The Long-Run Incremental Cost (LRIC) methodology represents the international standard for regulating telecommunications interconnection and network access tariffs. Adopted by the European Commission (Recommendation 2009/396/EC) [1], the International Telecommunication Union (ITU-T Recommendation D.140) [2], and the majority of national regulatory authorities worldwide, LRIC establishes tariffs reflecting the efficient economic costs of a hypothetical operator deploying modern equivalent assets.
This article examines the theoretical foundations, practical implementation, and regulatory applications of LRIC methodology, drawing on EXXING's experience across more than twenty regulatory proceedings in Europe and Africa.
Conceptual Foundations
Definition and Economic Rationale
LRIC represents the additional cost that an efficient operator would incur to provide an incremental service, using current technologies and assuming an optimised network structure. The methodology addresses a fundamental regulatory challenge: how to set access prices that promote competition whilst ensuring adequate returns for infrastructure investment.
The economic rationale derives from welfare economics. Prices set at marginal cost maximise allocative efficiency, but pure marginal cost pricing fails to recover fixed costs in industries with significant economies of scale. LRIC resolves this tension by defining costs over the long run, where all inputs become variable, and by focusing on incremental costs attributable to specific services [3].
The fundamental LRIC equation expresses this relationship:
LRIC = ΔTC / ΔQ
Where:
- ΔTC = Change in total long-run cost
- ΔQ = Change in quantity of service provided
Guiding Principles
| Principle | Description | Regulatory Rationale |
|---|---|---|
| Forward-looking | Costs based on current technologies, not historical investments | Encourages efficiency and innovation; prevents recovery of stranded assets |
| Incremental | Additional costs to provide the specific service | Avoids cross-subsidisation between services |
| Long-run | All costs are variable; no fixed costs | Reflects economic flexibility; ensures cost recovery |
| Efficiency | Hypothetical Efficient Operator (HEO) benchmark | Provides performance standard; prevents inefficiency pass-through |
The Hypothetical Efficient Operator concept is central to LRIC methodology. Rather than modelling actual operator costs (which may reflect historical inefficiencies), regulators construct a theoretical operator deploying optimal network architecture with modern technology. This approach creates incentives for actual operators to improve efficiency, as they retain the difference between regulated prices and their actual costs [4].
LRIC Variants
Regulatory practice has developed several LRIC variants, each appropriate for different regulatory contexts.
Pure LRIC
Pure LRIC includes only costs directly attributable to the incremental service, excluding any allocation of common costs. This variant produces the lowest tariffs and is typically applied where regulators seek maximum competitive pressure.
Regulatory Application: Mobile call termination rates across the European Union, following the 2009 EC Recommendation [1].
LRIC+ (LRIC Plus)
LRIC+ adds a proportional allocation of common network costs to pure LRIC. Common costs include shared network elements (transmission, core network) and shared support systems (network management, billing platforms).
The allocation formula typically follows:
LRIC+ = LRIC_pure + (Common Costs × Service Volume) / Total Volume
Regulatory Application: Fixed network access services (local loop unbundling, bitstream access) in most European jurisdictions.
LRIC++ (LRIC Plus Plus)
LRIC++ further adds an allocation of corporate overhead costs (headquarters, marketing, research and development) to LRIC+. This variant produces the highest tariffs and is typically applied where regulators seek to ensure full cost recovery.
Regulatory Application: Wholesale services in markets with limited competition or where investment incentives are prioritised.
Comparative Analysis
| Variant | Costs Included | Tariff Level | Typical Application |
|---|---|---|---|
| Pure LRIC | Direct costs only | Lowest | Mobile termination (EU) |
| LRIC+ | + Common network costs | Medium | Fixed access (LLU, bitstream) |
| LRIC++ | + Corporate overhead | Highest | Wholesale services, emerging markets |
The choice of variant reflects regulatory objectives. Pure LRIC maximises competitive pressure but may under-recover costs for operators with significant common infrastructure. LRIC++ ensures full cost recovery but may perpetuate inefficiencies if common cost allocations are not carefully scrutinised.
Implementation Methodology
EXXING's LRIC modelling follows a structured six-step process, refined through application across multiple regulatory jurisdictions.
Step One: Service Definition
The first step precisely defines the incremental service to be costed. For mobile call termination, this includes:
| Network Element | Function | Cost Category |
|---|---|---|
| Radio Access Network (RAN) | Signal reception, processing | Direct |
| Core Network (MSC, HLR) | Call routing, subscriber management | Direct |
| Transmission (backhaul) | Site connectivity | Shared |
| Interconnection | Interface with originating network | Direct |
| Support Systems | Billing, network management | Shared |
Clear service definition is essential because LRIC costs vary significantly depending on the service boundary. Including or excluding specific network elements can change calculated costs by 20-40%.
Step Two: Hypothetical Efficient Operator Modelling
The HEO model constructs a theoretical operator deploying modern equivalent assets with optimised network topology. Key modelling decisions include:
| Parameter | Modelling Choice | Rationale |
|---|---|---|
| Technology generation | Current best practice (4G/5G, not 2G/3G) | Forward-looking principle |
| Network topology | Optimised (scorched earth or modified scorched node) | Efficiency principle |
| Coverage obligation | Regulatory minimum or market standard | Reflects actual deployment requirements |
| Capacity utilisation | Target utilisation (typically 70-80%) | Balances efficiency and quality |
Case Study: Moroccan Mobile Termination (2024)
EXXING developed an HEO model for ANRT (National Telecommunications Regulatory Agency) with the following parameters:
| Parameter | Value | Source |
|---|---|---|
| Population covered | 36 million | ANRT statistics |
| Mobile penetration | 135% | ANRT market data |
| Voice traffic per subscriber | 180 minutes/month | Operator benchmarks |
| RAN technology | 4G/5G (excluding legacy 2G/3G) | Forward-looking principle |
| Network topology | Modified scorched node | Balances efficiency with practical constraints |
Step Three: Network Dimensioning
Network dimensioning translates demand forecasts into infrastructure requirements. The core calculation for radio sites follows:
N_sites = (Coverage Area × Population Density) / (Site Capacity × Load Factor)
Example: Urban Zone (Casablanca)
| Parameter | Value | Calculation |
|---|---|---|
| Coverage area | 220 km² | Geographic data |
| Population density | 18,000/km² | Census data |
| Subscribers | 5.3 million | 135% penetration |
| Traffic per subscriber | 0.1 Erlang | 180 min/month |
| Site capacity (4G) | 1,200 Erlang | Equipment specifications |
| Load factor | 70% | Quality target |
| Sites required | 630 | Calculated |
Similar dimensioning applies to transmission capacity, core network elements, and support systems.
Step Four: Cost Estimation
Cost estimation applies current replacement costs to dimensioned network elements. Key cost categories include:
| Category | Elements | Cost Basis |
|---|---|---|
| Capital expenditure | Equipment, civil works, installation | Vendor quotes, benchmark databases |
| Operating expenditure | Maintenance, energy, site rental | Operator data, industry benchmarks |
| Spectrum | Licence fees, opportunity cost | Auction results, administered prices |
| Corporate overhead | Headquarters, shared services | Percentage allocation (LRIC++only) |
Annualisation converts capital costs to annual equivalents using the tilted annuity method, which accounts for asset price trends:
Annual Cost = (WACC - Price Trend) × Capital Value / [1 - (1 + Price Trend)^n / (1 + WACC)^n]
For telecommunications equipment with declining prices (typically -5% to -10% annually), tilted annuities produce front-loaded cost recovery, reflecting economic depreciation patterns.
Step Five: Cost Allocation
Cost allocation assigns shared costs to specific services using cost causation principles. Common allocation bases include:
| Shared Cost | Allocation Basis | Rationale |
|---|---|---|
| Transmission | Bandwidth utilised | Capacity-driven cost |
| Core network | Busy hour traffic | Dimensioned for peak demand |
| Support systems | Number of transactions | Activity-driven cost |
| Corporate overhead | Revenue or direct cost | General allocation |
The allocation methodology significantly affects calculated costs. EXXING typically develops multiple allocation scenarios to test sensitivity and ensure robust conclusions.
Step Six: Unit Cost Calculation
The final step calculates unit costs by dividing total allocated costs by forecast volumes:
Unit Cost = Total Allocated Cost / Forecast Volume
For mobile termination, the unit is typically cost per minute. For fixed access, units may include cost per line per month (unbundling) or cost per Mbps (bitstream).
Case Study Results: Moroccan Mobile Termination
| Cost Component | MAD per minute | Percentage |
|---|---|---|
| Radio access (RAN) | 0.042 | 35% |
| Core network | 0.024 | 20% |
| Transmission | 0.018 | 15% |
| Interconnection | 0.012 | 10% |
| Support systems | 0.012 | 10% |
| Common costs (LRIC+) | 0.012 | 10% |
| Total LRIC+ | 0.120 | 100% |
The calculated rate of MAD 0.120 per minute (approximately €0.011) aligned with European benchmarks and was adopted by ANRT for the 2024-2027 regulatory period.
Regulatory Applications
European Union: Harmonised Mobile Termination
The European Commission's 2009 Recommendation established pure LRIC as the standard for mobile termination across all member states [1]. Implementation reduced average termination rates from €0.087 (2009) to €0.0091 (2020), a 90% reduction that transferred approximately €4 billion annually from mobile operators to consumers and competing service providers [5].
African Markets: Balancing Competition and Investment
African regulators face a distinct challenge: promoting competition whilst maintaining investment incentives in markets with lower penetration and higher deployment costs. EXXING has advised regulators in Morocco, Senegal, Ivory Coast, and Kenya on LRIC implementation adapted to local conditions.
Key adaptations include:
- LRIC+ or LRIC++ variants to ensure cost recovery
- Glide paths allowing gradual tariff reductions over 3-5 years
- Asymmetric regulation permitting higher rates for smaller operators during market entry
- Coverage obligations incorporated into HEO models
Fibre Access Regulation
LRIC methodology increasingly applies to fibre access regulation, though with significant adaptations. Key differences from mobile include:
| Dimension | Mobile | Fibre |
|---|---|---|
| Asset lives | 5-10 years | 30-40 years |
| Technology evolution | Rapid (2G→3G→4G→5G) | Stable (fibre is "future-proof") |
| Demand uncertainty | Moderate | High (take-up rates uncertain) |
| Cost structure | OPEX-heavy (spectrum, energy) | CAPEX-heavy (civil works) |
EXXING's fibre LRIC models incorporate demand uncertainty through scenario analysis, typically modelling low, base, and high take-up scenarios with corresponding cost implications.
Limitations and Criticisms
Model Complexity
LRIC models are inherently complex, requiring thousands of input parameters and modelling assumptions. Critics argue this complexity creates opportunities for manipulation and makes regulatory review difficult [6].
Mitigation: EXXING advocates for transparent modelling with published assumptions, sensitivity analysis on key parameters, and stakeholder consultation on methodology.
Forward-Looking Assumption
The forward-looking principle, whilst economically sound, creates practical challenges. Operators cannot recover costs of legacy investments, potentially undermining investment incentives.
Mitigation: Regulators may apply glide paths, allowing gradual transition from historical to forward-looking costs, or may use LRIC++ variants that provide fuller cost recovery.
Hypothetical Operator Criticism
The HEO concept assumes an idealised operator that does not exist. Actual operators face constraints (legacy systems, labour agreements, regulatory requirements) that the HEO ignores.
Mitigation: The "modified scorched node" approach retains existing site locations whilst optimising equipment, balancing efficiency with practical constraints.
Conclusion
LRIC methodology provides a rigorous, economically-grounded framework for telecommunications cost regulation. Its adoption across Europe, Africa, and globally has contributed to dramatic reductions in interconnection costs, promoting competition and benefiting consumers.
Successful LRIC implementation requires:
Technical Expertise: Detailed understanding of network architecture, cost structures, and modelling techniques.
Regulatory Knowledge: Familiarity with regulatory precedents, consultation processes, and stakeholder dynamics.
Economic Rigour: Application of sound economic principles to cost allocation, annualisation, and efficiency benchmarking.
Practical Judgement: Balancing theoretical purity with practical constraints and policy objectives.
EXXING combines these capabilities through fifteen years of regulatory experience across European and African markets, delivering LRIC models that withstand regulatory scrutiny and stakeholder challenge.
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References
[1] European Commission (2009). Commission Recommendation on the Regulatory Treatment of Fixed and Mobile Termination Rates in the EU (2009/396/EC). Official Journal of the European Union.
[2] ITU-T (2019). Recommendation D.140: Charging and Accounting Principles for International Telecommunication Services. International Telecommunication Union.
[3] Laffont, J.J., & Tirole, J. (2000). Competition in Telecommunications. MIT Press.
[4] Cave, M., Majumdar, S., & Vogelsang, I. (2002). Handbook of Telecommunications Economics. Elsevier.
[5] BEREC (2021). Termination Rates Benchmark Report. Body of European Regulators for Electronic Communications.
[6] Hausman, J., & Sidak, J.G. (2005). "Did Mandatory Unbundling Achieve Its Purpose? Empirical Evidence from Five Countries." Journal of Competition Law and Economics, 1(1), 173-245.
[7] ARCEP (2023). Modèle de coûts LRIC pour les services de terminaison d'appel mobile. Autorité de Régulation des Communications Électroniques et des Postes.
