The Proper Treatment of Spare Network Capacity in Regulatory Cost Models
32 Pages Posted: 21 Aug 2012
Date Written: May 20, 2005
Abstract
Despite the general abandonment of rate of return regulation in telecommunications regulation for large incumbents in recent years, cost models continue to play a prominent role in telecommunications regulation. Modern cost models used for regulatory purposes tend not to be fully-distributed cost models in which all booked costs are accounted for in some way or another, but rather are "incremental" cost models in which only costs incremental to specific services or elements are included and not all costs actually incurred are necessarily accounted for.
One of the key drivers of costs in these forward looking incremental cost models is the treatment of network spare capacity. An efficient network must incorporate spare capacity to efficiently accommodate demand variability over geography and time, demand uncertainty, demand growth, asset fixity, and administrative needs. However, whether the spare capacity is properly treated as incremental or shared in an incremental cost model depends on the cost object of study. We show that in so-called TELRIC models, in which the object of study is the element itself, the spare capacity of the loop network is entirely incremental to the loop and therefore properly included in the incremental cost study. In so-called TSLRIC models, in which the objects of study are services, some, but not all, of the spare capacity is incremental to individual services, and some is shared. Hence, the correct amount of spare capacity to include in a TSLRIC study is less than that which should be included in TELRIC.
This result relies on the statistical properties of shared capacity. We provide a simple but robust model of network demand and show, using the law of large numbers and the properties of the Normal distribution, that greater geographic density of demand leads to a less than proportionate increase in the optimal amount of capacity to serve the demand. While this result and its corollaries are certainly well understood among network engineers, their implications for correct inputs into incremental cost models do not appear to have been understood in the regulatory arena.
Keywords: Marginal cost, Regulation, Cost studies, Spare capacity, Telecommunications
JEL Classification: L51, L9, D24
Suggested Citation: Suggested Citation