A tale of fruit

Imagine, if you will, two fruit-growing islands somewhere in the Pacific – LARGE and SMALL.  LARGE produces pineapples and kiwifruit, while SMALL grows bananas.  A new competition authority for the Pacific islands, ‘PICA’, is set up to regulate the prices of LARGE because of its dominance in the fruit market.  It sets cost-based prices for both pineapples and kiwifruit.  It sees no reason to regulate banana prices but asks both LARGE and SMALL to suggest a methodology for establishing ‘fair and reasonable’ pricing.

In the interests of simplicity (sic), LARGE suggests that banana pricing should be linked to the regulated prices of pineapples and kiwifruit, and the volume of these that SMALL chooses to buy from LARGE.  So, if SMALL buys only pineapples from LARGE, bananas would be priced at the same level; similarly for kiwis.  If SMALL requires a mixture of pineapples and kiwis (as it does in practice), bananas are priced at the weighted-average pricing of SMALL’s purchases

SMALL says it would prefer to establish a free-standing (exogenous) price for bananas.  It objects to the LARGE algorithm on two grounds, i.e.

• SMALL is minded to buy its pineapples from another Pacific island but recognises that doing so would, using the LARGE algorithm, reduce the value of its own banana exports (because its purchases from LARGE would be weighted more towards kiwis).

• SMALL knows that some of the retailers and restaurants on the island organise their own sourcing of pineapples, and that these are not counted in SMALL’s official import figures.  LARGE has resisted attempts to consolidate the purchasing data.

PICA has said it wants to establish a long-term pricing strategy for bananas but has so far declined to comment on the fairness (or otherwise) of the LARGE algorithm.  DISCUSS.

Well, that discussion is currently going on – or should be.  With a bit of creative licence, the algorithm described above bears a striking resemblance to the old BT ‘reciprocity agreement’ for call termination charges on other fixed networks.  At its heart, this agreement provides that what BT pays to terminate voice traffic on another fixed network is a weighted average of its own single tandem and local exchange conveyance rates, the weights being derived from the other operator’s chosen mix of termination at BT’s tandem and local switches.  For fixed operators other than BT, this methodology creates very much the same problems as those faced by SMALL in the fruit trade, i.e.

·        An operator which contemplates buying less single tandem termination (pineapples) from BT, perhaps because it wants to route some traffic via a transit operator, will see its own termination revenue (banana price) fall;

·        Similarly, an operator that is already using transit to terminate calls on BT’s network (pineapples sourced directly by restaurants) might well argue that this traffic should be ‘counted’ in the calculation of its tandem/local mix.

The latter phenomenon formed part of a recent dispute between BT and COLT; the former has been a central issue in numerous disputes over non-BT call termination.  In all these cases, Ofcom has ultimately ruled that deviating from the (so-called) reciprocity agreement would not be ‘fair and reasonable’ – hence the agreement continues as the default solution for setting termination charges.   However, because the agreement was originally negotiated by the industry itself, and not imposed by the regulator, Ofcom (and Oftel before it) has never felt it necessary to judge whether that reciprocity agreement is itself fair to the other fixed networks.  Maybe a story of fruit will change that…