More on USF Programmes with Tariff Discounts

In continuation of my earlier posts on the issue of USF schemes/projects having a tariff discount component, I would like to add some further thoughts. A view has been expressed by a  very experienced USF expert that tariffs discounts in case of voice services, can create artificial differences with non USF areas and discourage operators who must have a business case to invest. I would say that these arguments have merit. In addition to my comments cautioning against being too optimistic about tariff discounts at the bottom of  the post at http://ictsforall.blogspot.in/2013/07/a-discussion-on-tariff-discounts-for.html, I  would like to clarify as follows.

In my previous posts I had alluded to a rural tariff ceiling. This was  set by the telecoms regulator and is pan India. Thus, it covers all rural fixed line subscribers uniformly. However, the regulatory requirement at present is that this tariff plan must be made available. It need not be the only plan. Operators are free to offer other tariff plans. The idea is to ensure that the poor have at least some basic plan for affordable service. Both operators and subscribers have a wide choice in this case.

In India, rural subscribers mostly opt for prepaid plans which ensures that they do not pay more than their budgeted amount. This is true for both  voice (which is almost entirely wireless) and data.  

By discounts in case of USF schemes I mean making available at least some cheaper plans so that the poor can avail of some service. As mentioned above, in the case of voice (fixed) this was mandated by the regulator not by USOF.

In fact when USOF scheme for rural household fixed lines brought in competition from CDMA phones, the Universal Service Providers (USPs) offered extremely attractive prepaid tariff plans with generous free incoming components to attract customers, and with great success in terms of increasing subscription (but not revenue. (Please see http://ictsforall.blogspot.in/2013/06/ensuring-affordability-of-usf-supported.html ).

These plans were far cheaper than the regulator's tariff ceiling plan. Thus, in the case of voice, USOF India did not specify tariff discounts.The USPs responded voluntarily with tariff plans in response to market conditions.

As already explained in my previous post post  http://ictsforall.blogspot.in/2013/06/ensuring-affordability-of-usf-supported.html, for data services (Wire line Broadband Scheme), USOF required entry level plans to be made available during the OBA contract period but the USP could also offer any number of other plans. This has worked well as a means to attract new users who have subsequently upgraded to costlier packages with higher download limits. As far as the operators business case is concerned, USOF calculated subsidy benchmarks assuming that the bulk of rural subscribers would at least initially prefer the cheapest plan. Thus, USPs stood fully compensated for the discounted tariff plan.

Incumbents and National Broadband Networks-Broadband Delivery U.K Project

As I have written earlier, despite our enthusiasm to roll out high speed, fibre based broadband networks, care must be taken not to re-create monopolies. While it may be easier, faster or even cheaper in the short run to rely on the incumbent for such roll outs, in the long run this may prove counterproductive.  The price that we may have to pay for lack of competition and the regulatory burden of ensuring genuine non-discriminatory, open access may literally take us back to the days of fixed line monopolies. There is also a good chance that the none of the  reasons for relying on the incumbent are ultimately validated by the actual roll out experience, in the sense of time and cost savings.

Even when bidding is resorted to, the project and bid design must ensure a level playing field between incumbents and other players. 

A recent news item about the Broadband Delivery U.K Project (BDUK) at  http://www.v3.co.uk/v3-uk/news/2279518/government-rural-broadband-plans-savaged-by-nao-report indicates that  doubts have been raised on this count and  the project has been criticised by the National Audit Office for  favouring British Telecom at the cost of competition and perhaps economy.

The chair of the Public Accounts Committee (PAC) is stated to have said that, 

“The DCMS has not had a good enough grip on its rural broadband programme. In an attempt to reduce public costs and risk, the department has ended up stifling competition,” ….......

"BT has won all 26 contracts so far. It is not much of a competition when you end up with only one supplier actively bidding in a framework, despite nine organisations being interested at the start.” 

A Discussion on Tariff Discounts for USF Supported Services

My esteemed colleague David Rogerson whose query had inspired my previous post on this subject titled "Ensuring Affordability of USF supported Services" has kindly shared his thoughts on the subject. My comments are a placed below his post.

Discount policy for Universal Access & Service Funds (UASF)

By David Rogerson

The objective of the UASF is to promote universal access and service (UAS).  It does this by subsidising network roll-out and customer access in situations where this cannot be achieved commercially.  The subsidy helps to extend the coverage of telecoms services and to make service affordable in these areas.  Such a policy not only benefits areas and customers that are newly connected to the network; it also benefits existing subscribers as they have increased opportunities to communicate with other network subscribers.  This is called a network externality effect. 

In some areas the benefits of USF subsidy, including both the direct benefits to the customers in the newly-connected area and the indirect network externality benefits experienced by all existing subscribers, will be maximised if a tariff discount is offered in the UAS area.  The reason is illustrated in Exhibit 1

Exhibit 1: Justification for tariff discount in UAS areas

The logic of Exhibit 1 may be described as follows:

• The tariff discount will increase demand in the UAS area, as lower prices are more affordable
• The increase in demand will (at least up to a certain point) increase profitability within the UAS area, since the costs of providing service are largely fixed whereas revenues are primarily a function of demand.  
• By setting the discount at the right level the amount of the subsidy required for the area may be minimised.  The level of the discount should theoretically be set at the level that maximises profits: beyond a certain point the loss of revenue from all subscribers in the UAS area paying the lower tariff will outweigh the increase in revenue from the additional subscribers who only come onto the network because of the discount.
• The increase in demand that results from the discount will have two other effects:
• It will increase the network externality benefits
• It will result in economic development within the UAS area . (Academic studies, including those of the World Bank, have shown a close correlation between GDP per head of population and telecom network penetration (i.e. subscribers per head of population).   
• Both of these additional effects are relevant in the construction of a discount policy:
• The increase in network externality benefits may be used to justify the discount policy in the first place
• The increase in economic development may be used to justify the reduction of the required discount level over time.  

A lot more work would be required in order to provide a detailed justification of the actual level of discount that should be provided.  Such work is beyond the scope of the present exercise.  However, based on the existing practice we may propose the taxonomy shown in Exhibit 2.  This suggests that the initial level of discount is established with reference to the ratio between average income levels in the UAS area compared with the nation as a whole; and the evolution of the discount level over time depends on the ratio between network penetration levels in the UAS areas compared with the nation as a whole.  Given that there is likely to be a time-lag between penetration increases and economic development, we further suggest that the discount level for each area is established for a period of 3-5 years at a time.

Exhibit 2: Evolution of UAS tariff discounts over time

My Comments:

David has presented  an interesting  and though-provoking analysis. Some additional considerations may be  as follows:

1. The assumption of incremental or marginal cost per additional subscriber being nominal (per se or compared to the loss of revenue on account of discounts) may not be applicable to all telecommunications services-take for example the case where the last mile involves copper line or OFC connectivity. 

2. Additional customers need not always translate into higher revenues as for example when customers in poor rural areas use the phone mainly to receive rather than make calls. A real example of this was seen in India where CDMA telephones were offered  by USPs with 3 year incoming free prepaid tariff plans (on voluntary basis) to lure more customers.(Additional upfront subsidy was paid for each additional customer added and  maintenance subsidy for customer  retention.) However, the USPs ended up having to pay for minimal recharges to avoid disconnection of these phones, which would have impacted the their subsidy disbursements under the USOF contract. The poor in rural areas would simply not make outgoing calls. They were happy to receive calls as for example from earning family members in urban areas.

3. However, there is no denying the network effect and positive externalities of  having hitherto unconnected citizens join the network. Hence, USF schemes must at times go beyond purely economic cost-benefit analysis at least in the short run and justification for the roll out or discounted tariff may have to encompass a wider socio-economic cost-benefit analysis. In any case, telecommunications services are proven to increase a nation’s competitiveness in the long run making a strong economic case for USF interventions.

4. In some cases as in the case of USOF’s Wire line Broadband scheme (discussed at  http://ictsforall.blogspot.in/search/label/Tariff   the discount strategy pays off in terms of giving customers a taste of a new service. While some subscribers may continue with an entry level plan, others do migrate to the available higher download (more costly) plans, giving the USPs revenues a boost and compensating for the discount and then eventual  withdrawal of subsidy.

5. The smart subsidy concept referred to in my earlier post at  http://ictsforall.blogspot.in/search/label/Tariff,   would thus take into account subsidy needed to fill the revenue gap, including that caused by discounted tariff.

6. If demand projections can be made with some degree of accuracy for the target area/population, an assumption about percentage of disposal income that would be spent on telecommunications (say 2.5-3%) could help us calculate the required discounted tariff to encourage subscription. As a USF Administrator, I would  be more concerned about using the modeled demand projections to calculate a tapering subsidy requirement keeping discounts fixed during the OBA contract period and leaving it to the USP to retain or dismantle discounts thereafter as per its business case. There could be customers who would not be able to afford the non-discounted tariff at least in the short/medium run. Thus, I may have to mandate that some discounted tariff plans continue beyond the contract period or I may have to subsidise these customers on an on-going basis even after the Output Based Aid contract comes to an end.

Ensuring Affordability of USF Supported Services

A query from an esteemed telecom expert and colleague made me feel that this may be a good topic to cover today.

Part of the reason for the Actual Access Gap referred in my previous post is the non-affordability of services for certain segments of the population. This could be because they have lower than average paying capacity in absolute terms (say the urban poor) and/or relative to cost of provision of the services (on account of geography/ own disability etc.). In developing countries, the bulk of the population in rural areas could easily fulfil both the absolute and relative criteria making it essential to provide services not only at par with urban tariff rates but at times below urban rates in spite of higher costs of provision.

The underlying rationale of many an output based aid (OBA) USF project is that if  subsidy can be provided to help the USP break even and cover CAPEX and OPEX for a finite period, demand will eventually pick up enough to make services profitable (even at a lower tariff rate.) In any case ideally in an OBA based USF project, once the USF contract comes to an end, the USP should be  free to revise traiffs as per market conditions and other (non USF related) regulatory restrictions. In the  interest of  protecting its investment the USP would not like to drive away customers by charging unreasonable tariffs.

In India, the USOF mostly follows the OBA route. USOF projects are bid out. Reverse bids are floated  with a maximum permissible subsidy level based on a detailed benchmarking exercise. Tariffs in India are regulated by the Telecom Regulatory Authority (TRAI) and beyond the jurisdiction of USF. Thus, USF may in its tenders/contracts refer to TRAI regulations on say fixed line tariffs in rural areas and require rental and call charges to be at par or lower than the same. Alternatively, as explained in my previous blog titled "Broadband Networks through the Infrastructure Sharing Route" the USOF tender/contract may require that during the contract period the USP offers subsidized infrastructure/services at a discounted rate with reference to TRAI's ceiling rates. In USOF's mobile infrastructure and services scheme, the static infrastructure was required to be offered rent free by the wining infrastructure provider to the three winning mobile service providers who would share the towers. However, mobile services themselves could be offered at any rate to end users. With their rentals costs being nullified and given the competition between three players it could be assumed that they would vie with each other to provide attractive tariff plans to the served rural population. In fact my own experience with monitoring of this scheme has shown that in this case it was customer services (such as regular supply of recharge vouchers for pre-paid connections and QoS  which distinguished the more successful USPs from the laggards). In USOF's Wire line Broadband Scheme a couple of very affordable entry level broadband tariff plans were arrived in consultation with the USP (selected by nomination in this case on account of incumbent owning 99.9% of rural wire lines). These were required to be offered along with any other tariff plans (as per USPs choice) to rural customers being served through subsidized infrastructure. (Broadband tariff is on forbearance). Significantly, and as predicted when the broadband scheme was first introduced, the entry level tariff plans formed the bulk of the uptake but over time, the higher value tariff plans offered by the USP in parallel gained popularity. As on April 2012, entry level packages constituted 32% of the total broadband subscriptions under the scheme whereas initially their share was up to 90%. Thus, the decision to discount tariffs is always a considered one based on the characteristics of the market and the gap that we need to address.

In each USOF scheme, the benchmark subsidy is modeled on the basis of projections of CAPEX, OPEX, estimated demand and paying capacity of subscribers separately for each bidding unit. This could be a state, selected individual districts, group of districts etc.The tariff assumptions/prescriptions form part of the subsidy model and benchmarking exercise.

ITU's ICTs Regulation Toolkit explains this approach in terms of 'Smart Subsidy':


‘A  smart subsidy is the term used to describe an initial subsidy (usually given on a once-only basis) that is designed to be results-oriented, does not distort the market, and encourages cost minimization and growth of the market. It helps to kick start a project or service, with the ultimate objective of the programme becoming commercially viable, whereas without the subsidy investors might otherwise have been reluctant to invest. Investors’ reluctance could be due to perceived risk or general lack of capital for the kind of service opportunities that are considered by government to be essential for socio-economic development. The important element of the smart subsidy zone is that an initial subsidy to private sector providers will make the project commercially viable on an ongoing basis by filling the financial gap with a one-time subsidy, which increases the operator’s rate of return and reduces his risk. No further subsidies are needed if the service targets are set realistically, with medium term commercial viability in view. Targeted interventions are usually implemented using a Universal Access and Service Fund (UASF).’