Day 5 Session 1

LRIC Cost Modelling:

Fixed Networks
Eric Tyson

Overview
What is LRIC?
What is the increment?
LRIC Modelling concepts
- Top Down
- Bottom Up

Forward Looking Modelling

Cost Volume Relationships
Routing Tables
Calculating Unit Costs

What is LRIC?
Long Run Incremental Cost
Economic principle that in a competitive
marketplace prices for services would tend to
marginal or incremental cost
Marginal cost = short run incremental cost
Cost of an additional telephone call practically zero

In the long run - all costs variable

All assets replaced

Different definitions of LRIC increment

Cost of individual network elements
Average costs of larger network sections

What is LRIC?
A way of calculating costs for wholesale services
Represents the economically efficiently incurred
costs by an operator to provide the services
Provides forward looking answers i.e. indication of
what costs will be in the future
Results in:
Stability in the sector from known future prices
Provides incentives to the incumbent (and mobile) operator
to operate in a more efficient way

Marginal Costing
Additional cost of providing one extra unit of output
In the case of many telecommunications services
the marginal cost is very close to zero - i.e. a minute
of switched voice traffic
Not true at all times of day e.g. in busy hour

Marginal cost will vary between services

extra access network pairs when cables are full

What is the Increment?

Incremental cost is the cost of providing an
additional amount of output
Unit cost will vary depending on the increment
Small change in output e.g. local calls
Addition (or removal) of a particular service
Addition (or removal) of a particular network
element
Addition (or removal) of a significant part of the
network (eg core network)

Mark Ups for Common Cost

Telecoms networks have significant fixed cost
Also shared between services or sections of the
network
Example is the trench and duct
Shared between services (local and long distance)
Shared between core and access network

Mark up incremental cost to allocate common costs

Ramsey pricing
Equal proportionate mark up

Forward Looking Cost and Forecasting

Long Run models cover 5 to 7 years
Several years of history
5 years of forward looking data
Need forecast data for costs
Capital equipment costs
Operating & labour costs
Demand for dimensioning

Use percentage growth/decline over time

Forecasts are always wrong!

Cost Drivers
When using large increments, need a methodology
for splitting asset costs between services using that
asset
Switching assets use volumes adjusted for
intensity of usage (routing factors)
Transmission assets use capacity based measures
to split between PSTN and non PSTN usage
Then adjust by intensity of usage

Cost Volume Relationships

How costs vary with
volume
Fixed and variable
elements
Develop CVRs using
Simulation models
Surveys
Interviews and
research

Top Down LRIC Modelling

Total Company Costs

Revalue capital costs

to current/modern
equivalent asset
values
Opex reductions to
reflect operator
efficiency
Usually done by
operator as they have
all the cost and other
data

Facility (Capital) Costs

Switching

Trunk

Operating Costs

Loop,
etc.

Servicespecific

allocation to
services
capacity

Common,
overhead

allocation to
services
capacity

Service
capital cost

Service
operating
cost

Total
service cost

Demand

=
Service
Unit Cost

Bottom Up LRIC Modelling

Fixed Core Network Model

Equipment volumes
calculated using an
engineering model based
on current and forecast
traffic volumes
Capital costs calculated
for this theoretical
network
Operating costs added
based on estimates
Common costs added,
usually as a % mark-up

Step 1:
Estimate Element
Volumes

Basic Inputs e.g.

Engineering Rules &
Infrastructure Lengths

Network Dimensioning

Tx Equipment

Tx Infrastructure

Buildings and Other

Service Minutes and RFs

Network Element
Volumes

Step 2:
Network Costing

Network Element
Cost Unit

Network Element Cost

Step 3:
Capex Annualisation

Annualisation Inputs

Annualised Element
Cost

Step 4:
Exclude non-Core and
Access Cost

Core Network Allocation

Network Element Cost Core

Annualised Network
Component Cost - Core

Step 5:
Service Costing

Core Network
Service Cost

Scorched Earth vs Scorched Node

Scorched node / modified scorched node:
Maintain current network nodes
May assume some local exchanges are provided as
RCUs to lower costs
Modify technology e.g. PDH/SDH

Scorched earth:
New efficient network configuration
Small number of large switches
Current technology e.g. fibre to the curb, NGN network

LRIC Cost Modelling Issues

Need to dimension a forward looking network
Consider when equipment should be deployed
i.e. in advance of when it is needed to provide
services
Using depreciation model:
Determine value of assets employed in each year
Determine total depreciation in each year

Apply agreed Return on Capital Employed

(ROCE) to assets employed
Determine what constitutes the common cost i.e.
NMC, some IT systems and add as a mark up

Switching Cost Issues

Connection dependent elements
Customer line cards and associated racks and equipment
how much?

Traffic dependent elements

Signalling
Common control
Switching matrix
Power and air conditioning sharing with connection
dependent elements
Billing

Transit/Trunk switching network

International switching network

Core Transmission Network

Calls

Core Network
Resource Consumption

IP

Leased Lines

Data

Other Services, e.g. CATV

Transmission Costing Issues

Value of assets if CCA applied

Fixed and distance related elements
PDH, SDH, IP and WDM technology
Access Rights
Costs must initially be apportioned between calls, leased
lines and other network usage e.g. data networks
Done based on 2Mbit/s equivalents
Factor required to convert voice traffic
Allocates spare capacity
spare capacity

data network

data network
calls

leased lines
calls

leased lines

Straight Line vs Economic Depreciation

Annual
Dep

Time

Straight line dep

Economic dep

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

Example Analysis of Local Calls in

Fixed Network
A Local Call can have one of the following scenarios:

Local Exchange

Local Exchange

Local Exchange

Local Exchange

Machine Usage
1 Local Exchange

Machine Usage
2 Local Exchanges
Machine Usage
2 Local Exchanges
1 Transit Exchange

Traffic Routing - Switching

Call Types
Local
Own Exchange
Local-Local
1 transit
2 transits

National
1 transit
2 transits
3 transits

Minutes
Total
% split of of calls
International number of traffic
of each
Switch
Minutes
types
type

Local Transit
Switch Switch

Local
Use of
Switch
switching minutes

Transit
Switch
minutes

2,000,000
2
2
2
2

0
0
1
2

0
0
0
0

55%
40%
5%

1100000
800000
100000
0

=2L
=2L
=2L+T
=2L+2T
Total

2200000
1600000
200000
0
4,000,000

0
0
100000
0
100,000

40%
50%
10%

600000 =2L+T
750000 =2L+2T
150000 =2L+3T
Total

1200000
1500000
300000
3,000,000

600000
1500000
450000
2,550,000

25%
75%

62500 =L+T+I
187500 =L+2T+I
0 =L+3T+I

62500
187500
0

62500
375000
0

1,500,000
2
2
2

International Outgoing
1 transit
1
2 transits
1
3 transits
1

1
2
3

0
0
0
250,000

1
2
3

1
1
1

Total
TOTAL Machine Minutes

250,000
7,250,000

437,500
3,087,500

Traffic Routing - Transmission

Call Types
Local
Own Exchange
Local-Local
1 transit
2 transits
National
1 transit
2 transits
3 transits
International Outgoing
1 transit
2 transits
3 transits

Total Machine Minutes

Inter
Trunk
Local Tx Tx

Total
number of
Minutes

International
Tx

Minutes
% split of of calls
traffic
of each
types
type

Use of
transmiss Inter Local Trunk Tx
ion
Tx Minutes minutes

International
minutes

2,000,000
0
1
0
0

0
0
2
3

0
0
0
0

55%
40%
5%

1100000
800000 L
100000 =2T
0 =3T
Total

0
800000
0
0
800,000

0
0
200000
0
200,000

600000 =2T
750000 =3T
150000 =4T
Total

0
0
0

1200000
2250000
600000
4,050,000

0
0
0
0
-

1,500,000
0
0
0

2
3
4

0
0
0

40%
50%
10%

0
0
0
-

250,000
0
0
0

2
3
4

1
1
1

25%
75%

62500 =2T+I
187500 =3T+I
0 =4T+I
Total
Total

0
0
0
800,000

125000
562500
0
687,500
4,937,500

62500
187500
0
250,000
250,000

Calculating Service Costs

Total Cost for network element
Unit cost
Of element = Total minutes of use of element

Service cost =

Unit cost
of element

Average use
of element
by service

Model Calibration

Need to verify with known data from the operator:

Number of items of each type of equipment in the network

Value of capital assets employed

Actual and forecast operating expenditure
Do outputs look correct are relative costs of calls
reasonable?

LRIC
Advantages
Forward looking
Cost causation well
defined
Uses current asset costs
Promotes efficient
investment within the
sector
Gives lower conveyance
rates - Price Floor
Provides a reasonable
reflection of the costs of a
new operator entering the
market

Disadvantages
Not the real world
Costly exercise
Results in complicated
models
External audit not easy
May not be appropriate if
traffic volumes begin to
reduce as many costs are
not avoidable
Will under estimate
running costs (opex)
The common costs have
to be estimated

Fixed Interconnection Rate

Benchmarks

European Fixed Termination Rates 2013

Layer 1 = Local Termination

European Fixed Termination Rates 2013 2

Layer 2 = Single Transit

European Fixed Termination Rates 2013 3

Layer 3 = Double Transit

Fixed Termination Rates MENA

Countries
2.5

Euro cents per minute

1.5

0.5

0
UAE Single

UAE - Morocco Bahrain Morocco Jordan Morocco Oman - Oman - Oman Double - Local
- Single
- Double Single Double Long

Qatar

Source - Regulator websites, operator RIOs and online sources 2013

Saudi
Arabia