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

Issued by the Director General of Telecommunications

Contents

The Direction

Explanatory memorandum

Chapter 1 – Summary

Chapter 2 – Background and history of the dispute

Chapter 3 – Initial representations of the parties

Chapter 4 – Responses to the draft direction

Chapter 5 – The Director’s decision

Glossary

Direction under the provisions of Regulation 6(6) of the Telecommunications (Interconnection) Regulations 1997 resolving a dispute between Cable & Wireless UK ('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, now Cable & Wireless UK ("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 as detailed and discussed in Chapter 4 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 2.0%.

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) In accordance with paragraphs 5.12 to 5.19 of the explanatory memorandum, which accompanies and is published with this direction, BT shall alter the Carrier Price List so that it accords with this direction.

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

25 March 2003

Explanatory memorandum

Chapter 1

Summary

1.1 The Director General of Telecommunications ('the Director') has issued a 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 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 considered the information provided by both C&W and BT and issued a draft direction and explanatory memorandum on 2 January 2003 in respect of this dispute to the industry as a whole for consultation. Comments were received and have been taken into account in making this final direction.

1.5 The details of the Director’s consideration of the responses to the draft direction, together with the reasons why the Director makes this final direction, are set out in chapters 4 and 5. The Director directs 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 2.0 per cent.

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 therefore published draft amendments to the two previous directions on 2 January 2003 to remedy the error and to ensure consistency with the draft direction in relation to this dispute. The Director has today also published final directions in relation to the NTS retail uplift calculation as follows:

• Amended 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;

• Re-amended Direction under the provisions of Regulation 6(3) of the Telecommunications (Interconnection) Regulations 1997 of BT’s retail uplift charge for calls to operators’ number translation services from 1 April 2000; and

• Direction under the provisions of Regulation 6(3) of the Telecommunications (Interconnection) Regulations 1997 of BT’s retail uplift charge for calls to operators’ number translation services from 1 April 2001.

1.7 Having considered the facts specific to this dispute and the matters set out in Regulation 6(8) of the Regulations, this direction, in the 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 costs of the content and 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 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 0 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

Initial representations of the parties

A. C&W’s referral of the dispute

3.1 In its referral C&W stated 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 argued 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 argued 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 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 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 believed 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 did 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

Responses to the draft direction

4.1 Responses to the draft direction were received from seven operators: BT, C&W, Energis and a joint response from Easynet, Kingston, Thus and Your Communications ('the joint operators'). The non-confidential versions of the responses can be found on Oftel’s website at www.oftel.gov.uk/publications/responses/2003/nts1202_4/index.htm.

4.2 Whilst the detailed submissions are not included in this document the Director has given each submission careful consideration in reaching his final decision and the main issues are addressed in this Chapter. In response to some of the issues raised the Director sought further information from BT and C&W using his formal information gathering powers. This additional information has been taken into account in making this final direction.

Request for retrospective adjustment

4.3 In the draft direction the Director set out his initial view that there were no compelling reasons to support the request for retrospective adjustment in this dispute, prior to the date that C&W proposed the change should come into effect when it submitted its OCCN to BT, which was 28 June 2002.

BT

4.4 BT supported the Director’s view against retrospective adjustment as the methodology behind the calculation of the PRS bad debt surcharge is merely being updated with up to date cost analysis as opposed to being corrected.

C&W and the joint operators

4.5 C&W opposed the Director’s view for several reasons. C&W argued that:

• No attempt had been made by the Director to distinguish between the exceptional circumstances that apply to the retail uplift but not to the PRS bad debt surcharge.
• All of the elements that impact on the NTS formula such as the retail uplift, PRS bad debt surcharge and discounts are all interrelated. As such, the Director’s decision to review and amend previous retail uplift directions to remove elements of PRS bad debt could justify OLOs forming a legitimate expectation that retrospection would apply to the PRS bad debt surcharge.
•  There are obligations on the Director to ensure cost-orientation and on BT to prove that its prices are cost oriented. The Director’s argument that BT had been complying with past directions is not strong. OLOs had raised the issue of the level of the PRS Bad Debt surcharge informally on a number of occasions and formally in responses to the retail uplift direction of 21 November 2001. BT and Oftel have had the opportunity to review the PRS bad debt surcharge but have chosen not to.
• It is unreasonable to expect OLOs to initiate disputes to ensure that the Director complies with his duties.

The joint operators broadly echoed these arguments made by C&W.

Energis

4.6 Energis also opposed the Director’s proposal. It questioned why the Director had applied retrospective adjustment to remove the erroneous inclusion of some PRS bad debt from the retail uplift but found no compelling reasons to apply retrospection in relation the level of the PRS bad debt surcharge. Energis also argued that the PRS bad debt surcharge should be cost-oriented and should have been reviewed regularly. Energis also stated that the lack of a dispute does not imply lack of concern.

Oftel’s response

4.7 In most cases, a retrospective decision represents a transfer of revenue between operators without a direct feed through to consumer benefits. The Director considers that decisions should only be made retrospective when there are clear and compelling reasons for doing so. In the case of the retail uplift, the April 1999 direction was a retrospective decision for the following exceptional reasons:

• BT had failed to review the retail uplift after August 1998; and
• Operators had a legitimate expectation that the retail uplift would be regularly reviewed following statements made by the Director

The amendments published today to the retail uplift directions for the periods from April 1999 and April 2000 do not represent retrospective decisions but are correcting an error in the calculation of the retail uplift after the Director discovered that some costs relating to PRS bad debt were inadvertently included in the baseline data underlying the calculation of the retail uplift. The retail uplift direction published today covers the time period from April 2002 to 24 July 2003 for the reasons given in that direction.

4.8 The Director is not persuaded by the arguments put forward in support of retrospection and his position on the date of application for the PRS bad debt surcharge has not changed. The date of the direction is the date initially proposed by C&W when it issued BT with a price change notice. This is consistent with Oftel’s resolution of other disputes.

Extra Working Capital associated with PRS calls

BT

4.9 BT suggested that the Director had used a simplistic 'bottom-up' model to calculate the working capital element of the PRS bad debt surcharge which does not necessarily reflect the actual working capital associated with PRS calls. BT argued that to be consistent with the retail uplift, the Director should adopt a different approach to determine the working capital by using the actual working capital data included within the BT regulatory Financial Statements. In response to Oftel’s request for further information, BT provided a breakdown of the relevant figures contained in the Additional Financial Statements. However, BT stated its view that the working capital associated with PRS calls should not be included in the PRS bad debt surcharge calculation. BT stated that this is because working capital is applicable to all calls, not just for PRS calls that BT does not receive payment.

C&W and the joint operators

4.10 C&W argued that BT already recovers its working capital costs through its charges and that by including this cost in the calculation of the PRS bad debt surcharge, means that OLOs are in effect funding BT’s credit control function. C&W referred to the discount that BT offers its residential customers that opt to pay their bills by direct debit. As payment by direct debit has the effect of guaranteeing income and reducing delays in payment, C&W argue that this reduces the opportunity cost that the PRS bad debt surcharge is meant to address.

4.11 C&W also argued that including an element in the PRS bad debt surcharge to recover BT’s opportunity cost cannot be justified in an increasingly competitive market. C&W suggested that by doing so BT has no incentive to improve its cash conversion cycle for PRS calls. C&W also stated that there is no evidence to support some of the figures contained in the calculation of the working capital element of the PRS bad debt surcharge.

4.12 The joint operators broadly echoed the arguments made by C&W.

Oftel’s response

4.13 Oftel has examined the figures available from the Additional Financial Statements in relation to BT to OLO PRS calls together with a further breakdown of this data provided by BT and concludes that the extra working capital associated with PRS calls has an immaterial effect on the calculation of the surcharge. In the light of this and the comments made by both OLOs and BT, Oftel has removed the working capital adjustment from the surcharge and amended the retail uplift directions accordingly. This has the effect of reducing the surcharge of 2.05 per cent contained in the draft direction by 0.05 per cent to 2.0 per cent in this final direction and also has an immaterial effect on the retail uplift calculations.

Use of non-AS data

BT

4.14 BT argued against the Director’s decision not to rely on data provided by BT on its Follow up Ratings ('FuR') in assessing the ‘incidence factor’ of the PRS bad debt surcharge as it was inconsistent with the methodologies used in deriving inputs used elsewhere in the calculations for this direction and NTS retail uplift directions. BT stated its belief that the Director is inconsistent in claiming cost recovery should be consistent with other regulatory pricing and costing mechanisms. BT argued that the retail uplift was a good example of this inconsistency in that the retail uplift charge does not allow the recovery of the common costs in the Fully Allocated Costs approach from elsewhere.

Oftel’s response

4.15 In the draft direction, the Director stated that the use of the FuR data would be inconsistent with other NTS directions as it would be using a separate cost allocation that does not reconcile with that in the Financial Statements. The Director believes that use of the FuR data could cause over-recovery by BT of bad debt costs across all calls. The Director does not agree that the calculation of the retail uplift charge results in an inconsistency. The charge is based on a recovery of costs that have been allocated between NTS calls and geographic calls, which is consistent with the 1996 price control review. Oftel is in the process of consulting on a new basis for the retail uplift in the recently published consultation market review entitled Review of the fixed narrowband wholesale exchange line, call origination, conveyance and transit markets (see note three below).

Allegation that PRS bad debt costs are recovered through other cost items

C&W

4.16 C&W questioned BT’s argument that the A1/AIT fraud process is not relevant to the PRS bad debt surcharge. BT had stated these relate to costs incurred by BT through interconnecting with other operators, whilst the PRS bad debt surcharge is incurred in respect of retail customers not paying for calls which they have made. In its response to the consultation C&W provided the Director with a confidential annex giving details of amounts withheld by BT in respect of call termination payments to C&W.

Oftel’s response

4.17 The Director has considered both the materiality of the extent of PRS call revenues withheld under A1 fraud/AIT rejection forms from terminating operators and the accounting of these withheld revenues by BT to establish whether there was a problem of double recovery.

4.18 In the draft direction the Director stated that compared to turnover on PRS calls the amount retained by BT in 2000/01 was insignificant and as such this issue was unlikely to have a material effect on his decision in relation to this dispute. In order to confirm this view the Director required BT and C&W to provide further details of amounts retained in relation to A1 fraud/AIT forms and turnover on PRS calls following the consultation period. After examination of this information, the Director is satisfied that the amount retained compared to turnover on PRS calls is not material to this direction.

4.19 BT has explained that where amounts are permanently retained BT simply reverses in its revenue accounts that part of the original amount billed to the end user customer and consequently BT does not write off the respective revenues as bad debt either before or after a case of suspected AIT has been closed.

4.20 Based on this information the Director does not believe that, even if the monies withheld were material, this would lead to double recovery as BT does not appear to remove the relevant retail debt by expensing it as bad debt. The level of the PRS bad debt surcharge has been based on the value of retail bad debt written off attributed to PRS calls as reflected within BT's regulatory Financial Statements for 2000-01. Such amounts, based on this evidence, will not have been inflated by amounts retained by BT in respect of the A1/AIT fraud process.

Note:

3. Available on Oftel's website at www.oftel.gov.uk/publications/eu_directives/2003/eu_narrow/index.htm.

Chapter 5

The Director’s decision

The relevant market and the position of the parties

5.1 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 four 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 decision

5.2 Having considered the representations of C&W and BT and the responses to the draft direction issued on 2 January 2003 in respect of this request for a direction together with the matters set out in Regulation 6(8) of the Regulations, the Director directs 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 2.0 per cent.

5.3 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. This ensures that the charge lies in between the Long Run Incremental Costs (floor) and the Stand Alone Costs (ceiling).

Calculation of the PRS bad debt surcharge from 28 June 2002

5.4 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.

5.5 The PRS bad debt surcharge covers the extra bad debt expense 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.

5.6 The extra bad debt expense can be divided 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’.

The ‘price factor’

5.7 BT provided Oftel with the total figure for 2000-01 PRS bad debt written-off from the amounts attributed by BT to PRS calls retail product groups for these costs. These retail product groups are subsets of BT’s Retail Systems Business disaggregated activities for which BT produces published regulatory Financial Statements. This gives a total figure for PRS bad debt, that encompasses the extra bad debt associated with the price factor of PRS calls, and the standard bad debt. 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).

Note: A+ B = Total figure for 2000/01 PRS bad debt written-off

5.8 The standard bad debt is part of the retail uplift charge and is equal to 0.11pence per minute. This figure is expressed as an average percentage of the PRS retail call price. This percentage figure is subtracted from the percentage ratio of PRS bad debt to PRS 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)

z% is the difference between x% and y% (ie. x% minus y%) and is the surcharge required on top of the retail uplift bad debt allowance to recover the additional ‘price factor’ bad debt costs associated with PRS calls.

The ‘incidence factor’

5.9 As set out in paragraphs 4.22 to 4.24 of the explanatory memorandum that accompanied the draft direction and paragraphs 4.14 and 4.15 of this explanatory memorandum, the Director has no robust information to suggest that the incidence of bad debt, as a percentage of turnover net of discounts, is materially different when contrasting PRS calls with the Local and National Calls disaggregated activities. The Director has therefore decided that no additional allowance for the ‘incidence factor’ needs to be included in the calculation of the PRS bad debt surcharge.

Calls & Access (C&A)

5.10 In the explanatory memorandum to the draft direction the Director explained that data provided by BT and used in calculating the proposed PRS bad debt surcharge contained C&A wholesale bad debt costs which should not be included in a bad debt figure used for NTS directions. This is because C&A bad debt is wholesale bad debt occurring as a result of C&A providers not paying their bills eg when C&A service providers go out of business. The PRS surcharge relates to retail bad debt incurred by BT due to end users defaulting on payment. For the purpose of the draft direction the Director estimated the C&A bad debt costs present in the data and stripped them out. During the consultation period the Director required BT to provide actual C&A information to enable these bad debts to be more robustly stripped out in the final direction. The actual information provided by BT confirmed the Director’s initial view that the impact of removing C&A bad debt has a negligible effect on the calculation of the surcharge. The data provided by BT does not alter the surcharge as proposed in the draft direction.

Conclusion

5.11 The Director’s decision in this case is to reduce the PRS bad debt surcharge from 4.4 per cent to 2.0 per cent. 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 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

5.12 In the draft direction, Oftel proposed changes to the process used by BT to implement Oftel directions through publication of pricing letters and OCCNs.

5.13 In response to other draft directions where these changes were proposed, a number of operators expressed concerns about how, under the proposed new process, perceived errors in BT’s implementation of the Director’s decision would be addressed. Oftel has considered these concerns and concludes that the implementation process in this direction should offer similar opportunities in terms of time for highlighting genuine errors in BT’s change proposals and subsequent negotiation and dispute, as the process already in operation for OCCNs.

5.14 The main difference compared to current OCCN procedure, for the purposes of implementing this direction, is that the Operators will not have to notify their approval of BT’s proposed changes within 14 days of receipt of the proposed changes. Instead, such approval will be deemed after 14 days in the absence of the Operator notifying BT otherwise as set out below.

5.15 Accordingly, and only in relation to the changes resulting from this direction, as soon as possible following publication of this final direction, BT will notify operators of the changes it proposes to make to the Carrier Price List ('CPL') in order to implement this direction. Operators will then have 14 days from receipt of the proposed changes to notify BT in writing of any concerns with BT’s proposed changes to the CPL stating why that Operator believes that the proposed changes do not correctly implement this direction. If an Operator is satisfied that the proposed changes do correctly implement this direction, there will be no requirement to notify BT of its approval of the changes.

5.16 If, after the 14 days, no formal concerns are notified to BT, the proposed changes to the CPL will be deemed to have been approved and BT shall include the changes in the CPL.

5.17 Where an operator does raise concerns that BT’s proposed changes do not correctly implement this direction BT and the operator shall have a further 14 days to seek to reach agreement as to the proposed changes so that they do correctly implement this direction. If the parties fail to reach agreement within the further 14 days either party may, not later than one month after the expiry of the second 14 day period, refer the matters in dispute to the Director. This process provides a means of bringing a dispute on the incorrect implementation of this direction and is not a route that can be used to reopen the issues already dealt with by the Director.

5.18 Until agreement of the proposed changes is reached by the parties, or the proposed changes are determined by the Director as a result of a dispute, the charges currently contained in the CPL shall continue to apply. The new changes, once agreed, shall then be included in the CPL.

5.19 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:

4. 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.

Glossary

Fully Allocated Cost (FAC) – An accounting approach under which all the costs of the company are distributed between its various products and services. The fully allocated cost of a product or service may therefore include some common costs that are not directly attributable to the service.

Long Run Incremental Costs (LRIC) – Costs that arise in the long run as a result of providing a given 'increment', eg, an additional amount of numbers. Long run costs assume that the supply of numbers is variable (not fixed).

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.

Premium Rate Service (PRS) – services, including recorded information and live conversation, run by independent service providers mostly within the number ranges 0900 and 0901. All calls to these companies are charged at a higher rate than ordinary calls to cover the companies' costs in providing the content of the call and the operator's cost for the special network facilities needed.

Stand alone costs – the costs to a single product firm of providing a service. The stand-alone costs of a service exceed the incremental costs to a multi-product firm if there are economies of scope.

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