Productivity and Price Cap Regulation: Theory and Practice

Presented to Telecom 99 International Telecommunication Union

David N. Townsend Peter . !tern October 1999

Productivity and Price Cap Regulation ITU Telecom 99

Table of Contents

I. INTR"DUCTI"N.......................................................................................................# II. PR"DUCTI$IT% N &%!I! ND T'&'C"((UNIC TI"N! R')U& TI"N.....*

2.1 The concept of productivity............................................................................................................................3 2.2 Productivity factors in Price Cap tariff regulation.......................................................................................3

III. PR"DUCTI$IT% C &CU& TI"N ('T+"D"&")I'!.........................................,

3.1. Options for productivity measures................................................................................................................5 3.2 Total Factor Productivity calculation method..............................................................................................6 Index Formula.....................................................................................................................................................7 Alternative ratio formula.....................................................................................................................................8

I$. PP&IC TI"N "- ('T+"D"&")I'!................................................................9

.1 !efinitions" calculation of inputs and outputs...............................................................................................# Definition of Inputs.............................................................................................................................................9 Definition of Outputs........................................................................................................................................10 .2 $easurement of input and output price changes %inflation&deflation'.....................................................11

$. D T

R'.UIR'('NT!.......................................................................................#*

5.1 Outputs............................................................................................................................................................13 5.2 (nputs..............................................................................................................................................................1

$I. ("D'& ND R'!U&T!......................................................................................#,

DAVID N. TOWNSEND/PETER A. STERN

OCTOBER 1999

Productivity and Price Cap Regulation ITU Telecom 99 I. Introduction

In the past decade or so as the telecommunications industr! in man! countries has under"one a transformation from state#o$ned monopolies to a re"ulated and li%erali&in" private sector Price 'ap s!stems have emer"ed as the methodolo"! of choice for re"ulatin" the prices of dominant operators. (his approach $hich $as first introduced %! Oftel in the )nited *in"dom in the mid#1980s upon the privati&ation of +ritish (elecom and has %ecome the prevailin" re"ulator! mechanism in the )nited ,tates 'anada and other developed countries has also %een $idel! adopted in the developin" $orld as a -e! component of industr! restructurin" and the esta%lishment of ne$ telecoms re"ulator! a"encies. Althou"h specific Price 'ap formulas differ from countr! to countr! the! t!picall! are %ased upon a standard )P( * + formula under $hich chan"es to the prices that the re"ulated firm can char"e for a defined %as-et of services depend upon %oth chan"es in inflation ./PI0 and chan"es in the productivit! .10 of the firm. 2hile national measures of inflation are "enerall! availa%le in most countries esta%lishin" the chan"e in productivit! of the re"ulated firm is far more challen"in". Indeed in most countries $here price cap formulas are %ein" applied the productivit! factor 1 has so far %een set either ar%itraril! %! the re"ulator or throu"h ne"otiation %et$een the re"ulator and the re"ulated firm. Other countries have simpl! ne"otiated price or revenue reduction commitments $ith the re"ulated firm or have set an earnin"s tar"et and used the 1#factor to ad3ust prices to$ard the tar"et .in effect revivin" rate#of#return re"ulation0. (his has %een relativel! unavoida%le %ecause in most cases neither the data nor the processes necessar! to esta%lish the productivit! factor have %een readil! availa%le. 4o$ever as ne$l! esta%lished re"ulator! %odies and privati&ed firms are implementin" %etter cost accountin" procedures and as industr! li%erali&ation and expansion is settin" in it is %ecomin" increasin"l! important to implement full! the principles of price cap re"ulation includin" accuratel! accountin" for operator productivit! "ains. On the one hand effective calculation of price caps should ensure fair and reasona%le tariffs for end users of services that remain non#competitive. 5speciall! in developin" countries under"oin" restructurin" there should %e room for su%stantial "ains .e.". a%ove 106 per !ear0 as operators move a$a! from historical inefficiencies and the 1#factor in the price cap formula is the most effective means for re"ulators to ensure that these "ains are passed on to the pu%lic rather than $holl! retained as profits often %! forei"n e7uit! o$ners. At the same time appl!in" appropriate price caps to dominant carrier services such as interconnection char"es can also %e an important tool for supportin" fair competition. (his paper presents a theoretical and practical %asis for esta%lishin" productivit! factors for telecommunications companies re"ulated under price cap s!stems in developin" countries. (he paper is %ased upon the authors8 experience $or-in" $ith the ,uperintendencia de (elecomunicaciones in +olivia $hich re"ulates 19 local telephone DAVID N. TOWNSEND/PETER A. STERN 1 OCTOBER 1999

Productivity and Price Cap Regulation ITU Telecom 99 cooperatives and a national lon" distance operator under a price cap re"ime and esta%lished ne$ 1#factors for those companies in earl! 1999. 2e descri%e some of the practical methodolo"ical challen"es faced in determinin" appropriate productivit! factors as $ell as the %asic model applied.

DAVID N. TOWNSEND/PETER A. STERN

OCTOBER 1999

Productivity and Price Cap Regulation ITU Telecom 99 II. Productivity analysis and telecommunications regulation /.# The concept o0 productivity

(he %asis for the concept of productivit! is the o%servation that the economic conditions of production of telecommunications services are not static %ut .under normal circumstances0 tend to improve over time re7uirin" less input for the provision of the same output or similarl! allo$in" the production of a lar"er 7uantit! of output for the same amount of inputs. 'onceptuall! an! productivit! index is a measure of the chan"e in the de"ree of efficienc! of an operator over time and focuses on the comparison of the consumption of inputs re7uired in relation to the level of output produced %! the operator. 'han"es in productivit! indexes t!picall! productivit! increases can %e caused %! a variet! of factors includin" the follo$in"; 'han"es in the relative prices of inputs< .e.". decreasin" trend in the cost of telecommunications e7uipment and soft$are0< 'han"es in technolo"!< 5conomies of scale< 'han"es in pricin" polic! .e.". mar"inal cost pricin" instead of cross#su%sidies0< 'han"es in mana"ement efficienc!.

It is theoreticall! possi%le to isolate the influence of various components of the productivit! measure .e.". throu"h the estimation of a cost function for the firm0. (his process ho$ever is technicall! difficult data intensive and sometimes uncertain in its results. =ost productivit! measures tend therefore to %e aggregate estimates of the level of efficienc! of a firm. In essence a calculation of the de"ree of chan"e in a firm>s productivit! estimates the avera"e overall improvement in the compan!>s a%ilit! to produce its arra! of services $ith the resources that are availa%le to it. /./ Productivity 0actors in Price Cap tari00 regulation

(he principles underl!in" most Price 'ap re"ulation re"imes are "enerall! fairl! simple. /ather than re"ulate individual telephone service prices directl! the re"ulator esta%lishes a ceilin" or ?'ap@ on the $ei"hted avera"e prices of one or more ?%as-ets@ of services. (his cap can chan"e over time accordin" to a formula that allo$s for increases e7ual to the rate of inflation minus an ad3ustment to reflect expected productivit! "ains %! the re"ulated operator. DAVID N. TOWNSEND/PETER A. STERN A OCTOBER 1999

Productivity and Price Cap Regulation ITU Telecom 99

In this context productivit! improvements represent the de"ree of increased efficienc! that the operator is expected to achieve .or alread! has achieved0 in comparison $ith the national econom! as a $hole. In the case of telephone operators in developin" countries B especiall! those that have %een recentl! privati&ed or $hose operatin" structure is under"oin" si"nificant reforms B productivit! "ains should %e 7uite lar"e for several !ears. 5ven in hi"hl! developed net$or-s such as the ).*. and ).,. productivit! factors have often %een set in the ran"e of C6#D6 or more in recent !ears. (he Price 'ap re"ulation methods that have %een adopted in man! countries are lar"el! similar althou"h their treatment of productivit! differs considera%l!. ,ome examples include; Ar"entina8s price cap s!stem doesn8t include an explicit 1#factor provision Australia uses a tradition 'PI#1 formula $ith different 1#factors for different %as-ets initiall! set %et$een :6 and 9.96 risin" to 7.96 in 1997. 'anada has set the 1#factor at C.96 for the !ears 1998#:000 for re"ulated carriers. 'olom%ia utili&es a non#traditional re"ulatin" scheme $hich caps compan! costs rather than prices %ut the formula does ta-e into account productivit! initiall! set at :6 throu"h :000. =exico $as one of the first developin" countries to esta%lish a price cap s!stem. (he formula maintained a &ero 1#factor until 1999 $hen 'ofetel esta%lished a 96 productivit! offset for the next A !ears. Peru has a price cap s!stem $ith a ran"e for price chan"es allo$in" tariff fluctuation $ithout an explicit productivit! factor. In the )nited *in"dom $hich esta%lished the first price cap s!stem the current 1#factor for +ritish (elecom is set at C.96 throu"h :001. In the )nited ,tates at the national level the latest revision to the F''8s price cap formula incorporates a D.96 1#factor. Eene&uela8s price cap s!stem set a &ero 1#factor for the initial !ears throu"h 199D follo$ed %! a 1.96 1#factor for lon" distance and international services .&ero for other services0 throu"h :000.

DAVID N. TOWNSEND/PETER A. STERN

OCTOBER 1999

Productivity and Price Cap Regulation ITU Telecom 99 III. Productivity calculation methodologies *.#. "ptions 0or productivity measures =an! successive means of measurin" productivit! have %een esta%lished historicall! in %oth academic literature and in re"ulator! practice. Althou"h the! "enerall! have in common the re7uirement to relate a value of input consumed to a value of output produced the! can var! "reatl! in their level of sophistication and performance. Ori"inall! most productivit! formulas $ere la%or#%ased productivit! measures .such as the often used measure of Output per Person Hour0< the most sophisticated productivit! measures ho$ever such as the Total Factor Productivity .(FP0 measure ta-e into consideration all relevant inputs. ,ince most firms are multi#product firms the calculation of a productivit! measure almost al$a!s re7uires the a""re"ation of flo$s of inputs and outputs that are of different ph!sical natures. Different choices can %e made relative to the $ei"htin" factors to use .prices cost factors fixed or mo%ile $ei"hts etc.0 and to the definition of the price and 7uantit! indices used in the a""re"ation formula. Amon" earlier methodolo"ies the Faspe!res and Paasche indices are closel! related and can %e derived from each other. Faspe!res indices a""re"ate 7uantities and prices %ased on fixed $ei"hts .calculated in a $ei"ht %ase !ear0 allo$in" an eas! calculation of a""re"ate 7uantities. Paasche indices on the contrar! recalculate the $ei"ht factors ever! !ear %ut also tend to Ga"eG over time due to their reference to a fixed time %ase re7uirin" periodical ad3ustments. +oth indices ho$ever tend to %ecome poor measures $hen the structure of the industr! examined is under"oin" a rapid chan"e in particular $hen the chan"e is affectin" the relative prices of inputs or outputs or the relative proportions of 7uantities of inputs or output. Finall! the Divisia#(orn7vist index of (otal Factor Productivit! is a more complicated %ut more effective method of calculatin" price and 7uantities indices particularl! in the context of a d!namic industr! $here production structures are chan"in" rapidl!. 2henever data availa%ilit! permits its calculation (otal Factor Productivit! has %een in recent !ears the preferred method for the calculation and monitorin" of telecommunications companies8 productivit!. It is the method used %! the ).,. Federal 'ommunications 'ommission amon" others. (he choice of (FP is prefera%le to a Fa%or# %ased measure due to the importance of the capital factor durin" "ro$th periods. Productivit! in telecommunications services provision is "enerall! sensitive to chan"es in the DAVID N. TOWNSEND/PETER A. STERN 9 OCTOBER 1999

Productivity and Price Cap Regulation ITU Telecom 99 productivit! of capital. (his is due to the critical influence of net$or- e7uipment in the cost characteristics of telecommunications carriers. Durin" "ro$th periods .in $hich lar"e capital investments are made into the net$or- in order to support fast expansion0 measurin" the productivit! influence of capital is even more critical to the accurac! of the measure. (he onl! do$nside of the (otal Factor Productivit! measure is that it re7uires more data than the traditional Output per Person 4our measure. In particular there is a need for detailed accountin" data to determine the cost share of the various input factors considered in the (FP formula. In man! developin" countries such data have not %een maintained or are availa%le onl! in a""re"ate form. (he challen"e is to define data filin" re7uirements earl! enou"h in the process to ensure that needed information $ill %e availa%le $hen the productivit! anal!sis must %e performed. *./ Total -actor Productivity calculation method

(otal Factor Productivit! =easures have in common a "eneral calculation formula that relates the rate of chan"e of (FP to the rate of chan"e of the ratio of a""re"ate output to a""re"ate input.1 A "eneral expression of this formula is the follo$in";
TFP ln !"# $ ln !F#

$here; Q is a $ei"hted a""re"ate index of all relevant compan! input varia%les .from iH1 to iHn0< F is a $ei"hted a""re"ate index of all relevant compan! output varia%les .from 3H1 to 3Hm0< ln is the natural lo"arithm In addition each compan!#specific (otal Factor Productivit! =easure re7uires empirical choices to %e made relative to the definition of all of the follo$in" factors; 1. :. A. C. /elevant set of input varia%les .from iH1 to iHn0 /elevant set of output varia%les .from 3H1 to 3Hm0 2ei"ht factors for input varia%les .Wit from iH1 to iHn0 2ei"ht factors for output varia%les .Pjt from 3H1 to 3Hm0

1 . (he formulas are ta-en from Denn! Fuss and 2averman .19810 a stud! of compan!# specific +ell 'anada data from 19D7 throu"h 197D and present the conventionall! measured Divisia#(orn7vist index of (otal Factor productivit!. Denn! =. =. Fuss and F. 2averman G(he =easurement and Interpretation of (otal Factor Productivit! in /e"ulated Industries $ith an Application to 'anadian (elecommunicationsG in Productivity Measurement in Regulated Industries (. 'o$in" and /. ,tevenson eds. Ie$ Jor-; Academic Press 1981. DAVID N. TOWNSEND/PETER A. STERN D OCTOBER 1999

Productivity and Price Cap Regulation ITU Telecom 99

(nde, Formula (he a""re"ate input and output formulas are defined as follo$ed accordin" to the

% n ' it ln !F# !&it ) &i t $ % # ln! # ( i% ' it $ %

(orn7vist index methodolo"!; .a0 2ei"hted a""re"ate input index;

&i t

!Wi t # !' it #
i %

!Wi t # !' it #

$here; Sit is for each input i and for the period t the share of input i in total compan! input cost< Wit is the varia%le selected for the a""re"ation of all input i .most fre7uentl! the price of the input i0< Xit is for each input i and for the period t the 7uantit! of input used. .%0 2ei"hted a""re"ate output index;

ln !"#

% ! # (
Rj t

j %

! Rj t ) Rj t $ % # ln !
! Pj t # ! "j t #

"j t # "jt $ %

j %

! Pj t # ! "j t #

DAVID N. TOWNSEND/PETER A. STERN

OCTOBER 1999

Productivity and Price Cap Regulation ITU Telecom 99 $here; Rjt is for each output j and for the period t a measure of the share of output j in total compan! output revenue< Pjt is the varia%le selected for the a""re"ation of all output j .most fre7uentl! the price of the output j0< and "it is for each output j and for the period t the 7uantit! of the output produced. -lternative ratio formula (he a%ove formula represents an ideal theoreticall! ri"orous calculation of the chan"e in productivit!. (he lo"arithmic approach com%ined $ith relative $ei"htin" of individual cate"ories of inputs and outputs 7uantities and prices can %e expected to !ield the most accurate estimate of true historical productivit! chan"es and is su%3ect to the least varia%ilit! due to uncertain data sources. An alternative more simple formula to calculate (FP %ased upon lar"el! the same source data involves ta-in" the $ei"hted ratios of inputs to outputs $here all values are expressed in ad3usted financial terms. In this formula the chan"e in productivit! $ould %e expressed as; .A('0 K A(/00 .A('1 K A(/10 $here; A('n H Ad3usted (otal 'osts for period n< and A(/n H Ad3usted (otal /evenues for period n.

,u%tractin" 1 from the a%ove formula $ould !ield the productivit! chan"e from !ear 0 to !ear 1. (his alternative t!picall! !ields results that are close %ut not identical to the lo"arithmic formula. It has the advanta"e of permittin" a strai"htfor$ard a""re"ate calculation $here detailed data on specific cate"ories of inputs and outputs as $ell as prices ma! not %e availa%le.

DAVID N. TOWNSEND/PETER A. STERN

OCTOBER 1999

Productivity and Price Cap Regulation ITU Telecom 99 I$. 1.# pplication o0 methodologies De0initions2 calculation o0 inputs and outputs

(he calculation of productivit! chan"es usin" either of the methodolo"ies descri%ed a%ove depends essentiall! upon the same sets of data and initial assumptions and calculations. =ost of the anal!tical challen"es re7uirin" simplif!in" assumptions involve the input .cost0 data althou"h certain ad3ustments must t!picall! %e applied to output .revenue0 data as $ell. !efinition of (nputs (he first 7uestion is to define the different cate"ories of inputs to %e used in the anal!sis. )ltimatel! this definition $ill depend upon the level of detail of the availa%le data. Ideall! for the (FP calculation there $ould %e a lar"e num%er of specific t!pes of investments and purchases $ith -no$n 7uantities and prices for each period. In the a%sence of this de"ree of information the preferred approach should at a minimum classif! costs accordin" to the follo$in" cate"ories; 1. Fa%or :. =aterials .includin" /ents and ,ervices0 A. 'apital .a/or costs are the direct and indirect costs of all personnel involved in the operation of the telephone compan! and the production of its services. Fa%or costs include all salaries and %enefits such as pension and health %enefits and an! other compensation paid %! the compan! to its emplo!ees. Fa%or costs ma! if data are availa%le %e divided accordin" to cate"ories of emplo!ees; mana"ement full#time part#time clerical en"ineerin" contract la%or etc. Other$ise la%or costs should %e "rouped as a total cost cate"or!. $aterials costs are non#la%or expenditures that t!picall! are consumed in the same !ear the! are purchased and thus do not %ecome part of the fixed asset %ase. (hese can include various supplies costs of consuma%le inputs such as ener"! and costs of outside services such as auditors or consultants .$hich $ould not %e considered la%or0. In addition pa!ments to other telephone operators such as interconnection char"es should %e considered in this cate"or!. Capital costs are t!picall! lon"#term investments in plant and e7uipment $ith a useful life of more than one !ear and $hich are usuall! depreciated on the compan!>s accounts rather than paid full! in the !ear the! are ac7uired. In man! cases it is difficult to distin"uish from availa%le records %et$een =aterials expenses and capital investments in a "iven !ear. (his aspect of the input anal!sis is su%3ect to the most variation and hence 3ud"ment as to the appropriate means to calculate costs and chan"es in costs. DAVID N. TOWNSEND/PETER A. STERN 9 OCTOBER 1999

Productivity and Price Cap Regulation ITU Telecom 99

'apital costs of providin" telecommunications services can %e anal!&ed from more than one perspective. At an! "iven time the entire %ase of fixed assets can %e said to contri%ute to service output and it is chan"es in this asset %ase that should enter into the calculation of chan"es in productivit!. 'han"es in the asset %ase are t!picall! measured %! t$o factors; .10 depreciation of in#place assets< and .:0 investment in ne$ assets. Depreciation .andKor amorti&ation interest and dividend0 costs represent the annuali&ed cost of the entire fixed asset %ase in one !ear. Additions to these assets are represented %! the volume of ne$ capital investments in one !ear. 4o$ever $hereas the existin" capital %ase is li-el! to support existin" services ne$ investments ma! contri%ute to current services or ma! %e aimed at producin" ne* services in the future. 'apital investments that are primaril! intended to support future services .i.e. do not "enerate revenues in the same !ear as the investment0 should not necessaril! %e considered in an anal!sis of historical productivit! chan"es for existin" services. It ma! %e difficult ho$ever to isolate onl! ne$ service investments from total annual plant additions. For purposes of productivit! anal!sis the most appropriate method to measure the contri%ution of capital inputs is to consider the de"ree to $hich ph!sical investments are ?consumed@ %! the production of services in a "iven !ear. (his ?capital consumption@ is "enerall! measured %! the amount of capital depreciation $hich should %e directl! proportional to the total value of fixed assets. For the %ase !ear the effective depreciation rate $ill %e the amount of depreciation and amorti&ation expense divided %! the total fixed asset %ase for that !ear. (he formula that $e have applied ad3usts the value of ne$ investments after the %ase !ear to account for input price inflation .see %elo$0 and then applies the %ase !ear effective depreciation rate to the ad3usted fixed asset %ase to estimate the contri%ution of capital to productivit! in that !ear. (his result ho$ever must then %e further ad3usted to the %ase !ear cost of capital as explained %elo$ to achieve a proper comparison of e7uivalent capital inputs from one period to the next. !efinition of Outputs Outputs are defined in a more strai"htfor$ard manner in direct relation to service volumes and revenues. In the optimal model output $ould %e measured directl! in terms of 7uantities of service provided .su%scriptions lines in service minutes of use etc.0 2here this information ma! not %e recorded in ade7uate detail the telephone operator>s total output is "enerall! assumed to %e e7uivalent to its total revenues from all services. .In the case of mixed re"ulated and unre"ulated activities the relevant measure of output is the revenues from re"ulated services< ho$ever inputs must also %e distin"uished %et$een these t!pes of services as $ell.0 (here ma! %e cases $here chan"es in volumes of service provided are not accuratel! reflected in chan"es in revenues; for example $here flat#rate usa"e tariffs appl! or $here the structure of tariffs chan"es from one period to the next. (hese effects should ideall! %e incorporated in the productivit! anal!sis e.". %! attri%utin" e7uivalent avera"e DAVID N. TOWNSEND/PETER A. STERN 10 OCTOBER 1999

Productivity and Price Cap Regulation ITU Telecom 99 prices per unit of output from the different tariffs and measurin" the chan"e in per#unit terms rather than actual revenues. (he main cate"ories of telecommunications services for $hich chan"es in outputs are t!picall! measured on a disa""re"ated %asis include the follo$in" .$ith units of service0; +asic telephone service su%scription .monthl! rent0< Focal telephone usa"e .minutes< ma! %e partl! included in rent0< Iational lon" distance usa"e .minutes %! distanceKtariff re"ion0< International lon" distance usa"e .minutes %! countr!Kre"ion0< 'ellular service su%scription usa"e .su%scri%ers minutes0< Data transmission and leased circuits .circuits capacit!0< Pu%lic telephones .minutes total pa!ments0< (ele"raph telex .messa"es0

Of course not all telephone operators provide all of these services and there ma! %e other speciali&ed cate"ories of service for different operators. 1./ (easurement o0 input and output price changes 3in0lation4de0lation5

As discussed a%ove one of the most critical elements of the stud! of productivit! chan"es is the ?normali&ation@ of %oth inputs and outputs to remove the effect of price chan"es from one period to the next. (his must %e done under either formula for (FP as the lo"arithmic formula depends upon multipl!in" unit 7uantities times price in each time period $hile the ratio formula utili&es inflation#ad3usted a""re"ate cost and revenue results. If exact price or cost chan"es are not -no$n for each cate"or! of inputs as is t!picall! the case then estimates of input cost inflation need to %e developed to ma-e ad3ustments to the results for periods follo$in" the %ase !ear. 'han"es in Fa%or input prices .$a"es salaries %enefits etc.0 mi"ht %e availa%le from compan! records accordin" to different "rades of emplo!ees .for example ne"otiated $a"e increases for union $or-ers0. If such information is partl! availa%le this is prefera%le to utili&e in com%ination $ith an overall anal!sis of per#emplo!ee la%or costs. (he a""re"ate measure of la%or price chan"es can %e determined %! dividin" total la%or costs in the %ase period %! the total num%er of emplo!ees. (he resultin" per#emplo!ee cost .la%or input price0 serves as the inflation#ad3usted emplo!ee cost for su%se7uent !ears. 2e multipl! this amount times the num%er of emplo!ees in each !ear to determine ad3usted total la%or costs. For inflation in =aterials costs it is t!picall! necessar! to rel! upon econom!#$ide inflation data. If there are data specific to hi"h technolo"! industries or %usiness inputs "enerall! such measures are prefera%le to retail consumer inflation factors. 4o$ever a consumer price index is accepta%le if no other factor is availa%le. (his effectivel! assumes DAVID N. TOWNSEND/PETER A. STERN 11 OCTOBER 1999

Productivity and Price Cap Regulation ITU Telecom 99 that =aterials unit input prices have increased from the %ase !ear at the "eneral economic rate of inflation for each !ear studied. Inflation in capital costs occurs in t$o $a!s. 2hen ne$ plant investments are made these ma! occur at different unit price levels than past investments and therefore additions to fixed assets after the %ase !ear need to %e deflated accordin" to the national input inflation level or some technolo"!#specific price index .similar to materials inflation0. For the value of the contri%ution of capital assets to production in each !ear relative to the %ase !ear it is necessar! to estimate chan"es in the companies> internal or external costs of capital or financin" costs to support investments. ,ince return on investment as $ell as cost of de%t varies for different companies the most appropriate measure of capital costs for a specific operator is the actual return on investment that it earns in a "iven !ear. (his can %e calculated %! su%tractin" Fa%or and =aterials costs from total revenues and dividin" the result %! the total value of net fixed assets ."ross investment minus accumulated depreciation0. (his allo$s calculation of an internal rate of return for the %ase !ear and $e then ad3ust relative capital costs for su%se7uent !ears %! appl!in" the same %aseline cost of capital to each !ear>s ad3usted level of net fixed assets. (his method $hich has %een applied %! the ).,. F'' amon" others has the advanta"e of utili&in" each compan!>s o$n operatin" results and data rather than %road estimates of industr! capital costs chan"es. One further ad3ustment that is sometimes applied to input costs in productivit! studies is called an ?input price differential@. (his ad3ustment attempts to capture di++erences %et$een the input prices facin" the telecommunications industr! and price chan"es in the econom! as a $hole. On the assumption that telecommunications e7uipment and related prices have %een increasin" at a rate slo$er than "eneral inflation such an ad3ustment $ould assure that the productivit! calculation reco"ni&es this %enefit to telephone operators .e.". it allo$s them to purchase more of the same e7uipment for a lo$er real price0. If relevant data are availa%le such a factor should also %e included in the anal!sis. Finall! $ith re"ard to price chan"es affectin" the value of Outputs .service revenues0 it is most desira%le to rel! upon the actual tariff chan"es themselves as $ell as avera"e measures of effective price chan"es. For services $ith simple tariff structures .and availa%le demand data0 direct chan"es in tariffs durin" the stud! period can %e used to deflate revenues to %ase !ear price levels. For services $ith more complex tariff structures .e.". lon" distance services0 $e simplif! the anal!sis %! dividin" total revenues %! total minutes of use in the %ase !ear. (his produces a $ei"hted avera"e tariff for that !ear $hich can then %e applied to future !ear total demand levels to produce ad3usted future revenues. 2here revenues from several services are com%ined in the data it is necessar! to examine the tariff chan"es for all services and estimate a $ei"hted avera"e price deflation index.

DAVID N. TOWNSEND/PETER A. STERN

1:

OCTOBER 1999

Productivity and Price Cap Regulation ITU Telecom 99 $. Data re6uirements (his section identifies the accountin" and other information that should %e provided %! re"ulated telephone operators to allo$ for the calculation of productivit! trends accordin" to the methodolo"ies descri%ed. (he lists of data re7uirements are not exhaustive and do not necessaril! define in precise detail the exact format and scope of data that $ould %e most useful in conductin" the studies. Ior is it certain that the operators> accountin" s!stems and data records $ill contain all of the desired information in the formats or de"ree of detail identified here. Ideall! the information should %e provided as annual results for a period of at least C !ears to the extent relevant and consistent data are availa%le. ,.# "utputs +asic local services; (otal num%er of %asic service su%scri%ers (otal %asic su%scription revenues (otal num%er of local exchan"e s$itches in the net$or (otal line capacit! of local s$itchin" net$or (otal minutes of local telephone usa"e .if availa%le0 (otal interconnection .access0 minutes .lon" distance international cellular0 (otal interconnection .access0 revenues .lon" distance international cellular0 Fon" distance services; (otal minutes of national lon" distance usa"e %! tariff cate"or! if availa%le (otal revenues from national lon" distance services (otal out"oin" international minutes to each countr! or re"ion (otal incomin" international minutes from each countr! or re"ion (otal revenues from out"oin" international service Iet settlement pa!ments from incomin" international services %! countr! Other services; (otal num%ers of leased circuits and data circuits %! t!pe of circuit (otal revenues from leased and data circuits (otal num%er of pu%lic telephones (otal minutes of use from pu%lic telephones (otal revenues from pu%lic telephones (otal telex and tele"raph revenues (otal revenues from other services (ariffs for all services for each !ear identif!in" all chan"es in tariffs

DAVID N. TOWNSEND/PETER A. STERN

1A

OCTOBER 1999

Productivity and Price Cap Regulation ITU Telecom 99 ,./ Inputs (otal compan! annual operatin" costs (otal value of fixed assets in service as of %e"innin" of each !ear (otal ne$ capital investments each !ear identif!in" nature of investment (otal annual depreciation and amorti&ation expenses (otal accumulated depreciation reserve if an! each !ear (otal annual interest pa!ments on investment de%t (otal annual real propert! taxes paid on fixed assets (otal annual expenses for materials rents and services %! t!pe of cost (otal annual la%orKpersonnel costs .salaries $a"es %enefits0 %! t!pe of emplo!ee (otal num%er of emplo!ees %! t!pe of emplo!ee

DAVID N. TOWNSEND/PETER A. STERN

1C

OCTOBER 1999

Productivity and Price Cap Regulation ITU Telecom 99 $I. (odel and Results

DAVID N. TOWNSEND/PETER A. STERN

19

OCTOBER 1999

Productivity and Price Cap Regulation ITU Telecom 99 (he follo$in" pa"es present the "eneral format and calculations alon" $ith sample O<TP<T INDE; CA$C<$ATIONS Productivity -actor Calculations: !ample local local telephone company -actor Calculations: !ample ), <na&7#ste& re4en#es 195*9+1*1") -,5*9,,*-,+ )1"*),)*15! ) "*,5"* 9 $-8$!8$1-8$1!8$-18$-58$)+ inputs andtotal results from the productivit! model usin" data that is reasona%l! representative of Installat%on "utput 0actor calculations Input 0actor calculations a)5 local telephone operator>s performance durin" a period in$-/$), a developin" countr!. R +.+1 +.+1 +.+- of "ro$th +.+) ;t/;t91 1.-1.,1 +.9$)'t(/$)'t91( (he example does not include lon" distance services $hich should t!picall! %e modeled 1995 199 199! 199" So#rces 1995 199 199! 199" So#rces )! for5#la +.++55 +.+11, '+.++-"( A$)5't(8$)5't91(B1ln'$) ( Bas%c tar%ff $hether or not the! are provided %! an inte"rated carrier. separatel! $ABOR Total Revenues #9,29:#2#;* /1,29112/1: *#;2*1*2#,< *=;21,;2==9 1R Data res.onse f%l%n/ )" +.1" +.1! +.1! +.1! $!/$),
1 )9 ,+ ) ) ,1 , ,, 5 ,) 5 ,, ,5 ,! ! " " 9 ,! 1+ 9 ," 11 1+ ,9 11 5+ 11) 1, 15 1 Total salar%es an& benef%ts 'Bs( ;t/;t91 Deflat%on factor Installat%on for5#la d7usted la8or e9pense Re4en#es $ocal traff%c Ne3 %nstallat%ons R 0ATERIA$S A4era/e re4en#e .er %nst. ;t/;t91 Net 0ater%als e1.ense Installat%on tar%ff for5#la Deflat%on d7usted factor total revenues 3?9, prices5 Interconnect%on Rd7usted (aterials e9pense Bas%c 0ont?l2 Ser4%ce ;t/;t91 CAPITA$ Re4en#es for5#la Net f%1e& assets 'be/%nn%n/ of 2ear( N#5ber Ot?er ser4%ces of s#bscr%bers Total ne3 %n4est5ent A4era/e re4en#e .er s#bscr%ber R 0ont?l2 / Deflat%on tar%ff factor ;t/;t91 d7usted totalne3 revenues 3?9, prices5 for5#la 6 A&7#ste& %n4est5ent A&7#ste& /ross f%1e& assets $ocal traff%c ln'C( Re4en#es De.rec%at%on '1995( Total 5%n#tes A4/ f%1e& assets before &e.rec%at%on A4era/e re4en#e .er 5%n#te Base 2ear a4era/e &e.r. rate Tar%ff .er &e.rec%at%on 5%n#te A&7#ste& e1.ense d7usted totalnet revenues 3?9, prices5 Total a&7#ste& f%1e& assets 'eo2(
Interconnect%on Ser4%ces Cost of Ca.%tal '1995 base( Nat%onal $on/ D%stance A&7#ste& total re4en#es Re4en#es 9 $abor e1.ense Total 5%n#tes 9 0ater%als e1.ense A4era/e re4en#e .er 5%n#te 6 Net re4en#es A&7#ste& total re4en#es '@95 .r%ces( / net f%1e& assets Internat%onal $on/ D%stance 6 Base 2ear #n%t ca.%tal cost Re4en#es 1 A&7#ste& net f%1e& assets Total 5%n#tes A4era/etotal re4en#e .er 5%n#te d7usted capital input A&7#ste& total re4en#es '@95 .r%ces( Cell#lar Re4en#es D>U!T'D T"T & C"!T! Total 5%n#tes A4era/e re4en#e .er 5%n#te A&7#ste& total re4en#es '@95 .r%ces( INDE; CA$C<$ATIONS Total o0 ad7usted revenues

)9*99+*11, 1.+++ *9299:2##1 -*!++*+++ 9*+++ +.1 )++ 1+*9 9*55 )++ 1.+++ /2<::2::: #:29=92,,= +. 1

)5*"15*,-1 -+)*),5*9-! " *+1" 1*911*+9+ ,1 +.+, 1.+++ )! *,2;#,21/# 1*911*+9+ - 5*-5!*+1! )1*,-+*+"15*,5)*1)+ -!!*-) *+1, -),*)+1*,!+.11 +.+ +.11 15*,5)*1)+ *#21/:2:;/ -,9*"+)*""!

)5*,9"* !" 1.1) +."," +.+,-1 1#2;<;2:,9 )*)+!*-++ 11*+-, +.15 )++ 1.1 1,*5*1 ! )++ +.+,!, 1.1*2*:<2/:: #/29:*2=/* +. ) 1.-) ,+*"1-*",+ +.-5,) -,9*"+)*""! 9!*+,"1*-+-*5+, ,-1 +.+, 1.1)! 1.1" 1:21:,219; !-*1)-*),5 +.+1-+ )-1*9) *-)+.1"1 )!* -1*5 )--*,!+*5 -9+*,+5*1)9 +.+ +.119*15)*)9, *=2,1=2==1 )+-*!"-*")"

,5*""-*5 1.1 1.+99 +.+,9! 1#2<192**= *--+*"++ 15*55+.19 ,++ 1.1 1 *""-*!), ,++ +.+51) 1.1"" 12==,2=:: #12/#:2*,: +.5" 1.15)* +.1,1) !"*595 )+-*!"-*")" 11-*59, )*9),*),+ ,!! +.+, 1.1"" 51.,, 1=2;;:29:* 5)*"1,*11) +.+-9, )5 *59 *951 +.1,1*111*1,, )!,*1,9*" )),*!5+*++" +.+ +.1 --*+!"*11! 1/21:*2=,# )),*51"*"))

59*)9 1.1) *15+ 1.,)! +.+,+! 1#2*/:2/,< 5*!5-*+++ 1,*)"+ +.19 ,++ 1.1! 1 *)+.+5"" +* ,++ ," 1.-,, 12*#12::: #*2#,#2,9: +.5! 1.1, -*5,5*-51 +.1, )),*51"*")) 1- *9!, ,*"1+*, ) ,9) +.+5 1.-,, 51.19 ,/2;=;2*/# 5-*+9"*--+ +.+1 ! )" * 1!*+5) +.1)+ !1*19!*-"5 ,)5*9+1*!,) *9-,*+ 5 +.+ +.1 -,*-++*1-! ) 1921:/2#9< -*,1 *9-!

Data res.onse f%l%n/ $"'t(/$"'t91( See %nflat%on calc#lat%ons A$)"'t(8$)"'t91(B1ln'$)9( $1/$Data res.onse f%l%n/ > $1-/$), $-/$) $1)'t(/$1)'t91( Data Data res.onse res.onse f%l%n/ A$,1't(8$,1't91(B1ln'$,-( See %nflat%on calc#lat%ons $)1$,'1995( $,/$5 '$1!8$-18$-5(/$), $-9't(/$-9't91( Data res.onse f%l%n/ A$,,'t(8$,,'t91(B1ln'$,5( $1 > Data res.onse f%l%n/ $!/$" $)+/$), See Data%nflat%on res.onse calc#lat%ons f%l%n/ $)-'t(/$)-'t91( $"1$9'1995( $"/$9 A$,!'t(8$,!'t91(B1ln'$,"( $!8$1+ +.51'$)!8$,+8$,)8$, 8,9( $1)1$15 Data res.onse res.onse f%l%n/ Data $1-/$1) '1995( Data res.onse f%l%n/ $1)1$1, $1)1$15'199,( $119$15

1! 1! 1" 1" 19 19 -+ -+ -1 --1 -) --) -, -,

-5 -5 -! -" -9

195*9+1*1") )"*1!9*+")9*99+*11, 11*,9+* "1 1+*9 9*55 ).)1,,*9,1*51) )"*1!9*+"-,9*"+)*""! +.5"+ 5!*!5,*),1 -,9*"+)*""! )*55)*+15 1 .#11291#2,#* 5!*!5,*),1

5+*+!!*,15 1)*",9*5). , *+1 * 1+ +.5"+ !5*+"-*)"1 )+-*!"-*")" ,*)1)* -9 1!.,1 #<,2=;#2:/1 !+*11"*1)9

59*5)5*559 15*1)-*5,9 ).9) 5+*-!9*599 +.5"+ ""*))1*,," )),*51"*")) ,*)59*9!9 -+.#912:9129// !+*"!1*559

"*, 5*"9) 1 *!+!*9),.1+ 55*51)*9" +.5"+ 1+1*5"1*1 5 ) -*,1 *9-! 5*+1)*9! -+./#:2/;#29;< "1*5+-*-9)

See O#t.#t calc#lat%ons Data res.onse f%l%n/ $) > $ $1!/$1" $1!9$1"9$19 $1"1$19'1995( $1 $-+/$-1 '1995( Data res.onse f%l%n/ $1 > $-1/$-$--:$-) $--1$-)'1995(
Data res.onse f%l%n/ $)8$ 8$-, > $-5/$$- 1$-!'1995( $-+8$-,8$-"

-)*1+1*!) /*:21=/2<:= )+*+)-*95- /,:2:,12=:; )5*))-*5!9 /=12<,*2;*, ,+* )-*, #9,29:#2#;* ,-*++)*15! 5,* +5*) " !"*51 *",) 9+*-9,*) 9 +.55 +.55 +.,5 +.,5 -)*1+1*!) )+*+)-*95,)*1",*- ) ,9* 1*9+) ##92:*,2#,9 #1=2#=<2<:/ #=12**,21// #;=2=<;2#;*

- A&7#ste& total costs Ot?er ser4%ces )+ Total ot?er ser4%ce re4en#es $ABOR )1 Deflat%on factor -! S d7usted total revenues 3?9, prices5 )- ;t/;t91 -" -9 for5#la )) D>U!T'D T"T & R'$'NU'! 0ATERIA$S )+ S )1 ;t/;t91 )- for5#la CAPITA$ )) S ), ;t/;t91 )5 for5#la ) ln'=(

195*9+1*1")
*9)+*5-1 1.+++ +.-+ =29*:2,/# #9,29:#2#;*

-)+*, -*!+
9*++9*"" 1.1++ +.1" ;2#9:2;:, 1.+5

-5+*+5,* +"
1,*1))*+)1.-++ +.1! ##2<<<2,/= 1.++

- ,*!5)*")5
1"*-",* 1+ 1.)++ +.1 #12:=,2:;1 +.99

$-5
Data res.onse f%l%n/ See Inflat%on calc#lat%ons $)/$$)+1$)1 $)'t(/$)'t91(

+.+1!" /*12=#<2;=9 +.+ 1.1" +.+1"-

'+.++11( /<:2:=*2#:/ +.+ 1.1+ +.+1+9

'+.++))( *:<2*/<2<;= +.+5 +.9) '+.++"-(

'$-!'t(8$-!'t91((1ln'$-"( $ 8$118$1 8$-98$)$11/$$11't(/$11't91( '$)+'t(8$)+'t91((1ln'$)1(

+.+

+.! 1.-1 +.1, +.+91

+.!" 1.1+ +.15), +.+"-

+.!9 1.+" +.1-5" +.+5!

$-,/$$-,'t(/$-,'t91( '$))8$))(1ln'$),( +.51'$-98$)-8$)5(

DAVID N. TOWNSEND/PETER A. STERN

1D

OCTOBER 1999

Productivity and Price Cap Regulation ITU Telecom 99

Productivity -actor Calculations: !ummary o0 Results

1995 RATIO CA$C<$ATION 1 A&7#ste& Total Re4en#es - A&7#ste& Total Costs ) Rat%o of CostsDRe4en#es , C?an/e %n Pro&#ct%4%t2 5 A4era/e 195*9+1*1") 195*9+1*1") 1.++++

!ample local telephone company

199

199!

199"

So#rces

-),* 1!*" 9 -)+*, -*!+ +.9"-) 1."+E

-!+*+ )*1+-5+*+5,* +" +.9-59 .+9E

)+!*)-!*!" - ,*!5)*")5 +." 15 !.,"E 5.1-E

O#t.#t calc#lat%ons In.#t calc#lat%ons $-/$1 A$)'t91(/$)'t(B91

$OFARITG0IC CA$C<$ATION In&e1 of a//re/ate %n.#t Aln'=(B ! In&e1 of a//re/ate o#t.#t Aln'C(B " Total =actor Pro&#ct%4%t2 c?an/e Aln'C( 9 ln'=(B 9 A4era/e +.+91) +.1"+! ".9,E +.+"1 +.1,1 .++E +.+5!1 +.1-9" !.-!E !.,+E In.#t calc#lat%ons O#t.#t calc#lat%ons $!9$

DAVID N. TOWNSEND/PETER A. STERN

17

OCTOBER 1999