Ok kids. Gather around. Today’s lesson is engineering economics. How do you put together a business case for expanding broadband into a previously unserved area?

Putting together a business case is an important life skill. You can apply these kinds of studies to personal purchase decisions, or putting together a business case to launch a new service or discontinue an old one. And most importantly, it will help you understand better how to analyse discussions about rural broadband.

Let’s look at a business plan to expand broadband service into a certain area. For the sake of simplicity, we’ll start with an assumption that there are sufficient investment funds available to fund all the construction into unserved areas, subject to a condition that the investor is able to get a certain return on their investment.

Based on that constraint – a positive return on investment, the engineering department should be able to define an area that qualifies for construction. Their calculations would be based on a variety of assumptions: Capital cost of equipment and construction; annual operating expenses including maintenance; retail market share (and thereby retail revenue); wholesale market share (and wholesale revenue); taxes, etc.

All these numbers go into a spreadsheet and the engineer can keep adding more homes to the construction plan as long as the business case continues to be positive.

At some point in the exercise, the next incremental home has a negative impact on the business plan. The engineer can then draw a line on a map delineating a boundary.

That boundary effectively defines the digital divide: where the economics are unable to support traditional investment in infrastructure. On one side of the boundary, the more urban side, the private sector can line up investors willing to support broadband expansion.

On the other side of the boundary, the more rural side, a different approach is required. These households are candidates for government rural subsidy programs.

But let’s go back and look at the ‘urban’ side of the boundary line. That boundary is defined as precisely where the business case goes from positive to negative. Homes on the boundary effectively have a net present value (NPV) of revenues less costs of zero.

What happens if the revenue assumption changes? If revenues somehow increase, the boundary gets pushed outward. More homes (on the ‘rural’ side of the boundary) would potentially now have a positive business case. On the other hand, if revenues somehow decreased, the boundary gets pushed in the other direction and the business case is no longer positive for as many homes.

When the CRTC sets wholesale rates, it is implicitly setting the wholesale revenues for our mythical engineer’s business case calculations. The CRTC doesn’t impact the capital costs, they don’t change the retail rates, or even the market share assumptions. But, the regulated wholesale rates are what drives the wholesale revenue line in the business case. Drop the rates, wholesale revenues go down and total revenues for that area go down.

When the facilities-based carriers warn that changes to wholesale rates impact the incentives to invest in rural broadband, this is what they are talking about. These aren’t threats; it’s just basic economics.

The Federal Cabinet understood these principles of economic studies.

Now you do, too.

Is costing more of a subjective art, or is it an objective science?

A recent opinion piece by former CRTC vice-chair Peter Menzies in the Financial Post says “It [The CRTC] has a cost accounting process that is supposed to be objective and provide certainty for an industry on which, as COVID-19 has made starkly clear, Canadians and their economy depend.”

If it was only that simple.

Costing is at the centre of the appeals of last August’s Telecom Order CRTC 2019-288, “Final rates for aggregated wholesale high-speed access services”. In response to an appeal, a little over a week ago, the Federal Cabinet declined to act but said it believed the CRTC erred and set rates too low, impacting the incentives to invest.

The Menzies opinion piece says “The CRTC has the power to stand its ground based on the evidence before it. It should do so.” The implication in the OpEd is that costing is an objective mechanical process; just input a bunch of numbers into a template and out should pop the costs and the resultant wholesale rates.

In reality, there are a lot of subjective decisions required in telecom costing exercises.

The CRTC Order was complex, following a lengthy consultation. The Order itself was divided into 4 broad sections, labelled by the CRTC as “Issues”, and each Issue contained numerous individual determinations, each impacting the resultant costs and wholesale rates:

1. Costing issues common to all wholesale HSA service providers
• Annual capital unit cost change assumption
• Bell Canada’s, Bell MTS’s, and RCCI’s unrecovered costs
• Working fill factors
2. Costing issues specific to the cable carriers
• Coaxial facility costs
• Segmentation facilities – segmentation fibre, optical nodes, and CCAPs
• Segmentation fibre facilities: Access versus usage
• Cable carriers’ proposed growth rates for annual peak period upstream traffic
• RCCI’s and Videotron’s transport fibre facility costs
• RCCI’s project development costs
3. Costing issues specific to the ILECs
• Labour costs per DSLAM port
• Bell Canada’s explicit costing approach
• Attribution factors to be applied to DSLAM equipment, umbilical fibre, and Ethernet port costs
• Bell Canada’s productivity enhancements costs
• Umbilical fibre costs: Access versus usage
• Bell Canada’s FTTN bonded access installation rate
• Bell Canada’s project development costs for aggregated FTTN access rates
• TCI’s financial parameters
• SaskTel’s VDSL Access service charge
• SaskTel’s VDSL interface monthly charge
• SaskTel’s other charges
4. Other issues
• Markup
• Effective date of the final aggregated wholesale HSA service rates
• Computation errors
• Subsequent tariff applications

As can be seen, the CRTC Order actually consists of 24 decisions, each one having an impact on the rates charged to ISPs reselling carrier access services, and impacting carrier revenues.

From some of the section headers, it should be obvious that not all of these were purely objective, mechanical determinations. There is analysis required and judgment calls made in each of these sections.

For example, let’s look at some of the discussion in the “Markup” section. The CRTC introduced the section saying “Markups have varied over time depending on a number of factors, including whether the wholesale service is essential and whether there may be additional risk to network investment if the wholesale service is mandated.” The Commission acknowledged the subjectivity of setting the markup rate, saying “in setting rates, it balances the need to ensure that network providers are reasonably compensated for their costs with the need to ensure that markups are not so high as to significantly impede competitors from providing competitive alternatives in the marketplace.”

Reading such discussions in the CRTC Order helps challenge the assertion that the CRTC “has a cost accounting process that is supposed to be objective”.

In fact, there is a lot of subjectivity applied, resulting in the potential for a wide margin of error. That potential for error in any regulatory process is one of the reasons that our system includes three avenues to appeal a determination to another authority: to the regulator; to the Courts; and, to Cabinet.

As we heard from one of those avenues a little over a week ago, “the Governor in Council considers that the rates do not, in all instances, appropriately balance the policy objectives of the wholesale services framework and is concerned that these rates may undermine investment in high-quality networks, particularly in rural and remote areas.”

These are reasonable concerns for Canada’s Cabinet to have expressed. The need to focus on “investment in high-quality networks, particularly in rural and remote areas” has become more acute over the past 6 months.

In considering its own review of the August 2019 Order, the CRTC can certainly “stand its ground based on the evidence before it”. However, the Commission first needs to reassure itself that it balanced the competing Policy priorities when it made subjective determinations.

The CRTC just may find that a fresh look shines a light on a margin of error in some of those judgment calls.

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This article appears on National Newswatch.

An article in The Hill caught my eye this past weekend. In “No more gut-based strategies: Using evidence to solve the digital divide”, Gregory Rosston and Scott Wallsten write:

COVID-19 has, among other things, brought home the costs of the digital divide. Numerous op-eds have offered solutions, including increasing subsidies to schools, providing eligible low-income people with a $50 per month broadband credit, funding more digital literacy classes and putting WiFi on school buses. A House bill would allocate $80 billion to ideas meant to close the digital divide.

The key missing component of nearly every proposal to solve the connectivity problem is evidence — evidence suggesting the ideas are likely to work and ways to use evidence in the future to evaluate whether they did work. Otherwise, we are likely throwing money away. Understanding what works and what doesn’t requires data collection and research now and in the future.

Gregory Rosston is Senior Fellow at the Stanford Institute for Economic Policy Research and Director of the Public Policy program at Stanford University. He previously served as Deputy Chief Economist at the Federal Communications Commission. Scott Wallsten is president and senior fellow of the Technology Policy Institute and was the economics director for the FCC’s National Broadband Plan.

Many people mistakenly think the connectivity problem is simple to solve. All we need to do is lower the price and we’ll magically attain universal broadband adoption.

If it was only that easy.

In reality, we have gained some experience, learning from programs like Connecting Families, Internet for Good, and Connected for Success that other factors are in play. South of the border, “Learning from the FCC’s Lifeline Broadband Pilot Projects” [pdf, 1.8MB] looked at the outcomes of 14 experimental wireline and wireless broadband Lifeline projects facilitated by the FCC around the United States.

There were some very important observations made from those US trials.

• The most consistent result was unexpected: an extremely low participation rate. Wireline providers and mobile providers (except those in Puerto Rico) managed to sign up less than 10 percent of the number of participants they had expected despite extensive outreach efforts. Puerto Rico mobile providers met their participation goals probably because of mass-market television advertising. These results demonstrate the difficulty of encouraging low-income people without connections to sign up even with large discounts, suggesting that subsidies are likely to go to people who already subscribe rather than working to close the digital divide.
• The trials also revealed subscribers’ willingness to trade off speed for lower prices, with subscribers regularly choosing plans that offered less than 10 Mbps, which is the FCC’s current required minimum for rural broadband subsidies. Because faster broadband typically costs more, higher minimum speeds are likely to blunt the (already likely low) beneficial effects of subsidies by increasing the price of eligible plans.
• Finally, subscribers generally expressed a preference to avoid digital literacy training classes. In one project, many participants were willing to forego an additional $10 per month savings or a free computer in order to avoid taking those classes.

As Wallsten and Rosston write, “The change in adoption we should expect at different price levels is just one of many questions that need to be answered to effectively address the digital divide.”

As we saw in the Cabinet pronouncement this past weekend, as far as the Canadian government is concerned, Canada’s future depends on connectivity.

The former economists from the FCC advise “The first step toward making real progress is recognizing what we don’t know and doing something to fill that gap in our knowledge.”

Solving the digital divide will need more than just building the infrastructure. Broadband availability is necessary, but insufficient to achieve universal digital adoption.

We need to ensure that we are gathering more evidence, and learning from the data. Using evidence to solve the digital divide,

On Friday, the CRTC issued a Decision finding both Iristel and TELUS guilty of violating the non-discrimination provisions of the Telecom Act (Section 27(2)) and it also issued a companion Notice of Consultation, seeking public comment on whether it should issue fines for the incidents.

Nearly 4 years ago, I wrote about the back story on all of this [see Gaming the system • November 2016].

The allegation at the time was that Iristel was artificially stimulating calls to telephone numbers operated the company in area code 867. Because these numbers were in the far North, the terminating carrier received an exceptionally high rate to route long distance/ calls to the final destination. There was a financial incentive to create an artificial imbalance of calls and in December 2017, the CRTC found that Iristel was guilty of “engaging in regulatory arbitrage activities”. No penalties were issued at that time.

At stake was the financial viability for Canadian telecom service providers to continue to offer nationwide calling that included calls to the north. Even though the cost of routing calls to the North was so substantially higher than calls to the rest of Canada, service providers considered the extremely low percentage of the population living there are were willing to take the financial risk.

Skip ahead. Just 7 months later, TELUS filed an application with the CRTC saying Iristel “stopped only briefly after the issuance of that decision” and was back in the traffic stimulation business again.

As one of the major wholesale long distance providers, TELUS started limiting the size of its trunk groups to Iristel in a move to mitigate its financial exposure.

TELUS and Rogers submitted data to the CRTC that showed the volume of calling to Iristel’s telephone numbers in the 867 area code dropped in after the CRTC’s 2017 Decision, but then traffic volumes started to increase. “By May 2018, the volume of traffic had increased to levels similar to the volume of traffic levels that existed prior to the effective date of Telecom Decision 2017-456.”

So, on Friday, the CRTC decided to retroactively (and significantly) change the rate that Iristel charges for calls to its customers. The rate drops about 75% retroactive to November 2018.

The Commission found that Iristel was conferring upon itself an undue preference, and that TELUS unjustly discriminated against Iristel, both in contravention of Section 27(2) of the Telecom Act.

The regulatory process is not speedy. It took more than 2 years for the CRTC to respond to the TELUS complaint. The CRTC took 3 and a half months to respond to applications for interim relief. Tens of millions of dollars were at stake representing hundreds of millions of minutes.

As the CRTC wrote “[TELUS] submitted that its control of traffic was justified, given the renewal of traffic stimulation activities and the associated costs that it would incur if it ceased that control.”

On the other hand, the CRTC says “there are avenues available for Commission direction to stop the offending activity. It is not open to [TELUS] to take matters into its own hands.”

As the Commission moves into the penalty phase of this proceeding, it will be interesting one to follow. Will the CRTC take into account the mitigating circumstances for TELUS’ traffic management, and the audaciously “narrow interpretation” of the Commission’s 2017 Decision that led to the continued traffic pumping? Will the retroactive rate setting be able to be implemented meaningfully?

Is self defense justified in telecom traffic management?

“Canada’s future depends on connectivity.” Those were the opening words in the statement issued by Innovation, Science and Industry Minister Navdeep Bains in discussing Cabinet’s decision not to formally intervene in last summer’s wholesale internet Order by the CRTC. While declining to take action, Cabinet sent a clear message that it expects significant changes to those rates in the pending outcome of the Commission’s own review of the Order.

The CRTC’s Order was issued August 15, 2019. Under Section 12(1) the Telecom Act, subsequent to a ‘petition’, “within one year after a decision by the Commission”, Cabinet (the Governor in Council) could “vary or rescind the decision or refer it back to the Commission”.

Exactly one year later, Cabinet decided not to take any of those actions, at this time.

The statement from Minister Bains explicitly acknowledges that the original CRTC Order got the rates wrong and says that the Commission did not strike the appropriate balance between the competing objectives of the Telecom Act, failing to apply sufficient weight to Section 7(b): “to render reliable and affordable telecommunications services of high quality accessible to Canadians in both urban and rural areas in all regions of Canada”. Cabinet recognized that wholesale rates got set so low that carriers were unable to continue expanding their networks into unserved and under-served regions.

On the basis of its review, the Governor in Council considers that the rates do not, in all instances, appropriately balance the policy objectives of the wholesale services framework and is concerned that these rates may undermine investment in high-quality networks, particularly in rural and remote areas. Retroactive payments to affected wholesale clients are appropriate in principle and can foster cooperation in regulatory proceedings. However, these payments, which reflect the rates, must be balanced so as not to stifle network investments. Incentives for ongoing investment, particularly to foster enhanced connectivity for those who are unserved or underserved, are a critical objective of the overall policies governing telecommunications, including these wholesale rates. Given that the CRTC is already reviewing its decision, it is unnecessary to refer the decision back to the CRTC for reconsideration at this time.

With such strong views about the CRTC’s Order, some may ask why Cabinet didn’t exercise its power to formally “refer it back to the Commission.”

The better question is “Why would it bother referring it back to the CRTC?” All that would do is cause a delay.

The CRTC already has its own review of the Decision underway. That process began last November and submissions have already been received. Had Cabinet chosen to exercise its option to “refer it back to the Commission”, the resultant process might have to start over.

By setting forth a statement outlining its expectations for the Commission’s own review process, Cabinet is expediting the process that will ultimately release wholesale rates that balance the competing objectives. Although it declined to act, Cabinet is sending a signal to the Commission for what could trigger a subsequent review of the CRTC’s reconsideration proceeding.

[The CRTC’s Order was also the subject of a judicial process that was heard by the Federal Court of Appeal this past June. The Court imposed a stay of the Order, saying “the implementation of the CRTC Order that could result in a permanent market distortion which would be difficult to remedy posteriori.”]

A little over a week ago, I wrote that there are “other regulatory or policy levers that don’t require direct subsidies to improve the business cases for rural expansion”. In today’s release, we see Cabinet pulling a powerful policy lever that will significantly improve the business case for network investment including rural expansion.

Sometimes, the best decision is choosing not to make a decision at all.

A few months ago, in “A key to recovery? Communications leadership”, I wrote “Set clear objectives; Align activities with the achievement of those objectives; Stop doing things that are contrary to the objectives.”

Canada’s future depends on connectivity.

That is a strong statement, around which we can build objectives.

Last month, in “The COVID wild card”, I wrote about the supplementary comments filed in the CRTC’s mobile services review. “The importance of maintaining incentives for investment figures prominently in the final comments submitted last week.” On the subject of mandated resale of mobile services, I noted that Bell wrote “It would be particularly destructive now, during a period of unprecedented economic turmoil brought on by the COVID-19 pandemic and at a time when large investments of private capital are required to support rapidly expanding usage, the roll-out of 5G, and the continued extension of access to underserved rural and remote communities.”

With the ability to declare victory on falling prices for mobile services, the government is rightly turning its focus on maintaining incentives for investment in advanced facilities and expansion in unserved and under-served markets. What implications can we extract from today’s Cabinet release that may guide the outcome of the CRTC’s review of mobile services?

After all, Canada’s future depends on connectivity.