Review of the Price Cap Mechanism

• Jurisdiction: Barbados
• Court: Fair Trading Commission (Barbados)
• Judgment Date: 01 February 2008
• Docket Number: No. FTC/UR/2008-1

Review of the Price Cap Mechanism

No. FTC/UR/2008-1

Fair Trading Commission

First Decision

TABLE OF CONTENTS

1. SECTION 1 Introduction	3
Background	3
Requirements under Compliance Rules	4
Review Process	5
2. SECTION 2 First Decision	7
Decision	7
Reasons for Decision	7
3. SECTION 3 Development of the Second Price Cap Plan	13
Possible Revisions to Price Cap Structure	18
APPENDICES
APPENDIX 1 Legislative Framework	19
APPENDIX 2 Additional Information on New Telecommunication Policies	23
APPENDIX 3 Examples of Price Changes	24

SECTION 1 INTRODUCTION

1. Background

1 Price cap regulation of telecommunications services came into force as a result of the Fair Trading Commission's “the Commission” Decision FTC/UR/2005/01. In this Decision, the Commission outlined the reasons for the move from the Rate of Return form of economic regulation to the Price Cap methodology to regulate the telecommunications services provided by Cable & Wireless (Barbados) Limited “Cable & Wireless”. In accordance with its Decision 1 the Fair Trading Commission is mandated to review the Price Cap Mechanism no later than nine months before the expiry of the current Price Cap Plan.

2 In order to assess the Company's performance under the Price Cap Plan the Commission, in the Price Cap Mechanism Decision and the complementary Price Cap Compliance Rules and Procedures established a process to fully review the initial experience of price cap regulation.

3 The review includes:

• a) an assessment of the Company's regulatory and financial performance, its productivity achievements, and the overall market developments that have impacted and would continue to impact its performance;

• b) public consultation inviting interested parties to comment on the Price Cap Plan; and

• c) Consultation with the Company.

4 The Commission also takes into consideration the perceived level of competition and the liberalisation of the telecommunications sector.

5 The Commission is guided by policy decisions issued by the Minister responsible for Telecommunications, with respect to the services to be regulated.

2. Requirements under Compliance Rules

6 The review of the Price Cap mechanism requires that the Commission issues two decisions.

7 In the first instance the Commission is required to make a decision as to whether it will continue with price cap regulation or adopt another method of incentive regulation for regulating Cable & Wireless. This is in accordance with the Price Cap Compliance Rules Section 13.7 which states:

“The Commission shall publish its determination at least 6 months before the end of the initial Price Cap Plan.”

8 This first Decision will also identify elements of the current mechanism that will be revised.

9 The Compliance Rules also state that in the event the Commission concludes that the Price Cap Mechanism is not the appropriate form of regulation, the Commission shall announce that the initial Price Cap Plan shall end on 31 July 2008 and give notice of the form of incentive regulation that should be applied. The Commission will then consult with the Service Provider and interested parties regarding the appropriate form of regulation to be used thereafter.

10 The second Decision will be delivered after the Commission has held further discussions with the service provider and any interested parties, who so request, on revision to the structure of the Price Cap plan or any other incentive regulation. This second decision will provide detailed information on the mechanism to be used to regulate the prices of the regulated services of Cable & Wireless and the associated rules and procedures.

3. Review Process

11 The review included engagement of consultancy services to assist the Commission in analysing the financial and regulatory information provided by Cable & Wireless. The assessment of the current price cap regime will inform recommendations for the regulation of Cable & Wireless's telecommunications services.

12 The Commission also issued its consultation paper on the price cap regime (FTC/CON2007/01) on September 19, 2007. Interested parties were invited to respond by October 26, 2007. The Commission received a total of eight (8) responses from:

• a) Barbados Association of Non-Governmental Organisations (BANGO).

• b) Barbados Consumers Research Organisation (BARCRO).

• c) Caritel.

• d) Cable & Wireless (B'dos) Ltd.

• e) Digicel.

• f) Blue Communications Ltd.

• g) Ideas 4 Lease (BARBADOS) Ltd.

• h) The Office of Pubic Counsel.

13 Meetings were also held with parties who responded to the consultation paper. They also met with the Commission and its consultants to discuss their concerns.

14 An Information Paper was subsequently issued on January 4, 2008 and two (2) responses were received, one from Caritel and the other from the Office of Public Counsel.

15 Several consultation meetings have been held with Cable & Wireless in order for them to respond to queries and concerns raised during this process.

16 The Commission thanks all those persons and organisations who responded to the Consultation and Information papers.

17 The review process is on going.

SECTION 2 FIRST DECISION

4. Decision

18 The Fair Trading Commission has decided that it will continue to regulate Cable & Wireless using Price Cap Regulation.

19 The Commission believes that a price cap mechanism still remains the best regulatory approach to satisfy the regulatory objectives and principles which were set out in the 2005 Price Cap Decision and which are still valid today. The Commission has also determined that the current structure of the price cap mechanism will be modified.

5. Reasons for Decision

20 During this review the Fair Trading Commission has received responses from interested parties and extensive financial and regulatory information from Cable & Wireless (Barbados) Ltd. In assessing the information the primary question that the Commission addressed in this first Decision was,

Should Price Cap Regulation continue to be used for the regulation of Cable & Wireless (Barbados) Ltd.?

21 The Commission in answering this question sought to examine whether its objectives for adopting price cap regulation as set out in its 2005 Decision were met. The Commission's assessment of each of the objectives is as follows:

Objective a) Provide the company with the economic incentive to reduce operating costs;

22 The Commission is of the opinion that price cap regulation provides a regulated Company with an economic incentive to reduce costs and improve efficiency since, by doing so, it can retain any increased earnings generated by exceeding the target productivity (X) factor included in the price cap formula.

23 The financial and productivity information provided by Cable & Wireless, indicates that Cable & Wireless has, in fact, reduced its operating costs under the current price cap regime.

Objective b) Provide the company with an incentive to be innovative and replace plant in an efficient and prudent manner;

24 The Commission is also of the view that price cap regulation provides the regulated Company with an economic incentive to be innovative and replace plant in an efficient and prudent manner. The Commission has also noted that the drive to replace plant may have been influenced by technological changes. With respect to respondents' concerns pertaining to potential decrease in quality of service provided by Cable & Wireless, the Commission's Standard of Service scheme instituted in June 2006 was implemented to mitigate such concerns. However the Commission recognises that there are still some unresolved quality of service issues and these will be addressed in the review of the Standards of Service which is due later this year.

Objective c) Provide the company with a reasonable opportunity to earn a fair return;

25 The Commission established the first price cap mechanism using a forward-looking zero profit price cap model (PCM) that relied on, inter alia, forecasts of market developments over the course of the price cap period. It was explicitly designed to provide Cable & Wireless with a reasonable opportunity to earn a fair rate of return on its regulated services (which, at the time, was determined to be 17% before taxes). Based on available historical financial information for Cable & Wireless, it appears that Cable & Wireless was able to exceed the targeted rate of return. This may be attributed to the fact that the Company increased its prices to the ceiling in the case of domestic access rental in Basket 1, as well it may have achieved greater efficiency and incurred lower input costs.

Objective d) Allow efficiency gains to be passed onto consumers through reduced prices of telecommunications services;

26 The current price cap regime was designed to allow the benefits of expected efficiency gains to be passed onto the consumer through reduced rates of services assigned to Baskets 2 and 3 (e.g., business, VAS 2 and outgoing IDD 3, etc.), while prices for residential access services were allowed to rise within a set limit. To date, the rates for services in Baskets 2 and 3 are priced, on average, below their respective allowed price caps.

Objective e) Foster competition within the telecommunications market;

27 Although the price cap regulation has not been in existence long enough to assess whether it contributed significantly to competition in Barbados, nevertheless the Commission believes that the regime has not hampered competition. The fact that the prices for Baskets 2 and 3 are below their respective allowed price caps reflects that Cable & Wireless was subject to some competitive constraints for these services. While competition for international services can be expected to develop relatively quickly in the future...