IUC Cut: A Welcome Step Closer to Zero, or a Low Blow?
Different strokes for different folks
If there is one area in which Jio has been fortunate, it is on the regulatory front. Ever since RIL started working upon Jio, any changes in telecom policies have always seemed to work out positively for the company. There has, however, been one contentious policy debate between Jio and incumbent telecom operators for quite some time now – the one around Interconnect Usage Charge, or IUC.
Interconnect Usage Charge is the fee that operators exchange in order to connect with each other’s network. Different countries take different approaches to IUC. In some countries, the telecom regulator allows telecom operators to negotiate the IUC amongst them while in others, the regulator decides a fixed IUC amount. India falls in the latter category where the regulator, i.e., TRAI, decides the IUC amount.
With changes in telecom technology and dynamics of the telecom sector in India, the IUC amount has constantly been revised. It was earlier revised from 20 paise/minute (p/min) to 14 p/min and in the very latest release has been revised from 14 p/min to 6 p/min. The latest revision has attracted a fair deal of attention with almost everyone having their own take on it. Let us take a closer look at what exactly it means.
How does IUC work?
As mentioned earlier, in India, the IUC is fixed by the telecom regulator, TRAI, with the latest rate being 6 p/min. What this effectively means is that every time a telecom operator connects a call with another telecom operator’s network, the operator from whose network the call originates has to pay 6 paise (0.06 Rupees) for every minute of the call to the operator where the call terminates. So for example, suppose there are two people, Rahul and Roshan. Rahul uses Airtel whereas Roshan uses Idea. Now when Rahul calls Roshan for 6 minutes, a call originates from Airtel’s network and ends on Idea’s network. So Airtel now has to pay Idea IUC for 6 minutes, which under the current rate would be 6 x 6 p/min = 36 p
That might not sound like a lot of money, but then, Indian telecom operators work at a whole different scale. An operator like Airtel has a subscriber base of close to 280 million which is more than the population of several countries.
Let us go back to Rahul and Roshan. And let us assume that after Rahul (Airtel) called Roshan (Idea) for 6 minutes, Roshan (Idea) called back Rahul (Airtel) for 4 minutes. In such a scenario, Airtel would get interconnection charges for 2 minutes while Idea receives nothing like the four minutes of calling between Airtel to Idea and then Idea to Airtel cancel each other out.
This example makes it abundantly clear who benefits from a higher IUC and who benefits from a lower IUC. Most larger (often incumbent) operators because of their vast subscriber base are net receivers of interconnection charges as the number of calls incoming on their network from a particular operator almost always exceeds the number of calls outgoing from their network to the same operator. Incumbent operators after accounting for the difference in traffic between incoming and outgoing calls to a particular operator almost always have more incoming than outgoing, which means they receive IUC. For smaller operators, outgoing calls almost always exceed incoming calls from bigger operators, which means they have to pay IUC.
So when IUC are lowered, bigger operators lose money and smaller operators either make money or at least cut their losses. On the other hand, if IUC is increased, then the tables are turned: bigger operators make money while smaller operators lose out. For the past few years, TRAI has been steadily reducing the IUC which means operators like Airtel, Vodafone and Idea have constantly been losing out on IUC revenue, even while this benefits operators like Jio, Rcom, and Aircel since they have to make less IUC payments.
Cutting IUC: the incumbents suffer…
It is now time to analyze the impact of the IUC cut on the profits of incumbent telecom operators. Telecom in India is a very low margin business. Operators make very little money on every call minute/MB of data they carry on their network. The only thing that makes Indian telecom sustainable is the scale at which it operates. Airtel’s subscriber base of 280 million, for instance, means that if it were a country, it would be the fourth largest country on earth.
The fact that Indian telecom operators rely so much on their scale to make their operations sustainable means that every single pricing metric has outsized influence in determining the profit or loss of a telecom operator. A change of a few basis points (1 basis point = 0.01 percent) in any pricing metric when multiplied by a customer base of hundreds of millions can alter the profit or loss picture for a particular quarter.
IUC is also one such pricing metric and one that contributes significantly to the profit of incumbent telecom operators since the IUC revenue that they receive from smaller operators is pure profit for them. In such a scenario, TRAI’s decision to cut the IUC from 14 p/min to 6 p/min would have a dramatic effect on the industry.
Now, this is not the first time that TRAI has cut IUC. It had revised IUC from 20 p/min to 14 p/min in February 2015 but this was done at a time when the industry was in a healthy state and incumbent telecom operators were posting healthy revenue and profit growths. So the cut in IUC was easily absorbed by telecom operators.
Things are a bit different today. At the time of writing, the industry is in severe financial stress. Ever since Jio’s entry, incumbent telecom operators have seen their revenue and profits fall every single quarter. The only incumbent operator that’s profitable anymore is Airtel and operators like Idea and Vodafone are already making losses. Even in the case of Airtel, their profits are far lower than in the past.
In such a scenario, cutting the IUC from 14 p/min to 6 p/min is going to make losses of incumbent telecom operators even larger. Airtel’s IUC revenue for Q1 2018 was Rs 628.3 crores and Idea’s IUC revenue was Rs 332 crores. If we were to assume that Airtel and Idea’s voice call volumes remain the same, then that would mean that Airtel’s IUC revenue would drop to Rs 359.01 crores and Idea’s IUC revenue would drop to Rs 189.7 crores. This is going to reduce their EBITDA by 8-10 percent and considering the super low margin at which the Indian telecom industry operates, such a reduction will have an even more drastic impact on EBIT and net profit/loss.
And Jio benefits again!
For all practical purposes, the only operator that gains from the IUC cut is Jio. On paper, smaller operators like Aircel, Rcom and Tata Docomo, should also gain but most of these operators are in such dire financial conditions that over the long term, it does not even matter to them if the IUC is increased or reduced. They have far bigger problems to tackle than IUC.
Jio on the other hand by virtue of being a medium-sized operator comes out a winner. It by now should have approximately 130-140 million subscribers while operators like Idea, Vodafone and Airtel will in the near future have more than 300 million customers. This means that the number of outgoing calls from Jio’s network to the incumbent operators will always be more than the number of incoming calls. In such a scenario Jio would be a net payer of IUC and any cut in IUC would help Jio save a significant amount of money.
Going by Jio’s annual report for 2016-2017, the company paid approximately Rs 2588.90 crores as IUC. The annual report was till 31 March 2017 and Jio started commercial operations on September 5 2016. That means that for eight months approximately, Jio paid IUC of Rs 2588.90 crores or an annualised rate of Rs 3883.35 crores. A 60 percent cut on this IUC would go a long way in helping Jio achieve EBITDA break even at a much faster pace than initially expected.
Another thing to note here is that the IUC cut has come exactly when Jio is going to start the delivery of its JioPhone. The JioPhone primarily targets people living in Tier 2 and Tier 3 towns as well as villages. These people will at least initially use their JioPhone primarily to make calls and a lot of it since calling is free and unlimited on the JioPhone. In such a scenario, a reduction in IUC will once again benefit Jio.
Make it a zero sum game… but in 2020 please
There are obviously divided opinions on the IUC cut. The incumbent operators are planning to take the legal route to settle their differences with TRAI on IUC while operators like Jio are welcoming the revision. On my part, I feel that IUC has to be reduced to zero. It has has been a kind of unfair moat that the incumbents have been using since a long time to protect themselves. The IUC is a self-reinforcing cycle whereby larger operator are net receivers and thereby more profitable than smaller ones. This allows the larger operators to keep expanding their networks and increase their subscriber base, thus further increasing their IUC income.
So speaking for myself, I fully support TRAI’s decision to revise IUC to 0 p/min starting 2020. What I do NOT support is the present day reduction in IUC charge to 6 p/min from 14 p/min. Most telecom operators are already having a tough time keeping their balance sheets in the black. In such a scenario, reducing a key metric like IUC by as much as 57 percent just adds more uncertainty to an already debt-laden industry. In my opinion, TRAI should have kept the IUC unchanged at 14 p/min till 2020 after which it could have been revised to 0 p/min. This would have given telecom operators enough time to change their revenue streams and business models. But then, clearly the regulator thought otherwise. And once again, by some coincidence, the change favoured a certain operator.