25 February 2022

Economic replicability testing (ERT) is the most recent regulatory approach to price control in Europe and of increasing interest to SMP operators and challengers. Graham Johnson, Aetha Partner, makes the case.

Introduced by the European Commission in 2013 as an alternative to the established long running incremental cost (LRIC) model, economic replicability testing (ERT) brought the promise of enhanced market competition and investment in next generation access (NGA) networks. Offering a new framework for regulating wholesale pricing, ERT can provide more pricing flexibility to significant market power (SMP) operators and challengers making it an attractive option.

What is ERT?

ERT compares the retail prices the SMP operator offers to consumers against the result of adding up the wholesale and downstream costs to produce a ‘pass/fail’ output – if the sum of the costs is less than (or equal to) the retail price, the test is passed. In contrast to a LRIC model, which sets SMP operators’ wholesale prices directly, an ERT approach is indirect and leaves SMP operators free to set both their retail and wholesale prices – making it a more flexible model.

What are the benefits of ERT?

The key benefit of ERT is that it offers more flexibility, and therefore opportunities for efficiencies, for both SMP operators and challengers. Notably, it is firstly a technologic agnostic approach, and secondly it facilitates benign price discrimination.

ERT is agnostic to the technologies that SMP operators use to provide their wholesale services, thus encouraging efficiency. This is significant given the ever-widening range of deployment technologies available, as illustrated in Figure 1. In addition, high-speed access networks based on 5G will also compete, adding to the range of network architectures.

Figure 1:   Numerous dissimilar access network technologies, each requiring its own ‘LRIC’ approach model

An ERT approach is better at allowing benign price discrimination. Firstly, it enables speed-price ‘gradients’ – i.e. consumers who can afford high speeds pay for them, while those who cannot can still obtain a good, if slower, internet service. A well-structured smooth and progressive speed-price gradient accommodates demand at all levels, maximising the take up of broadband services, at both the retail and wholesale levels, and generating sufficient revenues to incentivise investment in the necessary infrastructure.

The second type of benign price discrimination is volume-based discounts, which allows for some coordination and risk-sharing between challengers and SMP operators. In return for a commitment to resell a certain number of wholesale lines, a challenger can be given a discount. This provides incentives to sell high-speed broadband, filling up the network more quickly than it otherwise might, favouring economies of scale that catalyse investment and growth. However, this type of discounting must be carefully designed to avoid favouring specific challengers, or favouring one broad group of wholesale products over another group.

Making the case for ERT to regulators

The first step for many operators perceiving potential opportunities from ERT is to persuade their regulator to adopt the model as part of its toolkit. Regulators regularly invite stakeholders to comment on cost model methodology, which provides the opportunity to present a case. Adoption rates of ERT among European regulators remain relatively low, with 12 countries employing the method to date for wholesale broadband access ­– but this could change. While there are complexities associated to an ERT approach, there are, as I have argued above, distinct advantages over the LRIC model.

Overcoming ERT challenges

While an ERT approach brings flexibility to SMP operators, it requires these organisations to provide more data to the regulator. In short, implementing an ERT modelling framework can be challenging due to the many detailed methodological choices to be made. Multiple questions can arise in this process, and these require careful consideration and even expert input. Examples include:

• Over what period of time should one-off costs be spread in an ERT model?
• Which retail products, bundles and speeds should be considered ‘flagship’ products and thus subjected to the test?
• What constrains retail and wholesale prices from drifting upwards, while still passing the ERT?
• Who should have visibility of the methodology, the model, and its data: the public; the challengers; a ‘confidentiality ring’; or only the regulator?

There is no ‘one size fits all’ solution to the above types of challenges. Much depends on what regulator and operators have already accomplished in terms of pricing structures, systems and procedures for challengers successfully to use wholesale access in the geographic areas where the challengers’ own networks do not yet provide significant competition. Negotiating wholesale access is often tense, as some wholesale products are a regulatory obligation, not a voluntary offering, by SMP operators. The greater attention devoted to questions of detail, the more likely is it that both sides can move some products towards a more consensual style of retail-wholesale collaboration.

Potential for growth

This regulatory approach is relatively new but analysis points to potential for growth. SMP operators and challengers will welcome the pricing flexibility that ERT offers and regulators are likely to be met with increasing demand to add this approach to the established LRIC model, creating conditions that enable investment and innovation to flourish. There are certainly challenges associated to an ERT approach – but they can be addressed and are well worth overcoming.

[1] BEREC, ‘Regulatory Accounting in Practice 2020’, 10th December 2020. Figure 62 – Ref Figure 5 – Margin squeeze test, M3a and M3b