World Telecommunication Day 1998

May 4, 1998

Settlement System on Last Legs

Rows about telephone companies making excessive profits from international calls are nothing new, but the richest telcos are now agitating hardest for change. For years, telcos were accused of running a cartel, charging exorbitant prices for international calls. Little could be done, because most countries' international traffic was handled by monopolies.

Typically, they charged a premium rate for international calls because in the past their network capacity to overseas destinations had been relatively scarce, and businesses, rather than individuals, bore the brunt of the cost. In fact international-call revenue subsidized local calls for the general population, also known as voters, who paid little or nothing at all.

Operators negotiated bilaterally how much they would charge for delivering each other's international calls under the accounting rate system, a global scheme overseen by the International Telecommunication Union (ITU), a specialized agency of the United Nations. In this system, they charged each other the same amount for call delivery in their territories.

This so-called settlement rate, plus a profit margin and the additional cost of running their domestic networks, was then passed onto the consumer.

In recent years, the accounting rate system has run into trouble. Where the telecoms sector was liberalized early, as in North America, the United Kingdom, Finland, Sweden, Australia and New Zealand, among other places, competition began to bite, with new telcos negotiating lower settlement rates. These savings, plus the fact that new networks that exploit modern technology are generally cheaper to deploy and run, meant they were able to charge consumers less.

Consequently, far more traffic originated in liberalized countries, where international calls were cheaper. The effect of this was compounded by the use of callback and refile.

Finding the loopholes

Callback companies' services provide overseas customers with a dial tone from the United States, which has some of the cheapest international call charges in the world. The ITU reckons that callback traffic has increased at least tenfold since 1993.

In addition, many telcos are using a practice called refile, whereby a call between two countries where a high settlement rate is in force is diverted through a third country with a lower rate to the destination country. The destination country loses revenue, and the conspirators split the difference. Maev Sullivan, an independent, London-based telecoms consultant, says, ''International traffic is increasingly based on arbitrage, with operators exploiting accounting rate discrepancies for their own advantage.''

Controversial FCC move

The ITU estimates that as many as 6.4 billion international-call minutes were accounted for by callback and refile in 1997. The U.S. national telecoms regulator, the Federal Communications Commission (FCC), says that the imbalance of outgoing international traffic cost the country $5 billion in trade deficits. This is all the more remarkable since, as Tim Kelly, head of operations analysis at the ITU, points out, international traffic comprises less than 2 percent of the world's telecoms traffic by volume, and about 8 percent by value.

It was clear that the situation could not continue. Much to the fury of most other countries, the FCC took a unilateral decision in August 1997 to impose its own tariff scale for settlement rates, to which U.S. carriers would be obliged to adhere. The scale is based on countries' gross domestic product and will be phased in over the next five years. The least-developed economies will be given the longest time to comply. This unilateral action was contrary to the spirit of the multilateral approach taken by the World Trade Organization agreement.

For many developing countries, high settlement rates are a precious source of hard currency. In addition, as these countries typically have older networks that are more expensive to operate and still have a monopoly carrier, their costs are higher. Also, monopoly carriers have never needed to allocate costs and would be very hard pushed to produce ''transparent accounting'' to fit in with the demand that their prices reflect costs. Indeed, in the liberalization process everywhere, accurate cost allocation has proved a significant challenge.

While the FCC's action provoked outrage, it also did much to galvanize telcos around the world.

Basing rates on costs

In March, the ITU World Telecommunicaton Policy Forum appointed Anthony Hill, Jamaican ambassador to the United Nations, as chairmain of a focus group on reform of the accounting-rate system. ITU member states have already proposed settlement rates of not more than $0.66 per minute, to be implemented in 1998. As all ITU decisions have to be reached by consensus among its member states, this is already a significant sign of progress

The next step is to agree upon another transitional arrangement for 1999. Mr. Hill says he feels ''very confident it will happen.'' A longer-term goal is to arrive at a mutually agreed cost-allocation methodology or methodologies so that settlement rates everywhere finally reflect costs. Mr. Hill feels this will be achieved two to three years into the next millennium. For its part, the FCC has said it is willing to back this multilateral approach, but there is still a long way to go.

Toward a fairer system

Pekka Tarjanne, secretary-general of the International Telecommunication Union, points out that operators in developing countries rely on income from the present system to maintain and expand their networks.

''This system provides a framework for a transfer of resources from the developed north to the developing south of around $10 billion a year,'' he recently said. ''If you put together all the lending programs for telecoms from all the development banks around the world, the total sum they invested during the first half of the 1990s would still amount to less than is generated in one year under the accounting rate system.'

The statement underlines how crucial it is for all parties to get the balance right when working out reasonable settlement rates. To understand the potential impact of accounting-rate reform and a reduction in settlement rates, the ITU has undertaken a series of country case studies to better understand their needs and costs. The countries studied were the Bahamas, Colombia, India, Lesotho, Mauritania, Samoa, Senegal, Sri Lanka and Uganda.

Gross domestic product per capita in the economies studied ranges from $12,280 in the Bahamas to just $251 a year in Uganda. For many of the countries, telecoms income itself is important, aside from the role of telecoms in underpinning and expanding the economy.

Many factors have been taken into account in the studies. They found, for example, that continuing political instability has hampered the government of Sri Lanka in attracting outside investment into its telecoms sector; that the network-development costs of islands such as Samoa and Sri Lanka are very different from those for large countries such as India or for small, landlocked countries like Lesotho; that the Bahamas has the challenge of connecting 15 inhabited islands; that Colombia has already digitized 84 percent of its trunk network, while Lesotho has four PBX switchboards and a one-cell cellular network providing voice services to rural areas.

The case studies report concludes that there are significant differences between the countries in the cost of terminating international phone calls. The report found that the range of call-termination costs varies between $0.13 per minute and $0.45. In comparison, ''best practice'' rates available on competitive rates in Europe are less than $0.08 per minute

Cost-based accounting systems should allow operators to negotiate settlement rates that they can prove reflect their costs (and therefor must be judged reasonable) and, in general, run their telecoms services in a more effective and profitable way.

Mr. Hill acknowledges that the trick will be finding a cost-based accounting system that is acceptable to the international community. In addition, monopoly telcos will have to move away from subsidizing local calls from international-call revenue if they are to introduce competition, otherwise new entrants will simply cherry pick the most lucrative sectors.

This rebalancing of tariffs will make international calls affordable to many more businesses and help economies overall. It could also do much to get back revenue that at the moment is lost to callback and other revenue-draining operations.

But Mr. Tarjanne warns that such revenue may not be sufficient to replace the hard currency earned from the present system, and so developing countries may find it difficult to expand their networks and increase access (see his article, ''Taking Account of the Revolution,'' in this section).

The phasing and timing of this process will be key. All of the countries studied have long waiting lists for telephones. The ITU's 1998 World Telecommunication Development Report suggests that if access to telephone service was sensibly priced and uniformly available, then a further 300 million households could have access to telephones, in addition to the 500 million already connected.

Annie Turner

For more information, click here to go to the ITU's Web site:

What is the accounting rate system?

Reforming the International Accounting Rate System

Issues in Accounting Rate Reform

Focus Group on transitional arrangements toward cost-orientation

Country Case Studies

Executive Summary: Country Case Studies