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Day 4 Session 3

Overview of Principles of
Cost Modelling
Eric Tyson

Overview

Cost Causation
Access and Core Networks
Direct, Joint and Common costs
Capital and Current Account costs
Common cost mark ups
Use of Glide Paths

Cost Causation
Cost causation is key to all forms of cost
modelling:
Why was a cost incurred?

What does the cost contribute to?


Applies to capital costs for purchase of equipment
Applies to current account costs including labour

Labour activities need to be analysed carefully

Network Elements
Network elements reflect the joint or shared costs
in a telecoms network
Switching and transmission networks consisting
of:
Switching (local, trunk/transit, international)
Transmission (inter-local, local to trunk, inter-trunk,
international)
Intelligent Network
Signalling
Billing

International
Switch

Trunk
Switch

International
Network

Inter-Trunk Transmission

Trunk
Switch

National
Core Network
Local
Switch

Local-Trunk
Transmission

Inter-Local
Transmission
Local
Switch

RCULocal
Transmission
RCU

Access Network

Accounting Separation
Developed as a way of regulating business of
incumbent fixed operators
Separate business for:
Access
Core network
Retailing
Other activities

Each business has costs and revenue and produces a


profit and loss statement
No cross subsidy between businesses
Ultimately Access and Core networks provide services
at wholesale prices to Retail and all OLOs
Interconnection charges originate from the Core
Network business

Elements of Cost in a Fixed Network

Accounting
Separation:

Retail
Access
Network

Core
Network

Other
Costs

Local Access Costing Issues


Key is: Connection dependent vs Traffic dependent
Sharing of network components in the access
network
leased line tails which use copper pairs
core network
links to RCUs (which are included in the local switching
costs)

FAC v LRIC Modelling Issues


What is the effect of current cost accounting?
RCU policy

Local Switch - Access/Core Boundary


Access Network

Core Network

Switching
Matrix

Connection
Dependent

Customer
Line
Cards

Traffic
Dependent

Trunks

Signalling

Shared by
Access and
Core
Accommodation

Power

Software

Types of Costs
Direct costs
Related to one service only e.g. SMSC

Joint or shared costs


Costs with relate to two or more services e.g.
transmission, switch processor

Common costs
Costs which relate to all services e.g. human resources
department, payroll system, HQ building

Types of Costs
Capital costs:
Relate to the purchase of equipment
May also include labour costs for installation

Recovered over a number of years through depreciation


Recovery period set dependent on the expected
productive life of the equipment e.g. telephone exchanges
7-10 years, duct and poles up to 40 years
Return on Capital Employed often set and regulated for
wholesale services
Calculated annually from the Fixed Asset Register

Types of Costs
Current account costs:
Costs which are fully expensed at the time of spending

Include manpower costs


Recorded monthly in the General Ledger
Often coded based on accounting conventions rather than
cost modelling requirements

Cost Modelling
Can be created using spreadsheets
Need virtual team of people from across the
business:
Finance (lead?)
Network planning
Billing
HR
Regulatory Affairs

Takes time and will involve iterations as more data


becomes available

What is being costed?


All relevant services
all retail calls
interconnection calls
value added services

Core network transmission for:


Leased lines
Data networks
Interconnection links

Provision and maintenance of access lines (in the


case of an FAC cost model)

Cost Allocation Principles


1. Identify costs
2. Identify services which are provided

3. Identify elements within the network which


provide the services based on cost causation
4. Group costs into cost pools based on the
network elements
5. Identify relationships between the services and
the cost pools

6. Divide cost pools into unit costs using volume


information
7. Allocate appropriate unit costs to services

Calculation Methodology
Allocate costs to network elements
Directly
Indirectly using drivers

Calculate total minutes passing through network


elements (machine minutes)
Calculate unit cost of network element (eg cost
per minute per network element)
Sum unit costs of elements used on average for
each service

Typical Model Structure

Drivers
Cost
Pools

Manpower
Analysis

Current
Account Cost

Functional
Activities

Direct
Shared

Depreciation

Common
Algorithms

Final
Services

Input Data Required


Not just financial data is required:
Call minutes for each call type, including untariffed calls
Average routing info for each call type
Numbers and speeds of leased lines
Transmission network apportionment between services
(e.g. data, voice, ATM network etc)
Use of telephone exchange and office building space
Sharing of ducts and cables between network types
Manpower numbers, costs and activities
Training activities
Use of vehicles
Stores items consumption

How much data is available and is it in the form


required?

Common Cost
Common Cost is the cost which relates to all or a
group of services
HR
Finance
Senior Management

Two methods are used for incorporating common


cost
Equal Proportionate Mark Up
Ramsey Pricing

Common Costs
Equal Proportionate Mark-up (EPMU)
Allocates common cost in proportion to the direct and joint
costs already allocated to each service

Common cost
Network cost

o/g
call

i/c
call

onnet
call

Ramsey Pricing
Common cost
Ramsey pricing is based on
taxation theory
Common costs are allocated
based on price elasticity

Network cost

On-net and outgoing calls


are elastic as customer
behaviour is based on the
cost of the call
Incoming calls are inelastic
as customers will make them
irrespective of the cost

Incoming calls are therefore


used to recover the majority
of common cost

o/g
call

i/c
call

onnet
call

Model Outputs
The cost models output 24 hour average costs
Need to use retail tariff gradients to set Peak, OffPeak and (if appropriate) Weekend charges
Current interconnection charges often seen to be
well above cost
Common for Regulators to use 3 or 4 year Glide
Paths rather than significant step reductions

Glide Paths
Increasing Regulation of
Termination Rates
Glide Paths used by
regulators to bring rates
towards an expectation
of cost over time
Rates set
By determination of price
each year
By reduction to target end
price

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