Pricing Principles in the Power and Telecom Sectors

Slightly updated version of note prepared by

Akshay Mishra, Electrical Engineering, student in IE 504 in 2011

Price

Everybody needs signs to disclose the correct price

Price discussion is usually the last step in any negotiation

Value is realized in initial discussions, however price usually is the last thing that is

announced

Interaction between cost of production, cost to establish infrastructure, value to user

and the competition in the market (number of sellers and buyers) determine the

prevailing market price.

Pricing

Price in a mature market (with large number of buyers/sellers and minimal regulatory

control) is determined by laws of demand and supply

The buyers and sellers of certain goods create or define its market. The price at which

to sell certain goods or service is very complex and may be impossible to determine

accurately

Price cannot be determined only by its value to the buyer

Regulation

For mature markets pricing is based on demand and supply

Markets for essential commodities usually have a regulator

Markets are regulated to prevent game-play or to see that the greed of a few does not

affect the many

Telecom Sector

BSNL used to have regular STD & low cost STD at different times of the day. STD

rates also had distance based tariff

Pricing was very complicated and it required very complex billing systems at STD

booths

Prices fell drastically post 2000 and now call rates in India are among the lowest in

the world

The figure of merit for a telecom operator is the Average Revenue Per User ARPU

This indicates revenues, profit indications, success of strategies and marketing efforts

ARPU (Mumbai)

Operator ARPU (Jul-Sep'12) Vodafone Essar 254.30 Bharti Airtel Ltd 226.49 IDEA Cellular 83.96 Aircel 71.74 Uninor 64.77

Reference: http://www.coai.com/revenue.php

Resource Utilization

Telecom Infrastructure is designed for peak traffic -- the capacity is under-utilized in

off-peak hours

Usually the cost per call / the variable costs / Operating Expenses are very low for an

operator as compared to the fixed costs/Capital Expenses

To maximize revenues, off-peak hour utilization is incentivized

Companies try to push add-on services like caller-tunes, SMS advertisements

Even abuse of the infrastructure installed will get them revenue

Broadband services

Enabling broadband to a customer is the most expensive part of the exercise for a

wireline broadband vendor

For an existing customer, service/Quality of Service upgrades are cheap to avail and

the service provider usually obliges

Service providers also provide an option of advance annual payment this way they

buy the customer for a committed time and provide up-to 10% discounts

An example of broadband tariff

Sr. No. Plan Speed Monthly Fee Annual Fee

1 DSL_Combo 320 kbps 495 NA

2 DSL_UL_599 512 kbps 599 6589

3 DSL_UL_999 1Mbps 999 8230

Reference: http://mtnlmumbai.in/index.php/unlimited-plan

Pricing in the Power Sector in India

India has Availability Based Tariff (ABT), a law reformed and amended under

Electricity Act 2003

ABT attempts to provide a rational tariff structure for power supply from generating

stations, on a contracted basis

It is a formal system of financial incentives to promote grid discipline

Quality of Power

Frequency of the grid is an indication of demand/supply gap

o >50.3 Hz indicates low demand

o Between 49.5 50.3: stipulated demand

o Below 49.5: high demand, low supply

Operating outside the frequency band is bad for consumers as well as for the

generators & distribution grid

Long term damage is ignored for short term benefit (Game Theory Selfish

behaviour)

ABT attempts to curb this behaviour

Before ABT, if a beneficiary decided to not draw power, he did not have to pay the

fixed cost associated with the share of capacity allocated to him

Generators had a perverse financial incentive to go on generating even when there

was no demand. This results in high frequency in the grid as is endemic in the

East

This cost is then paid by people who are drawing energy

This is unfair since the cost of generation is now borne by people who may be within

their entitlement

ABT discourages such behaviour

The beneficiaries now have well-defined entitlements and are able to draw power up

to the specified limits at normal rates of the respective power plants.

In case of over-draw, they have to pay at higher rate during peak load hours, which

discourages them from over drawing further. This payment then goes to beneficiaries

who received less energy than was scheduled, and act as an incentives/compensation

for them.

It is not very easy for suppliers to cut down supply at short notice, of for consumers

(especially industrial consumers) to cut don consumption at short notice

ABT

ABT has 3 components namely:

o Fixed Cost, Variable Cost and Unscheduled Interchange (UI)

The fixed cost is the cost of infrastructure expense. The total amount payable to a

Power Station which go towards its fixed cost, amortized over a given lifespan of the

plant under a revenue model, depend upon the average availability of the plant. If the

power station is efficient, it can get a better yield

Variable cost is the cost of raw material in generating the output. This is called

Energy Charge.

The energy generation charges are for scheduled generation only. If higher generation

can be achieved for a given capacity, the generation company can get rewards at

prevailing rates

Unscheduled interchange (UI) is the migration from scheduled behaviour for either

the generator or the customer and it is penalized at prevailing rates

In economic terms it reflects the marginal value of energy at the time of supply.

A day is divided into 96 blocks of 15 minutes each

Each generating station declares its capacity for each block time with a caveat that the

capacity in peak hour cannot be less than the capacity in off-peak hours

This is given to the Regional Load Dispatch Centres (RLDCs) that distribute this

capacity to various agencies distributing power to end customers

Transmission losses are apportioned in proportion of drawn energy

ABT attempts fair price for performance, incentivizes planning and achieving higher

efficiency and penalizes deviations (generating less than committed power) from

schedule (UI Charges)

These are essential for fair markets and the efficient regulator should, after policy

formulation, be required only for monitoring and future policy formulation and

the present system should be self-correcting

Power Exchanges (e.g. Power Exchange India Limited)

It is a common platform where buyers & sellers of electricity come together for trade.

Institutional buyers and producers take part in the power exchange

Buyers want low prices, sellers want high prices. These conflicting forces determine

the correct price of a commodity at a given time.

An exchange helps in determining the true price for power

The price is arrived at by the following method:

The demand curve is drawn by plotting the sum of purchase (buying) data (volume)

against price. This curve has a slope downwards

The supply curve is drawn by plotting the sum of sale data (Volume) against price.

This curve has a slope upwards.

These two curves intersect at a point. This is the point of equilibrium. At this point

price for both buying and selling is same.

If a perpendicular is drawn from point of equilibrium to price axis i.e. Y axis it will

meet at a point on Y axis. Price representing this point is market clearing Price (MCP)

If a perpendicular is drawn from point of equilibrium to volume axis i.e X axis it will

meet at a point on X axis. Volume up to this point represents Market clearing volume.

Mathematically it can be proved that the area under supply curve up to point of

equilibrium taking X axis as base is equal to the area under demand curve from point

of equilibrium to the high point of the curve taking the MCP line which is parallel to

X axis, as base.

All sale bids having price less than or equal to MCP value and all purchase bids

having more than or equal to MCP value will be cleared for trade.

Conclusions

The basic means of demand, supply are used to arrive at pricing in these two markets

Telecom Service Providers incentivize customers to use the infrastructure more and

they reduce off-peak hour rates

Energy Utility companies incentivize frugal behaviour as far as energy utilization is

concerned and charge higher during peak hours.

These principles may not hold true in the same way for transport services (Bus, Auto,

Rail, etc) where the variable cost (fuel) is a bigger component of the expense and

more resource (driver) intensive