Although the UK has increasingly competitive telecommunications markets, regulation remains necessary to control prices in markets where competition is not effective.

To prevent anti-competitive behaviour, Oftel needs to understand how companies' costs are calculated and to be able to analyse available financial data.

In this issue, we look at some of the many economic and other financial terms frequently used in telecommunications regulation.

Some companies are subject to tougher regulation because they either have market influence (MI) or significant market power (SMP). MI is a UK term used by Oftel, defined as the ability to raise prices above the level that would be expected in a competitive market without losing sales to such a degree as to make this unprofitable.

SMP is a test set out at a European level and has a legal definition in various Directives. National regulators such as Oftel carry out a market assessment to see whether SMP should be applied - for example Oftel is currently consulting on whether BT Cellnet and Vodafone should be classed as SMP operators (see page 4).

Price control is one of the best known tools that regulators can use to prevent exploitative pricing in markets where competition is not effective.

Price controls are commonly applied to a service or group of services using the RPI-X formula. RPI stands for Retail Price Index, which measures average prices for a group of goods and services. Inflation is measured by the annual increase in the RPI. For example, BT's retail prices are currently subject to a price cap of RPI-4.5%.

RPI-X means that each year, the average prices for the services subject to the control cannot increase by more than the rate of inflation minus X%. If 'X' is more than the increase in the RPI, then prices must fall. For example, if the increase in the RPI in any given year is 3% and Oftel has set the value of 'X' at 10, average prices for the controlled services in that year must fall by 7%.

The aim of the price control is to reduce prices so that by the end of the price control period the regulated firm earns its cost of capital. The cost of capital is defined as the minimum rate of profit that a company needs in order for it to invest.

BT's profits, as reported in its regulatory accounts, are used to calculate its returns on capital employed (ROCE). The ROCE measures the return that BT earns on the assets used in the business.

BT's ROCE for price-controlled services in any year may be higher than the estimated cost of capital, because if BT 'beats' the price control by making efficiency savings it gets to keep the additional profit. This gives BT an incentive to increase its efficiency.

Returns can also be shown before deductions, such as taxation, and this is known as EBITDA (earnings before interest, tax, depreciation and amortisation).

Oftel also uses RPI-X controls on wholesale interconnection services The charges for BT's interconnection are based on long run incremental costs (LRIC) plus a mark-up for common costs.

Common costs are those costs that are not directly linked to providing one particular service, but contribute to a range of services - for example, billing.

Long run incremental costs (LRIC) are the additional costs incurred in providing a service given that other services are already provided. Only costs that are directly incurred as a result of the service are included in LRIC.

A third type of costs is fully allocated costs (FAC), which includes both directly incurred costs and overheads.

BT's regulatory accounts are based on current cost accounting (CCA) conventions under which the cost of replacing an asset is used (rather than the price BT originally paid for that asset, which would be historical cost accounting (HCA)).

BT is obliged to offer interconnection services to all operators at the same price - including parts of its own business. For example, BT Openworld is treated the same as any other service provider and buys services from BT Ignite at the same price. The regulatory accounts allow Oftel to make sure that BT is complying with this requirement.