LRIC, FAC, SAC… What do they mean?
You could literally write a doctoral thesis about the different models used in economic regulation.
Academics in the field will likely shudder at the extent to which we boiled down the concepts in this piece, but that’s OK – the audience is not a conference for economic regulators, it is telecommunications entrepreneurs wishing to better understand some jargon.
There are three models that are in common (but not exclusive) usage in our experience. We shall give a quick overview of each; however, before we do, we need to set the scene of our analogy.
Imagine a factory that makes two products in different quantities; around one-third of its business is making tins of baked beans and the other two-thirds is making bars of chocolate. It is not part of a group of companies, it’s a long-standing family business that produces those two things and nothing else.
Long-Run Incremental Cost (LRIC)
The LRIC (often pronounced like ‘lyric’) is the basis of many charge controls, certainly in the United Kingdom and the European Union. It should always generate the lowest result of the three models we are looking at.
It is, for the purposes of this article, the incremental cost of producing just one more of the items in question. In terms of our factory analogy, it is the incremental cost of producing one more tin of beans – i.e., the tin, the beans and the tomato sauce. It makes no allowance for common costs, such as the procurement manager or CEO.
Fully Allocated Cost (FAC)
Pronounced ‘fack’, this model was the basis for many charge controls, before the increasing popularity of LRIC in regulation. It should always be somewhere between LRIC and DSAC and is calculated by reference to the LRIC plus an allowance for common costs. Common costs are costs which are shared across multiple products, i.e., apportioning a percentage of the CEO’s time and an amount for the procurement manager etc.
In our hypothetical factory, you would imagine adding one-third of the CEO’s cost to the LRIC of all the tins of beans and two-thirds to all the bars of chocolate to arrive at the result.
It is a relatively simplistic calculation for a business to perform, as the principles mirror that of the management accounts many produce to monitor business unit or product line performance.
Stand-alone Cost (SAC)
Referred to as ‘sack’, this should result in the highest of the three numbers discussed here. It is calculated often by hypothetical means because of a lack of real-world examples that can be modelled. The DSAC is, broadly, the cost of an entity producing one unit of something if that is all that entity produces, regardless of the efficiencies of scale a multi-product company will enjoy. In our factory example, the SAC of all the bars of chocolate has allocated to it the entire cost of the CEO and procurement manager.
What about ‘distributed’ methodologies?
You may hear LRIC, and SAC prefixed with ‘Distributed,’ becoming DLRIC (‘dee-lyric’) and DSAC (‘dee-sack’) respectively. These are variations of those models to account for large multi-product companies (especially those with similar lines of products and services – so if our imaginary factory also made tins of spaghetti-hoops) and the effect of large increments in the volume of a product or service on the cost models. The UK’s telecoms regulator published a consultation in the 2010s on the subject which discusses these more nuanced methodologies as well as considers the subject in more depth andwith helpful diagrams. It is not often we commend reading their documents, but in this case, it makes for good further reading.
What’s the relevance?
Charge controls are set by reference to these models – which is to say that for the regulated, it affects the amount that can be recovered in the market for the supply of that product or service. For those purchasing these services, it directly affects the input costs.
In Competition Law, they are used as reference points for assessing the functioning of a market. If a dominant entity is selling below the LRIC, it is almost certainly engaged in a margin squeeze. If it can sustain prices more than the SAC, then it is likely earning a super-normal return and operating without the constraint of competition.
There’s so much more to it than just those data points when assessing the competition in a market – the effect of substitutes (i.e., if the price of baked beans rose, could people just eat spaghetti-hoops?) and whether price rises encourage new entrants into the market are just two other factors to be considered.
Members of Exonia’s team have been involved in litigation involving these matters – if you would like to learn more, please do not hesitate to reach out.