The case for reducing IUC in the telecom sector
The objectives of competition and efficiency will be best served by aligning interconnect usage charges (IUC) with marginal cost recovery
One of the main fronts in the ongoing war for market share in the telecom sector is interconnect usage charges (IUC). While all the incumbents are supporting a rise in IUC rates, the new giant entrant, Reliance Jio, has backed a reduction. IUC is a charge telco A pays to telco B, to enable B’s customer who is the receiver of a call from A’s network. The argument is that B has invested in the network to receive the call, and should be paid for it accordingly. This is regulated by the Telecom Regulatory Authority of India (Trai) since monopoly power can be exercised by B since B’s customer is bound to B’s network.
This is not a problem in most countries since their phone companies charge the consumer both for sending and receiving calls. In that scheme, they adopt a system called Bill and Keep, where each firm bills its own customer for sending and receiving calls. But in India we have the calling party pays regime, where the calling party of A pays to A for the entire incidence of the call, and the receiver of a call pays nothing (except while in roaming). This has helped poor people, who receive calls much more than make them, enormously. We have perfected the art of sending a “missed call”. As a result, since the customer does not pay for receiving a call, the cost of receiving the call has to be reimbursed to the receiver’s phone company. Trai fixes this rate which A should pay to B for receiving calls from A.
Telephone investments are lumpy investments and are mostly what are called sunk costs, i.e. costs that cannot be recovered when there is competition between telcos. Besides, the receiving network is not distinguishable from the sending network; no telco makes any investment exclusively under this category to receive calls. So strictly speaking, they do not incur any incremental or direct costs for receiving; receiving is a by-product of sending. According to this position, the question of paying for receiving just does not arise because no one invests specifically for receiving calls.
But then, the telco may say, “It is my network, and I won’t receive your call from your network, unless I am paid.” To tackle this problem, governments have legislated “compulsory, non-discriminatory open access” to further competition. Now, if one agrees to the principle that the receiving network has to be compensated for receiving, then one has to define what this cost is and then compute it. The telecom industry has three types of costs for this purpose: fully allocated costs (FAC), long-run incremental costs plus (LRIC+), and pure long-run incremental costs. FAC is the highest and pure LRIC is the lowest in quantum. FAC is pro-investors and pure LRIC is pro-competition. The bottom line is that this cost for receiving calls cannot be separately found by any simple manner of cost accounting, let alone have clarity on which type of cost is justified for which situation.
There is nothing stopping telcos from increasing their prices to recover this cost. In telecom parlance, this is called the “water bed” concept, where, if the cost rises in one place, the price can rise elsewhere. However, the fear of losing market share keeps telcos from truly employing this logic.
Thus, IUC becomes free money for telcos. On a net basis, telcos with smaller networks end up paying money and those with bigger networks end up receiving money. Unsurprisingly, the big networks who receive money typically argue for a high IUC based on full cost recovery. Meanwhile, smaller networks argue for low IUC based on marginal cost recovery, which is close to zero. Naturally, both parties offer partisan arguments. There was a case of a Norwegian telecom major arguing for full cost recovery in its home country, where it was big, but arguing for marginal cost-based IUC in India, where it was a small competitor, using the same expert economist.
The regulator has also to be seized of the fact that the money- receiving telcos will use this “free money” to subsidize their on-net calls, i.e. calls made within their network, thus trying to further increase the disparity in size and consequently increasing monopoly power.
Trai has been progressively reducing the IUC from 20 paise to 14 paise, and there is scope for further reduction. Until now, reducing IUC has been pro-competition and happened to also favour smaller network companies. But now there is a paradoxical situation: reducing the IUC will favour the giant player that has entered the market and threatening the existence of erstwhile leaders. But that is not an argument for not reducing IUC where the objectives of competition and efficiency will be served by aligning IUC with marginal costs.
The basic plaint of incumbent telecom majors seems to be that competition from an entrant is hurting them. This is because the entrant has redefined the market as data instead of voice, made voice a by-product, and also lowered the rates on data significantly besides offering voice free. It is playing the volume game, which is the main feature in telecom. By changing the strategy from spectrum-voice based to fiber-optic-data based, it has reintroduced a natural monopoly in an industry which was rid of it through spectrum, towers and mobile.
The prognosis is that prices will be lowered to new levels, because there is surplus transmission capacity and marginal cost is close to zero. If incumbents do not change and play to the new strategy, they may be forced to exit this price war, wounded. But such exits, I venture to say, may be good for the industry. So, neither the regulator nor government should be persuaded by the argument that industry is facing difficulties and offer sops for being inefficient.
V. Ranganathan is a former member of Trai.
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