7.30 In arriving at our proposal, we have considered the following basket design options for ECCs:
• option 1 - a combined Ethernet basket including ECCs; and
• option 2 – a separate control on ECCs.
Option 1 - a combined basket including Ethernet services with associated ECCs
7.31 This option would give the greatest pricing flexibility to Openreach. As discussed in Section 4, we often have a preference for broad baskets as they allow for the efficient recovery of common costs. In LLCC 2009, we included ECCs in the main service
baskets. This meant that the margin for ECCs was part of the overall value of X for these baskets.
7.32 However, for this control, we consider that this would not be the most appropriate approach for ECCs for three reasons. Firstly, ECCs share very few common costs with other Ethernet and TI services, as they are essentially construction costs rather than circuit costs267. Secondly, the anticipated future trend of the costs is different.
Thirdly, ECCs represent a low value compared to the overall Ethernet basket (£32m in the 2010/11 RFS) and this means that placing them in a combined basket would not in itself result in an effective control of their prices, without an additional sub-cap.
Option 2 - a separate control on ECCs
7.33 We generally seek not to constrain BT’s pricing behaviour unduly by having baskets that are too narrowly defined. Having a separate control on ECCs would, however, reflect the fact that ECCs share very few common costs with TI and Ethernet
services and are likely to follow a different cost trajectory. Placing a separate control on ECCs also has the advantage that the ECCs apply both to TI and Ethernet services, whereas including them in the baskets for the relevant circuits could mean two controls on the same ECCs.
7.34 We therefore propose that these services are subject to a separate control, distinct from the main basket controls.
We propose to use a sub-cap of GBCI-0% on each ECC charge
7.35 Having made starting charge adjustments, we then need to apply a cap going forward. We normally use RPI-0% or RPI-RPI for safeguard caps, which would keep charges constant in real or nominal terms.
7.36 However, we are concerned that the use of RPI may be inappropriate for ECCs as a significant proportion of the costs is simply passed through from the contractor, and thus these costs may follow a different cost trend from Openreach’s overall costs.
The use of an RPI-0% cap may place Openreach at risk of not recovering its costs, if its contractors’ cost or Wayleaves costs increase faster than RPI. We have therefore considered two alternatives:
• the use of an alternative index which specifically reflects construction costs; or
• regulation of BT’s mark-up over its construction costs.
Use of an alternative index
7.37 We have considered regulating ECCs based on the GBCI of construction costs published by the Royal Institute of Chartered Surveyors (‘RICS’)268. The GBCI is a national index which measures the costs of construction work including materials and labour. Our view is that this construction index is a better indication of the cost trend for ECC than RPI. In Section 3, we explained that we sometimes have concerns in using sector-specific cost indices where BT’s own costs form a significant proportion of the index. If the index is not independent of BT, then there is a risk that BT has
267 The only common costs are the overhead costs allocated relating to the administration of ECCs.
268 The General Building Cost Index is published by the Building Cost Information Service (‘BCIS’), a service of the RICS. Information on the GBCI and the GBCI data is available at
http://www.bcis.co.uk/construction
fewer incentives to minimise its costs as any cost increase would be passed on because they themselves affect the index. In the case of ECCs, we consider that this risk is low. ECCs are likely to constitute a small proportion of the overall GBCI, so the overall index should be independent of BT’s actual ECC costs.
Regulating the mark-up over construction costs
7.38 We have also considered regulating BT’s mark-up over its construction costs, including an allowance for overheads. This has the benefit of protecting BT against any rise in construction costs. The approach of regulating the mark-up will be most appropriate where BT has no control over its input costs, and therefore there is no need to provide incentives for efficient procurement of costs.
7.39 Whilst BT’s actual charges have been largely based on a pass-through of input costs, we propose to reject this approach as such cost pass-through mechanisms have very poor incentives for cost minimisation. BT retains some control over how it manages its contractor costs, and under this approach it would have little incentive to minimise these costs as it would not retain the benefit. We are also concerned that regulating a mark-up may reveal commercially sensitive information, such as the level of BT’s input costs.
7.40 We consider that the GBCI index is more appropriate for the ECC basket than the RPI index or regulating BT’s mark-up over contractor charges.
Sub-caps on each charge
7.41 We have also considered whether to apply the GBCI-0% control to an overall ECC basket, or to each ECC charge. As noted in Section 4, our general preference is for wide baskets. We have not identified any anti-competitive incentive on Openreach to discriminate between different ECCs. Applying the cap at the basket level may also be appropriate as, whilst on average ECC costs may be expected to increase at the level of the GBCI, it is possible that some individual charges may increase slower or faster than this.
7.42 However, in order to demonstrate compliance with an overall ECC basket, BT would need to provide prior year revenue weights for ECCs. BT has indicated that this data is difficult for it to provide. This may mean that it would be difficult for BT to
demonstrate compliance in the event that ECCs changed by differing amounts.
Based on this information, we propose to apply the constraint of GBCI-0% on each and every charge, although we would consider reverting to a basket structure if the difficulties relating to compliance with a basket could be resolved.
Cost orientation
7.43 As discussed above, we propose to adjust starting charges and apply a cap of GBCI-0% to each charge in the basket. In our view, this approach will be effective at constraining the level of the ECC charges. As such, we do not see the need to apply a cost orientation obligation on those services as well.
7.44 Given our analysis above, we propose to impose a cap of GBCI-0% on each ECC.
Question 6: Do you agree with our approach and proposals for controls for excess construction charges? If not, please explain why and propose an alternative approach with supporting information.