Contents

Chapter 1 – Summary

Chapter 2 – Introduction and background

Chapter 3 – Responses to the consultation

Annex A – Consent

Annex B – Glossary

Chapter 1 – Summary

S.1 On 19 April 2002, pursuant to Condition 69.23 of BT’s Licence, BT requested the Director General (Director)’s consent to increase the call handling element of the charge it makes to other PTOs for calls made by their customers to BT’s emergency operator (answering) service, above the safeguard cap of RPI+0%.

S.2 BT advised the Director that the proposed increase was driven by the need to deploy essential new call handling equipment for BT’s operator call centres. BT requested an increase from 52.00 pence per call to 60.66 pence per call and BT proposed that this change took effect from 17 May 2002.

S.3 On 10 May 2002 the Director wrote to BT seeking further information in relation to the increased charge. The Director also advised BT that he expected to consult interested parties about the proposal and so was unlikely to reach a decision before 17 May when the increased charge was due to be introduced.

S.4 In the light of this BT advised the Director on 8 May that it would not be implementing NCCN 332 on 17 May. NCCN 332 was formally withdrawn on 16 May 2002. However, BT asked that if the Director was prepared to grant the requested consent under Condition 69.23, he determine that the original proposed effective date of 17 May is reasonable under Condition 45.8 of BT’s Licence.

S.5 In a consultation document ‘A consultation on charges for Emergency Service (999) calls’ issued on 5 March 2003 (see www.oftel.gov.uk/publications/pricing/2003/bt9990303.htm) the Director reviewed the need for this new equipment and was satisfied that its deployment was necessary to ensure the quality and safety of providing its emergency operator (answering) service. The Director also reviewed BT’s costs of providing the service and was content that an increase of the charge to other PTOs above the safeguard was justified. The Director was minded to grant the necessary consent but proposed that the increase should be set to 58 pence per call. The Director also considered he had no powers to grant retrospection in this case.

S.6 Comments to the consultation were received from BT, Vodafone, Orange, ntl and Energis. As a result, the Director has reviewed the elements of BT’s costs of providing the service raised in the responses. The Director remains content that an increase of the charge to other PTOs above the safeguard cap is justified but that the increase should be set at 57.2 pence per call.

Chapter 2 – Introduction and background

Note: when 999 is referred to in this document it equally applies to services provided by dialling 112.

2.1 Condition 69.23 of BT’s Licence provides a ‘safeguard cap’ restricting the level of increase that BT can make to the fixed call handling charge for access to its 999 service to no more than RPI+0% in any 12 month period from 1 October to 30 September. The ‘safeguard cap’ was set to ensure that provision of this essential service does not disadvantage other PTOs.

2.2 BT can seek the Director’s consent to larger increases if it can demonstrate that failure to do so would endanger the quality and security of its handling of emergency calls.

2.3 Further details of BT’s request and the Director’s initial views can be found in the consultation document of 5 March 2003 at www.oftel.gov.uk/publications/pricing/2003/bt9990303.htm. A short summary follows.

BT’s request

2.4 BT advised the Director that the latest proposed increase follows a significant increase in the underlying costs of providing the emergency operator (answering) service.

Cost information provided by BT in support of its request

2.5 BT deployed three new 5ESS switches into the network in October 2001, making an investment of £23 million. One of these switches is dedicated to 999 use to give added resilience and the other two have 23 per cent of their capacity for 999 use. Based on these figures, the investment relating to 999 use is £11.2 million. BT’s investment in the new switches, along with the associated changes to its call handling software and other infrastructure such as 999 recorders, was incorporated into BT’s 999 service ‘cost stack’ which details the component costs of the call handling service and submitted to the Director with BT’s application.

2.6 BT submitted a simple depreciation and FAC based approach to recover the costs associated with the 999 service and derived a total charge of 60.66p per call, that is, an increase of over 16 per cent. However, BT’s calculation ignored an inherent accounting distortion. While the 999 charge can increase in line with the safeguard cap, BT’s approach implies a declining path of capital costs (as the mean capital employed will diminish over time). Other things being equal, this would give BT the opportunity to over-recover costs during the lifetime of the switches. Given this distortion and for other reasons, the Director considered that an alternative calculation of the charge for the 999 service was appropriate.

The Director’s initial views

Safety and quality of the service

2.7 The Director considered that the installation of the three new switches was necessary to ensure the quality and safety of the 999 call handling service. The previous switches had become obsolete and support for the previous platform supplied by Marconi was to be discontinued. As a result there was an urgent need to replace this system. The Director considered that the 999 service needs to be absolutely resilient and cannot afford to be placed at risk – the risk of the system failing in the absence of readily available maintenance could have had extremely serious consequences. The Director also considered that the massive growth of calls in the mobile sector, especially large numbers of accidentally dialled ‘silent calls’ originating from mobiles, has contributed to a changing balance between non-emergency and emergency calls on BT’s Operator switches and required greater sophistication in handling and distributing these calls across the network.

The Director’s methodology

2.8 In contrast to BT’s calculation, the Director considered that a discounted cash flow (DCF) approach to recover the LRIC of providing the service was more satisfactory in the context of investment in new switches. The DCF based calculation derives the constant (ie real) per call charge which if allowed to grow at the rate of inflation and given forecast usage, would yield a revenue stream with a present value equal to the present value of capital and operating costs over the life of the investment (ie five years).

2.10 Capital costs: the Director used BT’s derived figure for total switch expenditure allocated to the 999 service. Of the total outlay of £23 million for 3 5ESS switches the allocation to the 999 service is £11.2 million – on the basis of 1 switch being dedicated to the 999 service to ensure resilience and the other two being used 23 per cent of the time. As a proxy for other ‘up-front’ capital outlay the Director used BT’s mean capital employed figure for 2000-01, stated on an incremental cost basis. This figure was £3.4 million. The other relevant capital outlay is a software upgrade anticipated half-way through the life of the switches, estimated by BT at £1.1 million.

2.11 Operating costs: these were assumed to be driven by total operator handling time. Forecasts for annual total operator handling time were derived by multiplying the forecast annual number of calls (see table below) by the 2001-02 per call operator handling time. To forecast annual LRIC operating costs, the Director first calculated the historic three-year average ratio of LRIC operating costs to total operator handling time (based on years 98-99 – 00-01). Annual LRIC operating costs were then derived by multiplying this ratio by the forecast annual total operator handling time (derived as above).

2.12 The volume of calls estimated over the life of the switches is shown in the following table.

Actual and forecast number of calls to BT’s 999 call handling service

*The 2001/02 figure is for the actual number of calls – as submitted to by BT. BT only provided forecasts for the two years post 2001-02. Forecasts for 2004-05 and 2005-06 were derived by the Director and assume 2 per cent p.a. growth for these years. The upward trend of the last few years in the actual number of calls is anticipated to level out mainly because mobile handset growth has flattened. In any case, the calculated charge is not particularly sensitive to reasonable variation in the call growth assumption.

2.13 Resulting 999 call handling charge: finally, the Director calculated the real charge per call which, if allowed to increase at the rate of inflation, would just allow recovery of the capital costs and subsequent discounted annual LRIC operating costs. The resulting base case charge per 999 call was 58 pence for the financial year 2001-02. This represented an increase of approximately 11.5 per cent, 9.6 per cent higher than the 2001-02 safeguard cap.

Request for retrospection

2.14 BT asked that if the Director were prepared to grant the requested consent under Condition 69.23, he should also determine that the original proposed date of 17 May 2002 was reasonable under Condition 45.8 of BT’s Licence. The Director considered that he has no powers to grant retrospection in this case.

2.15 Condition 69.23 of BT’s Licence does not give the Director any power to grant consent for an increase in the charge retrospectively. However, Condition 45(8) allows the Director to make retrospective decisions when considering a term of an interconnection agreement (including a charge).

2.16 The Director believed that his ability to grant retrospection under Condition 45(8) has to be considered in terms of his powers under the EC Interconnection Directive 1997 (ICD). The ICD is implemented by the Telecommunications (Interconnection) Regulations 1997 (the Regulations).

2.17 Pursuant to Regulation 6(6) of the Regulations, the Director can make a direction to resolve an interconnection dispute. The Director considered, however, that he could not make a direction under Regulation 6(6) (and so make a retrospective decision under Condition 45(8)) in this case as there is no dispute.

2.18 The Director noted that he may consider a term of an interconnection agreement which has already been concluded when he acts under his own initiative pursuant to Regulation 6(3) of the Regulations. If the Director could intervene on this basis, Condition 45(8) could be relevant to how he exercised his powers. However, the test for intervention under Regulation 6(3) requires both exceptional circumstances for intervention and justification in terms of ensuring effective competition. In this case, intervention is not on the basis of ensuring effective competition. This is because the safeguard cap does not derive from the need to ensure competition but to ensure that the quality and security of the emergency services is maintained. The Director did not therefore consider that he has any power to intervene on an own initiative basis under Regulation 6(3) as the test is not satisfied in relation to ensuring competition. If following consultation the Director remained of the view that the increased charge were justified, he proposed that it should be effective from the date of consent.

Chapter 3 – Responses to the consultation

3.1 Comments were received from BT, Vodafone, Orange, ntl and Energis. BT requested that their response remained confidential but the other responses can be found on Oftel’s website at www.oftel.gov.uk/publications/responses/2003/bt9990303/index.htm. A number of issues were raised concerning the Director’s views. The operators generally accepted the principles and also accepted the Director’s methodology. Comments were made on some of the assumptions used and costs included in the calculations. The points made are discussed further below.

Economic life of the switches

3.2 Vodafone noted that a five year life for the new switches appears considerably shorter than the typical lifetime of a switch and that a more realistic asset life of eight years should be considered in calculating the 999 charge. Orange suggest that a ten year asset life is more appropriate and is in-line with standard industry accounting practice for the depreciation of switch equipment. Orange added that the approach adopted by the Director in estimating the charge for the 999 service is likely to result in over-recovery of capital investment by BT.

3.3 The Director, however, remains of the view that a five year life for the switches is reasonable. BT has told the Director:

3.4 The Director’s view takes into account the network in which the switches are deployed. BT’s network is older and larger than those of competing operators which means that BT may encounter more problems in interoperability as changes are made to the network. BT needs to ensure that the overall network continues to operate effectively, particularly for the 999 service. The other operators tend to have newer, smaller networks and are less likely to have problems with upgrades. It therefore seems reasonable that a switch may need replacing or upgrading earlier in the BT network than in some other networks. The Director concludes that a five year life for the switches is reasonable within the BT network, while accepting the views expressed by the other operators that the switches could last longer in their networks.

Forecast 999 volumes over the life of the switches

3.5 BT does not agree with the Director’s view that there will be a modest (2 per cent) rise in calls to 999. BT claim that recent growth has been mainly due to calls from mobile phones, many of which are accidental. They also point to underlying trends noted by the emergency services such as more people reporting the same incident as more have access to mobile phones. As handset manufacturers and the mobile networks address these problems and as the sales of new mobile handsets has slowed, BT are of the view that there will be a modest decrease rather than an increase in the number of calls to 999. They anticipate a decrease in overall call volumes over the five-year appraisal period of between 5 per cent and 10 per cent.

3.6 The Director notes that the recent period from 2000 – 2002 shows an extremely high growth in numbers of 999 calls – as high as approximately 25 per cent year on year. Much of this increase is due to 999 calls originating from mobiles. The Director recognises that as the rate of growth in the number of mobile users slows, the rate of increase in the number of 999 calls is also likely to slow. However, the trend shows that the number of mobile users continues to rise.

3.7 Technical improvements to handsets may over time help to reduce the problem of accidental calls. However, the speed at which the number of calls decline depends on the speed with which newer handsets replace current models. In the short term, therefore, it is unlikely that handset changes will arrest the increase.

3.8 The Director is of the view that while the number of calls to 999 are likely to be reduced in some areas, the factors that give rise to an increase in calls are likely to outweigh these. The conclusion reached is that the modest growth of 2 per cent per year for the last two years of the appraisal period is a reasonable forecast.

Mobile calls

3.9 ntl noted that as the majority of traffic changes are driven by mobile calls, the costs should be appropriately apportioned between fixed and mobile. The Director notes that the proportion of 999 calls from mobile users is now slightly greater than the proportion of calls from fixed lines (BT figures show 52 per cent against 48 per cent). However, the efficiency gains resulting from the deployment of the new switches benefit all operators and each operator makes a contribution based on the number of calls it generates. The Director therefore concludes that the contribution made to the 999 service is in direct proportion to the number of calls made by each operator and no further apportionment of costs between fixed and mobile is warranted. 

Operating costs/efficiency gains

3.10 Orange, ntl and Vodafone made comments in respect of the expectation of improvements to operator handling time with the new switches. Vodafone noted that the Director’s approach of using historical figures in his calculations is not a good representation of future operating costs with the new hardware.

3.11 The Director agrees. Operator efficiency gains deriving from the deployment of the new switches, not current average historical operator handling time, should be reflected in anticipated future average operator handling time. BT has provided evidence that average operator call-handling time was expected to fall by five seconds following the installation of the new switches. The Director therefore considers that a five second efficiency gain per call should be included in his calculations for operator handling time.

Retrospection/effective date

3.12 BT submitted that in order to avoid an outcome which requires the under-recovery of costs by BT for the 999 service for the period in question, BT had expected that Oftel would be able to use its discretion to allow any new charge to become effective on a retrospective basis.

3.13 For the same reasons noted in 2.12, the Director considers he has no powers to grant a retrospective charge in this case.

3.14 However, the Director also recognises the charge set must allow BT to recover all its legitimate costs in operating an emergency answering service as it would not be proportionate to force BT to make a loss. Therefore as BT has continued to charge for the service at 52 pence per call, revenues recovered from the period of installation of the new switches to the present can be subtracted from the present value of costs to be recovered since the period of installation. The charge calculated by the Director is designed to cover the outstanding present value of costs.

BT’s methodology

3.15 BT noted the Director's concern regarding the capital element included in its cost calculation. A calculation based on the gross capital employed would represent, an ‘inherent accounting distortion’. This is true because the fair cost of capital should be derived not from the gross capital but from the mean capital employed (MCE) throughout the life of an asset ie half the gross figure. To calculate ROCE on the gross capital would indeed lead to over-recovery of costs.

3.16 BT claims that it has correctly derived ROCE from the mean capital employed and this ROCE figure will change a little throughout the appraisal period because the non-switch capital in year one may fluctuate in subsequent years. Such fluctuation is likely to be almost immaterial to the charge calculation.

3.17 In the consultation document, the Director has disregarded BT’s methodology because it ignores an inherent accounting distortion and gives BT the opportunity, to over-recover costs. In BT’s view there is no accounting distortion since BT’s calculation of ROCE gives an annual return on the mean capital employed which is smooth throughout the investment period. Neither does this methodology give BT any opportunity to over-recover costs as the only capital cost BT is recovering is the permitted regulated return of 13.5 per cent per annum.

3.18 The Director’s concern with BT’s approach is that it ignores BT’s ability to increase the charge per period in line with the safeguard cap and the timing of cashflows. He therefore considers that a calculation based on the initial switch outlay, the discounted stream of future expected costs and an allowance for nominal charge growth in line with inflation to be a more accurate basis for determining the appropriate level of the charge in the present context.

Capital costs related to 999 call handling service

3.19 Orange and ntl commented that they would like the Director to ensure the costs recovered are wholly and directly necessary for the upgrade to the 999 service. ntl were concerned at the lack of transparency over the costing information.

3.20 The Director considers that BT can provide the 999 service more cost-effectively by handling 999 calls alongside other operator assisted calls on a shared operator assistance (OA) platform. BT’s OA switch platform consists of three switches which have the same facilities for handling all call types. The Director considers that for the added resilience requirements of the 999 service, BT has had to operate a third live switch. Therefore, the Director considers that a reasonable way to separate the capital costs for 999 from other OA services is to allocate the capital costs for one switch to 999 and the capital costs of the other two in proportion of the 999 traffic carried over them.

3.21 The Director requested more detailed costing information following the operators’ comments. This information consisted of a breakdown of the switch costs at each location, a breakdown of the software costs and details of modifications made to hardware and software to integrate the switches into BT’s network. In addition, the Director requested copies of invoices to show the timing of the expenditure. With this information, the Director was able to analyse which costs were specifically for 999 services, which were for more general operator services and which were shared by both. The 999 specific costs are included in their entirety in the Director’s calculations, the costs for other operator services are excluded and the shared costs are included by a factor of 23 per cent based on the proportion of 999 traffic described above. Having gone through the exercise of reviewing BT’s costs down to the invoice level, the Director finds that the costs attributable to the 999 service are £10.55 million, lower than the £11.2 million capital costs used in his previous calculations.

3.22 As a result of this exercise, the Director is satisfied that of the total investment outlay for the 3 5ESS switches the allocation to the 999 service is £10.55 million (including software upgrades) – on the basis of one switch being dedicated to the 999 service to ensure resilience and the others being used 23 per cent of the time. As a proxy for other ‘up-front’ capital outlay the Director, as in his consultation document, used BT’s mean capital employed figure for 2000-01. This figure is £3.4 million.

Conclusion

Resulting 999 call handling charge

3.23 The Director calculates the real charge per call which, if allowed to increase at the rate of inflation, would just allow recovery of the capital costs and subsequent annual discounted LRIC operating costs over the life of the switches less the present value of revenues already earned. As noted above, capital costs include £3.4 million ‘up-front’ costs and £ 10.55 million investment in the new switches, on the basis of one switch being dedicated to the 999 services and the other two switches being used 23 per cent of the time. Also, a five second efficiency gain in the operator handling time is assumed in the forecast annual LRIC operating costs.

3.24 The Director calculates the charge using a DCF methodology, with a 13.5 per cent cost of capital and a five year life for the switches. However, for the reasons explained above, the calculations recognise that there has been revenue recovery since the implementation of the switches. The resulting charge per 999 call is 57.2 pence for the financial year 2001-02. This is an increase of 10 per cent, approximately 7.9 per cent higher that the 2001-02 safeguard cap which is the starting point of the Director’s calculations. In addition BT can increase the charge in line with the safeguard cap where it has not yet done so. BT can recover RPI+0% for years 2001-2 and 2002-3 (If BT decides to do this, the new charge for 999 calls will become 59.2 pence.)

3.25 The Director is therefore minded to grant BT the necessary consent to increase the 999 call handling charge to 57.2 pence per call (in 2001-02 values).

3.26 The safeguard cap will remain unchanged at RPI+0% allowing BT to recover inflationary increases. Therefore, as BT has not adjusted the charge for inflation since 2001, it may increase the new charge by RPI+0% for the last two periods (October 2001/September 2002 and October 2002/September 2003).

Impact of the EU Directives

3.27 The safeguard cap is implemented through Condition 69.23 of BT's licence. All licences will be revoked on 25 July 2003 under the provisions of a package of new EU Directives. However, continuation notices will be issued for certain conditions to take them forward beyond the 25th July. It is intended that Condition 69.23 will be subject to a continuation notice and the obligation to maintain charges within the safeguard cap and this consent will continue.

Annex A – Consent

TELECOMMUNICATIONS ACT 1984

CONSENT UNDER CONDITION 69.23 OF BT’S LICENCE

WHEREAS:

(1) On 22 June 1984, the Secretary of State granted a Licence (the "Licence") to British Telecommunications under Section 7 of the Telecommunications Act 1984 (the "Act") for the running of the telecommunications systems specified in Annex A to the Licence and subject to the conditions contained in its Schedule 1;

(2) By virtue of section 109 of, and paragraph 20 of schedule 5 to, the Act, the Licence has effect as if granted to British Telecommunications plc (the "Licensee").

(3) Condition 69.23 of the Licence requires that except to the extent that the Director otherwise consents (on the grounds that the quality and security of the Service would be endangered), the Licensee shall secure that each discrete charge for the non-conveyance element of a Public Emergency Call Service (as defined in the Licence) does not increase by more than the safeguard cap calculated in accordance with that condition.

(4) On 19 April 2002, BT requested the Director General’s consent to increase the call handling element of the charge it makes to other public telecommunications operators for calls made by their customers to BT’s emergency operator (answering) service.

(5) The increase is from 52.00 pence per call to 57.2 pence per call for the Relevant Year 2001/2002 with effect from [date 2003].

(6) This charge of 57.2 pence per call represents an increase to the charge of 10.0%.This is in excess of the safeguard cap set out in Condition 69.23 by 7.9%. The proposed increase can only be introduced therefore with the Director General’s consent pursuant to Condition 69.23.

(7) The Licensee has requested that the increased charge be permitted

following the deployment of essential new call handling equipment for the Licensee’s operator call centres which was required to ensure that the quality and security of its Public Emergency Call Service (as defined in the Licence) would not be endangered.

(8) The Director has consulted the Licensee and other Interested Parties (as defined in the Licence) and is content that the revised charge is justified on the grounds set out in Condition 69.23.

THEREFORE:

The Director hereby consents to the call handling element of the charge the Licensee makes to other public telecommunication operators for calls made by their customers to the Licensee’s emergency operator (answering) service being increased from 52.00 pence per call to 57.2 pence per call (in 2001/2002 values) with effect from 23 June 2003.

CHRIS KENNY

Director of Compliance

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

23 June 2003

Annex B – Glossary

5ESS Switch – widely used, modern digital switch, manufactured by Lucent.

Network Charge Control (NCC) – The arrangements under C69 of BT’s licence for regulation of BTs interconnection regime. BT issues Network Charge Change Notifications (NCCNs) whenever BT changes the charge for a BT wholesale service or offers a price for a new BT wholesale service.

Points of Connection (POC) – also known as Switch Connections ie where an operator’s network interconnects with BT usually at a Digital Main Switching Unit (DMSU) or Wide Area Tandem (WAT). Points of connection with BT in the context of Oftel’s Direction of BT’s NTS Conveyance refer only to switch connections carrying NTS calls where the links were ordered by the operator and agreed with BT according to forecasts of capacity requirements provided by the operator. The operator will also have paid any appropriate charges. Circuits provided by BT for its own network management purposes, referred to as NTS Extension Circuits (NTSECs), do not qualify as they are not a BT standard interconnection product. These are distinct from Interconnection Extension Circuits (IECs) which are a BT Standard Service.

Public Telecommunications Operator (PTO) – network operators providing services to the public with powers granted by the Secretary of State for Trade and Industry under the Telecommunications Act 1984 to enable them to install their systems on public and private land, property etc.

Publicly available telecommunications services – whether a service is "publicly available" is likely to be a question of fact and judgement which will depend on all the circumstances. As a minimum it is likely that a telecommunication service will be publicly available if it is "on offer" to anyone who is prepared to pay for it, probably with standard terms and conditions. Sometimes this criterion may not be sufficient. Public accessibility of the network over which the service is provided may also need to be taken into account.

Relevant Year – for the purposes of Condition 69 only, any of the four periods of 12 months beginning on 1 October starting with 1 October 2001 and ending on 30 September 2005

RPI-X – the system of price control where average annual price changes for the price-controlled services are limited to the increase in inflation (as measured by the Retail Price Index) less a specified number (X).