Contents

The draft Direction

Explanatory memorandum

Chapter 1 – Summary

Chapter 2 – Background and history of the dispute

Chapter 3 – Representations of the parties

Chapter 4 – The Director’s decision and reasons

Chapter 5 – Consultation and timetable for responses

Glossary

Draft direction under the provisions of Regulation 6(6) of the Telecommunications (Interconnection) Regulations 1997 resolving a dispute between Cable & Wireless Communications (Mercury) Limited ('C&W') and British Telecommunications plc ('BT') over a bad debt surcharge relating to calls to Premium Rate Services

WHEREAS:

(A) The Secretary of State granted to British Telecommunications on 22 June 1984 a licence ("the BT licence") under section 7 of the Telecommunications Act 1984 ("the Act") for the running of telecommunications systems specified in that licence;

(B) By virtue of section 109 and paragraph 20 of schedule 5 of the Act the BT licence has effect as if granted to British Telecommunications plc ("BT");

(C) The Secretary of State granted to Cable & Wireless Communications (Mercury) Limited ("C&W") on 5 December 1991 a licence under section 7 of the Act for the running of telecommunications systems specified in that licence;

(D) C&W entered into a Standard Interconnect Agreement ("the Agreement") with BT on 1 May 1998;

(E) On 1 January 1998 the Interconnection Directive came into force and was implemented in the UK through the Telecommunications (Interconnection) Regulations 1997 ("the Regulations") and conditions in the licences of operators;

(F) Regulation 6(6) of the Regulations provides that where there is a dispute concerning interconnection between organisations, the Director General of Telecommunications ("the Director") shall, at the request of either party, take steps to resolve the dispute within six months of the date of the request. The direction which the Director makes to resolve the dispute must represent a fair balance between the legitimate interests of the parties, and must be notified to the parties in accordance with Regulation 8(3). The parties are entitled to a full statement of the reasons on which the direction is based;

(G) On 30 January 1996 the Director issued a determination setting the Interim Charges for BT’s Standard Services for the year ended 31 March 1996 ("the 1996 determination"). The determination included a formula ("the NTS formula") which set out how telecommunications operators share the revenue from calls made to Number Translation Services ("NTS").

(H) The NTS formula may be summarised as follows:

Originating Network Operator ("ONO") keeps P – D + C

Terminating Network Operator ("TNO") keeps D – C

Where

"P" is the actual retail price charged by the ONO to the customer

"D" is the deemed retail price for the call.

(I) The 1996 determination stated that ONOs would retain an additional 6.0% of the net retail price of every Premium Rate Service ("PRS") call originated to cover the bad debt costs associated with PRS calls. This is known as the "the PRS bad debt surcharge". On 14 May 1997 the Director issued a determination setting the Final Charges for BT’s Standard Services for the year ended 31 March 1996. The PRS bad debt surcharge for this period was reduced from 6.0% in the 1996 determination to 4.4%. Since that time, the Director continued to set the PRS bad debt surcharge at 4.4% prior to the new Network Charge Control ("NCC") coming into operation on 1 October 1997.

(J) On 5 April 2002, C&W issued an Operator Charge Change Notice ("OCCN") to BT. The OCCN sought a change to the terminating payment to be paid by BT to C&W in respect of calls to C&W PRS number ranges by reducing the PRS bad debt surcharge from 4.4% to 0%. C&W proposed that the change should take effect on 28 June 2002;

(K) On 19 April 2002 BT rejected C&W’s OCCN on the basis that it did not comply with the existing NTS formula established by the Director and applied by BT and other operators;

(L) On 9 May 2002, in accordance with the provisions of Regulation 6(6) of the Regulations, C&W referred this dispute to the Director for determination;

(M) The Director has a duty to encourage and secure adequate interconnection in the interests of all users in a way which provides maximum economic efficiency and gives maximum benefit to end-users;

(N) The Director has considered, inter alia, the information provided by the parties and the matters set out in Regulation 6(8) of the Regulations. The principal points are summarised in the explanatory memorandum that accompanies, and is published with, this direction;

(O) The Director issued a draft of this direction and the explanatory memorandum that contains the Director’s reasons on 2 January 2003 and responses were invited by 30 January 2003;

(P) Comments were received from [….] as detailed and discussed in sections [….] and [….] of the explanatory memorandum that accompanies, and is published with, this direction. These comments have been taken into consideration by the Director in making this direction;

NOW, THEREFORE:

PURSUANT TO REGULATION 6(6) OF THE INTERCONNECTION REGULATIONS, AND HAVING CONSIDERED THE VIEWS OF THE PARTIES AND THOSE MATTERS SET OUT IN REGULATION 6(8) OF THOSE REGULATIONS, THE DIRECTOR MAKES THE FOLLOWING DIRECTION TO RESOLVE THE DISPUTE BETWEEN C&W AND BT:

(1) The PRS bad debt surcharge shall be reduced from 4.4% to 2.05%.

(2) This direction shall have effect from 28 June 2002.

(3) Any amount payable by BT to C&W as a result of this direction should be paid together with interest calculated in accordance with Clause 13.13 of the Agreement.

(4) Any amount payable by C&W to BT as a result of this direction should be paid together with interest calculated in accordance with Clause 13.13 of the Agreement.

(5) BT shall, in accordance with paragraphs 13.11 and 13.15 of the Agreement, alter the Carrier Price List so that it accords with this direction and shall send a copy of the alterations to the Carrier Price List to C&W.

(6) Except as otherwise defined in this direction, words or expressions used shall have the same meaning as in the Act, the BT licence or the Agreement as appropriate.

Heather Julie Clayton

Director of Investigations

A person authorised under paragraph 8 of Schedule 1 of the Telecommunications Act 1984

[….] 2003

Explanatory memorandum

Chapter 1

Summary

1.1 The Director General of Telecommunications ('the Director') has issued a draft direction in accordance with the provisions of Regulation 6(6) of the Telecommunications (Interconnection) Regulations 1997 ('the Regulations') for the resolution of a dispute between Cable & Wireless ('C&W') and British Telecommunications plc ('BT') under the terms of their Standard Interconnect Agreement ('the Agreement').

1.2 The dispute is about the additional 4.4 per cent retention that BT has been recovering under the existing NTS regime to cover the extra bad debt costs and financing of working capital associated with Premium Rate Service ('PRS') calls compared to other NTS calls ('the PRS bad debt surcharge').

1.3 This draft Direction sets out the Director's proposals to resolve the dispute as to the level of the PRS bad debt surcharge that BT as an originating operator can retain from PRS calls that terminate on C&W’s network.

1.4 C&W referred this dispute to the Director on 9 May 2002. The Director has considered the information provided by both C&W and BT and is now issuing a draft direction in respect of this dispute to the industry as a whole for consultation. Comments are requested by 30 January 2003 and will be taken into account in making a final Direction.

1.5 The details of the Director’s consideration of the information provided by C&W and BT, together with his draft decision, are set out in chapter 4. In summary, the Director is minded to direct that:

1.6 In considering this dispute the Director discovered an error in the calculation of the NTS retail uplift as previously determined (see note one below) by the Director. He discovered that costs were inadvertently included within the calculations. The Director has therefore today published amendments to the two previous directions to remedy the error and to ensure consistency with this draft direction. Those amendments will be confirmed at the same time as the Director makes his final direction to resolve this dispute. This document should therefore be read with the amendments made to the earlier retail uplift directions.

1.7 Having considered the facts specific to this dispute and the matters set out in Regulation 6(8) of the Regulations, this draft direction, in the initial view of the Director, represents a fair balance between the interests of the parties in each case, having regard to the Director’s wider duties to promote, encourage and secure adequate interconnection in the interests of all users in a way that provides maximum economic efficiency and gives the maximum benefit to end users.

Note:

1. See Amended Direction of BT's retail uplift charge for calls to operators' number translation services from 1 April 2000 - 8 April 2002 available on Oftel's website at www.oftel.gov.uk/publications/pricing/2002/nts30402.htm and Direction under the provisions of Regulation 6(6) of the Telecommunications (Interconnection) Regulations 1997 resolving a dispute between Energis and BT concerning BT's method of calculating its NTS retail uplift charge since April 1997 - 19 September 2002, available on Oftel's website at www.oftel.gov.uk/publications/pricing/2002/ener0902.htm.

  Chapter 2

Background and history to this dispute

2.1 NTS describes a range of specially tariffed services such as Freefone (080x), Local Call Fee Access or LCFA (0845), National Call Fee Access or NCFA (0870) and PRS (mostly 0900/0901). These services are offered at specific price points in order that customers calling from any fixed network will be able to associate the number range with a particular pricing arrangement.

2.2 PRS services are one type of NTS service. PRS services include calls to recorded information (eg. a recorded weather information service) and live conversation (eg chatlines). PRS calls are charged at a higher rate than other calls in order to cover the content and the special network facilities required.

2.3 In previous directions of NTS charges the Director has given a detailed description of the NTS revenue sharing arrangements and how they were arrived at. Most operators are now familiar with this narrative and it is not, therefore, repeated here. Earlier NTS directions (also known as determinations) can be found on Oftel’s website.

2.4 This draft Direction and explanatory memorandum is concerned only with the additional 4.4 per cent of the net retail price (ie excluding VAT and after discounts) that BT currently retains to cover the extra bad debt costs and financing of working capital associated with PRS calls compared to other NTS calls. This additional retention is otherwise known as the 'PRS bad debt surcharge'.

2.5 On 14 May 1997, the Director issued a determination setting the Final Charges for BT’s Standard Services for the year ended 31 March 1996. In that determination the PRS bad debt surcharge was reduced from the level of 6.0 per cent, as set in the determination setting the Interim Charges for that period, to 4.4 per cent. The PRS bad debt surcharge has remained at that level since.

2.6 On 5 April 2002, C&W issued an Operator Charge Change Notice ('OCCN') to BT. The OCCN sought a change in the terminating payment to be paid by BT to C&W in respect of calls to C&W PRS number ranges, by reducing the PRS bad debt surcharge from 4.4 per cent to zero per cent. The OCCN proposed that the change take effect on 28 June 2002 in accordance with agreed practice of providing notice of 56 working days in the absence of reasonable justification for otherwise. On 19 April 2002, BT rejected C&W’s OCCN on the basis that it did not comply with the existing NTS formula established by the Director and applied by BT and other operators. On 9 May 2002, in accordance with the provisions of Regulation 6(6) of the Regulations, C&W referred this dispute to the Director for determination.

  Chapter 3

Representations of the parties

A. C&W’s referral of the dispute

3.1 In its referral C&W states that BT is dominant in the provision of PRS call origination services and competes with other operators in the market for the termination of PRS calls. C&W argues that over-recovery of costs by BT in originating these calls provides the potential for BT to adopt margin-squeeze strategies in its pricing of PRS termination services, to the detriment of long-term competition.

3.2 C&W argues that the amount retained by BT in applying the PRS bad debt surcharge is inconsistent with the principle of cost-orientation and leads to an over-recovery of costs by BT. C&W stated its belief that the actual bad debt costs associated with PRS calls are recovered through other cost items recovered by BT, namely the NTS retail uplift, the Product Management, Policy and Planning ('PPP') charge and the A1 fraud/Artificial Inflation of Traffic ('AIT') rejection forms (see note two below).

3.3 C&W argued that the PRS bad debt surcharge was only ever – at best – based on a ‘broad-brush’ assessment of the likely bad debt costs that BT would incur by originating other operators’ PRS calls. C&W stated that as the Director has now moved away from this methodology for the NTS retail uplift and adopted one that tries to more accurately attribute retail costs to NTS minutes, he should also seek to move away from the ‘broad-brush’ approach to bad debt for PRS.

3.4 C&W has therefore requested that the Director resolve the dispute by ensuring that any bad debt retention which BT makes through the PRS bad debt surcharge recovers only those retail bad debt costs associated with PRS calls which are not recovered elsewhere. Furthermore, C&W has requested that the Director recalculate the PRS bad debt surcharge for the period since the start of the Network Charge Control ('NCC') (namely 1 October 1997), or at least be consistent with NTS retail uplift directions in requiring BT to retrospectively apply a charge for the period in which the PRS bad debt surcharge was not cost-oriented. C&W argued that other operators have not had sufficient exposure to BT’s actual costs to challenge BT’s NTS charges within the NCC regime before now. For instance, C&W stated that it only became aware that there was a bad debt element in the PPP charge when BT issued the Standard Contract Review in December 2001 on credit vetting procedures.

B. BT’s response to the referral

3.5 BT had rejected C&W’s OCCN on the basis that the PRS bad debt surcharge level requested by C&W did not comply with the NTS formula established by the Director and applied by BT and other operators.

3.6 BT stated that the ‘broad brush’ approach applied in the past has in fact led to an under-recovery of bad debt. It agreed with C&W that bad debt charges (and the NTS retail uplift) should be on the basis of cost-orientation, and argued that using a higher percentage of revenue for PRS bad debt costs reflects this approach. BT believes that the higher rate (ie the surcharge) for PRS bad debt will give the correct economic incentives to terminating operators and should encourage them to develop offerings that attract customers with a low credit risk.

C&W’s reference to PRS bad debt costs being recovered by BT through other cost items

3.7 BT stated that the PPP charge and the A1 fraud/AIT rejection forms are not relevant to the PRS bad debt surcharge. This is because they are costs incurred by BT through interconnecting with other operators, whilst the PRS bad debt surcharge in the NTS formula is incurred in respect of retail customers not paying for PRS calls which they have made.

C&W’s request for retrospective adjustment

3.8 BT does not agree that there is any rationale for a retrospective review of the PRS bad debt surcharge before 2002. Furthermore, it believes that as a matter of policy, retrospective adjustments should be avoided for the following reasons:

• regulatory certainty should be maintained by the Director not revising past decisions;
• BT, along with other operators, require certainty in order to operate and predict revenue streams and to make commercial decisions going forward; and
• the industry accepted the rates at the time they were determined.

Note:

2. The A1 process allows for cash to be retained by the originating operator (hence the out-payment is not made to the terminating operator) when a fraud or artificial inflation of traffic (AIT) is suspected. Appendix E of Annex A in the BT Standard Contract lists issues which may be AIT related. The BT Standard contract is available on BT's website at www.btinterconnect.com/.

  Chapter 4

The Director’s draft decision and reasons

The relevant market and the position of the parties

4.1 C&W is in dispute with BT concerning the PRS bad debt surcharge that forms part of the price for an interconnection product. For the purposes of the Interconnection Directive 97/33/ (the 'ICD') (see note three below), BT has been determined as having Significant Market Power ('SMP') in the markets for fixed public telephone networks and services, and is therefore required to offer interconnection to operators with Annex II status. C&W is an operator with Annex II status (referred to, in the BT licence, as a Schedule 2 Public Operator). Article 7(2) of the ICD requires BT to show that its charges are cost-oriented and for the national regulatory authority (ie the Director) to require that charges be amended where they are not cost oriented.

The Director’s requests to the parties for information

BT

4.2 The Director sent C&W’s referral to BT on 22 May 2002, seeking its comments and advising that he would be considering what additional information he would require from BT to resolve the dispute. On 5 July 2002 the Director made a request to BT to provide an analysis of bad debt expense consistent with the regulatory Financial Statements. At the same time the Director offered BT the opportunity to provide an alternative analysis of the total bad debt expense based on an alternative fully disclosed basis of cost attribution. The Director made a further information request to BT on 14 November 2002 in relation to NTS volume and revenue data.

C&W

4.3 In its referral document of 9 May 2002 C&W stated that it had additional background information that it would supply to the Director. C&W provided further information on 3 September 2002.

The Director’s draft decision

4.4 Having considered the representations of C&W and BT in respect of this request for a direction and the matters set out in Regulation 6(8) of the Regulations, the Director is minded to conclude that:

from 28 June 2002, the date originally proposed by C&W, the PRS bad debt surcharge in the NTS formula shall be reduced from 4.4 per cent to 2.05 per cent.

4.5 BT’s dominance in call origination underpins the rationale for the interconnection charging regulation. The Director is imposing this regulation to ensure that wholesale interconnection charges are cost- orientated ie that incremental costs of the service are covered, alongside a reasonable contribution to common costs.

4.6 Cost-orientation is in the interests of users, since it minimises end user prices, which results in a consumer benefit. Application of cost-oriented charges in a non-discriminatory way facilitates effective competition at the retail end. In addition, cost-orientation of wholesale charges is likely to allow resources to flow into the stimulation of innovative market offerings and providing users with a wide range of telecommunications services.

4.7 In considering this dispute the Director discovered an error in the calculation of the NTS retail uplift as previously determined. Some costs were inadvertently included in the calculation. The Director has therefore today published draft amendments to the two previous directions correcting this error and ensuring consistency between those directions and this draft Direction.

The Director’s reasons

The PRS bad debt surcharge from 28 June 2002

4.8 There are some costs which it may be more appropriate to recover as a percentage of net retail turnover rather than as a fixed amount per call. This is because these costs are more closely related to the net retail price of an individual call than call volumes.

4.9 With the PRS bad debt surcharge there are two cost types which have been treated in this way. These are the extra bad debt expense and the extra financing costs of working capital associated with an average PRS call, over and above the fixed amount recovered within the NTS retail uplift for a local or national rate call.

4.10 The extra bad debt expense can be further subdivided between two distinct factors:

• PRS calls on average have a significantly higher pence per minute net retail price than local or national rate calls - the 'price factor’. For example, if a person made 100 minutes worth of local calls charged at 4ppm, and the person defaulted on paying, the bad debt would be £4. However, if a person made 100 minutes of PRS calls charged at 50ppm and defaulted, the bad debt would be £50.

• PRS calls, as compared with local or national rate calls, may experience a different level of bad debts expressed as a percentage of relevant turnover due to the fact that the customers who make these calls are more (or less) likely to default on payment – the 'incidence factor’.

4.11 The Director asked BT to provide the following information to enable him to examine the effect of these factors:

• an analysis of bad debt expenses reflected within the operating costs and turnover disclosed in the regulatory Financial Statements covering 2000/01 for BT’s Retail Systems Business (RSB) disaggregated activities (of which RSB Local Calls, National Calls and Other are relevant to this dispute);

• a breakdown of these costs by product group for RSB National Calls and RSB Other disaggregated activities as it is within these activities that the product groups containing PRS calls are to be found; and

• NTS volume and revenue data.

4.12 The Director asked for this information in respect of the year to March 2001 so that it could be reconciled with the published set of audited regulatory Financial Statements for that period. This would enable the Director to derive some measure of assurance from the Accounting Separation ('AS') information provided. The information provided by BT did provide a clear trail to amounts disclosed in the 2001 Financial Statements.

4.13 It has subsequently come to the Director’s attention that the PRS bad debt figure provided by BT contains Calls and Access ('C&A') wholesale bad debt. This is the bad debt expense incurred by BT as a result of C&A providers not paying their bills eg as a result of going out of business. It is a wholesale cost, so it should not be included in a bad debt figure used for NTS directions.

4.14 For the purpose of this draft direction the Director has estimated the C&A bad debt costs present in the overall cost figure and stripped them out. This estimate is based on Oftel’s Market Information data on C&A subscribers for 2000-01. In addition, the Director has estimated the C&A PRS volumes for that year, and stripped these out of the volume figure. Actual cost and volume information from BT has been requested to enable the Director to more robustly strip out these bad debts for the final direction. According to the Director’s estimated numbers, the impact of removing C&A bad debt has a negligible effect on the surcharge.

The ‘price factor’

4.15 To calculate the ‘price factor’ of the cost of bad debt for PRS calls, it is necessary to remove the standard bad debt allowance from the overall PRS bad debt cost figure. The standard bad debt refers to that incurred by any general call type:- it excludes the excess bad debt incurred by a PRS call. This adjustment is necessary because the bad debt figure includes the excess PRS bad debt and standard NTS bad debt (which is covered by the retail uplift charge). This adjustment will therefore eliminate double counting of standard bad debt, which should only feature in the retail uplift charge (see diagram below).

4.16 The standard bad debt is derived by determining the proportion of the retail uplift pence per minute figure that comprises bad debt. This figure is then expressed as an average percentage of the PRS retail call price. This percentage figure is subtracted from the percentage ratio of bad debt to turnover as follows:

• x% = PRS bad debt cost figure (£s) expressed as a percentage of total PRS retail revenue (£s);
• y% = standard bad debt in retail uplift (pence per minute) expressed as a percentage of the PRS retail price (pence per minute); and
• z% (the bulk of the PRS bad debt surcharge) is the difference between x% and y% ie x% minus y%.

Extra working capital associated with PRS calls

4.17 In the previous surcharge calculation (ie setting the surcharge at 4.4 per cent), information from BT suggested that on average, BT receives call revenues from retail customers three months in arrears and pays Payments to Other Licensed Operators (POLOs) two months after they have been incurred. This leaves a month in which BT must finance its debtors after it has paid its creditors. This implies that BT is incurring an opportunity cost due to this timing factor. The greater the POLO and the shorter the timing gap, the lower the liability. So, for example, if the POLO was 100 per cent of the retail price ie all retail revenue was payable to the OLO and this was paid after three months, BT would incur no liability because its out-payments would exactly match its receipts both in terms of timing and value. If the POLO was a very small percentage of the retail price and had to be paid immediately, BT would incur maximum liability of three months before it received the revenue. In other words, BT is incurring a higher cost of working capital – this is the finance that BT must have in place in order to finance its own costs and payments to other operators before it receives payments from its retail customers.

4.18 An allowance has to be made for BT to recover this extra cost. Using new information provided by BT about the POLO as a percentage of the retail price, the Director has derived the net capital employed associated with the call. This figure is adjusted by the working capital from a standard call type in order to prevent BT from over recovering costs.

4.19 The following BT information (with some adjustments made to reflect current circumstances) is used to calculate the extra working capital associated with PRS calls (actual numbers are, in most cases, confidential):

• PRS call revenues and volumes for 2000-01;
• average retail PRS price (derived from above);
• SNR (special national rate) and SLR (special local rate) call revenues and volumes for 2000-01;
• average retail price for NTS Local and National calls;
• net retail price (ie average PRS price minus average NTS Local and National price);
• proportion of net retail PRS price (as defined above) made up by POLO;
• proportion of net retail SNR and SLR retail price made up by POLO;
• billing cycle = quarterly (every three months for customers not paying by direct debit);
• bill preparation time = three days;
• bill payment date = one month after receipt (for customers not paying by direct debit);
• interconnection payment cycle = one month; and
• percentage of BT’s customers on direct debit or Monthly Payment Plans (source: 2001-02 Price Control Review data).

4.20 The following calculations show the methodology used to calculate the extra working capital associated with PRS calls. It is worth noting that the extra cost associated with financing working capital represents a minimal proportion of the overall PRS bad debt surcharge. The bulk of the surcharge is caused by the calculation of ‘z%’ as outlined in paragraph 4.16 above.

A) The ‘income debtor’ (the retail customer) is calculated as follows:

Table 1: Calculation of income debtor

The total income debtor is applied to the retail price to obtain a debtor figure as follows:

Let x = % of customers on direct debit or monthly payment plan

x*0.6 + (1-x)*2.6 = y

y/12 x net retail price (as defined in paragraph 4.19) = (a) pence

B) The ‘POLO creditor’ (ie the creditor balance arising from payments owed to the terminating operator) is calculated as follows:

Table 2: Calculation of POLO creditor

The POLO creditor is therefore 2/12 x (proportion of net retail price made up by POLO) = (b) pence

C) Net capital employed per call minute = (a) – (b) = (c) pence

This figure is multiplied by PRS call volumes to obtain the additional working capital for PRS calls ie:

D) To calculate BT’s opportunity cost, a cost of capital of 13.5% (this is BT’s cost of capital as used in the Director’s statement of February 2001 entitled Network Charge and Retail Price Controls from 2001) is applied to C) above:

E) This figure is divided by retail revenues for PRS bad debt to obtain a percentage figure:

4.21 The two percentage figures obtained from the calculations set out in paragraphs 4.16 and 4.20 are added together to obtain the level of the PRS bad debt surcharge based on the higher price of these calls :

The ‘incidence factor’

4.22 As mentioned in paragraph 4.11 the Director asked BT to provide an analysis of bad debt expenses reflected within the operating costs disclosed in the regulatory Financial Statements. BT was asked to split this analysis between CSS (ie BT’s Customer Service System database billing system) and non-CSS because it is on the CSS bill that PRS calls are invoiced to retail customers. BT was only able to provide data on bad debt which had been written off as opposed to the charge to the profit and loss account which would also include any movement in the bad debt provision for the relevant disaggregated activity or product group. The movement in the CSS Bill bad debt provision could not readily be isolated by BT, because within AS, BT attributes the total movement in the bad debt provision of all billing systems in total, and not by individual billing system, to the different product groups within each disaggregated activity. The information provided by BT suggested that the incidence of bad debt, as a percentage of turnover net of discounts, is not materially different when contrasting PRS calls with the Local and National Calls disaggregated activities. BT attributes bad debts in the case of customer telephony revenues on the basis of the relevant turnover, weighted to take account of BT's billing and provisioning policies for different categories of revenue. The Director does not think that this attribution basis is likely to fully reflect the principle of cost causality particularly at the level of BT's product groups.

4.23 The Director therefore also invited BT to provide a different analysis of bad debt expense for the year to March 2001, based on an alternative fully disclosed basis of cost attribution. Instead, BT provided information on its Follow up Ratings ('FuR') payment profile system. This is a mechanism whereby all of BT’s business and residential customers are allocated into one of eight categories depending on their likelihood of defaulting on payment. So for example, category one contains those customers that never delay on payment and category eight contains those customers who are most likely to default or delay on payment. The value of calls on the bills of customers thus classified are then analysed between the different call types. According to the data provided by BT, PRS revenue as a proportion of total billed revenue is higher for those customers in the worst credit rating categories. In other words, those customers that have the worst credit ratings have a higher proportion of PRS revenue in their bills which points to a higher PRS bad debt surcharge.

4.24 However, There are a number of reasons why the Director is not minded to rely on this information in this dispute. These reasons are as follows:

Overall level of PRS bad debt surcharge

4.25 Based on the best information available, the Director is of the initial view that the PRS bad debt surcharge should be reduced from 4.4 per cent to 2.05per cent.

The Director’s views on C&W’s claim that PRS bad debt costs are recovered by BT through other cost items

The NTS retail uplift

4.26 As discussed in paragraph 4.7, the Director has taken action to correct previous NTS retail uplift directions so that this charge does not include PRS bad debt costs in its calculation. He will confirm those amendments at the same time as making his final decision to resolve this dispute in order to ensure that consistency remains.

PPP charge and the A1 fraud/AIT rejection forms

4.27 BT has stated that the PPP charge and the A1 fraud/AIT rejection forms are not relevant to the PRS bad debt surcharge. This is because they are costs incurred by BT through interconnecting with other operators, whilst the PRS bad debt surcharge in the NTS formula is incurred in respect of retail customers not paying for PRS calls which they have made. The Director is of the initial view that even if some element of retail PRS bad debt were to be recovered under these cost items, the amount recovered is unlikely to materially affect his proposed decision in relation to this particular dispute for the following reasons.

A1 fraud/AIT rejection forms

4.28 From information provided by BT, it is apparent that BT retains only very small amounts in relation to A1 fraud/AIT rejection forms for PRS calls originating on BT’s network and terminating on another operator’s network. Compared to turnover on PRS calls, the amount retained by BT in 2000-01 was insignificant. As such the Director is of the opinion that this is unlikely to have a material effect on his proposed decision in relation to this dispute.

PPP

4.29 The PPP charge is designed to recover 'carrier administration' costs associated with the sale of interconnection services by BT's Network Business to Other Licensed Operators (OLOs) and likewise purchases by BT's Network Business of interconnection services from OLOs. It is therefore designed to recover certain costs incurred by BT's Network Business. PRS bad debts are a retail cost which should be reflected within the appropriate disaggregated activities of BT's Retail Systems Business. Therefore the cost base which PPP is designed to recover is quite distinct from that for retail bad debts. The latter is recovered via the NTS retail uplift charge with a further surcharge as a percentage of revenue in the case of PRS calls.

C&W’s request for retrospective adjustment

4.30 The Director is of the view that retrospection should not be applied in the absence of strong evidence or argument to support its application. The Director’s initial view is that there are no compelling reasons to support the request for retrospective adjustment in this dispute, prior to the date that C&W proposed the change come into effect when it submitted its OCCN to BT, which was 28 June 2002.

4.31 Whilst the Director accepts that BT has an obligation to ensure that its charges are cost-oriented, a prime consideration for the Director in this particular dispute is the fact that the level of the PRS bad debt surcharge was determined by previous directions and not set by BT itself. BT has been complying with these directions and the Director notes that until now no operator has referred a dispute to the Director.

4.32 The Director has also considered whether the parties have a legitimate expectation that retrospection would apply in this case. In its referral C&W requested that the Director be consistent with his decisions to set BT’s NTS retail uplift retrospectively from 1 April 1999 and from 1 April 2000 in requiring BT to retrospectively adjust the PRS bad debt surcharge, were the Director to determine any change in the figure from the current level of 4.4 per cent. However, the Director’s decision in relation to the retail uplift was based on the exceptional circumstances particular to that case as outlined in the explanatory memoranda. The Director’s initial opinion is that no such exceptional circumstances exist in relation to this dispute.

Conclusion

4.33 The Director’s draft decision in this case is to reduce the PRS bad debt surcharge from 4.4 per cent to 2.05 per cent. Having considered the facts specific to this dispute and the matters set out in regulation 6(8) of the Regulations, this draft direction represents, in the opinion of the Director, a fair balance between the interests of the parties in each case, having regard to the Director’s wider duties to encourage and secure adequate interconnection in the interests of all users in a way that provides maximum economic efficiency and gives the maximum benefit to end users.

Implementation of the Direction

4.34 The Director is aware that there currently exists some delay in the implementation of previous directions because of a failure of BT and operators to agree amendments to their contracts.

4.35 In accordance with paragraphs 13.11 and 13.15 of the Standard Interconnection Agreement between operators and BT, the Director proposes that as soon as reasonably practicable following the making of the final direction BT shall make the necessary, correct and accurate, alterations to the Carrier Price List. BT shall then send a copy of the alterations to the Carrier Price List to C&W and no further agreement between BT and C&W will be required in order to implement the final direction.

4.36 BT is required to provide interconnection services to operators on a non-discriminatory basis under Condition 57 of its licence. The Director therefore expects BT to implement the final direction for all other operators, notwithstanding the fact that the final direction will relate specifically to the dispute between BT and C&W.

Note:

3. Directive 97/33/EC of the European Parliament and of the Council of 30 June 1997 on interconnection in Telecommunications with regard to ensuring universal service and interoperability through application of the principles of Open Network Provision.

Chapter 5

Consultation and timetable for responses

5.1 The Director’s draft direction is being made available to interested parties, together with the Director’s reasons, so that they may have a reasonable opportunity to make representations. Having considered any such representations, the Director will, if appropriate, make the Direction and will notify BT and interested parties of that Direction and his reasons for making it. The closing date for submitting representations is 30 January 2003.

5.2 Where possible, comments should be made in writing and sent by e-mail to keith.loader@oftel.gov.uk. However, copies may also be posted or faxed to the address below. If any stakeholders are unable to respond in one of these ways, they should discuss alternatives with the Oftel manager named below:

Keith Loader
Oftel
50 Ludgate Hill
London
EC4M 7JJ

tel: 020 7634 8793
fax: 020 7634 8949
e-mail: keith.loader@oftel.gov.uk

5.3 This document can be viewed in the Publications section of Oftel’s website, under classification Pricing and price control. Paper copies and more accessible formats such as large print, Braille, disc and audio cassette can be made available on request. Please contact Oftel’s Research and Information Unit by phoning 020 7634 8761 or by sending an e-mail to infocent@oftel.gov.uk.

Publication of representations made by stakeholders

5.4 On this occasion, Oftel is not programming a formal period during which interested parties may comment on the representations made by others. However, in the interests of transparency, all representations will be published, except where respondents indicate that a response, or part of it, is confidential. Respondents are therefore asked to separate out any confidential material into a confidential annex which is clearly identified as containing confidential material. Oftel will take steps to protect the confidentiality of all such material from the moment that it is received at Oftel’s offices.

5.5 Non confidential representations can be viewed on Oftel’s website in the Publications section under classification Responses to Oftel consultations. They can also be viewed at Oftel’s Research and Information Unit. Appointments must be made in advance by phoning 020 7634 8761or sending an e-mail to infocent@oftel.gov.uk.

Glossary

Accounting Separation (AS) – the preparation of separate accounts for different businesses and parts of businesses run by the same company or group of companies, so that the costs and revenues associated with each business and part of a business, including disaggregated activities (and transfers between them) can be separately identified and properly allocated.

Number Translation Services (NTS) – the process associated with the routing of a non-geographic number to a network termination point eg the number is translated from its non-geographic format into a geographic or mobile number to enable it to be routed to a geographic location or to a mobile phone.

Operator Charge Change Notice (OCCN) – the process used by operators, including BT, for offering and amending charges in payment for access to another operator’s services.

Originating operator – operator on whose network the call originates ie the operator with the line to the customer.

Systems Business (SB) – currently defined in BT's licence as being, essentially, that part of BT's business involving the installation, running and maintenance of its network and the conveyance of live speech and telex messages, as distinct from the Supplemental Services Business.

Terminating operator – the operator on whose network the call terminates.