IPP vs FPP: What the High Court has to say about it all

The High Court has ruled against Chorus in its battle to overturn the Commerce Commission determination on UBA pricing.

This possibly won’t be the end of it – it’s unclear yet whether Chorus can or even will appeal the decision further – but for now we have guidance on how Section 18 of the Telco Act should be applied.

I’ve written about s18 and what it means for the industry elsewhere – in brief, due consideration must be made by the Commission to the needs of investors in new technology.

The Commission argued that it couldn’t go beyond the available evidence when considering its responsibilities under s18, that it couldn’t take in all the evidence, discuss the matter with the industry, work up a draft and then a final determination and then throw it all away because one clause of the Act says it should consider the needs of investors in new technology.

Chorus argued that the Commission should apply s18 at every step of the process and that by waiting until the end to apply s18, it had erred in its interpretation of the law.

“[Chorus argued that] s 18 is a mandatory relevant consideration, which must be applied at every point where a material judgment is made that affects the ultimate result. That would include process decisions, decisions of exclusion of eligible benchmarks, investment in further information gathering, decisions on the  range within which a price point would be selected (if there is any narrowing of options at that stage), and selection of the final price point.”

The Judge, the Honourable Justice Stephen Kos, disagreed with Chorus and said:

“In my view the statutory language is not prescriptive that s 18 is a consideration borne into (and interwoven through) the benchmarking analysis to be undertaken by the Commission, at the evidential stage. Indeed, I can see every reason why it would not be. That sort of external consideration does not seem to me to form a relevant part of the evidence-gathering exercise. Rather, it is relevant to what to do with the evidence once it is obtained.”

The Commission’s argument around s18 is that it can’t be used to move the determination outside the process laid down in the Act, and it’s that which swayed the Judge’s decision.

The whole issue has arisen out of the difference between the Initial Pricing Principle (IPP) and the Final Pricing Principle (FPP) and as the Judge points out, the very reason we have an IPP in the first place.

Conducting an FPP is a lengthy, laborious and costly task. It requires the Commission to build an economic cost model for the service being regulated, based on an efficient supplier’s costs.

Typically these things take a very long time to build, involve much shouting and wailing from all parties and are used only once or twice before being discarded, surplus to requirements.

Because of that, the recommendation (originally made way back in the Fletcher Inquiry of 2000) was that the Commission use a cheap and cheerful benchmarking exercise for the easy stuff. That is, instead of building expensive bespoke cost models, it would simply benchmark against countries that use a similar methodology to New Zealand.

In the past this has been enough for the parties involved. Until now, nobody has called on the Commission to conduct the full FPP process. We’ve looked around the world, found similar regimes and compared our price with theirs. It’s not perfect, but it’s supposed to be quicker and cheaper.

In this instance, the IPP found a benchmark set of only two countries, which certainly alarmed both the Commission and the telco industry. However, after conducting its usual tediously transparent process that included input from all the parties, including the users and investors, the Commission ran a cross-check against a wider group of countries that included a set that were excluded from the final group for various reasons. That range ran from $6.56 to $11.45, effectively bracketing both the draft determination and the final $10.92 price determined by the Commission. Nothing the Commission did fell outside the law.

Which raises an interesting question – if the IPP is supposed to be the quick version, how does the Commission think it can conduct a full FPP for not one but two services in ten months, when the IPP process took far longer?

But that’s a question for another time. For now, the High Court has handed down confirmation that the Commission’s process follows the law as it stands and even, at times, exceeds the expectation.

To quote the Judge once more:

“The Commission has exercised a judgment, as it is required to. It has done so following a process probably more extensive than Parliament had in mind. It certainly took longer than Parliament had in mind. It is worth reminding ourselves that the Fletcher Inquiry, the progenitor of this IPP pricing process, had in mind that New Zealand could simply piggy-back international evidence, and that the result would be a “quick and cheap” process compared to the FPP cost-based modelling approach.”

The Commission hopes to have the FPP decision completed and made public in time for the 1 December deadline. I’m no betting man but I think that’s optimistic and we’re more likely to see a result this time next year, if not later.

That final price? I’d say it will fall to below $10 per line per month.