Wrangle over telco report continues

Debate continues on the soundness of economic data that went into the report of the government's telecommunications inquiry but on some points the protagonists are 'agreeing to differ'.

Debate continues on the soundness of economic data that went into the report of the government’s telecommunications inquiry but on some points the protagonists are “agreeing to differ”.

The Auckland University-based Centre for Research in Network Economics and Communications (CRNEC), which prepared the economic model used in the report, has come under fire from the Sydney-based Network Economics Consulting Group (NECG) and the Wellington-based NZ Institute for Economic Research (NZIER). Both allege CRNEC overstated the savings that would result from regulation.

CRNEC has partially climbed down from the position taken in its analysis for the inquiry. It acknowledges an algebraic error in one part of the analysis; and of four other factors alleged by NECG to be shaky, it agrees with two.

John Small, author of the original CRNEC report, has issued “a revised set of estimates of the effect of the inquiry’s designation recommendations” – its recommendations to regulate certain telecomms services. “These recommendations are now expected to result in pure welfare gains of between $20m and $40m per annum [compared with a figure of $44m in the original CRNEC analysis] and additional transfers to consumers of about $200m per annum,” says Small’s report.

“Expressing these estimates as a range recognises that they are necessarily based on many assumptions, and in hindsight the original CRNEC report should have adopted this strategy.”

The “welfare gain” figure represents the effect of new users being attracted to a service by a lower price and existing users using more of the service for the same reason. The “transfer” figure represents the pure effect of lower prices in transferring money from the provider’s pocket to that of the consumer.

The welfare gain depends on “elasticity” – the degree to which customer demand responds to price drops. Elasticity figures used in the original CRNEC report “are quite clearly an approximation to the truth,” says Small. “Under- and over-statements of the true elasticities are likely to be present.

“NECG’s arguments on these issues are no more convincing than the ones underpinning the original CRNEC estimates and there is consequently no good reason to modify those estimates.”

But CRNEC has adjusted other input figures, such as the ratio of call-end minutes (the period when the user is connecting or disconnecting) to conversation minutes: “Perhaps the most critical parameter in our analysis is the figure used to represent the regulated price of interconnection, which is 1.5 cents per minute. It should be emphasised that this figure is not based on a full benchmarking analysis, as would be performed by the [suggested Electronic Communications Commissioner] under the recommended regime.

“Without undertaking a full benchmarking study, the estimate of the interconnection price that might result from the proposed regime can be no more than an educated guess," the report says.

“The bottom line,” Small told Computerworld, “is that I agree with some of [NECG’s criticisms], and on others we have simply taken different positions.”

The rebuttal document “covered off” all the issues in NECG’s criticism, says Small. However, in an address to a Wellington "post-telecommunications-inquiry" conference next week, he will tackle both the NZIER criticisms and the NEGC's points to which they relate.

NZIER’s report - like NECG's, commissioned by Telecom - is intended as a “peer review of the NECG review of the CRNEC report.” It substantiates NECG’s key criticisms and adds some of its own.

NZIER director Alex Sundakov says it is “implausible to assume – as CRNEC had - that industry pricing would only change with regulation. He says in reality both interconnection and toll bypass are under particular price pressure. Ignoring that effect causes a “significant” overstatement in welfare gains, he says.

Sundakov says another key concern is that the CRNEC report looks at consumer benefits only in terms of demand for call minutes, rather than considering other elements such as the number of lines or quality of service. It is “implausible” to assume consumer demand for lines is completely insensitive to prices, he says.

"The CRNEC study, by abstracting from the effect of these other attributes," says Small, "effectively assumed that they would either stay constant under regulation, or improve. In my view, this is a very reasonable approach.

"NZIER seem to imply that service quality will fall as a consequence of regulation, yet the opposite appears far more likely." In theory regulated providers can save costs by skimping on maintenance. "But this issue is generally addressed by setting minimum service standards, benchmarking fault rates with similar firms and even through the imposition of financial penalties for poor service. In other words, service quality is likely to be monitored much more closely under the proposed regime than under the status quo."

Another implausible argument of CRNEC is that lower profits of network providers would have no effect on investment incentives, NZIER suggests.

The institute further suggests that CRNEC has misunderstood the way the New Zealand market operates with respect to interconnection. New Zealand telecomms are characterised by two-way interconnection – a call originates in one provider’s network and terminates in the other’s. Finding no adequate model for this, CRNEC adopted a “one-way” interconnection model; a call is passed from Telecom’s network to a rival’s, then at the end, returned to Telecom for termination. This applies to national toll calls, but not to local calls, NZIER says. “Consequently, we concur with the NECG view that the estimated efficiency gain from local access should be reduced.”

While the institute had not quantified its suggested adjustments, “the welfare effects of the proposed regulatory regime appear minutely small and are either a little positive or a little negative.”

Small, in his conference paper, will suggest that the NZIER, in dismissing some of the effects of the entry of additional carriers to the market, is operating from the present-day perspective where one carrier (in this case, Telecom) can control the price of access to its network.

"Since the entire purpose of the cost-benefit analysis is to contrast the present with the proposed future, these concerns cannot be regarded as valid criticism of the proposals unless there are good reasons to suppose that the perceived problems will persist in the new environment. Neither NECG, nor NZIER offer any such reason. In my view, no such reason exists."

CRNEC’s original report is at www.teleinquiry.govt.nz/reports/final/final-17.html#P1705_308446

NECG’s analysis of that report can be found at www.necg.com.au/021100-CRNEC-critique-public-version1.pdf

The NZIER review is at www.telecom-media.co.nz/releases/pdf/necg_report_1.pdf

When Computerworld spoke to John Small this week, he said CRNEC’s rebuttal of the NECG report and its comments on the NZIER report would shortly be put up on the CRNEC site, at www.crnec.auckland.ac.nz

CRNEC fights back
  • CRNEC has adjusted some calculations due to reports commissioned by Telecom from NECG and NZIER that say it overstated the savings that would result from regulation, but rejected other criticisms
  • It offers a range of welfare gains (increased business from new customers coming on and existing customers using more services in response to lower prices) of between $20m and $40m per annum rather than $44m and additional gains to consumers from price drops of about $200m
  • Has adjusted its interconnection calculations but says only full benchmarking can reveal true costs
  • The three bodies differ on issues such as likely number of lines, quality of service, profits of providers

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