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Also in this special
  Connectivity of Internet networks
Charge for capacity, not time
Autor: Mark Kennet
There are a number of "sexy" issues in the area of telecommunications. Citizens' rights to access the Internet and universal service are two that come to mind. But shouldn’t we also be interested in the structure of connectivity charges, although this may seem a daunting topic reserved  only for experts? Here are some reasons why we might all want to pay attention.

At the outset, we need to recognize that the current success of the telecommunications sector depends on the presence of several operators in the market competing with each other. Furthermore, nobody doubts that the nature of the networking industry would become a monopoly if there were no government intervention.

This can be seen clearly in the case of Mexico, where the leading mobile operator controls 77% of the market. Under this arrangement, other operators can compete as long as the network can be interconnected with the main operator at a price that allows them to offer services comparable to those of the dominant company. This does not mean that the main operator should not recover the cost of its investment in the network. We could not conceive of a regulatory scheme in which an operator must offer its connectivity services to the competition free of charge. If this were the case, competition would be artificial and would not help the economic efficiency of society as a whole.

So the major challenge for the regulator is to identify that "sweet spot" that enables healthy competition, while at the same time allowing operators to recover what they invested in their infrastructure, in order to arrive at a fair connectivity fee.

This fee is known in the world of telecommunications as the Mobile Termination Rate (MTR).

How is the MTR calculated?

In almost all countries with a privatized sector, the method for calculating the MTR is to estimate the cost of the infrastructure investment needed to increase the carrying capacity of interconnection traffic, and divide that number by the number of minutes of interconnection traffic. In Mexico, the MTR was set at about 40 centavos per minute, according to the latest Cofetel decisions.  This computational approach is justified by the notion that the rate needs to be set on a per-minute basis, but the reality is more complex.

In the case of retail markets, the rate charged is effectively per minute of traffic. This approach is taken because it enables the possibility of offering the service to a wider client base:  Those clients who use the service more pay more, effectively subsidizing those who use it less (who are often poorer).

For wholesale markets, however, the charge per minute of traffic does not make much sense. There are many reasons for this:

First, it is easy to see that interconnection charges based on minutes of traffic are not associated with the cost of the service. This is because the cost of the service does not occur because of minutes of traffic, but rather by the cost of installing additional capacity on its network to handle the traffic. Thus, in the absence of a link between interconnection rates and infrastructure costs, the economic efficiency of the market is automatically reduced.

Second, this lack of relationship between rates and costs prevents the spread of competition. If a company charges an MTR of, say, 40 cents per minute, and at the same time offers its subscribers 25 cents per minute plans for in-network calls (when the calls begin and end on the same operator's network) it is difficult for other operators to compete on equal terms.

Finally, it is time to recognize that new products and services offered by operators are not confined to voice. Smartphones are changing this situation to the extent that there is a decrease in voice services versus data exchange and sale. It is common knowledge that data traffic is measured not in minutes of traffic, but in kilobytes, even in the retail market.

Moreover, insisting on charges based on minutes of traffic using any other method of calculation discourages the use of interconnection, which would imply very slow adoption of new services and new technology.

What is a capacity charge?

One possible solution is to calculate the MTR based on capacity charges. It is still a little-known alternative, but it has slowly gathered supporters throughout the world.

How does this work? Instead of charging per minute of traffic, or per kilobyte, the operator that wants to terminate its traffic on the network of another purchases the capacity (bandwidth) required to carry the maximum traffic that it will require; that is, the ability to carry traffic during peak hours.

Under the capacity fees model many things would be clarified, as each operator would pay the company providing the termination service an amount not directly dependent upon minutes of traffic.

This interconnection fee would not discourage free and fair use of the network because the price paid by the network generating the traffic would be included in fixed costs, so there would be no need to recover it with each call, connection or kilobyte.

For the end user, it would cost the same to call the subscriber’s network as a different network. In addition, there would be no justification for setting different rates for on-network and off-network use and, perhaps most significantly, data traffic flow, such as entertainment content over the Internet, would be paid for by the bandwidth required and not by the number of kilobytes.

This fee system would help eliminate disputes that abound in Mexico. Suppose that Cofetel established an MTR of two pesos for voice traffic, and a 0.001 per kilobyte for data traffic (obviously, these values are made up). What would one expect to happen in these conditions? Everybody would convert their voice traffic into IP traffic, using applications like Skype for their conversations, resulting in a significant decrease in voice traffic. If the relationship between the prices were reversed, it would have the opposite effect. The result of this situation is litigation, with no one winning except the lawyers.

Finally, a capacity payment model encourages competition and eliminates anti-competitive practices such as pricesqueezes. These occur when a company lowers its fees for its on-network users (its customers), and charges higher rates to users who initiate their communication in other networks, but that end up in that company. This practice has anti-competitive effects, as users prefer to join the network charging (lower) on-network rates.

The MTR model I have described is not without limitations. The most important is that the fee charged must be accurate; if too much is charged, the amounts that the companies pay will not be enough to recover the value of the investment for providing the service, and there are no incentives for re-investment. Conversely, if charges are high, final prices for users could be set at a level that discourages efficient use of infrastructure.

Another limitation is the lack of regulatory experience in the application of these criteria. Although in recent decades much has been published on the subject, few regulators have implemented this strategy, let alone done it well. Perhaps before trying to implement these criteria, it would be good to research best practices and the feasibility of their implementation in Mexico.

Any model for regulating connectivity charges based on minutes of traffic tends to become outdated, since the technology environment depends less and less on minutes of traffic. Has the time come for Mexico to be a pioneer in the creation of new rules that better fit the new market realities?

Mark Kennet is an independent consultant on telecommunications policy and regulations. He holds a Ph.D. in Economics from the University of Wisconsin and is a specialist in interconnection agreements and rural telephone service. He has worked for organizations like the World Bank, the Federal Communications Commission in the United States and Mexico’s Cofetel, among others, http://www.markkennet.com/, markkennet@yahoo.com.
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