to cover costs when it pays for use of the BT network at rates equivalent to those available to other operators.

On the principles of interconnection, the statement set out a three stage process of development. The 1993 BT/Mercury determination was to be used as the basis for determining interconnection charges for other operators, up to the end of 1994. From the start of 1995, a standard price list for over sixty separately identified interconnection services would be the basis for interconnection pricing. The third stage of the programme was to involve a fundamental review of the principles of interconnection pricing, and of other related issues.

A consultation document on the future of interconnection, entitled A Framework for Effective Competition was published in late 1994 (OFTEL, 1994b). On interconnection pricing, the paper set out four options. Under Option 1, the present system of fully allocated costs and of access deficit contributions would be broadly maintained. This option is described as having long-term disadvantages, though of potential use as an interim solution.

Under Option 2 interconnection prices would be based upon forward looking incremental costs (estimated either from an engineering-economic model of the network, or on the basis of current cost accounts). To these would be added a mark-up to recover common costs. Several alternative mark-up principles are discussed, including the Efficient Component Pricing Rule, Ramsey interconnection prices and an equal mark up. Table 1.9 shows the effects of these alternative pricing principles, together with that of the current system. (For the purpose of calculating Ramsey prices, the assumed price elasticities of demand are -0.2 for local calls, -0.4 for long distance calls and -0.6 for international calls.) The Table reflects the broad similarity between the current regime of fully allocated costs and access deficit contributions and the interconnection prices implied by the ECPR. Not surprisingly, the rankings of interconnection charges based upon the ECPR and on Ramsey pricing are reversed, reflecting the high price elasticity of demand on international calls, contrasted with their current high levels of profitability.

Option 3 involves, in addition to the move to incremental costs as the basis for charges, elimination of the RPI+2 price constraint on quarterly rentals described above. Relying on an incremental costing methodology and eliminating this constraint would undermine the logical basis of the “access deficit”. Pricing would be the outcome of a commercial decision by BT rather than of a regulatory constraint. Access deficit contributions would thus be inappropriate.

Finally, Option 4 looks forward to a system of less intrusive regulation of interconnection pricing. Three variants are considered:

a. The retail market is competitive, but network bottlenecks remain. OFTEL polices anti-competitive behaviour using licence conditions dealing with unfair cross-subsidies, undue discrimination, accounting separation and a possible new general provision on anti-competitive practices.

b. Where retail competition is insufficient for Variant 1, a retail price cap and a requirement on BT to make a reasonable rate of return on its retail activities could be