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• 7. Eligibility

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151. The cost for TSO local telephone service supplied in commercially non-viable areas is funded through a mix of customer sales revenue and TSO levy. For a particular geographic area, less sales revenue through lower retail service charges means less revenue to offset any losses for commercially non-viable customers, and consequently a higher TSO charge levied on the telecommunications industry.

7.1 Eligibility for Service

152. The Local Service TSO Deed does not explicitly define "Telecom residential customers" who are eligible for the local residential telephone service covered by the Deed's paragraph 7 supply principles. Eligibility for local residential telephone service is in principle open to all people who request supply of the service to a residential or household premise, irrespective of whether the service will also be used for business purposes.

153. The definition of residential connections applied by Telecom⁷ states that:

"…Residential connections are for the social and domestic purposes of the occupier and his or her family and guests, or for a home business but only for the first three connections. A home business is a significant part-time or full-time business (or business activity) which is conducted in or based from a residential household. The account holder must reside full time at the same address as the business and the primary purpose of the dwelling must be residential…"

154. Consequently, Telecom makes standard local residential telephone service⁸ available to residential users who also use the service to support operating and managing a home based business, with the farm businesses most prevalent in this category for rural areas. Where such customers are located in a, so called, commercially non-viable area,⁹ this will typically increase the net cost for supplying service to the area, and thereby the TSO charge levied on retail telephone service providers. The total cost of this subsidy charge for home based businesses located in rural areas is estimated to be up to $10 million per annum (approximately 15% of the TSO charge).

155. Telecom's business telephone service is not covered by the Local Service TSO Deed provisions. The standard price is $58.42 per month (excl GST) and local calls are charged at 4.55 cents/minute peak and 0.99 cents/minute off-peak. Telecom reduces these standard prices in areas where it faces competition.

156. Concerns have been expressed about the level of investment in, and the adequacy of, key fixed network infrastructure in rural areas. It is generally agreed that substantial investment in rural telecommunications infrastructure will be required to deliver broadband capability in line with that available in OECD countries with comparable rural conditions.

157. Rural communities have expressed a need for substantially improved broadband services. Certainly, many rural business operations are likely to be enhanced by the availability of better broadband services.

158. The costs of providing fixed network telephone service in many rural areas are higher than the revenues received from the standard residential telephone service price. This reduces service providers' incentives to invest in network infrastructure upgrades, including for broadband.

159. It is likely that a range of funding options will need to be considered for addressing rural broadband infrastructure requirements. This raises the question of whether there is a case for improving investment incentives by some form of price increase for residential premises based businesses that are currently paying the standard residential telephone service rental. Home business users of residential telephone service can claim a tax rebate on half of the line rental. This situation raises a fairness issue as home based businesses can pay a line rental that is about 15% lower in essence (through the "discounting" of tax deductibility) than the line rental a household pays for the same form of local telephone service.

160. Public comment is sought on the merits of possibly:

• Maintaining the status quo (acknowledging the dampening effect on rural telecommunications investment);
• Realigning "home based business" line rental rates where appropriate (including where business tax deductions are claimed) to those of other business users; or
• Developing a hybrid telephone service that the Local Service TSO provider would supply for home businesses based in residential premises. Such a service arrangement could be defined as follows:
  • the service could comprise the same service features as ordinary residential telephone service priced at the standard business line rental, and be applicable depending on whether telephone service rental is claimed as a business expense for income tax (with a price increase up to the standard business telephone line rental phased in over a three year period); and
  • there could be a requirement that the incremental revenue received by the Local Service TSO provider for the additional line rental charges must be placed in an escrow investment account which the Local Service TSO provider could have access to assist financing capital expenditure for upgrading of rural network infrastructure.

7.2 Price Cap

161. The subscription "line rental" charge to residential customers for ordinary local residential telephone service is controlled through the TSO requirement capping the charge to rise by no more than the rate of the Consumer Price Index (CPI), as the official measure of general price inflation in the economy. The retail price cap for line rentals is uniformly applicable across all areas where TSO local service is available irrespective of whether or not the supply of service in a particular area is commercially viable. The intention of the cap was to enable Telecom to rebalance prices (aligning prices closer to costs) in the face of competition, while protecting residential customers.

162. The TSO price cap for local residential telephone service prevents Telecom from raising the line rental for service above a prescribed standard rate, with that standard rate being adjusted for CPI increases. This restriction applies for TSO local service supplied in any area of New Zealand. The TSO expressly states that the line rental for customers in rural areas cannot be higher than this prescribed standard rate. Telecom is allowed to charge less than the standard rate in any area if it wishes, but it cannot increase the rates in other areas to compensate.

163. Since the Kiwi Share was established in 1990, and subsequent to commencement in 2001 of the Local Service TSO (superseding the Kiwi Share service requirements), Telecom has periodically adjusted the standard line rental up by the full allowable amount consistent with the rate of CPI, except in areas where it has faced direct competition. It is likely that the increase in the standard line rental has been above the rate of actual cost increases for the telecommunications industry as measured by the Communications Producer Price Index (PPI) over the period for which this index is available^.10

164. The graph below (Figure 9.1) shows the divergence between CPI tracking against PPI. The graph suggests that the real price Telecom receives may have increased by about 25% over the period. This raises the question of whether the price applicable in urban areas now more than fully recovers the cost of supplying service, and consequently is there a case for introducing a different price change mechanism, such as CPI-x in urban areas.

Figure 1: Relative change CPI and PPI

→ Full size version of Figure 1 [17 kB GIF]

165. Setting of the price cap for TSO local telephone service should be sensitive to the:

• commercial viability of supplying TSO service;
• level of market competitiveness for local service;
• glide path for price rebalancing to more closely align price with cost; and
• actual industry cost increases.

166. To maximise the opportunity for infrastructure competition to emerge in the market for telephone access services it is desirable that prices are allowed to increase to better reflect the costs for supplying service. In this respect it is proposed that the price cap for each area depends on its commercial viability and competitiveness as follows:

• the line rental for service supplied in commercially non-viable areas be tied to keep pace with CPI;
• the line rental for service supplied in areas which are commercially viable and are not competitive should be allowed to increase up to CPI (at the discretion of TSO provider) and;
• the line rental for service supplied in areas which are commercially viable and competitive should not be capped.

167. Continuing to allow line rentals to rise by the rate of inflation for commercially non-viable areas will slowly over time move prices for service in these areas closer to full cost recovery, and therefore gradually reduce the level of TSO subsidisation over time and so improve the prospect of competitive market entry.

168. For commercially viable areas there is by definition already full cost recovery for service supplied and no need for TSO subsidisation. To protect against excessive pricing where there is not full competition (say due to short term capacity shortfalls of an alternative network) for such areas it is reasonable to keep the CPI cap, while giving the service provider the flexibility to set the price up to the rate of CPI depending on the impact of competition and cost characteristics for each service area.

169. For commercially viable areas having full competition there seems to be no reason to keep a price cap in place. Few areas, at least initially, are expected to be classed as fully competitive for the supply of residential local telephone service. However, assessing the competitiveness of an area in determining whether the retail price cap should continue to apply for service in the area will have an administrative overhead cost.

7.3 Free Local Calling

170. The option of free local calling is a long standing basic service requirement for residential customers, which the Government has maintained. Under the option of free local calling for residential users there is no toll charge (per call, call minute or other usage basis) applied for local calling. However, local calling is not entirely "free of charge" as the cost of this calling is recovered as part of the line rental for local telephone service paid by the residential customer.

171. Free local calling has become an expected part of residential telephone service in an equivalent way that free emailing is a generally accepted element of an Internet access subscription. Free local calling has been adopted by alternative service providers of residential local telephone service in the New Zealand telecommunications market.

172. Free local calling of itself is not considered to impede competition in the telephone services market or be a fundamental inhibitor to greater take-up of broadband service. Government policy is to preserve "free local calling" going forward in any new NGN local service.

7.4 Price Rebalancing, Deaveraging and Wholesale Services

173. The Local Service TSO addresses service affordability in a general way through price averaging or uniform pricing nationwide. A standard line rental charge applies for TSO local service nationwide irrespective of cost differences for supplying service between low density areas and high density areas. This deflates the price for service in high cost areas and inflates the price for service in low cost areas i.e. relative prices are not aligned with relative costs.

174. The regulated price proposed¹¹ for unbundled local loop service has been set on a geographically deaveraged basis with an urban / non-urban charging split. This wholesale service could be used to facilitate the supply of alternative retail local telephone service. To ensure competitive neutrality it could be desirable to zone TSO retail line rentals consistent with the price zones for unbundled local loop service and other wholesale subscriber access services.

7.5 Upfront Subscription Charges

175. The upfront subscription charges Telecom applies for establishing an access line connection for local telephone service can vary depending on whether or not an access line is already installed. The amount of capital cost recovery split between the upfront installation charge and the ongoing rental charge can also vary depending on circumstances.

176. Telecom currently applies a three tier charging structure for new connections depending on the population density for the area where the customer premises connecting to the telephone network are sited.

177. The upfront charges for telephone connection are not covered by the Local Service TSO. There is a risk of double cost recovery for the capability facilitating supply of telephone service if it is not transparent what each of the charges (installation charge and rental charge) respectively cost recovers.