The EC’s May 2009 recommendation on the treatment of voice termination1 states that the rates for termination of fixed and mobile voice services should be based on an efficient operator bottom-up cost model with a pure long-run incremental cost (pure LRIC) approach. This pure LRIC approach is defined by considering wholesale voice call termination traffic as the relevant service increment. This means that the bottom-up cost model should calculate the generic operator costs with and without voice termination traffic, and divide the difference by that traffic volume to provide the incremental cost of voice termination per minute.
As a result, the pure LRIC voice termination unit cost is lower than the long-run average incremental unit cost plus a potential mark-up (LRAIC or LRAIC+) result that has commonly been used by regulators in Europe to set regulated mobile termination rates. In the LRAIC or LRAIC+ approach, the model normally considers total traffic as the relevant service increment and potentially also allocates some common costs (e.g. certain overhead costs) as a mark-up to traffic-driven costs (the “+”). For example, whereas mobile LRAIC/LRAIC+ cost models typically provided a mobile termination cost of between EUR0.03 and EUR0.06 per minute in the long term (depending on depreciation methods and various other considerations), the pure LRIC models that we have built for regulators recently (for example, in Belgium, the Netherlands and Norway) typically provide outputs of less than EUR0.02.
Our recent experience has also highlighted the following behaviours, that might initially appear counter intuitive:
- whereas LRAIC/LRAIC+ decreases with volume growth, pure LRIC (which is very small for low volume) increases with volume
- at very high volume levels (and the same technology), the pure LRIC can move towards the LRAIC/LRAIC+ level.
This evolution is in fact logical. As shown in Figure 1A, total mobile network cost increases relatively slowly with very low volumes, as total network cost is mainly determined by network coverage (i.e. there is a minimum installed capacity irrespective of the capacity actually required in the network). Then, as the network becomes more heavily loaded, higher volumes of traffic increase the total cost, as additional network capacity upgrades are required. As illustrated in Figure 1B, this means that the LRAIC/LRAIC+ unit cost is initially high for low traffic volumes and then declines with larger volumes (as a result of economies of scale). In contrast, the pure LRIC unit cost is small for low traffic volumes (because the coverage network has spare capacity), but then increases as the total network cost becomes volume driven.
![Figure 1: Illustration of the evolution of total mobile network cost and unit cost according to traffic volume [Source: Analysys Mason]](/PageFiles/16006/Comm_June-2010-St%c3%a9phane%20Piot.jpg "Figure 1: Illustration of the evolution of total mobile network cost and unit cost according to traffic volume [Source: Analysys Mason]")
Figure 1: Illustration of the evolution of total mobile network cost and unit cost according to traffic volume [Source: Analysys Mason]
However, there are two caveats that should be noted regarding the behaviour described above:
- the depreciation method that is used (e.g. economic depreciation or accounting depreciation) has an influence on the difference between pure LRIC and LRAIC/LRAIC+ levels
- the cost–volume relationship presented in the graph above is based on a single year/single service and especially a single technology. In practice, mobile operators will tend to upgrade their network to the most efficient technology (e.g. 2G, 3G or soon LTE) that will provide them with the lowest unit cost, given their traffic volume.
During the last three years, Analysys Mason has worked on more than 20 fixed and/or mobile costing models in more than 12 countries around the world.
1 See http://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=OJ:L:2009:124:0067:0074:EN:PDF