An assessment of universal service funding in Canada · 2011-02-04 · 2. Long distance and mobile operators pay asubsidy charge Local loop still monopoly. Local operators still have

An assessment ofuniversal service funding

in Canada

Lisa LeidigOvum Ltd.

April 2000

1

An assessment of universal service funding in Canada Ovum

Table of Contents

1. About Ovum........................................................................................................................3

2. Summary..............................................................................................................................4

3. Introduction.........................................................................................................................5

3.1 The impact of competition on universal service policies...........................................................................................................5

3.2 Best practices............................................................................................................................................................................5

3.3 Is reform needed in Canada?....................................................................................................................................................7

4. Costing universal service..............................................................................................10

4.1 When is support for universal service justified?........................................................................................................................10

4.2 What costs are included in an assessment?.............................................................................................................................14

4.3 What costs are not included?..................................................................................................................................................15

4.4 Essential steps for calculating the net cost of universal service................................................................................................17

5. Financing universal service costs ..............................................................................19

5.1 How should universal service costs be financed?.....................................................................................................................19

5.2 Reviewing subsidy requirements and reimbursing operators....................................................................................................20

6. Recommendations for Canada....................................................................................21

1. The European Union ......................................................................................................25

1.1.Definition and scope...............................................................................................................................................................25

1.2 Funding strategy.....................................................................................................................................................................25

1.3 Cost calculation......................................................................................................................................................................26

1.4 Fund administration................................................................................................................................................................26

2. France.................................................................................................................................27

2.1 Definition and scope...............................................................................................................................................................27




3. United Kingdom...............................................................................................................31


3.2 Funding Strategy....................................................................................................................................................................31



2


4. Australia .............................................................................................................................34





3


1. About Ovum

Ovum is an independent research and consulting company, offering expert advice onIT, telecommunications and new media.

We specialise in the analysis of key market, technical and regulatory developmentsand our work is highly respected worldwide for its authority, quality and clarity.

Owned by its staff and with clients worldwide, Ovum prides itself on its independentand international viewpoint.

Established in 1985, Ovum has offices in London, Boston and Melbourne. We employover 80 consultants who provide reports, advisory services and strategic consultancyto 10,000 clients worldwide.

Lisa Leidig is a Principal Consultant at Ovum and a recognised world expert onuniversal service issues. She is the author of Ovum’s 1999 report, Universal ServiceFunding: World Best Practice. While Lisa has been at Ovum, she has advised 12countries on how to develop a universal service policy appropriate for competitivetelecommunications markets. She received the US Government Bronze Medal Awardin 1995 for efforts to establish a new universal service policy in the United States,while working for the National Telecommunications and Information Administration(NTIA), the executive branch agency responsible for advising the US Administrationon telecommunications and information issues. Lisa has also worked for PriceWaterhouse and for the US Trade Representative, Office of the White House.

4


2. Summary

The current universal service funding mechanism that is operational in Canada isunlikely to meet the government’s goals of keeping universal services affordable andachieving effective competition. This is because it:

• compensates ILECs for their access deficits and thus, removes any incentive forthem to maximise efficiencies. This has the added-on effect of raising the overallcosts of universal service

• deters competition from developing in the local market, as new entrants cannotcompete with subsidised ILEC tariffs

• deters operators, especially smaller new entrants, from competing in the longdistance market because of high contribution charges, which grow according totraffic volume and not revenues earned

• encourages operators to bypass ILEC networks in order to avoid high contributioncharges. This practice could result in the disappearance of universal servicesupport in the long term.

Reform is necessary. Ovum suggests the following recommendations:

• the current funding strategy is replaced by one that is appropriate for a fullycompetitive environment

• funds are collected to support a universal service fund on the basis of the net costof providing universal service

• the net cost should be calculated according to a forward looking cost methodologythat takes into account efficient operations and current technologies

• the process for determining the net costs should be transparent and allow for theparticipation of the whole telecommunications industry

• a review of the net costs should occur annually. If the amount collected in any oneyear exceeds the subsidy required, contributing operators should be reimbursed orcredited against future contributions.

5


3. Introduction

3.1 The impact of competition on universal service policies

The worldwide trend to liberalise telecommunications is driving the development ofnew universal service funding mechanisms. There are three main reasons:

• incumbent local exchange carriers (ILECs) are being left with the financial burdenof providing essential services below costs in order to keep users connected innewly competitive environments

• long distance and mobile operators are paying an unfair burden in environmentswhere competition has progressed from partial liberalisation (local access still amonopoly) to full liberalisation

• local competition is not developing in the residential market where rates have notbeen rebalanced to the extent required to provide economic incentives for newentrants.

Policy-makers are either reforming existing universal service policies, orimplementing them for the first time to:

• ensure a level playing field among operators – where no one operator pays anunfair burden

• promote competition in the residential market and thus increase quality, choiceand price of services for residential customers

• meet national objectives of promoting an Information Society for all citizens –“Connectedness.”

3.2 Best practices

Ovum has identified five key success factors for meeting the universal servicechallenge in competitive environments. These factors are described in Figure 3.

Figure 3 : Key success factors

Select a funding mechanism to match the environmentFunding mechanisms need to be adjusted over time to reflect changes brought aboutby market liberalisation, government policy and economic indicators

Promote a level playing fieldNo one operator or group of operators should bear an unfair cost burden. Incumbentsshould not bear all of the burden in providing universal services if costs are high. Onthe other hand, incumbents should not be overly compensated for meeting goals, whilestill dominant.

Base subsidies on the net cost of providing universal service: do not overcharge operatorsOperators required to make financial contributions should do so based on the net costof providing universal services. The net cost should be reviewed annually andcontributors should be reimbursed if contributions exceed costs

Maximise efficiencies: create incentives not burdensRequire operators to calculate net cost based upon an efficient operator using currenttechnologies. Funding mechanisms that encourage operators to compete for supportare the most desirable as they will likely lead to innovation in both the provision ofuniversal service delivery as well as lowering overall costs

6


Implementation: ensure a transparent processCriteria and procedures should be practical and allow the determination of costs in atransparent environment. Subsidies should also be explicit.

Selecting a funding mechanism to match the environment

There is no one perfect funding mechanism. Funding mechanisms need to be adjustedover time to reflect changes brought about by market liberalisation, governmentpolicy and GDP per capita, among other factors. Adjustments are needed to ensurethat government goals continue to be met through different stages oftelecommunications liberalisation. Figure 3.1 illustrates the five primary scenariosthat lead to the use of specific funding mechanisms.

Figure 3.1: Funding scenarios

Funding mechanism Environment Country examples1. Incumbent covers cost Competition does not exist or is in early

stages. Policy makers require operatorsto meet specific goals per licenceobligations

Majority of countries prior to marketliberalisation

2. Long distance and mobile operatorspay asubsidy charge

Local loop still monopoly. Localoperators still have high access deficits

Canada(US and Australia prior to fullcompetition)

3. Incumbent and other local operatorscover costs

Full liberalisation but incumbent is stilldominant. Cost of universal service islow. Population density and GDP percapita are high.

UK, Italy

4. All operators share cost Full liberalisation – medium to highlevel of competition. Universal servicecosts are high due to networkdevelopment goals and/or roll- out ofnew advanced services.

GDP per capita can be low or high

Large rural areas

US, France, Australia, Colombia

5. Government funds costs Full liberalisation – high level ofcompetition. High GDP per capita.Costs of universal service are low.

Finland

Promoting a level playing field

Funding strategies should promote a level playing field among operators:

• no one operator or group of operators should bear an unfair cost burden

• incumbents should not bear all of the burden of providing universal service wherecosts are high

• incumbents should not be overly compensated for meeting goals while stilldominant.

If these conditions are not met, consumers are unlikely to benefit from a fullycompetitive environment.

7


Calculating operator contributions: do not overcharge operators

If a decision is taken that it is necessary to support the universal service provider’snet cost, policy makers must ensure that contributions required of other operators :

• do not jeopardise their financial viability

• do not create disincentives for competing in telecommunications markets.

The amount that operators pay should be linked to cost studies that project annualnet costs of meeting policy goals. Amounts paid should not be arbitrary. Operatorsshould be reimbursed if contributions collected exceed calculated cost in any givenyear.

Maximising efficiencies: create incentives not burdens

Policy makers should strive to create a universal service regime that maximisesefficiencies. Regulators should require cost assessments that are based on an efficientoperator using current technologies. This will help ensure that operators pay for thenet cost of providing universal service rather than supporting operators withuniversal service obligations (USOs).

Funding mechanisms that provide incentives rather than burdens can lead toinnovation as well as lowering the cost of universal service. For example, competitivebidding processes are being used in Colombia, the US, Peru, and Chile to bring downthe costs of universal service by rewarding the most efficient operator.

The decision to award subsidies through a competitive bidding process must bepredicated on whether or not operators, in addition to the incumbent, can meetuniversal service goals on a regional or national basis. In most developed countriesthis case has not been made. However, in countries where network roll-out is stillneeded, awarding capital grants to the most efficient operator is desirable. This maybe the case in the remote areas of Canada where a significant number of people still donot have access to basic telecommunications services, let alone advanced services suchas the Internet.

Implementation: ensure transparency

The process for implementing funding mechanisms and how to qualify for fundsshould be transparent. Once rates have been rebalanced to encourage localcompetition in the residential market, mechanisms should replace any implicitsubsidies with explicit subsidies in order to reflect the real costs of providing serviceand send the right signals to the market

3.3 Is reform needed in Canada?

Previous universal service polices and corresponding funding mechanisms helpedCanada achieve one of the world’s highest telephone household penetration rates at98%. This is remarkable considering its large rural areas and disperse population.However, if policymakers want to ensure that they keep universal services affordable,as well as promote competition, reform is essential. Reform is necessary because thecurrent funding mechanism no longer corresponds to the Canadiantelecommunications market. The effect is:

• policies are not promoting a level playing field among operators and thus effectivecompetition is not developing

8


• operators are not contributing on the basis of the net costs of providing universalservice

• there is no mechanism in place to reimburse operators for making contributionsthat exceed the subsidy required

• efficiencies are not being maximised

• the processes are not transparent.

Figure 3.2 shows the change drivers that drive universal service funding in monopolyenvironments through initial competition, and then finally to full competition.

Figure 3.2 Change drivers

Monopoly provider pays all-achievedthrough cross-subsidies from:• urban to rural• business to residential• international to long distance• long distance to local

•Long distance and mobile operators payaccess charge to connect to local loop

•All operators share costs of USO•Access charges are lowered or phased-out over time•Operators compete to receive USOfunding

Liberalising environment(monopoly still in local loop)

Full competition(local loop opens up)

Monopoly environment

Change drivers:increase investment

(Privatisation/licencenew operators)limited competition

Change driver:Open licensingenvironment

The current funding mechanism that is operational in Canada coincides with themarket conditions typical of a partially liberalised environment; whereas Canadianlegislation promotes a fully competitive environment. Thus, the current mechanism isunlikely to achieve the government’s goals because it:

• compensates ILECs for their access deficits and thus, removes any incentive forthem to maximise efficiencies. This has the added-on effect of raising the overallcosts of universal service, which are ultimately passed on to consumers

• deters competition from developing in the local market, as new entrants cannotcompete with subsidised ILEC tariffs

• deters operators from competing in the long distance market because of highcontribution charges, which grow according to traffic volume and not revenuesearned

9


• encourages operators to bypass ILEC networks in order to avoid high contributioncharges. This practice could result in the disappearance of universal servicesupport in the long term.

10


4. Costing universal service

4.1 When is support for universal service justified?

In developed economies where there is a high teledensity(lines per 100 people) andGDP per capita, the burden is on universal service providers to prove that they sufferan undue cost burden before they can be compensated. This is the case for all EUcountries. From 1997 to 2000, regulatory authorities in Germany, the UK and Italydecided that current universal service providers do not suffer an undue burden and sono compensation is authorised. France is the only EU Member State where auniversal service fund has been established to support the incumbent.

To make the case for support, USO providers must fulfil a two step process:

1. prove that there is a net cost

2. prove that this net cost represents an unfair burden.

Figure 4. illustrates the formula prescribed in Europe and in Australia for proving netcosts.

Figure 4.

Costs of service delivery avoidable if universal services were not provided touneconomic areas, customers and pay phones

- Revenues forgone from not serving these areas, customers or pay phones

= Direct net cost

The next step in the process is to assess whether the net cost represents an unfairburden. This step helps regulators guarantee that incumbents are not overlycompensated in an environment where they are still dominant. It also acts as asafeguard to ensure that universal service providers do not inflate their costs ordeflate their revenues to get a higher subsidy.

Oftel, the regulator in the UK, makes this assessment by requiring British Telecom(BT) to assess the benefits derived from:

• Life cycle effects. BT may lose money on a particular customer at a certain stagebut retain their loyalty when they become profitable

• Enhancement of corporate reputation. BT can benefit from the marketing valueassociated with being a universal service provider

• Ubiquity. BT receives certain advantages from being recognised as serving allregions of the country

Ovum’s philosophy is that covering an incumbent’s entire net cost is undesirable.However methodologies used to calculate intangibles like brand recognition andubiquity are not precise. Thus, we advocate that the regulator make an additionalsubtraction to the formula illustrated in figure 4 according to the degree of marketdominance enjoyed by the incumbent and the extent to which the market can bear thecost. For example, in Australia the government reserves the right to reduce the net

11


cost claim if it is in excess of widely accepted benchmarks, common industry practiceor world best practice. In 1999, the government agreed to pay only 32% of Telstra’s1

claim for universal service costs. Telstra’s claim of $1.83 billion would have been asubstantial cost burden on new entrants (Australian $200 million). The Ministry ofCommunications also set a three year cap on the net cost level that can be claimed byTelstra.

Figure 4.1 clearly indicates that the majority of ILECs in Europe do not receivesupport for USOs as they have yet to prove their case.

1 Telstra is the incumbent provider in Australia responsible for providing universalservices

12

Assessment of Canada’s universal service policy

Ovum

Figure 4.1: Universal service funding in Europe

CountryUSO Requirement

for Incumbent Time Limit Contribution Mechanism

United Kingdom BT

KingstonCommunications

(Hull)

First consultation issued in 1997

Second consultation issued in 1999. Results areforthcoming

Next review scheduled for 2001

None

In 1997, Oftel decided a funding mechanism was not necessary because BT did not suffer anundue financial burden. Thus, BT, the primary USO provider, does not receive compensation formeeting USOs.

Denmark ü Until 2007 None

National legislation allows for a funding mechanism if the case can be made.

Spain ü Under review

(Telefonica is required to meet universal service goalsuntil 31/12/05)

None.

National legislation allows for a funding mechanism if Telefonica can demonstrate that its USOrepresents a net cost and unfair burden.

Italy ü Reviewed every two years

Review occurred in 1999

None

In 1999, the regulator rejected a request from Telecom Italia for L1.45 trillion (US$800 million) incompensation for costs linked with providing universal services. Telecom Italia is still obliged tocarry the burden without compensation from other operators.

Ireland ü Under review None

Telecom Eirean is evaluating the net costs associated with meeting its obligations in order to beeligible for compensation.

The regulator is considering a compensation mechanism in the form of a fund and/orinterconnect surcharge in the event TE can make a case for support consistent with ECregulations.

Portugal ü Under review None

The regulator is considering various mechanisms of compensation if Portugal Telecom can makea case.

Netherlands ü X None

Belgium ü X None

Finland X X None

All operators are required to meet all requests for service. Tariffs are not geographicallyaveraged, which means that operators are allowed to set prices according to the cost ofproviding service. Low income individuals receive direct support for basic telephony from theMinistry of Social Affairs.

France üTelecoms law

allows for otheroperators to be

USO providers ifthey can provide

the range ofservices nationally

Reviewed every four years (first review in 1997)

Next review scheduled for 2000

A universal service fund became operational in 1997. All operators offering public voicetelephony are required to contribute. Operators make two types of payments: 1) a surchargepaid in addition to interconnection charges; 2) a payment to the fund that is a proportionate shareof France Telecom’s net universal service costs, calculated on a pro-rata system linked totraffic volume

Operators pay into the fund three times a year.The surcharge to interconnection component of the contribution mechanism was removed in late1999

Germany ü

USOs are notunder the

obligation of anyone provider;however, DT

currently meetsnational goals

If DT decides not to be the universal service provideror changes the content of its provision, it mustinform the regulator one year in advance. The

obligation would then be open to bids from otheroperators.

None

In 1998, the regulator decided that DT generates enough revenues to support its USOs.However, if DT can demonstrate that it bears a net cost using a forward looking costmethodology, RegTP will consider establishing a fund.

If a fund were established, all public operators that have achieved a 4% market share for aparticular market would be required to contribute.

Greece ü Under reviewNone

13

Assessment of Canada’s universal service policy

Ovum

The Ministry of Communications has begun a process to develop a definition of universalservice and determine whether there is a net cost

Switzerland Open to bids fromall operators

5 Year period Government offers financial support to operators providing USO services

Austria ü Review in 2002 (The regulator will decide whether ornot to tender USO)

NonePTA covers the cost of universal service per EC regulations. The Ministry of Finance covers thecost of social tariffs for the disabled and low income individuals.

14

p/OVUMFINA.DOC Ovum

In developing countries where resources are limited, the trend is not to offercompensation to incumbent providers to recover their historical costs for building anational network. Instead, government policy is to provide incentives to any operatorthat wishes to develop new networks as well as provide new services. For example,universal service funds in Colombia, Chile and Peru award capital grants to the mostefficient operator that offers to build out networks in rural areas.

ILECs in Canada have not been asked to prove that they incur an unfair net costburden. The current policy, which allows universal service providers to make claimsfor funding on the basis of shortfalls they incur on residential lines may be viewed inother markets as anti-competitive. This is because it is difficult to know whetherthese shortfalls are due to the operator’s inefficiencies in providing the service orbecause the operator suffers a net cost in supplying the service.

4.2 What costs are included in an assessment?

The following costs are generally associated with providing universal service indeveloped economies similar to Canada:

• uneconomic areas (where the cost of providing services exceeds revenues) – theseareas tend be high-cost rural areas, but also include some urban and suburbanareas

• uneconomic customers – these customers are unprofitable because

they do not generate enough revenues to cover the cost of providing service, or

they have to be subsidised based on disability, low income or other criteria

• non-profitable payphones – in many countries, USO providers have to meet publicpayphone obligations in order to ensure that everyone has access totelecommunications services. Operators are obliged to install payphones in areaswhere insignificant traffic is generated and, therefore, they cannot recover thecosts of providing service

• providing access to the Internet is a growing requirement. In developed economieslike the US, providers are being subsidised to offer Internet to schools, librariesand rural health care centres. In developing economies, where the policy isuniversal access rather than universal service, operators are being asked tosupport the costs of bringing advanced information services to designated publicaccess sites.

Universal service costs vary between countries and are influenced by the followingfactors:

• definition of universal service – definitions can consist of a single concept or acombination of concepts to achieve specific national goals. The number of servicesor concepts that forms the definition will influence the total cost of providinguniversal services

• income distribution (affordability levels) – this will affect the net costs, since pricesare set at levels that are affordable to most of the population. Universal servicecosts are directly related to people below affordability levels

• rural and urban population ratio – rural areas are normally high-cost areas; hencelarge populations in rural areas will increase the size of subsidies and the cost ofuniversal service/access

• population density – costs increase in areas where population is scattered; forexample, northern Canada

15

p/OVUMFINA.DOC Ovum

• geography of the country – this influences the choice of telecommunicationssolutions and, therefore, the cost of providing telecommunications. The costs aredistance-dependent and terrain-dependant

• Operator efficiency – inefficient operations will increase the costs – particularly inhigh-cost areas; whereas efficient operators and selection of appropriatetechnologies will bring down the costs.

Ovum expects the number of rural areas, low population density and geography inCanada to increase the costs of universal service. Meanwhile, we also expect thatthese costs will be brought down by Canada’s:

• high GDP per capita/income distribution - this factor increases the affordability oftelecommunications services

• operator efficiency. Universal service providers in Canada should be evaluatedaccording to efficient operators typical of other developed economies whereadvanced management techniques and state-of-the art technologies arecommonplace. Figure 4.2 shows our view of how universal service costs areimpacted in Canada.

Figure 4.2: Impact on universal service costs in Canada

Number of rural areas

Low populationdensity

Geography

Operator efficiency

Definition

Income distribution

Increasing costs

Loweringcosts

4.3 What costs are not included?

The goal of modern universal service policies is to subsidise customers who would notbe served if there were no universal service policy. These customers would not beserved because they cannot afford cost based prices. Some of these customers will bein rural areas and some will be in urban areas.

The goal is not to support an operator’s access deficit as this practice inhibits effectivecompetition. In fact EU legislation prohibits the use of access deficit schemes afterJanuary 1, 2000.

An access deficit occurs when the net cost of building and maintaining the localnetwork is greater than the revenue collected through recurring monthly charges andinstallation charges. As local operators have historically been obliged to keep localprices affordable for everyone as part of a universal service obligation, access deficits

16

p/OVUMFINA.DOC Ovum

have been commonplace. In fact, the majority of universal service fundingmechanisms financed through explicit, usage-based subsidy charges, cross subsidiesor a central fund have helped local operators recover this deficit in monopoly or quasimonopoly environments. This characterises the funding strategies in the US andAustralia before the local loop was open to competition. This system is still in place inCanada.

Explicit usage-based subsidy charges and cross-subsidies enabled operators to meetgovernment requirements for a geographically averaged tariff, which was believed tobe necessary in order to increase telephone penetrations as well as to keep usersconnected in high cost areas (e.g. the cost of service in an urban area may only be$US8 but in remote areas it may be as high as $US80).

However, in fully competitive environments, an ILEC’s access deficit is a diminishingconcern because:

• in many cases the incumbent has already recovered a significant portion, if not all,of the historic costs of building its network

• other revenues generated from services other than reoccurring monthly chargesand installation charges enable the provider to make an overall profit for aparticular subscriber line

• regulators are requiring local operators to rebalance tariffs so that prices are moreclosely aligned with costs. This has two advantages: 1) it decreases or eliminatesan operator’s access deficit; 2) it promotes competition in the local loop as there is amore viable business case for entry in this market. Special tariff packages can beintroduced to ensure that individuals and groups do not fall of the network due tothe inability to afford cost-based prices. The net cost of these packages would thenbe included in the overall net cost of universal service.

Furthermore, usage-based subsidies are an unsustainable support system foruniversal service goals. This is because new entrants can bypass incumbent LECsand offer lucrative high-volume customers equivalent services at lower charges, evenif they are less efficient than the incumbent is. In addition to being non-competitive,this situation could lead to the disappearance of universal service support.

Finally, support for universal service that is collected through usage-based subsidycharges can potentially reduce competition for low-volume customers (i.e. residential),as few operators will choose to serve them. This is because would be competitorswould not be able to beat the incumbent LEC’s local tariffs, supported by subsidies.

Thus, the focus of modern universal service is how to finance uneconomic customersand areas. Examples of two countries where subsidy charges have been reformed areexplained in figure 4.3.

Figure 4.3: Examples of reform

France US

In 1997 a universal service fund becameoperational for the first time. Operators wererequired to pay two interconnection surcharges.One to support uneconomic areas resulting fromgeographical price averaging. The other tosupport France Telecom’s (FT) access deficitresulting from unbalanced tariff structures.Operators no longer have to pay for the lattersurcharge as FT has rebalanced tariffs to the

In 1988, the FCC implemented a new accesscharge system based upon forward lookingcosts, which significantly lowers accesscharges. The new system replaces trafficsensitive charges with flat rate charges. It alsoimplemented a new system, which requires alloperators to contribute to universal servicefund according to a percentage of net revenues.The flat rate access charge will eventually be

17

p/OVUMFINA.DOC Ovum

benchmark of affordability set by the regulator. phased out completely.

4.4 Essential steps for calculating the net cost of universal service

If regulators are going to require other operators to support an incumbent in itsprovision of universal service, they must agree to the costing approach andmethodology used. To ensure that the level of contributions required from otheroperators is fair, regulators should oversee a cost calculation process that is:

• non-discriminatory – this means that companies required to make contributionsshould not pay more for these services than would be payable if the services wereoffered under competitive conditions. The goal is to ensure that cost datacorresponds to efficient service provision. The cost data should cover the costs ofuneconomic customers and areas and payphones, depending on legislation (not allcountries require operators to meet public payphone obligations)

• transparent –this ensures the legitimacy of the process. Obviously there is someinformation that should remain confidential but the majority of it should be in thepublic domain so that contributing operators have the opportunity to comment andsuggest better approaches

• objective. The ultimate decision regarding the amount of costs to be supported bycontributing operators should rest with the regulator. To make this decision, theregulator must balance the goals of promoting competition with meeting universalservice policy objectives.

Costing methodologies

Long run incremental costs (LRIC) are increasingly required by regulators as themethodology of choice for determining the net cost of universal service. For example,the EC Interconnection Directive requires the application of forward-looking costs,which the LRIC methodology incorporates. Operators in the EU, the US andAustralia are already using LRIC to assess the cost of universal service.

The benefits of LRIC are:

• it is consistent with the idea that universal service costs should be measured onthe basis of avoidable costs. Costs may be avoidable as a result of better networkdesign, the use of modern assets or improved efficiency

• it requires that a cost assessment is based upon an efficient operator using currenttechnologies. This is important because if costs are calculated with a methodologythat does not fulfil efficiency requirements, contributing operators are liable to endup subsidising the USO provider rather than supporting its true net universalservice costs

To make the transition from the traditional approach of historic cost accounting andfully allocated costs to LRIC, countries are following one of the three paths:

1. Implementing LRIC direct from traditional approach. This transition path willsuit areas where new infrastructure is being installed (e.g. developing countriesand rural areas)

2. Transition path 1 which uses an interim stage of current cost accounting (CCA)while still using fully allocated costs. This transition path will be appropriatewhere the provider of universal service/access operates a substantially digital

18

p/OVUMFINA.DOC Ovum

network. In this case the move to CCA will be an evolution from the traditionalcosting methodology

3. Transition path 2 which uses an interim stage of incremental costs (ICC) whilestill using historic cost accounting. This approach should be used where theincumbent’s network is largely analogue, and the move to current cost accountingwould undermine the incumbent’s ability to make investment in digitaltechnology.

19

p/OVUMFINA.DOC Ovum

5. Financing universal service costs

5.1 How should universal service costs be financed?

Once a net cost has been determined, a decision must be made about how to financeit. Ovum has developed a series of models to help regulators with this decision.Figure 5 shows financing options appropriate for Canada - a developed country wherethere is full telecommunications liberalisation.

Figure 5.1: Funding for a developed country with full liberalisation

Telecom industry

is a majorengine of the

economy

Option 3Explicit tax onsubscribers

Option 2General income

tax on all taxpayers

Option 1Tax on alloperators

Developed country characteristics1. GDP per capita > US$15,0002. Teledensity > 50%3. Low urban poverty4. Full liberalisation

Best practices

All operators pay a taxbased on percentage of neteligible revenues to a fund

Government supportsuniversal service costs

throughthe national budget

Operators add a lineitem to subscriber

bills to support costs

Universalservice/access

goals

Emphasis on people belowpoverty line, minorities and

the disabled

Number of uneconomicareas becomes critical

cost factor

Definition moves beyondbasic telephony to

include access to advancedservices

Implementationoptions

Key driversFundingstrategy

Universalservice

fund

Users buy intogovernment

goals

Universal servicecosts are low.

The majority of subscriberscan affordservices

Figure 5.1 above identifies three funding options used to support a universal servicefund:

• a revenue tax on all operators

• a general income tax on all tax payers

• an explicit tax on subscribers.

Tax on all operators

This option requires all operators to pay a tax based on a percentage of net eligiblerevenues to a central funding mechanism. Mobile operators and Internet serviceproviders are also obliged to contribute. This option is best used in countries wherethe cost of universal service is high and where telecommunications is a major engineof the economy. This form of financing is used in the US, Peru, Colombia, Zambia and

20

p/OVUMFINA.DOC Ovum

Australia. The advantage of this approach is that it ensures a constant flow ofrevenues. This compares with subsidy charges that could vanish over time asoperators bypass incumbent LECs through local loop unbundling or by building theirown networks to reach the most profitable customers. This approach also ensures thatoperators contribute on the basis of actual earnings.

Potential disadvantages arise from the increasing difficulty of assessing revenues inthe telecommunications industry as services are increasingly bundled.

General tax

For this option, government supports universal service objectives through thenational budget. This form of financing is used in Finland, South Africa and Chile.For this option to be effective one of two conditions must exist:

• the cost of universal service is low. This helps ensure that the amount of moneyneeded to support goals is small and thus not likely to suffer from competingdemands for funds in the society at large (case of Finland)

• the government views the development of telecommunications as essential toeconomic growth and social development and so commits substantial resources togrow the industry (case of South Africa and Chile).

Explicit tax on subscribers

For this funding option, operators add a line item to subscriber bills for an amount setby the regulator. This amount is submitted to the fund and goes to support alloperators meeting universal service objectives. These objectives could include servinghigh cost areas and customers as well as providing discounted Internet access toschools, libraries and hospitals.

5.2 Reviewing subsidy requirements and reimbursing operators

Mechanisms should be in place to review subsidy requirements periodically. The exacttime period should be determined by the regulator but should not exceed one year. Inthe US, operator contributions are revised on a quarterly basis. In the first quarter of2000, operators in the US will be reimbursed for contributions required for the schoolsand libraries fund in 1999 as funds collected exceeded demand. France is anotherexample of where operators are reimbursed if the provisional cost that they have paidin is more than the actual cost incurred by France Telecom.

Besides Canada, Ovum is not aware of another country where regulators do notreview the subsidy required to support universal service goals on an annual basis. Areview is even more important in Canada as there is already some evidence that thecontributions collected are exceeding the subsidy requirement.

21

p/OVUMFINA.DOC Ovum

6. Recommendations for Canada

As explained above, universal service policy reform is needed if policy makers want toachieve universal service goals as well as promote full competition in Canada. Ovumsuggests the following:

1. The current funding strategy is replaced with a strategy appropriate for a marketin full competition. Figure 6 outlines the choices. Ovum recommends that Canadapursue option 2.

Figure 6: Funding strategies used in fully competitive markets

Strategy Implementation Outcome

1. Cross-subsidies The incumbent bears the cost if it isthe dominant market player and ifcosts are low (e.g. UK & Italy)

No incentive for new entrants to serveuneconomic areas and customers

2. All operators sharecost

Universal service fund. Funds arecollected from all operators orsubscribers on the basis of net costswhere costs are high and wouldconstitute an unfair burden

No one operator bears the burden.This can encourage competition in thelocal loop if all operators are eligiblefor support through a competitivebidding process

3. Targeted assistance Funds from the national budget areused to issue capital grants orvouchers to support specific operatorsor individuals when costs are low

No geographic averaging of prices.Operators set tariffs at cost. Funding istargeted to those in need. Thisencourages competition in the localloop

Option 2 satisfies the government’s goal of continuing to ensure that universal serviceis kept affordable in a market where costs may be an inhibiting factor. It alsopromotes a level playing field among operators as subsidies cannot be higher than thenet cost of universal service.

2. CRTC should oversee cost studies that calculate the net cost of providinguniversal services. Ovum recommends that the costing methodology employ LRICbecause it is consistent with the idea that universal service costs should bemeasured on the basis of avoidable costs. Costs may be avoidable as a result ofbetter network design, using modern assets or improving efficiency. LRIC alsorequires that a cost assessment is based upon an efficient operator using currenttechnologies. This is important because if costs are calculated with a methodologythat does not fulfil efficiency requirements, contributing operators are liable toend up subsidising the USO provider rather than supporting its net universalservice costs

3. The process for determining the net costs should be transparent and objective. Itshould allow for the participation of the whole telecommunications industry – thisensures the legitimacy of the process. Obviously there is some information thatshould remain confidential but the majority of it should be in the public domain sothat contributing operators have the opportunity to comment and suggest betterapproaches. The ultimate decision regarding the amount of costs to be supportedshould rest with CRTC. If covering the total net costs would jeopardise thefinancial viability of contributing operators or cause dissent among subscribers,

22

p/OVUMFINA.DOC Ovum

the CRTC may have to make a decision to cap the amount of the subsidy, whichcan be recovered in order to ensure effective competition

4. A review of the net costs should occur annually. And, if the amount collected inany one year exceeds the subsidy required, contributing operators should bereimbursed or credited. If the CRTC chooses a strategy whereby subsidies arecollected through a subscriber line charge, these charges can be reduced insubsequent years if the subsidy required decreases.

23

p/OVUMFINA.DOC Ovum

Appendix: Country profile

25

p/OVUMFINA.DOC Ovum

1. The European Union

1.1.Definition and scope

The European Commission’s concept of universal service is laid out in two directives –the Voice Telephony Directive (COM96) and the Interconnection Directive 1997. TheInterconnection Directive defines universal service as a:

‘Minimum set of services of specific quality, which are available to all usersindependent of geographic location at an affordable price’.

It also includes the provision of:

• free directories

• directory enquiry services

• public payphones.

The Directive does not define precisely what the scope of the services will be, leaving itto each country to legislate according to its specific situation. The Directive does,however, limit the services that a member state can finance through a universalservice funding mechanism (the Interconnection Directive, ref.19, art.5(1), EuropeanParliament and Council of the EU). The Interconnection Directive states that:

‘it would be disproportionate for national funding schemes to be used to recovercosts associated with the provision of communications services outside the scopeof universal service to schools, hospitals or similar institutions’ (COM 96/608).

1.2 Funding strategy

The Interconnection Directive, art.5(1), proposes that member states may establishmechanisms for sharing the net cost of universal services with other organisations‘operating public telecoms network and/or publicly available voice telephonyservices’. However, EC Directives do not require member states to set up nationalcompensation schemes to fund universal service goals. National RegulatoryAuthorities (NRAs) are permitted to establish a funding system only if operators withuniversal service obligations can prove that they face a net cost constituting an unfairfinancial burden (art.5(1)).

In cases where the NRA does conclude that there is a net cost, it must develop afunding scheme that is transparent and in which the total funds collected do notexceed the net cost of the universal service obligation. In keeping with EC Directives,the NRA must spread the net cost of universal service proportionately amongst allcompanies providing public telecommunications networks and services. Paymentsshould be made according to an operator’s traffic volume, gross revenues or number ofcustomers. Operators that would be exempt from making payments towards auniversal service fund include: public network operators offering network or closeduser-groups services; service providers providing data communications or value-addeddata services; and service providers offering enhanced voice telephony services such asvideo conferencing and voicemail services. (The Commission does not consider theInternet to be a voice telephony service. Therefore, operators that provide this serviceare exempt from making contributions towards a universal service fund).

Member States were allowed to implement a surcharge to interconnection to recoveraccess deficits until January 1, 2000. After this time period, the EU requires that anyaccess deficit recovering schemes be separate from national schemes to finance the netcosts of universal service.

26

p/OVUMFINA.DOC Ovum

1.3 Cost calculation

The Interconnection Directive requires the application of a forward-looking costmethodology to determine whether or not there is a net cost associated with meetinguniversal service obligations. NRAs are responsible for verifying the net cost ofuniversal service obligations and determining whether they represent an undueburden.

1.4 Fund administration

The European Commission Directive, EC COM 96/608, requires NRAs to meet thefollowing criteria where national schemes incorporate a universal service fund:

• the fund must be administered by an independent body

• the body shall be responsible for collecting contributions from liable operators andservice providers, and will oversee the transfer of sums due and/or administrateout-payments to universal service providers.

27

p/OVUMFINA.DOC Ovum

2. France

2.1 Definition and scope

According to the 1996 Telecoms Act, universal service obligations include:

• the provision of basic telephony services at an affordable price2

• the free forwarding of emergency calls

• the provision of information services

• the provision of a telephone directory, printed and electronic forms

• the establishment of public payphones over the French territory.

This definition is consistent with EU directives3. It is also subject to review everyfour years. The next review will take place this year - 2000.


France is the first and only country in the EU to implement an operational universalservice fund. The French government believes that a universal service fundingmechanism is necessary to help ensure social and economic equality. Furthermore,the fact that approximately 50% of the population live in areas with less than 100inhabitants per square km creates substantial costs for operators with universalservice obligations.

In 1997, the Ministry of Communications issued a Universal Service Decreeimplementing the provision of the Telecommunications Act 1996 (Ch. 3). This decreeinstated a funding mechanism to finance universal services. It designates FranceTelecom (FT) as the public provider of universal services. However, the law allowsother operators to be designated as universal service providers if they are able toprovide the range of universal services nationally.

The Act stipulates that geographically averaged tariffs and reduced-rate social tariffs(for specific categories of the population such as the disabled or less privileged) arerequired to ensure all consumers have access to universal services. All operators areentitled to participate in programmes to provide discounted services to qualifying low-income users. Operators providing social tariffs will have the cost of the servicededucted from the contribution they are obliged to make to the fund.

Who contributes?

All operators offering voice telephony to the public are required to contribute to thefund.4. This excludes carriers that just carry long distance services but do notinterconnect with end users.

Operators are required to pay two types of payments:

1. an explicit surcharge paid in addition to interconnection charges;

2 French Telecommunications Act 1996, Article L35-1

3 The Interconnection Directive (1996 Commission of European Communities)

4 ISPs and long distance operators who do not terminate calls on public networks donot contribute to the Fund.

28

p/OVUMFINA.DOC Ovum

2. a payment to the fund that is a proportionate share of FT’s net universal servicecosts calculated on a pro rata system linked to a carrier’s traffic volume.

Initially, there were two interconnection surcharges. One supporting geographicalprice averaging and the other supporting unbalanced tariff structures. The combinedamount for both of these surcharges was forecasted to be 1.80 centimes (0.29 cents) for1998. For 1999, this charge was decreased to 0.49 centimes (0.08 cents), because FTrebalanced tariffs close to the amount required by the l’Autorite de regulation destelecommunications (ART). The surcharge supported unbalanced tariffs (effectively anaccess deficit charge) was phased out for 2000. The current surcharge exclusivelycovers geographical price averaging.

Figure 2 shows the costs of providing specific universal services and the type ofoperators required to contribute in 1998 and 1999.

29

p/OVUMFINA.DOC Ovum

Figure 2: Universal service costs and the operators liable for contribution(provisional cost for the years 1998 and 1999)

Components ofuniversal service

Financing method Cost FFrmillions(1998)

Cost FFrmillions(1999)

Mobileoperators/serviceproviders

Fixedoperators/serviceproviders

Service providersnot providing voicetelephony

Interconnectionsurcharge,centimes perminute

1998 0.80

Tariffdisequilibrium

1999 0.00

2,242 2,027 û ü û

Interconnectionsurcharge,centimes perminute

1998 1.00

Geographiccoverage

1999 0.49

2,717 1,550 ü ü û

Telephonebooths

Fund 163 189 ü ü ü

Social tariffs Fund 921 1,105 ü ü ü

Directories Fund 0 0 ü ü ü

Key:

ü Contribution is required on a pro rata basis linked to the company’s volume of traffic

û No contribution is required

Source: Ministry of Economy, Finance and Industry, 1999


The provisional amount of net contributions to be paid by operators is calculated byART and then fixed by the Ministry of Telecommunications.

In 1999, ART evaluated the cost of universal service provision at FFr 4871 millionand the Ministry fixed the cost at that amount. France Télécom received FFr 95million from the fund and interconnect surcharges, which represent 1.6% of the costof France Télécom's universal service provision. For 2000, the evaluated cost ofuniversal service provision is FFr 5644.

30

p/OVUMFINA.DOC Ovum

Method used to calculate cost

The French Universal Service Decree requires mechanisms used for calculating thecost of national coverage to be based on two factors:

• the net costs of unprofitable zones

• the net costs of unprofitable subscribers situated in profitable zones.

ART specifies the accounting rules, use of costing model and determines the numberof non-profitable zones or uneconomic areas. It also calculates the net costs of theseobligations based on relevant provisional avoidable costs obtained from informationsupplied by France Telecom, which are lower than historical costs. ART also usesmodels of the Association of French Telecommunications Operators, which take intoaccount the best available technologies. France Telecom's model incorporates a costingmethodology similar to long run incremental cost (LRIC) methodologies. For 1999 costprojections, LRIC was used.

The primary costs associated with meeting universal service objectives in Francerelate to geographical constraints. France is the largest land mass in the EU with thelowest population density. This reality increases the number of potential uneconomicareas to be served.


The universal service fund is managed and administered by Caisse des Dépôts etConsignations. This is an independent financial institution overlooked by the Ministryof Economy. The institution receives an estimated fee of FFr20,000 – 80,000 ($3,238 –12,948) for administration costs. Each operator pays a part of this fee calculated on apro rata system linked to its traffic volume.

Operators pay into the fund three times a year. The definitive cost to be paid by theoperators is evaluated by ART and fixed by the ministry on the basis of the auditedcosts of the year in question (for example, in 1999 for the cost of 1998). Operators arereimbursed if the provisional cost that they have paid is more than the actual costincurred.

31

p/OVUMFINA.DOC Ovum

3. United Kingdom


According to Oftel:

`universal service means the level and quality of telecommunications service, whicheveryone in the UK should be able to receive on reasonable request at an affordableprice'.

For the period 1997-2001, Oftel has defined universal service in the UK as thefollowing:

• a connection to the fixed network, able to support voice telephony and low-speeddata and fax transmission

• the option of a more restricted service package at low costs

• reasonable geographic access to public pay phones across the UK at affordableprices

• access to emergency services, itemised billing, call blocking, operator assistanceand directory information.

Internet

Oftel does not believe that the scope of universal service should be upgraded beyondlow-speed data and fax transmission. It states that universal service should not beused as a means of rolling out new technologies, but as a means of ensuring thatservices that the market has provided to most people, and which have becomeessential, become generally available to everyone.

3.2 Funding Strategy

BT is the only provider of universal services in the UK. Precise obligations aredetailed in its licence agreement. BT does not receive compensation for providingdesignated services, as the regulator for the sector (Oftel) has determined that it doesnot suffer an undue burden. Although doubts exist about the size of the current andfuture universal service costs, Oftel believes that BT derives some benefit from beingthe national universal service provider in a competitive environment.

Kingston Communications is the only other incumbent access network operator withuniversal service obligations. It serves the local area of Hull, England.

In 1997, Oftel decided that a fund was not necessary in the UK because BT does notbear an undue burden as the national provider of universal service.

Oftel began a second review in 1999 to consider the development of a competitivetendering scheme to encourage the most efficient provision of universal services. BTbelieves that this scheme could convincingly demonstrate the existence of universalservice costs. Furthermore, the regulator will also consider the introduction of a `play-or-pay' scheme if funding arrangements were in place. Under such a scheme,operators could choose to provide packages for customers with affordability problems,thereby eligible for universal service funding, which would be netted off against theoperator's contribution towards universal service net costs. Results will be publishedin April 2000.

32

p/OVUMFINA.DOC Ovum


In 1997, Oftel estimated future costs at £40-80 million (US$65-130 million), of which£40-60 million (US$65-98 million) was attributed to uneconomic customers. BT'sestimates were higher at £65-85 million (US$106-139 million). However, Oftel foundBT's costing procedures inadequate, due to a lack of detailed information on incomingcalls and area-by-area call data. BT, on the other hand, believed that Oftel hadoverestimated the size of any benefits it receives as a universal service provider. Oftelissued a consultation document in July 1999 to review costs. This produced forecasts,which were slightly higher than the previous calculations for 1995/1996. Figure 3compares 1995/1996 and 1998/1999 estimates.

Figure 3: Oftel's estimation of BT's costs in 1995/1996 and 1998/1999*

Components of universalservice

Universal service cost after efficiencyadjustment (£m)(Original estimate 1995/1996)

Universal service cost after efficiencyadjustment (£m)(Forecasts 1998/1999)

Uneconomic areas 5-10 5-10

Uneconomic customers 30-40 38-48

Uneconomic pay phones 10-15 10-15

Total 45-65 53-73

*Cost estimations after efficiency adjustments and before benefitsSource: Universal Telecommunications Services, Oftel 1997 and 1999

Oftel has attempted to value the benefits arising from serving uneconomic areas andcustomers as the universal service provider. Oftel acknowledges that precisequantification of the benefits to the universal service provider is not easy, but viewsthe benefits to BT as being large. Oftel's approximate valuation of the benefits for eachfactor defined above is shown in Figure 3.4.

Figure 3.4: Revised estimates of cost of universal service obligation

Components of universalservice

Universal service cost after efficiencyadjustment (£m)(Original estimate 1995/1996)

Universal service cost after efficiencyadjustment (£m)(Forecasts 1998/1999)

Uneconomic areas 5-10 5-10

Uneconomic customers 30-40 38-48

Uneconomic pay phones 10-15 10-15

Total cost 45-65 53-73

Benefits 102-151 61

Source: Universal Telecommunications Services, Oftel 1999

Based on the evaluation of costs and benefits to BT, Oftel felt that BT did not bear anundue financial burden as the universal service provider, and so there was nojustification for a funding mechanism.

33

p/OVUMFINA.DOC Ovum

Method used to calculate cost

Oftel assesses costs for the following universal services:

• uneconomic areas

• uneconomic customers

• uneconomic public call boxes.

Oftel also assesses benefits to BT as the provider of the universal services. Thisassessment is based on:

• terms of lifecycle effects - BT may lose money on a particular customer at a certainstage but retain the loyalty of that customer when they become more profitable

• ubiquity - BT receives certain advantages from being recognised as serving allregions of the country

• brand enhancement and corporate reputation - BT could use this as a marketingtool.

Oftel uses a costing methodology that incorporates the following key concepts:

• costs exist if revenues generated by a customer, or a group of customers, areinsufficient to cover the long-run avoidable cost of providing service to thatcustomer or group of customers

• efficiency adjustments are made to ensure that the costs do not hide inefficiencies

a forward-looking valuation of assets.


The UK does not have a universal service fund. However, Oftel is working inconjunction with a working group (consisting of telecoms experts and consultants) todesign a blueprint for a funding mechanism in line with EU directives, if deemednecessary at a later date.

34

p/OVUMFINA.DOC Ovum

4. Australia


Part 7 of the Telecommunications Act 1997 defines the services subject to theuniversal service obligation as:

• standard telephone services

• payphone services

• prescribed carriage services (none have been prescribed at this stage).

At present the standard telephone service is a telephony service capable of deliveringfax service. Following election commitments given by the Government during thecourse of the 1998 Federal Election campaign, the Government has asked Telstra toprovide all residential and business customers who request it with a digital dataservices at 64 kbit/sec. at commercial prices.


Telstra is currently the national universal service provider in Australia, although thelegislation provides for a system in which different carriers may take on the USO indifferent areas or different carriers may take on different parts of the USO in a givenservice area (e.g. one might supply pay phones and another standard telephony). Eachcarrier which is a universal service provider must submit a plan saying how it willfulfil its USO in respect of the service area concerned. These arrangements have yetto be implemented.

Who contributes?

With very few exceptions, carriers (but not service providers) contribute to meetingthe costs of the USO. They contribute to a universal service fund in proportion toeligible revenue. Eligible revenue includes revenues from connections, line rentals,carriage of calls, leased lines and interconnection services.

The Government issued a discussion paper in the first half of 1999 on the subject ofwhether to put USOs out to tender. The discussion paper sought views within theindustry. Some operators with alternative customer access technologies, such asVodafone, argued strongly in favour of introducing a competitive tender mechanismopen to mobile operators as well as fixed operators.

Pre-1997 arrangements

The arrangements for the administration and funding of the universal serviceobligation were established in 1991 with the introduction of an additional licensedgeneral carrier and two additional licensed mobile carriers. The arrangement wasbased on the creation of a universal service fund framework within which carrierswere credited with the costs of their contributions to the provision of service in defineduniversal service areas, and debited with the benefit they derived from theseexpenditures, in proportion to the level of defined minutes of timed traffic for whichthey were responsible.

The basis of costing for the purpose of this scheme is the principle of net avoidablecosts – that is, the costs that the carrier would have avoided by not supplying theservice or services in question, less the revenue received as a result of having done so.

35

p/OVUMFINA.DOC Ovum

The ACA assessments for the 1997/98 financial year are set out in Figure 4 below.

Figure 4: Assessments of universal service costs and credits for 1997/1998

TelstraCorporation

OptusCommunications

Vodafone Others Total

Net universalservice cost

$ 253.32 mil $ Nil $ Nil $ Nil $253.32 mil

Levy Debit * $215.4 mil $30.9 mil $4.3 mil $2.7 mil $253.32 mil

Levy credit?/debit $38.6 mil credit $30.9 mil debit $4.3 mil debit $2.7 mil debit

Receivable /Payable to Fund

$38.6 milreceivable

$30.9 mil $4.3 mil $2.7 mil

Note: * based on minutes of timed traffic All numbers rounded.

Source: ACA Assessment of 22 December, 1998

1997 arrangements

Part 7 of the 1997 Telecommunications Act specifies the new arrangements forfunding universal service. These are largely based on the pre-existing arrangements.In summary the legislation provides as follows:

1. Under the Universal Service requirements, all people in Australia, wherever theyare, should have reasonable access on an equitable basis to standard telephoneservice, payphones, and prescribed carriage services.

2. There is currently one national universal service provider in Australia, althoughthe legislation provides that Australia may be divided into service areas foruniversal service funding purposes, with, potentially, competition for servicedelivery in each area. This has yet to be implemented.

3. With very few exceptions, carriers (but not service providers) will contribute tomeeting the costs of the USO. They will contribute to a universal service fund inproportion to eligible revenue. Eligible revenue will include revenues fromconnections, line rentals, carriage of calls, leased lines and interconnect services.

4. The universal service provider in a service area must not charge more than theuniversal service charges for the services it provides under its USO. There isprovision for universal service charges to be controlled through Ministerial pricingdeterminations. These can take a number of forms including:

- maximum charges

- parity with charges in other areas

- the speed with which universal service charges might change.

5. There is a net cost to the universal service provider in meeting its USO in certainareas. Such areas are known as net cost areas. They are declared at thebeginning of the year for which the fund operates by the AustralianCommunications Authority (after it has studied proposals from the universalservice providers). Operators can claim USO funding only for declared net costareas.

6. The size of the universal service fund is the sum of the net costs in net cost areas.The net cost for a service area is normally estimated as:

36

p/OVUMFINA.DOC Ovum

- the cost avoided in not serving the service area less

- the revenue forgone in not serving the service area.

There is, however, provision for other options to be adopted. For example, carriersmay be invited to bid competitively to become the universal service provider toserve an area for the lowest subsidy. Simpler methods of estimating net costs(instead of the method set out above) may also be used if all parties affected agree.

7. In calculating the net cost in an area, safeguards are required to ensure that theuniversal service provider does not inflate its costs (or deflate its revenues) to gaina bigger subsidy. The universal service provider is allowed to claim actual avoidedcosts (rather than the costs of an efficient operator) but the Government reservesthe right to reduce these costs if they are in excess of “widely acceptedbenchmarks, for example, common industry practice or world best practice”

8. The aggregate net cost of each universal service provider is then met from theuniversal service fund. Carriers contribute to the fund in proportion to eligiblerevenues and draw from it according to the sum of the net costs for the serviceareas where they act as the universal service provider.


In accordance with the procedures nominated in the Act, Telstra submitted a levycredit claim in respect of financial year 1997/98 to the ACA in September, 1998. Theclaim was for a total net cost of $1.83 billion. This amount was substantially in excessof the previous year’s assessed figure of $252 million.

The reaction of industry was hostile. A pay out of around $200 million was considereda substantial cost burden during the start up phase of new entrant operations.

The Minister responded to industry concerns by asking Telstra to voluntarily cap itsnet cost level for claim purposes at $253 million, as an interim measure, and, failingthat, indicated that the Government would legislate for such a cap.

On 30 July, 1999 the ACA published its preliminary assessment of the claim at$580.2 million (around 32% of the Telstra claim).

Method used to calculate costs

The net cost for a universal area is normally estimated as the cost avoided in notserving the area minus the revenue forgone in not serving the service area.

There is a provision for other options to be adopted. For example, carriers may beinvited to bid competitively to become universal service providers and serve an area atthe lowest subsidy. Simple methods of estimating net costs may also be used if allaffected parties agree. The universal service provider is allowed to claim actualavoided costs (rather than the costs of an efficient operator), but the governmentreserves the right to reduce these costs if they are greater than ‘widely acceptedbenchmarks; for example, common industry practice or world best practise’.

The Universal Service Avoidable Cost Determination of September 1998, whichadopts the Bellcore universal service obligation net cost model, adopts the principle ofbasing assessment costs on the use of forward-looking technologies.


The Australian arrangements amount to a ‘virtual’ fund and are administered by theACA, the regulatory agency. The ACA assesses the net cost claim of Telstra, and the

37

p/OVUMFINA.DOC Ovum

liability of carriers to contribute based upon their share of eligible revenue for the yearin question. The ACA will then arrange for invoices to be issued on carriers in debit,and once these amounts have been collected, arrange payment to carriers entitled toreceive a contribution – Telstra alone at this stage in the development of the scheme.

The costs of administration have been variously estimated at $ 1.5 – 3 million perannum, based on the resources deployed on universal service costing by Telstra, thecarriage industry, and the regulator. This estimate represents an administrativeoverhead cost of 0.6-1.2% of the $253 million involved in 1997/98 – a fairly modestimpost that will likely decrease as the new detailed arrangements become fullyimplemented.

Documents

An assessment of universal service funding in Canada · 2011-02-04 · 2. Long distance and mobile operators pay asubsidy charge Local loop still monopoly. Local operators still have