Behind the interim termination rate decision that sparked a court fight
McPherse Thompson, Assistant Editor - Business
It was the fragile state of competition in Jamaica's mobile phone market and concern over possible reversion to monopoly status that led the Office of Utilities Regulation (OUR) to introduce an interim call-termination rate, according to documents perused by Sunday Business.
The Herfindahl Hirschman index, a measure of the size of firms in relation to the industry and an indicator of the amount of competition among them, had shot up from 5,104 before Digicel Jamaica acquired and subsequently closed down the Claro Jamaica network, to 7,223 post acquisition.
That reading signalled that the market was close to becoming a monopoly and as such less competitive, according to the OUR's termination rate determination. The index ranges from zero to 10,000.
Although the OUR had already begun a process to determine cost-based termination rates, the regulator decided there was need for an interim rate pending the completion of a cost study, "to prevent the two remaining mobile operators from leveraging their dominance in terminating calls on their respective networks".
According to the determination, "the interim measure will also immediately reduce the imbalance which exists between fixed-line networks and mobile networks".
At the same time, the OUR - which Digicel has hauled over the coals for introducing the interim rate of J$5 per minute, effective July 15 - contends that up to the date of its determination on June 4, the telecoms company had not submitted some of the information requested to assist its decision.
However, Richard Fraser, head of Legal and Regulatory, Digicel Jamaica, says determination of the cost-based termination rates was "distinct from the issue of the OUR setting an interim mobile termination rate where it did not adhere to the principles of natural justice by failing to consult with the industry".
Digicel has taken the matter to the Supreme Court, seeking an injunction to prevent the implementation of the interim rate, pending a challenge to the OUR's decision. The matter continued on Friday, June 29.
In response to Sunday Business queries, Fraser said the OUR "has always maintained the position that in order for it to establish cost-based termination rates, it would need to undertake a detailed cost-consultation process."
He said the OUR begun that process in February 2012 and forecasts that it will complete consultation by September 2012.
"As part of this consultation, it requested that Digicel provides information regarding its network costs and traffic patterns. All information required by the OUR has, in fact, been provided by Digicel," Fraser said.
Among the issues the OUR considered in arriving at its decision were the effects of above-cost termination rates, which it said could distort the proper functioning of the markets and retard the level of competition.
The OUR report said that having termination rates that were higher than the cost of providing the service allowed an operator to price other services, typically on-net services, below cost.
"This cross subsidisation between networks benefits the operator with the larger market share who tends to be a net receiver of calls. Therefore, even in a case where termination rates are high and reciprocal between two networks, the smaller network ends up paying a transfer to the bigger operator," said the OUR determination.
The regulator said this affects the ability of the smaller operator to compete as it will either have to carry the loss or increase the price of some other service in order to recoup the lost revenue.
"This could significantly affect the ability of the smaller network to innovate and expand," the regulator added.
As a direct result of the cross subsidisation between networks, an above-cost termination rate allows the larger network to maintain a high market share by using the windfall profits from termination to offer large on-net discounts, said the OUR.
"This provides an incentive for customers to gravitate towards the network with the larger market share to benefit from the cheaper price of making an on-net call relative to the cross-network charge they would face if they were a subscriber on the smaller network. This may be especially problematic for potential entrants as they would find it difficult to gain market share," the regulator argued.
The OUR suggested that a termination rate that is set above its true cost result in a transfer of welfare from consumers to the terminating operator.
However, it noted that in the absence of effective competition at the retail level, a reduction in the termination rate may not automatically be passed to consumers in the form of lower retail rates.
The shutdown of the Claro network in March has changed the mobile telecoms landscape in Jamaica, with the largest player, Digicel, increasing its market share, OUR said.
In preparing to set a regulated termination rate, a process started in June 2010. The OUR said it asked the operators to submit a reference interconnection offer (RIO) inclusive of rates and a justification as to how those rates were derived.
Both LIME and Claro responded and provided the documents by the September 2010 deadline, but the OUR said "Digicel to date has not submitted any justification for its termination rate despite repeated requests to do so."
The regulator said it was "reasonably satisfied" that the information provided in a cost model by LIME and Claro was reliable because it formed the basis of termination rates that profit-maximising operators were proposing to charge for terminating calls on their network.
"Given that termination is a monopoly service, the operators would have no incentive to propose a termination rate below the true cost of providing the service," the OUR suggested.
Due to that monopoly position, the regulator said operators were more likely to exaggerate their costs in order to have the termination rate set above the actual cost and earn monopoly profit.
"Therefore, the office is only reasonably satisfied about the reliability of the information in the cost model as it perceives a possible risk of overestimation," said OUR.
"This view is supported by the fact that the MTR (mobile termination rate) proposed in the tariff schedule of LIME is above the rate that was being charged between Claro and LIME when Claro was in operation."
The OUR also noted that LIME and Claro had been charging each other a termination rate of J$4 per minute for more than three years.
"The monopoly rent-seeking behaviour is also exemplified in Digicel's tariff schedule which proposes a rate of J$9, which is almost twice the rate proposed by the other operators, although Digicel has a subscriber and traffic base that is significantly larger than that of the other two operators," said the OUR determination.
The OUR said Digicel did not comply with a request to supply cost and traffic data to substantiate the termination rate proposed in its reference interconnection offer.
However, the proposed tariffs in Digicel's offer ranged from J$7.75 for domestic calls on weekends to J$9 for domestic calls during peak hours. The proposed rate for terminating international calls was about J$12, a rate the regulator said was significantly above the telecoms firm's proposal for terminating domestic calls.
Even the lowest rate proposed by Digicel for terminating a domestic call was above the highest rate of J$6.31 from the submitted models, according to the determination.
"Given that traffic on Digicel's network is significantly higher than that of the other networks, the MTRs proposed by Digicel are unrealistic and cannot be substantiated," the OUR said.
Using data from Digicel's 2009 audited annual report and data relating to its network traffic for the corresponding period, the OUR estimated that the company's total voice service cost was more than 2.5 times that of Claro's.
However, it noted that the higher network cost was more than offset by total traffic on Digicel's network which was approximately 11.9 times the traffic on Claro's network.
Therefore, a termination rate calculated for Digicel's network would be lower than that for the other operators "as Digicel experiences significant benefit from economies of scale. This underscores the point that Digicel's submitted MTRs are baseless," the OUR said.