to make up the new and old charges for a service whenever it notifies a forthcoming change to an interconnection charge. These details have to be set out in an NCCN. The information to be contained in each NCCN is established by Condition 69.4 of BT’s licence.

Requirement for BT to provide data when it introduces a new service

3.16 BT is required by Condition 69.3 of its licence to publish a full list of its standard services. The precise requirements of publication are set out in Condition 69.3. The List of Standard Services is available on website of BT Wholesale (www.btinterconnect.com).

Accounting Separation and Financial Reporting

3.17 BT is required to prepare and publish financial information for interconnection services unless Oftel is satisfied that it is not a proportionate obligation for it to require this level of cost and charge information. BT has to publish financial information to enable: a) the industry to view actual long run incremental, current and stand alone costs and charges for interconnection services and the components making up these services; and b) to provide transparency in the calculation of interconnection charges so that other market players are in a position to ascertain that these charges have been fairly and properly calculated. The financial information also helps to enable Oftel to make determinations on specific charges or in assessing whether BT has breached competition rules. This information is contained in the Financial Statements, Accounting Documents and supporting methodology documents available on BT’s website (www.groupbt.com/corporate/index.htm).

Annex A

Standard Services subject to charge controls

Non-competitive services, October 2001

[* Although these components are within a charge control ‘basket’ they are actually individually indexed.]

Services that Oftel proposes to charge control, July 2001

Prospectively competitive interconnection services, October 2001

Other services subject to charge controls

Annex B

Floors & ceilings

B1 In general, Oftel would consider a good first order test of whether a charge is unreasonable or otherwise anti-competitive to be whether the charge in question falls within a floor of long run incremental cost and a ceiling of stand-alone cost. Oftel explains its methodology for deriving floors and ceilings in paragraphs B3-B5. A charge at the service level set below the floor could mean that BT was not recovering sufficient of the incremental cost of conveyance from the service and might indicate the possibility of anti-competitive behaviour. A charge at the service level set above the ceiling might mean that BT was recovering more than an appropriate share of the full (or stand-alone) costs in providing conveyance, which would indicate possible abuse of a dominant position in the market for the service.

B.2 In investigating complaints about charges, Oftel would not apply the floors and ceilings test mechanistically. The floors and ceilings tests are an effective first order test for the likelihood of anti-competitive or exploitative charging. However, there may be circumstances in which charges set outside the band of floors and ceilings are not abusive, or charges set within the band are abusive. If asked to investigate charges, Oftel will seek to analyse the effect of the charge in the relevant market and will take a view on this based on the individual circumstances of each case.

Deriving floors & ceilings for inland conveyance

B.3 Floors and ceilings for inland conveyance services are derived using the output of the incremental costs modelling process. Details of the incremental costs methodology are set out in the Accounting Documents. Further background reading can be found in NERA’s report to Oftel Reconciliation of the Top Down and Bottom Up Models, December 1996.

Incremental and Stand-Alone Cost of Inland Conveyance (figure B1)

B.4 There are two increments in the incremental cost methodology – the whole of conveyance and the whole of access in a stand-alone network of inland PSTN and private circuits. In investigations of charges by Oftel, the floors for the inland conveyance network components will be given by the incremental cost of conveyance, broken down into the costs of network components and expressed on a pence per minute basis. The ceilings will be given by the stand-alone cost of conveyance, broken down into the costs of components and expressed on a pence per minute basis. The stand-alone cost of conveyance is the sum of the incremental cost of conveyance and the common costs between conveyance and access. Figure B1 demonstrates the relationship between the incremental and stand-alone costs of conveyance. Floors and ceilings for network components are illustrated in Figure B.2.

Illustration of floors and ceilings for conveyance components (figure B2)

Notes:

1. Ceilings are based on the costs of an efficient operator.

2. Where there are common costs between more than one component and access, these common costs are apportioned equally between those components.

B.5 The methodology derives floors and ceilings initially in terms of component costs but, to be used as a test for abusive charging, they will be applied to interconnection services (because interconnecting operators purchase services not components). In setting interconnection charges, the use of components in interconnection services is reflected in routing factors. With the approach to floors and ceilings for components set out above, floors and ceilings for services can be derived by applying the appropriate routing factors for the services to the relevant component floors and ceilings as illustrated in Figure B.3.

Deriving floors and ceilings for interconnection charges (Figure B3)

Interaction of floors and ceilings with the RPI­X% constraint (charging flexibility for BT)

B.6 For services within charge control baskets, BT’s ability to set charges close to the ceiling will be constrained by the requirement for it to comply with the charge control. This is because the control is designed to regulate charges relative to the incremental cost of conveyance plus a proportion of common costs between access and conveyance apportioned on the basis of equal mark-ups. Ceilings are derived from the stand-alone costs of conveyance, i.e. the incremental cost plus all of the common costs between access and conveyance. Within a charge control basket, setting one charge near the ceiling (ie with a larger proportion of common costs between access and conveyance) will mean that other charges in the basket will need to be set nearer the floor (with a smaller proportion of the common costs between access and conveyance) to meet the requirements of the control.

Setting floors and ceilings: incurred costs and costs of an efficient operator

Floors

B.7 Because floors are intended to prevent excessively low pricing, they should, in principle, reflect BT’s incurred costs, since this would provide a more appropriate guideline for anti-competitive low pricing than the incremental cost of an efficient operator.

Ceilings

B.8 Ceilings should reflect the costs of an efficient operator because they are intended to prevent excessively high or exploitative pricing. Purchasers are exploited if they pay charges in excess of the stand-alone costs of an efficient operator. The costs of an efficient operator are calculated by applying the efficiency gap for network costs, derived from the study of BT’s efficiency commissioned by Oftel, to the incurred costs. It is expected that the efficiency gap will narrow over the charge control period as BT drives inefficiencies out of its network costs to satisfy the requirements of the charge caps. Oftel’s financial modelling will take account of this and will enable Oftel to forecast the efficiency gap at any point in the charge control period.

B.9 Oftel will take account of these principles in deriving floors and ceilings when conducting investigations of BT’s interconnection charges.

B.10 It is possible that tensions will arise from the use of incurred costs for floors and the costs of an efficient operator for ceilings. Three examples of this are covered here.

Floors and charge caps

B.11 If BT fails to make the necessary cost reductions to keep pace with the charge controls, the constraint might require BT to set charges below floors measured on the basis of incurred costs. This possibility is a characteristic of all price caps. It is, in practice, extremely unlikely to happen because, for a charge based on incurred costs to fall below a floor, BT would have to under perform the constraint to the extent that it would have negated both the equal mark-up and any supernormal profit element in the current level of charges.

Ceilings and safeguard caps

B.12 Services that are likely to become competitive during the charge control period are subject to safeguard caps of RPI+0%. However, because costs will fall over the charge control period, it is possible that ceilings will fall below safeguard caps. It should be noted that safeguard caps are neither intended nor expected to be the effective constraints and that they operate as a fail-safe mechanism to protect customers from excessive charges in the event that services are not as competitive during the charge control period as Oftel has anticipated. Oftel would expect charges subject to safeguard caps to be driven down by competitive pressure. The requirement for charges to be reasonably derived from costs implies that the ceiling should generally take precedence over the safeguard cap if it is lower.

Ceilings below floors

B.13 In theory, the costs of an efficient operator could be less than incurred incremental costs for a service (in which case, the ceiling would be below the floor). In such circumstances, Oftel would need to consider the possibility of anti-competitive charging. It would need to make a judgement about whether the ceiling or the floor had precedence. In practice, this situation will be so exceptional that it would merit specific consideration and a hard and fast rule is not appropriate. The floors and ceilings test is not the only test for anti-competitive charging and the judgement would therefore also depend on other relevant considerations, as set out in The Application of the Competition Act in the Telecommunications Sector.

The effect of regarding components as increments, and the use of combinatorial tests in investigations by Oftel

B.14 Floors and ceilings for inland conveyance, derived as set out in these guidelines with the increment defined as the whole of conveyance, can be contrasted with the average incremental and stand-alone costs which would result from regarding each network component individually as an increment. The definition of the increments in the methodology set out in these guidelines implies that the proposed floor would normally be larger than the average incremental cost of the network component (derived on the basis that each component is an increment) and that the proposed ceiling would normally be smaller than the average stand-alone cost of the component (derived on the basis that the component is the increment).

B.15 This is because, if components were regarded as increments, their costs would be calculated without the common costs within conveyance (i.e. between components or services) which result from the economies of scope arising from the sharing of facilities by services. However, the stand-alone cost of each component regarded as the increment would include all the common costs within conveyance related to that component. Hence BT’s LRIC Financial Statements refer to the service floors and ceilings calculated on the basis that the whole of conveyance is the increment as ‘distributed incremental cost floors’ and ‘distributed stand-alone cost ceilings’. If components were regarded as the increment, the sum of the incremental costs of the components would therefore be less than the incremental cost of conveyance by an amount equal to the common costs between components (i.e. within conveyance). In contrast, the definition of the whole of conveyance as the increment (as the incremental costs methodology for inland conveyance does) will mean that the sum of the cost of components is equal to the incremental cost of conveyance because common costs between components are not separately identified. This is illustrated at Figure B.4 (in which, for simplicity, the link and length network components for inter-tandem transmission are ignored).

Floors and ceiling at network component level: illustrative example (figure B4)

Note: In constructing ceilings, costs which are common between access and more than one component (e.g. duct common costs between access, junction transmission, and trunk transmission) will be split between the ceilings for those components consistent with the overall approach that ceilings reflect the stand-alone costs of conveyance broken down into component costs

B.16 If components were regarded as increments, floors and ceilings would need to be satisfied not only for each component individually but also for each combination of components where there are common costs between components. So the revenue from any combination of components would need to cover the common costs between the components as well as the incremental cost of each component.

B.17 This combinatorial principle should also be applied for all components taken together, so the rates for all components should generate sufficient revenue to cover the incremental cost of each component and all of the common costs between components (which together make up the incremental cost of conveyance). Oftel’s approach of defining the whole of conveyance as the increment would therefore automatically ensure that rates satisfy any combinatorial test (because common costs are already included in the break down of incremental costs to the component level). However, it could be argued that floors set using this methodology are too high because they include a proportion of common costs and will therefore be higher than the incremental cost of a component (where the increment is defined as the component). Oftel would take account of this in investigating complaints about anti-competitive charging.

B.18 It could be argued however that the appropriate theoretical benchmark for floors is more complicated. Since interconnecting operators purchase services, cost information on the basis of interconnection services as increments would be relevant. This would involve a degree of further complexity beyond the scope of the incremental costs methodology developed so far because the incremental costs of services would depend not on the total incremental costs of components, but on the shape of the cost function for each component. To apply the combinatorial tests correctly, it would also be necessary to derive the common costs between each combination of services.

B.19 If estimates of the incremental and stand-alone costs of services were produced using a generally accepted robust methodology, Oftel would take such evidence into account in investigating complaints about charges. However, to establish such a methodology would require a substantial amount of work beyond that carried out so far.