Comparing Alternative Approaches to Calculating Long-Run Incremental CostRun Incremental Cost

Bruno Fink

1. Overview

1 Review of economic concepts

2 Total Service Long Run Incremental Cost (TSLRIC)

3 Total Element Long Run Incremental Cost (TELRIC)

4 Main differences and examples

5 Conclusions

1. Basic Concepts

• Multi-product firm

• Common Cost

• Incremental Cost▫ Total cost of production with A – total cost

without A (holding other outputs fixed)

• Long Run Incremental Cost

• Stand Alone Cost

2. TSLRIC• Based on product costs, not common

• Based on forward looking technology

2. TSLRIC

• Example:Products A and B, fixed cost F

TC = F + C + CTC = F + CA + CB

TSLRIC = LRIC of supplying A = CA

2. TSLRIC

• TSLRIC cost + product specific common costs = TSLRIC+

• Example:• Example:A and B again, F = fixed costs, FB are fixed costs for product B

TSLRIC+ of A = F + CA + CB – (FB + CB)

TSLRIC+ of A = CA + (F – FB)

3. TELRIC

• Total Element Long Run Incremental Cost comes from FCC in 1996

• Increase competition• Increase competition

• Facilitate element-by-element unbundling

• Few common costs

3. TELRIC

• Problems with element definition:“Access to the local exchange network when the transmission involves a long distance call…may not be an ‘element under the act’ even though call termination an ‘element under the act’ even though call termination service is an ‘element’”

• FCC has the power to apply TELRIC from the supreme court

4. TELRIC X TSLRIC+

• In TELRIC is difficult to say what is each element of the network

• In TSLRIC+ is difficult to calculate the common costs

4. TELRIC X TSLRIC+

• Let’s go back to our example:

▫ Product A and B, with F▫ Now we have the elements X, Y, Z and its costs▫ Now we have the elements X, Y, Z and its costs▫ Let X be a link, Y and Z are switches▫ X is common cost for both services and always

needed▫ Y is used by A and B. In the long run Y could be

reduced with a one-third saving in costs.▫ Z is only for product B

4. TELRIC X TSLRIC+• Let’s calculate the company LRIC:

F = CX + CY

CA = 0CB = CZCB = CZ

LRICA = CX+CY+CZ – [CX+⅔CY+CZ] = ⅓CY

LRICB= CX+CY+CZ - [CX+⅔CY] = ⅓CY+CZ

4. TELRIC X TSLRIC+

• What is this company common costs?

CC = CX+CY+CZ – [LRICA–LRICB] = CX + ⅓CY

• Now we can go to the TSLRIC+ and TELRIC. However the telecom companies allocate common costs in minutes base, suppose the share of traffic is “s”.

4. TELRIC X TSLRIC+

TSLRIC+B = LRICB + s.CC= s.CX + (1+s)⅓CY + CZX Y Z

TSLRIC+A = (1-s)CX + (2-s) ⅓CY

4. TELRIC X TSLRIC+

• TELRIC: allocate costs on the basis of shares, does not consider the common costs.

• TELRIC = s.C + s.C + C• TELRICB= s.CX + s.CY + CZ

• TELRICA = (1-s)CX + (1-s)CY

• Comparing TSLRIC+B and TELRICB:▫ Considering CX=200 CY=100 CZ=100

4. TELRIC X TSLRIC+

350

400

450

0

50

100

150

200

250

300

350

0 0.05 0.1 0.15 0.2 0.25 0.3 0.35 0.4 0.45 0.5 0.55 0.6 0.65 0.7 0.75 0.8 0.85 0.9 0.95 1

TSLRIC+b

TELRICb

LRICb

4. TELRIC X TSLRIC+• Comparing TSLRIC+B and TELRICB:

▫ Considering CX=100 CY=200 CZ=100

350

400

450

0

50

100

150

200

250

300

0 0.05 0.1 0.15 0.2 0.25 0.3 0.35 0.4 0.45 0.5 0.55 0.6 0.65 0.7 0.75 0.8 0.85 0.9 0.95 1

TSLRIC+b

TELRICb

LRICb

5. Conclusions

• TELRIC was right in 1996, but not anymore

• Defining each element is confusing• Defining each element is confusing

• TELRIC does not respect price floor or ceiling

5. Conclusions• What is the best approach?� TSLRIC+

• How to apply?

• Who is in charge of calculatingthe common costs?

5. Conclusions• Is it possible to calculate all the common costs?

▫ Bottom-up Approach▫ Top-Down Approach

• Most of the countries are trying to apply TSLRIC+

That’s All Folks!!That’s All Folks!!That’s All Folks!!That’s All Folks!!

Questions?

6. Main References

Gans, S. Joshua; King, Stephen P; “Comparing Alternative Approaches to Calculating Long-Run Incremental Cost”, 2004.

ICT Regulation Tool Kit; “Long-Run Incremental Cost Modeling”, http://www.ictregulationtoolkit.org/en/Section.2092.htmlModeling”, http://www.ictregulationtoolkit.org/en/Section.2092.html

Commerce Commision; “TSLRIC Reports and Submission” http://www.comcom.govt.nz/IndustryRegulation/Telecommunications/InterconnectionDeterminations/TotalServiceLongRunningIncrementalCost/submissions.aspx

New Zealand Commerce Commission; “Application of a TSLRIC Pricing Methodology – Discussion Paper: