Monday, 11 January 2016

Did we ask the right question?

Normally I'd take time out early on, to explain some of the telco/regulation jargon, but as I suspect virtually everyone likely to read this post already knows what UCLL, UBA, WACC and TSLRIC are, I'm going to plunge right in.

Unless there is some diehard with a large legal budget to burn, last month's final decision by the Commerce Commission setting the wholesale price of copper-based broadband at $41.19 brings the curtain down on a long, complex and contentious process.

I'm not going to spend much time revisiting the details of the Commission's decision, other than to note that in an exercise like this one, with so many moving parts, there is inevitably going to be room for even reasonable people to disagree.  In their place, I might well have gone a different way on aspects of WACC, for example, or taken a different position on the challenge of digging trenches through New Zealand's allegedly idiosyncratic topography, but so what: overall it was a reasoned, careful piece of work.

The end result looks to have ended up in the right area, and I say “area” advisedly: there is no single “true” point-estimate answer to these sorts of questions. You only have to glance at Figure X1 of the decision, for example, to see how second thoughts on various component bits can have significant impacts on the final price. I was comforted in particular, as I thought it was a realistic result, by the Commission's calculation (in paras X34-5) that its price on a “like for like” basis came out lower, at $31.60, than the entry-level UFB price of $37.50. And no, I don't want comments from conspiracy nutters who think the Commission was steering its decision to within cooee of the UFB price.

But let's step back from the specifics and consider some broader picture issues.

For me, the big one was the task the Commission was constrained to do. By law, it had to set a forward-looking TSLRIC price, and it did. But that task answers the question, “what would be the cost to use a shiny new whizzbang broadband network rolled out efficiently today”, not the question, “is Chorus ripping off my broadband provider, and, at one remove, me?”. Or as the Commission summarised it
E109 … our task is to set a price according to TSLRIC which we and submitters agree is best set relative to the forward-looking efficient costs of the hypothetical efficient operator, rather than the past costs of the regulated entity.
E110 Putting that another way, we do not consider that concepts such as “windfall gains” or “windfall losses” are particularly relevant. A price determined according to TSLRIC does not attempt to regulate the incumbent’s revenues such that it earns a normal return on its actual investments. Rather, it attempts to set a forward-looking price based on modern technology and irrespective of the incumbent’s past investment decisions.
The Commission is completely correct in saying that its hands were tied, and that any financial impact on Chorus was beside the point. And I know that TSLRIC is a good price to use if (for example) your main issue of interest is whether retail broadband providers (or others) are given a fair go at getting into the wholesale broadband business for themselves. And that's an important point if you believe that consumers are best served in the long run by competing suppliers deploying a choice of infrastructures.

But I'm still not convinced that the Commission was asked the right question in the first place. There was a good consumer case for an alternative approach, the one the Commission described in the extract quoted above as an “attempt to regulate the incumbent’s revenues such that it earns a normal return on its actual investments”, and which is standard in many regulatory proceedings.

Consumers, for example, are wearing the cost of a hypothetical brand new network. It's as if the government had decided to regulate the price of cars, and as part of the exercise decreed that only the latest new models in the showroom would be made available. Many of us, however, would prefer to get our cars from Honest John's Japanese import yard. Instead, we're being asked to pay the depreciation costs of a brand new car, and we've lost the option of paying a lower price for an already depreciated second-hand one.

So yes, I'm still concerned that the inherent design of the regulatory regime had the capacity to deliver windfall gains to Chorus (at consumers' expense) or windfall losses (at Chorus's expense). The whizzbang modern technology element probably counts against Chorus if it is still using some earlier generation gear, as does the efficiently deployed element, if it is still carrying inefficiencies from its dominant incumbent Telecom days. But the depreciation aspect is a clear bonus for Chorus: the price is based on a brand new network, with its deployer entitled to a reasonable rate of return on the whole amount invested. Chorus, on the other hand, has already recovered some proportion of its investment, through depreciation, and should only receive a reasonable rate of return on the funds still invested. To that extent Honest John is being paid the new car price.

There's another aspect that also leaves me wondering if the TSLRIC question was the right one to ask.

Earlier, the Commission had provisionally set the broadband price on an international benchmarking basis. It's an approach which I hope survives the current review of telco regulation, as I remain convinced that it can in many circumstances provide a decent enough approximation of what the New Zealand price ought to be. But it didn't work on this occasion: the Commission was (again) constrained, and could look only at the overseas prices in countries that also costed broadband on a TSLRIC basis. And the answer to that quest was – Sweden.

Understandably, various parties weren't happy that New Zealand prices were going to be set on the basis of an overseas sample of one, we moved smartly into the final pricing process that concluded last month, and the initial benchmarking exercise became moot. But it still leaves a big question unanswered: how come there are only two countries in the developed world that are setting broadband prices this way?

I know, there will be times when there are just a few enlightened countries ahead of the pack, and most everyone else is doing it wrong. I'm not sure, though, that this is one of those times. While we're in the mood to have a rethink of our telco regulation regime, why don't we ask ourselves if we can live with mainstream overseas practice – especially if the alternative is fractious, protracted, complicated, and expensive.