Application by Telstra Corporation Limited ABN 33 051 775 556

[2010] ACompT 1


Application by Telstra Corporation Limited ABN 33 051 775 556 [2010] ACompT 1



File number:

1 of 2009





Date of determination:

10 May 2010


TRADE PRACTICES – telecommunications – access regime – access undertaking – rejection of access undertaking by ACCC – review of decision of ACCC – whether TSLRIC+ approach reasonable – whether modelling by TEA Model version 1.3, including assumptions upon which that modelling was based, reasonable – consideration of particular assumptions and inputs into modelling – degree of network optimisation/ “scorched node” approach – depreciation – value of weighted average cost of capital (WACC) – operating and maintenance costs – long term interests of end users – consideration of non-price terms of undertaking – desirability of certainty in terms of undertaking – decision of ACCC affirmed – Trade Practices Act 1974 (Cth), Part XIC, s 152AB, s 152AH and s 152CF


Trade Practices Act 1974 (Cth)

Telecommunications Act 1997 (Cth)

Telecommunications National Code 1994 (Cth)


Cases cited:

Telstra Corporation Limited [2006] ACompT 4

Telstra Corporation Ltd (No 3) [2007] ACompT 3

Re Optus Mobile Pty Limited & Optus Networks Pty Limited [2006] ACompT 8

Telstra Corporation Limited v Australian Competition Tribunal [2009] FCAFC 23

R v Hunt; Ex Parte Sean Investments Pty Ltd (1979) 180 CLR 322

R v Toohey; Ex parte Meneling Station Pty Ltd (1982) 158 CLR 327

Seven Network Limited [2004] ACompT 10

Seven Network Limited (No 4) [2004] ACompT 11

Re Telstra Corporation Ltd (No 1) (2006) 204 FLR 384

Application by Telstra Corporation [2009] ACompT 1

Access Dispute between Primus Telecommunications Pty Limited and Telstra Corporation Limited – Unconditioned Local Loop Services, Final Decision of ACCC, December 2007”

Verizon Communications Inc v FCC (2002) 535 U.S. 467 (2002)

Re Gasnet Australia (Operations) Pty Limited [2003] ACompT 6




Dates of hearing:

24, 25, 26, 27 and 28 August 2009




Adelaide (via video link to Melbourne and Sydney and Canberra)







Number of paragraphs:




Counsel for the Applicant:

N Hutley QC, C Moore and J Hewitt



Solicitor for the Applicant:

Gilbert + Tobin



Counsel for the Australian Competition & Consumer Commission:

M Sloss SC and A McClelland



Solicitor for the Australian Competition & Consumer Commission:

DLA Phillips Fox



Counsel for Chime Communications Pty Ltd, Agile Pty Ltd, Adam Internet Pty Ltd, PowerTel Limited, Request Broadband Pty Ltd:

M Hoyne



Solicitor for Chime Communications Pty Ltd, Agile Pty Ltd, Adam Internet Pty Ltd, PowerTel Limited, Request Broadband Pty Ltd:

Herbert Geer & Rundle



Counsel for Optus:

S Free



Solicitor for Optus:

Minter Ellison




File No 1 of 2009
















10 MAY 2010






1.                  The decision of the Australian Competition and Consumer Commission made on 22 April 2009 is affirmed.

Note:Settlement and entry of orders is dealt with in Order 36 of the Federal Court Rules.
The text of entered orders can be located using Federal Law Search on the Court’s website.




File No 1 of 2009
















10 MAY 2010





THE ISSUES...................................................................................................................


UNCONDITIONED LOOP SERVICE.........................................................................


BACKGROUND TO THE PRESENT APPLICATION..............................................


The ACCC Pricing Principles.....................................................................................


Previous Telstra undertakings and ACCC decisions................................................




The meaning of TSLRIC+..................................................................................


Application of TSLRIC+....................................................................................


i. The cost concept..............................................................................................


ii. TSLRIC+ access pricing................................................................................


iii. Scorched node................................................................................................


iv. Valuation of assets........................................................................................


v. Allocation of common fixed costs...................................................................


ALTERNATIVE TECHNOLOGIES FOR THE PROVISION OF RETAIL VOICE AND BROADBAND SERVICES.................................................................................


Optical fibre................................................................................................................


i. Background......................................................................................................


ii. HFC networks.................................................................................................




THE ACT........................................................................................................................


The Terms of the 2008 Undertaking..................................................................


TSLRIC + METHODOLOGY......................................................................................


The views of the parties.............................................................................................


TSLRIC+ and the reasonableness criteria...............................................................


Choice of technology..................................................................................................


THE TEA MODEL........................................................................................................


Costs of a hypothetical new entrant...........................................................................


Conclusions regarding the TEA Model.....................................................................


Conclusions regarding the proposed monthly charge of $30....................................




WEIGHTED AVERAGE COST OF CAPITAL...........................................................


The WACC parameters..............................................................................................


OPERATING AND MAINTENANCE COSTS...........................................................


Overview of the top-down methodology....................................................................


Calculating the O&M factors....................................................................................


Calculating O&M costs..............................................................................................


The areas of dispute...................................................................................................


(a) The methodology used to estimate operating costs and the annualized capital cost for network support and indirect assets.............................................................


(b) The allocation of operating expenses for fibre-related assets, multiplexing systems and local switching........................................................................................


(c) Overlap between asset categories........................................................................


(d) Whether the methodology used to calculate operating costs is susceptible to compounding errors....................................................................................................


(e) The methodology of calculating overhead loading (including transparency and efficiency of the overhead loading figures advanced by Telstra).............................


The Tribunal’s views on O & M costs.......................................................................






1                     Telstra Corporation Limited (Telstra) has applied to the Australian Competition Tribunal under s 152CE(1) of the Trade Practices Act 1974 (Cth) (the TP Act) for review of a decision of the Australian Competition and Consumer Commission (the ACCC) under s 152BU(2) of the Act  to reject an access undertaking offered by it.  The ACCC Final Decision was notified to Telstra on 28 April 2009, but is dated 22 April 2009 (the Final Decision).

2                     The ACCC decision was made in respect of an ordinary access undertaking lodged with the ACCC by Telstra on 3 March 2008 (the 2008 Undertaking).  It specifies some of the terms and conditions under which Telstra would meet its standard access obligations (SAOs) in respect of the unconditioned local loop service (ULLS) for Band 2 areas (for practical purposes, the metropolitan areas of the major cities within Australia and excluding the Band 1 areas, which are the central business districts).  The Band 2 areas are those exchange areas set out in detail in the annexure to the 2008 undertaking. 

3                     The 2008 Undertaking proposes a monthly charge of $30 for each Telstra ULLS connected at an exchange building in a Band 2 exchange service area.  If accepted, the 2008 Undertaking will remain until 31 December 2010.

4                     The ACCC of course participated in the hearing.

5                     Optus Networks Pty Limited (Optus) was given leave to participate in the proceeding.  Optus took an active role in the proceeding before the ACCC and on this application.

6                     In addition, a number of other entities were given leave to participate in the proceeding.  They are Chime Communications Pty Ltd; Agile Pty Ltd; Adam Internet Pty Ltd; PowerTel Limited and Request Broadband Pty Ltd.  Each of those entities receives the Telstra service in issue from Telstra.  Each has notified an access dispute to the ACCC pursuant to s 152CM(1) of the TP Act which relates to Telstra’s terms and conditions of access to that service.  Depending on the outcome of this application, the ACCC may proceed to make a determination in those ULLS access disputes different from the terms of Telstra’s proposed undertaking.  Those parties, other than Optus, were jointly represented.  In these reasons for decision they are collectively called “the Interveners”.

7                     The Tribunal’s powers on the review are set out in s 152CF(1) of the Act.  Relevantly, s 152CF(1) provides:

On a review of a decision of the Commission under subsection 152BU(2), … the Tribunal may make a decision:

(a)        in any case – affirming the Commission’s decision; or

(c)                in the case of a review of a decision of the Commission under subsection 152BU(2), … to reject an undertaking – both:

(i)         setting aside the Commission’s decision; and

(ii)        in substitution for the decision so set aside, to accept the undertaking;

8                     The 2008 Undertaking is said by Telstra to be based on the costs to recover the forward-looking economically efficient incremental costs of providing the ULLS over the long run, plus a contribution towards common costs shared by the ULLS.  This approach is known as the total service long run incremental cost “plus”, or TSLRIC+.  Telstra submitted that its proposed monthly charge is supported by the Telstra Efficient Access Model (TEA Model), and that the TEA Model properly and appropriately models TSLRIC+. 

9                     The ACCC first declared the ULLS pursuant to s 152AL(3) in Part XIC of the TP Act in August 1999.  Once a service is declared, carriers and carriage service providers supplying the declared service to themselves or others are subject to the SAOs as set out in s 152AR of the Act.  The ACCC re-declared the ULLS in July 2006 for a period of three years, with effect from 1 August 2006.  Those Declarations were duly published.

10                  The service description of the ULLS is contained in Appendix A of the first Declaration and is defined in the same terms in the ACCC Final Determination of July 2006 on its Declaration inquiry for the ULLS (and other services), as well as in Appendix 2 of that document.  It reads as follows:

The unconditioned local loop service is the use of unconditioned communications wire between the boundary of a telecommunications network at an end-user’s premises and a point on a telecommunications network that is a potential point of interconnection located at or associated with a customer access module and located on the end-user side of the customer access module.

A “communications wire” is defined as:

A copper-based wire forming part of a public switched telephone network.

A “customer access module” is also defined in Appendix A as:

A device that provides ring tone, ring current and battery feed to customers’ equipment.  Examples are Remote Subscriber Stages, Remote Subscriber Units, Integrated Remote Multiplexers, Non-Integrated Remote Integrated Multiplexers and the customer line module of a Local Access Switch.

11                  More simply, in its reasons for its Final Decision, the ACCC described the ULLS in the following terms:

The ULLS is most commonly a twisted copper wire pair that provides a communications path between the telephone exchange and the consumer or business end-user premises.  As a result, the ULLS is an essential input used by other telecommunications access seekers in combination of their own equipment to provide competitive telephony and high-speed broadband services to consumers and businesses.

12                  It was said in the course of submissions that the ULLS also includes a small, but irrelevantly small, element of aluminium wire. It is not necessary to refer to that further.

13                  As noted, by the 2008 Undertaking, Telstra proposed a monthly charge of $30 to be paid by access seekers for access to the ULLS in the Band 2 metropolitan areas.  At the time of that undertaking, that proposed charge was substantially above the then currently regulated access charge of $16.75.  The proposed charge was, however, significantly lower than a higher figure estimated by Telstra as the appropriate one, using its proposed cost model.  In fact, the TSLRIC+ cost estimated by version 1.3 of the TEA Model for Band 2 is $46.54 (subsequently adjusted slightly by reason of an acknowledgment made by Telstra in the course of the hearing).  Its proposed monthly charge is therefore only about two-thirds of the figure which its modelling produced. Other non-price terms were also proposed.  It is necessary to refer to them in a little detail later in these reasons.

14                  The ACCC rejected the 2008 Undertaking because, according to the Executive Summary of the Final Decision, it:

·         is unlikely to promote the long term interests of end-users, as it will not promote competition and will not encourage the economically efficient use of, and investment in, infrastructure;

·         will result in Telstra recovering more revenue than is necessary to promote Telstra’s legitimate business interests;

·         will harm the interests of access seekers and persons who have rights to use the service;

·         contains price terms which will exceed the direct costs of providing access;

·         does not have a material effect on the operational and technical requirements necessary for the safe and reliable operation of telecommunications services; and

·         is not likely to facilitate the economically efficient operation of the ULLS.

15                  The Final Decision by the ACCC followed the release of a Discussion Paper on the 2008 Undertaking on 4 June 2008 (the Discussion Paper), and subsequently on 13 November 2008, the publication of a draft decision entitled “Assessment of Telstra’s Unconditioned Local Loop Service Band No 2 Monthly Charge undertaking” (the Draft Decision).  The Draft Decision also proposed to reject the 2008 Undertaking.

16                  Under s 152BV of the TP Act, the ACCC is directed not to accept such an undertaking unless, relevantly, it is satisfied that the undertaking is consistent with the SAOs that are applicable to the carrier or provider; and unless it is satisfied that the undertaking, if it deals with price or the method of ascertaining price, is consistent with any Ministerial pricing determination; and unless the ACCC is satisfied that the terms and conditions specified in the undertaking are reasonable.

17                  On this application, the Tribunal stands in the shoes of the ACCC.  Its decision is taken to be a decision of the ACCC: s 152CF(2).  It, too, must not accept the 2008 undertaking unless it is “satisfied that the terms and conditions specified in the undertaking are reasonable”: s 152BV(2)(d).

18                  The summary by the ACCC of its reasons set out above at [14] reflects its assessment of the reasonableness of the 2008 Undertaking.

19                  Section 152AH deals with the topic of reasonableness.  It provides:

(1)        For the purposes of this Part, in determining whether particular terms and conditions are reasonable, regard must be had to the following matters:

(a)        whether the terms and conditions promote the long-term interests of end-users of carriage services or of services supplied by means of carriage services;


(b)        the legitimate business interest of the carrier or carriage service provider concerned, and the carrier’s or provider’s investment in facilities used to supply the declared service concerned;


(c)        the interests of persons who have rights to use the declared service concerned;


(d)        the direct costs of providing access to the declared service concerned;


(e)        the operational and technical requirements necessary for the safe and reliable operation of a carriage service, a telecommunications network or a facility;


(f)        the economically efficient operation of a carriage service, a telecommunications network or a facility.

(2)                Subsection (1) does not, by implication, limit the matters to which regard may be had.

Certain of those matters are further explained in other provisions of the TP Act.

20                  Part XIC of the TP Act contains the Telecommunications Access Regime.  It commences with s 152AA containing its simplified outline.

21                  Then s 152AB describes the object of the Part.  Section 152AB(1) says that its object is to promote the long-term interests of end-users of carriage services or of services provided by means of carriage services (the LTIE).

22                  Section 152AB(2) of the TP Act provides that, in determining whether a particular thing promotes the LTIE of either carriage services or services supplied by means of carriage services (together defined as listed services), regard must be had to the extent to which the thing is likely to result in the achievement of three specified objectives.  They are:

(c)        the objective of promoting competition in markets for listed services;


(d)               the objective of achieving any-to-any connectivity in relation to carriage services that involve communication between end-users;


(e)                the objective of encouraging the economically efficient use of, and the economically efficient investment in:

(i)         the infrastructure by which listed services are supplied.

Section 152AB(3) provides that s 152AB(2) is intended to limit the matters to which regard may be had.

23                  However, s 152AB(4) and (5) provides that, in determining the extent to which a particular thing is likely to result in the achievement of the objective of promoting competition in markets for listed services, regard must be had to the extent to which the thing will remove obstacles to end-users of listed services gaining access to listed services.  That does not limit the matters to which regard may be had on that topic.

24                  Section 152AB(6), (7), (7A) and (7B) of the Act concerns the objective in s 152AB(2)(e) of encouraging the economically efficient use of, and the economically efficient investment in, the infrastructure by which listed services are supplied.  Those subsections direct the ACCC to have regard, inter alia, to the following matters:

(a)                whether it is, or is likely to become, technically feasible for the services to be supplied and charged for, having regard to:

(i)         the technology that is in use, available or likely to become available; and

(ii)        whether the costs that would be involved in supplying, and charging for, the services are reasonable or likely to become reasonable; and

(iii)       the effects, or likely effects, that supplying, and charging for, the services would have on the operation or performance of telecommunications networks;

(b)               the legitimate commercial interests of the supplier or suppliers of the services, including the ability of the supplier or suppliers to exploit economies of scale and scope; and

(c)                the incentives for investment of the infrastructure by which the services are supplied and any other infrastructure by which the services are, or are likely to become, capable of being supplied, having regard (without limitation) to the risks involved in making the investment. 

That does not, by implication, limit the matters to which regard may be had. 

25                  The tasks of the Tribunal, having regard to those provisions, was discussed in Telstra Corporation Limited [2006] ACompT 4; Telstra Corporation Ltd (No 3) [2007] ACompT 3 (Telstra No 3); Re Optus Mobile Pty Limited & Optus Networks Pty Limited [2006] ACompT 8; and Telstra v Australian Competition Tribunal [2009] FCAFC 23 (Telstra v ACompT).  It is not necessary to refer to those decisions in detail at this point.  It is sufficient to note that, if the Tribunal is satisfied that the LTIE as explained in the TP Act, commencing with s 152AB(1), lies with acceptance of the 2008 Undertaking, the Tribunal has no residual discretion to refuse to accept the 2008 Undertaking.

26                  The Tribunal is not bound by the rules of evidence: s 103(1)(c) of the TP Act.  It is, however, confined by s 152CF(4) to considering its decision on the material that was before the ACCC or referred to it.  There was some debate between the parties as to the extent of that material.  The Tribunal has separately discussed that matter later in these reasons.  In any event, nothing really turns on the resolution of that dispute.

27                  Telstra submitted that the Tribunal’s task on that material is to compare the “future with” the 2008 Undertaking (if it is accepted) and the “future without” the 2008 Undertaking (if it is rejected), and to consider which state of affairs is in the LTIE. 


28                  In the course of the hearing, the parties very helpfully prepared a list of 31 issues to be addressed.  They proved to be of considerable assistance in focusing attention to the significance of particular submissions and of the material before the Tribunal.  To some degree, they overlapped or intersected.  The Tribunal has not, therefore, dealt discretely with each of those issues.  It is convenient to note first the principal headings under which the individual issues appeared.  They included:

·                    The Act

·                    Telstra’s Undertaking

·                    Role of TSLRIC+ and Historical costs

·                    The TEA Model

·                    Asset Lives

·                    Depreciation

·                    WACC

·                    O&M

·                    International Benchmarking

·                    Retail Pricing

·                    Other Cost Models

·                    Other Issues

·                    Support for $30 Charge

29                  The Tribunal has found it necessary to discuss only some of them in detail.  Before doing so, it is helpful to record more about the nature of the proceeding.

30                  The main question in issue between the parties was the reasonableness of the proposed access charge of $30 per month.  To demonstrate its reasonableness, having regard to the terms of s 152AH, some form of modelling was – it was commonly agreed – an appropriate step.  That was the means by which Telstra’s earlier proposed access charges in its earlier undertakings were sought to be justified.

31                  It was common ground that the integrity of any form of modelling would depend not only upon the model itself, but also (and obviously) upon the data input into the model.  Telstra, for its part, was clearly conscious of the need to justify not simply the form of modelling but the data inputs.  It was also conscious, as its senior counsel acknowledged, that it was vulnerable to the ACCC (or the Tribunal) deciding that a particular data input, or perhaps several of them, was or was not reasonable.  The result might well affect the modelled output, the access charge.  It did not want to have the 2008 Undertaking rejected for some relatively minor difference about the reasonableness of particular data inputs, so affecting the assessment overall of the reasonableness of the outcome produced by its modelling.  Its monthly charge of $30 therefore simply allows for some “tolerances” or difference of views on those matters.  There is no reason why Telstra should not have based its 2008 Undertaking on such a “broad brush” reduction from the modelled outcome.  However, the consequence is that it may be necessary – at least to a degree – to address a series of cascading questions.  Some are fundamental.  Some are a matter of detail. 

32                  The first fundamental question is whether the use of TSLRIC+ is an appropriate means of assessing the reasonableness of the proposed monthly charge.  As part of this issue, it will be appropriate to address the extent to which the historical costs of Telstra in establishing the ULLS provide either a basis for, or a cross-check for, a means of determining the reasonableness of the proposed monthly charge. 

33                  The next fundamental question is whether modelling the TSLRIC+ by the TEA Model version 1.3 is still an appropriate means of providing an outcome which may inform the reasonableness of the proposed monthly charge.  The modelling by the TEA Model version 1.3 was done on the basis of an all copper network.  It is clear enough that any future provision of services such as are provided by means of the ULLS, ie using the ULLS as an input to services provided to end-users, would not be done on that basis.  There are alternatives as new technology emerges.  The Tribunal refers to that matter later in its reasons.

34                  The next stage of consideration, if it were required, involves particular assumptions or inputs into the TEA Model version 1.3 modelling.  Different inputs will produce different outcomes.  The parties identified a number of inputs into the TEA Model version 1.3 modelling, or assumptions made to select the inputs, which were contentious and which had a sufficient sensitivity to produce a significantly different output.  Given the basis upon which Telstra has selected its proposed monthly charge for the 2008 Undertaking, Optus and/or the Intervenors have understandably adopted the approach of challenging some of the sensitive inputs or assumptions underlying them, as well as attacking the TEA model approach more fundamentally.  Using the description of those matters adopted by the parties, they relate to: 

(a)        the degree of network optimisation (the “scorched node approach”);

(b)        the extent of trench sharing;

(c)        the surface barrier assumption for breakouts and reinstatement costs;

(d)        the use of non-tapered architecture;

(e)        cabling down one side of the street;

(f)         inclusion of lead-in costs; and

(g)        the equipment prices used in the TEA Model.

35                  In anticipation of the possibility that some of those inputs or assumptions might be regarded by the Tribunal as not reasonable, Telstra provided in its submissions in reply a “sensitivity test of the TEA Model results” showing some of the changes in the modelled outcome which each of them individually may produce, adopting the change proposed by the respective respondent parties.

36                  That table included sensitivity analysis relating to two of the more significant assumptions or inputs into the TEA Model version 1.3.

37                  One relates to the asset life of the copper cable used in the ULLS, and the annuity used in calculating depreciation on the ULLS.  The inputs used by Telstra attracted significant adverse comment.  There is a potential for quite a substantial adjustment to the modelled monthly charge, depending upon whether the Tribunal is of the view that Telstra’s input is reasonable in all the circumstances.

38                  The other group of inputs which have the potential for quite a substantial adjustment to the modelled monthly charge, depending on the Tribunal’s view as to the reasonableness of Telstra’s inputs, are those concerning the weighted average cost of capital (WACC).

39                  Finally, in the constellation of inputs or assumptions into the TEA Model version 1.3 are a series of matters relating to the operating and maintenance of the ULLS.  As the parties identified them, they were:

(a)        the methodology used to estimate operating costs and the annualised capital cost for network support;

(b)        the allocation of operating expenses for fibre related assets, multiplexing systems and local switching;

(c)        overlap between asset categories;

(d)        the transparency of the methodology used by Telstra to calculate operating costs;

(e)        whether the methodology used to calculate operating costs is susceptible to compounding errors; and

(f)         the methodology of calculating an overhead loading (including transparency and efficiency of the overhead loading figure advanced by Telstra).

40                  For reasons appearing below, the Tribunal has not needed to consider in detail the quality of each of the inputs into the TEA Model version 1.3 set out above.  It has, however, made certain observations and findings about some of the more significant ones.  As is apparent, certain of those matters had greater potential significance than others.  Because Telstra adopted a “broad brush” approach to deciding the $30 monthly charge proposed in the 2008 Undertaking, and apparently one which gave it substantial room for adjustment of a number of inputs, the Tribunal has addressed certain of those inputs or assumptions which may have the greater impact upon the modelled outcome if the Tribunal does not consider that they are reasonable.  If, contrary to the Tribunal’s view, the modelling of TSLRIC+ by the TEA Model version 1.3 were an appropriate basis to determine the reasonableness of the 2008 Undertaking, and if the Tribunal concluded that certain of those more significant inputs or assumptions are not reasonable and that reasonable inputs or assumptions would produce a modelled outcome or access charge in the order of $30 only, in any event, it would not be necessary to give such detailed consideration to the range of other contentious inputs or assumptions..  If there were little or no remaining flexibility in the modelled outcome to allow for further adjustment of the access charge, that is if the modelled outcome thereby becomes quite sensitive to any further adjustment of an input or assumption which might further reduce it, the Tribunal would not need to quantify precisely the consequence of such an adjustment to reach the view that the access charge proposed is not reasonable.  In that event, as was common ground, the Tribunal should not be satisfied that the 2008 Undertaking was itself reasonable.

41                  Telstra did not contend that, if the Tribunal did not regard the access charge of $30 per month as reasonable, nevertheless the 2008 Undertaking could itself be regarded as reasonable.


42                  When an access seeker such as Optus seeks access to a ULLS in respect of a particular customer, Telstra will take the copper wire which leads from that customer’s premises back to the local exchange, disconnect it from Telstra’s equipment (assuming that the customer is a Telstra customer) and connect it to the equipment of the access seeker which is housed in the exchange building.  More precisely, although the wire remains terminated on the Main Distribution Frame (MDF) in the exchange, instead of the termination point being connected by a jumper to Telstra’s equipment, a jumper instead connects the wire to the access seeker’s equipment.  The wire is now connected to the network of the access seeker and is not connected to Telstra’s network.  The access seeker obtains use of the wire to provide certain services it may wish to provide, which typically will comprise telephony and ADSL internet.  The wire is “unconditioned” in the sense that no electronic devices are attached to the line between the customer’s premise and the MDF.  Further, Telstra does not control the operation of the line in any way – it carries no signal or current from Telstra.

43                  The copper wire used in the Customer Access Network (CAN) is typically comprised of a number of individual copper wires divided into “pairs”.  The CAN is described in a little more detail below.  Each wire has a plastic insulation covering and the two wires are twisted together to form the pair. One copper wire pair is required to provide the ULLS service.

44                  The ULLS is a service provided over copper.  Fibre or wireless technology cannot support the ULLS as defined in the current Declaration.  It provides that the ULLS is “the use of unconditioned communications wire”, where “communications wire is a copper based wire forming part of a public switched telephone network”.  The same or similar services that are supplied to end users via the ULLS (being telephony and broadband internet services) can be supplied over optical fibre and wireless technology, as discussed later in these reasons.

45                  The ACCC considers that the telephony and broadband internet services provided over wireless generally are not substitutes for the telephony and broadband internet services provided via the ULLS.

46                  A copper wire network may incorporate “pair gain” systems, which use equipment attached to the copper pairs in the CAN, which allows the copper pairs to service more than one end-user. However, copper pairs that are attached to “pair gain” systems are not suitable for the supply of ULLS as they are “conditioned”. That is, such wires are not “unconditioned communications wire” for the purposes of the ULLS Declaration.  For an access seeker to use the ULLS to provide a service to an end-user, there must be an uninterrupted metallic (ie copper or aluminium) pair of wires between the customer’s premises and the access seeker’s equipment located at the Customer Access Module (CAM). Where there is a “pair gain” system at some point along the metallic path, this requirement will not be met.

47                  The ULLS gives an access seeker the use of the copper pair without any dial tone or carriage service. This allows the access seeker to use its own equipment in an exchange to provide a range of services, including traditional voice services and digital subscriber line (DSL), to end-users connected to that exchange.  Access seekers can therefore supply local and long-distance telephony services and other standard (circuit-switched) voice services, without relying on the resale of Telstra’s wholesale and local call services.

48                  The ULLS has no prescribed bandwidth as the access seeker receives the twisted copper pair without conditioning or specific carriage technology. The access seeker may deploy its own infrastructure in Telstra’s exchange to supply a range of downstream services, including the supply of high bandwidth data communications and voice services.

49                  A DSLAM is a Digital Subscriber Line Access Multiplexer. It is a device required to connect a subscriber to a DSL service, and to connect an end user to voice services via the ULLS. 

50                  The copper wire CAN forms part of the Public Switched Telephone Network (PSTN). The PSTN consists of telephone circuit switches connected by transmission systems on one side of a MDF and the CAN comprising customer access lines on the other side. The telephone switches are generally specific to a set of services. The transmission systems are typically shared by all of the switches.

51                  The PSTN is Telstra’s largest telecommunications network. As at 30 June 2008, there were approximately 9.86 million fixed line services connected to Telstra’s PSTN. The physical elements of Telstra’s PSTN comprise the CAN, local telephone exchanges and the Inter Exchange Network (IEN).

52                  The CAN is that part of the PSTN that connects the terminal device at each end user’s premises back to the access point with the IEN, typically at the local telephone exchange. The “network termination point” or terminal device at the end-user’s premises is typically the first telephone socket on the customer’s premises.  The terminal device is the customer's equipment (for example, telephone handset or fax machine), which typically connects to the first socket. The first socket is the Network Boundary of the carrier’s CAN.  The CAN provides connectivity between the customer’s location and the exchange. The point of demarcation is typically the first wall socket. In a commercial building or large multi-dwelling unit (MDU), that is the building distributor or MDF. In a small number of cases a Network Terminal Device is used.

53                  The part of the CAN that is serviced by a particular exchange is referred to as an Exchange Service Area (ESA). An ESA comprises the whole of the CAN which is connected to that particular, and only that particular, local telephone exchange.

54                  There are 584 Band 2 ESAs.  Band 2 ESAs are defined as those with more than 108.4 Services in Operation in a square kilometre area which is not a Band 1 area (Band 1 areas are the central business districts of NSW, Queensland, South Australia, Victoria and Western Australia).  As noted above, the Band 2 areas are the metropolitan areas outside of the central business districts of NSW, Victoria, South Australia Queensland and Western Australia.  They cover 67% of services in operation (SIOs) (approximately 6.9 million SIOs from a total of 10.2 million lines), 70% of the population, but only 0.2% of the land mass.

55                  As at August 2008, there were [X] SIOs in Band 2.

56                  As at March 2009, the CAN comprised 170,291 kilometres of trenching, 375,482 kilometres of copper cable sheath, 168,933 manholes and, Telstra says, some 3,860,630 pits.

57                  The CAN comprises 2 component networks referred to as the main network (also called the feeder network) and the distribution network.

58                  The main network comprises the cables and associated equipment which are located between the local telephone exchange and what is known as a point of cross connection. The point of cross connection is typically a pillar. The use of the term “point of cross connection” refers to the fact that such a point is one at which a connection between the main and distribution networks can be readily made.

59                  The distribution network is comprised of the cables and associated equipment which are located between the pillar and each end-user’s premises. The copper wire pairs are split off along the streets to serve individual premises.

60                  A pillar contains “terminal units” which allow for the connection of copper wire pairs in the distribution network to copper wire pairs in the main network. The collections of end-user premises that are connected to one particular pillar comprise what is referred to as a Distribution Area (DA). Each DA is served by one, and only one, pillar.

61                  The terminal units contain a set of connection terminals for each main network pair that is connected to the pillar. The pairs from the distribution network can be connected to any one of those main network pairs to obtain a continuous circuit back to the local telephone exchange.  The pillar therefore provides an important point of flexibility in the network as it allows any main network pair to be connected to any pair in the distribution network back to the local telephone exchange. As a result, it is possible to connect new end-users to the distribution network in a particular DA without having to make any, or any significant, changes to the main network cables.

62                  It should be noted that there is now some debate about the capacity of the CAN to meet additional demand satisfactorily.

63                  A segment of cable known as a “lead-in” is used to make the connection from the distribution cables which are located in the street, to the network boundary point at the end-user’s premises.  That is, in a standard residential situation, the lead-in is the copper pair that is specific to that individual dwelling that connects back to the distribution cable.

64                  Lead-ins are installed either underground or aerially. In today’s legislative and regulatory environment, lead-ins tend to be placed underground, although aerial cabling remains a possibility.  However, as the ACCC stated in the Final Decision, underground cabling would now most likely be required because of local council requirements.  Prior to 1997, aerial cabling could be used because the Telecommunications Act 1991 (Cth) and the Telecommunications National Code 1994 (Cth) did not distinguish between underground and aerial cabling.

65                  The Government has indicated that it may relax regulatory burdens in respect of aerial cabling that relates to the fibre rollout of the proposed National Broadband Network (NBN).  Specifically, the Government has indicated that it would allow optical fibre to be rolled out overhead on existing poles to expedite the process and to reduce the costs of deploying the network.

66                  A copper wire cable of the kind used in telecommunications networks such as the CAN is typically comprised of a number of individual copper wires grouped into “pairs”. Each wire has a plastic insulation covering and the two wires are twisted together to form the pair.  The pair count of a cable indicates the number of pairs contained within the cable. One copper wire pair is required to provide one unconditioned local loop service.


The ACCC Pricing Principles

67                  Section 152AQA of the TP Act requires the ACCC to determine principles relating to the price of access to a declared service. The determination may also contain price-related terms relating to access to the declared service. Such a determination must be made at the same time as, or as soon as practicable after, the ACCC declares or varies a declared service. The ACCC is also required to publish a draft of the determination, invite submissions on the draft and consider any submissions received, before it makes a final pricing determination.

68                  In its July 1997 access pricing principles paper, the ACCC stated that pricing based on total service long-run incremental cost (TSLRIC) to recover the efficient costs of a “forward-looking” network will satisfy the broad statutory criteria, including the reasonableness criteria under s 152AH of Part XIC of the Act.

69                  Following the first declaration of the ULLS by the ACCC in July 1999, the ACCC finalised pricing principles for the ULLS in March 2002.  In its 2002 Pricing Principles, the ACCC stated that TSLRIC should be applied in the costing of provision of the ULLS.  The ACCC also stated that, in practice, TSLRIC is usually defined to include a contribution to indirect costs.  The ACCC now considers that the past rationale for implementing TSLRIC or TSLRIC+ may be less relevant at the present time.  TSLRIC+ is explained in the next section of these reasons.

70                  In July 2006, as part of the ACCC’s Final Determination in respect of the Declaration Inquiry for the ULLS, the ACCC published its Draft Pricing Principles Determination for the ULLS.  In November 2007, the ACCC made its final ULLS Pricing Principles Determination as required by s 152AQA of the Act.  The ACCC did not then specify indicative prices in the 2007 ULLS Pricing Principles Determination.

71                  The ACCC at that time stated that, historically, it has been of the view that TSLRIC+ pricing “is consistent with the price that would prevail if an access provider faced effective competition, and that it usually best promotes the long-term interests of end-users” and best accords with the relevant legislative criteria.

72                  In June 2008, the ACCC made the 2008 ULLS Pricing Principles and Indicative Prices Determination. That determination included indicative prices on ULLS monthly charges to apply until 31 July 2009, and stated that ULLS pricing should be based on TSLRIC+ methodology.  The ACCC said that, until it has settled upon its own fixed network cost model, indicative prices based on TSLIRC+ pricing principles should be based on the PSTN Ingress and Egress Model II (PIE II) network cost model.  The ACCC used the PIE II network cost model in making its 2008 ULLS Pricing Principles and Indicative Prices Determination. 

73                  However, in making the 2008 ULLS Pricing Principles and Indicative Prices Determination the ACCC also stated that:

The ACCC continues to hold concerns about the transparency of the PIE II model but

considers that, given the benefits of issuing indicative prices, it would not be appropriate to wait until an alternative cost model is available and tested.

The ACCC believes that, with reservations and appropriately considered inputs, the PIE II model can be used to set indicative prices for the ULLS.

The PIE II model was used in preference to the TEA Model, which was at that time untested.

74                  The indicative prices for ULLS monthly charges on a per service, per month basis for Band 2 for the period to 31 July 2009 are as shown:













Monthly Charge










75                  The indicative prices for ULLS monthly charges for Band 2 prior to 2005/06 were higher than the period 2005/06 to 2008/09.  The indicative prices for the ULLS monthly charges for Band 2 were as shown:







Monthly Charge






76                  Telstra said that it relied upon the ACCC’s 2007 ULLS Pricing Principles in constituting the TEA Model, version 1.3, used in calculating the economic cost of building the CAN for the supply of the ULLS.  It claimed that it had taken into account “real world natural, man-made and legal obstacles to deploying the CAN”.  It submitted that its modelling, reviewed and supported by experts as suitable to accurately estimate the TSLRIC+ price of supplying the ULLS, provided the presently most realistic network cost model for that purpose.

Previous Telstra undertakings and ACCC decisions

77                  On 9 January 2003, Telstra lodged an undertaking with the ACCC in relation to the supply of the ULLS (2003 Undertaking).   The material lodged by Telstra in support of the 2003 Undertaking included Telstra’s economic costing model, the PIE II model.  The 2003 Undertaking covered the 2003-04, 2004-05 and 2005-06 financial years. Telstra proposed a monthly price of $13, $22, $40 and $100 for the ULLS in Bands 1, 2, 3 and 4 respectively. 

78                  In October 2003, the ACCC published its Final Determination for model price terms and conditions of the PSTN, ULLS and DSL services.  In that Final Determination, the ACCC stated that the indicative access price for ULLS per SIO per month for Band 2 areas for 2003-04, 2004-05 and 2005-06 was $22.  Telstra subsequently withdrew the 2003 Undertaking and submitting a replacement undertaking on 14 November 2003 (2003 Replacement Undertaking).   In October 2004, the ACCC published a draft decision to reject the 2003 Replacement Undertaking.     Telstra subsequently withdrew the 2003 Replacement Undertaking and submitted a revised ULLS monthly charge undertaking on 13 December 2004 (2004 Revised Undertaking).   On 21 December 2005, the ACCC issued a final decision to reject the 2004 Revised Undertaking.

79                  On 23 December 2005, Telstra lodged a ULLS monthly charge undertaking proposing a single (average) price of $30 per month (2005 Undertaking).  The single price was averaged across Band 1, Band 2, Band 3 and Band 4.  In support of the 2005 Undertaking, Telstra relied on the PIE II Model to estimate its network costs. 

80                  The PIE II Model is a total long-run incremental cost model.  It is said to determine, on the basis of various inputs, the network elements which would be necessary to construct a CAN, the costs of those elements, the annual amounts necessary to recover those capital costs, the operational and maintenance and indirect costs applicable to the CAN and the proportion of the CAN costs that relate to the ULLS.

81                  For the purposes of the 2005 Undertaking, the PIE II Model was used to determine a uniform ULLS monthly access charge of $30 across all four Bands (Band 1, Band 2, Band 3 and Band 4), based on the average of its estimated efficient costs of supplying the ULLS in those four areas for each of the years of the 2005 Undertakings.  

82                  Telstra claimed that “[t]he PIE II model is the best available model for estimating the TSLRIC of ULLS”.

83                  In August 2006, the ACCC rejected Telstra's 2005 Undertaking.  On 17 May 2007, the ACCC's decision was affirmed by the Australian Competition Tribunal: Telstra (No 3)

84                  Under s 152CM of the Act, parties may notify the ACCC to arbitrate an access dispute if the parties are not able to agree on the terms and conditions of access to the declared service.  Seven access seekers notified the ACCC of a total of eight access disputes with Telstra regarding the ULLS monthly charges.  There was overlap in the terms of access that were disputed.  After seeking the parties' views, the ACCC held a joint arbitration to consider the terms of access that were commonly disputed between the access disputes.  On 28 June 2007, the ACCC provided to the parties a draft final determination and accompanying consultation paper.   The draft final determination reflected the ACCC’s preliminary views pending consideration of the parties’ submissions.  In December 2007, March 2008 and April 2008, the ACCC made final determinations in the arbitration of the eight disputes between Telstra and access seekers regarding the supply of the ULLS.  These final determinations specified the monthly charges under which Telstra supplied the ULLS to access seekers, expiring on 30 June 2008.  As at August 2008, the ACCC was arbitrating over 12 ULLS access disputes, all of which involved ULLS monthly charges.   There are currently a number of access disputes before the ACCC.

85                  Since the PIE II model was originally designed to reflect a network as then in place and to calculate network costs for the period 2001-02 to 2004-05, in order to calculate costs for 2005-06 and beyond a procedure was required to take costs from years up to and including 2004-05 and extrapolate them to 2005-06 and beyond.  Telstra provided the ACCC with an updated PIE II model and amended the underlying databases with updated information for 2006 to 2008.  In its Statements of Reasons in respect of the various arbitration determinations, the ACCC noted that it had used Telstra’s updated PIE II model, populated with the ACCC’s preferred inputs to estimate network costs.  In calculating prices for 2007-08, the ACCC used the risk-free rate at the start of the 2007-08 financial year to re-calculate the appropriate Weighted Average Cost of Capital (WACC).  The PIE II model was then used by the ACCC to recalculate prices relevant to that year (in contrast to previous years where the historical risk-free rate was used in the ULLS final determinations).  In determining indicative prices for 2008-09, the risk-free rate as of 26 May 2008 was used to determine the appropriate WACC.  Network costs for each year of the PIE II model were calculated and then a trend line applied to obtain cost estimates for 2008-09.  In June 2008, the ACCC stated that, until it had consulted and settled upon its own fixed network cost model, it considered that indicative prices based on TSLRIC+ pricing principles should be based on the PIE II network cost model.  There were significant problems with the PIE II model.  It is not presently necessary to recite them.

86                  The arbitrated monthly access charges for Band 2 ULLS were $12.30 for 2005/06, $13.70 for 2006/07, $14.30 for 2007/08 and $16.00 for 2008/09.  The ACCC prices that applied to industry from 2004/05 to 2006/07 ranged from $22 to $17. 

87                  The ACCC also made its ULLS Pricing Principles Determination of June 2008 using the PIE II model.  The indicative price was $12.30 for 2005/06, $13.70 for 2006/07, $14.30 for 2007/08 and $16.00 for 2008/09.

88                  In December 2007 Telstra lodged an ordinary access undertaking relating to the terms and conditions of supply of the ULLS for Band 2 Areas with the ACCC (December 2007 Undertaking). This undertaking was withdrawn on 3 March 2008.

89                  On 3 March 2008, Telstra replaced the December 2007 Undertaking with a new ordinary access undertaking relating to the terms and conditions of supply of the ULLS for Band 2 areas with the ACCC.  That is the 2008 Undertaking.  The 2008 Undertaking, as noted above, has led to the present application.

90                  Prior to the 2008 Undertaking, the ACCC used the n/e/r/a model and the PIE II model to assess Telstra’s ULLS undertakings.  The Telstra Efficient Access model (TEA Model) was developed by Telstra to support its 2008 Undertaking.  It is referred to later in these reasons.  The n/e/r/a model was commissioned by the ACCC in 1999 for assessing PSTN prices. It was further modified in 2002 for use in assessing ULLS prices.  The ACCC has not used the n/e/r/a model in its regulatory price-setting or price-assessing roles since 2002.  The ACCC did not rely on the n/e/r/a model in rejecting the ordinary access undertaking in respect of the ULLS given to the ACCC by Telstra on the 2005 Undertaking.  

91                  On the basis that both the ACCC and Telstra considered the n/e/r/a model was “significantly out of date”, the Tribunal (in considering the ACCC's final decision in relation to the 2005 Undertaking) was also not satisfied that the n/e/r/a model provided a reasonable estimate of the efficient network costs associated with the providing the ULLS for purposes of considering the 2005 Undertaking: Telstra  (No.3) at [377].

92                  The TEA Model was used to replace Telstra's PIE II model for the purpose of providing estimates of the cost of the ULLS.  It was first provided to the ACCC by Telstra in support of its December 2007 Undertaking.

93                  As with any cost model, the TEA Model necessarily involves the making of a number of assumptions, which impact the reasonableness of the cost model.


The meaning of TSLRIC+

94                  TSLRIC is an acronym for “total service long run incremental cost”.  The “+” refers to the allocation of common fixed costs, or contribution to indirect costs.  It can be understood by breaking the concept into its components.

(a)        “Total service” refers to the cost of production of an entire service, not to the cost of a particular unit. However, the cost is usually expressed on a per-unit basis by dividing by the number of units supplied;

(b)        “Long run” means that the concept refers to a period where all factors of production can be varied, as opposed to the short run, where the amount of at least one factor of production is fixed;

(c)        “Incremental cost” means that the concept refers to the additional costs of supplying the service over and above the situation where the service was not supplied, assuming the scale of all other production activities remains unchanged; and

(d)        “+” refers to the allocation of common fixed costs, or contribution to indirect costs. 

95                  The terms “common costs” and “indirect costs” are interchangeable (they both refer to costs not directly attributable the production of any one service).

96                  TSLRIC+ is also an attributable cost concept as it refers only to those costs that can be attributed to the production of the service. However, in the case of ULLS, it is produced using production elements shared with customer access lines and the Integrated Services Digital Network (ISDN), and these costs are rolled-in and shared over all lines. 

97                  The existence of common fixed costs (costs common to two or more services and therefore costs which do not form part of the incremental costs of any of the individual services to which they are common) means that, if all services were priced on the basis of TSLRIC+, total revenues would fall short of total cost.  To prevent such a shortfall, common fixed costs are allocated and recovered via a mark up on TSLRIC+.

Application of TSLRIC+

i. The cost concept

98                  TSLRIC+ is a broad theoretical concept, which can be implemented in a number of different ways.   TSLRIC+ can be based on forward-looking economic costs, although it does not have to be.  There is nothing to prevent TSLRIC+ from being estimated on the basis of costs incurred in the past (historical cost) to provide the service. However, in order to create efficient pricing signals it is common ground that it is preferable to use estimates of cost that will be incurred in the future.  Forward-looking economic costs are the costs of providing the service using the best available and commercially proven technology and efficient production practices. Such costs are derived using current asset prices. 

99                  Like all models, TSLRIC+ is dependent on the quality of the cost inputs and assumptions made in relation to them for its utility.  They must reflect “forward-looking best available technology and practices consistent with a real-world network architecture and actual conditions”.  The input values must be consistent with each other and with the purpose of the modelling.  They must reasonably allocate joint and common costs.  They must take account of costs incremental to providing the ULLS to as many potential customers as possible.  Hence, its utility depends on the quality of decisions about how to measure and allocate costs.  The input can obviously affect the output as an access price very significantly, as can the choice of pricing methodology.  Clearly, achieving satisfactory inputs is both complex and critical.  The parties accepted that it is appropriate to have regard to the existing network design in determining TSLRIC+ estimates, and they also agreed that should be done having regard to the nature of the declared service.  There was significant debate on a range of those issues between the parties.  One of those issues was whether it was appropriate to model the cost of providing the ULLS as an exclusively copper wired CAN when considering the LTIE, and so to determine whether the 2008 Undertaking was reasonable, as referred to in s 152AH(1)(a) and s 152AB(2) of the TP Act.  Another concerned the capacity of the TEA Model, as it was used, to meaningfully determine or assist in determining those matters.

100               Hence, whilst Telstra maintained that a standard TSLRIC+ principle is that the cost of a network of an efficient operator should reflect today’s values, so that an operator should only be able to recover costs necessary for maintaining future real-asset values in a competitive market, and therefore, the asset valuation should be derived from current cost accounting methodologies, neither Optus nor the other Interveners agreed, and the ACCC’s attitude was also qualified. 

101               The ACCC’s position is that, for a forward-looking TSLRIC+ estimate, the better estimate is on equipment costs at today’s costs, i.e. replacement costs with the modern equivalent assets.  Those assets should have the same service potential, and so represent the best (least-cost) option under current or best-in-use technology.  Where replacement cost is difficult to quantify, historical cost (appropriately inflated) or reproduction cost (to replace existing plant in substantially the same form at current prices) might be used to provide an estimate of replacement cost, provided the current assets embody the most efficient technology of providing the service.  Optus and the other Interveners agreed generally with the ACCC.

102               TSLRIC+ may also be estimated by reviewing the historical and current costs of operators, or by applying an optimised cost model using forward-looking (current) costs.  Optus said the perspective should be narrower in relation to Telstra’s avoidable costs: its operating and maintenance costs during the period of the proposed undertaking, and the cost of any required renewal or replacement of infrastructure or equipment.  It said there was a case for using a regulated asset value on the basis of historical cost accounting valuation, ie the written down value.

ii. TSLRIC+ access pricing

103               The ACCC states that the implementation of TSLRIC+ depends on how costs are measured and allocated, and the parameter values and underlying network assumptions used to produce cost estimates.  Optus submitted that, in principle, the application of a traditional implementation of a TSLRIC+ framework would value all assets at the cost of a Modern Equivalent Asset (MEA). A MEA is the lowest cost asset built with the latest available, proven technology which can provide the equivalent service potential as the service which is being costed.  The ACCC has acknowledged that “[i]f the rolling out of fibre closer to the customer makes the prospects of efficient duplication more remote, then some of the key rationales for a TSLRIC+ approach to pricing will be less relevant”.  Allocative efficiency is promoted by setting marginal consumption signals equal to short run marginal cost.  Bypass of an infrastructure asset occurs when a rival invests in competing infrastructure that provides substitute services.  Those matters are discussed below.

iii. Scorched node

104               The first step in TSLRIC+ modelling is to determine the configuration and technology of the network.  There are three main approaches to determining network configuration: 

(a)        Existing network design, which maintains the locations of existing network nodes and uses the types and volumes of equipment currently in place at and between nodes, regardless of whether the existing design and technology is efficient;

(b)        Scorched earth, which is based on the most efficient (i.e. least cost) network architecture, sizing, technology and operating practices that are currently available.  If this approach is taken, network nodes can be relocated in order to build an optimal network and minimize the costs of access lines, switching and interoffice transport; and

(c)        Scorched node, which maintains the network nodes in their current positions but uses efficient technology and volumes of equipment in and between the current node locations.  There is no universally accepted notion of which “nodes” ought to be used in the scorched node approach. 

105               “Nodes” are key features of the network.   In the TEA Model, the following components of the existing network are retained: the telephone exchange location, DA boundaries, pillar locations and customer locations.  Certain contentions were put that, by reason of that starting point in the modelling, the TEA Model could not usefully provide an output access charge which could or should satisfy the requirements of s 152BV(2)(d) – the reasonableness test – as informed by s 152AH.

106               There was also significant disagreement as to whether the TEA Model can, and should, use an optimised subset of the existing Distribution and Main cable nodes (using the existing rights of way).

107               What constitutes a “node” for the purposes of implementing a scorched node approach to TSLRIC+ estimation itself depends on the assumptions made.  The ACCC considers that a “scorched node” approach is based on the existing network, but optimised between and within the nodes.  The nodes that are to be fixed and the degree of “scorching” in a scorched node approach is a choice that is up to the modeller.  In general, the more nodes that are fixed, the less optimisation that occurs.  The scorched node assumptions typically made in TSLRIC modelling are that the exchange and customer locations are fixed but the other aspects of the network (e.g. cables, trenches and ducts etc) are subject to optimisation.   Marsden Jacob Associates, Review of the TEA Model – A Report prepared for Competitive Carriers Coalition, 12 August 2008, stated that “[t]he scorched node assumption typically used in TSLRIC modelling fixes the exchange location, but it allows other aspects of the network (cables, trench, duct etc.) to be variable and subject to optimisation”. 

108               Hence, there are different optimisation methods.  The ACCC and Optus expressed concerns about aspects of the optimisation in the TEA Model.  Optus said that, as the scorched node approach maintains some elements of the existing network and legacy decisions which may not be the most efficient in the current period, it will give a high estimate of TSLRIC+ as compared to a scorched earth model.  Under a scorched earth approach all network elements (e.g. pillars, exchanges, routes) are subject to most efficient/best practice analysis and optimisation. This approach generally gives the lowest possible estimate of TSLRIC+ as it removes all inefficiencies associated with the historical development of the network through time.  At the other end of the spectrum, a network can be based on the current costs of the existing firm. This will give the highest possible estimate of TSLRIC+ because it does not allow for any optimisation beyond what is already contained in the actual existing network.  Those parties said that the TEA Model is not based on a conventional scorched node approach, but is a hybrid between standard bottom-up and top-down model approaches.  For what it is worth, we note that the TEA Model’s approach on this issue is apparently contrary to that adopted in a number of jurisdictions in unbundled local loop models: see eg Network Strategies, Report for Optus: Review of Telstra’s TEA Model Version 1.1 – ULLS Undertaking (5 September 2008).

109               NERA Economic Consulting (NERA) stated that standard practice in TSLRIC+ models is to employ a scorched node approach.  This involves taking the existing number and location of network nodes but assuming best in use technology and efficient volumes of equipment within and between these nodes.  

110               Ovum Consulting (Ovum) stated in August 2008 that a scorched-node approach is one that bases the costs of the network on the existing network topology while a scorched-earth approach is based on a network with an ideal network topology that would meet the demands of a fully efficient operator.   Ovum further stated that the network modelled by the TEA Model is based on a scorched-node approach, as the main nodal locations are fixed.   Ovum stated that the modelled network was a fair starting point but that the model should be modified to eliminate Telstra’s inefficiencies.  Ovum concluded in August 2008 that the TEA Model (then version 1.0) did not reflect a network of an efficient operator and so failed to meet standard TSLRIC+ principles. 

111               Ovum later stated in February 2009 that the TEA Model, version 1.2, was working as originally described by Telstra and that the dimensioning of cables, ducts, pits, manholes, cable joints, cable gauges and pillars were all appropriate for a “scorched node” model of a copper access network for an efficient operator.  These calculations include efficiency gains over the existing network.   Ovum stated that although a “modified scorched node” approach may be beneficial in terms of efficiency, this would be a major undertaking and that Ovum did not advocate doing it.  Ovum stated that the “scorched node” approach, in which the Distribution Areas are fixed, is satisfactory for determining the costs of an efficient operator. 

112               It is not clear that the Ovum statement of February 2009 relates to engineering issues rather than to economic principles.  Moreover, Ovum states that the TEA Model is a “scorched node” model where the pillar locations are fixed.   Ovum uses the language “modified scorched node” to describe the situation where only some of the nodes are used as a starting point for the network design.  Ovum indicates that a “modified scorched node” (as described by it) “may yield further efficiencies but would be a substantial undertaking and is probably not justified for the purpose of the access undertaking”.  It also noted that “[i]n Europe and across the world many regulators have adopted [what Ovum describe as] a modified scorched-node approach”.

iv. Valuation of assets

113               It should be noted that TSLRIC+ modelled by the TEA Model, at best, is an estimate of what it would cost a hypothetical firm to replace Telstra’s current network in today’s conditions in a very short period of time using a single vintage of the best technology currently in use.  That would be impossible to achieve in the real world.

114               Implementing the TSLRIC+ concept requires the making of decisions about how to measure and allocate costs that potentially can have as large an effect on the access price as the choice of pricing methodology.

115               For example, a “scorched earth” approach to estimating TSLRIC+ assumes that nothing is fixed (and the cost estimate is based on the costs of the network that would be built if no network existed).   The ACCC appears to accept that it is appropriate to take into account the existing network design in determining TSLRIC+ estimates, but says that the extent to which it is appropriate to do so depends on the nature of the declared service.  Optus did not accept that as a legitimate starting point.

116               Standard practice is to value assets using the cost of replacing them with the MEA. The MEA is the lowest cost asset, providing at least equivalent functionality and output to the asset being valued.

v. Allocation of common fixed costs

117               TSLRIC+ requires an allocation of common fixed costs to services using some kind of mark up.  The Interveners, however, say that the appropriateness of such inclusion is a matter for debate amongst economists.  In its Pricing Principles, the ACCC stated that it is appropriate to allocate common fixed costs when discussing the application of TSLRIC+.  Most TSLRIC+ models use an equal proportionate mark up to allocate common fixed costs to different services. 


118               Broadband and telephone services can be delivered in the following ways: 

(a)        through metallic wires;

(b)        through optic fibres;

(c)        wirelessly, either by satellite or a mobile phone style of network; and

(d)        through fixed wireless means, such as WiMAX technology (which uses an air interface (as an alternative to copper or fibre) to connect a broadband service. 

119               Hybrid fibre-coaxial cable (HFC) networks are also capable of providing broadband and telephone services.  An HFC network is a network consisting of both fibre optic cabling and coaxial cabling.  Fibre optic cable is used at the trunk level and may be used up to a service area or up to the curb.  Coaxial cable is then run from either of these points into the end-user premises.   Both analogue and digital services may be run over cable.  The capability of HFC networks to provide both voice and broadband services depends on the manner in which they are configured. 

120               There has been some reduction in fixed line usage over recent years.  Fixed lines in Australia peaked at 11.66 million in 2004.  They fell by some 740,000 between 2004 and 2007.  It is not clear whether these numbers include HFC lines or are confined to copper fixed lines.  If those statistics include HFC customers, then the decline in Telstra’s fixed line customers may be larger than the 6% which they indicate.  Over the period 2003-04 to 2006-07, demand for existing access lines on Telstra’s network (retail and wholesale basic access and ULLS) fell by a significant number each year.

121               Telephony customers on Optus’ HFC network were 502,000 at 30 June 2004 and 513,000 at 30 June 2007.   This represents an increase of 2.2%.  However, telephony customers on Optus’ HFC network have grown 3.7% from 30 June 2007 to 30 June 2008.

122               At 31 December 2007, there were 6,933,814 SIOs in Band 2.  At 31 December 2008, there were 6,816,695 SIOs in Band 2.  The compound annual growth rate, as assessed by Telstra, was -1.4%. 

123               The TEA Model does not take into account the forecast decline in future demand.

124               ULLS uptake for all bands, however, has seen positive growth since June 2005.  Between 30 September 2007 and 31 December 2008, a very significant percentage of the growth in ULLS SIOs was attributable to Band 2.  At 31 December 2007, there were 10,264,732 SIOs across all bands.  At 31 December 2008, there were 10,115,537 SIOs across all bands.  The compound annual growth rate is assessed by Telstra at 1.2 percent. 

Optical fibre

i. Background

125               Optical fibre uses light waves for the transmission of all forms of telecommunications traffic, permitting the carriage of traffic at very high speeds with little interference. At the local access network level, it is used for transmission between network nodes and switches, and also for access to the premises of high-volume business subscribers and multi-storey office buildings. 

126               If a telecommunications carrier were to build a CAN today, it is more likely that optical fibre cable technologies would be used.  Optical fibre cable is not copper based and therefore not a “communications wire” for the purposes of the Declaration for ULLS.  Optical fibre can be rolled out to the kerb or to the home.  In Canberra, TransACT offers a fibre to the kerb network.   Optical fibre connections to the home or building were not widely available in 2008.  As discussed in the next section of these reasons, that is a significant matter.

127               It is accepted that, to ensure that all developers install networks for the future using fibre optic technology, the Government proposes to mandate the use of fibre optic infrastructure to the home and workplace in greenfield estates across Australia that are approved after 1 July 2010.   Indeed, as the Interveners urged, the evidence indicates that it is very likely, if not inevitable, therefore that optical fibre would be used rather than copper to build a CAN today.  There is evidence that fibre cables are much smaller, so they could be laid via micro trenching compared to the trenching required for larger copper cables, but to the extent that is relevant there may nevertheless be access difficulties for that trenching.  In addition, by way of contrast, there is evidence that copper cables are particularly susceptible to corrosion; in order to keep moisture out they need to be grease filled or filled with pressurised air.  There is no corresponding requirement for fibre.  Finally, if the TEA Model were to include fibre wherever it is more cost effective than copper wire cable, the effect would be that the longest local loops would be provisioned with fibre.  This is because those loops represent the copper loops with the highest capital cost because they require the most copper wire cable.  Telstra argues, therefore, that if the TEA Model assumed that the longer loops were provisioned by fibre, this would significantly understate the cost of provisioning those longer loops using copper (so that they were capable of being used for ULLS) which would result in the average cost of loops calculated by the TEA Model for the purpose of estimating the cost of ULLS being significantly below the true cost of providing the ULLS to access seekers.

ii. HFC networks

128               In metropolitan areas of Sydney, Melbourne and Brisbane, Telstra and SingTel Optus have deployed their own HFC networks. 

129               A typical HFC network consists of an optical fibre network that feeds nodes and a coaxial cable network from the nodes to customer premises.  Each node has up to 4 coaxial outputs. 

130               In the Final Decision, the ACCC stated that in Band 2 ESAs, the proportion of ESAs with the presence of HFC competitors was a significant percentage by December 2008.  Optus commenced its rollout of an aerial HFC network across Australia in the mid 1990s.   Optus’ data on its HFC network from some years ago indicated that Telstra and the Optus HFC networks at that time passed 2.2 million homes.   In March 2008, Optus stated that the Telstra HFC networks pass around 2.5 million homes. 

131               The Optus HFC network is in residential areas in metropolitan Sydney, Melbourne and Brisbane.   The majority of Telstra’s ESAs which overlap with the SingTel Optus HFC network are in ULLS Band 2 areas.   Telstra estimates that the HFC network covers 227 ESAs in Band 2, being 38% of Telstra’s Band 2 ESAs.  In 75% of these ESAs, Optus’ HFC network services 50% or more of the dwellings in each ESA.

132               It is important to note, however, that the mere fact that a HFC network may be present in an ESA, does not indicate the extent to which the network may be available in that ESA.  That is, the HFC is said to be “present” in an ESA if just one premises in that ESA is serviced by the HFC, and there is no evidence of any wholesale services being supplied using either Telstra’s nor Optus’ HFC. 

133               To provide services to premises not currently connected to the Optus HFC network, Optus has to make a physical connection to these premises which includes lead-in cabling, and more significant infrastructure installation in the case of MDUs.  The ACCC has previously noted there are significant barriers to infill expansion of the Optus HFC network, namely, some houses are genuinely unserviceable by either Optus or Telstra using their respective HFC networks, and there are significant barriers to connections of MDUs to the HFC.  Optus stated that it supplies residential customers via its HFC network, rather than Telstra’s CAN, where the premises are determined to be “serviceable” by the HFC network. 

134               Of the 2.2 million homes passed by the Optus HFC network, Optus treats approximately 800,000 homes as “unserviceable”.  The Optus HFC network passes approximately 514,000 dwellings located in MDUs that are not currently serviced.  The balance of approximately 286,000 are Single Dwelling Units (SDUs).  Optus does not supply services via HFC to MDUs.  Optus classified approximately 36% of homes passed by the Optus HFC network as unserviceable.   Telstra classified approximately 6.58% of homes passed by the Telstra HFC network as unserviceable. 

135               In addition, Telstra uses its HFC network to service MDUs only for cable broadband and Pay TV services. It uses the CAN to deliver telephony services to MDU customers.

136               Optus stated that it faces a range of costs to connect homes passed by its HFC network.  Some homes are less costly to connect and serve using HFC; others are more costly due to, for example, difficult terrain, or being a long distance from the HFC cable.  In order to minimise production costs, Optus is more likely to serve the more costly homes using Telstra wholesale services. SingTel Optus considers that this approach is technically efficient because the cost of serving a particular customer is minimised.


137               Wireless broadband and voice services can be provided over mobile wireless, which has evolved from mobile phone technology. The access network is provided by means of a radio channel (air interface) using cellular topology which offers roaming from interconnected regions of service.  Mobile wireless is not the only platform of wireless broadband.  Fixed wireless plays an important role in providing broadband in Australia.   There were 225 companies operating fixed wireless broadband services in Australia in 2008.  

138               In its Determination regarding Telstra’s exemption application in respect of the Optus HFC network, the ACCC stated that mobile services were only an effective substitute for fixed line voice services in a small percentage of cases.  The ACCC stated that the reasons for those findings in that Determination included the costs associated with mobile services and the inconsistency of call quality and consumer practice.   The ACCC noted that developments in the market may contribute to the future substitution of these products.

139               The ACCC also stated that wireless networks may not be close substitutes with DSL broadband networks, given the coverage and functionality which could be provided over higher bandwidth fixed networks.  The ACCC’s view was that it would be prudent to adopt a conservative approach in considering the substitutability of wireless networks for the purposes of its decision regarding Telstra’s exemption application in respect of the Optus HFC network, despite signs that wireless offerings were becoming increasingly competitive, because the extent to which consumers were considering wireless and mobile broadband internet technologies as substitutes for fixed technologies was unclear. 


140               As foreshadowed in the previous sections of these reasons, there are three broad issues which need to be addressed before considering the quality of the modelling and the inputs or assumptions into the modelling.  They are:

(1)               the criteria for assessing the 2008 Undertaking and the role and function of the Tribunal;

(2)               the terms of the 2008 Undertaking; and

(3)               the role of TSLRIC+ methodology and the TEA Model in assessing the 2008 Undertaking.

The ACCC, when addressing issue (2), also made submissions about two further issues: uncertainty about Telstra’s ability to impose charges in addition to the monthly $30 charge; and whether Telstra’s proposed non-price terms are appropriate.  The Tribunal will deal with those two further issues as part of issue (2).

141               As noted above, the Tribunal’s role is to stand in the shoes of the ACCC, on the basis of the material before, or considered by, the ACCC rather than to endeavour to identify particular error in the Final Decision of the ACCC: Telstra Corporation Limited (2006); [2006] ACompT 4 (the LSS Decision) at [16].  It is convenient to call that decision the LSS Decision because it concerned Telstra’s proposed Line Sharing Service monthly rental charge.

142               Relevantly, in the present circumstances, the Tribunal must therefore decide whether it is satisfied that the 2008 Undertaking is consistent with the SAOs that are applicable to Telstra, as required by s 152BV(2)(b), and that the terms and conditions of the 2008 Undertaking are “reasonable” having regard to the matters set out in s 152AH.

143               The Tribunal noted above Telstra’s emphasis upon the object of Part XIC of the Act of promoting the long-term interests of end-users of the carriage services or of the services applied by means of the carriage services, requiring regard to be had to whether the 2008 Undertaking is likely to result in achieving the objectives set out in s 152AB(2), and only those objectives.  Obviously, it does not follow that s 152AH must be ignored.  It would be contrary to the Act to do so.  Section 152BV(2)(d) requires the Tribunal to be satisfied that the terms and conditions in the 2008 Undertaking are reasonable.  Section 152AH requires the Tribunal to have regard to specified matters in deciding whether those terms and conditions are reasonable.  Each of the matters referred to in s 152AH(1)(a) to (f) must be considered and weight given to each of them as a fundamental element in the decision: see R v Hunt; Ex Parte Sean Investments Pty Ltd (1979) 180 CLR 322 at 329; R v Toohey; Ex parte Meneling Station Pty Ltd (1982) 158 CLR 327 at 333.  So much was recognised by the Tribunal in the LSS Decision at [68].  The assessment of reasonableness, by reference to those matters, is of course informed by the stated object of Part XIC in s 152AB(1) as explained and confined by s 152AB(2).  Indeed, s 152AH(1)(a) specifically refers to the object of Part XIC as expressed in s 152AB(1), and s 152AH(1)(f) reflects in a less specific way the objective described in s 152AB(2)(e).

144               The Tribunal does not consider that the decision in Telstra v ACompT dictates any different conclusion.  It did not concern the review by the Tribunal of a decision under s 152BV(2) or the application of s 152AH.  Rather, it concerned applications by Telstra under s 152AT of the Act, and s 152AT(4) expressly precluded the granting of such an application unless the decision maker was satisfied that the making of the order would promote the long-term interests of end-users: see at [139] to [141].  In the present context, ss 152BV and 152AH inform how the object of Part XIC is to be served or fulfilled.

145               The Tribunal also does not accept Telstra’s contention that, based upon that decision, it should simply look to the alternatives of the “future with” and the “future without” the 2008 Undertaking.  That inquiry was of course important in the context of that case.  But the Tribunal’s task is defined by the provisions of the Act.  As was said in the decision in Re Seven Network Ltd (No 4) [2004] ACompT 11 (the Seven Network Decision) at [119], the “future with” and the “future without” approach provides helpful guidance in testing the LTIE, but it is to be applied in the context of the particular legislative provisions directly applicable.  The Tribunal has pointed out that, in this matter, its focus is upon its satisfaction of the reasonableness of the 2008 Undertaking under ss 152BV(2) and 152AH.  That is, the legislative setting in which the LTIE is specified to be assessed.  If the Tribunal is not so satisfied, the “future without” almost certainly involves the ACCC arbitrating access disputes concerning the ULLS in Band 2 areas, with an outcome of arbitrated terms and conditions – including price – which will then indicate the LTIE.  It is not possible to assess the “future without”, except as ascertained by the process of arbitration and its outcome.  Its outcome is in one sense unknown.  But there is no reason to think that its outcome would not be appropriate, or would not be the result of appropriately followed arbitration processes.  Nor is there any reason to think that its outcome will not be in the LTIE.

146               Consequently, in the Tribunal’s view, it is required to consider the reasonableness of the methods and principles used by Telstra in proffering the 2008 Undertaking, principally in relation to the proposed monthly charge: see Telstra Corporation Limited [2006] ACompT 4 at [63], as explained in s 152AH.  If it is satisfied of its reasonableness, it will accept the 2008 Undertaking: Optus Mobile Pty Limited [2006] ACompT 8 at [9]; Telstra Corporation Limited [2006] ACompT4 at [20].  If it is not, it cannot accept the 2008 Undertaking.

147               Before turning to the terms of the 2008 Undertaking, this is a convenient point to deal with a discrete issue concerning the material to which the Tribunal could refer: the Evidentiary Limit.

148               Section 152CF(4) of the TP Act sets out the evidentiary limit on a review of a decision of the ACCC under s 152BU(2). Section 152CF(4) provides:

(4)        For the purposes of a review, the Tribunal may have regard only to:

(a)        any information given, documents produced or evidence given to the Commission in connection with the making of the decision to which the review relates; and

(b)        any other information that was referred to in the Commission’s reasons for making the decision to which the review relates.

149               Section 152CGA provides:

(1)        If the Commission:

(a)        makes a decision referred to in section 152CE; and

(b)        gives a person a written statement setting out the reasons for the decision;

the statement must specify the documents that the Commission examined in the course of making the decision.

(2)        If a document is specified under subsection (1), information in the document is taken, for the purposes of paragraph 152CF(4)(b), to be referred to in the Commission’s reasons for making the decision.

The Final Decision of the ACCC under s 152BV(2) is a decision referred to in s 152CE.

150               The ACCC says that, to the extent that any submissions of the parties fail to identify the material relied upon as evidencing factual matters contended for, the Tribunal must first be satisfied that those factual matters are evidenced by material within the evidentiary limit.

151               In the course of the submissions, both written and oral, certain documents were referred to which, the ACCC says, are not within the evidentiary limit, being documents not falling within the scope of ss 152CF(4) or 152CGA.  The documents were, however, included in the review book, which was before the Tribunal, but were not included in the ACCC’s Final Index.

152               After the hearing of the matter, on 2 September 2009, the ACCC provided to the Tribunal a copy of a revised list of the documents referred to by one or other of the parties which may raise evidentiary limit concerns. That document was prepared following a review of all of the written and oral submissions of all the parties, and of the Statement of Material Facts. The ACCC identified those documents referred to by the parties that did not appear in the Final Index of s 152CF(4) documents  dated 18 August 2009, or in the supplement to that index of 21 August 2009 (together with the Final Index), and it made submissions as to whether those documents (which were documents cited in one or other of the documents listed in the Final Index) had been used in accordance with the evidentiary limit established by s 152CF(4) and as applied by Goldberg J in Seven Network Limited [2004] ACompT 10 and Seven Network Limited (No 4) [2004] ACompT 11.  The ACCC says that in preparing the revised list, it included those reference documents relied upon by the parties that have been used for a purpose other than the purpose to which they were put in the Final Index document in which they were cited, so the ACCC says, in contradiction to the ruling of Goldberg J.

153               By reason of s 152CGA, the evidentiary limit includes any documents that the ACCC examined in the course of making the decision.  In Re Telstra Corporation Ltd (No 1) (2006) 204 FLR 384 at 390-1, the Tribunal found that the ACCC’s obligation to provide a statement of documents which it examined in the course of its decision making under s 152CGA should be performed from time to time as the occasion arises.

154               In Re Telstra Corporation Ltd (No 1) (2006) 204 FLR 384 at 391, the President of the Tribunal, Goldberg J stated:

Just because a document is referred to in the statement given for the purposes of s 152CGA, and just because a document falls within the scope of the documents under s 152CF(4), it does not follow automatically that the Tribunal either will consider, or is bound to consider, and examine those documents. Even if a document is referred to in a Final Index it is still open to an applicant, and indeed any other party, to submit that a document should not be examined or looked at by the Tribunal or by other parties.

155               In that matter, in the context of considering whether the Tribunal could have regard to the reference document from which a quotation was drawn (that is, a document cited in a document that was produced to the Commission, and thus clearly within the evidentiary limit), Goldberg J considered that the Tribunal could go to the reference document “for the purpose of understanding the context and to find where that quotation appears”. Goldberg J went on to indicate that such reference documents are not produced to the Commission “to trawl through to find anything else it might be interested in which isn’t referred to in the body of the submission”.  His Honour agreed with counsel for the ACCC in that case that what is “given” to the Commission in such circumstances is not the reference document itself, but the information reproduced in the submission (in that case, the quote) and the source.

156               There are six documents which were the subject of submissions about which the ACCC said the reference to them exceeded the evidentiary limit.

157               The first document is authored by iiNet, described as an iiNet presentation to UBS Small Cap Telco Conference, dated November 2005, specifically slide 7.  That document was cited by Telstra in Telstra’s Response to Access Seeker submissions (dated 18 November 2008).  The latter document is in the ACCC Final Index.  The footnotes referring to the first document are given for the following two statements:

Additionally, in a presentation dated toward the end of 2005 discussing “Why iiNet builds infrastructure”, iiNet assumes that ULLS prices are $22. iiNet claims that migrating customers from resale to ULLS will reduce network costs from just over $80 to just over $40, a cost benefit of $40.

The second document is a letter re Analysis Cost Model for Australian Fixed Network Services Version 1.1.  The third “document” is Telstra’s local carriage service and wholesale line rental exemption applications, Draft Decision and Proposed Class Exemption.  The fourth document is a submission to the ACCC in Response to its Draft Decision on Telstra’s Exemption Application in respect of the Optus HFC Network, Public version.  The fifth document is a letter concerning asserted errors in the ACCC’s cost model (and attachment)).  The sixth document is a document authored by the Federal Communications Commission, “In the matter of Review of the Commission’s Rules regarding the pricing of unbundled network elements and the resale of service by incumbent local exchange carriers, WC Docket No 03-173, FCC 03-224” (the FCC Report, released on 15 September 2003).  The FCC Report is referenced in two of the documents listed in the Final Index.

158               The Tribunal does not need to formally rule upon whether those six documents, or any of them, or the use for which they are now referred in the submissions of one or other of the parties, go beyond the evidentiary limit.  That is simply because the Tribunal does not regard any of those documents as having such significance as to warrant their detailed consideration in the context of the concerns of the ACCC.  It does not propose to rely upon that material beyond the use which the ACCC acknowledges it was given when the ACCC was reaching its Final Decision.

The Terms of the 2008 Undertaking

159               The significant terms of the 2008 Undertaking are set out above.

160               The ACCC pointed out some additional features of the 2008 Undertaking, in addition to the monthly charge, which should be noted.

161               There is a disconformity between the ULLS as defined in the Declared Service and the service defined in paragraph 1 of Part B of the Attachment to the 2008 Undertaking (Telstra service).  In particular:

(a)        The 2008 Undertaking provides that the Telstra service will support a connection with DC continuity but there is no requirement for the Telstra service to support any other service.  Thus, a connection that does not support a DC continuity is not governed by the 2008 Undertaking, notwithstanding that such a connection is part of the Declared Service.

(b)        The Telstra service is defined in a way that limits the service to an agreed point of interconnection located at or associated with a Telstra CAM.  The Declared Service extends to service of a potential point of interconnection.  No mechanism is provided in the Undertaking for determining what is to occur if a point of interconnection cannot be agreed between Telstra and an access seeker.  Thus, if a point of interconnection cannot be agreed, it would appear that Telstra is not bound to provide the ULLS to the access seeker on the terms and conditions in the Undertaking.

162               The 2008 Undertaking stipulates a monthly charge for each Telstra service of $30.00.  However, the 2008 Undertaking also provides that Telstra may levy charges on access seekers in addition to the monthly charge.  In particular, the Undertaking provides for a “connection charge” (which is not dealt with by the 2008 Undertaking), as well as charges “for other aspects of the service” including (apparently without limitation) charges for operational aspects such as service qualification inquiries and order withdrawals (which are also not dealt with by the 2008 Undertaking).  It is unclear, therefore, to what extent Telstra would be permitted by the 2008 Undertaking to levy charges on access seekers in addition to the proposed monthly charge of $30.  For example, it is unclear whether the 2008 Undertaking would permit Telstra to charge access seekers amounts required to recover its ULLS specific costs (as opposed to its ULLS network costs).  Telstra has asserted that the proposed monthly charge includes ULLS specific costs, but that clarification does not appear in the 2008 Undertaking.

163               The 2008 Undertaking contains non-price terms and conditions on which Telstra is obliged to provide the Telstra service.  The ACCC says that clause 1.4 appears to allow some discretion to Telstra as to whether it is obliged to provide the Telstra service.

164               Finally, the ACCC says that the 2008 Undertaking does not contain provisions which address all of the SAOs specified in s 152AR of the Act.  Further, in respect of the SAOs which are addressed, the 2008 Undertaking does not purport to include all possible terms and conditions on which those SAOs will be met.

165               As to the second and fourth of those matters referred to, the ACCC accepts that the 2008 Undertaking should not be rejected on that basis alone.  They are matters noted by the ACCC in its Final Decision, but not as reasons in themselves for the ACCC not being satisfied that the 2008 Undertaking is reasonable.

166               It is clear enough that the 2008 Undertaking cannot be seen to be reasonable if its scope of operation is uncertain.  Access seekers will not be able to make informed commercial decisions unless the extent of their obligations is clear, and unless the regulatory framework is specific.  If they are inhibited from competing in the supply of services by such uncertainty, that will not be in the LTIE.

167               Telstra does not accept that there is any ambiguity in relation to the price it proposes for access to the ULLS under the 2008 Undertaking.  What you get for the $30 access price, it says, is the use of the ULLS.  The additional matters referred to by the ACCC relate to operational aspects of the ULLS.  In any event, Telstra’s position is that any additional charges to which it may be entitled need not be specified as an undertaking under Part XIC of the Act need not specify all of the terms and conditions.  Consequently, if there is potentially an unspecified additional charge which is not agreed, the ACCC could resolve that issue under s 152AY(2)(b)(ii) of the TP Act.

168               The Tribunal does not need to resolve the question as to the full scope of the 2008 Undertaking, and so whether the proposed access charge of $30 per month is comprehensive of all services which might be required of Telstra to provide access to the ULLS.  That is because the Tribunal has come to the view that, in any event, it is not satisfied that the proposed access charge specified in the 2008 Undertaking is reasonable.  The issue, moreover, did not loom largely in the Final Decision.  However, the Tribunal makes the observation that the access charge will generally be the, or one of the, most significant terms of an undertaking.  It will generally be important in a matter such as the present that the ACCC, or the Tribunal, have a clear understanding of the services covered by the proposed access charge and any related “operational services” which are, or may not be, covered by the undertaking.  The satisfaction as to the reasonableness of the undertaking, including the access charge, should not be dependent on a debatable interpretation of the terms of the undertaking.  If there are particular services not covered by the proposed undertaking, it is desirable that they be clearly identified.  The entities seeking access to the ULLS should not be left in a state of uncertainty as to what is covered by the access charge.  They should not be left to interpret the undertaking to make an informed, but arguably erroneous, view as to what it covers.  It is, in the Tribunal’s view, a feature relevant to the reasonableness of an undertaking that those who may seek access to the ULLS can clearly know whether the undertaking applies, and the extent to which it does not apply.

169               However, as the Tribunal has indicated, in this matter it is not necessary to put such matters on to the scales when assessing the reasonableness of the 2008 Undertaking.

170               In this context, it is also convenient to deal briefly with certain other matters raised by Optus and the Interveners.

171               The Tribunal does not accept that, if it were satisfied that the 2008 Undertaking were otherwise reasonable (including the access charge), it should not be satisfied that it is reasonable simply because the proposed access charge is significantly higher than that presently applying.  It might have been that the TEA Model, and the inputs and assumptions on which the TSLRIC+ output is presented, are appropriate, and the proposed access charge might have been reasonable.  The processes prescribed by the TP Act to determine the reasonableness of an undertaking do not require the Tribunal to perpetuate a low access charge if it is satisfied that a higher one, even a significantly higher one, is reasonable. 

172               In this matter, whilst the “dramatic increase” (to use Optus’ description) on the current access price for the ULLS may be but a stepping stone to a higher proposed access charge after 31 December 2010, and whilst it may demonstrate some unpredictability and potential instability in access pricing, the claims of Optus and the Interveners that their capacity to compete in downstream markets and their incentives to make efficient investment in infrastructure and efficient use of existing infrastructure remain not fully tested.  The evidence does not enable the Tribunal to make findings about those assertions. 

173               Counsel for the Interveners also submitted that Telstra’s proposed access charge is not supported by new material, but is only the outcome of the TEA Model, not previously used.  Hence, the Intervenors submit, there is no real foundation for so significantly increasing the access charge.  The Tribunal does not accept that submission.  The Tribunal’s function is to form a view as required by the TP Act.  If, as is asserted, the only new factor is the TEA Model, so be it.  Modelling becomes refined and improved over time.  As noted earlier in these reasons, there is some evidence that the ACCC is in the process of developing a further new model for the purpose of assessing the reasonableness of any future undertaking proposing an access charge for the ULLS.  Of course, that does not entitle the Tribunal to assume that TSLRIC+ pricing, because it has been used in the past as a means of assessing the reasonableness of an undertaking, is necessarily an appropriate means of assessing the reasonableness of the 2008 Undertaking.  That is a matter for the Tribunal to address, as it has been raised as an issue.  Nor is the Tribunal entitled to simply accept the TEA Model as reasonable because it is said to be based on TSLRIC+ principles.  Again, that is a matter for the Tribunal to address, it having been raised as an issue.  The Tribunal notes that it has not reviewed the data used in the past in the earlier modelling process to determine whether in fact it remains unchanged.  In its view that would be a sterile exercise.

174               There was a further submission by the Intervenors that the regime between the parties by which the confidentiality of commercial information of each of the parties has been sought to be protected has impaired them from properly assessing the TEA Model.  It is not clear where that submission takes the Intervenors, having regard to the role of the Tribunal under the TP Act.  The appropriateness of using the TEA Model, and its various inputs, are all matters which the Tribunal is to address.  It will do so upon the whole of the evidence, and in the light of the submissions of the parties.  The evidence includes the opinions of a number of experts on the TEA Model and its various inputs.  It was not suggested prior to the hearing that the access regime under the TP Act involved any procedural unfairness.  Nor ultimately did the Intervenors submit that that was the case. 

175               The Intervenors also submitted that certain non-price terms in the 2008 Undertaking were not appropriate.  They identified terms which require access seekers to comply with various Australian Communications Industry Forum (ACIF) (now Communications Alliance) codes, including the ULLS – Network Deployment Rules in ACIF C559:2005; the ULLS – Ordering, Provisioning and Customer Transfer code in ACIF C569:2005; and the ULLS – Fault Management Guidelines in ACIF 9572:2001.  It also requires access seekers to comply with “the applicable industry safety standards”.  Those requirements were said to be inappropriate for a number of reasons: firstly, that the applicable standards are not specified (other than as stated); secondly, that they are not contained in the material before the Tribunal so it cannot assess the reasonableness of their requirements; thirdly, that the standards are themselves not sufficiently specific; fourthly, the 2008 Undertaking does not spell out the consequences of an access seeker failing to comply with a term or terms of an applicable standard, with the prospect of access to the ULLS on the part of an access seeker being cancelled for a relatively minor infraction; and fifthly that compliance with those standards should not be included as a condition of access to the ULLS as, to the extent to which they are required to be complied with by the Telecommunications Act 1997 (Cth), that Act contains its own provisions for their breach.

176               With one qualification, the Tribunal does not accept those contentions.  If there is an uncertainty about the scope of the standards referred to, clearly unless they are expressed in the 2008 Undertaking, they would not extend beyond those which the Telecommunications Act 1997 (Cth) imposes upon persons using the ULLS.  If the 2008 Undertaking were to have a wider scope, it would have to say so expressly.  Moreover, because the 2008 Undertaking refers to the standards referred to as amended from time to time, it recognises that the standards applicable are so confined, and that the legal obligations from time to time are the relevant standards.  The extent of those legal obligations will also be the extent of the obligations imposed by the 2008 Undertaking.  In the absence of any provision in the 2008 Undertaking specifying particular consequences of a breach of a particular provision of an applicable standard, the obligation imposed could not routinely lead to unreasonable consequences to the access seeker.  Indeed, apart from the reassertion of the legal obligations imposed by applicable standards, the consequences of any such breach may – except in the most obvious and serious instances – not lead to any remedy available to Telstra.  It would be up to the regulator to address the consequences of such breach.  There is no reason to conclude, as a matter of construction of the 2008 Undertaking, that Telstra might be able to impose any inappropriate consequences (such as the posited termination of the right to access) upon an access seeker.

177               The one qualification adverted to relates to the fifth reason.  There is a question as to the utility of Telstra by the 2008 Undertaking importing compliance with the law, or with particular legal obligations, into the terms of access.  That is not a matter which leads the Tribunal in this matter to the view that the 2008 Undertaking for that reason, is not or might not be (weighed in the scale with other considerations) reasonable.  It is unlikely in any circumstance that importing into an undertaking the obligation to comply with the law, without more, could lead to the view that the undertaking is not reasonable.  It would be unfortunate, however, if such an obligation in an undertaking which did have the purpose of providing significant sanctions for breach of a law should lead to an unnecessary focus on the details of those laws and how their breach might lead to consequences.  It is therefore desirable that, if an undertaking requires compliance with a particular law or laws for a particular purpose or purposes, beyond the generality referred to, that it be specific about those matters and about the consequences of non-compliance.  As the Tribunal has already remarked, the assessment of the reasonableness or otherwise of an undertaking under Part XIC should not turn upon arguable constructions of its meaning and effect.  They should be clear.

178               Finally, in dealing with the “Other Issues” as categorised by the parties in the Revised Issues List, the ACCC contended that Telstra’s proposed $30 monthly access charge was so removed from the modelled outcome, being only some 60-65% of it, that there is no basis for being satisfied as to its reasonableness.  The ACCC says that the unexplained difference between the modelled outcome which Telstra presents as its efficient costs and the amount specified in the 2008 Undertaking raises the question whether Telstra seriously believes that the TEA Model produces a reliable and reasonable estimate of efficient forward-looking ULLS network costs.

179               The Tribunal has adverted in general terms to that contention and to Telstra’s response earlier in these reasons.  Its function is to determine whether it is satisfied that the terms of the 2008 Undertaking, and most relevantly the $30 monthly access charge, is reasonable.  That does involve consideration of the appropriateness of TSLRIC+ and of the TEA Model, and its inputs.  The fact that the proposed access charge is much less than the modelled outcome is not of itself a reason to doubt the appropriateness of TSLRIC+ or of the TEA Model.  It is equally consistent with Telstra’s asserted confidence in those matters, and in the inputs to the model and its outcome, that it should have adopted a significant margin for error.  Or, more accurately, a significant margin for the ACCC, and now the Tribunal, to take a different view about the reasonableness of a number of the assumptions made and the inputs into the modelling.  The sensitivity analysis produced by Telstra shows that changing certain of the assumptions and inputs may produce a not insignificant change in the modelled outcome.  As earlier indicated, the Tribunal is not of the view that Telstra’s adoption of the proposed monthly access charge so different from the modelled outcome itself indicates any lack of confidence on its part in the modelling process or its inputs or its outcome.


180               The application of TSLRIC+ and the differing views of the parties have been canvassed above.  In its Draft and Final Decisions and in its submissions, the ACCC re-affirmed its long-held view that an appropriately implemented TSLRIC+ approach to estimating ULLS access charges is likely to satisfy the relevant legislative criteria, and it notes that the Tribunal has, on previous occasions, supported its view.  The ACCC also restated its view that how TSLRIC+ is implemented is an important consideration in assessing whether a proposed monthly charge is likely to satisfy the reasonableness criteria in s 152AH.  For a number of reasons, the ACCC concluded that Telstra’s implementation of TSLRIC+ through the TEA Model is unlikely to result in its proposed charge being reasonable.  Further than that, and as noted above, the ACCC threw some doubt upon the rationale for a TSLRIC+ approach to pricing in current circumstances.

181               The Tribunal does not consider that it is possible sensibly to evaluate the use of a TSLRIC+ approach without concurrently considering how it is implemented and, in particular, the way in which costs are estimated.  Indeed, discussion of the TSLRIC+ approach in the submissions is, perhaps unavoidably, sometimes conflated with discussion of its implementation, with TSLRIC+ being assumed to have certain features beyond those, explained earlier in these reasons, by which it is named.  A forward-looking basis is generally assumed to be part of the TSLRIC+ approach, and further assumptions about how forward-looking costs should be estimated are often embedded in the treatment of TSLRIC+.

The views of the parties

182               The ACCC considers that an access charge based on efficient, forward looking economic costs of supply of the ULLS service creates signals for efficient build decisions by an incumbent, regulated carrier or carriage services provider and efficient “build or buy” decisions by access seekers.  A charge higher or lower than this, it submits, would be inconsistent with the LTIE objectives of Part XIC of the TP Act.

183               Telstra, at the level of principle, is in agreement with this part of the ACCCs submissions.  It further refers to the ACCC’s Final Decision stating that TSLRIC+ pricing is designed to mimic the price that would prevail if the access provider faced effective competition caused by the threat of being displaced as a supplier through the possibility of by-pass.  Telstra further argues that this is achieved by estimating what it would cost a hypothetical firm to replace Telstra’s current network in today’s conditions in a very short period of time using a single vintage of the best technology currently in use.

184               Optus and the Interveners dispute this line of reasoning for numerous and somewhat different reasons.  The key element in both cases, however, is that a TSLRIC+ estimate based on full forward-looking hypothetical replacement costs of the CAN/ULLS will result in access charges that are likely to be too high.

185               The essence of the arguments Optus advances against TSLRIC+ in principle is that estimates of Telstra’s costs based on continually revaluing Telstra’s assets at hypothetical modern equivalent replacement costs would overcompensate Telstra, because it ignores the previous (partial) recovery of Telstra’s investment.  The relevant method of setting access charges, on Optus’ argument, would be to allow Telstra to recover only the unrecovered capital costs of its prudent investment in the CAN, plus a “normal” return on that investment, an allowance for Operating and Maintenance costs and a return on, and of, any additional prudent capital expenditure necessary to maintain the service potential of the CAN.  That, Optus claims, would be sufficient to provide Telstra with incentives to efficiently maintain its existing infrastructure and invest in additional infrastructure.

186               The Interveners make submissions similar in spirit to those of Optus, but different in content.  Specifically, they submit that since investment in the CAN is sunk, it is only Telstra’s incremental costs that are important in determining whether it will have a significant incentive to invest.  In the past, they suggest, there has been a somewhat misplaced emphasis on (at least in principle) encouraging investment in competing local loops when a large-scale replication of Telstra’s network would always have been inefficient.

187               The Interveners and Optus also make much of the claim that the current TSLRIC+ approach, supported by the ACCC, cannot any longer be justified in the face of the federal government’s roll-out of the NBN.  This, they submit, suggests that there should be a compromise between TSLRIC+ pricing and historical cost pricing.  In verbal submissions, the Interveners specifically proposed that TSLRIC+ pricing, based on modern equivalent asset replacement costs, should only be applied where that would provide access charges less than those that would be determined by reference to Telstra’s (prudent) historical costs.

TSLRIC+ and the reasonableness criteria

188               As all parties noted, the Tribunal has previously endorsed the use of an appropriately applied TSLRIC+ methodology as a basis for setting access charges.  The Tribunal must now examine the specific implementation of TSLRIC+ in the context of the 2008 Undertaking.

189               It is said that the TSLRIC+ approach seeks to estimate charges that mimic those that would apply in workably competitive markets, if the carriage service provider were, hypothetically, to face such competition.  A hypothetical new entrant would face the costs associated with a modern replacement equivalent asset and, the charge an incumbent service provider could sustain would be what a competitive provider would require to ensure that it would recoup its capital and operating costs in the long-run. 

190               The adoption of the TSLRIC+ pricing approach by the ACCC was based on a judgment that it is likely to generate prices that are reasonable in terms of s 152AH.  That is, the ACCC considered that this approach might meet all six of the criteria set out in s 152AH(1), or at least may best balance those criteria in such a way that acceptance of an undertaking applying such an approach is in the LTIE.  The argument goes as follows.

191               A long-established body of economic analysis  supports the view that a competitive price sends the right signals for promoting competition in markets for services provided by access seekers by means of their use of the ULLS (i.e. for listed services in the terms of s 152AB(2)(c)); and for the economically efficient use of, and investment in, the infrastructure by which listed services are supplied by both Telstra and its wholesale customers, i.e. access seekers (s 152AB(2)(e)).  (Achieving any-to-any connectivity is not at issue.)  Thus, a competitive price is consistent with the likely result of achieving the objectives set out in s 152AB(2).  These are the objectives, the achievement of which must be had regard to in determining whether the price promotes the LTIE (s 152AH(1)(a)).

192               A price that would be charged by Telstra if it faced competition in the provision of the ULLS would be consistent with Telstra’s legitimate business interests, since no business has a right to revenues higher than those obtainable in a competitive market (s 152AH(1)(b)).

193               Such a price would be consistent with the interests of those who have rights to use the ULLS, viz access seekers such as Optus and the Interveners, because they could expect no lower a price than would be charged in a competitive market (s 152AH(1)(c)).

194               Such a price would allow Telstra to recover the direct costs of providing the ULLS in the sense that it would not allow it to recover, in addition, any lost profits in the provision of services to which the ULLS is an input, where it competes with access seekers (s 152AH(1)(d)).

195               Such a price would also be consistent with requirements for the safe and reliable operation of the ULLS (s 152AH(1)(e)), and with its economically efficient operation (s 152AH(1)(f)).

196               Consequently, so the argument goes, if it can be ascertained that TSLRIC+, properly implemented, would, in fact, generate a price mimicking that which would prevail in a competitive market, then it is likely that such a price would be reasonable in terms of s 152AH.

197               What a hypothetical market for the ULLS would look like, and what sort of prices would prevail in it, are very difficult to ascertain in the current circumstances; more so than was the case at the time when the ULLS was declared, because since that time the nature of the fixed-line market has become very uncertain with the proposed investment in the NBN coming on top of what was already a clear trend towards Telstra pushing fibre further and further towards customers’ premises, thus reducing, over time, the extent of the ULLS.

198               However, as will become clear, the Tribunal has a basic difficulty with the proposition that the costs of a hypothetical new entrant, at least as modelled by Telstra, should form the basis for the access price.

199               The Tribunal notes that the ACCC has said that it may revisit its pricing principles in the light of the evolving nature of the telecommunications industry and the lack of deployment of competing end-to-end infrastructure by access seekers.  In those circumstances, a simpler and more appropriate pricing methodology might be, for example, to apply a “regulated asset base” approach, like that used in relation to other regulated infrastructure providers.  The Tribunal considers that such a review of the ACCC’s pricing principles is highly desirable.

Choice of technology

200               A significant issue that arises in estimating efficient forward-looking costs concerns the choice of technology.  There is widespread agreement that if the estimates of costs of providing the relevant service(s) are to be genuinely forward-looking then the technology assumed to be embodied in the assets used to provide them by a hypothetical new entrant must also be Modern Equivalent Assets (MEAs), capable of providing at least the same service potential as the incumbent’s existing assets.

201               It is also widely agreed that the technologies to be modelled cannot reasonably be considered to be the “best available” in the sense of the most recent breakthrough, but rather should be technologies that are commercially available and in use that is “best-in-use” or, perhaps more appropriately, “best in widespread use”.  This is so for a number of reasons.  In particular, the cost properties of utilising recent breakthroughs would be unknown, or poorly known at best, and attempting to base estimates of forward-looking costs on them would be hazardous.  Relatedly, since the commercial viability of deploying a recent technological breakthrough on substantial scale would be uncertain, it would be unreasonable to subject the incumbent to a cost standard based on the breakthrough or at least to do so without including a substantial risk premium that a business deploying the technology would require.

202               In its estimation of forward-looking costs as the basis for its proposed monthly charge, Telstra has assumed that a hypothetical new entrant would deploy an all-copper network in Band 2 areas.  What is in dispute is whether doing so is an appropriate basis for estimating efficient forward-looking costs.  The Tribunal will deal first with the question of technology, i.e. whether a copper-based network is the appropriate basis, and secondly with the notion of a hypothetical new entrant and how the TEA model estimates its costs.

203               In its Final Decision, the ACCC says that, because Telstra’s TEA model estimates the (efficient) costs of an all-copper network, Telstra’s estimates “will not reflect the optimal network design and best-in-use technology in the present day.”

204               The ACCC accepts that its conclusion in the Final Decision reflects a change in its view from that contained in its Draft Decision.  It indicates that, while the Draft Decision noted that the issue of alternative technologies had been raised by Marsden Jacobs Associates (MJA), this was an isolated submission and the ACCC had, at that stage, taken the view that, because the ULLS service description is technology-specific, the hypothetical (efficient) network to be modelled is copper only.  It now considers that the technology-specific nature of the ULLS service description is irrelevant to the hypothetical network design and that, by failing to consider other technological options that may offer greater service potential, Telstra’s TEA model’s cost estimates “will necessarily not be forward-looking.”

205               In support of that change of position, the ACCC, inter alia, refers to the fact that, in response to its Draft Decision, it received several additional submissions indicating that a hypothetical new entrant would be unlikely to build an all-copper network.  The submissions specifically referred to by the Commission were from Unwired, CEG and the CCC.

206               The ACCC and the Interveners in this matter contend, and Telstra in its final submissions accepts, that if the Tribunal considers that modelling a (hypothetical new) copper network is not an appropriate basis for estimating efficient forward-looking costs, then the Tribunal could not be affirmatively satisfied that Telstra’s proposed monthly charge is reasonable in the terms required by the statutory criteria, and the matter would rest on that account.

207               Before turning to consider the submissions and contentions made by the various parties to the Tribunal’s hearing of this matter, the Tribunal has two initial observations to make relevant to its considerations of this issue.

208               First, the Tribunal notes that the ACCC’s depiction, in its Final Decision, of the conclusions it drew in its Draft Decision omits a part of the reasoning it earlier relied upon.  That is, it saw itself as supporting “a pragmatic implementation of TSLRIC methodology” in accepting the modelling of an all-copper network, including because of the need actually to be able to determine a price for the ULLS.

209               Second, and relatedly, the Tribunal notes that the submissions concerning alternative technologies quoted in the ACCC’s Final Decision [at pages 142 and 143] do not identify what technology or specific mix of technologies a hypothetical new entrant would most likely deploy specifically in Band 2.  The nearest they come to doing so is by reference to the conditional statement by CCC that “… if a new operator were to re-dig the trenches … it would lay fibre to the home rather than copper.”  CCC then goes on to say the costs of doing so would be “about the same” (as for laying copper), albeit that it would result in “a significantly higher quality of service.”  Since the Tribunal has not been asked by any of the parties to consider some notion of “quality adjusted” costs, this is of some importance.

210               Telstra’s submissions in response to this aspect of the ACCC’s Final Decision contain three separable strands.  However, the first of them is critical – that is the service description – and the Tribunal restricts its considerations to that issue, since Telstra’s submissions live on or die by reference to that alone.

211               Telstra’s principal contention is that the service description of the ULLS contained in the ACCC’s determination that the ULLS should be a declared service in effect rules out consideration of a network constructed with anything other than copper.  The service description defines the ULLS as involving the use of “unconditioned communications wire” and, in turn, defines a communications wire as a “copper-based wire”.  It follows, Telstra submits, that any service delivered by a technology that is not copper-based will not use a “communications wire” and hence will not satisfy the ULLS service description.

212               Telstra also points to – and makes substantially more of – the fact that the service description specifies that the communications medium (wire, literally speaking) should be “unconditioned”.  In the current copper-based system, the import of that requirement is that an access seeker is required to be given physical access at (usually) a telephone exchange to the copper pairs which connect each of the access seeker’s customers (end-users) to the exchange.  This enables the access seeker to use its own equipment in an exchange to provide a range of services to its customers, including but not inherently limited to, traditional voice services and broadband services, of a type and quality determined by the technology the access seeker chooses to install in the exchange, as opposed to being able only to acquire at a wholesale level, and on-sell, the menu of services and service-qualities chosen by Telstra as the infrastructure owner.

213               The control that the ULLS gives to access seekers over the nature and quality of the services that they can provide to end-users is, Telstra contends, a critical attribute of the ULLS, based as it is on copper wires.  Importantly, it is an attribute that is not shared by other technologies such as fibre, cable, wireless or satellite transmission.  Telstra submits:  their use can only be acquired by an access seeker on a “conditioned” basis such that the access seeker can only on-sell the bundle of services and service qualities chosen by the owner(s) of the communications infrastructure.  That being so, Telstra argues, only a copper-based network can be said to provide the carriage service at issue the unconditioned local loop service.

214               In support of its position, Telstra points to the benefits that unbundling of the local loop, and the consequent facilities-based competition from and between providers of services, has facilitated (including by reference to a speech by the Chairman of the ACCC).  The evidence is, it suggests, that that competition, and the innovation that it has stimulated, has led to lower prices for and a higher quality of, services to end-users, especially in relation to broadband services.

215               In various ways, Optus, the Interveners (and the ACCC) contend that the technology-specific nature of the ULLS service description is irrelevant to the network design, including technology, that a hypothetical new entrant would likely utilise.

216               Optus contends that Telstra’s argument, in effect, characterises the issue as one concerning competition between the hypothetical new network operator and Telstra in the provision of declared services to access seekers rather than competition between them in the provision of listed services to end-users.  This, it suggests, is absurd and unhelpful.  Moreover, Optus quotes the Tribunal as observing that Part XIC is technology neutral in Application by Telstra Corporation [2009] ACompT 1 at [125]:

[T]he focus of Part XIC of the telecommunications access regime is on services.  This focus reflects a fundamental tenet of good telecommunications regulation that it should, to the greatest possible extent, be technology-neutral, else the specification of one technology restrict the development of alternative technologies.

217               Optus also contends that the effect of Telstra’s approach of estimating the replacement cost of a copper network without considering more efficient technological alternatives for substitutable services is inconsistent with the generally accepted requirement that the measure of costs should be forward-looking.  A forward-looking efficient operator today, Optus asserts, would use a variety of technological platforms to deliver carriage services to end-users, and points to the fact that Telstra has replaced copper with fibre in certain parts of its network, affecting over 10% of services in operation.  It is unclear what proportion of this 10% is related to Band 2 areas which are exclusively the subject of the 2008 Undertaking in the matter before the Tribunal.

218               It is to be noted that Optus considers that there are circumstances in which it would be more appropriate to base access charges on historical costs rather than on forward-looking replacement costs, but this is a separate issue.

219               The Interveners also consider that Telstra’s arguments drawing on the ULLS service description are irrelevant and potentially misleading.  They drew the Tribunal’s attention to the ACCC’s original declaration of the ULLS in 1999 to indicate that the Commission had expressed a preference for service descriptions that are technologically neutral but had departed from that preference for pragmatic reasons, including because with other technologies “unbundling would involve complex issues”.

220               By reference to fibre which the other Interveners unambiguously assert is the appropriate modern equivalent asset they also address Telstra’s contention that it would not give access seekers the same control over service offerings as the ULLS does.  Like Optus, the other Interveners in effect say that it is not functionality from the perspective of access-seekers that is relevant but, rather, from the perspective of end-users and assert that there is no suggestion that other technologies cannot provide to end-users every single aspect of functionality that the ULLS can provide.  They do not, however, provide evidence that end-users would be indifferent to the fixed level of functionality provided by alternative technologies irrespective of cost a matter of some importance to the choice of MEA since it has to be commercially viable in the Band 2 context in order to qualify as relevant.

221               Like the Interveners, the ACCC submits that treating the service description as limiting the choice of technology with respect to which estimates of efficient forward-looking costs are derived is an error on Telstra’s part.  It goes on to suggest that, appropriately delinking the choice of technology from the current service description, the notion that an all-copper based network could be considered forward-looking is impossible given the existence of what it contends to be “… more economic means of service delivery, such as radio, wireless, satellite or fibre …”.  The service description, the ACCC submits, is reflecting the reality that what an access-seeker has access to is the copper wire, but when applying appropriate pricing principles it is necessary to enter a hypothetical world.  However, like the Interveners, the ACCC offers no evidence that other technologies would be commercially viable, and dominant, in Australia in the Band 2 context.

222               Although not precisely in those terms, the ACCC disputed Telstra’s contention that the reference in the ACCC’s pricing principles to the hypothetical alternative network being required to provide “… the same service potential” meant it had to offer unconditioned access to access seekers.  The ACCC’s reasoning was, essentially, that both the hypothetical service provider and access seekers might see advantage in offering and purchasing, respectively, a higher service quality, even if it provided access-seekers wholesale-only access options.  However, the ACCC offered no evidence to substantiate that that would, in fact, be so.  Nor did it offer evidence that the alternative technologies would be less costly the key issue in relation to access charges.  Indeed, it conceded that there was no evidence before the Tribunal about the comparative cost of a fibre network as opposed to the fact that it would have enhanced functionality.  It did, however, make reference to speculative estimates, not Band 2 specific, by Network Strategies that “using alternative access technologies could reduce the cost per metre of some areas of the distribution network by up to one-third”.  The ACCC also indicated that the Analysys model being prepared for the ACCC to estimate costs for all fixed-line services (which would include Band 2) was using algorithms that would “deploy either copper or fibre depending on the demand to be served at each location”.

223               The Tribunal considers that the fact that the service description refers to the relevant communications medium as a copper wire is, of itself, of no great significance.  The description has to make clear what the physical characteristics are of what is being declared to remove uncertainty.  Certainly, it has to be conceded that the description of the declared service is not technology neutral.

224               However, the part of the service description that refers to the service being unconditioned is not so readily dispensed with.  All parties agreed that access-seekers having unconditioned access to the local loop because it uses a copper wire technology has been an important source of innovation, providing end-users with a diverse menu of service quality and price options through facilities-based competition.  Because they use their own equipment in combination with the unconditioned copper pairs, they are able to differentiate their services offerings to end-users.  None of the parties offered evidence that technologies other than copper wires could provide unconditioned access to the CAN by access-seekers.  Telstra asserted that none could do so.  No other part affirmatively disputed its claim.

225               It could be said to be strange therefore, that the non-Telstra parties are now inviting the Tribunal to conclude that alternative technologies that do not provide the same functionality to access seekers and menus of choices to end-users could be said to be appropriate alternative technologies for the purpose of setting access charges.  The Tribunal is also mindful of the fact that it has been offered no solid evidence that the cost of providing access even to a conditioned loop would, in fact, be lower and it is costs, not “quality-adjusted” costs, that are at issue.  Reference to speculative estimates, including by one of Telstra’s own experts, are not sufficient.

226               The Tribunal’s view is that this the central argument in the Interveners and the ACCC’s responses to Telstra’s submissions should not be accepted, especially absent any clear evidence about the cost of rolling out alternative technologies in today’s actual circumstances.  Hypothetical alternatives must have some grounding in reality if they are to be considered practically useable in assessing access charge undertakings such as the 2008 Undertaking.

227               To sum up, the ULLS cannot be provided except through copper pairs.  It is an intrinsic feature of the ULLS that access seekers physically interconnect with the copper pairs that provide access to customers’ premises.  The ULLS is not a service capable of being provided to end-users.  It is an input to such a service.  Access seekers could not interconnect with and purchase an unconditioned service in a fibre-based CAN.

228               In this context, however, it is important for the future to note (as the Tribunal noted in Application by Telstra Corporation [2009] A CompT 1 at [125]) that Part XIC is technology neutral.  Its purpose is to promote the LTIE of carriage services or of services provided by means of carriage services (the listed services).  It is competition in the market for the listed services which is to be promoted, not competition in the market for the declared service.  Nor could it now be said that limiting consideration to a copper-wired CAN would encourage economically efficient investment in the infrastructure by which listed services are supplied.  Section 152AH(1) clearly recognises, by use of the different terms, that the declared service and carriage services or services supplied by means of carriage services are not the same. 

229               However, for the reasons given, the Tribunal does not take that step, that is it does not finally determine the question referred to in [32] above, in this matter.


Costs of a hypothetical new entrant

230               What then are the ongoing costs that Telstra would incur in providing the ULLS as efficiently as possible?  Here the notion of a hypothetical new entrant arises, as Telstra specifically describes the TEA model as one “which calculates the TSLRIC+ of an efficient new entrant supplying the ULLS”.  The TEA model implementation of TSLRIC+ estimation involves estimating these costs but with the constraint that the new entrant replicates the exchange locations, distribution area boundaries and pillar locations of Telstra’s network (the scorched node approach as implemented in the TEA model).

231               The TSLRIC+ approach seeks to estimate Telstra’s ongoing costs of providing the ULLS.  But on the face of it Telstra’s ongoing costs have nothing to do with those of a hypothetical new entrant to the market providing the declared service, especially as the TEA Model is premised on a scorched node approach. 

232               The hypothetical new entrant approach appears to be based in large part on the objective of determining a price that would give a potential new entrant the right signals as to whether to “build or buy”, i.e. whether to in fact displace, replace, replicate or bypass (perhaps part of) the existing CAN – provide its own infrastructure to gain access to customers – or to purchase the ULLS from Telstra.  (Note that the four terms just mentioned tend to be used interchangeably, although they have different meanings in ordinary English.)  But in fact it is inconceivable that any access seeker would now build a copper-based CAN across all Band 2 areas in the manner that the TEA model and Telstra’s implementation of TSLRIC+ hypothesise.  How can a hypothesis so far from reality be useful?

233               Here it is necessary to return to the thinking that underlies the idea of mimicking a competitive price.  That is what has led to all this consideration of forward-looking costs and hypothetical new entrants.  In the first place, Telstra cannot face even hypothetical competition for the supply of the ULLS in the usual sense that a new entrant could enter the market, gradually build out a copper-based network, compete customers away from Telstra, and potentially supply a ULLS itself.  

234               The reason for this is that the provision of the ULLS is likely to have technical characteristics (related to minimum efficient scale) that make it impossible for two firms to jointly supply the ULLS to the market except at a higher cost than a single firm can do so.  That follows from the likelihood that the CAN has natural monopoly characteristics, or to put it another way, from the nature of the ULLS that led the ACCC to declare it in the first place.  In economic terms, such entry would be economically inefficient.  No price for Telstra’s ULLS – and this is fundamental – would induce a general “build” decision of that kind by a new entrant, because Telstra’s cost structure would inevitably be lower than the potential new entrant’s.  Of course, the new entrant would in any case be seeking to provide services to end-users, and would not now choose to do so by building out a copper network that was more expensive and provided lower functionality than modern alternatives.

235               The TEA Model’s hypothetical new entrant represents not competition in the market, in the normal case, but competition for the market, ie the replacement of Telstra’s network holus bolus by a network that looks remarkably similar, despite vast changes in population distribution over the decades, right down to not only the locations of exchanges but also Distribution Area boundaries and the locations of pillars.

236               The TEA Model estimates the costs that a new entrant would face for the market, ie to exclusively supply the ULLS in place of Telstra.  But a hypothetical new entrant building a replacement copper network would assuredly not be constrained to the essential layout of Telstra’s network, as it is a historical artefact of the period over which the network was built.  Its components may all represent prudent investment decisions at the time.  Alternatively, since many of those decisions were made well before Telstra was a commercially-oriented business but was part of the Postmaster-General’s Department, they may not.  The key point is that a new entrant would have many, many alternative network design options for reaching customers, allowing for lower costs of, for example, cables, ducts and trenches. 

237               The Tribunal accepts Optus’s submission that by assuming the use of existing locations of pillars, manholes and pits – and hence severely limiting the optimisation of cable routes – the TEA Model is not capable of estimating the efficient costs of supplying the ULLS.  Whether this is a failure to apply the scorched node approach correctly, or a more fundamental attack upon that approach, is not to the point.  Nor is this the place to decide exactly what degree of network optimisation is necessary in estimating efficient costs.  But it is clear to the Tribunal that taking so much of the existing network architecture as given cannot provide a basis for efficient pricing.

Conclusions regarding the TEA Model

238               On the one hand, the Tribunal has rejected the arguments that the ULLS should be priced on the basis of costs of providing services that are not copper-based and would not even provide access to unconditioned copper pairs, as the ULLS does.  It was not presented with evidence of the costs of rolling out infrastructure that could provide listed services by other means.  On the other hand, it also rejects the argument that the ULLS should be priced on the basis of the up-to-date costs of replacing a historical relic while keeping most of its essential design features and merely updating its equipment.

239               But the Tribunal’s difficulty with the submissions presented to it on TSLRIC+ goes deeper than the specifics of the TEA Model.  It is troubled by the notion that prices should be set on the basis of hypothetical competition for a market that has natural monopoly characteristics, just as it would be puzzled by a proposal to price access to an electricity distribution network in a way intended to cause users to choose whether or not to overbuild the whole network, replacing it completely.  Quite separately, the Tribunal notes that the ACCC proposes to examine TSLRIC+ as part of its review of pricing principles. The Tribunal encourages that review and the consideration by the ACCC of alternative pricing regimes, for example whether pricing on the basis of depreciated optimised replacement cost might be appropriate.  Alternatively, if TSLRIC+ continues to be preferred, more guidance needs to be given on how it should be implemented.  In the absence of submissions dealing with this rather large issue, it is impossible to say more here. 

240               But in the present case, what is needed is a return to the legislative basis for determining whether a ULLS price is reasonable.  The price estimated by the TEA Model is based on the cost of a new entrant starting all over again and building a copper-based CAN from scratch, but using a scorched node approach in which cable routes are constrained to be at best a subset of those laid over many decades in Telstra’s legacy access network.  Such an approach would not promote competition in the provision of services supplied using the ULLS unless that price reflected Telstra’s costs of providing the service (s 152AB(2)(c)). 

241               Such a price would not encourage the economically efficient use of Telstra’s network infrastructure unless the price reflects the long-run costs to the community of the resources tied up in, and used to operate, the ULLS (s 152AB(2)(e)).  If, say, the costs of a hypothetical new entrant (and hence the price of the ULLS to an access seeker) were higher than Telstra’s costs of supplying the ULLS to itself, then Telstra would have an advantage providing retail voice and broadband services to end-users.  Given that the network is in place, but is to be or may be in the future replaced by, or at least compete with, the NBN, the long-run costs to the community of those resources are not those of a new entrant hypothetically building a replacement copper access network within the constrictions permitted by the TEA Model at present.

242               For the same reason, such a price would not encourage efficient investment by access seekers.  It would not reflect the true resource costs to the community of providing the ULLS (i.e. the opportunity cost of not being able to use those resources in a higher value way).   And such a price would have no bearing on Telstra’s investment decisions, since it does not reflect costs actually faced by Telstra, which has trenches, ducts, etc already in place (s 152AB(2)(e)).

243               Consequently, the costs of a hypothetical new entrant, as estimated by the TEA Model, do not provide the basis for a price that would promote the LTIE (ss 152AB(2) and 152AH(1)(a)).

244               Nor would such a price reflect Telstra’s legitimate business interests, which are to receive a commercial return on its prudent (past) investment in the infrastructure used to supply the ULLS, not a hypothetical new investment (s 152AH(1)(b)). 

245               Whether such a price had due regard to the interests of access seekers turns on the same condition that determines whether the price would promote (efficient) competition, viz whether they would face the same cost in purchasing the ULLS as Telstra faces in using it to supply retail services (s 152AH(1)(c)).  But there is no relation between that cost and that of a hypothetical new entrant.  As already stated, such a price does not reflect the direct costs of providing access (s 152AH(1)(d)).

246               It follows that the Tribunal cannot be satisfied that the TEA Model is capable of generating estimates of costs that would be an appropriate basis for prices that would meet the reasonableness criteria in s 152AH. 

Conclusions regarding the proposed monthly charge of $30

247               The question remains whether the proposed monthly charge of $30 might nevertheless be reasonable, given that it is far less than the estimate produced by Telstra’s use of the TEA Model.  The inputs to the TEA can be varied to reflect other assumptions or data from those employed by Telstra.  The Tribunal was provided with estimates of the materiality of individual changes, and the sensitivity of the estimates to a combination of changes.  However, it follows from the Tribunal’s reasoning above that, because of the way in which the TEA Model is based on the new entrant costs hypothesis, no changes to inputs to the model could throw light upon the reasonableness of the $30 figure.  The assumptions on which the TEA Model is based are, as already explained, simply too far from those capable of reflecting the reasonableness criteria.

248               Moreover, there is no material before the Tribunal that independently addresses the reasonableness criteria as they might apply to the $30 figure.  Consequently, the Tribunal is unable to satisfy itself that $30 would be a reasonable price.

249               It is therefore unnecessary for the Tribunal to examine submissions by the parties addressing other issues.  However, the Tribunal considers that, where major issues have been argued fully and it is able to reach conclusions, it should express those conclusions for the purpose of assisting future regulatory decision-making processes.


250               Telstra’s TEA Model generates annual capital costs reflecting depreciation and the opportunity cost of capital.

251               Depreciation is calculated using the straight line method where the level of depreciation is equal every year of the asset’s life. In order to achieve the same annual capital charge in each year, a process of ‘levelisation’ is applied. Under this approach annual cost factors calculated for each year of the assets life are converted into a flat annuity over the assets life.  The approach has the effect of a depreciation profile that is ‘back-loaded’ – meaning that the asset loses more of its ‘value’ later in its life.

252               The ACCC says that Telstra’s use of a flat annuity to calculate the ULLS monthly charge is not reasonable.Instead the ACCC has applied a tilted annuity approach. The ACCC applied a 3% tilt to ducts and pipes and copper cables in its application of the TEA model – reflecting expected price trends for those assets.

253               Under a tilted annuity approach an access price will change by a fixed percentage (the “tilt”) over the economic life of the assets used to provide the ULLS. A “positive” tilt assumes that the monthly charge will increase over time. Under the tilted annuity approach the “back-loading” effect is more pronounced.

254               Optus and the Interveners also say that the TEA model inappropriately uses a zero-tilt depreciation method.

255               The difference between the positions is apparent in the following graphical representation of the effect of straight line, flat or positively tilted annuity depreciation profiles - the work of Telstra’s consultant, Ergas which is contained in the Statement of Material Facts (SOMF). The Tribunal makes no comments on the accuracy or otherwise of the graph. We have extracted it simply for the purpose of illustration as it provides a visual representation of the differences in approaches.

256               Telstra says that straight line depreciation is well understood and widely used in regulation – Australian regulators, including the ACCC, have applied straight-line depreciation in other industries including aviation, electricity, gas and rail.

257               Telstra also says that there are a number of international jurisdictions (including the US, Canada and the UK) where a tilted annuity is not applied.

258               However, the ACCC asserts that in the regulation of telecommunications in Australia and overseas, it is common to use a tilted annuity.

259               Optus also says that in at least six comparable international jurisdictions a tilted annuity rather than a zero tilt has been considered as an appropriate proxy. This includes the Swedish, Danish, Irish and New Zealand regulators.

260               Telstra says its approach is consistent with TSLRIC+ principles, and is therefore reasonable.

261               Telstra relies on a report by NERA. NERA analysed the four main asset types in the CAN network – main duct, main copper cable, distribution duct and distribution copper cable. It did this by employing an economic depreciation model and comparing the resulting annual capital charge profile for each asset with the profiles produced by the main accounting depreciation methods.

262               NERA found that overall the TEA Model will tend to understate economic depreciation and more closely approximates economic depreciation than a tilted annuity.

263               In its report, NERA defines economic depreciation as the change in the value of an asset when measured by the change in the Net Present Value (NPV) of future cash flows.

264               NERA observes that due to measurement difficulties regulatory authorities often use other proxies for economic depreciation. These include straight line, tilted straight line, annuity and tilted annuity methods.

265               Telstra considers that the positive tilt used by the ACCC will defer cost recovery into the future. It suggests that if a tilted annuity with a +4% price trend is applied to an asset with a 30 year life, then by year 23, only 0.02% of the original cost of the asset would be recovered. By year 25 less than 20% of the asset would be recovered. Only by year 28 would more than half the asset’s cost be recovered.

266               Telstra also says that although the deferral of depreciation ensures low prices now, those prices will have to increase significantly toward the end of the assets’ lives. Telstra suggested that adopting a tilted annuity in the TEA Model and using the ACCC’s price trends would result in the monthly cost equalling $188 in year 40.

267               The ACCC disagrees. It says that the positive tilt only applies to the period of the Undertaking and not to the entire life of the ULLS network assets. Also Telstra’s analysis is based on nominal, and not real, dollars. As the tilt used by the ACCC is based on forecast inflation, a monthly charge in 40 years time, while high in nominal terms, should (approximately) equate in real inflation adjusted terms, with the monthly charge in the first year of the assets’ lives.

268               Telstra also maintains that it modelled other scenarios which suggest that the prices charged increase significantly over time which the ACCC did not challenge in its submission.

269               Telstra also says that the titled annuity’s deferral of depreciation delays cost recovery to a time when there will be fewer customers from which to recover those costs. This is because customer demand for the CAN is decreasing and Telstra faces competitive bypass.

270               By-pass is said to arise from a number of sources including the national broadband network, Optus’ hybrid fibre co-axial cable (HCF), voice and broadband services delivered over wireless networks and alternative network operators that are investing in their own fixed and wireless networks. Telstra points to the fall in the number of CAN fixed lines with projections for further decline with the growth of mobile usage. ACMA has also reported that demand for fixed line services reached its peak in 2004 and since that time the number of SIOs has declined.

271               Harris and Fitzsimons assert that in an increasingly competitive environment, a tilted annuity approach will increase the risk that Telstra will not recover its costs. An increase in costs in such an environment may accelerate a loss of market share, further compounding the problem.

272               Harris and Fitzsimmons argue that even if losses in access lines were not an issue, to recover TSLRIC+ would require price rises in an environment of increasing competition. The competitive process they say will drive down prices and make it difficult for Telstra to increase prices without further endangering the loss of access lines.

273               They argue that the necessary increases in prices for cost recovery will accelerate the decline in demand for the CAN. The result is that a substantial portion of the costs of the ULLS will never be recovered. The ACCC rejects this argument. It says that under the tilt it has applied the monthly access charge would remain constant or possibly decline in real terms.

274               Harris and Fitzsimmons agree with the views of another of Telstra’s consultant (Ergas) that the tilted annuity approach, with its reliance on back-loaded depreciation would seem to contradict trends supporting more front-loaded depreciation models.

275               The ACCC says that Telstra’s assertion that the deferral of depreciation into the future will expose it to the risk of failing to recover its costs should be given little weight. This is because many of network assets used to provide the ULLS have been in existence for considerable years and have most likely already been depreciated.

276               The Undertaking is for a fixed period. Therefore if a monthly charge is insufficient to ensure cost recovery, the ACCC says Telstra can argue for a higher access charge in the next period. Despite this, Telstra maintains that the fact that the Undertaking is for a fixed period should not preclude the most accurate and appropriate depreciation profile being adopted now.

277               The ACCC also argues that there is no evidence to suggest that the decline in CAN lines will continue. Irrespective, the ACCC says that it is inappropriate to allow a rate of depreciation that takes into account Telstra’s loss of a monopoly market share from increased competition.

278               The ACCC considers that where the efficient forward-looking costs of providing the ULLS are expected to increase over time, the use of a flat annuity formula overcompensates the access provider. The ACCC explained that:

This is because in earlier regulatory periods, the cash flow required to allow the efficient capital costs of providing the ULLS will have been calculated by reference to a flat constant monthly charge (in nominal dollars) over the life of the network assets. If the monthly charges in fact increase in the future, the cash flow enjoyed by the access provider will be greater than that assumed in the earlier regulatory period. The use of a flat annuity method in those circumstances effectively creates a hidden tilt.


279               The ACCC has assumed that the price of ducts and pipes and copper cables will increase by slightly less than forecast inflation from December 2008 to December 2010 – broadly the period of the Undertaking. The ACCC considers that its assumption is conservative and has therefore applied a 3% tilt to ducts and pipes and copper cables in its application of the TEA Model. The result was a reduction in the estimate of network costs generated by the TEA Model from $46.54 to $40.21.

280               Telstra says that as vendor prices for plant and equipment have fallen historically there should be no concern about rising prices during the Undertaking period. Therefore applying straight line depreciation will not result in any over recovery of costs. Indeed it is likely to result in an under recovery.

281               Telstra refers to statistics produced by the Australian Bureau of Agricultural and Resource Economics which suggest that 2009 world copper prices would decline by 8% and for the supply of copper to outgrow demand. Spot prices for copper on the London Metals Exchange have also declined. Ovum also indicated that the forward-looking trend of equipment prices appears to be falling.

282               Nevertheless, Ovum concluded that the tilted annuity is the preferred principle. This is because as prices fall the tilt will prevent under compensation and if prices are increasing, the tilt can prevent over compensation.

283               Telstra argues that if the ACCC is concerned about applying a flat annuity in an environment of rising unit costs, this is best addressed in the next regulatory period. In that next period the cost of those factors can be actually observed rather than relying on uncertain price forecasts.

284               Telstra also considers that unit costs are not the only determining feature in the next regulatory period. A future determination may use a different asset base, influenced by then prevailing technology, different engineering rules and different views regarding future price trends. Telstra says that the ACCC can consider all the factors that might lead to the over or under recovery of the initial investment cost, not just unit prices for plant and equipment.

285               Telstra also relies on the work of Ergas. Ergas examined the ACCC’s “Access Dispute between Primus Telecommunications Pty Limited and Telstra Corporation Limited – Unconditioned Local Loop Services, Final Decision of ACCC, December 2007” (Primus) in an attempt to understand the ACCC’s rationale for a tilted annuity.

286               In Primus the ACCC explained that when asset prices are increasing, the asset price in the model will be higher year on year. A tilted annuity will defer cost recovery until later years. Similarly, when an asset price is decreasing over time, the asset price in the model will be lower year by year. A tilted annuity will bring forward recovery to earlier years.

287               Ergas refers to Telstra’s view that a tilted annuity suffers from the “year 1 problem”. The problem is described as follows:

Whenever capital charges vary over time, as is the case with a tilted annuity(whenever the tilt value is non -zero), the TSLRIC methodology which assumes that a new optimised network is installed each year, will result in the infrastructure owner receiving revenue to compensate for year 1 capital charges.


Where capital charges are front-loaded, this will result in the owner of the assets being overcompensated for the cost of the assets, as it will receive revenues consistent with the year 1 capital charge every year. Conversely, if the capital charges are backloaded, this will result in under-compensation.


In Telstra’s PIE II model, the tilt applied for the majority of CAN assets is positive. That is, the replacement cost of CAN assets is generally increasing overtime so that the tilted annuity results in a back-loaded profile of capital charges. However, the only capital charge that is ever used from PIE II is the year 1capital charge, the lowest value over the entire life of the assets.


288               In Primus, Optus submitted that the annuity formula accounts for future price movements by revaluing the asset base each time the tilted annuity is applied (ie. when the next year is priced), and that accordingly the year 1 problem does not exist. It submits that Telstra will recover “year 2” in the next period.

289               The ACCC similarly considers that the “year 1” problem does not exist.

This is because, in addition to the tilted annuity being applied, the asset prices for later years are increased by the estimated change in prices. Accordingly, while Telstra is only paid for the first year of a tilted annuity, in each subsequent period the actual value of the payment increases in line with the estimated price trends. This results in a cost recovery profile that mirrors the profile under a tilted annuity over time.

290               In Primus the ACCC said that a flat annuity would result in an over-recovery by Telstra of the value of its network assets, especially if, as Telstra submits, asset prices should also be increased each year.

291               In Primus the ACCC said that there are economic reasons for applying a tilted annuity consistently, regardless of the direction of the tilt. When prices are rising, a tilted annuity reflects the fact that costs can be recovered in higher prices in later periods, when any entrant will face the higher level of costs. This is consistent with the outcome likely to occur in a competitive market. The ACCC considers it would be inconsistent to apply the tilt only when it resulted in a price increase.

292               In Primus the ACCC also said that access charges that reflect forward-looking efficient costs better promote competition, as they will allow the access provider and access seeker to compete in downstream markets. The ACCC considers that adopting Telstra’s approach would inflate costs for access seekers and inhibit competition.

293               In Primus, the ACCC also took the opportunity to consider its approach against the statutory criteria in s152AB(2). Section 152AB(2) provides a list of factors to which regard must be had in determining whether the long term interests of end users are promoted. As the Tribunal is also required to consider section 152AB(2), this discussion is relevant to our consideration.

294               In Primus the ACCC said that its approach will better encourage efficiencies under paragraph 152AB(2)(e). This is because a cost-reflective price will encourage competition in downstream services and encourage efficiencies in markets for these services. The ACCC considers this approach will also lead to more efficient build/buy decisions as the ULLS prices will reflect the efficient cost of the CAN.

295               The ACCC also said that its approach will meet the legitimate business interests of the provider and its investment in the CAN under paragraph 152CR(1)(b) – A tilted annuity will enable Telstra to recover an amount commensurate with its legitimate business interests, including its recovery of direct costs. Conversely, Telstra’s approach would result in over recovery.

296               The ACCC considers that a tilted annuity approach will best meet the interests of access seekers under paragraph 152CR(1)(c). The ACCC believes Telstra’s approach would lead to an inflated ULLS network costs, giving it a significant cost advantage, and preventing access seekers from competing with Telstra on their merits.

297               The ACCC’s comments in Primus lead Ergas to conclude that the ACCC’s preference for a tilted annuity is because it assumes asset prices are rising.

298               However as the discussion above shows, the ACCC’s preference for a tilted annuity is based on a number of considerations, including the statutory criteria and the considerations the statutory criteria impose.

299               Ergas argues that even if asset prices are not rising, it does not agree with the ACCC’s use of tilted annuity.

300               First, successive revaluations have not lead to increased valuations of ULLS assets.

301               Second Ergas does not accept the ACCC’s argument that the tilted annuity leads to “better” signals for competing entry. Entry does not hinge on the costs that would be incurred in a hypothetical network, but on the actual costs likely to be incurred.  Purely hypothetical costs will not provide the correct entry signals as asserted by the ACCC.

302               Third, the claim that a tilted annuity reflects what would occur in a textbook competitive market is not relevant because in these markets firms do not incur substantial sunk costs and are not vulnerable to regulatory time inconsistency.

303               Fourth, it is incorrect to characterize a tilted annuity as better reflecting opportunity costs than alternative depreciation profiles – it is unclear what the relevant foregone opportunity is that the tilted annuity better reflects.

304               Ergas concludes that the primary benefit of the tilted annuity is that it leads to lower prices in the short-term. However, Ergas say that from an efficiency perspective, there is no gain from lower prices today if it means higher prices tomorrow.  The greater uncertainty about recovering these costs in the future is socially costly. Ergas maintains that although the increased risk could be compensated by a higher rate of return, it would be inconsistent with the Capital Asset Pricing Model (CAPM) which only rewards systematic risk.

305               Ergas considers that a number of factors make a front-loaded depreciation preferable from an ex ante capital maintenance perspective.

306               Under a financial capital maintenance perspective Telstra says that investors would be expected to prefer to recover more of their capital earlier rather than later. This is because of the risks of regulatory error. It is also because of the risks of technological obsolescence and competitive bypass. These risks are said to increase as wireless alternatives and HFC networks improve and with the planned NBN.

307               Ergas says that, in contrast, a tilted annuity approach imposes a high degree of back-loading and exposes investors to greater commercial and regulatory risk. If there is a risk that future earnings are reduced, then capital maintenance is no longer assured.

308               The higher risks from back-loading is said to be compounded by the ACCC’s policy of successive asset revaluations. Ergas believes that successive asset revaluations have resulted in reductions in asset values, compared to earlier valuations. Once written down, their remaining value cannot be recovered under the depreciation charge and Telstra’s investors are said to incur a financial loss. Ergas considers that this financial loss is magnified because the tilted annuity implicitly defers depreciation.

309               The ACCC considers that broadly, an access seeker will be indifferent between depreciation profiles, provided they deliver the same present value.

310               Telstra rejects this argument. Telstra’s consultant Ergas argues that this proposition does not consider broader social welfare objectives. The choice of depreciation profile may result in some shareholders being unable to recover their investment and may lead to suboptimal investment.

311               Optus argues that a tilted annuity is the only approach that will allow a firm to recover (but not over recover) efficient investment costs.

312               Optus asserts that a tilt is commonly applied to reflect the expected price trends of assets (as these reflect new technologies and replacement costs), and to mimic the cost recovery conditions in a competitive market. Although a tilt will deliver the same NPV, Optus says that the profile of that compensation will rise or fall over the asset’s life – corresponding to the tilt.

313               Optus argues that a positive tilt is generally suited to a market environment in which input prices (assets and operating costs) are forecast to rise. Conversely when input prices are forecast to fall, a negative tilt provides quicker cost recovery. 

314               The Tribunal accepts that straight line depreciation has been used in a number of industries in Australia and other jurisdictions. It also accepts that a tilted annuity has been used in some jurisdictions in the regulation of telecommunications.

315               Examining comparable jurisdictions where a tilt or straight line depreciation has been applied perhaps provides some reassurance that a similar approach here may accord with regulatory precedent. However, the Tribunal not been provided with detail of the approaches applied in these other jurisdictions to enable us to draw conclusions as to their relevance to Australia. Even if the Tribunal had, it must consider whether Telstra’s access charge is reasonable in the context of Australia’s regulatory environment - specifically the statutory criteria we are required to apply. Although it is useful and relevant to examine the decisions of other jurisdictions, that of itself is not an adequate foundation for our decision. Accordingly the Tribunal has also considered the other arguments raised in these proceedings.

316               A part of Telstra’s argument focuses on the view that under a TSLRIC+ approach a depreciation model must be used that most closely approximates economic depreciation. Telstra and its consultants suggest that straight line depreciation does this. The ACCC prefers to focus broadly on regulatory depreciation or what should be the expected return of capital to a regulated business. Both approaches recognize that in practice a decision will need to be made on a suitable real world depreciation methodology.

317               Ultimately, the choice of depreciation method is not helpfully determined by assessing whether or not it more or less closely mimics economic depreciation or otherwise. It is guided by whether the choice of methodology will ultimately satisfy s152AH that the access charge is reasonable, including because it promotes the LTIE.  Indeed to do otherwise is to lose sight that the objective of regulation is to promote competition in markets for listed services as a means of promoting the LTIE.

318               Although the Tribunal makes no comment on the Primus decision itself, it agrees with the approach of the ACCC to examine the choice of depreciation methods against the statutory criteria. In doing so it has invariably been drawn back to many of the arguments raised by Telstra and the ACCC in these proceedings.

319               One of the reasons proffered by Telstra for rejecting a tilted annuity is that it defers cost recovery. A number of scenarios were presented to the Tribunal about the amount by which prices would need to increase in the future to recover deferred costs. There was considerable dispute as to what these prices would need to be. In an environment of increasing price trends a tilted annuity will have the effect of deferring cost recovery, though the Tribunal is unable on the evidence presented to be entirely comfortable as to the extent of those increases.

320               Even so, a fundamental issue (particularly for Telstra) is whether the environment it would face in the future would make this recovery possible. As the Tribunal said above, it does not agree with the ACCC’s view that the systematic risk of providing the ULLS may decline. While this is possible, it is inconsistent with the evidence that has been presented to the Tribunal to date of both a decline in the use of CAN lines and the growth of alternative technologies.

321               The implication of this is that Telstra potentially faces an environment that will make cost recovery more difficult. However, as the Tribunal indicates below, we consider that Telstra has overstated the competitive future it faces - more accurately as we said, it cannot presently forecast that decline or threat of competition with the level of certainty which it asserts.

322               Irrespective, it does not necessarily follow that new technologies and new players will result in increased competition. As the Tribunal said in Telstra (No.3), it is more relevant to consider whether the environment or the conditions for creating competition have developed. This is because competition is a dynamic, rather than a static process.

323               Although Telstra can point to new players and new technologies, it has not demonstrated to us that they will impose on it the competitive discipline that would make cost recovery difficult.

324               It is also important to remember that on the evidence presented to us, an irretrievable decline is unlikely to occur immediately. Competition takes time to develop as new players develop a market presence. Telstra may well have the opportunity to respond to any competitive pressures, such as they are or may be.

325               Even if competitive pressures pushed prices down, it is open to Telstra to put forward evidence of a higher access charge in a subsequent regulatory period,broadly as the United States Supreme Court also alluded (albeit in a different context ) in Verizon Communications Inc v FCC  (2002) 535 U.S. 467 at p 519 (Verizon).

326               Verizon needs to be viewed with some caution because of the different regulatory regime and statutory criteria. The Tribunal alludes to it as simply reflecting a broad proposition that it is open for adjustments to be made in another period, if there is demonstrated need.

327               Telstra also argued for a front loaded depreciation profile from a capital maintenance perspective. The argument is that investors would prefer to recover their capital earlier rather than later for the reasons submitted by Telstra and its consultant Ergas. However investors are said to have this preference because new technologies and the risk of by-pass (among other things) will reduce future revenue flows. As the Tribunal has mentioned above, we do not accept that Telstra necessarily faces such an environment - more accurately faces that environment as Telstra has characterised it.

328               Telstra has also argued that one of the advantages of straight line depreciation is that it does not rely on forecasting of price trends and information about an asset’s future efficiency profiles and susceptibility to obsolescence.

329               The Tribunal agrees that, under the tilted annuity approach, forecasts will be required of future price trends. Invariably a regulator will need to make some judgments regarding these trends and rely on the best available estimates. Particular care needs to be taken to ensure that data, including from other regulators, does not ‘lock in’ inherent errors.  That said, the estimation risks are likely to be low because price trends are based on data from public sources. In Australia, this includes transparent data from the Australian Bureau of Statistics.

330               In saying this, the tribunal should not be taken to be expressing a view on the price trends employed by the ACCC in its approach. That issue was not debated in sufficient detail to enable the Tribunal to express a concluded view. For the purpose of our decision, it is also not necessary that it do so.

331               In an environment where prices are changing, the Tribunal also considers that a tilted annuity will better reflect competitive outcomes because it will send signals to potential entrants of the costs (and competition) they face. In Primus Optus expressed it this way:

(a)        when input prices are falling, the incumbent operators will know that a

new entrant in the future will have a lower cost base. As a result, incumbent operators will only invest in the market today if they can recover more of their capital in the early periods, because they know they will face a lower cost entrant in the future; or alternatively


(b)        when input prices are rising, the incumbent operators will know that a new entrant in the future will have a high cost base, therefore their future return will be ‘protected’, they are[sic] can therefore afford to invest and compete price down today in the knowledge they will not face a new entrant with a lower cost base in the future.


332               This cost reflectivity is more conducive to the promotion of allocative efficiency and the creation of the conditions for competition to occur.

333               Telstra’s consultant has rejected the argument that a tilted annuity will send better signals for competing entry. This is because entry is said not to depend on hypothetical but actual costs faced by new entrants.

334               It is wrong to assume that a new entrant will only be guided by the actual costs faced. That certainly will be one of the considerations, but not the only one.  The Tribunal would expect investors also to be concerned with what costs they are likely to incur now and into the future. 

335               In either case, if one accepts this argument, then straight line depreciation also suffers from the fact it is merely a compromise between front ended and back ended depreciation, where prices are changing. In that sense at any point of time it may be no more reflective of “actual costs” than a tilted annuity approach.

336               The Tribunal is also not persuaded by Telstra’s argument that from a financial capital maintenance perspective investors would prefer to recover more of their investment earlier than later, including because of competitive by-pass and other factors.

337               The Tribunal can conceive the possibility that some investors may prefer to recover their investment earlier rather than later. Even if that were so, a significant reason for Telstra’s view relates to its concern that the uncertain future environment is what would drive investors to have this preference.  The Tribunal has already expressed its views on the future environment. That view does not support Telstra’s concern – at least not to the extent that Telstra maintains.

338               For these reasons, the Tribunal considers that straight line depreciation will not result in an access charge that is reasonable under the statutory criteria in relation to the 2008 Undertaking.


339               The ACCC accepts that in arriving at an estimate of the efficient costs of providing the ULLS, it is appropriate to allow for a reasonable return on efficiently incurred investment - the weighted average cost of capital (WACC). However, in its Final Decision the ACCC affirmed the view expressed in its Draft Decision that it is not satisfied that Telstra’s proposed vanilla WACC and its pre-tax WACC are reasonable.

340               Telstra used a vanilla WACC of 12.28%, (or a pre-tax WACC of 16.46%) in its TEA model to generate its estimate of ULLS network costs.

341               The ACCC’s estimate of a reasonable vanilla WACC is 8.83% (or a pre-tax WACC of 9.64%).

342               The ACCC considers that Telstra’s vanilla WACC and its pre-tax WACC are significantly above a fair estimate based on the Capital Asset Pricing Model (CAPM).The ACCC says that Telstra’s WACC is not reasonable.

343               Unsurprisingly, Telstra and the ACCC identified the WACC used in the TEA model as one of the main issues for the Tribunal.

344               Optus also submits that the WACC values used in Telstra’s TEA model are unreasonable, for the reasons identified by the ACCC in the Final Decision. Optus broadly relies on the ACCC’s written and oral submissions regarding WACC.

345               The Interveners, other than Optusalso consider that the WACC used by Telstra is excessive.

The WACC parameters

346               The ACCC drew the Tribunal’s attention to Telstra’s reference to the vanilla WACC rather than the pre-tax WACC.  The ACCC suggests that the Tribunal should be cautious about the references to the vanilla WACC for two reasons.

347               First, the ACCC says that the references to the vanilla WACC, obscures the difference between the ACCC’s position and Telstra’s position.  When the Vanilla WACC is grossed up for tax, the difference the ACCC says between the two positions is more stark. Secondly it is the pre-tax WACC that is used in the TEA model.

348               The ACCC’s consultant – Ovum, observed that in most jurisdictions, regulators have chosen a pre-tax WACC.

349               Ovum also says that the WACC used in the TEA model is not the same WACC that Telstra tendered in its latest submission to the ACCC “Weighted Average Cost of Capital document, 4 April 2008”. Differences relate to higher figures for cost of equity and cost of debt – 13.93% and 8.43% respectively. If these values are applied then the post tax and pre tax WACC in the TEA model will be equal to 12.28% and 16.46% respectively.

350               Ovum says that based on the submitted WACC input parameters, the calculated pre-tax WACC of 16.46% is very high when compared to the cost of capital calculated in other countries. Indeed it says that it is the highest among the other countries.

351               The ACCC submits that the monthly charge generated by the TEA model is highly sensitive to the assumed WACC. The ACCC says that Telstra’s vanilla WACC estimate of 12.28%, when used as an input into the TEA Model, generates a monthly charge of $46.54. The ACCC’s vanilla WACC estimate of 8.83% generates a charge of $35.19 – a reduction of 24.38%.

352               The ACCC does not dispute that many of the input parameters used to calculate the WACC require an element of judgment and estimation. It says that the estimation of the WACC is, to an extent, imprecise and involves some element of judgment.  As such there may be legitimate scope for a difference of opinion.

353               Nevertheless the ACCC says that the estimation of WACC input parameters is not unprincipled or subjective. The ACCC argues that Telstra has estimated generous values for almost all of its WACC input parameters.

354               The ACCC concedes that in isolation, the impact of a high estimate for a single input parameter may not result in the overall WACC being unreasonable. However, the aggregate effect of Telstra’s methodology has been to inflate Telstra’s vanilla WACC estimate to 12.28% (pre-tax WACC of 16.46%), which is so high that the Tribunal should not be satisfied that it is reasonable.

355               Despite the importance of WACC, because of its technical nature and for reasons of space, the ACCC choose not to address it in its written submissions. Instead the facts on which it relies are contained in the consolidated version of the SOMF that are before the Tribunal.

356               Telstra considers this decision by the ACCC unhelpful. In part, it is for this reason that Telstra says that it is unclear on the extent to which its WACC is in dispute. This is because, as indicated above, the ACCC concedes that many of the input parameters require an element of judgment and estimation and that a high value for one parameter may not render the overall WACC unreasonable.

357               Telstra therefore surmises that the ACCC’s criticism appears to be in relation to the aggregate effect of the parameters, which it says produces a WACC estimate which is so high that the Tribunal should not be satisfied that it is reasonable. However Telstra says that the ACCC does not advance any theory or scale against which the overall WACC should be measured and determined to be too high.

358               However the ACCC says that it has outlined its position on the parameters in the SOMF.  That was said to be the purpose of the ACCC tendering to the Tribunal a guide to where the ACCC’s contentions in respect of each of those parameters is to be found in the SOMF. That guide, contains an explanation by the ACCC as to which of the parameters are in dispute, why it is that Telstra’s estimation of that particular parameter is unreasonable and an explanation as to what the ACCC regards to be a reasonable estimation of that parameter.

359               Telstra says that in light of this approach, it is difficult for Telstra to sensibly address the issue of WACC in its submissions. For that reason, its submissions focus on the parameter differences between Telstra and the ACCC which have the greatest impact on the WACC.

360               The Tribunal shares Telstra’s criticisms of the ACCC’s decision to provide limited written submissions on WACC. As its title suggests, the SOMF merely captures issues of fact and not great detail of the arguments that relate to them. The SOMF is also a truncated document, interspersed with what amount to admissions or denials and occasionally points of clarification. While the SOMF is a very helpful document in capturing the facts in contention, it is not as useful a document for extensive submissions by the ACCC. Also in our view the ACCC has overstated the features of and the assistance to be gained from the guide it tendered to the Tribunal. The Tribunal also finds it hard to understand why the technical nature of WACC would not lend itself to written submissions. Indeed the importance attributed by the ACCC (and Telstra) to WACC and its complexity, are reasons enough for written submissions.

361               The SOMF included a waterfall chart prepared by the ACCC. The chart was intended to illustrate the effect on the TEA model if the ACCC’s estimate of the WACC input parameters were substituted. Telstra’s Senior Counsel, objected to that chart based on its accuracy. During oral submissions, ACCC’s counsel tendered a document headed “Waterfall chart of WACC parameter changes”. This document was intended to replace the waterfall chart in the SOMF. The replacement waterfall chart was said to be more accurate than that used in the SOMF and the subject of Telstra’s objections.

362               The replacement waterfall chart contains a spreadsheet. The spreadsheet corresponds to each column of the waterfall chart. The chart shows the cumulative effect on the price generated by the TEA model of replacing each of Telstra’s WACC parameters with the ACCC’s estimated parameters.

363               The WACC parameters are usefully summarized in two tables appearing in the SOMF. The first table sets out the parameters used by Telstra in support of its vanilla WACC of 12.28%. It includes Telstra’s high, low and point estimates for each of the WACC parameters.

364               The second table includes almost all the information in the first table as well as the ACCC’s estimate of each of the WACC parameters. That second table- reproduced below, provides a convenient reference for each of the WACC parameters, particularly in relation to the difference between Telstra’s position and the ACCC’s position on each of those parameters.


Telstra’s low estimate

Telstra’s point estimate

Telstra’s high estimate

ACCC estimate

Risk free rate





Debt ratio





Debt risk premium





Debt insurance cost





Cost of debt





Debt beta





Tax rate





Asset beta





Equity beta





Equity issuance cost





Market risk premium










Cost of equity capital





Vanilla WACC





365               What this table reveals is that there is a difference in the WACC values of Telstra and the ACCC across almost all of the WACC parameters.

366               The revised waterfall chart submitted by the ACCC suggests that the risk-free rate and the equity beta are the two parameters that have the most significant impact on the access prices generated by the TEA Model.

367               Although critical of the ACCC for its failure to articulate its views in its written submissions, Telstra’s submissions also focused on the parameter differences between Telstra and the ACCC which have the greatest impact on the WACC.

368               In its oral submissions Telstra indicated that it saw little value in seeking to justify each input parameter.  However Telstra said that there are two inputs over which there is a significant dispute - the risk-free rate and the adjustment of the equity beta by the Blume adjustment.  The Blume adjustment is discussed below.

369               The Tribunal does not consider that it would be productive to consider every WACC parameter in dispute between the ACCC and Telstra. Instead the Tribunal has – as Telstra has done in its submission - focused on only those parameters having the greatest impact on the WACC and ultimately the ULLS charge. Those parameters are the risk-free rate and the equity beta.

370               The 2008 Undertaking was lodged with the ACCC on 3 March 2008.  The 2008 Undertaking lodged in 2008 supersedes a previous ULLS undertaking lodged by Telstra on 21 December 2007, the 2007 Undertaking, which Telstra withdrew at the time the 2008 Undertaking was lodged.  The 2008 Undertaking commences on acceptance by the ACCC and relevantly ends on 31 December 2010.

371               Telstra proposed a risk-free rate of 6.33%. The ACCC applied a risk-free rate of 4.51%.

372               The ACCC agrees with Telstra that this difference has a significant effect on the price generated by the TEA model. The value of the risk-free rate parameter is disputed.

373               Telstra, Optus, the ACCC and the consultant retained by the ACCC – Ovum, considered that it was appropriate to use Commonwealth Government Securities – specifically government bonds with a 10 year maturity as the appropriate proxy for the risk-free rate.

374               However Optus considered that the ACCC should use government bonds with a 3 year maturity to match the regulatory period, as changes in the 10 year rate could result in over or under recovery.

375               In its response to the ACCC’s draft decision, Optus explained its view in these terms:

If longer term rates are used to match the useful life of the asset (and there is an upward sloping yield curve) then the allowed cost of debt will compensate the access provider for risks that it is not taking. For example, the yield curve may be upward sloping because either the issuer may be expecting rates to rise, or it may simply be recognising the risk over the longer period. When regulation occurs in the next period, the access provider will be able to reset prices based on the new rates. If rates do actually rise during that first period then the provider will gain. Optus therefore considers that using a bond for a period longer than the regulatory period potentially allows the access providers to be over-compensated (or under-compensate if yield curves are downward sloping).

376               In a report to Telstra, Professor Bowman said that the maturity should be set at the long-term. Therefore, in the case of the CAN-related assets used in providing ULLS, the risk-free rate should be based upon 10 year government bonds.

377               In relation of other aspects of the disagreement on WACC, Optus relies on the submissions made by the ACCC, as do the Interveners.

378               Although Telstra and the ACCC agree on the use of government bonds with a 10 year maturity – the risk-free rate applied by each of them is considerably different. To understand that difference it is necessary to understand the process they each applied to estimate the risk-free rate.

379               Telstra used Reserve Bank of Australia data and estimated the yield to maturity on a 10 year Australian Commonwealth Government Bond as at the market close on 31 December 2007. On this basis Telstra estimated the risk-free rate as 6.33%.

380               The reason for selecting the date of 31 December 2007 was that Telstra set out to model the price for access to the ULLS as at 1 January 2008, corresponding to an assumed start of the regulatory period. This date was also used by Telstra in the 2007 Undertaking.

381               Like Telstra, the ACCC’s consultant - Ovum also used Reserve Bank of Australia data. In its report, Ovum assumed a regulatory period starting on 1 January 2008. Ovum estimated the risk-free rate as 6.31% by taking the average yield to maturity of a 10 year CGS based on the 10 days leading up to 31 December 2007.

382               In its Draft Decision the ACCC did not consider the difference between the risk-free rate estimated by Telstra (6.33%) and Ovum (6.31%) to be material.

383               However in its Draft Decision, the ACCC said it generally considers that regulated firms should use an averaging period when estimating the yield on the risk-free rate to address day-to-day market volatility. Despite this, the ACCC said that in this particular situation leading up to 31 December 2007, whether or not averaging was applied was immaterial.

384               Ovum says that as Telstra submitted its 2008 Undertaking on 3 March 2008, it has set the risk-free rate ex-post. Ovum says it can be argued that ex-post observation dates are generally not preferred, as dates that produce higher rates could possibly be selected to the benefit of Telstra.

385               Telstra considers that the use of an ex post risk-free rate from 1 January 2008 allows for consistent valuation of the assets across the asset base. Telstra also submits that the date chosen for the calculation of the risk-free rate was not chosen expost, as the date selected was maintained from when Telstra says that the risk-free rate was not the subject of any significant debate in the hearing before the ACCC.

386               Telstra maintains that there was therefore no further debate on the topic. However, Telstra said that  in its Final Decision, the ACCC unexpectedly, and without warning to Telstra, measured the risk-free-rate on the 10 trading days leading up to 8 April 2009. This produced a risk-free rate of 4.51%. That is the position the ACCC now maintains.

387               Telstra argues that it was inappropriate to measure a risk-free rate by using government bonds in March and early April 2009, at a time when yields on government securities had been significantly impacted by the global financial crisis.

388               Telstra says that the ACCC had evidence that the global financial crisis had the effect of dislocating and significantly altering the parameters relevant to CAPM, including the risk-free rate. Telstra says that for obvious reasons, regulatory precedent does not support measuring a parameter during a time when the parameter has an anomalous or unrepresentative value.

389               Telstra also says that the ACCC’s approach involves using parameters measured in different time periods – a risk-free rate measured at the height of the crisis, but a market risk premium measured much earlier. Telstra asserts that this is an inappropriate application of the CAPM. If a risk-free rate is to be measured in March or April 2009, then it would be necessary to measure the market risk premium at the same time.

390               As indicated, Telstra used Reserve Bank of Australia data and estimated the yield to maturity on a 10 year Commonwealth Government Bond at the market close on 31 December 2007. At that time, the yield and maturity on the relevant government bonds was 6.33%.

391               However the 2008 Undertaking was not lodged with the ACCC until 3 March 2008.  The ACCC maintains that Telstra’s point estimate was outdated at the time that the 2008 Undertaking was lodged.  The 2008 Undertaking commences on acceptance by the ACCC and relevantly ends on 31 December 2010. The ACCC agrees with Ovum that possible bias may have been introduced by Telstra when selecting the date for the risk-free rate as the Undertaking was resubmitted at the date used by Telstra.

392               Further, the ACCC argues that the risk-free rate used by Telstra in the TEA model was out of date at the time of the ACCC’s decision in April 2009. The ACCC says that there has been significant change in economic conditions since December 2007, which has seen an easing in monetary policy by the Reserve Bank of Australia as a consequence of the global economic crisis.

393               The ACCC considers it obliged to take into account the financial conditions at the time when it makes a decision to accept or reject an Undertaking.

394               The ACCC also said that an averaging period should be used when estimating the yield on the risk-free rate and yield on debt, to address day-to-day market volatility.

395               Having regard to the date of the 2008 Undertaking, the date of its expressed commencement, the requirement for averaging and the economic conditions since December 2007, the ACCC considers that the yield on Commonwealth Government Bonds on a particular day in December 2007 will not provide an accurate estimate of the risk-free rate if and when the 2008 Undertaking comes into effect.

396               On this basis the ACCC considers that Telstra’s risk-free rate would be 4.51% based on the 10 trading days leading up to 8 April 2009 - just prior to the publication of the ACCC’s Final Decision.

397               In its oral submissions counsel for the ACCC added that the use of historical data from December 2007 about the risk-free rate is inconsistent with the process of seeking to estimate the forward looking, efficient costs of providing the ULLS.  In that context, the relevant question is not whether the proposed monthly charge reflected the efficient, forward-looking costs of providing the ULLS in December 2007.  It’s whether they reflect those costs now.

398               In Re Gasnet Australia (Operations) Pty Limited [2003] ACompT 6 at [48],the Tribunal said that it is conventional to use a 10 year bond rate where the life of the assets and the length of the investment is long.

399               The Tribunal is aware that the Australian Energy Regulator (AER,) in its December 2008 Explanatory Statement, discussed the costs and benefits of moving away from a 10 year term assumption. It was aided by a number of papers designed to test the accepted position of using a 10 year bond rate.

400               The AER considers that that there are significant counter-arguments to a number of the Tribunal’s reasons in Gasnet for adopting a 10 year term assumption.

401               First, the issue did not appear to have been argued before the Tribunal in GasNet. It is therefore that the Tribunal’s decision did not specifically discuss or address the possibility of incorrect compensation resulting from the use of a term for the risk-free rate that exceeds the length of the regulatory period.

402               Secondly, given that energy network businesses are estimated to have a weighted average debt maturity profile of around five years or less, there is no evidence to suggest that network businesses will seek to issue long term debt as a matter of preference. The AER says that the evidence upon which this current assessment has been made was not before the Tribunal at the time of the Gasnet decision.  

403               The AER concluded that there is persuasive evidence to move away from a 10 year term assumption to a term that matches the length of the regulatory period.

404               Gasnet has suggested that a 10 year rate is appropriate where the life of the assets and the length of the investment is long. The Tribunal considers that this is the case here, given the nature of the CAN assets and the investment in those assets.

405               The Tribunal understands that the 10 year rate has also been fairly consistently applied by regulators in a number of industries in Australia since the Gasnet decision.

406               The regulatory period considered by the AER is also a different regulatory period to that covered by the 2008 Undertaking. The Tribunal also notes that the AER must specifically have regard to matters under the National Electricity Rules which bear on, among other things, the extent of evidence required before it departs from an established method.

407               The material considered by the AER in reaching its conclusion is not material that was the subject of any significant debate before us in this matter. Indeed the Tribunal does not know whether Optus in particular (but the other parties also) would wish to rely on the conclusion reached by the AER or its reasons for reaching this conclusion. The Tribunal is therefore unable to form a view on the validity or otherwise of that conclusion.

408               Until that debate is had, the Tribunal sees no present reason not to follow the decision in Gasnet. The Tribunal is therefore not persuaded to depart from the approach of the ACCC and Telstra to use government bonds with a 10 year maturity as an appropriate proxy for the risk-free rate.

409               The other significant area of disputes relates to the data used to estimate the risk-free rate.

410               Professor Bowman considered it appropriate to measure the 10 year bond rate at the close of business of the trading day before the beginning of the regulatory period.

411               Telstra used Reserve Bank of Australia data at the market close on 31 December 2007 for both its 2007 Undertaking and its 2008 Undertaking. The choice of that date as regards the 2007 Undertaking may (had that Undertaking not have been withdrawn and had it been accepted) have broadly coincided with the commencement of the regulatory period.

412               However, that is not so in the case of the 2008 Undertaking. The 2008 Undertaking was not lodged with the ACCC until 3 March 2008. The ACCC’s final decision was not published until 8 April 2009. The use of data at December 2007 does not coincide with the date of lodgement of the 2008 Undertaking, the ACCC’s final decision, or if approved the commencement of the regulatory period.

413               Despite this, the Tribunal understood Telstra to be arguing that regulatory precedent does not, in any case, support measuring a parameter during a time when, as Telstra put it, the parameter has an anomalous or unrepresentative value – specifically during the time of the global financial crisis.A consequence of using 10 year data immediately prior to the commencement of the regulatory period is that the data will inevitably include a period affected by the global financial crisis, reflected in the yields on bonds during that period.

414               Telstra maintained that if the risk-free rate is to be measured in March or April 2009, then it would be necessary to measure the market risk premium at the same time.  The market risk premium is the premium investors in a fully diversified portfolio expect to earn above the risk-free rate.  Telstra adduced some evidence, untested, that the market premium was in fact very much higher than the standard 6.5% assumed by the ACCC, reflecting a flight from risk, just as the low risk-free rate reflected a flight to safety.

415               The dispute turns on whether the data derived over the period chosen by the ACCC is anomalous or unrepresentative.

416               The risk-free rate refers to the return from an asset with no risk of default.  There is every reason to assume (and little evidence to doubt) that the yields on commonwealth bonds over this period continued to provide an accurate proxy for a return on assets bearing no risk of default. To the extent that the yields factored the impacts of the global financial crisis, the bond rate continued to provide a representative indicator of the risk-free rate.

417               It is also not unusual for yields to move from time to time in order to reflect prevailing market conditions and the expectations about the prospect for prices into the future. A downward movement in yields over this period is therefore hardly anomalous, given market conditions.

418               The Tribunal also notes that the approach advanced by Telstra would impose an obligation on the regulator (or the Tribunal) to make value judgments. Those value judgments include whether the period over which the data is taken is in some manner unusual, and whether the data derived is in some way anomalous or unrepresentative of the value that should apply to that parameter.  This could involve predicting future rates, although means are available to do that.

419               The Tribunal considers that the ACCC was right to conclude that the risk-free rate in December 2007 was unlikely to generate the best estimate of a TSLRIC+-based price.  On the other hand, it is difficult to see why the date when an undertaking comes into effect is especially significant.  An undertaking has effect over a period, and the price it sets need to be appropriate for the period.  Hence the WACC employed in deriving the price ought ideally to be representative of the period as a whole.  But this presents difficulties.

420               It is also noteworthy that the ACCC’s approach of requiring the risk-free rate to be set close to the time that an undertaking comes into effect means that an access provider could not specify actual prices in an undertaking, but only a formula for deriving them, since an undertaking only takes effect on acceptance by the ACCC (or later), which must be some (perhaps considerable) time after the undertaking is submitted.  The access provider could not know the Commonwealth Government Bond rate at some future date at the time of lodging its undertaking (although it could make a prediction).

421               The ACCC having reached its view, it ought at the least to have made it known at some time before publishing its Final Decision.

422               The Tribunal notes that the use of the WACC formula is only a means to an end, which is to estimate the required rate of return for an investment with certain characteristics of riskiness and debt.  That rate of return is unlikely to vary greatly over the short to medium term, and should not therefore be overly subject to the vagaries of short-term movements in parameters such as market interest rates.  Moreover, the rate of return applies over the period of the undertaking.  Both the access provider and the ACCC should keep these facts in mind to ensure that they do not, by lighting on parameter values that are unrepresentative, end up with a rate of return that is inappropriate to its purpose.

423               The asset beta represents the level of systematic risk associated with a particular asset that is, without gearing or debt. It is measured relative to a fully diversified portfolio of assets - typically by a broad measure of the relevant equity market as a proxy.

424               The equity beta represents the level of systematic risk associated with a particular asset as well as the financial risk from leverage.

425               The relevant asset beta is re-levered to incorporate the effect of gearing for the CAN-related assets, to derive the equity beta.

426               Telstra’s asset beta was in the range of 0.62-0.825. Telstra adopted a point estimate of 0.725.

427               Telstra converted the asset beta estimate into an equity beta estimate within the range 0.89-1.17, with a point estimate of 1.03. Telstra says that its estimate of the equity beta of 1.03 is reasonable.

428               Telstra argues that its CAN faces a significant and increasing level of risk from a decline in fixed lines and rights of compulsory access, at prices determined by the ACCC with little control by Telstra. Further, Telstra says the risk associated with providing the CAN assets on a forward looking basis can be expected to increase with the prospect of increased competitive bypass.

429               The Interveners maintain that by adopting an equity beta of greater than one, Telstra is suggesting that its risk of investing in the CAN is greater than investing in the share market generally. The Interveners say that this is an extraordinary proposition given that the CAN is a monopoly held bottleneck asset that is used to provide an indispensable service.

430               Telstra applied a variety of techniques in arriving at its estimate of the asset beta – income elasticity techniques, international benchmarking, and direct estimation.

431               Ultimately the disagreement relates to the value of the equity beta resulting from the application of these techniques. Invariably it also relates to how these techniques have been applied, the data used to support them and the conclusions drawn from their application.

432               Telstra estimated the asset beta using income elasticity techniques.

433               Income elasticity measures the susceptibility of demand for a particular product or service to fluctuating levels of income. Since incomes will generally move directly with the economic cycle there should be a positive relationship between income elasticity and beta. This technique suggested that the asset beta was 0.87.

434               Broadly, the ACCC considers that weight should not be given to these techniques when there is the opportunity to use benchmarking and direct estimation methods.

435               Telstra acknowledges that caution should be applied when considering international benchmarks of comparable entities. However it maintains that international benchmarks are a useful guide to the value of the asset beta of a stand-alone CAN provider.

436               Telstra does not consider that there is a listed entity that uniquely and solely provides the range of services supplied by the notional CAN-only provider. However, it considers that the remaining regional Bell operating companies (RBOCs) – Verizon, AT&T and Qwest, are reasonable analogues of the CAN-only provider.

437               The average estimated asset beta of the remaining RBOC’s is 0.67. The average estimated asset beta of the non-RBOC telecommunications companies is 0.74. The average estimated asset beta of the entire comparable group is 0.72.

438               As it noted in its Draft Decision, the ACCC considers that the RBOC comparators were originally used when Telstra was first privatised because there was no available market data for Telstra. Since 1999, the RBOCs have diversified their business interests and the ACCC considers they are now less relevant as comparators.

439               The ACCC maintains the view expressed in its Draft Decision that current estimates of RBOCs are likely to have a higher risk on average than Telstra. This is because American telecommunications companies operate in the liberalised and highly competitive US telecommunications market, with a different market structure to Australia.

440               Accordingly, the ACCC does not consider estimates of the RBOC’s betas to be representative of the systematic risk of the ULLS service. However, the ACCC did include the RBOC estimates in its benchmarking analysis.

441               Telstra also refers to the study by Professor Damodaran of New York University who estimated the average asset beta of US telecommunications firms to be 1.03.Telstra also refers to a further study which calculated the beta for various telecommunications companies in Europe, the US and Australasia, and calculated Telstra’s equity beta as 1.00.

442               The ACCC also undertook its own benchmarking analysis. It selected countries considered advanced by the OECD. As indicated, the ACCC included the RBOC estimates in its calculation of its benchmark equity and asset beta estimates. However it excluded a number of countries for a number of reasons including because they were not publicly listed or because of a lack of data.

443               The ACCC’s benchmarking analysis suggests that a benchmark asset beta of around 0.47 is appropriate for a large telecommunications company such as Telstra with both fixed and mobile networks.

444               The ACCC says this asset beta of 0.47 is likely to be higher than the asset beta of the Telstra’s CAN alone. This is because the Telstra’s CAN business is likely to bear lower systematic risk than Telstra’s average business due to higher systematic risk of other Telstra businesses, including mobile communications.

445               Telstra also argues that the ACCC cannot estimate the systematic risk of telecommunications without considerable uncertainty. Telstra submits that their benchmark suggests that the likely asset beta could be 15% above or below a point estimate. In addition, Telstra suggests that steps applied in calculating a beta, introduce additional uncertainty that is not captured in the statistical standard errors. The ACCC does not consider this uncertainty as a reason not to adopt a point estimate above the mean. As stated in its Draft Decision, the ACCC considers that this would result in an inappropriate overcompensation.

446               Although international benchmarking is helpful, the ACCC says more emphasis should be given to Ovum’s direct beta estimate based on five years of monthly data.

447               Telstra considers that Telstra-wide information will be a useful starting point for quantifying CAN-specific values for many of the WACC parameters. Consistent with this view, using data obtained from Bloomberg Financial Services (Bloomberg) on 11 February 2008 over a 2 year period, various estimates of the Telstra-wide equity beta was produced:



Adjusted beta

Standard error



Raw beta



















448               The “Adjusted beta” in the table refers to the use of the Blume adjustment. The Blume adjustment is a technique which assumes that a firm’s systematic risk reverts toward the mean of the market. This is discussed below.

449               This data suggests that the Telstra-wide asset beta is somewhere around 0.60 to 0.75 with a simple average around 0.65. As these estimates have a significant standard error, the Telstra-wide asset beta could range from 0.43 to 0.89.

450               The ACCC’s consultant, Ovum used a direct estimation method to estimate the Telstra-wide equity beta using Bloomberg data. The equity beta estimates were measured on trailing 18 month and 5 year prices, on a monthly, weekly and daily basis, relative to the S&P ASX 200 Index. Bloomberg took estimates up to 31 December 2007. Ovum reported the following results:




18 months at 31 December 2007



18 months at 31 December 2007



18 months at 31 December 2007



5 years average



5 years average



5 years average



451               As can be seen, Ovum’s estimate of Telstra’s equity beta is in the range of 0.394 -0.655.

452               Ovum referred to a Copenhagen study suggesting that daily data was less reliable. As can be seen, Ovum produced two estimates of Telstra’s equity beta using weekly data. On a 5 year average Ovum estimated the equity beta to be 0.534 and using 18 months of data to 31 December 2007 Ovum found the equity beta to be 0.655.

453               However, Ovum appears to have been guided by a recommendation of the ACCC in its draft decision “Access Undertaking – Interstate Rail Network, Australian Rail Track Corporation”, April 2008, which indicated a preference for monthly observed data of at least 5 years. On that basis Ovum concluded that an equity beta of 0.394 was an appropriate estimate of Telstra’s equity beta.

454               Telstra’s consultant, Bowman, says that Ovum cites Copenhagen Economics as recommending against using daily data, but makes no comment on why weekly data would not be as useful. Bowman also says that there is considerable competing research about beta estimation periods, intervals and methods so that Copenhagen Economics is not of itself authoritative.

455               Ovum notes the work of Associate Professor Henry who argued that a reasonable compromise was to use weekly data. Ovum notes that Henry used weekly observed data as the available sample which was short, and therefore monthly data was unlikely to be statistically reliable. However Ovum argues that monthly observed data should suffice where the data sample is sufficiently long.

456               Ovum refers to the views of the AER, which argues that “unrepresentative events” should be removed from beta estimates. One example of an “unrepresentative event” is the “technology bubble” during which market indices were driven upwards by telecommunications, media and technology stock prices, from the late 1990s to 2001. In light of this consideration, Ovum did not include any data from this time period.

457               The AER distinguishes between outliers attributable to business-specific events and events that are ‘unrepresentative’ of the market (for example the technology bubble.) In the case of business specific events the AER considers that caution should be applied in removing observations of a specific entity over a specified period of time as this can be subjective. It prefers applying econometric techniques which attempt to reduce the impact of the outlier observations.

458               The AER defines the second category of “unrepresentative events” as follows:

Events are considered ‘unrepresentative’ when the market conditions during this period are unlikely to be reflective of the market going forward. Accordingly, ‘unrepresentative events’ are generally removed from the sample, or a sampling period that does not overlap with unrepresentative events in estimating forward looking estimates of equity betas. For example, it has been argued that in the United States, the ‘technology bubble’, where market indices were driven upwards by telecommunications, media and technology stock prices from the late 1990s to 2001 resulted in a period where equity betas for energy businesses reached historical lows.

During this period it has been considered that the prices of energy businesses were not driven by technology stock prices, unlike the market index. As a result, regulators have treated this period as a one-off unrepresentative event and excluded this period for the purposes of estimating the corresponding period for both the market and businesses/portfolio being examined.


459               Even in the case of unrepresentative events, the AER says that ideally market observations should not be excluded. Rather it is preferable to use a longer time series to account for variations in market data or use estimation techniques which account for outliers. It acknowledges however that it has been standard practice to remove for example, observations that are relate to the technology bubble and that only for reasons of regulatory certainty would it not now depart from that approach.

460               The ACCC considers that Ovum’s direct estimate for beta using 5 years of monthly data is appropriate. Therefore it says, Ovum’s estimate of Telstra’s equity beta using this approach of 0.394 is fair.

461               Telstra and the ACCC both applied data from the same Bloomberg source. As Telstra has observed both sets of data produce similar results, with the exception of the 5 year average calculated using a monthly frequency. It is this number (0.394) which the ACCC has applied – Telstra says with little justification. This outlier, Telstra says is the one most likely to be affected by some irregularity in the Bloomberg data.

462               Bowman says this estimate is inconsistent with the other 5 estimates, which average 0.577. Bowman also says that an estimate of an equity beta below 0.4 is unusually low. This raises the possibility of problems with the data used to calculate the monthly, 5 year beta.

463               One explanation offered is that it is an outlier. The outlier is the observation for the month of September 2005, reflecting what occurred with Telstra’s shares and in the market overall. The suspicion is that the negative return for Telstra (-13.03%) indicates an unusual event in that month. The explanation offered is the possible revised earnings guidance issued by Telstra the previous day. The decline in Telstra’s share price on 5 September was the second worst daily decline in the 5 year period covered in Ovum’s analysis (a total of 1265 days). Bowman suggests that if the same analysis is undertaken, but with the September 2005 observation omitted, the result is an equity beta of 0.52.

464               In Bowman’s opinion, the estimate without the outlier month of September 2005 is more useful than that proposed by Ovum. Bowman says that while recognizing that unrepresentative events should be excluded from beta estimates, Ovum does not address the outlier in its data.

465               The ACCC considers that more weight should be placed on estimates using monthly data over a 5 year period, because:

(a)        it is the more commonly recommended estimation interval and length used in financial markets;

(b)        it picks up the systematic risk of an investment in Telstra’s equity relative to the equity market as a whole over monthly holding periods. This the ACCC believes is more representative of the risks facing longer term investors than using weekly or daily data holding period returns; and

(c)        it is also likely to remove trading effects.

466               The ACCC also notes that its own benchmarking analysis did estimate equity and asset betas using 5 years of data using both weekly and monthly sampling frequencies. Both sampling frequencies came up with very similar results and both supported the use of a benchmark asset beta of 0.50.

467               The ACCC also considers the use of 18 months or 2 years of data has too few sample points for monthly sampling and is arguably also too short an estimation period. This may result in unreliable estimates of equity beta.

468               A further point of difference between Telstra and the ACCC relates to the application of the Blume adjustment to the equity beta.

469               The Blume adjustment assumes that the firms systematic risk reverts towards the mean of the market. Telstra says that the Blume adjustment is appropriate because it considers that historical data would underestimate forward-looking betas.

470               Telstra considers that the Blume adjustment is reasonable because:

(a)                historical data is likely to underestimate forward-looking betas;

(b)                it is commonly used by Bloomberg and other data providers;

(c)                 the market average equity beta is 1. Raw equity beta estimates below the market average are likely to be underestimated. The Blume adjustment makes an adjustment to push the equity beta towards the market average beta of 1; and

(d)               the systematic risk of providing the ULLS is likely to increase over time due to the risk of competitive bypass. This includes technological alternatives such as wireless.

471               Telstra says that historical equity beta estimates are unlikely to be representative of the forward-looking beta of a hypothetical new entrant because during the 5 year period, ACCC decisions have placed downward pressure on Telstra’s share price. If these ACCC decisions had not been made, Telstra’s return could be expected to be more in line with the market return.

472               The ACCC disagrees with Telstra that historical data underestimates a firms’ forward-looking beta for firms with a beta of less than one. It disagrees that a Blume adjustment is required. It also disagrees with the assumption that the systematic risk of providing the ULLS will “change over time”. The ACCC took the opportunity in its Final Decision to clarify this statement - The ACCC considers that there is no reason to assume the systematic risk facing a regulated monopoly will revert towards the mean of the market (that is, a beta of 1).

473               Telstra says that the essence of the disagreement is whether the risk facing the CAN is likely to increase over time. Telstra says that the ACCC’s suggestion of increased demand for the CAN is inconsistent with evidence of a decline in demand for fixed services. Similarly, alternative technologies represent significant competitive risks. It is also broadly for these reasons that Telstra rejects Optus’ arguments that beta estimates of electricity and gas businesses can also be applied to the CAN.

474               While competition does exist from wireless and HFC, the ACCC says that it is not clear whether technological change will increase or decrease the systematic risk facing the CAN. The ACCC says that ADSL technology is advancing rapidly and the increasing need for high bandwidth may increase the CAN’s market power and reduce the systematic risk.

475               The ACCC notes that Bloomberg provide the option of using the Blume adjustment. However Bloomberg do not indicate whether the Blume adjustment is correct. Overall, the ACCC does not consider that applying the Blume adjustment is appropriate.

476               The dispute relates broadly to the data used by the parties as inputs to the various techniques they employed to generate the equity beta and to the application of those techniques themselves. Ultimately the dispute translates to the value to be attributed to the equity beta.

477               Both the ACCC and Telstra have employed a variety of techniques to estimate the equity beta. Each of these techniques is capable of generating a value for the equity beta. The Tribunal supports this approach. This is because the value of WACC requires an exercise of some balancing and judgment. It applies equally to the ultimate WACC value as it does to the individual parameter values - like the equity beta.

478               For that reason employing a variety of techniques provides a firmer foundation from which to make those judgments. It also allows parameter values derived under one technique to be effectively tested for its robustness against another technique. In this way the process of balancing and the exercise of judgment can be more refined.

479               Both Telstra and the ACCC applied a variety of techniques, including international benchmarking. They both agree that some caution should be applied to ensure that accurate comparables are used. However there is unlikely to be a perfect international comparison for the Telstra equivalent business. The best that can be achieved is to apply the closest possible comparables.

480               Telstra choose the RBOCs over the objections of the ACCC that the RBOCs are not now useful comparators.

481               The Tribunal prefers the countries (entities) used in the ACCC benchmarking for a number of reasons. In the Tribunal’s view Telstra has not provided compelling evidence to suggest that the entities (including the RBOCs) are still useful comparators. Faced with that uncertainty the broader data set used by the ACCC (which the Tribunal notes in any case includes the RBOCs) is more reliable. Part of that reliability lies not just in the broader data set itself – it is the fact that if that data set is inaccurate (because one of more included entities are not suitable comparators) that error is likely to be minimized by averaging across a broader set of comparables.

482               Despite the Tribunal’s preference, it is mindful of the caution expressed by both the ACCC and Telstra over the use of benchmarking. While The Tribunal has found it helpful to consider the benchmarking analysis, because of this caution we have not relied on it alone, to the exclusion of the other techniques employed by Telstra and the ACCC.

483               The Tribunal therefore also considered the other approaches, including the direct beta estimates which were the subject of extensive submissions by both Telstra and the ACCC. A considerable area of dispute related to the choice of monthly data by the ACCC and weekly data by Telstra. This was not simply a philosophical debate. Rather the preference had a direct bearing particularly on whether the beta of 0.394 calculated using a monthly frequency was reliable.

484               Estimating equity betas can be affected by a number of factors, including the representative sample and by other factors including the frequency in which stocks are traded.

485               As a matter of principle, monthly, weekly and daily returns should be considered to determine which frequency provides a statistically robust estimate of the equity beta. There may be a number of considerations that favour one over another in particular circumstances. For example, there may be too many one off events associated with daily data or too few observations available for monthly data.

486               Associate Professor Henry, referred to by Ovum, argued that a reasonable compromise was to use weekly data. Bowman similarly prefers weekly data. Although Ovum argued that monthly observed data should be used where the data sample is sufficiently long, it did not otherwise seriously argue against the use of weekly data. The Tribunal also notes that other Australian regulators have used weekly data.

487               Ultimately though the estimation period does not come down simply to the view of one consultant over another and that is not the approach the Tribunal adopted. Rather the choice involves a principled judgment between relevance of data and having adequate data for reliable estimates. It is for this reason that monthly, weekly and daily data should be tested for its reliability.

488               In this instance, the Tribunal considers that in adopting a weekly approach, Telstra has undertaken the principled analysis to which we have referred.

489               However in doing so we should not be understood as accepting the argument raised by Telstra that the monthly estimate of 0.394 is necessarily an outlier or a symptom of an unrepresentative event. Although Telstra’s expert Bowman has proffered an explanation, it is expressed no more strongly than a suspicion. Therefore even if that number were an outlier, Telstra has not satisfied us that it is attributable to an unrepresentative event.

490               The Tribunal does not agree with Telstra that the Blume adjustment should be applied. A Blume adjustment assumes that beta estimates will over time regress towards the mean of the market, or towards one. It does so by attaching a weight on the observed beta and the remaining weight on that of the market beta. Applying the Blume adjustment will therefore tend to move the beta estimate closer to one.

491               Although the Blume adjustment may be applied, Bloomberg does not mandate that it be applied. The Bloomberg data is therefore not compromised simply because the Blume adjustment is not applied.  The Tribunal is also aware that the Blume adjustment has not been widely applied by Australian regulators.

492               A rationale for the Blume adjustment is that it may improve beta estimates where data quality may cast doubt over the raw data or introduce a data bias. This may result from the data itself or through estimation errors.

493               However it may be that the process which drives the beta towards the market mean is the result of the progressive elimination of these very data errors. Also the gearing of an entity may, over time, become more consistent with the overall level of the market.

494               The Tribunal cannot be satisfied as to how much of the beta differences that have been observed are attributable to estimation errors that would justify the Blume adjustment. Telstra has also not fully articulated how the Blume adjustment would be applied here.

495               The Tribunal does not agree with the ACCC that the systematic risk of providing the ULLS may decline. This appears to be inconsistent with the evidence that has been presented to us of both a decline in the use of CAN lines and the growth of alternative technologies. However equally we consider that Telstra has overstated this decline - more accurately, it cannot presently forecast that decline or threat with the level of certainty to which it asserts.

496               It is not necessary for the Tribunal to reach a concluded view on this point. Even if Telstra were correct in its estimation, the Tribunal is satisfied that the raw beta estimates accurately factor this systematic risk, without the need for the Blume adjustment.

497               Conversely the risk of applying the Blume adjustment, where it is not warranted could result in the beta being overestimated. Rather than correcting for any bias inherent in the data, the Blume adjustment, improperly applied, may also bias the data upwards.

498               Faced with this risk, the Tribunal considers that other methods to reduce any perceived estimation errors to be preferable.


499               Operating and maintenance (O&M) costs are ongoing operational costs, (including labour and materials) that are directly related to the provision of the ULLS – if the service ceased, these costs would no longer be incurred.

500               Indirect costs are common costs (also known as overheads or unattributable costs) that would be incurred whether or not the ULLS or the group of services ceases to be offered, for example head office costs. Common costs are directly related to the provision of a group of services that would not be avoided unless provision of all the services in the group ceased.

501               In the Final Decision, the ACCC said that the TEA Model produced a total O&M expense of $836.0 million. The ACCC considered that these expenses were overestimated compared with its calculation of O&M expenses from Telstra’s 2006/07 RAF report, which the ACCC calculated as [X].

502               O&M costs may be derived by a ‘top-down’ or a ‘bottom-up’ approach. Telstra’s Senior Counsel referred the Tribunal to the following passage from the Report of the United States Federal Communications Commission, Rule Making Decision of September 2003 which conveniently describes the two approaches:

One area of controversy in state pricing proceedings has been the calculation of monthly operating expenses. In theory, the monthly operating cost should be calculated by estimating the total forward-looking operating expense associated with a particular network element (e.g., by conducting time and motion studies of likely maintenance activities) and then  dividing the total operating expense by the appropriate number of units, such as lines, to obtain the expected average operating expense. Such an approach is difficult to implement in practice, however, so regulators often estimate projected operating expenses by multiplying the projected investment in the network by an annual cost factor (ACF). An ACF typically is a ratio of current expenses to current investment for a particular account. The ratio is multiplied by the projected investment to obtain the projected expenses. An alternative method of calculating monthly operating costs is to look at current operating expenses and make any adjustments to reflect anticipated experience in the period for which the projection is made, such as adjustments for productivity and inflation.

503               In view of the practical difficulties of a bottom-up, it is common to apply a top-down approach. The O&M expenses in the TEA model were calculated using a top-down approach.

504               The ACCC and Optus argue that Telstra has in places applied a top-down approach and in others a bottom-up approach. It criticises this inconsistency.  Subject to this concern (and any consequences flowing from that inconsistency) a top-down approach - properly applied - is not seriously challenged.

505               Rather, the ACCC, Optus and the other Intervenors have identified six specific areas of dispute relating to Telstra’s calculation of O&M costs. It is sufficient at this stage to note that the areas of dispute relate broadly to the methodology applied by Telstra to calculate O&M costs and the transparency of that methodology.

506               In order to understand the areas of dispute it is necessary to understand the methodology applied by Telstra.

Overview of the top-down methodology

507               The capital costs of providing the ULLS fall into the following categories:

(a)        Direct assets - Assets used to provide the ULLS such as ducts and pipes and copper cable.

(b)        Network support assets - Assets that are used for the ULLS as well as other services which are provided as part of Telstra’s network.

(c)        Indirect asset - Assets that are not directly attributable to the ULLS or a particular service, but are used as part of Telstra’s overall business.

508               Under the top-down approach applied by Telstra, the TEA model does not directly estimate the ongoing O&M costs across these asset categories.  Instead, the TEA Model estimates operating costs by the use of 'factors’ or ratios. Broadly, these cost factors represent Telstra’s estimate of the dollar amount of O&M expense required for each dollar of assets modelled in the TEA model. In this context, these factors characterise the top-down approach.

509               The O&M factors used in the TEA model are calculated using Telstra’s accounts prepared under the Regulatory Accounting Framework (RAF). The RAF data is not split across Bands.

510               In the TEA Model O&M expenses associated with each category of network plant and equipment are calculated by multiplying the level of investment modelled for each category of plant and equipment by the relevant O&M factor. As will be seen, the O&M factor for a particular category of plant and equipment is derived by dividing the annual operating expense by the investment cost for the particular category.

511               The RAF data provides revenue and cost data for a range of Telstra's networks (including fixed and mobile networks). The TEA model uses historical cost values taken from the RAF account data that is aggregated across all services. The inputs are converted into the factors across four categories:

            (a)        direct O&M expenses

            (b)        indirect O&M expenses

            (c)        indirect assets

            (d)        Network Support assets

Calculating the O&M factors

512               O&M factors are calculated for plant and equipment comprising ducts and pipes, copper cables, inter-exchange cables, multiplexing equipment and switching equipment (local).

513               The O&M factor is derived by dividing the relevant Operating Expense numerator (taken from the “Operating Expenses” worksheet of the Factor Calculation Module) by the relevant “Investment Cost” denominator (taken from the “Investment Costs” worksheet of the Factor Calculation Module). The Factor Calculation Module is a separate Excel worksheet from the TEA model.

514               The numerator (operating expense) of the factor for each category of plant and equipment is calculated by taking the “maintenance” and “other expenses” expense items from the Capital Adjusted Profit Statements of the RAF for both the Internal and External Wholesale Businesses (defined in the RAF).

515               Two adjustments were then made. First cable costs were reclassified – that is, “Other Cables-CAN” was reclassified as “Inter-Exchange cables” because in Telstra’s view the RAF does not contain a separate investment account for “Other Cables-CAN” and it is not possible to calculate an O&M factor for this category alone. The ACCC disputes that there is no amount appearing in the RAF for this item.

516               Secondly installation costs were eliminated because these costs are not part of the ongoing O&M expenses associated with the access network.

517               The denominator (investment cost) for each category of plant and equipment was taken from the Fixed Asset Statements of the RAF. The full value of plant and equipment, namely the total asset value prior to depreciation, across all RAF products was taken for both the Internal and External Wholesale Businesses, as defined in the RAF.

518               The denominator of the O&M cost factor calculation was generally the “book investment cost” from the RAF for the particular class of plant and equipment.  However, a forward-looking adjustment was made to the investment costs for ducts and copper cables. For these categories of plant and equipment, Telstra has adopted the full investment costs from the TEA Model rather than from the historical RAF data. As 96% of O&M expenses are accounted for by ducts and copper cables, Telstra says the absence of a forward-looking adjustment for other assets is unlikely to affect the estimate of direct expenses associated with ULLS. Telstra argues that this addresses a criticism advanced by Optus that ratios based on historical data are likely to be different from those based on forward-looking costs.

519               The consequence of using the forward-looking investment cost modelled in the TEA Model rather than the book investment cost from the RAF reduced the O&M factor for ducts and pipes by a factor of 3.

520               Telstra subsequently adjusted the TEA Model to use historical costs for cables to take into account comments from access seekers. The ducts and pipes for which the TEA model continues to use forward-looking costs represent the largest cost item in the TEA model.

521               For copper cable, the denominator used in the O&M cost factor calculation of February 2009 was the book investment cost from the RAF, ultimately adjusted to X.

522               Telstra originally used the forward-looking investment cost for copper cable in its O&M cost factor calculation of April 2008, which was less than X (X-1) but ultimately used the book investment cost from the RAF (X), it says, because it reduced the O&M factor for copper cable.  The ACCC rejects this proposition, arguing that it has not been provided with evidence from Telstra that this was the reason for using the RAF value.

523               In its response Telstra maintains that this follows as a matter of mathematical calculation. It says that the denominator used to develop the O&M cost factor for copper cables was increased from X-1 to X. The numerator in the calculation was unchanged. Therefore it says that increasing the size of the denominator while holding the numerator constant decreases the size of the factor.

524               Telstra says that the O&M expenses included in the calculation of the O&M factors were ongoing O&M expenses only, as they were the expenses relevant to the ongoing ULLS monthly charge. All once-off costs such as installation costs were removed from the analysis. The ACCC disagrees – It says that a number of expenses not relevant to the cost of the ULLS remain in the calculation of O&M factors, including switching equipment and optical fibre.

525               Telstra maintains that the equipment in the model which is classified as “switching equipment” comprises the terminating blocks and associated cable racking on the main distribution frame. It says that these blocks are not part of the switch and are required to terminate CAN services. The “optical fibre” relates to fibre in the main cable which is included in the TEA model so that the costs of main conduit and trenching are appropriately shared between fibre and copper main cable networks.

Calculating O&M costs

526               After calculation of the relevant “factors” the TEA Model calculates O&M costs broadly as follows:

(a)          costs associated with the direct assets are calculated by multiplying the O&M factor by the TEA model’s estimate of the investment value of each category of direct asset. For example, the factor for ducts and pipes is multiplied by the TEA model’s cost estimate for ducts and pipes.

(b)          the costs associated with Network Support Assets are calculated by multiplying the capital cost factor for each relevant category of asset (eg, Network Land) by the Network Asset Capital Investment value allocated to each direct asset (for example, ducts and pipes) to produce an operating cost for that category of asset.

527               In addition to the costs associated with direct, network support and indirect assets, Telstra also calculates factors for “Indirect Expenses”. These are the additional operating costs from Telstra’s overall business that the TEA model attributes to the ULLS. In the annual cost sheet, the Indirect Expenses are calculated by multiplying the factor for each relevant category of asset (eg, Product and Customer Costs) by the O&M cost for each direct asset (eg, Ducts and Pipes).

528               Each of the capital costs and operating costs are added to produce a monthly cost per line. This is shown on the right hand side of the annual cost sheet against the line item “Monthly Cost”.

The areas of dispute

529               As indicated, six separate areas of dispute were identified. For convenience, in our consideration, we have addressed some of those areas together, rather than sequentially.

(a) The methodology used to estimate operating costs and the annualized capital cost for network support and indirect assets

530               As indicated, in order to estimate operating costs, the annual cost sheet multiplies the cost factors by the TEA Model’s estimated investment value for each category of direct assets (ducts and pipes, copper cable etc). The ACCC argues that if the values of those assets increase (for example through an accounting re-valuation), then the TEA Model assumes that operating costs associated with the ULLS will also increase. This approach it says is unreasonable because there is no basis for assuming that all operating costs associated with a service would be in any way linked to the valuation of the assets used in the supply of the service.

531               However Telstra maintains that when factors are used to calculate O&M, it is the factor which provides the basis for calculating an O&M expense related to the cost of the assets supplying the service.

532               In addition, the ACCC, Optus and the other Intervenors argue that the use of historical cost data to estimate operating costs is inherently unreasonable. In a forward-looking implementation of TSLRIC+, the optimised network is modelled as new. Operating expenses, particularly the maintenance component, would be lower in a new network than in Telstra’s legacy network. Although Telstra has made a so-called 'forward-looking adjustment' to ducts and pipes and copper cables for the purpose of calculating the cost factors. They assert that Telstra has made no adjustment to the historical costs it has used to calculate the factors to account for the fact that those costs were incurred in relation to an aged network. In those circumstances, they argue that the cost factors derived by Telstra from its historical data are likely to be inflated.

533               Telstra maintain that this argument lacks foundation. The O&M expenses calculated using the factors are, consistent with TSLRIC+ methodology, intended to apply for the entire lives of the assets used to construct the network. An analysis (to be provided separately) conducted using both the historical costs and indexed historical costs (from the Current Cost Accounts) shows that Telstra’s capital has been depreciated by approximately 50%, indicating that they are halfway through their lives. Accordingly, Telstra’s expense costs have been applied to a network of average age which Telstra says is appropriate for the TSLRIC+ analysis.

534               Optus broadly argues that the TEA model uses an inappropriate methodology to calculate O&M factors and therefore overestimates the O&M costs of an efficient network-operator.

535               The factors for O&M costs are derived from Telstra’s RAF. Optus argues that as the value for network capital costs in the RAF is based upon the wholly depreciated value of assets, while the O&M costs in the RAF are not depreciated, the TEA model would estimate a value for O&M costs that exceeds actual cost. Telstra rejects this assertion. It says that the mark-up factor for O&M costs uses a value for network capital costs (plant and equipment) based on the total value “prior to depreciation”. Telstra also considers that Optus ignores the forward-looking adjustment that was applied to ducts and pipes and copper cable and in so doing accounted for 96% of the O&M expenses.

536               Optus and the other Interveners maintain that (c) by using Telstra’s RAF there is an implicit assumption that the unit investment cost per line of ULLS Bands 1, 3 and 4 are the same as Band 2. Rural O&M costs, such as those experienced in Band 4 and parts of Band 3, are likely to be higher than urban O&M costs experienced in Bands 1 and 2. Optus says that in its experience, the average service assurance activity cost with respect to attending a rural fault is [X] higher than the cost of attending an urban fault.

537               Telstra rejects this argument. It says that the application of a constant factor to investments that vary by band necessarily means that the cost per line per band will differ. As the investments per line in Bands 3 and 4 are higher than the investments per line in Band 2, the calculated O&M costs are higher in those bands than they are in Band 2.In any event, Telstra argues that  developing band specific factors is not consistent with the normal process used in TSLRIC+ models. Telstra does not contend that the O&M costs associated with Band 2 assets are the same as those associated with assets in other bands. As the investment cost per line in Band 2 are lower than they are in Bands 3 or 4, the application of company-wide factors results in lower O&M costs in Band 2 than in Bands 3 and 4.

538               In much the same way as the ACCC has argued, Optus and the other Intervenors also consider that the O&M factors have been calculated based on Telstra’s historical costs associated with its legacy network, which does not recognise that a new entrant’s network with modern equipment would be cheaper to maintain than Telstra’s legacy network.

539               Optus states that while Telstra states that O&M costs are, on average, [X] below actual O&M costs allocated to the ULLS in the RAF, after removing costs that should not be allocated to the ULLS, such as multiplexing equipment, the TEA model actually produces O&M costs which are 6.5% higher than those in the actual O&M costs allocated to the ULLS in the RAF.

(b) The allocation of operating expenses for fibre-related assets, multiplexing systems and local switching

540               The ACCC says that the annual cost sheet used in the TEA Model lists items of plant and equipment as being direct assets which, in fact, have no role to play in the provision of the ULLS, specifically optical fibre cables, multiplexing systems and local switching). It argues that neither the capital costs nor the operating costs associated with those assets should have been included in the annual cost sheet. Similarly, the annual cost sheet includes operating costs for Network Power Systems despite the fact that the provision of the ULLS does not require power.

541               Optus and the other Interveners raise similar concerns.

542               In its response Telstra says that for the main network, the TEA Model takes account of the cost of some fibre and related equipment so as to allow the sharing of trench and duct costs by fibre and copper lines to be taken into account in the main network. In any event, it says the contribution of the fibre and related equipment to O&M was minor - at least 96% of the O&M expenses related to ducts and pipes and copper cables.

543               Telstra also says that the operating costs for Network Power Systems is on of the network support asset categories that has been “reversed out” of the direct asset categories to calculate O&M and indirect factors. As the construction of the RAF requires Telstra to allocate this, along with the other support assets associated with buildings and power, to communications plant and equipment categories, Telstra maintains that it is appropriate to also account for this asset category in the calculation of the cost of providing the ULLS.

(c) Overlap between asset categories

544               The ACCC asserts that the methodology used by Telstra to calculate operating costs lacks transparency. In particular, some of the categories of assets and expenses used in the annual cost sheet appear in more than one place. For example, “Land”, “Buildings” and “Building Improvements” appear as both “Network Assets” and “Indirect Assets”. Further, “Network Management Systems” are included as a “Network Asset Cost”, “Software” is included as an “Indirect Asset Cost” and “Information Technology” is included as an “Indirect Expense”.  The ACCC says that each of those costs appear to relate to the same thing and that the Tribunal cannot be satisfied whether there is any overlap between those costs.

545               Telstra disputes this.  It says that on the “Annual Cost Summary” worksheet, the asset categories “Network Land”, “Network Buildings” and “Network Building Improvements” appear as “Network Assets”, whereas the asset categories of “Land”, “Buildings” and “Building Improvements” appear as “Indirect Assets”.

546               As explained in Telstra’s Cost Factor Study, the Network Support Assets (also called “Network Assets”) are those support assets associated with buildings and power which the construct of the RAF required Telstra to allocate to communications plant and equipment categories. In order to calculate O&M and indirect factors, Telstra says it had to reverse this allocation to allow the separate identification of costs associated with support assets. Accordingly, the asset categories that appear as “Network Assets” are the support asset categories that Telstra “reversed out” of its direct assets. In contrast, the asset categories that appear as “Indirect Assets” are taken from the Fixed Asset Statements of the RAF. These asset categories are distinct and there is no overlap.

547               The ACCC also argues that Telstra has made a number of “adjustments” to its historical costs before using them to calculate the O&M factors. Some of those adjustments were made it says in order to – as the ACCC put it – “shoe horn” the categories of costs in the RAF into the categories of assets and expenses used in the annual cost sheet. Further adjustments were made to add depreciation and remove other costs. The ACCC is not satisfied that Telstra has provided a clear explanation of how the quantum of these adjustments was determined.

548               Telstra considers that the so-called “shoe horning” process and the adjustments made as a consequence were necessary to ensure that the O&M and indirect cost factors calculated were accurate. It says that the quantum of adjustments was explained in the detailed worksheets accompanying Telstra’s Cost Factor Study. In any event, Telstra says that the adjustments that the ACCC criticises had the effect of substantially reducing the indirect expenses and the indirect assets and as a result the indirect expense factor and the indirect asset factor.

(d) Whether the methodology used to calculate operating costs is susceptible to compounding errors

549               The ACCC and the other Interveners assert that the methodology used by Telstra to calculate operating costs is inherently susceptible to compounding errors. This is because Telstra’s methodology involves calculating costs by “building” on preceding calculations. For example, the calculation of direct O&M costs involves applying a factor to the value of direct assets. If the value of direct assets is inflated, then direct O&M costs will be inflated by a similar magnitude. Further, because indirect expenses are calculated by multiplying the indirect expenses factor by direct O&M expenses, an error at any of the preceding stages of the calculation (ie, the valuation of direct assets and the calculation of direct O&M factors) will also result in indirect expenses becoming inflated.

550               Telstra says that the ACCC has not identified any actual compounding errors. Rather it says that this submission is merely a restatement of the ACCC’s criticism of the top-down approach and should be rejected.

(e) The methodology of calculating overhead loading (including transparency and efficiency of the overhead loading figures advanced by Telstra)

551               The ACCC argues that Telstra has applied an overhead loading of X% to equipment costs to account for network planning, logistical support, warehousing and field supervision associated with the construction of the CAN. That is, the values of the direct assets used in the TEA Model it says are inflated by that percentage to include these overhead expenses. The ACCC maintains that the Tribunal should not be satisfied that the approach used by Telstra to estimate and account for overhead expenses is reasonable.

552               Telstra maintains that it is appropriate and reasonable for overhead costs to be capitalised by applying an overhead loading factor to direct asset amounts since these overhead costs are associated with the construction of the CAN. Telstra says that the statements of its experts indicate that indirect overhead is directly attributable to the building of the CAN, which is a capital asset. It also says that this is the manner in which they have been treated in the audited financial accounts of Telstra.

553               In its support Telstra submits that in his statement, [X] (Telstra’s senior financial analyst) has stated that a detailed review of the calculation of the internal overhead process confirmed that the activity type codes used in the derivation of the indirect overhead complied with the Australian Accounting Standards and Telstra’s Corporate Accounting policies.

554               Telstra argues that it applied a conservative estimate of the indirect overhead. The overhead loading factor was calculated in August 2008 to be X and was subsequently updated slightly upwards in December 2008 to Y. Despite this, a factor lower than the X was used in the TEA Model.

555               The ACCC also maintains that the methodology used by Telstra to generate the overhead loading is not transparent and that the statement of [X] (Telstra’s operations manager) is opaque and lacking in detail.  [X] refers to the use of “Allocation Matrices” to allocate overhead costs between various initiatives.  The ACCC says that this allocation methodology has not been explained, nor were the Allocation Matrices furnished to the ACCC.

556               Work on the CAN occurs either by Telstra’s internal workforce or its external contractors. The ACCC refers to the statement of [X] that the overheads associated with external contractors are lower than the overheads associated with Telstra’s internal workforce. However the ACCC says that he does not specify to what degree. As such the ACCC suggests that it is unclear why it would be reasonable to assume that the overhead applicable to Telstra’s internal workforce should be used in the TEA Model.

557               In its response, Telstra maintains that the statement by [X] explains a complex process as clearly as possible. Telstra also says that the fact that it did not provide the Allocation Matrices to the ACCC is of little consequence, as [X] states that the allocations (of overhead to each project or initiative within each construction program, which constitute the capital build program) contained in the Allocation Matrices were very closely aligned to the total expected expenditure for that financial year.

558               Telstra points out that contrary to the ACCC’s submission, the overhead applicable to Telstra’s internal workforce is not in fact used in the TEA Model. Telstra points to [X] statement that the majority of the direct capital work on the CAN is carried out by Telstra’s external contractors. Also, as the overhead loading is intended to be applied to the cost of capital network (undertaken by external contractors) the “support overhead” (representing the costs associated with internal support activity, such as management and supervision costs) is excluded from the calculation of the overhead loading factor. The exception is for overheads which relate to the whole Integrated Network Access Program which are allocated across all initiatives regardless of whether the work is undertaken by an internal workforce or external contractors).

559               The ACCC says that Telstra’s approach assumes that it is appropriate to capitalise overhead expenses by inflating the value of the direct assets used to provide the ULLS by a fixed percentage. The ACCC argues that this is not an appropriate way to treat internal labour costs that are not directly attributable to those direct assets. To the extent that it is reasonable to allow for overhead expenses, the ACCC says that they ought to be accounted for as expenses, and not capitalised.

560               The ACCC considers that the manner in which Telstra has accounted for overhead loading raises the potential for errors in the calculation of the overhead loading to be magnified in the calculation of other costs of providing the ULLS.

561               Telstra’s response is that the ACCC has provided no evidence of any errors. Furthermore, the processes involved in the calculation of overhead loading, as described in the statements by experienced Telstra employees, has been done in accordance with Australian Accounting Standards and Telstra’s Corporate Accounting policies.

562               The ACCC refers to the statement of [X] that the costs comprising Telstra’s internal overheads are recorded in Telstra’s accounts as expense items. If that is correct, then the ACCC argues that there will be double counting when the TEA Model estimates operating costs, because Telstra draws expenses from its RAF accounts to calculate the cost factors. If overhead expenses are included in the RAF accounts, then those expenses will inflate the numerators in each of the factor formulas, leading to higher factors. However, if the TEA Model’s estimate of the value of direct assets has already been marked-up by a fixed percentage to account for those expenses, then the ACCC says that Telstra’s methodology for estimating operating costs will account for those expenses twice - once by inflating the value of the direct assets, and again by inflating the cost factors which are multiplied by the value of those direct assets.

563               Telstra argues that the ACCC has not accurately characterised [X] statement - Telstra says that [X] statement indicates that when the costs comprising Internal Overhead are incurred they are initially recorded in Telstra’s accounts as expense items rather than capital items. The statement explains the monthly capitalisation routine in which these costs are accumulated and allocated across the various capital projects in the Integrated Asset program. As internal overhead is recorded in Telstra’s accounts as capital, not as an expense, Telstra says that the double counting asserted by the ACCC does not occur.

The Tribunal’s views on O & M costs

564               Since ducts and copper cables account for some 96% of O&M expenses, the Tribunal has confined itself to considering that element.  The Tribunal has three major concerns with Telstra’s estimation of these expenses.

565               The first is that the factors used, as described above, are calculated for all bands and thus represent averages across all bands, while it appears that O&M per unit of investment may be lower in Band 2 than on average.  It is not to the point that, as Telstra says, O&M expense as estimated is lower for Band 2 than for Bands 3 and 4 because investment is higher for Bands 3 and 4.  It may still not be relatively low enough.

566               The second concern is with the assumption that, once factors are calculated, their application implies the assumption that O&M varies with investment, including capitalised overhead expenses.  While a top-down approach may or may not be required because of data limitations, such an assumption seems too far from what might be expected to obtain in practice to be a reliable basis for estimation.

567               Thirdly, the Tribunal is not persuaded that the treatment of capital costs in calculating factors (as the denominators), on the one hand, and as the multiplicand with the factor to produce the O&M estimate, on the other hand, is consistent.  The mixed use of historical and forward-looking costs is confusing, with the potential to produce higher factors (because of lower denominators) and higher O&M estimates (because the factors multiply higher investment cost estimates).  It may be a consequence of this approach that the estimated O&M expenses in total are well above Telstra’s actual O&M expenses.  For reasons explained above in relation to the TEA model implementation of the TSLRIC+ approach, the Tribunal cannot be satisfied that such an outcome meets the legislative reasonableness criteria.


568               The Tribunal, for the reasons given, is not satisfied that the 2008 Undertaking is reasonable.

569               Primarily, it takes the view that the scorched node modelling used in the TEA Model version 1.3 makes assumptions about the location of the infrastructure of the ULLS and CAN that are not appropriate.

570               In addition, from its consideration of the topics of depreciation, the WACC, and the operating and maintenance costs, it does not consider that the assumptions and inputs into the TEA Model are appropriate in the respects identified.  Whilst the Tribunal has not precisely applied the sensitivity analysis to those elements of the make-up of Telstra’s modelled access charge, the Tribunal takes the view that the use of assumptions or inputs which would be appropriate would take the modelled access charge (assuming the scorched node approach is appropriate) to a figure so close to the access charge proposed in the 2008 Undertaking that the Tribunal would not be satisfied that the 2008 Undertaking is reasonable.  Telstra applied a very “broad brush” to the modelled outcome for the access charge.  If those three elements cause the Tribunal such concern about the validity of the modelling – in terms of the reasonableness of the output – that it is not satisfied that the proposed $30 monthly access charge is reasonable, it becomes unnecessary in any event to separately consider each of the less significant elements of the TEA Model assumptions and inputs, with their potential cascading effect.  Telstra sought to stand on the TEA Model with its assumptions and inputs, and then applied a “broad brush” reduction to the output.  The Tribunal has formed a view about those three elements which leaves it unpersuaded that the “broad brush” figure then arrived at is a reasonable one, without separately considering the other elements.

571               As also appears, the Tribunal is also concerned that the TSLRIC+ approach in the circumstances may no longer be an appropriate one for the reasons given.  That matter of principle was raised by Optus, and with perhaps lesser emphasis by the other Intervenors.  It was not necessary for the purposes of its decision for the Tribunal to finally resolve that question.

572               The Final Decision of the ACCC should be affirmed.


I certify that the preceding five hundred and seventy-two (572) numbered paragraphs are a true copy of the Reasons for Decision (public version) herein of the Honourable Justice Mansfield, R Steinwall & RF Shogren.


Dated:         10 May 2010