Cost Modelling

Cost modelling is used for a variety of purposes. For example, they can be part of a business case analysis, but they can also be an essential piece of evidence in competition cases.

We used cost modelling in regulatory cases in the Netherlands and Belgium. We also used cost modelling techniques in a position paper for Liberty Global, which explains how to interpret the new rules on symmetric access obligations. Below, we elaborate on these cases.

Review of the BIPT/Axon LRIC cost models in Belgium

In Belgium, the telecom regulator BIPT suggested regulated prices for wholesale access far below the costs of production. The BIPT’s decision was based on a cost model developed by Axon. The Belgian cable company Telenet asked e-Conomics to review the BIPT/Axon cost model.

Our job was first to identify the main cost drivers in the BIPT/Axon cost model. The investigation also focussed on the relevance and appropriateness of model inputs. Next, we reviewed the principles that the model used to allocate costs to services. Specifically, we assessed the appropriateness of the allocation of the total costs to common and incremental costs. In addition, we reviewed how sensitive the model was to certain key assumptions. In close cooperation with Telenet’s technicians and finance experts, we identified key assumptions that could be challenged. Next we suggested improvements and assessed their impact on the model’s outcome.

We concluded that the BIPT/Axon model was overall sophisticated. However, it undervalued costs of traffic for about 10%. This resulted in too low (variable) prices for bandwidth and too high (fixed) prices for cable access. Furthermore, we concluded that some of the model’s choices were completely wrong. This particularly related to the choice of treating the wiring in the access network as a non-replicable and re-usable asset.

Modelling the costs of re-usable and non-reusable assets

The EC prescribes that cost models apply different valuation techniques to non-replicable assets as compared to replicable assets. Non-replicable assets are part of the so-called Regulatory Assets Base (RAB). The valuation of the RAB should take into account how much of these assets have already been depreciated. For all other assets, valuation techniques should assume a newly built network. Consequently, it makes a huge difference which assets are considered part of the RAB.

Treating the wiring in the access network as part of the RAB is plainly wrong. Afterall, a challenger cannot re-use coaxial wiring when rolling out an FttH network. The EC only considers civil engineering infrastructure, such as ducts and poles, as part of the RAB. This is because a challenger can re-use ducts and poles. It would be highly inefficient to replicate ducts and poles, as opposed to replacing copper wiring. In fact, the regulatory framework is all about replicating wiring in the access network by FttH.

The RAB can make up a considerable part of the total asset base because trenching costs are typically allocated to ducts. Trenching costs are the most important cost driver of an access network. However, in the absence of ducts or poles (like in the Belgian context), trenching costs are allocated to wiring. The RAB is thus negligible in that case,

Distorting build-or-buy signals

The EC’s costing methodology ensures that regulated prices send the correct build-or-buy signals. However, the Axon/BIPT model fails to produce such outcomes. The resulting prices would distort the entrant’s “build-or-buy decision”. This, in turn, distorts the incentives for both Proximus and the cable operators to invest in network upgrades. Our analysis suggests that the appropriate costs of cable access should be twice as high as in the BIPT/Axon model.

The costs of providing wholesale cable access in the Netherlands

In the Netherlands, the ACM stated that KPN and VodafoneZiggo have a joint dominant position. That is why, according to the ACM, they will divide the market among themselves in the absence of regulation. The main mechanism for this would be to foreclose other competitors by not offering them wholesale access services.

To substantiate its claim, the ACM had to prove that VodafoneZiggo can indeed offer such services for a competitive price and still earn a reasonable return on investment. In addition, it had to substantiate that there was a (potential) demand for wholesale cable access in the Netherlands. The ACM failed to demonstrate the first and substantiated the second by drawing the wrong conclusions from a report by WIK-Consult.

VodafoneZiggo asked e-Conomics (together with Ecorys and Regulaid) to challenge the ACM on both claims. First we assessed the incremental costs for VodafoneZiggo of providing wholesale cable access. With this analysis we could verify whether VodafoneZiggo can indeed set up a profitable wholesale service. In addition, we reviewed WIK’s analyses of business cases of access seekers working with copper, cable or fibre access. Finally, we assessed whether the WIK report indeed substantiated the ACM’s conclusions that there was (potential) demand for wholesale cable access.

No business case for providing wholesale access

We concluded that VodafoneZiggo would need to make a number of changes to its network and organization to provide wholesale access. These changes would result in significant incremental costs. These changes include: investments in CMTS upgrades and in adjustments to the BSS/OSS system; a recurring and growing increase in CAPEX for annual improvements in capacity expansion and traffic handover; and an annual increase in OPEX. Total incremental expenditures (CAPEX and OPEX) during the period 2020 to 2025 would add up to millions of euros. To recoup these incremental costs, VZ would have to apply an incremental mark-up resulting in uncompetitive wholesale prices.

No demand for wholesale cable access

We found that WIK-Consult based its analysis of business cases of access seekers on several flawed assumptions. Amongst others, WIK overestimated the revenue potential of access seekers using wholesale cable access. In addition, it overestimated the wholesale costs of accessing KPN’s network. It followed that, contrary to what WIK claimed, there was no positive business case for access seekers to work with wholesale cable access. In any case, access seekers were unlikely to make use of wholesale cable access because its business case using copper or fibre access was far more superior. This latter conclusion, could even be drawn on the basis of the original analysis by WIK.

The original analysis by WIK showed that all business cases were positive above a certain markets share. The ACM interpreted this as proof of potential demand for wholesale cable access. However, this was a wrong conclusion because the WIK report also showed that, for all market shares, the business case for cable access was inferior to the business cases for copper and fibre access.

Modelling the costs of FttH roll-out

In 2018, the European Electronic Communications Code revised the regulatory framework for telecoms. One important change was the extension of the scope of symmetric regulation (see here for more information). Liberty Global asked e-Conomics to write an accessible report in understandable wording that explains how the new rules should be implemented.

As part of this study, we developed a dynamic business case model demonstrating incentives to invest in FttH roll-out under various access scenarios. Moreover, the model could account for different geographical characteristics such a population density and the presence of ducts.

Description of the model

We developed the model in MS Excel. The model is driver-based. More specifically, through transparently defined variables and input factors the model projected revenues, operational expenditures (OPEX) and capital expenditures (CAPEX) over a period of 10 and 20 years. For further transparency we based the model on various modules. These included a network design module that allowed for different assumptions on the architecture of the network. It also included an area costing module that allowed for different assumptions on the size of the area, the population density, and the location of the nearest MSAN. Finally, we developed an FttH costing module, allowing for different assumption on the costs of trenching, fibre lines, and equipments, as well on the presence of ducts.

Making the model dynamic

For different regions across Europe, the model allowed us to determine the expected payoff of investing in FttH for the copper incumbent and the access seeker/industry outsider. The model produced expected payoffs for the following scenarios a) no-one invests, b) the incumbent invests first, and c) the challenger invests first. Next, based on these expected payoffs, the model accounts for strategic interactions between challengers and the incumbent. In other words, the model examined the best response of each actor, given the expected payoffs of different scenarios. In other words, the model concluded with a game-theoretical analysis of the incentives to invest.

Based on this model, we assessed for different regions across Europe, to what extent stakeholders have incentives to invest in replicating network elements. The model can also analyse the effect of regulation in each scenario on the best responses of each stakeholder, and thereby on their incentives to invest in replicating network elements.

Impact

• The report for Telenet has resulted in a strong upward revision of regulated wholesale prices in Belgium.
• The analysis for VodafoneZiggo was key to the court overturning ACM’s WFA decision.
• The study for Liberty Global contributes to reorienting the scope of symmetric regulation to rural and sparsely populated areas.