Return on investment

There’s a tension between companies being regulated and the people doing the regulating. This is as it should be – their goals are different and the tools to achieve those goals tend to be at odds with each other.

Companies are required by law to maximise their return on investment. Shareholders are nominal owners of the company and yet have very little power, unless they’re big enough to have a seat on the board or similar. I’m always amused whenever a company claims rousing success with some venture or other based on shareholder approval, most of which is gifted to the CEO or chair by way of proxy votes.

Regulators, on the other hand, are required to do what’s right for the long-term best interests of the customer. That’s often not as straight forward as we customers would like. Issues like passthrough of wholesale savings, demand for investment, even the time it takes to produce a result are all seen as roadblocks on the way to better pricing.

Given that companies don’t like being regulated, those that are often complain about trying to second guess the regulator, about having no certainty in the market. Chorus has certainly cried foul about the lack of certainty with regard to the regulation of its copper line monopoly, although seeking a judicial review of the Commerce Commission’s determination doesn’t exactly endear the company to the industry as a whole.

Consistency is key to a good regulatory regime. It’s the only way companies that are involved in a regulated sector can avoid uncertainty. The regulator should be able to demonstrate the logic that it uses and apply the rules consistently wherever possible.

Which makes Vector’s submission on the UCLL pricing so interesting. (NOTE: the ComCom website does not do well with actual linking. Instead, it operates a one-step removed model that includes breaking the basic tenet of the internet, so rather than linking directly, I have to point you to a page where you must in turn fossick about looking for the submissions you’re after)

Vector, of course, has a lot to do with the regulator in its day job in the electricity sector. It’s not often that Vector comes out and says anything nice about the Commerce Commission – it has the scars to bear of many encounters.

What’s intriguing is that Vector has looked at the Commission’s treatment of Chorus’s profit making in light of the way the Commission treats Vector and others in the electricity sector.

Over there, in (ahem) sparky land, return on investment is heavily regulated. There’s a library-worth of regulation, argument, angry shouting and tears (all in the legal sense of course) and whatever else you might think about the electricity sector (that Max Bradford’s reforms, for example, should be held up as a shining light for how not to regulate a sector), the process itself is as robust as it can be.

By putting Chorus’s public data through the Commission’s “Electricity Distribution Information Disclosure Determination” process from 2012, Vector has worked out that Chorus is seeking a return on investment of between 19% and 23%.

Vector’s return is significantly less – closer to 10% – and the other regulated industries are around the same mark. Chorus hasn’t challenged this in its cross-submission – indeed, it doesn’t mention it at all. Instead, I’m left wondering whether we can use Vector’s figures as a kind of cross-check on just what Chorus is asking for in terms of income.

After all, the role of Chorus’s management is to maximise returns on its investment. It has to argue vigorously for a higher price, regardless of what’s good for the industry or the user.

That’s why an independent regulator is so important, and that’s why TUANZ joined the Copper Tax coalition. We need to get these figures right. Set the price too high and we reward Chorus for being inefficient. We also run the risk of encouraging Telecom to simply unbundle on a massive scale – tens of millions of dollars’ investment in copper at a time when both Telecom and TUANZ would rather see that money spent on fibre and on services that attract customers up the food chain, not down it.

Consistency is important, and I think at the least we will need to compare Chorus’s regulated return with the rest of those regulated entities in New Zealand. Looking around the world you’ll see New Zealand’s wholesale service is at the expensive end of the range. Looking at an ROI of 19-23% I can see why.

6 replies
  1. Donal Curtin
    Donal Curtin says:

    I haven’t the time to do anything as sophisticated as Vector’s analysis, but on what I would call conservative assumptions, and off the back of Chorus’s half year results to December ’13, I made a rough stab at Chorus’s full-year ROE (http://economicsnz.blogspot.co.nz/2014/02/am-i-missing-something.html). It came out at a post-tax 17.7% (minimum), or on a more conventional calculation based on the likely average equity for the 2013-14, at 19%. And yes, that’s POST tax.

    • Paul Brislen
      Paul Brislen says:

      That’s rather a large profit margin for a company screaming for govt intervention to prevent it from "going under". I suspect the E&Y report is on the money and the savings are there to be made within the company rather than by forcing us all to pay more for broadband.

  2. Philip Wong Too
    Philip Wong Too says:

    I am not sure if this is taken into account in Vector’s analysis, but electricity assets would typically have lives of in the 25-50 years, whereas I would think that quite a lot of Chorus assets (apart from the copper and fibre in the ground) would only have useful lives of about 10 years or so (who would want to be served by an ADSL1 DSLAM now), so there is a much shorter time to recover the cost of the asset over, for the equipment at the ends of the line/fibre anyway.

    • Paul Brislen
      Paul Brislen says:

      Quite right, but the vast bulk of the network is depreciated over a longer time frame. Having a ROI that is significantly higher than other telcos in a similar position and other utility providers in a similar position marks Chorus out as an extreme case.

  3. Sam
    Sam says:

    The Ernst and Young report on Chorus showed the ROI as 29%, significantly higher than any other regulated utility in NZ!

    • Paul Brislen
      Paul Brislen says:

      It did indeed and if we’re to harmonise our regulations, I think we should look across the board at similar utilities. That level of ROI is just unsustainable and so putting up the price of copper to support it is untenable.

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