Document(s) 12 of 21

INTRODUCTION

In the course of designing a least-cost subsidy auction for regional telecom networks to serve the underserved northeast¹ and deep-south regions of Sri Lanka, it was calculated that the existing backbone network of the Sri Lankan incumbent operator Sri Lanka Telecom Limited (SLTL) was likely to give it at least a USD 7 million advantage over other potential bidders if the auction was conducted without first ensuring that the winner could connect to and use the existing fiber ring to reach the urban concentrations of the west coast and international networks.

Chapter 9 shows the important role played by the massive backbone infrastructure deployed by the Indian incumbent operator Bharat Sanchar Nigam Limited (BSNL) in allowing it to win most of the universal service subsidy auctions. Lacking the cost advantage afforded by having their own fiber or digital microwave backbone networks and unable to gain timely access to the incumbent's backbone and (thereby match the incumbent's advantage), the private operators had to concede to the competition at considerable financial and political cost.

The discussion of Wi-Fi innovations in Indonesia in Chapter 6 also illustrates the critical importance of backbone infrastructure for Internet service providers. All these examples point to the significance of backbone infrastructure—the importance of having the infrastructure and of sharing what exists.

Backbone is that part of the network used to provide communications services. A distinction can be made between national and international backbones, or cable or fiber and radio-based backbones, or terrestrial and satellite links, as well as the level of coverage (entire country or partial). Various types of backbones exist including copper, fiber-optic cable, co-axial cable, digital microwave, Very Small Aperture Terminal (VSAT), and satellite transmission; the backbone includes not just the conduits for carrying traffic, but also the microwave towers and masts. Technologies are constantly being upgraded and per-unit costs are declining. The extent of upgradation and the extent of cost decline have been extensive. Indications are that such changes will continue. The increase in capacity has been very significant with fiber-based systems, but progress is being made with wireless systems too with substantially higher data transfer rates likely to be achieved in the near future.

Backbone infrastructure, or the 'big pipes' that knit a collection of local-access networks into a national network and national networks into a universal network that spans the globe, has attracted greater attention in recent times (see infoDev, 2005 report) for a number of reasons.

In the early stages of telecom reform in the mature, developed market economies, it was assumed that backbone networks could not, and would not, be duplicated. They were seen as 'essential facilities,' understood as 'facilities that cannot reasonably be economically or technically duplicated.' In many cases, new entrants faced a mandate to use the backbone facilities of the incumbent, for the reason that not to do so would cause wasteful duplication.

As this theoretically derived policy principle began to be applied in developing economies, problems appeared. In some cases, the incumbent simply lacked the capacity to provide facilities to new entrants, even if the will was present. The inefficiencies and constraints inherent in government monopolies precluded them from quickly supplementing backbone capacity to accommodate the new business. More importantly, the incumbents were averse to sharing their networks with, and making life easy for, the new entrants. This was the case even when adequate capacity existed. If lack of access to the backbone drove up the entrants' costs, that was all the better.

In this context, and in the absence of strong regulatory mechanisms to compel incumbents to share backbone, reformers retreated. The focus was placed on absolutely essential matters such as ensuring technical interconnection and adequate access to frequencies, with new entrants expected to solve their backhaul problems as best as they could. Wasteful duplication was not a concern, especially when it was known, or assumed, that the incumbent did not have adequate backbone capacity to accommodate the rapidly growing traffic volumes.

Understandably, new entrants were not keen to sink their capital into long-gestation backbone investments when pent-up demand in the urban agglomerations beckoned. The second-best solution of ensuring some kind of market entry, even if the regulatory preconditions could not be satisfied, led to a politically damaging outcome that reinforced the mantras of 'cream skimming' and 'cherry picking' favored by the opponents of reform.

As the supply of telecom services exploded in the urban areas thanks to aggressive new entrants and equally aggressive responses from incumbents, the political pressure began to build for serving the rural areas as well. Ministers and regulators exhorted the new entrants to venture out to rural areas; license obligations, where they had been written to include rural supply, were sought to be enforced when exhortation failed. The new entrants did their internal calculations, comparing the immediate and certain returns from investing in expanding the local-access networks in the urban agglomerations versus the longer-term and uncertain returns of building out backbone and local-access networks in regions with few customers likely to generate high revenues, and found the rural extensions uneconomical even in the face of penalties. Penalties were paid and the new entrants stayed in the urban redoubts.

In the face of this apparent obduracy, governments did what was within their power, at least in India where it had retained the authority to direct the incumbent; it ordered the incumbent to extend the network to rural areas. Possibly because the managers saw this as serving multiple purposes, the directions were followed. In addition to pleasing the political masters, rural backbone roll-out increased capital expenditures and strengthened the competitive position of the incumbent. It would be a stretch to claim that they understood the extension of reliable backbone infrastructure to rural exchanges as a surefire method of winning universal service subsidies, but that was a possibly unanticipated outcome of the roll-out of backbone infrastructure. Whatever the motive was, the end result, as shown in Table 7.1, was greatly beneficial to the incumbent, both politically and economically.

Table 7.1
Incumbent's Exchanges Connected to Reliable Infrastructure in India (March 2005)

Source: Authors, based on Telecommunications Regulatory Authority of India (TRAI) data.⁴

Notes: * Uttaranchal data has been combined with Uttar Pradesh (East).

** These other reliable media are underground cable (4 exchanges), Analog/Digital UHF² (458 exchanges), PCM³ (2 exchanges), and other media (450 exchanges).

Politics is short on memory and impatient with complexity. To a great extent, the judiciary of developing countries, which lacks familiarity with economic theory, is also prone to accept simple arguments whether or not they reflect economic reality. The extract from a news report given below is illustrative:

Rejecting the cellular operators' demand for sharing of the BSNL network and infrastructure, particularly in rural areas, the Minister said the government operator took initiative in areas where its private counterparts failed to venture. Now when the BSNL has turned into a good business opportunity, it needs to capitalize on it…. The Government has given enough concessions to the private players and they should now leave Delhi and work in other places to consolidate their position and build infrastructure. ('Remove Connectivity Hurdles,' 2005)

However, now that much of the pent-up demand in urban areas has been mopped up and the regulatory agencies are moving beyond fire-fighting to more sophisticated analyses of the problems of distorted network extension, the issue of backbone networks has risen in salience. The issues of incentives for building and sharing backbone have also risen on the agendas of the knowledge communities on telecom reform, as evidenced by the research on the subject, especially in Africa (infoDev, 2006).

This chapter addresses some of the issues of ensuring efficient roll-out of backbone infrastructure, with special reference to India, a country with backbone in place, even if not optimally used. It develops a simple model for assessing the viability of self supply of backbone by entrants and discusses the policy actions that can be taken to create the conditions for competitive supply of telecom services in rural areas. The model can be used to understand the supply of backbone by two kinds of providers: the 'pure' infrastructure provider, which does not provide services at the retail level, and the service provider, which provides access to others while using it to provide services directly.

THRESHOLD DEMAND AND PRICE LEVELS AND COMMERCIAL VIABILITY OF BACKBONE

The lump-sum nature and level of investment required for backbone infrastructure implies that there is a threshold level of demand, below which the investment is not commercially viable. In the case of India, in some areas and for some operators (primarily for the incumbent), demand appears to exist in the range of the threshold; in many areas, especially rural and underserved areas, demand and supply are not in line with threshold demand, requiring different forms of policy and regulatory intervention.

The longer it takes to reach this threshold level of demand, the greater will be the additional costs to cover (due to losses in the initial years). The payback period will become extended, particularly due to the discounting of applicable net revenues.

There has been considerable emphasis on open-access models for promoting the establishment of the telecom backbone. Important reasons for this include the lower costs that integrated or stand-alone operators supplying backbone infrastructure would have if the backbone is optimally used and the incentives they have to provide others with access to their backbone. However, to expect the infrastructure provider to have greater incentive to establish the backbone, on the grounds that its costs are lower, would not be correct in general. There will be situations when the incentive for a service provider to invest in the backbone is going to be greater than that for the infrastructure provider. In other situations, depending on the relative revenues and costs, only a service provider may invest in the backbone, or only an unintegrated or stand-alone infrastructure provider may do so.

Situations in which investment in the backbone will not be made commercially by both the service provider and the infrastructure provider can be identified. The government will have to take specific measures to assist the process, including providing incentives in these situations. To consider the various possible outcomes, prevailing demand is denoted 'D,' the threshold level of demand 'DT,' and the prevailing supply of backbone 'S.' Table 7.2 summarizes the conditions under which investment in backbone would be commercially unviable.

Table 7.3 summarizes the situations for which investment in backbone would be commercially viable.

Thus, in certain situations, it is necessary only to focus on addressing the supply constraint; increasing the prevailing demand in the market will not help increase backbone. On the other hand, in a number of situations, the supply of backbone will not increase unless the prevailing demand in the market rises.

Table 7.2
Likely Growth in Backbone and Requisite Policy Responses in Situations in Which Investment in Backbone is Commercially Unviable in India

Source: Authors.

Table 7.3
Likely Growth in Backbone and Requisite Policy Responses in Situations in Which the Investment in Backbone is Commercially Viable in India

Source: Authors.

If there is excess demand in the market and/or likely growth in demand, it is possible that the capacity demanded will exceed the threshold level for attracting investment in the backbone. Infrastructure sharing can increase incentives for investment, as the costs can be allocated among the various entities sharing the infrastructure. The effective cost of the backbone to the user is reduced by sharing. This is more likely to happen when the backbone is installed by an infrastructure provider than when it is installed by a service provider. Universal-service funds and government programs to expand and promote broadband can change the viability frontier; improved interconnection and access revenues can also increase viability, making backbone investment viable in areas that were previously commercially unviable.

There also exists a 'price-threshold level,' or a price level below which the extent of increase in demand would be so large that the stimulus from this large market demand would make investment in backbone self-sustaining and viable, even for what would otherwise be non-viable investments. It may, therefore, be desirable to take steps to create the conditions for prices to decline below the price-threshold level.

Once the market reaches the relevant price threshold, the future growth in demand and revenue sources (through value-added services, Internet, and broadband) would ensure that the investment becomes more attractive. Further, it is likely that with competition and introduction of new technologies, price would decline due to market pressures alone.

With respect to the adequacy of the telecom backbone in a country, the nature of analysis will depend on the particular circumstances in the country. Three possible scenarios can be postulated:

1. The backbone in the country is adequate. In this situation, within the proposed framework, the policy focus needs to be on access only, including policies related to infrastructure sharing.
   
   
2. Backbone in the country is generally adequate, but some areas have inadequate backbone supply. Where supply of the backbone is adequate, the focus would be on access; where supply of backbone is inadequate, policy would focus on both the establishment of the backbone and access.
   
   
3. Supply of backbone in the country is inadequate. Both the establishment of the backbone as well as access to the backbone have to be examined.

A STYLIZED EQUATION OF REVENUES AND COSTS

The analysis begins with an illustrative stylized equation for revenues and costs relevant for the telecom backbone. In simple terms, establishment of a backbone, or access to the backbone, depend on the returns from such activities.⁵ The capital intensive telecom industry requires relatively large investments in backbone, and since the gestation period for obtaining adequate returns is long, there are substantial uncovered costs, especially in the initial years. The present value for the surplus on the investment can be shown simply as:

(i) Present value of the investment = R–C, or Revenues–Costs.
Or as: where,

(ii) Present value = R₁ − C₁ + (R₂ - C₂)/(1 + β) + (R₃ − C₃)/(1 + β)² + … + (R_n - C_n)/(1 + β)ⁿ⁻¹
 or

where,

• 1, 2, …, n are the different years for which the investment is in operation;
  
  
• R₁, R₂, etc., are the revenues in different years from the investment in the network;
  
  
• C₁, C₂, etc., are the costs in different years from the investment in the network; and,
  
  
• β is the rate of discount.

For the investment to be viable, the present value must be greater than or equal to zero. In addition, the investor may also consider whether the payback period or the break-even period is short enough in view of the conditions in the financial market, that is, availability of funds over different periods of time. In effect, this implies an increase in the discount rate, β.

The presence of β in equation (ii) also shows that if there are some constraints or policy situations which delay the investment from becoming fruitful in terms of final capacity available and used, the present value of the project's returns will become less. Thus, high priority should be given to implement policies which bring revenues earlier, or to increase the revenue base in the critical initial years themselves (when use and consequently revenues are also likely to be low).

For understanding the factors which affect the establishment and provision of the backbone, it is useful to separately consider two types of operators. One is the operator who establishes the backbone only to sell the infrastructure service.⁶ We will term this operator as the 'infrastructure provider.' The other operator is one who establishes the network and sells telecom services using that backbone, and also provides others with access to its backbone. This operator will be termed as 'service provider.'

Bearing this distinction in mind, the components of equation (ii) above are slightly expanded yielding a stylized equation (iii), to give the following representation for the present value of the investment made in the backbone:

(iii) Present value

where,

• R_v, R_va, and R_is are the revenues from voice, value-added, and revenues from selling infrastructure (or access charges) respectively. All services which are non-voice services, are categorized as value-added services;
  
  
• I_k and I_v are the investment required to begin providing services, and additional investment required when volume of services provided is increased respectively;
  
  
• W_k and W_v are, respectively, the working expenditure counterparts of I_k and I_v;
  
  
• r is the required rate of return on equity;
  
  
• d is the depreciation rate on investment;
  
  
• I is the interest rate on debt;
  
  
• T is the total of the charges paid to government such as license fee and spectrum charge.

A consideration of the revenue and cost components in equation (iii) will provide a better insight into the difference in the response of a service provider and an infrastructure provider to various situations, as well as the different types of financial and public support policies that can be used to encourage the availability of the telecom backbone. The detailed equation will be relevant more in the section dealing with government policies. For most of the remaining analysis, the simpler forms of the equation, such as in equation (i), are adequate to examine the different factors which affect the establishment of, and f access to, the backbone. The simpler equations are easier to handle and are adequate to broadly indicate the importance of various relevant factors for the purposes of this chapter.

The general points that can be derived from equation (iii) are:

• An increase in revenues implies improved present value, as does a decrease in costs. The revenue increase can take place, for example, due to larger number of services being provided or due to an increase in use. Unit costs may decrease as technology changes, or with an increase in the utilization of the network.
  
  
• In equation (iii), the revenues from services are normally much higher than the revenues from selling only infrastructure.⁷ Thus, normally, R _v+ R_va > R_is.⁸
  
  
• Likewise, the incremental cost of increasing the capacity is less than the initial cost. This happens both because the costs of the system decrease over time, and because the capacity of the system can be increased with proportionately less investment. This implies that I_k > I_v and W_k > W_v. As a result, average costs per unit capacity will decrease with an increase in installed capacity.
  
  
• Since the establishment of the backbone requires a minimum, lump-sum investment, the average cost per unit of traffic will decrease as usage increases.
  
  
• The lump sum nature of investment also implies a threshold level of demand below which the investment is not commercially viable.
  
  
• The longer it takes to reach this threshold level of demand, greater will be the additional costs (due to losses in the initial years) to cover, and the payback period will become extended, particularly due to the discounting factor applicable to the net revenues of different years.
  
  
• With technological change, there is a decrease in costs, and an increase in the types of products under the value-added category that may be provided. The latter would imply an increase in R_va. The decrease in costs can result in price decline and greater use, which may change R_v—the change in Rv will depend on the extent of the increase in use in comparison to the decline in price.
  
  
• If changes in technology allow other service providers to cut into the market of established operators providing access services, there will be a downward pressure on R_v and R_va for established access providers.
  
  
• The various components of revenues and costs, the interplay between performance in different years, and the likelihood of backbone not being established in several areas which are commercially unviable, implies that the government may need to develop an overall vision and policy framework, and identify initiatives that must be taken by the private sector, and the supporting initiatives from government.

SERVICE-PROVIDER AND INFRASTRUCTURE-PROVIDER INCENTIVES

A 'pure' infrastructure provider and a service provider who also provides infrastructure in addition to retail services will have different incentive structures with respect to installation of backbone and providing backbone to others.

An infrastructure provider establishes the infrastructure only to supply access to others. By definition, therefore, the main issue for such an operator is whether or not to establish the backbone because, once established, the question of denying others access does not make sense.⁹ In other words, for an infrastructure provider, the establishment of infrastructure and access to infrastructure go hand in hand.

For operators with an interest in both the service market and the infrastructure market, an incentive favoring establishment of backbone is not automatically accompanied by an incentive to give others access. A service provider with infrastructure has three possibilities of earning revenues: revenues from voice services (R_v), revenues from value-added services (R_va), and revenues from selling infrastructure (or access charges) (R_i). A conflict may arise with respect to revenue earned by providing access to backbone (R_i) and the revenue sources earned from sale of the services using the backbone (R_v + R_va).

Normally, for any given capacity of the backbone utilized for provision of a service and for providing access to the backbone, the revenues earned through voice and value-added services will exceed the revenues from providing access to the backbone. In fact, by definition, for any specified capacity the corresponding amounts of revenue (R_v + R_va) > R_i; if it is not so, then the operator will generally not be able to lease capacity and then use it profitably, since the revenues earned through services sold will not cover the costs of providing services using that capacity.

Therefore, incentives exist for the service provider with infrastructure to use the network itself and not provide its competitors with access to that network. If a service provider believes that the market revenues from services will be reduced if he allows others to use his backbone and compete with him in the services market, such an operator will balk at giving others access to its backbone. This incentive structure is likely to prevail in general.

As a market is opened up, entrants will seek to capture the most valuable customers in the established market from the incumbent. The incumbent will be averse to actions that may contribute to such competition, such as providing access to the backbone. If the backbone is fully utilized before the opening of the market, there is a clear trade-off between earning R_v + R_va and earning R_i. Since the former is likely to be greater than the latter, access to the backbone will be provided by the incumbent only if mandatory. However, even when the backbone is not fully utilized prior to market opening, and R ican be earned without necessarily losing a portion of R_v + R _va,the incumbent is likely to refuse to supply access or offer access at an unreasonably high price or at unacceptably low quality because it wishes to hinder the ability of the entrant to compete in the services market. Here too, the efficient use of the backbone will rest entirely on regulatory intervention.

This kind of behavior will not be exhibited by an infrastructure provider. If competition in the backbone leasing market is to be encouraged, infrastructure providers are more likely to offer competitive pricing than service providers.

A service provider is more likely to provide access to its backbone, if it perceives the threat to its R_v + R_va to be minimal. This is likely to happen only when the market is growing so rapidly that the service provider with backbone can increase its market even in the presence of competition. However, in this scenario, it may experience or perceive constraints to backbone capacity and may restrict supply to competitors as a result. Here, regulatory action to ensure non-discriminatory treatment will be required.

If the price for access to the backbone is low in relation to cost, the supplier will not have an incentive to provide it and buyers will lose all incentive to build additional infrastructure. Setting the right price to maintain the balance between 'build' and 'buy' decisions is a challenge for regulation. If R_i is relatively low, others will prefer to 'buy' rather than 'build,' and those with the backbone will prefer not to sell at all. In fact, if R_i is set too low, even the infrastructure provider may not have incentive to build and maintain the network.

In light of the differing incentives of infrastructure providers and service providers in terms of giving access to the backbone, particularly the disinclination of service providers to give access under most conditions, a strong case can be made for a separation of functions. In this view, the operations of the service provider should be segregated into two separate units, one dealing with the establishment and provision of network elements such as backbone, and the other providing services through the lease of backbone, and such like, from the infrastructure unit. One example is the recent voluntary structural separation of British Telecom (BT).¹⁰

COMMERCIAL VIABILITY OF PRIVATE INVESTMENT IN BACKBONE IN INDIA

Table 7.1 provides a picture of a widely spread backbone in India. Three points may be emphasized with regard to this data.

First, India is prepared with its widespread optical fiber backbone network to provide broadband in much of the country. With increasing sophistication of radio-based technologies, this coverage could be extended practically across the entire country.

Second, the growth of the backbone in India has taken place in a manner analogous to that of Korea, with the government bearing the burden of building the backbone. The difference is that BSNL, on behalf of the government, made these investments from its funds (supported by revenue sources such as Access Deficit Charges at a later time). The important point is that in both countries, the government intervened to extend the backbone to provide a basis for further growth of the telecom services.

Third, the extensive roll-out of the backbone was achieved by a single operator, the incumbent. This implies that the other operators have to be provided access to the existing backbone, or they should build a backbone of their own. For this, the following issues need to be examined:

• How the backbone is being extended in terms of distribution across the country, and the factors which will affect the viability of the backbone's extension, for example, revenues earned and the demand for services.
  
  
• Since the extension of the backbone will take some time, it is also necessary to consider the issue of access to the backbone, including the policy regarding infrastructure sharing and difficulties that may be experienced by private operators in laying backbone.¹¹

If commercial considerations govern the laying of telecom backbone, it would first be laid on routes yielding adequate returns on investment. Thus, one could have significant backbone capacity but it would serve mainly cities and towns. Hence, in addition to the total availability of the backbone, distribution must also be considered.

The main private operators are extending their backbone networks across the country. Table 7.4 shows the extension of backbone by an operator who holds licenses for all the regions or circles in the country. The infrastructure providers are also increasing their capacity and coverage. For example, RailTel is planning to have about 42,000 route km of fiber by March 2008 (Table 7.5). PowerTel was planning a broadband network of about 19,400 km to be completed in 2006. As on March 2005, the network commissioned by PowerTel was 15,534 km. These infrastructure providers will keep increasing the coverage and capacity because they plan to enter the telecom market as national long distance service providers.

Table 7.4
Reliance Infocomm (India): Optical Fiber and Digital Microwave (March 2005)

Source: Authors, based on TRAI data provided.

Note: Phase II has been completed in some circles, and will be fully completed by end 2005.

Table 7.5
Optical Fiber Cable of RailTel Corporation of India

Source: Authors, based on TRAI data provided.

As shown in Tables 7.4 and 7.5, the backbone is likely to be extended by the major operators to cover a large part of the country. However, the private operators will cover only those parts which are commercially viable for them after fulfilling their roll-out obligations, which are specified mainly in terms of 'Points of Presence.' The analysis of commercial viability could be conducted in terms of direct revenues or direct and indirect revenues. These concepts may be explained by considering investment in an incremental portion of the backbone.

Direct revenues are the additional revenues generated by subscribers in the incremental area covered by the incremental investment. Indirect commercial viability means the overall revenues generated by the additional possibilities opened up through the incremental backbone. These incremental revenues are generated not only by subscribers in the area covered by the incremental backbone but also by those who call these subscribers, as well as derived from the general impression about the network giving a more complete coverage, and, therefore, providing better communication facilities for subscribers who are roaming or are mobile in various villages, and so on.¹²

This becomes clearer by considering two different situations: one based on the revenues required to recover the investment in the backbone, and the other based on the data in Table 7.6.

Table 7.6
Reliance Infocomm (India) Subscriber Base in Different License Areas and Notional Subscriber Base for Indicative Viability of Backbone

Source: Authors.

Revenue to Recover Investment in Backbone

The cost of laying the fiber and installing the relevant equipment can be considered in terms of cost per km. This cost may range between INR 200,000 and INR 250,000 per km (approximately USD 4,483). There are other, higher estimates, ranging from about INR 270,000 to INR 400,000 (or USD 6,052 to 8,966) per km. However, the available evidence supports the former. Of this amount, one third is considered the relevant amount that should be earned each year to recover costs and give reasonable returns.¹³

Based on industry data reported by TRAI, on the outgoing and incoming minutes for long distance calls, the amount of revenues earned per subscriber from such calls can be estimated to be about INR 600 (approximately USD 13.45) per subscriber per year. Accordingly, it appears that revenues from about 140 subscribers would be adequate to recover the costs of 1 km of fiber. Commercial viability based on direct revenues would require 140 subscribers per km for every incremental extension of the backbone.

Table 7.6 compares a private operator's subscriber base in December 2004 and the notional number of subscribers that would yield the direct revenues which would make the backbone installed in each circle viable. In the metros, the number of current subscribers is far in excess of those required to make the investment in backbone viable. This does not mean that more backbone should be put in the metros. Rather, the subscribers in the metros need to talk to others in other circles also. Thus, the revenues generated by these subscribers can contribute to the costs of the backbone in the other circles too. For assessing the viability of the network, the indirect revenues have to be considered and not just the direct revenues. Hence, the number of subscribers required to make investment in the backbone viable would be fewer than derived from the direct-revenue method. However, the direct-revenue method is used because it uses a specific amount or subscriber base which is not easy to estimate for the indirect method. The direct-revenue method overstates revenues required to cover the investment costs, compared to the indirect-revenue method.

Where the value in columns 5 and 6 is below 1, Reliance's planned incremental fiber is commercially viable. The higher it is, the less viable is the fiber. Accordingly, column 6 shows that only Punjab and the metro circles at the top of the table can justify commercial investment at the combined Phase I and II levels planned by Reliance Infocomm at the present subscriber levels. The lower levels of fiber roll-out under Phase I can be justified in Gujarat, Kerala, Punjab, and Western and Eastern Uttar Pradesh in addition to the four metro circles. The conclusion for Himachal Pradesh is curious in that the relevant value is below 1 in column 5 and considerably higher than 1 in column 6. This shows that the decision not to roll-out fiber in Phase 1 is commercially justified and that the 103 km of fiber planned in Phase 2 cannot be justified.

However, Table 7.6 also shows that with growth of just over 10 percent of Reliance's subscriber base and the resultant aggregate indirect revenues, the overall investment in the backbone will become viable. However, indirect revenues have to be seen not in aggregate or average terms, but in terms of the incremental investment at each stage. It is likely that the incremental investment would not be covered by indirect revenues especially where there are large shortfalls of direct revenues (for example, in the lower rows in Table 7.6). With the notional subscriber base falling far short of what is needed to recover costs for these circles, it is likely that incremental extension of the backbone will be commercially viable, even taking into account indirect revenues. These circles, therefore, require policy intervention to promote installation of the backbone.

In India, this problem is less serious because the incumbent has installed its backbone in most places. However, minimal demands should be placed on the incumbent. The universal service obligations (USOs) policy in India has therefore identified Short Distance Calling Areas (SDCAs)or local call areas which do not provide adequate revenues to recover costs (termed net cost positive SDCAs). The USO Fund Administrator has identified 1,685 such SDCAs, and USO assistance is to be given to operators to provide rural household connections in these areas, with BSNL covering 1,267 SDCAs, Tata Teleservices covering 215 SDCAs, and Reliance Infocomm covering 203 SDCAs (see Table 7.7). Table 7.8 shows the percentages of net cost positive SDCAs in different circles. This table shows a surprising result, namely, that circles which otherwise appear to be relatively profitable have a substantial portion which gives low revenues. Also, several circles with a large proportion of SDCAs which are net cost positive are also among those which have more than 90 percent of their BSNL exchanges linked with fiber.

Table 7.7
Net Cost Positive SDCAs in Different Circles and the SDCAs in Areas Served by Various Service Providers in India

Source: Authors.

Table 7.8
Percentages of Net Cost Positive SDCAs in Circles in India

Source: Authors.

Note: Shares of more than 50 percent net cost positive SDCAs and shares of more than 90 percent exchanges linked with fiber are highlighted.

Another noteworthy feature is that the main private operators are planning to extend their network across the country even without taking the USO assistance into account. These operators' plans are, by definition, indications of commercial viability. This suggests that the direct-revenue method may be too conservative.

Nevertheless, analyzing demand in terms of aggregate direct revenue effects gives a good perspective on the minimum revenues required to lay the requisite fiber; it identifies the necessary (but not sufficient) conditions for the backbone to be extended to specific locations. More detailed and location-specific information would be required to assess the sufficient conditions for the provision of backbone. However, with greater competition, which will also include the selling point of comprehensive network coverage, more market revenues coming from broadband, and with progress in technologies which can cover larger areas with lower investments, the results based on the necessary condition will more and more reflect those based on the sufficient condition for the investment in backbone being generated.¹⁴

POLICY AND REGULATORY RESPONSES

Contrary to conventional wisdom regarding reducing wasteful duplication of backbone infrastructure, Indian policy appears to give greater weight to maximizing the freedom of BSNL to do what it pleases with its network. As quoted earlier, the government has accepted the simplistic argument that BSNL should be free to enjoy the benefits of its investment in backbone infrastructure without being compelled to share it with competitors.

This is in line with the Department of Telecommunication's position on the sharing of BSNL's infrastructure by other operators in the context of the subscribers of other mobile operators being allowed to roam on BSNL's network, which has the largest national footprint. BSNL objected to such a ruling on the ground that it laid its network at considerable expense, which provides it with a unique competitive advantage. The Indian policy makers accepted the argument that forcing BSNL to allow other operators' subscribers to roam on its network, where the other operators did not have their own networks, would amount to penalizing BSNL by taking away its market growth strategy and helping the other operators even though they had not invested in the area.

The gist of these policies and announcements is that Indian operators should not only install their own local-access networks, but also build their own backbones to the extent that commercial negotiation with BSNL does not yield satisfactory leasing arrangements.

TRAI recently gave its recommendations to the government on unified licensing,¹⁵ including one to allow a 'niche operator' in each SDCA with less than one telephone per hundred inhabitants. These niche operators would require access to the existing network in order to function; the alternative of expecting them to build their own backbone is utterly unrealistic. It would be worthwhile to consider allowing infrastructure sharing at least in these SDCAs, with appropriate cost-based prices being charged. One complication would be if these SDCAs are also net cost positive SDCAs (which is very likely) and are hence covered by the USO program. It would be necessary to decide how to handle the overlap of USO and potential infrastructure sharing, particularly for broadband purposes. In fact, such a policy could be determined after a year or two for the entire rural area, with the main operators having spread their infrastructure in the meantime.

Other countries less protective of the rights of incumbents over infrastructure, more concerned about avoiding wasteful duplication of infrastructure and more willing and capable of enforcing open-access regulation may wish to take a different course of action. This chapter identifies the various scenarios that are likely to face policy makers and regulators, in terms of supply, demand and threshold demand, and provides the tools to identify the nature of the shortfall in backbone. Such diagnostic tools enable better targeting of policy remedies.

NOTES

¹ North East includes the following circles: Manipur, Mizoram, Arunachal Pradesh, Nagaland.

² Data provided to authors by TRAI.

³ Ultra High Frequency.

⁴ Pulse Code Modulation.

⁵ Regarding the various factors that are considered by investors, Bruce and Macmillan (2002, p. 5), mention the following: (i) Operating statistics and ratios: subscribers (or lines), employees per subscriber (or line), minutes of use per subscriber, churn rate, country penetration; (ii) Financial/Operating ratios: average revenue per user (ARPU), revenue per minute, subscriber acquisition cost, enterprise value per subscriber, capital expenditure per subscriber, capital expenditure per minutes of use; and (iii) Financial Statistics/Ratios: operating revenues, EBITDA, EBITDA margin (EBITDA over revenues), free cash flow, debt/EBITDA (Earning Before Interest, Taxes, Depreciation and Amortization), debt/market capitalization, enterprise value/EBITDA, capital expenditure/revenues, Free Cash Flow (FCF) yield, Price-to-Earnings (P/E) ratio, earnings per share, and return on equity.

⁶ A number of countries have recognized the importance of such specialized service, especially by other utilities, of providing only infrastructure. They have thus created a special category of license for allowing exclusively the service of infrastructure provision. Likewise, the licensing regimes in a number of countries have evolved to distinguish between those who have infrastructure (which they may or may not use to provide telecom services also), and others who do not have their own infrastructure but themselves provide telecom services using the infrastructure resources taken from others.

⁷ Although, the cost of bad debts, collection costs, billing problems, etc., can increase the cost of provision of services.

⁸ While this is likely to be true in general, the easiest way of conceptualizing this is to consider the same level of capacity to be used for two alternative sources of revenues, that is, one, leasing the capacity to others, and the other being the use of the capacity to sell telecoms services. A number of simplifying assumptions underlie this comparison, such as the extent of traffic being the same as that reflected in the implicit capacity utilization considered for determining the access charge for leasing the backbone. Thus, the statements based on this analysis should be seen more as indication of the broad likely features rather than being valid under all possible circumstances. These broad features enable us to get a general perspective on the factors that will affect the establishment of and access to the backbone. More detail in terms of the level of capacity utilization is considered in the later sections.

⁹ However, there is a possibility that the provider may adopt a pricing model that discourages high volumes—the usual monopoly pricing problem.

¹⁰ For more detail, see www.btplc.com

¹¹ In this regard, BSNL does not face the same type of situation as private operators because under the Indian Telegraph Act, the erstwhile Department of Telecom (DoT) and now BSNL have greater powers and flexibility for laying their backbone.

¹² At present, such a perception is a strong selling point for the mobile service of BSNL.

¹³ This is in effect a higher return than is normally given in cost based tariffs. This is especially because the depreciation for the most costly items is very low, that is, the lifetime for those items is relatively long.

¹⁴ This is also indicated by the result in different tables which show that a number of circles which are considered to be relatively high potential revenue earners are also those which have relatively larger number of SDCAs which are net cost positive.

¹⁵ http://www.ictregulationtoolkit.org/files/657_file_3663177.pdf

REFERENCES

Bruce, R. and Macmillan, R. (2002). Feedback to regulators from investors—Telecommunications in crisis: Perspectives of the Financial sector on regulatory Impediments to Sustainable Investment. Report for Global Symposium of Regulators. Geneva: ITU Bureau for Telecom Development.

infoDev (2005). Open access models: Options for improving backbone access in developing countries (with a focus on Sub-Saharan Africa). Retrieved October 14, 2007, from http://www.infodev.org/en/Document.10.aspx

Remove Connectivity Hurdles (2005). The Hindu, April 27.

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