Don’t cry for MEA – why modern equivalent assets are so important

There’s a term we’re going to hear a lot this year as the arguments about wholesale price of access to Chorus’s network reach fever pitch – modern equivalent asset (MEA).

Before you can decide what ISPs and telcos should pay for a service, you have to work out what it costs to deliver that service.

The Commerce Commission has already done that, based on benchmarking against other similar countries. It considers a raft of appropriate measures and issues, thins down the list of potential countries to those with similar regulatory regimes (among other things) and produces an “Initial Pricing Principle” (IPP).

It’s a quick way of working out what the local price should be; quick being relative of course. This is the Commerce Commission so it takes about 12 months. It involves picking a range and then, in years gone by, choosing the 50th percentile mark on that range. That’s moved somewhat and recent decisions have moved to the 75th for a variety of reasons.

But it is just a compare/contrast exercise and when there’s enough unhappiness, the Commission can be asked to conduct a Final Pricing Principle (FPP) wherein it’s supposed to work out what the service actually costs to deliver.

However, the Commission is run by lawyers and economists, not engineers, so don’t get too excited about the phrase “actual cost” because it’s not. Instead of pricing up network build costs and determining what the actual “actual cost” is, the Commission must build an economic model that takes into account how much it costs to raise the money to build a network (sigh), efficient costs but not inefficient costs and so on. As part of that, the Commission must determine the MEA of a new network and use that for the basis of its pricing.

If that seems a little odd (“I have based the sale price of my 1978 Triumph TR7 on the current equivalent which is of course the Aston Martin DB9…”) that’s because it is. It’s very odd to consider building an economic model for the price of one product built over the past century by looking at the price of a similar asset that would be built today. Not every country considers MEA to be appropriate and there’s a good outline of the various issues and complexities associated with this kind of exercise on the Ofcom website, “Alternative methodologies for the valuation of BT’s duct assets” which is as thrilling a read as you’d expect from a title like that.

So what would a modern network look like? The government, in its long tarnished discussion document, suggests that the obvious MEA is a fibre to the home network such as the UFB. It even points to the European Commission where the regulator says as much in a press release:

“the appropriate ‘modern equivalent asset’ for calculating copper access costs seems to be a fibre network: after all, no operator would today build a copper network”

But there is a lot of disquiet about that position. BEREC (the Body of European Regulators for Electronic Communication) suggests that using a UFB network as the MEA adds new problems, not least of which is a high price for copper services for those that are left on copper and will never see fibre deployed.

If we are to go down this MEA model route, and we are because those are the FPP rules, then we need to very carefully consider the question of the technology itself.

First you need to consider what the asset was built for, as well as what a modern asset would be designed to do, which brings us to Murray Milner’s mushroom model.

Milner, a long-time Telecom stalwart who has since moved on to board roles with Crown Fibre, among other luminaries, described the mushroom model to me many years ago. Telcos will build high density capacity in areas of high customer density, medium capacity in areas of medium demand and so on.

That means in CBDs you get fibre, the suburbs get copper and rural New Zealand gets wireless.

That still holds true today: compare, for example, our UFB and RBI projects.

Any MEA used to price copper must use a technology-neutral approach to working out what a modern asset looks like. It’s not as simple as declaring fibre to be the winner. The MEA for a 1978 Triumph isn’t an Aston Martin at all, it’s a small car or a bus pass or a scooter or any of the modern choices we have available.

A modern asset model must consider the modern world and modern uses, in all their various options. Anything else simply doesn’t stack up

All together now

Last week InternetNZ organised a forum to discuss the Telecommunications Act discussion document. The document proposes setting the price that Chorus charges for access to the copper network above the Commerce Commission’s recommendation; meaning we all pay more.

The discussion was held under Chatham House rules, and TUANZ CEO Paul Brislen described it as “a remarkable meeting”. He provides his take on the issues confronting the industry as discussed at the meeting.

NOTE: This piece first appeared in the TUANZ This Week newsletter and in IITP’s Newsline

It takes quite a bit to get every telco, ISP and user group to agree on something and while I’m sure there are a couple of businesses that don’t mind the ICT Minister’s copper tax, for the most part there was outrage.

Outrage that after building a regulatory system that provides certainty and incentives to invest the government will override it for such a flimsy reason.

The upshot is that the only reason that the Minister has directed the ministry to come up with these prices is because Chorus’s share price will be affected.

That’s it.

If we give Chorus an extra $100 million a year (the amount its estimated Chorus will earn if the higher copper price, as suggested in the discussion document, is approved) it won’t result in a faster network build. It won’t result in a better network. It won’t result in a larger network – it will simply result in Chorus meeting its contractual obligations to build the Ultra Fast Broadband network (Chorus has argued it needs higher copper prices to fund the fibre rollout).

In the meantime, investment in unbundling is not only stranded, but actively penalised with an increase in the costs for unbundled lines in one of the “options” put forward, and the risk to the Local Fibre Companies (LFCs) is increased because Chorus will be allowed to aggressively lower its prices for copper broadband in those areas where someone else is building the fibre network (Chorus has about 70% of the UFB build).

The incentives to invest are removed, the ability to compete by differentiating is removed and everyone in the industry aside from Chorus is left wondering just what the rationale is for this decision.

One thing we did learn is that the discussion document’s three options are not the only options. TUANZ will be submitting that the status quo should be restored, that the Commerce Commission should hold sway over telco regulation and the Minister should stick to policy work.

There’s another reason why this should happen – the World Trade Organisation.

New Zealand is a signatory to the WTO and its “telecommunications annex” clearly says that governments should have an independent regulator so as to avoid conflicts around government investments. It should also avoid cross-subsidisation like the plague.

The good news is, there’s an enforcement arm in Brussels. Perhaps it’s time we wrote them a letter.

On Monday Chorus reported a higher than expected net profit of $171 million on revenues of $1.057 billion in its first full financial year. In commentary posted on the NZX website, Chorus pointed out that the outcome of the regulatory review will result in a reduction in future earnings.

“While these regulatory headwinds remain, management is pleased with the principled approach the Crown is taking to the regulatory review”, said CEO Mark Ratcliffe.

“We’re seeking a clearer, more aligned regulatory environment that delivers the right incentives to encourage the transition to our fibre network, and help New Zealand realise the productivity and economic benefits UFB and RBI can deliver.”


Intervening to keep prices high

The Commerce Commission is pressing on with its
determination of copper wholesale pricing.

I’ve been asked why the Commission would waste everyone’s
time and money on this when the Minister, Amy Adams, has decided to ignore it.

The answer’s simple – it is legally required to undertake
the review. The Telecommunications Act was amended in 2010 by the current
government to include the move from “retail minus” pricing to “cost plus”
pricing for wholesale service.

The expected drop in price was considered enough of a risk that
it was outlined in both the Ministerial Regulatory Impact Statement and Chorus’s
own float prospectus
document (page 80).  On top of
that, the minister of the day, Steven Joyce, included a three year delay so as
to allow Chorus to get its house in order in plenty of time.

The difference in approach between the Commerce Commission
and the Beehive is quite extreme.

The Commerce Commission is comparing our pricing regime with
others around the world, benchmarking against those countries that have similar
approaches to wholesale. There aren’t many, only two in fact, but they are
pitched at about the same price as the Commission’s draft determination. That
is, somewhere in the $8 to $10 per line per month bracket.

The Minister has ignored international comparisons

The Commerce Commission then asks for submissions, puts out
a draft determination, holds a conference, accepts inputs from various parties
(including user group representatives as well as the various telcos and ISPs),
considers all the views and then comes up with a final determination.

The Minister has decided the cost of copper wholesale will
equal that of fibre.

One of the more compelling pieces of information to come out
of the Commerce Commission’s conference came from Graham Walmsley of CallPlus.

CallPlus is one of our tier two telcos – that is, it’s not a
Telecom, Vodafone or Chorus but is a leader of the next tier down.

CallPlus has spent a lot of money on unbundling Chorus
exchanges so as to better control the product that it delivers to end users but
also so as to build a wholesale business of its own. CallPlus sells access to
its network to a variety of other providers and is a very good proxy for Chorus’s
own network costs.

How much does CallPlus charge? It charges between $8 and $10
per line per month.

The Minister thinks that price should be between $13 and
$33.57 and if she chooses the lower price, she’ll increase the cost of an
unbundled line to ensure the overall total matches the price of a fibre line –
$40 a month.

The Minister has intervened in a legally required process in
order to ensure costs don’t come down for users.