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Response to the ERG Consultation on the Recommendation on cost

By Jesus Miller,2014-10-29 20:39
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Response to the ERG Consultation on the Recommendation on cost

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    Response to the ERG Consultation on the Recommendation on

    cost accounting and accounting separation

    Orange SA

A. Introduction

     11. This paper is addressed to the ERG on behalf of the Orange Group in response to

    the ERG’s Consultation on proposed changes to the Commission Recommendation

    on Accounting Separation and Cost Accounting (the Recommendation). Orange

    welcomes the opportunity to comment on the proposed changes to the

    Recommendation, which clearly deals with issues of significant importance to our

    business.

    2. Orange is very concerned to note that the proposed changes to the

    Recommendation imply an assumption that cost accounting and accounting

    separation obligations are equally appropriate for both fixed and mobile markets.

    The methodologies presented in the original version of the Recommendation in 1998

    were designed to address SMP issues in the fixed markets. Given the significant

    differences both in terms of market structures and cost components - between the

    fixed and mobile markets, the approach set out in the existing Recommendation

    should not therefore simply be carried over and applied to the mobile sector.

    3. Any accounting obligations applied to mobile operators under the NRF must fully

    reflect the specific characteristics and architecture of mobile networks. Orange

    therefore considers that the current draft of proposed changes to the

    Recommendation would not be appropriate for application to mobile operators

    without significant amendments.

    4. Accounting obligations are highly intrusive and would necessarily impact on the

    whole of the business concerned. We therefore believe the Recommendation

    should clarify that where as in the case of the mobile sector - only small parts of an

    operator’s business are considered to require ex-ante intervention, there should be a

    presumption against the use of these obligations. Any recourse to such obligations

    should therefore be justified through a full cost-benefit analysis, in the light of this

    presumption. In addition, NRAs should have full regard to the availability of other

    remedies, as well as the provisions of the NRF requiring NRAs not to impose SMP

    remedies on services outside SMP markets.

    5. Regulators should also keep in mind that the mobile sector is currently experiencing

    a period of major market evolution. Operators are required to commit to investing in

    further innovation, as well as rolling out a new generation of 3G technology services.

    It will be critical to the future of the industry moving forwards that NRAs have regard

    to the implications of regulatory obligations on the industry’s ability and incentives to

     1 The Orange Group comprises member companies in ten EU Member States: Austria, Belgium, Denmark, France, Luxembourg, the Netherlands, Portugal, Poland, Slovakia and the UK. We also have European operations in Romania and Switzerland.

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    make these commitments. In particular, Orange is concerned that the introduction of accounting separation is likely to result in unnecessary costs and internal business complexity.

    6. With regard to obligations concerning accounting systems in general, NRAs should clearly avoid imposing obligations requiring operators to make unnecessary changes to their existing systems. Orange also wishes to emphasise the need for any methodology employed to reflect the large common cost elements of the mobile business, together with proper provisions for recovery of investments and return on capital employed.

    B. The need to ensure appropriate and proportionate regulation

    7. It is important that the remedies selected by regulators reflect the goal of appropriate and proportionate regulation based on minimum necessary ex-ante regulation, in

    accordance with the NRF. In this context, we are therefore concerned that there may be a common perception that accounting obligations amount to a “light touch” regulation. For the avoidance of doubt, we must emphasise that obligations concerning cost accounting systems and/or accounting separation are among the most intrusive and onerous remedies available to regulators in respect of the mobile sector, under the NRF.

    8. In general, EU mobile operators have not been subject to ex-ante regulatory requirements to implement accounting separation. However, by way of exception, we are subject to such an obligation in France, through article 13-4 of our 3G licence, which requires us to allocate costs and revenues between 2G and 3G. This measure is intended to facilitate the calculation of 3G mobile fees and ensure that no cross-subsidies occur between 2G and 3G activities. Its underlying purpose is to preserve fair competition between existing operators and new entrants. However, given that there is currently no new entrant for 3G services in France, the justification of this objective is questionable.

    9. From a practical perspective, our experience shows that the implementation of such obligation is particularly complex and involves considerable costs. The operator must essentially either re-engineer its accounting systems or develop extra data processing, in order to comply with this obligation. The subsequent on-going work required on the part of both operators and regulators in order to define and

    maintain these systems and to retrieve the required data, is also very considerable. In France, a multilateral working group was set up in June 2002 to deal with this issue but an operational solution will only be available at the end of this year.

    10. The difficulties demonstrated by our experience in France have been recognized by the NRA and the Government, who now accept the need to simplify the current methodology. For instance, it has been decided that several ratios will be used where it is clearly impossible to separate revenues (e.g. where a communication commences using 3G and terminates using 2G). However, notwithstanding these simplifications, the accounting separation requirements remain a considerable burden. Our experience in France therefore clearly demonstrates the need for any further application of such obligations to be clearly justified by regulators.

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    11. Orange recognises that, following their market analyses under the NRF, NRAs have the power to impose obligations in respect of cost accounting systems and/or accounting separation on mobile operators designated with SMP. However, it can be expected that in practise, regulation (if any) will be limited to only two of the three wholesale mobile markets listed in the EC Recommendation on Relevant Markets (i.e. roaming and call termination). We do not believe that accounting obligations would be a proportionate or appropriate response to the particular issues which regulators may seek to address in respect of these markets.

    12. In this context, we welcome the point clarified in Section 1 of the proposed draft Recommendation, which states that the imposition of accounting obligations must be, “justified by the objective pursued and the nature of the problem identified by the market analysis”. Moreover, any such obligations must also, “comply with the principles of proportionality, transparency and competitive requirements demanded by national or Community law”. In line with this approach, any ex-ante obligations

    imposed should be specifically designed to remedy problems in the particular markets concerned.

    13. The mobile markets currently identified in the EC Recommendation on Relevant Markets as potentially requiring ex-ante intervention constitute only very limited segments of the mobile business. However, the imposition of cost accounting systems and/or accounting separation in respect of these markets is likely to entail our adapting our entire cost accounting systems (both general ledger and fixed assets) for our whole business.

    14. It would, of course, be impossible to restrict the accounting obligations to the regulated parts of the business in question, due to the need to recover common costs, to be allocated across the whole business. The cost accounting system for the whole of the business would therefore have to be significantly re-engineered, in order to meet regulatory requirements put in place to address issues in respect of only small market segments. Essentially, this would amount to the extension of cost accounting obligations to non-SMP areas.

    15. It may be argued that regulatory accounting obligations were initially designed to address situations where a significant part of the business is regulated and a large proportion of total revenue is likely to come from regulated services. However, this is not the case for mobile operators and such obligations would be disproportionate. In terms of any cost-benefit analysis, the costs of such regulatory intervention are very likely to outweigh any possible benefits in respect of the markets concerned. In view of the availability of other remedies to address mobile markets under the NRF, Orange can see no justification for such an approach.

    16. We must also emphasise in this context that we cannot accept any suggestion that accounting obligations put in place to address small segments of our business might be justified by regulators’ desire for further cost information in respect of our non-

    regulated services. This would amount to a breach of the provisions of the NRF requiring NRAs not to impose SMP remedies on services outside SMP markets.

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    17. In this context, Orange is therefore concerned to note the suggestion in Section 6.3

    (page 43) of the draft Recommendation that the NRF empowers NRAs to, “monitor

    the evolution of a non-regulated service using accounting information, by requesting

    proportionate and fair accounting information to the firm”. NRAs will be aware that

    Article 5(1) of the EC Framework Directive only allows them to require operators to

    provide financial information insofar as this is necessary for NRAs to, “ensure

    conformity with the provisions of or decisions made in accordance with” the NRF.

18. NRAs should respect the fact that non-SMP markets are not subject to ex-ante

    regulation. The imposition of cost accounting obligations on SMP mobile markets in

    order to gather information on non-SMP services would clearly be designed to

    circumvent the NRF. Orange considers that as such, it would amount to an abuse.

    19. Orange also wishes to underline the fact that it would be inappropriate for regulators

    to require mobile operators to provide the markets (i.e. competitors and investors)

    with detailed and normally confidential financial information. We note that

    Section 6.1 of the draft Recommendation appears to recognise this.

    20. Ultimately, it is clear that accounting obligations necessarily impact on the whole of

    the business concerned. Orange therefore proposes that the Recommendation

    should clarify that where as in the case of mobile - only small parts of an operators’

    business are considered to require ex-ante intervention, there should be a

    presumption against the use of accounting separation. Any recourse to such

    obligations must be clearly justified by regulators in the light of this presumption,

    having particular regard to the availability of other remedies under the NRF, as well

    as the other considerations outlined above.

    21. On this basis, we find it extremely difficult to envisage any circumstances where the

    imposition on mobile operators of ex-ante accounting separation obligations could be

    justified. The recent OFCOM decision that UK mobile operators are not engaged in 2an alleged margin squeeze appears to support this position. In the decision,

    OFCOM states that it, “currently regulates wholesale mobile termination charges,

    and considers that any competition concerns relating to wholesale mobile termination

    charges are being addressed by the charge controls that have been implemented in

    this area” (see paragraph 202). It follows that any additional imposition of accounting

    separation obligations would be unjustified.

    C. Cost accounting methodologies

    22. Cost accounting obligations can clearly be applied in situations where accounting

    separation is not (although the reverse is not so) and we recognise that NRAs have

    already used such systems to produce inputs for cost models to support price

    controls. Orange therefore accepts that obligations to implement cost accounting

    systems may have more relevance to mobile markets than accounting separation

    (subject to all other requirements for SMP being fulfilled). We have therefore set out

    below a number of specific comments in this respect.

     2 OFCOM decision of 21 May 2004 on a suspected margin squeeze by Vodafone, O2, Orange and T-Mobile

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    23. We must emphasise, however, that Orange nevertheless questions the necessity of

    detailed cost accounting requirements in the context of price controls, as well as the

    cost effectiveness of such an approach. In particular, the need for mobile operators

    to make changes to their accounting systems in order to provide such inputs should

    be avoided, in view of the burden that this would represent. It should also be borne

    mind that other methodologies are possible in the context of price controls. These

    include the implementation of a retail-minus approach (e.g. for setting mobile

    outbound prices), the use of benchmarks, or NRA negotiations with the operators to

    agree glidepaths.

    24. With regard to the correct approach to mobile cost accounting methodology itself,

    Orange wishes to emphasize the importance of ensuring that the Recommendation

    properly reflects the distinction between fixed and variable costs. The majority of the

    costs of a mobile network are driven by the need to carry certain levels of traffic

    capacity (i.e. mobile operators have TRXs on their base stations to carry the level of

    traffic needed). The number of cells we have is defined by our need to carry traffic,

    so less traffic would imply the need for fewer cells, as well as fewer TRXs.

    25. There is therefore no equivalent to "local loop” fixed costs for mobile operators and

    our network costs are largely long run variable costs even though in the short run,

    these costs may sometimes appear to be fixed. Essentially, from our point of view,

    we reduce the proportion of our fixed costs and increase the proportion of variable

    costs.

    26. Orange also has some concerns with regard to the proposed approach to common

    costs. In this context, it is important to note that fixed and common costs are not the

    same, although there is often considerable overlap. We are concerned that the

    threshold of materiality proposed in Section 5.5 of the draft Recommendation (page

    39) assumes that at least 90% of costs can be allocated on the basis of direct or

    indirect cost-causation.

    27. Essentially, where a cost is common to all services, it should be allocated to common

    costs, so that it can be recovered across all services (including SMP services).

    Mobile services have very significant common costs and we would underline the

    need to include the following (non-exhaustive) list of cost elements in any attribution

    of mobile common costs:

; Network coverage;

    ; Spectrum and license fees (including 3G);

    ; Commercial costs (including customer acquisition, retention and servicing; and ; Administrative costs.

    28. The real levels of common costs for the mobile industry are currently not known and

    could only be established through a detailed Study into this issue. In the absence of

    such a Study, we find the proposed 90% threshold unacceptable and submit that the

    Recommendation should refrain from putting forward any thresholds for the

    allocation of common costs.

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    29. Finally, with regard to cost allocation methodologies, we believe that no further

    discussion of cost allocation methodologies should be entirely closed off. We

    therefore find it particularly unhelpful and unacceptable that Ramsey Pricing should

    be dismissed as ”practically unfeasible”. The draft Recommendation should be

    amended in this respect.

D. Conclusions

    30. Accounting obligations are among the most onerous and intrusive ex-ante regulatory

    remedies available to NRAs under the NRF. Their implementation would almost

    certainly involve the need for significant re-engineering of mobile operator’s existing

    systems and result in very considerable costs both up-front and on an on-going

    basis.

    31. It can be expected that in practice, any ex-ante regulatory intervention in respect of

    mobile will be limited to one or two wholesale mobile markets, representing very

    restricted market segments within our overall business. However, accounting

    obligations would necessarily impact the whole of our business, including non-SMP

    services. On the basis of any cost-benefit analysis, Orange therefore believes that

    accounting obligations would clearly be disproportionate to any benefits to the

    regulated markets. In this context, we would underline the fact that an NRA’s choice

    of regulatory remedies should be determined by the objectives pursued and the

    nature of the problem identified in the SMP market in question.

    32. We are particularly concerned that the imposition of cost accounting obligations

    should not be driven by NRA’s interest in obtaining further cost information in respect

    of our non-regulated services. As explained above, this would amount to a serious

    abuse of NRA powers under the NRF.

    33. Ultimately, Orange finds it extremely difficult to envisage any circumstances where

    the imposition on mobile operators of ex-ante accounting separation obligations

    could be justified. We do accept that cost accounting obligations may be more

    relevant to mobile markets. However, as explained above, we must emphasise that

    we not accept the necessity of detailed cost accounting requirements in the context

    of price controls and NRAs should keep in mind the availability of alternative

    approaches.

    34. Finally, where ex-ante accounting obligations are applied to mobile operators we

    wish to emphasise that NRAs should aim to restrict the need for operators to

    implement changes to their existing systems. Any obligations must also fully reflect

    the specific characteristics inherent to mobile networks. On this basis, Orange

    therefore considers that the current draft Recommendation would not be appropriate

    for application to mobile operators without significant amendments.

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    For further information concerning the views expressed in this paper

    please contact:

    Sonia Hilton

    Orange SA, EU Affairs

    tel. +44 7976 016 711

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