Enhanced tariff proposals designed to meet large customers’ needs
By Victor Glass
Like normal vision, common sense is not as common as you might think. I won’t dwell on eye sight or correcting it. Instead, I want to talk about seeing the world of access pricing through a new set of lenses that have brought reality into sharp focus for NECA.
Gone are the days when a large access customer had no alternative than to buy services defined and priced by incumbent local exchange carriers. Now, a large access customer issues a request for proposal to many potential network providers. The RFP specifies in great detail the terms and conditions for services demanded and the geographic area covered, which is typically much larger than a study area. After issuing an RFP, a large access customer will either invite bids or specify acceptable rates for the services it wants, or both.
Innovative solution accommodates specific needs
This increasing trend of large customers issuing RFPs covering multiple member study areas and dictating the terms for purchasing access services led us to develop additional targeted term and volume discount tariff proposals to accommodate the specific needs of these customers. Subject to FCC approval to implement these new tariff plans, the new proposed tariff enhancements would allow pool members, either individually or as a group within a state, to:
- offer additional term and volume discounts that would be available to the requesting large customer and any other similarly situated customer;
- offer a group uniform rate or individual company rate, with prices fixed for the term of the agreement; and
- not have to buy down rates if overall pool rates increase, as long as costs associated with the tariff service remain in line with forecasts used to develop the tariff rates.
In effect, the new tariff terms and conditions mimic arrangements and pricing strategies one would find in an open, competitive market while still maintaining the risk sharing and administrative benefits of pooling.
New pricing strategy
NECA’s proposed tariff enhancements include quite a few innovations in price setting and tariffing services. Let’s start by examining the new pricing strategy. It is based on the common sense concept that prices have to cover costs; otherwise you are out of business. In practice, this pricing strategy rules out pricing based on saying, “it costs me almost nothing to provide service because I have network out there already.” This isn’t a sustainable strategy in the long term because eventually you have to generate enough cash flow to replace the old network.
The long term view of pricing also rules out setting prices based on historical costs – sunk costs – that are no longer relevant for estimating the true economic cost of providing new service. The sustainable price is based on the actual investment outlays and related expenses for particular projects. If priced correctly, future revenues will exceed current and future outlays, which benefits all pool members.
In line with the long term pricing strategy, large customers will be eligible for volume and term price discounts not available to smaller customers. These discounts will reflect real cost savings associated with take rate differences, no churn, and big pipes to concentrated locations.
Discounts based on cost study and pool settlements data
Naturally, the actual price discounts will have to be grounded in solid cost savings. We have developed a spreadsheet that uses cost study and pool settlements data to estimate study area loop cost, circuit equipment cost, and direct and overhead costs. Even more precise project-specific estimates will be needed and we have prepared a spreadsheet that gathers this type of data. The spreadsheet itself is very streamlined. It focuses on outlays that a company would need to estimate to bid on a contract. Once we receive the data, we can quickly calculate a price range that will at least cover revenue requirement.
Besides quoting competitive prices, a key pricing requirement for winning an RFP is price stability over the term of the agreement. Towards that end, the new tariff options will allow rates to remain in effect for the term of the agreement, and participating companies in a tariff option will not be penalized, even if NECA rates rise, as long as reported project-specific costs remain within a reasonable range of projected costs. To protect the pool, however, a company that under-forecasts its costs by a wide margin will have to compensate the pool for the overage.
New tariff options
We are exploring two new tariff options that would offer additional term and volume discounts: an individual company tariff option and a group tariff option. The individual company tariff option would be tailored to a big customer’s requirements within a particular study area. Rates, terms and conditions would be posted by study area in NECA’s tariff. Any other similarly situated customer could purchase the same type of connections to the same locations at the same rates. For example, in a wireless scenario, it would mean that any other wireless carrier that wanted connections to the same towers at the same speeds in the same study area would get the same price quote as the original customer. Any change in speed or location requirements would trigger a new tariff option.
The proposed tariff options have the advantage of simplicity. They are essentially targeted term and volume discounts to large similarly situated customers based on the lower costs to serve them. They do have drawbacks, however. For example, they won’t recognize that a wireless carrier wants to connect to fifty towers in a state. As a result, an individual tariff option misses the administrative economies of setting one rate across multiple study areas resulting in savings that could be passed on to the customer.
Group tariff option
A group tariff option would recognize geographic scale economies. It would allow us to set:
- one rate for all members of the group covering a wide geographic area such as a state instead of a study area; and
- size thresholds for tariff option eligibility that clearly differentiate between big and small customers.
With a group tariff option, the customer buys from all the pool members in a consortium. This will limit cherry-picking by access customers where they buy from low-cost companies and bypass high-cost companies. The risk of a cost forecast miss penalty would also be reduced. For example, a group may meet its target forecast, even though each company in the group had large forecast misses. No penalty would be necessary to compensate the pool for missed forecasts because of the benefits of forecast averaging. With a group tariff option, any similarly situated customers who want the same service package would pay the same rate.
A group tariff option does present some challenges, however. For example, the FCC will have to agree that setting one group rate across multiple study areas for the service provided furthers their broadband deployment goals. A group tariff option would also alter existing pooling arrangements. A low-cost member of the consortium that decided to exit the pool would produce a revenue shortfall. We would require the exiting company to compensate the consortium for the contribution loss. This would not be a hardship for the exiting company because it would still be billing the uniform rate outside the pool. This rate would be above its own unit costs.
Average schedule settlements would not be affected by either the individual or group tariff options. The discounted prices envisioned for the new tariff options would be incorporated into the average schedule tariff rate index as a means for adjusting revenue to approximate the real value of services being sold, which, in turn, are used to estimate the costs of providing service.
As you can tell, our tariff option proposals are well beyond the concept stage. We believe we are ready to present the new tariff options to the FCC as soon as our members provide us the information needed to move forward. Hopefully, the FCC will recognize that enhanced term and volume tariff options will help promote broadband deployment in rural areas. They will allow big access customers, including schools and libraries, to buy the types of services they need at a reasonable cost. They will give our pool members the ability to bid for business at prices based on true economic costs. They will allow pool members to pass on to customers administrative and insurance cost savings that pooling offers. This should be a win for all concerned.
Victor Glass, Ph.D., is director of Demand Forecasting and Rate Development. He can be reached at email@example.com.