Costing Methodology for

Next Generation Networks

Technology, Media & Telecommunications

Executive summary

Legacy, circuit-switched telecommunications networks and the newer, packet-switched networks have traditionally
occupied different spaces within organisations, with the former used for voice traffic and the latter for data. While
they do share tasks, they perform, for the most part, discrete functions.

But as the telecommunications ecosystem continues to develop rapidly and in particular, shift towards Internet
Protocol (IP)-centric solutions for voice and video, there is now a greater need than ever for the deployment of Next
Generation Networks (NGNs). NGNs, which are packet-switched and IP-based, are able to support the convergence
of previously distinct applications, mirroring the end user experience of converged devices and services. In the
meantime, however, as operators begin work on the mammoth task of building the new networks, they will have to
contend with maintaining these hybrid networks until the evolution is complete.

As the telecommunications industry continues to advance at breakneck speed, its costing methodologies will need to
keep up. Originally designed based on the properties of legacy networks, price regulations for monopolistic services
have generally utilised cost models adopting various costing methodologies. The increasing deployment of IP-based
fixed and mobile infrastructure in combination with the still unanswered search for data monetisation have intensified
the pressure on the industry to review its costing methodologies for both regulatory and commercial cost analyses.

This paper discusses the general concept of costing for telecommunications services, the challenges faced by
operators and regulations with the introduction of NGNs, as well as the implications of NGN on traditional costing
methods.

3
The need for a dedicated cost
model for NGN
Traditional telecommunications cost models • Fully Allocated Cost (FAC): All costs are considered
Traditionally, cost models were tools used by and allocated to all services provided by the network;
regulators to monitor and control prices for access this approach is commonly used in conjunction with
and interconnection services which are monopolistic a top-down model. Resulting costs for services will be
in nature. Over time, operators have also developed the highest possible and provide an indication of the
cost models to analyse their own cost structures for cost ceiling.
regulatory and business purposes. With developments
in new technology, services and regulations, cost • Long Run Incremental Cost (LRIC): With the LRIC,
models have gradually evolved to reflect these changes. only incremental costs and/or service-specific fixed
At present, the capabilities of cost models have costs are allocated to services. If joint and common
expanded and can be used for regulatory pricing (tariff costs are allocated through mark-ups, the LRIC
regulations), profitability analysis (pricing strategies), method will begin to resemble FAC. Resulting costs
regulatory accounting (accounting separation), and cost for services will be minimal and provide an indication
optimisation, amongst other purposes. of the cost floor.

Types of cost models Between the FAC and LRIC models, there are variations
Telecommunication networks are capital-intensive and of LRIC, mostly relating to differences in the inclusion
involve shared platforms and systems that support or exclusion of certains costs and treatment of common
multiple services. As a result, numerous cost models costs, with their specific uses dictated by circumstances.
exist and the treatment of such costs will need to be A summary of the different methodologies and their
defined. The three main models are: corresponding inclusion of cost types is illustrated in
Figure 1.
• Standalone Cost: This approach is used when the
modelled network is providing only a single service
and thus all costs (service-specific, joint, and common
costs) are allocated to a single service.

Incremental
Long Run Incremental Cost (LRIC)
cost
Total Service Long Run Incremental
Incremental Service-specific
Cost (TSLRIC) / Long Run Average +
cost fixed cost
Incremental Cost (LRAIC)

Total Element Long Run Incremental Service-specific Allocation of part of

+ +
Incremental Cost (TELRIC) cost fixed cost joint and common cost

Incremental Service-specific Allocation of part of Allocation of residual of

TELRIC + uniform mark-up* + + +
cost fixed cost joint and common cost joint and common cost

Incremental Service-specific
TSLRIC / LRAIC + + Allocation of all joint and common cost
cost fixed cost

Fully Distributed Cost (FDC) / Incremental + Service-specific + FAC-based allocation of all joint and common cost
Fully Allocated Cost (FAC)* cost fixed cost

Incremental Service-specific
Standalone Cost + + All joint and common cost
cost fixed cost
Notes:
• In this example, FDC/FAC is assumed to be calculated based on forward-looking economic cost methodology.
• The total costs of the three cost concepts identified by an asterisk, *, do not necessarily have to be equal, as shown in this example.
• The relative sizes of the costing concepts are indicative only and should not be taken as an approximation of actual costs.

Figure 1: Cost methodologies and corresponding cost types (Source: International Telecommunications Union)

4
Globally, and especially in the European Union, there has been (MTR), Roaming, Interconnection (IC), Local Loop Unbundling (LLU))
a marked shift from FAC to LRIC as the costing standard for would consider only the incremental or marginal costs incurred by the
telecommunication services. Regulators using LRIC cost models operators, and thus the prices would be lower relative to the FAC model.
to regulate prices for services (e.g. Mobile Termination Rate

NGN and the key differences from legacy networks

NGN has been defined by the International Telecommunication In traditional legacy networks, each service is operated on its own
Union as “a packet-based network able to provide services dedicated network – fixed line telephony on public switched telephone
including Telecommunication Services and able to make use of networks (PSTNs), mobile voice services on mobile networks, television
multiple broadband, quality of service (QoS)-enabled transport broadcasting on satellite and cable networks, etc. These networks are
technologies and in which service-related functions are designed independently and specifically for a single service.
independent from underlying transport-related technologies1.”
It is an IP-based network with a multi-layer architecture for NGN offers services independent of the type of network because it
services, control, transport, and access. Traditional switches are is a converged multi-service network, as illustrated in Figure 2. These
replaced by media gateways and soft switches. differences will impact current cost modelling methodologies.

Traditional legacy networks Next Generation Networks

Services
Content Content

Mobile
network
Cable television Applications Control
network
Telephony
network
IP / Ethernet
Data backbone network
network

Mobile Coaxial
network network

Fibre / copper
network

Figure 2: Architectural differences between traditional legacy networks and Next Generation Networks

1
NGN Working Definition, International Telecommunication Union (2004)

5
Creating a successful NGN cost model

Existing costing approaches and methodologies have A new approach

been designed based on the characteristics of legacy For an NGN network, a new approach is required to
networks and thus are effective when used to model quantify the relationship between traffic volumes,
costs of legacy networks. The emergence of NGNs, service quality, and capacity to determine the costs
however, presents a new set of considerations for that are causally attributable to the various services in a
telecommunications companies as it is much more multi-service, packet-based environment2.
difficult to apply the traditional cost causality principles.
NGNs can have significant impacts on the traditional For IP-based services on packet-switched networks, a
costing models, including cost allocation, treatment of QoS routing algorithm, that is, one that allocates costs
incremental costs, and regulations based on LRIC. by QoS to services, is preferable as QoS is correlated
with bandwidth requirements. The bandwidth usage in
Network utilisation routing table no longer one-hour intervals (preferably within at least a 12-hour
sufficient for cost allocation timeframe) for each modelled service is required.
As multi-service platforms, NGN networks would
have much higher fixed shared and/or common costs A sample of the hourly bandwidth utilisation is given in
as compared to legacy networks. Consequently, an Figure 3. Based on this value, the cost of each modelled
effective cost allocation method of services is required. service will be distributed based on the weighting of
In traditional cost models for circuit-switched networks, the bandwidth demand by each service, as illustrated in
cost allocation to services was commonly performed Figure 4.
through a network utilisation routing table. Network
routing scenarios were defined for each particular
service using the principle of cost causality and costs
have been allocated via degree of utilisation of network
elements to their corresponding services.

An NGN network, as an integrated packet-switched

network, is capable of handling a wide range of traffic
types, each with its own service quality requirements.
Service quality is a more complex concept in a packet-
switched network and involves a number of criteria such
as bandwidth, delay, jitter, packet loss, and blocking
probabilities. Consequently, network utilisation routing
tables are no longer sufficient to determine the amount
of capacity required to meet a given service quality
standard. To do this, bandwidth pattern information of
services on an NGN network would be required.

2
Davies, Hardt, Kelly – Network Dimensioning, Service Costing and Pricing in a Packet Switched Environment

6
 Bandwidth pattern (MBps)

12.00

10.00

8.00

6.00

4.00

2.00

0
1:00 2:00 3:00 4:00 5:00 6:00 7:00 8:00 9:00 10:00 11:00 12:00

Service A Service B Service C

Figure 3: Hourly bandwidth utilisation pattern for sample services

Service unit cost (US$/MBps)

0.70
0.60
0.63
0.50
0.48
0.40 0.44
0.30
0.20
0.10
0
Service A Service B Service C

Cost share Total cost of service Peak bandwidth Service unit cost
Service
(%) (US$) (MBps) (US$/MBps)
Service A 14.70 1.45 3.00 0.48
Service B 22.05 2.18 5.00 0.44
Service C 63.26 6.26 10.00 0.63

Figure 4: Sample results from a cost allocation by QoS exercise

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 Treatment of legacy costs during migration to The use of MEA with NGN costing must be done
NGN with great care, and other alternative asset valuation
As NGN network deployment involves new investments methods such as indexation, absolute valuation, and
with no historical accounts, valuation of assets will appraisals may be considered. Striking the right balance
follow a current cost accounting (CCA) approach, between costing historical and future investments is
usually with the use of the Modern Equivalent Asset essential, and this should be done in consideration of
(MEA) method. The MEA method is the standard the operators’ business and the regulator’s objectives.
approach to asset valuation in a situation where there
has been a change in technology (resulting in significant Regulating prices based on LRIC
improvements in productive efficiency, functionality or LRIC is typically used to regulate the prices of wholesale
operating cost reductions, for example) and the asset in (interconnection and access) voice services. The
use cannot be purchased in the form currently utilised incremental or marginal cost of increasing voice volumes
by the operator. is used to set interconnection and access rates. NGN
networks have extremely large capacities of network
If existing assets cannot be replaced in an identical form, elements as compared to traditional legacy networks.
the replacement costs of a particular item can be based As a result, the incremental or marginal cost for traffic in
on the cost of a modern equivalent asset. By using the an NGN network can be close to zero. This is illustrated
MEA method, the new investments would be valuated in Figure 5.
according to their actual purchase price or current cost.
A solution to overcome the differences in incremental
Dealing with “cost hump” cost between the two types of networks is to define
During actual NGN deployment, operators will precisely the increments in LRIC. For NGN networks, the
experience a phase where they are building new increment has to be larger to reflect the large additional
networks whilst maintaining existing ones until the capacities of the network. With a larger increment, the
evolution completes. This hybrid period could also imply pricing of services based on incremental cost can again
a “cost hump” for operators. be established.

Using MEA to valuate the legacy network would ignore

a majority of the costs and thus past investments would
not be recovered. If regulators base price regulations
on such methods and operators are not allowed to
recover historic investments, incentives to invest in new
infrastructure would be reduced.

Traditional legacy networks Next Generation Networks

Traffic Traffic

Small increment Large increment

Cost Cost

Figure 5: Differences in LRIC for traditional legacy networks and Next Generation Networks

8
Conclusion

With increasing deployment of NGNs leading to the An NGN network element has extremely high capacities
coexistence with – and, eventually, the replacement as compared to legacy network elements. Regulating
of – legacy networks, the impacts of NGNs can no prices based on LRIC and small increments would imply
longer be overlooked. Price regulations have generally near zero rates for services on NGN networks. The
utilised cost models based on methodologies designed definition for increments would have to be redefined
on the properties of legacy networks. The development to reflect the actuality of network capacities in NGN
of NGNs means that these traditional cost models networks.
will need to be reconsidered in light of its differences
with legacy networks. Three main areas are impacted Nevertheless, the costing of NGN networks is still in
and this is evident in the application of traditional cost its infancy as legacy networks are gradually replaced
methodologies to NGN: cost allocation; treatment of by NGN networks around the world. Costing
costs; and regulations based on LRIC. methodologies and regulations must develop hand-in-
hand with technological developments, keeping in mind
Cost allocation for NGN and IP-based networks should that the objective of cost models is to reflect the reality
reflect the relationship between traffic volumes, service of networks.
quality, and capacity. An allocation key using QoS and
bandwidth requirements is recommended instead of the
traditional network utilisation routing table.

In the process of migrating to NGN, the cost of

migration and treatment of costs of legacy networks
would contribute to a significant portion of the overall
service costs of operators. Exclusion of such costs
would mean that operators are not allowed to recover
historic investments and thus incentives to invest in
new infrastructure would be reduced. Striking the
right balance between costing historical and future
investments is essential, and this should be done
in consideration of the operators’ business and the
regulator’s objectives.

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