Annex 3

Deficit Arising Due to Social Obligations

 

 

 

 

(a) Deficit not covered by the regular telecom pricing mechanism

The diagram above shows three different price levels, namely,

1. Bar A gives the price level per unit call that would cover all forward-looking fully allocated costs.
2.  
3. Bar B gives the price level per unit call that would prevail if price is based on some specification of long term incremental costs.
4.  
5. Bar C gives the reduced price after the price level is lowered (generally or for certain target groups) in order to achieve social objectives.

There are two components to the deficit. One is the deficit arising due to the difference between Bar A and Bar B, and the other is due to the difference between Bar B and Bar C. In the case of the latter deficit, it is clear that the deficit arises because of social objectives.

 

The deficit between A and B could be funded through an increase in rental or in tariff, or both. However, in order to encourage a rise in teledensity (or to provide universal service), the increase in rental might be limited up to a particular level. The other option is to increase the tariff. To the extent that a cap in the rise in tariff is put for social reasons, the deficit is again due to emphasis on social objectives. Otherwise, the price could be increased to cover the difference between A and B in the diagram above. Thus, even if there is a deficit due to the first reason, i.e. due to a gap between A and B not being covered by rental or by an increase in price (i.e. an increase in B), this deficit would arise for social reasons.

 

 

 

(b) Certain aspects relating to universal service obligation

The discussion above has certain implications for the calculation of the cost of meeting universal service obligations (USO). For simplification, without addressing the issue of the exact content of USO, consider the situation given below.

In the diagram above, CC shows the forward-looking cost of linking up and providing some basic telecom service to different subscribers. The subscribers are arranged in the order of increasing costs. CC is similar to a marginal (or addition to total) cost of linking up the different subscribers to the network. The average cost of doing so is given by AA, which will be below CC. For simplification, we can consider the normal commercial return to be linked to the average cost, i.e. to AA.

Suppose OQ subscribers have to be linked to the network. The line RR shows the per subscriber average revenue obtained by the operator, which includes a rental per subscriber and an average estimate for revenue from a cost-based benchmark price. The position of RR is such that a reasonable commercial return is provided to the operator. In the diagram above, this return is shown by the area of the rectangle formed by RR’AA’ (not drawn in the Figure).

One way of considering the cost of USO would be to calculate the net costs (i.e. costs not covered by returns) which arise when the high cost segments are covered. In the diagram above, this would correspond to the triangle BCA’, which shows the deficit arising due to linking up Q1Q subscribers because the costs of linking them are more than the average return from the link up.

A noteworthy feature of this situation is that the point B in the diagram above is based on the principle of profit maximization (or marginal cost equal to marginal revenue), but the price RR is determined on the principle of reasonable commercial return. This reasonable commercial returns is based on average costs AA, which incorporate the average effect of the cost BC in the diagram above. If in addition to the reasonable return, a revenue equal to BCA’ were to be provided to the operators, the total revenue would exceed the previously determined reasonable commercial return. Three different options could be considered in this context.

• Since the price RR provides a reasonable commercial return, there is no need to consider the issue further. The operators would be required to link up all the subscribers up-to OQ. Of course, funding for the deficit arising due to Bar B minus Bar C above would be additionally taken into account.

• Suppose the cost of linking subscribers OQ1 can be considered separately from subscribers Q1Q. Then, a cost-based price could be derived on the basis of costs of linking up subscribers OQ1 and this price could be used as a benchmark price. The higher average cost (plus reasonable return) for subscribers Q1Q could be compared with this benchmark price, and the deficit arising thereby could be considered as the relevant deficit relevant for linking up the subscribers Q1Q to the network.

Retain price RR, and provide the additional revenue corresponding to BCA’. Take this additional payment into account in a price cap type of mechanism, keeping in mind also the funding required for the deficit arising due to Bar B minus Bar C above.

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