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Capacity based interconnection - has its time come?

Capacity based interconnection (CBI) is an alternative to the usual method of charging for interconnection traffic on a per minute basis. Instead operators charge each other on the number of interconnection circuits carrying traffic between the networks of the interconnecting operators. CBI has been discussed since the mid 1990s, and now an increasing number of countries are introducing it as an alternative to per minute charging for internet and voice traffic. In this article we examine the arguments for and against CBI, and describe the position in the four countries which have introduced or are introducing CBI.

The advantages of CBI

More efficient cost structure

The first argument in favour of CBI is that it is closer to the actual structure of costs in a telecommunications network than per minute charges. Networks are built to accommodate the volume of traffic carried at the peak hour, not the total traffic carried over a day. The main building blocks of a network are units of transmission and switch capacity, not call or data minutes. As a result:

• additional costs are incurred in much larger units than call minutes;
• the marginal cost imposed by off peak traffic is almost zero because most of the costs are caused by dimensioning for peak hour traffic.

Under CBI, new entrants face the same cost structures as incumbent operators because they purchase interconnection capacity, not termination minutes. The closer that prices are to the structure of costs, the more economically efficient will be the decisions based on these prices. In addition, the scope for unexpected outcomes is more limited. For example, operators setting interconnection prices based on per minute charges have to assume a certain level of traffic in order to calculate the per minute price. If traffic levels exceed the forecasts, the incumbent operator gains unexpected revenues, and vice versa.

Retail pricing innovation

The second argument in favour of CBI is that it gives greater freedom to operators in the setting of retail prices. Most telecommunications retail prices have been based on per minute charges, but fixed price retail packages are increasingly popular for both voice and data in many countries. If interconnection prices are based on per minute charges, the operator introducing a fixed price package that includes unlimited calls takes on the risk that its customers will make more calls incurring interconnection charges than expected. CBI reduces this risk, and operators can introduce much more flexible pricing in order to recover the fixed costs of interconnection.

Under CBI off peak traffic has almost zero marginal cost, and hence operators can afford to reduce the prices of off-peak traffic significantly, or to price them in more imaginative ways. The greater variety of pricing packages should benefit consumers who can choose a pricing package that suits their needs more closely, and who will make more use of the network.

Advocates of CBI also point to the simplified interconnection billing system required to support it, and to the greater predictability of interconnection costs and revenues.

Disadvantages of CBI

Disadvantage for small operators

The first argument against CBI is that it disadvantages small operators who have low volumes of traffic. They will have to pay for the interconnection capacity irrespective of whether they have sufficient traffic to fill the circuit, and hence they have a greater risk in starting up. As their traffic levels grow, they have to acquire capacity in larger units which will take some time to fill. Hence the minimum size of capacity available under CBI becomes an issue.

Handling overflow traffic

The second problem created by CBI is how to handle overflow traffic. Peak hour traffic levels will vary from the average and at some times will exceed the capacity of the interconnection link. An interconnecting operator will want to have spare capacity to cope with overflow traffic, and a sensible operator would want to pay for the base load of traffic on a CBI basis, and overflow traffic on a per minute basis. However the per minute interconnection capacity will be idle for most of the time, and not provide any revenues for the terminating operator which has to handle the overflow traffic. Hence rules are necessary to ensure that interconnection capacity is used efficiently.

Variety of termination arrangements

The next challenge lies in the mix of interconnection traffic. In many countries different termination rates are used for fixed and mobile traffic, and for traffic carried to different destinations (especially international traffic). Different methods of interconnection charging have been developed for different types of traffic, such as freephone, shared revenue traffic and internet traffic. Which types of traffic should be permitted to use capacity based interconnection circuits? If certain types of traffic are excluded, separate interconnection links will be required to carry this traffic, adding to the cost of interconnection.

Some opponents of CBI have raised the issue of spam calls. If CBI results in operators offering free calls to retail customers, this may encourage spam calls, as happens with email.

Case studies

Colombia

Colombia has a long experience of interconnection ¹ . Telecommunications in Colombia developed originally as a local public service, resulting in many local telecommunications companies. There are now about 25 local telecommunications companies in operation in Colombia. In the 1950s a long distance company (ENTEL) was formed with a monopoly over long distance services. Until the 1980s interconnection payments were made to the local telcos for the origination of long distance traffic based on the number of lines provided by the local telcos. This arrangement was then replaced by one based on the volume of traffic. With the development of mobile operators in the early 1990s, the system of interconnection was overhauled by the national regulatory agency, the Comisión de Regulación de Telecomunicaciones (CRT), and the principle of cost base interconnection was introduced.

In 2001 the CRT moved to a system of setting maximum prices for interconnection rates, permitting operators to negotiate lower prices if they wished. The maximum prices were set by a combination of international benchmarks, a LRIC cost model, and an analysis of existing interconnection rates. A price cap was set on these maximum prices, which were set to decline by 2% per year in real terms over the following four years, reflecting assumed productivity improvements.

The new maximum rates were set out in Resolución 463, which also:

• grouped the local operators into three groups (high, medium and low cost), based on their size, the financial impact of the new interconnection rates, and the cost base as estimated in the LRIC model. The level of the maximum termination rates differs according to which group the local operators belongs;
• introduced the concept of capacity based charging.

CRT permits the use of capacity based charging as an alternative to per minute charging. It believes that this leads to more efficient use of spare capacity in networks, especially outside the peak hours. It permits terminating operators to recover the costs of additional capacity built to accommodate terminating traffic and associated administration, which are fixed rather than variable costs. In order to prevent the under-ordering of interconnection capacity, CRT sets a maximum of 1% blocking factor on traffic crossing points of interconnection.

Spain

Fixed network competition started in Spain in 1998. In 2001 the national regulatory authority, the Comisión del Mercado de las Telecomunicaciones (CMT), required Telefónica, the fixed network incumbent operator, to introduce a capacity based charging system for interconnection. This followed an extensive public consultation on the draft Reference Interconnection Offer produced by Telefónica. Some alternative operators argued for the introduction of capacity based charging as a way of encouraging the introduction of flat rate retail charging. CMT also took the view that capacity based charging would enable new operators to emulate more closely the cost structure of incumbent operators, thus leading to more effective competition.²

The prices and terms and conditions for capacity based charging are set out in the Reference Interconnection Offer published by Telefónica³, and this shows how some of the issues identified above are resolved in Spain. This document offers capacity based interconnection as an alternative to per minute charging, and operators can use both schemes simultaneously.

The main terms and conditions for capacity based charging are as follows:

• capacity based charging does not have to be reciprocal (hence one interconnecting operator can use time based charging while the other uses capacity based charging);
• the operator selecting capacity based interconnection has to produce a plan for overflow traffic at each point of interconnection. The plan will specify whether the overflow traffic will simply be lost, or whether an alternative route will be used. In the second case, two possibilities are offered:
  • either the overflow traffic uses an interconnection link which is subject to time based charging, and the overflow traffic will then be charged at the per minute charge multiplied by five;
  • or the overflow traffic will be routed to the same point of interconnection by another route, in which case the interconnecting operator is liable for a fixed cost per point of interconnection to reflect the actual costs of re-routing, plus a traffic charge based on the existing time based interconnection charges;
• capacity is available in 64 Kbit and 2 Mbit links, and can be ordered for either for internet traffic only or for both internet and voice traffic (there is no difference in charges for internet only and internet and voice traffic);
• interconnection capacity is available at all levels in the network (local, metropolitan, single transit and double transit exchanges). However if a call is sent that requires interconnection at a higher level in the network (for example national traffic sent to a local exchange), this will be charged at a time based rate (which reflects the difference between the price for traffic handled at that level in the network and the full interconnection price for the call);
• some call types are excluded from capacity based interconnection, in particular transit calls, international calls, short code calls and intelligent network calls, directory enquiry calls, and emergency calls.

The Offer also sets out specific contract periods, notice periods, and ordering processes for capacity based interconnection.

Portugal

In December 2004 ANACOM, the national regulatory agency for Portugal, started a public consultation on its proposal to impose a requirement on dominant operators in interconnection markets to offer capacity based interconnection. It concluded this process in October 2005, when it instructed the incumbent operator, Portugal Telecom (PT), to implement a CBI scheme⁴.

During the consultation a number of important issues were raised, as follows:

• What interconnection traffic should be permitted to use CBI? ANACOM decided that traffic originating and terminating at local, single transit and double transit points of interconnection should be eligible, including traffic to non geographic numbers. ANACOM estimated that traffic to non geographic numbers contributed about 1% of PT's interconnection revenues and traffic, and so concluded that its inclusion would not have a material effect. The only traffic to be excluded from CBI is emergency calls, international transit calls and international termination calls.
• What should be the minimum size of capacity for CBI? ANACOM decided that 2 Mbit should be the minimum, on the grounds that if 64 Kbit was the minimum size, significant expenditure would be required to reorganise PT's networks and to increase the capacity of switches.
• How should overflow traffic be handled and priced? ANACOM had proposed two options for overflow traffic - it is routed on other CBI routes to other points of interconnection, or it overflows on to a per minute circuit and charged at a premium. ANACOM suggested that the premium should be five time the normal per minute rates. After the consultation ANACOM decided that the first option should be followed first, and then the second option if all routes are full. The penalty for overflow in the second option should be two times the time based charge.
• How long should PT take to provide CBI circuits or to migrate operators from time based circuits to CBI circuits? ANACOM proposed that PT should take 5 working days to validate the request, and 1 month to provide the circuit if a network structure needed altering, or 15 working days in other cases. It also decided that if these periods are not met, then CBI charges would be applied after the target date, whether or not the migration had taken place, and that if a request for a new circuit or an expansion of a circuit was not met, the penalty for overflow traffic would be reduced by 50% (that is to normal levels).
• Should there be a minimum period of contract for CBI? ANACOM decided a minimum period of two years was necessary in order to compensate PT for risk of changing to a different charging system.

However, as at July 2006, PT has not published its prices and terms and conditions for CBI.

Jordan

In June 2005 the Telecommunications Regulatory Commission issued instructions for the introduction of CBI⁵ . All operators, including mobile operators, are required to offer CBI as an alternative to per minute charging. The price is to be based on the long run incremental costs (which are to be calculated a Total Service Long Run Incremental Cost model), and in addition operators are required to offer a "spot" price for spare capacity on their networks. The TRC set up an industry forum in August 2005 to guide the introduction of LRIC pricing, with the intention of completing this work by July 2006 and of introducing CBI shortly afterwards.

Pricing for CBI

Three countries have published the basis for CBI prices (Colombia, Portugal and Spain). They have based the price on the estimated minutes of use per month multiplied by the average per minute charge. However the detailed calculations have differed between the three countries, and we summarise them in the table below.

The method used in Portugal and Spain starts with the theoretical capacity of a 2 Mbit circuit at a given blocking factor, and this is translated into the minutes per day using statistics on peak hour traffic as a percentage of total traffic. This figure is then converted into a per month charge using assumptions about the number of busy days per month and the number of busy months per year (that is, excluding holiday periods). The resulting average minutes of traffic per month is then used to calculate the fixed CBI charge. In Colombia an average figure is used of 250,000 minutes per month per 2 Mbit circuit which was produced by the International Telecommunications Union. The resulting figures from these calculations in Portugal and Spain are significantly different, with the average for Portugal being about 37% greater than for Spain, reflecting the differences in the peak hour load and the assumptions about the number of busy days per month.

This method of calculation allows the terminating operator to receive the equivalent amount of revenues as under the per minute charging system, but the originating operator can increase its off peak traffic at no additional cost.

In Tables 2 and 3 we show the prices charged for capacity based interconnection in Colombia and Spain, the two countries with published prices.

Per minute call termination prices are a little lower in Spain than in Colombia, and this, along with the differences in assumptions about the number of minutes at peak times, results in prices for capacity based interconnection being lower in Spain. To date no prices have been published in Portugal or Jordan.

Conclusions

We believe that capacity based charging is a valuable alternative to per minute pricing. As well as having a better economic foundation, it should enable greater flexibility in retail pricing, and hence will be of greater benefit to consumers. As the case studies show, it does pose some challenges for operators, but these problems can be resolved.

We therefore think that national regulatory authorities should require operators to offer capacity based interconnection in interconnection agreements in addition to per minute charging.

¹CRT. Revisión integral de los cargos de acceso a redes fijas en Colombia. November 2005
²Comisión de Mercado de Telecomunicaciones. Resolución sobre la modificación de la oferta de interconexión de Telefónica. MTZ 2001/4036. 9 August 2001, especially pages 314 - 375
³Oferta de servicios de interconexión de referencia de Telefónica de España. April 2004. Section 9
⁴Anacom. Relatorio da consulta sobre interligacao por capacidade. October 2005
⁵Telecommunications Regulatory Commission. Instructions on adoption of long run incremental cost methods and interconnect rate structure. June 14 2005

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