CA’s move to cut termination rates good for telco industry

The move by the Communications Authority of Kenya (CA) to slash domestic mobile termination rates (MTRs) and fixed termination rates (FTRs) to Sh0.12 from Sh0.99 effective January 1, 2022 is positive for the telecommunications sector.

A termination charge is the interconnection cost to terminate a voice call, whether fixed or mobile on a network. Think about two cattle ranchers co-locating within a single large area but each with his own water pan and a unique identifier for every animal in the ranch.

The duo then decide to charge each other, at a pre-agreed rate, for every cattle that quenches in each other’s water pan. At the end of a period, the mathematics boils down to how many of your cattle quenched in my water pan versus mine in yours (and everything nets off).

Part of the reason for the charging is so that each rancher can recoup the cost of constructing the pan (water pans can be an expensive affair especially in Kenya). However, due to passage of time, the cost of maintaining the water pans drastically comes down as each rancher gets adequate recompense for the initial set-up costs.

Hence, the pre-agreed rate will have a downward glide path. It is the same story in telecommunications, except that the pre-agreed rate is set by a regulatory authority (in this case the CA).

Since 2010, Kenya’s telecommunications market has been operating on MTR and FTR of Sh0.99. This means that operators can charge each other up to a maximum of Sh0.99 but are at liberty to negotiate lower interconnection rates with one another.

However, this was based on a five-year glide path that expired in 2015, and a review of the interconnection charges was somehow overdue. Broadly, interconnection charges are designed to compensate for infrastructure set up costs incurred and generally should not be seen as cash-cows.

Further, termination rates in Kenya are already regulated on a long-run incremental cost (LRIC) basis. Basically, the additional cost a firm incurs in the long run in providing a particular service as a whole, assuming all its other production activities remain unchanged.

Given the current glide path, the next review will now probably drop MTRs and FTRs to the floor (zero). But what does MTRs and FTRs at Sh0.12 mean now? First, it means operators should now do away with on-net and off-net tariff differentials and let their customers enjoy levelled-down tariffs.

Network operators have this penchant to lower their tariffs when their subscribers call within the network – but ‘premiumise’ tariffs when they acquire calls/texts from other networks.

Basically, making a call within your network tends to be cheaper than making a call across another grid. And this has been primarily due to the interconnection charges.

However, this comes with a little caveat: price is not a proposition in the voice market. Instead, operators will still need to focus on widening customer touch-points as the core proposition.

Secondly, this now presents some level of cost savings for Airtel and Telkom, being net payers to Safaricom #ticker:SCOM over the years. In 2017, Analyst Mason noted that Telkom and Airtel paid around eight per cent of their revenue to Safaricom for mobile termination.

With Safaricom’s off-net traffic having doubled between 2018 and 2021, implying that traffic domiciliation by both Airtel and Telkom has been growing, my back-of-the-envelope calculations suggest that termination costs for Telkom and Airtel could drop by as much as half, which partly explains Safaricom’s decision to appeal the move by the CA.

Airtel and Telkom can then deploy these savings into improving their network infrastructure.

Bodo is a financial analyst