Contributing to Telecom's "Kiwi Share" losses

One of the most significant changes to New Zealand's telecommunications regulatory regime brought about by the Telecommunications Act 2001 (the 2001 Act) was the introduction of a statutory requirement for Telecom New Zealand's (Telecom's) competitors to contribute to the net costs of Telecom's compliance with the updated Kiwi Share.

The updated Kiwi Share, now known as the Telecommunications Service Obligation (or TSO), is New Zealand's main universal service obligation. It requires Telecom to provide, among other things:

• basic telephone access as widely available as it was at December 2001;
  
  
• free local calling for residential customers, for both voice and data calls;
  
  
• charge residential customers in rural areas no more than the standard residential line rental;
  
  
• low-speed internet to nearly all of New Zealand's population; and
  
  
• a monthly line rental no higher than the CPI adjusted price of the residential line rental charged in November 1989.

At the end of June, the New Zealand Commerce Commission released its draft determination on the calculation of Telecom's net cost of complying with the TSO for the period 20 December 2001 (the commencement date of the 2001 Act) to 30 June 2002 (the end of Telecom's financial year).1

The Commission calculated the net cost for that period to be NZ$38.84 million or NZ$73.45 million on an annualised basis.

This figure is significantly below Telecom's own most recent net cost calculation of NZ$178 million for the period, or NZ$357 million on an annualised basis.

The 2001 Act requires the Commerce Commission to determine the unavoidable incremental costs to an efficient service provider of providing the TSO service to commercially non-viable customers.

Unavoidable incremental costs are the difference between the long-run costs an efficient service provider would incur with the obligations imposed by the TSO, and those it would incur without those obligations.

The 2001 Act also requires Telecom's net cost to be apportioned between Telecom itself and operators classified as "liable persons". The Commerce Commission determined that these liable persons were New Zealand's two largest competitive carriers, TelstraClear and Vodafone, as well as six other smaller carriers.

These liable persons are to contribute to Telecom's net costs in proportion to their retail revenues. Telecom was determined to have approximately 80% of total industry revenues, leaving 20% of the net cost to be apportioned among the liable persons.

The Commerce Commission applied a "bottom-up" approach in modelling the network of an efficient operator. It applied the Hybrid Cost Proxy Model developed by the Federal Communications Commission in the US as the primary "bottom-up" model.

The Commerce Commission made two key findings in its calculation of the TSO net cost. The first was its determination that the number of commercially non-viable customers served by Telecom was approximately 51,000. This compares to 1.3 million residential customer lines currently operating in New Zealand.

The second key finding required to calculate TSO net cost was its determination of the amount of the reasonable return on capital to service the non-viable customers.

The Commerce Commission concluded that serving fixed line residential phone customers is a low risk business, made even lower by the element of insurance provided by the contributions of liable persons under the 2001 Act.

The Commerce Commission determined that an after tax return of 6 percent was reasonable.

The main reasons given for the vast difference between the Commerce Commission's calculation of net cost and Telecom's calculation included:

• the Commerce Commission assumed a more extensive reconfiguration of Telecom's network would be required to measure efficient costs than Telecom had assumed;
  
  
• Telecom counted unused capacity in its network. The Commerce Commission only recognised capacity for growth, and disregarded other excess capacity; and
  
  
• differing approaches had been taken to the cost of capital, reflecting different views of the risks faced by Telecom as the TSO provider (Telecom had assumed a cost of capital of 13.2%, as opposed to the Commerce Commission's 6%).

As expected, the Commerce Commission's determination pleased none of the main players in the New Zealand market.

Telecom said it was not surprised by the determination. According to its representative: "You get a low number if you use a 6% return on capital in the calculation, and then go and base the rest of the calculation on a hypothetical network that's got little to do with the actual cost involved in providing every New Zealander with telecommunication services."

Infrastructure provision was a challenge. "Under-compensating the businesses that invest in New Zealand is not the way to ensure we have adequate infrastructure."

TelstraClear stated its belief that there was no need for a competitor-funded TSO because Telecom's monthly line charges more than cover the cost of serving customers. It hoped the net cost figure would be revised downwards. "Today's $73.45 million is 4% of fixed line revenues, while overseas the rates range from 0.3% to 2.2%," it said.

Vodafone described the contribution mechanism under the 2001 Act as a tax on competition. Its representative said, "For Vodafone, this tax means that the more successful we are, and the more revenue and customers we take from Telecom, then the more we have to pay them."

The Commerce Commission is expected to issue a final determination on Telecom's TSO net costs in August or September this year.