Intermodal Competition and Telecommunications Deregulation in Florida

T

William E. Taylor Senior Vice President

34th Annual PURC Conference February 16, 2007 Intermodal Competition and Telecommunications Deregulation

Network convergence affects regulation.

§ Assumption of a single vertically­integrated ILEC network with dependent competitors drove regulatory structure – Long­distance carriers [1978 – 1996] – CLECs [1996 ­] – Led to economic regulation of both retail and wholesale services.

§ In theory, such dual regulation (wholesale and retail) is perilous.

§ In practice, with intermodal competition, deregulation of wholesale services must be considered.

1 Intermodal Competition and Telecommunications Deregulation

Overview July 2006 § State of competition in Florida

(2005): Intermodal Competition in Florida Telecommunications

Prepared for: BellSouth Telecommunications, Inc., Embarq Florida, Inc., Verizon – Wireline carriers Florida Inc., and Windstream Communications Florida, Inc. – Intermodal carriers By — Cable William E. Taylor Senior Vice President — Wireless Harold Ware — VoIP Vice President — Joel M. David Fixed wireless Senior Analyst

http://www.psc.state.fl.us/library/filings/06/06521­06/nera%20fl%20white%20paper.doc § Effects of wholesale regulation in these markets – Essential facilities – Wholesale regulation when the retail market is competitive? – Regulatory reform

2 Intermodal Telecommunications Competition in Florida

2005 Telecommunications Competition in Florida

Florida PSC: “Status of Competition in the Telecommunications Industry as of May 31, 2005”: § [A] report on local competition would be incomplete without [an] analysis of the alternatives, such as wireless, cable (VoIP­based), broadband, and … (VoIP). These… intermodal competitors…have developed and evolved to challenge the traditional telephone wireline companies for market share. (p. 2) § Simple CLEC market share … understates the true market share held by competitors including wireless, cable, and other IP­enabled (Internet Protocol) providers. The gap between the CLEC market share and the true size of the competitive market share is unknown today, but we believe it will continue to grow as alternatives become more generally accepted. (p. 3) § In previous years, the analysis of this statutory requirement has focused primarily on the wireline sector of the telecommunications market. As noted throughout this report and the 2004 report, wireless and, to a lesser extent, VoIP competition have become a significant portion of the voice communications market…increasing numbers of customers are replacing traditional wireline service with these options and, therefore staff must conclude that they are providing functionally equivalent local exchange service to residential and business customers…. (p. 69) §

4 Wireline Subscription

§ Year­end 2000: about 3.4 million more 16,000,000 CLECs 14,000,000 ILECs Wireless Subscribers mass market (residence and small Wireless and Residential and Small Business Broadband

s 12,000,000 er b

business) wireline access lines than total i cr s 10,000,000 ub

wireless subscribers and mass market r S o 8,000,000 s ne i L

high­speed broadband lines. f 6,000,000 o ber 4,000,000 um

§ N Year­end 2002: about 1.3 million fewer 2,000,000

mass market wireline lines than total 0 wireless subscribers and mass market 12/31/2000 12/31/2001 12/31/2002 12/31/2003 12/31/2004 Note: Due to differences in reporting, June 30, 2005 data are not available. broadband lines. Source: FCC December 2000­December 2004 Local Competition and High­Speed Internet Reports.

§ Year­end 2004: about 7 million fewer 12,000,000

ILEC and CLEC mass market lines Actual Lines

10,000,000 es Predicted Lines n combined than total wireless and mass i L 2.5 million lines 8,000,000 cess

market broadband lines. c A d

che 6,000,000 t i

§ w l S

Trending residential access lines using a i t 4,000,000 en the historical relationship with population d esi suggests a more rapid reduction in R 2,000,000

­ wirelines. 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

5 Wireline Usage

50,000,000

45,000,000 Actual Local Calls

§ ) 40,000,000 Predicted Local Calls

A dramatic decline in expected wireline ds n a

us 35,000,000 o

usage in Florida based on historical h 27 billion calls

T 30,000,000 s ( ll relationships with population. a 25,000,000 l C ca

o 20,000,000 l L

ua 15,000,000 nn

A 10,000,000

5,000,000

­ 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

§ A similar dramatic reduction in Florida 100.0% 84.0%

e 80.0% s

wireline long distance usage, as U

f o s

e 60.0% measured by the cumulative changes in t 45.9% 41.7% 37.5% Minu

40.0% 33.5% n i switched access minutes of use 1995­ e 20.7%

ng 20.0% ha

2000 compared with 2000­2005. C e g

a 0.0% nt e c r ­20.0% ­14.4% ­11.6% Pe ­23.8% ­40.0% ­31.4% BellSouth Verizon Embarq Windstream Total of 4 Carriers 1995­2000 2000­2005

Source: FCC, National Exchange Carrier Association, Network Usage Data.

6 Cable Telephony

§ Table 3 Cable telephony is widely Advanced Cable Services Are Widely Available in Florida

Homes Passed Percent of Homes Passed available across Florida. Broadband Telephony Broadband Telephony Company Total Ready Ready Ready Ready

Comcast 3,392,721 3,304,487 1,203,565 97.4% 35.5% – Cable passes 95% of Bright House 2,024,048 2,024,048 2,005,903 100.0% 99.1% Knology 334,379 334,379 334,379 100.0% 100.0% households Cox 332,308 332,308 332,308 100.0% 100.0% Atlantic Broadband 54,748 54,748 ­ 100.0% 0.0% Advanced Cable 44,255 44,255 44,255 100.0% 100.0% Mediacom 28,158 28,158 25,472 100.0% 90.5% – Cable penetration is 78% of Other 40,909 27,335 ­ 66.8% 0.0% Total 5,917,147 5,815,339 3,611,503 98.3% 61.0%

homes passed Note: Because Knology is an overbuild operation, Knology homes are subtracted from the totals shown. As a result, totals include the primary provider only and may thus understate the services available. – Broadband deployed to 98% of Comcast includes the former Adelphia and Time Warner systems in Florida. Source: Warren Communications News, Cable Fact Book, GIS Format. homes passed

Table 5 – Telephony enabled to 63% of Cable Telephony Share of Households

homes passed. Cable Telephony Share of Households § Population Density First Half of Oct. 2005 ­ A substitute for basic telephone Area (persons/sq. mile) 2005 Mar. 2006 MSA Group 1 over 1,000 1.4% 4.7% service? MSA Group 2 500­1,000 0.8% 3.9% MSA Group 3 Less than 500 2.5% 4.4% Non­MSA Area 0.4% 3.7% Statewide 1.6% 4.4%

Source: Cable share: TNS Telecoms ReQuest® Consumer Survey.

7 Cable Telephony

§ National penetration rates for Cox 21.6% Knology 20.8%

cable telephony. Cablevision 19.4%

Bright House 11.1% – Data presented in chronological Time Warner 8.0% Comcast 5.0%

order of deployment (from top Charter 4.9% to bottom) Insight 11.6% Mediacom 9.1% – Penetration increases 0.0% 5.0% 10.0% 15.0% 20.0% 25.0% Source: VoIP Deployment & Strategies Update: Cable Operators , Broadband Advisory Services, Pike & Fischer, July 2006, p. 3; Bright House Networks Press Release, More than 225,000 Florida Families Switch significantly with time. to Bright House Networks Digital Phone: Now Announcing a Florida Unlimited Calling Plan , May 2, 2006 and Table 1; Knology Inc, SEC, Form 10­Q, March 31, 2006, p. 12.

140 100% C

Circuit Switched Homes Passed a b l 90% e T

§ ) VoIP Homes Passed

120 e s l n e p Cable telephony availability is o 80% li Cable Telephony Homes Passed h o n

100 as % of All U.S. Homes y (Mil

70% H d e o s m forecasted to increase s a 60% e P s

80 s P e a s m 50% s o e d H dramatically. as y 60 n

40% o % h p o e f A l e 40 30% T ll

le U b 20% .S a . C 20 H o

10% m e s ­ 0% 2002A 2003A 2004A 2005A 2006E 2007E 2008E 2009E 2010E

Source: J. Halpern, et al., Bernstein Research, Quarterly VoIP Monitor: VoIP Growth Still Accelerating , April 18, 2006, Exhibit 12.

8 Cable Telephony

25 20.0% 18.0% § Cable Telephony Subscribers 20 16.0% Sha

Cable telephony penetration is Share of U.S. Households ) r

14.0% e o f

illions forecast to grow rapidly 15 12.0% U . M S. (

H

rs 10.0% o us ibe

r 10 8.0% e c ho § s

6.0% lds

But from a small base as a Sub 5 4.0% proportion of addressable 2.0% ­ 0.0% households. Room for 2002A 2003A 2004A 2005A 2006E 2007E 2008E 2009E 2010E

Source: J. Halpern, et al. ,Bernstein Research, Quarterly VoIP Monitor: VoIP expansion. Growth Still Accelerating , April 18, 2006, Exhibit 13.

9 Mobile Wireless

§ National penetration grown to 62% of the population and over 90% of the 20­49 population. $0.45 600

) s

r $0.40

§ a l

l 500 Dramatically lower prices and M o

$0.35 i D n (

u e t

higher usage volumes. t e

u $0.30 400 s

n o i f

M U

$0.25 r § s e e 300

p

Substitute or complement? p

e e $0.20 r u

M n e o v $0.15 200 e § n t R h Substitute for basic exchange

e $0.10 g

a 100 r

service? e

v $0.05 A $0.00 0 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

Minutes of Use Per Month Average Revenue Per Minute

Source: FCC, Tenth Annual CMRS Competition Report, Table 8.

10 Mobile Wireless

§ Florida subscription growing 14 80 Subscribers 12 70

Penetration ) rapidly. n

tio ) 60 s la

n 10 u io p l il 50 M f Po o (

s 8 r e (%

§ ib 40 n r o c s ti b In December 2004, wireless a 6 u tr e

S 30 n s s e l Pe e 4 s r s i

20 e subscribers exceeded wireline l e W r i

2 W subscribers by almost 2 million. 10 ­ 0 2000 2001 2002 2003 2004

Note: Wireless penetration not available for 2000. Source: FCC December 2004 Local Competition Report, Table 14 and Florida PSC 2005 Competition Report , Figure 13.

90.0%

80.0%

70.0%

e

t 60.0%

§ a

Growth has occurred throughout R n 50.0% o i t

ra 40.0% Florida economic areas. et en

P 30.0%

20.0%

10.0%

0.0% Fort Myers­ Pensacola, Jacksonville, Orlando, FL Miami­Fort Tampa­St. Sarasota­ Tallahassee, Cape Coral, FL FL­GA Lauderdale, Petersburg­ Bradenton, FL­GA FL FL Clearwater, FL FL

2001 2002 2003 2004 Source: Seventh­Tenth CMRS Reports .

11 Mobile Wireless

45,000 14

s)

40,000

n 12 ) s io n l l o i 35,000 i l l i M 10 (

30,000 M se ( rs U f 25,000 8 be o i cr es t 20,000 6 ubs inu S

15,000 s M s

4 e l e ine

10,000 r el

2 Wi 5,000 Wir 0 ­ 2000 2001 2002 2003 2004 Wireline Minutes Wireless Subscribers

Note: Minutes of use are interstate switched access minutes for Alltel, BellSouth, Embarq and Verizon. § Source: FCC, National Exchange Carrier Association, Quarterly Minutes of Use Data; FCC December 2004 Wireless calls have displaced Local Competition Report, Table 13.

wireline minutes of use in 4000 Florida. 3750 3500

e

in 3250 L

r e 3000 s p l l

a 2750 C 2500

2250

2000 1999 2000 2001 2002 2003 2004 2005

Note: (1) Total lines are total switched access lines from ARMIS. Data include BellSouth, Verizon and Embarq. Source: ARMIS, Report 43­08, Tables III & IV

12 Broadband and VoIP

§ Every zip code in Florida has 2 or more broadband providers.

§ 96 percent of zip codes have 4 or more providers.

§ High­speed DSL connections available to 85% of Florida households;

§ Cable modem service available to 94 percent of homes passed.

13 Broadband and VoIP

§ Florida PSC survey shows 3,500,000

3,000,000 s Residential & Small Business e

in Total

broadband penetration L

2,500,000 d e e

p 2,000,000 S (12/2005) as percent of ­ h g 1,500,000 Hi of

population was 46%, above the r 1,000,000 e b m

u 500,000

national average of 36%. N ­

9 0 2 3 3 4 00 00 001 01 002 00 00 04 005 /199 2 20 2 20 2 200 2 /200 2 20 2 § 1 0/ 1/ 1/ 1/ 0/ 1 0/ 3 3 30/ 3 30/ 3 3 3 /30/ 3 30/ 6/ 6/ 2/ 6/ 6/ 6 2/ 6/ FCC data show dramatic 12/ 12/3 1 12/ 12/ 1 Note: Data on residential & small business not available until 12/31/00 and is residential only at 6/30/05. growth. Source: FCC June 2000­June 2005 and December 1999­December 2004 High­Speed Internet Reports.

§ 3,000 WI­FI access widely available in 2,642 Florida 2,500 1,927 2,000 § WiMAX: Clearwire in Daytona, 1,500 937 Jacksonville. 1,000 500 385

­ 2003 2004 2005 2006

Note: 2006 figure as of June. Source: JiWire Hotspot Directory, available at www.jiwire.com.

14 Broadband and VoIP

§ Rapid national growth in independent VoIP subscribers.

§ VoIP suppliers have local area codes throughout Florida.

§ Package prices competitive with wireline / wireless packages.

15 Consequences for Regulation Economic Regulation of Telecommunications Services

§ Long experience in regulating and deregulating retail markets. – Cost­of­service replaced by price regulation replaced by pricing flexibility or deregulation where warranted. – General agreement on market power as trigger. General disagreement on everything else.

§ Less experience, but long­time economic regulation of wholesale services in the U.S. – Carrier access services since 1984 – Wholesale local exchange services (UNEs / resale) since 1996. – Little thought regarding regulation or deregulation of wholesale services. – Understanding the relationship between retail and wholesale services and regulation is now necessary, due in part to intermodal competition.

17 Economic Regulation of Telecommunications Services

§ In economics, benefits from wholesale regulation are different: – welfare effects are measured in the market for final goods. – If wholesale regulation has no effect downstream, it has no benefits for consumers.

§ Costs of wholesale regulation are more complex: – Induces distortions in retail markets because some platforms are regulated and others are not. – Incentive effects are important because network investment is sunk and irreversible.

18 Economic Regulation of Telecommunications Services

Essential Facilities § Assume the retail market is competitive. – Assume all competitors are dependent on ILEC facilities. ILEC – The ILEC has the ability to exercise market power in the wholesale market. CLEC 1 CLEC 2 CLEC 3 CLEC 4 — Increase in the wholesale price passed through by all carriers — Hence extraction of additional profit from wholesale monopoly requires effective market power downstream.

§ Not unreasonable to regulate Retail Telecommunications Services wholesale services when they meet the conditions for an essential facility. – May be more efficient methods than ex ante regulation.

19 Economic Regulation of Telecommunications Services

Intermodal Competition

§ The retail market is competitive and would be absent the dependent CLECs. Wireless Cable VoIP ILEC § Even though the ILEC is CLEC 1 CLEC 2 (assumed to be) a monopoly supplier of the wholesale service, it possesses no market power. – Has no ability to extract Retail Telecommunications Services supracompetitive profits from dependent CLECs – Has no incentive or ability to price wholesale services at an anticompetitive level (entailing a margin squeeze).

20 Economic Regulation of Telecommunications Services

Conclusions

§ Ex ante economic regulation of both wholesale and retail services is generally unwarranted, inconsistent and rife with inefficient, unintended consequences. – Particularly, if retail market is effectively competitive

§ Ex ante regulation of wholesale services is best confined to essential facilities. BUT: – We frequently don’t know if a facility is essential at competitive market prices. – Efficiency consequences of regulating some platforms but not others recalls the debacle of surface transport regulation: truck / rail / barge. – Ex post regulation through competition law avoids these costs.

21