Contents

The Final Direction

Chapter 1 - Summary

Chapter 2 - Background and history of the dispute

Chapter 3 - Summary of responses to the draft Direction

Chapter 4 - The Director's decision and reasoning

Annex - Explanation of the cost benefit analysis

Direction under regulation 6(6) of the Telecommunications (Interconnection) Regulations 1997 relating to a dispute between Energis plc and British Telecommunications PLC ("BT") over BT’s rearrangement charges

WHEREAS:

A. the Secretary of State for Trade and Industry 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 Annex A to that licence;

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

C. the Secretary of State for Trade and Industry has granted to Energis Communications Ltd ("Energis") on 24 May 1993, a licence under section 7 of the Act for the running of telecommunications systems specified in that licence;

D. Energis entered into a Standard Interconnect Agreement with BT on 20 June 1997;

E. on 20 December 2001, Energis submitted a written request entitled ‘Statement of Requirements’ ("SoR") to BT requesting inter alia that the existing rearrangement service be split into two distinct services for software rearrangement and physical rearrangement, in order to reflect the difference in costs associated with the two types of rearrangement;

F. on 8 July 2002, BT formally rejected Energis’s SoR and a dispute has arisen;

G. on 30 July 2002, in accordance with the provisions of regulation 6(6) of the Telecommunications (Interconnection) Regulations 1997 (the "Regulations"), Energis referred the dispute to the Director General of Telecommunications (the "Director") for determination of the following four issues, namely that: (i) BT be required to offer to provide both physical and software rearrangement as separate service options; (ii) cost oriented charges are to be applied to physical and software rearrangement services; (iii) actual oriented charges for those separate services be set; and (iv) the software rearrangement charges be applied retrospectively for the period 1 April 2001 to 31 March 2002, on the one hand, and 1 April 2002 onwards, on the other hand;

H. regulation 6(6) of the Regulations provides that where there is a dispute concerning interconnection between organisations, 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;

I. 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 which accompanies, and is published with, this direction;

J. the Regulations place upon the Director the general responsibility to encourage and secure adequate interconnection in the interests of all users, exercising his responsibility in a way that provides maximum efficiency and gives the maximum benefit to end-users;

K. the Director issued a draft of this direction and the explanatory memorandum which contained the Director’s reasons on 4 December 2002 and responses were invited by 10 January 2003;

L. Non-confidential comments were received from BT and MediaWays as detailed and discussed in Chapters 3 and 4 of the explanatory memorandum which accompanies and is published with this direction. The Director in making this direction has taken these comments into account; and

NOW,

therefore, pursuant to regulation 6(6) of the Regulations, and having considered, inter alia, the views of the parties and those matters set out in regulation 6(8) of the Regulations, the Director hereby makes the following direction to resolve the dispute between BT and Energis:

1. BT is not required to offer physical rearrangement and software rearrangement as separate service options to Energis.

2. BT is not, therefore, required to make any retrospective refunds to Energis, as requested for either of the periods referred to in recital (G) above.

3. Except as otherwise defined in this direction and its recitals:

i. paragraph 4 of the BT licence shall, with the necessary changes, apply to this direction as it applies to the BT licence; and

ii. words or expressions used shall have the same meaning as in the Act or in the BT licence, as appropriate.

iii. This direction shall take effect on the day it is published.

 

HEATHER CLAYTON

DIRECTOR OF INVESTIGATIONS

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

30 January 2003

  Chapter 1

Summary

S.1 The Director General of Telecommunications (the "Director") has now issued a Final 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 Energis Communications Ltd ("Energis") and British Telecommunications PLC ("BT"). The dispute relates to BT’s rearrangement charges for Intra Building Circuits ("IBCs").

S.2 Energis referred this dispute to the Director on 30 July 2002. Energis requested that the Director determine that:

• BT be required to offer to provide both physical and software rearrangement as separate service options;
• cost oriented charges are to be applied to both physical and software rearrangement services;
• actual cost oriented charges for these services be set by the Director; and
  
• the charges be applied retrospectively for the periods 1 April 2001 to 31 March 2002 and 1 April 2002 onwards.

S.3 The Director considered the submissions made by Energis and BT and issued a draft Direction in respect of the dispute on 4 December 2002 for consultation ("the draft Direction"). The draft Direction stated that the Director did not propose to require BT to offer separate physical and software rearrangement service options. Comments were requested by 10 January 2003 and have been taken into account in making the Final Direction.

S.4 The details of the submissions made in response to the draft direction can be found in Chapter 3. The Director’s analysis and his reasons for making his decision can be found in Chapter 4.

S.5 The Director remains of the view that the arguments in favour and against de-averaging are, for the most part, balanced. The cost benefit analysis performed by the Director has, however, shown it is likely that the costs of introducing separate physical and software rearrangement services would outweigh the benefits of doing so. In the absence of clear benefits, the Director is of the view that the imposition of additional regulatory requirements is undesirable, particularly where it appears likely that it would lead to higher costs. The Director has therefore concluded that BT should not be obliged to offer separate physical and software rearrangement service options.

S.6 Having considered the facts specific to this dispute and the matters set out in regulation 6(8) of the Regulations, this Direction represents, in the opinion of the Director, a fair balance between the interests of the parties in this case, having regard to the Director’s wider duties to promote competition and the development of the telecommunications industry in the UK and 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.

Chapter 2

Background and history of the dispute

2.1 Intra-building Circuits are circuits that run within the same exchange building linking a large incoming circuit to the digital switching unit within the exchange (Charges for these circuits can be found in Section B2.02.2 of BT's Carrier Price List at www.btinterconnect.com). Charges for these circuits form part of the Interconnect Specific Basket for the purposes of the Charge Control (Details of the latest Charge Control can be found in Oftel's Statement "Proposals for Network Charge and Retail Price Controls from 2001", published in February 2001). Rearrangement of these circuits will be necessary when an operator wishes to alter the actual routing of the circuit within the exchange (physical rearrangement) or the type of service offered over the circuit (software rearrangement).

2.2 Prior to 1998, BT levied separate charges for seven different types of rearrangement. After consultation with the industry, during which BT claims only one operator raised significant concerns, BT proposed the introduction of a single rearrangement charge based on a weighted average of the existing seven charges. This proposal was notified in Network Charge Control Notice ("NCCN") no. 1 on 17 October 1997 and took effect from 17 January 1998.

2.3 In order to comply with its Charge Control obligations, BT sets a new rearrangement charge each year. Charges for the Interconnect Specific Basket are set in the December of the preceding year (i.e. charges for financial year 2001/02 were set in December 2000). They are based on the cost ceilings and floors available from the prior year’s financial results (i.e. the charge set in December 2000 was based on the 1999/2000 financial accounts).

2.4 On 20 December 2001, Energis submitted a written request entitled ‘Statement of Requirements’ ("SoR") to BT requesting that the existing rearrangement service be split into two distinct service options for software rearrangement and physical rearrangement, in order to reflect the difference in costs associated with the two types of rearrangement.

2.5 BT formally rejected Energis’s SoR on 8 July 2002. On 30 July 2002, Energis submitted a request for resolution of the dispute to the Director.

  Chapter 3

Summary of responses to the draft Direction

 3.1 The Director issued a draft Direction setting out his proposed decision on 4 December 2002. Responses were received from BT and MediaWays. Non-confidential versions of these responses can be found on Oftel’s website at: http://www.oftel.gov.uk/publications/responses/2002/denb0402/index.htm.

3.2 Energis did not respond to the draft Direction.

BT

3.3 BT welcomed the draft Direction not to require BT to offer separate physical and software rearrangement service options as a pragmatic and proportionate response to the dispute. BT stated that the draft decision avoided the imposition of increased regulatory burdens at a time when the new EU Directives called for regulation to be applied only where absolutely necessary to remedy a perceived market problem.

3.4 BT emphasised that it had never questioned the actual practicality of introducing separate physical and software rearrangement service options, only the reasonableness of doing so due to the impact upon BT and other operators of such a change. BT advised that it could implement the product changes requested by Energis but that to do so would lead to increased costs which have not been demonstrably justified as being of benefit to the industry as a whole.

3.5 BT pointed out that Energis’s objective of securing lower charges for software only rearrangements could not even be guaranteed by de-averaged charges. Even if lower software rearrangement charges were guaranteed, some operators would be advantaged while others would be disadvantaged by the charge changes, depending on the balance of software and physical rearrangement services that they ordered.

3.6 BT noted the Director’s comments in paragraph 4.25 of the draft Direction that any comments from other operators would be taken into account when drawing up the Final Direction but expected that the principles espoused by the Director in the main body of the draft Direction would still form the foundation of his final decision.

MediaWays

3.7 MediaWays advised that it had approached BT in February 2001 with a request to clarify the applicable charges for changing the traffic on a 2Mbit capacity interconnect circuit from indirect access (IDA) to FRIACO, and vice versa. Correspondence between MediaWays and BT on the issue continued throughout 2001, culminating in December 2001 with MediaWays summarising a request for separate, lower software rearrangement charges.

3.8 As part of its response, MediaWays has provided a copy of an e-mail exchange which took place between it and BT in December 2001 (some of the contents of the e-mail are confidential). MediaWays alleges that the e-mail exchange shows that BT:

1. agreed that the change of a traffic route from IDA to FRIACO does not involve physical work and that only data is needed;
2. provided indicative pricing for a software only rearrangement that was significantly lower than the averaged rearrangement charge;
3. agreed a remedy to assure MediaWays that the "agreed" lower price would be applied and invoiced;
4. agreed to begin the process of developing the new product.

3.9 MediaWays states that as a result of the discussion with BT (outlined in paragraph 3.8 above), it took the decision to rearrange a number of circuits during February and July 2002. MediaWays advises that it has not been invoiced for the majority of these rearrangements, with the exception of a few circuits for which it has been invoiced for £500. MediaWays has challenged this invoice with BT.

3.10 MediaWays pointed out that as it was incorporated in 2000, it had not been in a position to contribute to the consultation in 1998 that led to the introduction of a single, averaged rearrangement charge. It supports Energis’s view that there has been a significant increase in the requirement for software rearrangements.

3.11 MediaWays argues that BT’s response to its request for a separate software rearrangement charge strongly supports the view of Energis that it should be relatively simple for BT to implement a separate software rearrangement service option. MediaWays further argues that BT’s estimate of implementation costs is too high and that the low indicative prices for software rearrangement suggest that these were based on a substantially lower implementation cost.

3.12 MediaWays disputes the conclusions of the draft Direction that there may be some overlap between the cost floors and cost ceilings of separate software and physical rearrangement service options. MediaWays argues that the additional items of work undertaken to carry out a physical rearrangement would make up the larger part of the overall cost and that this is supported by the indicative pricing provided by BT.

3.13 MediaWays argues that the assumptions used in the Cost Benefit Analysis (CBA) in the Annex to the draft Direction are incorrect as the charge for software rearrangement should be significantly reduced (based on the indicative pricing provided by BT), compared to the 15% reduction used by Oftel. Additionally, MediaWays believes that the implementation costs should be reduced.

3.14 MediaWays further argues that the CBA fails to take account of the benefits that operators would obtain indirectly from a de-averaged regime, including a significantly reduced risk in the FRIACO business. Although recognising that it is difficult to attach a precise monetary value to the effect of this reduction, MediaWays argues that it will nevertheless impact on the overall price for FRIACO-based services.

3.15 MediaWays argues that it had a clear and legitimate expectation that BT would introduce two separate charges for physical and software rearrangement services and that BT would start the implementation work. MediaWays states that it has received no notification from BT breaking the agreement and that the commercial situation of MediaWays would be adversely affected if the software rearrangement service option was not introduced as expected.

3.16 MediaWays argues that its response should change the Director’s analysis with respect to at least principles (i), (ii), (iv), (vi) and (vii) of the draft Direction, in favour of supporting Energis’s request for the introduction of separate physical and software rearrangement service options. As the draft Direction was based on a balance of arguments, MediaWays argues that the Director should conclude that BT be required to offer de-averaged charges.

Chapter 4

The Director’s decision and reasoning

4.1 Energis is in dispute with BT concerning rearrangement charges for IBCs. This is an interconnection product. For the purposes of the EC Interconnection Directive (97/33/EC) [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.] (the "ICD"), 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. Energis is an operator with Annex II status (referred to, in the BT licence, as a Schedule 2 Public Operator).

4.2 The Director has been requested to determine the following four questions:

A) Should BT be required to offer separate physical and software rearrangement services?

4.3 The Director believes that there are a number of broad principles to take into account when considering requests for charges to be de-averaged. These principles are based on a number of factors, including the requirements of the ICD and the Telecommunications (Interconnection) Regulations 1997 (the "Regulations") (SI 1997/2931)and Oftel’s general principles of cost recovery (These derive from the six principles of cost recovery that the Monopolies and Mergers Commission (now the Competition Commission) adopted in its 1995 enquiry; see the MMC's report entitled Telephone number portability: a report on a reference under section 13 of the Telecommunications Act 1984). The de-averaging principles which the Director has considered in this dispute are:

1. cost causation;
2. cost minimisation;
3. distribution of benefits;
4. effective competition;
5. practicality;
6. original reasons for averaging;
7. legitimate expectation.

(i) Cost Causation

4.4 In the explanatory memorandum that accompanied the draft Direction of 4 December 2002, the Director advised that he was minded to conclude that software and physical rearrangements were broadly similar services and that de-averaging would lead to increased costs and the possibility of no price change, due to the apparent overlap between the cost floors and cost ceilings of separate software and physical rearrangement services. The Director advised that he was minded to conclude that the existing rearrangement service was sufficiently unbundled for the purposes of Article 7 of the ICD and that, as such, the cost causation principle did not support de-averaging.

4.5 MediaWays has provided evidence in its response to the draft Direction showing that BT had provided an indicative price for software rearrangement that was substantially lower than that for the averaged service. MediaWays argues that this indicative price suggests that the additional items of work necessary to carry out a physical rearrangement form the larger part of the overall cost of physical rearrangement. As such, MediaWays disputes the Director’s conclusion that there would be an overlap between the cost floors and cost ceilings of separate software and physical rearrangement services.

4.6 MediaWays’ arguments in favour of de-averaging are primarily based on correspondence during 2001 between it and its Business Manager at BT. The e-mail that MediaWays has included with its response to the draft Direction appears to contain a proposed solution by BT to a problem put forward by MediaWays. BT makes clear in the e-mail that the price quoted is indicative and that a substantial amount of work would be required before a separate software rearrangement service option could be introduced. MediaWays itself refers to the price as being indicative throughout its response to the draft Direction. Furthermore, it is also clear from the e-mail that the proposed solution still required sign-off within BT and that the offer was not guaranteed.

4.7 The indicative price was provided to MediaWays within 13 days of its request to BT for a separate software rearrangement service option. It is not clear how full an assessment of the costs of introducing the proposed solution BT was able to carry out in this time period. BT’s e-mail makes clear that the price quoted to MediaWays is only indicative and that it would take a number of weeks to set a final price. Furthermore, before BT could implement a new price, it would need to notify this to the Director in the form of an NCCN, which requires the provision of 90 days notice as the service is deemed not to be competitive.

4.8 The Director is of the view that the indicative price provided to MediaWays by BT does not appear to be based on a full assessment of the costs. Moreover, it does not appear to take into account all the costs of carrying out software rearrangement and implementing de-averaged charges. Given this, the Director remains of the view that there is an overlap between the cost floors and cost ceilings of separate software and physical rearrangement services. He has, therefore, concluded that the cost causation principle does not support de-averaging.

(ii) Cost minimisation

4.9 In the draft Direction, the Director advised that he was minded to conclude that the cost minimisation principle suggested that BT should not be required to offer separate rearrangement service options. This was based on the estimated costs to BT of implementing Energis’s proposals to de-average the rearrangement charge. The Director carried out a cost benefit analysis ("CBA") (see the Annex below), which found that BT’s estimated implementation costs of £75,000 to £100,000 would need to fall by at least 50% before the service would break even over a five-year payback period.

4.10 MediaWays argues in its response to the draft Direction that the assumptions underlying the CBA are incorrect. In particular, MediaWays suggests that the software rearrangement charge and the de-averaging implementation costs used by the Director are too high, based on the indicative prices for software rearrangement provided to it by BT. MediaWays further argues that the CBA fails to take account of the benefits that operators would indirectly obtain from de-averaged charges.

4.11 As discussed in paragraphs 4.6 to 4.8 above, the Director has concerns about the basis of the indicative price quoted by MediaWays and does not consider it appropriate to base his consideration of BT’s costs on this indicative price. Any measure of indirect benefits to operators from de-averaged prices would be difficult to quantify and runs the risk of using erroneous assumptions. Since MediaWays has not provided a view on what the likely costs of implementation would be, the Director is of the view that the CBA can only be undertaken on the basis of the information that BT has provided. Given that the rest of MediaWays’ arguments about the inaccuracy of the CBA are based on the indicative price, the Director is satisfied that his CBA is appropriate. He has, therefore, concluded that the cost minimisation principle suggests that BT should not be required to offer separate rearrangement service options.

(iii) Distribution of benefits

4.12 The Director advised in the draft Direction that he was minded to conclude that the distribution of benefits principle suggested that there were no compelling arguments either in favour or against de-averaging. Any move from an averaged rearrangement charge could result in benefits to those operators taking software rearrangements and costs to those taking physical rearrangements. However, given the apparent overlap between the cost floors and ceilings of separate software and physical rearrangement service options, it was not clear to the Director that there would be any benefit to operators as a result of de-averaging – particularly when implementation costs were taken into account.

4.13 As discussed at paragraph 4.6 above, MediaWays is of the view that there would be no overlap between the cost floors and cost ceilings of separate software and physical rearrangement service options and that the implementation costs quoted by BT are too high. As a result of this, MediaWays concludes that some operators will obtain benefits from de-averaged rearrangement charges.

4.14 MediaWays comments are again based on the indicative price for software rearrangement provided by BT. As explained at paragraphs 4.6 to 4.8 above, the Director is satisfied that there is likely to be an overlap between the cost floors and cost ceilings of separate software and physical rearrangement services. He has, therefore, concluded that the distribution of benefits principle provides no compelling arguments either in favour or against de-averaging.

(iv) Effective Competition

4.15 On the basis of his findings that any price differential between separate software and physical rearrangement service options was likely to be relatively small and that IBCs are used to offer a wide range of services, the Director was of the view that it was unlikely that effective competition between operators would be adversely affected by whether or not separate rearrangement service options were introduced. As a result of this, the Director was minded to conclude in the draft Direction that the effective competition principle provided no compelling arguments either in favour or against de-averaging.

4.16 Based on the indicative price for a separate software rearrangement service option provided by BT, MediaWays is of the view that the price differential between separate software and physical rearrangement service options is likely to be significant.

4.17 The Director is satisfied that the indicative price does not form a sufficiently reliable basis for him to base cost calculations upon. He remains of the view that it was unlikely that effective competition between operators would be adversely affected by whether or not separate rearrangement service options is introduced and has therefore concluded that the effective competition principle provided no compelling arguments either in favour or against de-averaging.

(v) Practicality

4.18 Although recognising in the draft Direction that it would not be impractical to require BT to offer separate physical and software rearrangement service options, the Director was minded to conclude that the practicality principle provided no compelling arguments either in favour or against de-averaging. Whether the services were averaged or de-averaged, they would still be included in the Interconnect Specific Basket of the Charge Control and would still be available to all operators.

4.19 Both MediaWays (in its response to the draft Direction) and Energis (in its original submission) have argued that it would not be impractical for BT to be required to offer separate software and physical rearrangement service options. BT has not disputed this point. In its response to the draft Direction, BT emphasises that its opposition to de-averaging is based on the increased costs that it would incur and the fact that the benefits of de-averaging have not been demonstrably justified as being of benefit to the industry as a whole.

4.20 There appears to be no dispute amongst operators about the practicality of requiring BT to offer separate physical and software rearrangement service options. The Director, however, remains of the view that this in itself does not provide a compelling reason to require BT to offer separate services. The Director has, therefore, concluded that the practicality principle provided no compelling arguments either in favour or against de-averaging.

(vi) Original reasons for averaging

4.21 The averaged rearrangement charge was introduced in 1998 after consultation and agreement with the industry. Energis suggested in its original submission that the introduction of circuit specific services had led to an increased requirement for software rearrangement and that as such it was no longer appropriate to average the charges.

4.22 In addition to Energis and BT, the Director also sought informally the views of five other operators that have ordered substantial numbers of rearrangements over the last two years. These operators either expressed support for, or at least sympathy with, Energis’s request for de-averaged charges, suggesting that the whole industry no longer agrees, as a matter of course, with averaged charging for rearrangements.

4.23 The Director made clear in the draft Direction that the consultation provided an opportunity for all other interested parties to formally comment on this matter and that these comments would be taken into account when drawing up the final Direction. Only one operator responded to the consultation in support of de-averaged charges. The lack of responses to the draft Direction from the industry as a whole would suggest that there is no widespread support for de-averaging or, at least, that operators do not feel strongly enough about the subject to raise their concerns with the Director. The Director has therefore concluded that the original reasons for averaging principle suggests that there is, at present, insufficient industry support to require BT to reverse its policy of averaging rearrangements – a policy that had previously been agreed by the majority of the industry.

(vii) Legitimate expectation

4.24 The Director advised in the draft Direction that he did not consider that, in this case, there was any evidence that any operator has had a legitimate expectation that the rearrangement charge will be de-averaged. He was, therefore, minded to conclude that the legitimate expectation principle provides no compelling arguments either in favour or against de-averaging.

4.25 MediaWays has argued in its submission that it has a legitimate expectation that BT would introduce a separate, lower priced software rearrangement charge. MediaWays pointed to an exchange of e-mail correspondence between itself and BT, during which it claims that BT agreed to provide a software rearrangement service option and a price that was significantly lower than the combined rearrangement charge.

4.26 The Director would like to clarify that the legitimate expectation principle is not intended to cover disputes between parties as to whether there is a formal agreement or not, as this is a matter for the courts to consider. The legitimate expectation principle is intended to cover certain statements made by the Director. Expectation gained from certain public statements made by operators or from formal service or price publications may also be considered in this context.

4.27 The Director has considered the e-mail evidence provided by MediaWays. The e-mail from BT makes clear that implementing a change to BT’s systems to allow it to offer a separate software rearrangement option would be a large job that would need to be planned, agreed and implemented. Although an indicative price was quoted in the e-mail, it was again made clear that before a final price could be set that a full assessment of the costs would need to be carried out. The e-mail also makes clear that the proposed solution of a separate software rearrangement service option ran the risk of not getting approval.

4.28 The Director is of the view that the e-mail correspondence does not properly evidence the claims of legitimate expectation put forward by MediaWays. BT offers interconnection services and prices for those services through standard interconnection agreements and the publication of NCCNs. BT has not issued an NCCN concerning a separate software rearrangement service. The Director, therefore, remains of the view that the legitimate expectation principle provides no compelling arguments either in favour or against de-averaging.

Conclusion

4.29 The Director has used the principles in paragraph 4.3 above to assess Energis’s determination request. On the basis of his reasoning above and in the explanatory memorandum accompanying his draft Direction of 4 December 2002, the Director is of the view that, on balance, the arguments against requiring BT to offer separate physical and software rearrangement service options outweigh the arguments in favour of doing so. Most of the principles provide no compelling arguments either in favour or against de-averaging. It appears likely that the economic costs of de-averaging will outweigh the benefits of doing so and that BT may still be able to set the same charge for separate physical and software rearrangement service options whilst meeting its cost orientation obligations. The Director has therefore concluded that BT should not be required to offer de-averaged charges.

B) Should BT be required to charge for these services on a cost oriented basis?

4.30 The requirement in Article 7(2) of the ICD is for BT to show that its charges are cost oriented and for the national regulatory authority (i.e. the Director) to require that charges be amended where they are not cost oriented. Similarly, BT must be able to demonstrate to the satisfaction of the Director that its charges are cost oriented under Condition 69.1 of its licence. The Director, therefore, considers that BT should charge for the single rearrangement service on a cost oriented basis. Were he to have required BT to offer separate software and physical rearrangement service options, these would also have been subject to cost orientation obligations.

C) What are the appropriate cost oriented charges for these services?

4.31 Energis has requested that in addition to requiring that rearrangement charges be cost oriented, the Director determine the actual charges that BT should levy. Given that the Director has rejected Energis’s request for separate software and physical rearrangement service options, this question is no longer relevant. However, even if the Director had required BT to offer separate rearrangement service options, he would not have been minded to set the specific charges themselves.

4.32 Oftel’s Network Charge Controls are designed to provide BT with flexibility to set prices for specific services within a given basket, subject to safeguards on appropriate cost floors and ceilings. Separate physical and software rearrangement service options would likely have been included in the Interconnect Specific basket of the Network Charge Control and charged on a cost oriented basis. As such, the Director does not believe that there would have been sufficient reason to set specific cost oriented charges for each service.

D) Should BT be required to apply any de-averaged charges retrospectively?

4.33 Energis has requested that the Director retrospectively apply any de-averaged charges to the period 1 April 2002 onwards as this would have been the period covered had BT not rejected Energis’s request for de-averaged charges.

4.34 In addition, Energis argues that the effects of having an averaged rearrangement charge first became evident during the period 1 April 2001 to 31 March 2002 and that any de-averaged charges should therefore be retrospectively applied to this period as well.

4.35 Again, given that the Director has rejected Energis’s request for separate rearrangement charges, this issue is not relevant. Even if he had obliged BT to offer separate service options, the Director would not have considered it appropriate to retrospectively apply the de-averaged charges to the period 1 April 2001 to 31 March 2002. Energis did not submit a SoR for separate physical and software rearrangement service options until December 2001. This request was not rejected by BT until July 2002 with the result that the parties were not in dispute for the period 1 April 2001 to 31 March 2002. The Director therefore sees no compelling reason put forward by Energis to retrospectively apply charges to that period.

Annex

Cost Benefit Analysis – the economic benefits of de-averaging

A.1 When considering whether a previously averaged charge should be de-averaged, it is necessary to evaluate the benefits of doing so in relation to the costs of implementing the de-averaging. One way to do this is to perform a cost-benefit analysis. This can be done by comparing the costs with the overall welfare to society from de-averaging through the use of a simple model, such as that described below.

The model

A.2 The Director has assumed that the demand for retail services (into which rearrangements are an input) can be expressed by the following functional form:

where q is the quantity, p is the charge and a and b are parameters.

A.3 The point elasticity is –βp, calculated as below:

Consumer surplus is then q/β, calculated as below:

A.4 Total welfare or benefit can then be defined by the sum of the consumer surplus and the producer surplus. In the first instance, the total benefit is the sum of the benefits from providing each type of rearrangement at an average charge. In the second instance, total benefit is the sum of the benefits from providing each type of rearrangement at the de-averaged charge. If the net benefits exceed the costs of implementing the de-averaging, a case could be made for de-averaging.

A.5 BT has provided the Director with an estimate of the number of hours required for each of software rearrangement and physical rearrangement and the weighted average that it currently uses to calculate the single rearrangement charge. These weights are the proportion of the number of hours of each type of rearrangement in the average number of hours. Using these weights, it is possible to calculate de-averaged charges for separate physical and software rearrangement options. Doing this reduces the charge for software rearrangements by 15% while increasing the charge for physical rearrangements by 19% from the averaged charge (When calculated this way, the producer surplus after de-averaging will be zero as the new charge is set equal to the cost of providing the product).

A.6 The impact on q at the amended charges can be calculated by assuming a range of elasticities for retail services using software and physical rearrangement.

A.7 An operator would decide to rearrange IBCs when the costs of doing so are lower than the cost of ordering a new circuit. When operators pay for rearrangements, they tend to pass on the costs to consumers through the retail price. Since the retail price is made up of a number of costs, of which rearrangement is only a proportion, the impact on retail prices would be smaller than that on wholesale prices.

A.8 An operator, however, typically uses IBCs to provide a variety of services and estimating the impact of de-averaging on all the services and the corresponding retail prices that would be affected is very difficult. A proxy for the retail price is required. The method adopted by the Director is to estimate the average price per minute paid over all fixed calls on the PSTN. This would include local, national, international, NTS, premium rate services, ISDN, DQ services and calls to ISPs and others – for details, please refer to Oftel’s market information statistics http://www.oftel.gov.uk/publications/market_info/2002/fixed/). Using the relevant figures for volumes of minutes and revenues for 2001/02, the average retail price per minute works out to about 3ppm.

A.9 In order to estimate the impact of de-averaging on this price, an assumption on the contribution that rearrangement costs make to the retail price is required. With so many different services using rearrangement, this is a difficult exercise. Again a proxy for determining the contribution is required, and the FRIACO service is considered as a suitable proxy. The Director has assumed that there is one rearrangement for every 45 64kbit/s FRIACO circuits (0.67 rearrangements per 2 Mb FRIACO circuits in use), although the actual number may well be lower. Assuming that 8 customers can be served on each circuit (using a contention ratio of 8:1), and assuming a monthly price for retail unmetered access to be £16, this would mean that the cost of rearrangements as a percentage of the retail price is about 0.87%.

A.10 In order to estimate the price change from de-averaging, the Director applied this percentage to the required de-averaged price/cost changes of 85% and 119% for software and physical rearrangement respectively. This provides the percentage price changes to the retail price of 3ppm against which the consumer surplus is to be calculated. These percentage changes are –0.13% in the case of software rearrangement and +0.16% in the case of physical rearrangement.

A.11 Since the retail price is made up of all types of calls, each of which might have a different responsiveness with regard to the price, there would be a wide range of elasticities associated with the retail price. These elasticities are likely to be lowest for local voice calls (around -0.25 assumed) and highest for Internet calls (around -0.7 assumed). An average elasticity figure that could be assumed for the responsiveness of consumers to the average retail price is –0.45 each for software and physical rearrangement.

A.12 Using the above elasticities and calculating the benefits from de-averaging, the Director estimated the overall benefits to be around £8,500 per year. Assuming constant volumes going forward, and discounting at a rate of 3.5% (the public sector rate – see http://www.hm-treasury.gov.uk/media//05553/Green_Book_03.pdf), cumulative benefits can be calculated each year.

A.13 BT has estimated that it would cost £75,000-£100,000 to implement the de-averaging. At these costs, it will take about 11 years before the cumulative benefits can exceed the costs of £75,000. Sensitivities were performed on (a) the elasticities and (b) the percentage contribution of rearrangement charges to the retail price. Against a range of probable values for (a) and (b) above, it does not appear that benefits would exceed costs over a reasonable period of 5 years.