Session Five:
Wireline Carriers--Regulation II

Lecture Notes

Accompanying Slides

Wireline Carriers Regulation II

The great issue in telecommunications has always been, what is a fair price for service? When Theodore Vail stated that Universal Service was to be the goal of the Bell System, he stimulated a policymakers addendum—"at a fair price". Policymakers long tried to prevent the Bell System from making "excessive" profits from its monopoly, since consumers had no alternative. At the same time, regulators learned they could manipulate the rate structure in order to achieve social policy goals. Within this framework lay the seeds of political conflict and controversy.

Actually, the telecommunications industry is regulated in several ways. International rates, or tariffs, are set by the International Telecommunication Union, ITU, in Switzerland. The U.S. sends one ambassador and a substantial staff to support ITU actions. This body sets international calling standards and provides the forum for negotiating rates.

Within the U.S., The Federal Communications Commission, F.C.C., has primary responsibility for regulating common carrier issues in interstate commerce. Intrastate rates and issues are regulated by the state Public Utility Commissions, which have a variety of names, but similar purposes, and which are generally referred to as PUCs. In addition, various standards agencies set standards for network interconnection, safety, quality and reliability. Some of these are done by such federal entities as the National Institute for Standards and Technology, NIST (located in Maryland along the I-270 corridor!), and various industry groups such as Bellcore. The North American numbering plan is an important item maintained by Bellcore. Carriers get telephone numbers assigned by this group, and getting a certain pattern of numbers can be an important competitive item.

But the most contentious regulation has seldom erupted over engineering or technology. The most contentious has always been pricing.

Historically, under the Communications Act of 1934, the FCC and the state PUCs set rates based on a fully distributed cost formula. (This formula is examined in detail in Pierce and Gellhorn.) In this regulatory method, historic costs are determined and allocated to each specific service. Taxes are added, depreciation subtracted, and a factor for a "reasonable" profit added to determine exactly what the price should be for each service. It was through this process that the cross subsidies between long distance and local exchange services evolved and were implemented.

This system had several weaknesses. It was slow to respond to change, especially to changes in technology. Since it was based on historic data, there was always a problem of accuracy and applicability, especially during periods of great inflation. The hearings were held in a quasi-judicial framework, which made the relationship between the regulator and regulated adversarial. Worst of all, it created an incentive for "gilding" or "gold plating". This practice meant building costs high in order to justify still higher rates in the regulatory bodies. It lent itself to padded payrolls, meetings in expensive locales, and other practices which a highly competitive industry might eschew to hold down expenses.

Divestiture provided the impetus for revamping this system at the federal level. Still operating within the framework of the Communications Act of 1934, the FCC adopted a new form of regulation based on "price caps." With this method, the Commission established the concept of the "dominant" carrier, which in long distance meant AT&T.

AT&T would create so-called "market baskets" of services. Rather than set the exact price for each service, the FCC would set a cap upon what could be earned from each "basket.’ This process was supposed to stimulate AT&T to offer more and better services at lower prices, because it would be allowed to retain more of its earnings than under rate regulation. That is, it would have an incentive to lower the costs associated with the service so that it could keep more, without having to charge more. The other common carriers, the nondominant ones, usually followed suit with what rates the dominant carrier charged.

The opportunity which price caps created for both long distance and local carriers to keep more of what they earned stimulated reorganizations among AT&T and the RBOCs, and most frequently led to substantial downsizing, internal cost cutting, and a surge of interest in "total quality management".

The FCC wanted to alter its methods of regulation more substantially. Under the 1934 Act, the FCC did not have authority to pick and choose which services would be regulated or in what way. While the FCC had in fact deregulated customer premise equipment by commission action in 1984, it felt it could not apply the same authority to deregulation of common carrier services. Despite some substantial flexibility in the Act, the FCC largely felt constrained from either being able to forbear from regulating, or to reimpose regulation once a product or service had become competitive.

This issue at the Commission, coupled with the desire of the RBOCs to enter manufacturing, long distance, and information services, created the stimulus for congressional actions leading to the Telecommunications Act of 1996. Congress debated RBOC entry, and later the converse, entry into local exchange markets, for a dozen years before adopting the Act.

We’ll get into the details of the Act, which is now the legal and regulatory cornerstone for telecommunications in great detail in the next session. For now, the important point is that it allowed a policy of forbearance by the FCC, and for more regulatory latitude. It also determined the standard by which local and long distance companies could enter each other’s markets.

The FCC has been struggling with the issue ever since. The Hybrid Cost Proxy Model is the current attempt by the FCC to implement a rational model for regulating rates. This model requires a huge amount of data, as you will see when you visit the web site, and is quite difficult to implement and understand. Whether the FCC succeeds in making this a useful tool to determine "fair" rates remains to be seen.

In the meantime, what having this model out does is provide a basis for discussion. All those affected by regulation, including carriers, competitors, and customers, can all look over the method, evaluate it, and offer comments to the commission. This public access to the process is a key element in US regulatory procedures—no surprises.

The FCC must provide access, as you know from Pierce and Gellhorn—to all affected parties. While this tenet allows for some delay, it also usually means that the outcome is one that the affected parties can live with. Having heard the evidence and testimony of many witnesses, the Commission can decide, with all parties having had their say. If a party still feels that the regulatory decision is wrong or inadequate or somehow legally flawed, they then have the right to seek a judicial review, that is, take it to court. In the past the FCC has usually managed to avoid having many of its decisions taken to court, or, once there, overridden.

Its bipartisan composition has helped it to avoid political controversy on the Hill and at the White House. The Commissioners are appointed by the President and subject to Senate approval, but , by and large, the FCC has an impressive track record of independence and intelligence in creating and implementing its decisions.

Go to the FCC web site and surf a while. See how it is organized, and who the key players are. Read a few of their policy documents to familiarize yourself with some of their views and their current issues. You will probably return to this site many times in the course of a career in telecommunications.

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