TELECOMMUNICATIONS REFORM IN GERMANY: LESSONS AND PRIORITIES
Bonn, Germany
Conference Repor t 20 November 1997
American Institute for Contemporary German Studies The Johns Hopkins University Conference Report
TELECOMMUNICATIONS REFORM IN GERMANY: LESSONS AND PRIORITIES
Bonn, Germany 20 November 1997
American Institute for Contemporary German Studies The Johns Hopkins University The American Institute for Contemporary German Studies (AICGS) is a center for advanced research, study, and discussion on the politics, culture, and society of the Federal Republic of Germany. Established in 1983 and affiliated with The Johns Hopkins University but governed by its own Board of Trustees, AICGS is a privately incorporated institute dedicated to independent, critical, and comprehensive analysis and assessment of current German issues. Its goals are to help develop a new generation of American scholars with a thorough understanding of contemporary Germany, deepen American knowledge and understanding of current German developments, contribute to American policy analysis of problems relating to Germany, and promote interdisciplinary and comparative research on Germany.
Executive Director: Jackson Janes Research Director: Carl Lankowski Board of Trustees, Cochair: Steven Muller Board of Trustees, Cochair: Harry J. Gray
The views expressed in this publication are those of the author(s) alone. They do not necessarily reflect the views of the American Institute for Contemporary German Studies.
©1998 by the American Institute for Contemporary German Studies ISBN 0-941441-37-7
This AICGS Conference Report paper is made possible through grants from the German Program for Transatlantic Relations, AT&T and o.tel.o communications GmbH. Additional copies are available at $5.00 each to cover postage and processing from the American Institute for Contemporary German Studies, Suite 420, 1400 16th Street, NW, Washington, D.C. 20036-2217. Telephone 202/332-9312, Fax 202/265-9531, E-mail: [email protected], Web: http://www.jhu.edu/~aicgsdoc
ii C O N T E N T S
Foreword...... v
INTERCONNECTION AND UNBUNDLING POLICY IN NORTH AMERICA Richard Simnett...... 1
INDEPENDENCE AND THE REGULATORY ARRANGEMENT ISSUES IN INSTITUTIONAL DESIGN Richard J. Schultz...... 12
LONG RUN INCREMENTAL COSTS AND THE REGULATION OF INTERCONNECTION CHARGES IN THE UK Geoffrey Myers...... 22
COSTING AND PRICING OF INTERCONNECTION SERVICES IN A LIBERALIZED EUROPEAN TELECOMMUNICATIONS MARKET Günter Knieps ...... 51
COSTING AND PRICING OF INTERCONNECTION CHARGES IN THE U.S.: LESSONS FOR GERMANY? Ingo Vogelsang...... 74
INFRASTRUCTURE COMPETITION AND LOCAL-LOOP UNBUNDLING Martin Cave & Peter Crowther...... 102
UNIVERSAL SERVICE OBLIGATIONS: COMPARISON OF THE UNITED STATES WITH THE EUROPEAN UNION Dr. Barbara A. Cherry...... 113
iii RECENT DEVELOPMENTS IN THE REGULATION OF INTERNATIONAL TELECOMMUNICATIONS Dr. Andrea Huber...... 130
Conference Agenda...... 150
iv F O R E W O R D
As part of its focus on comparative public policy issues of importance to the United States and Germany, AICGS has been monitoring the development of telecommunications reform in Germany before and after the passing of new telecommunication legislation in the summer of 1996 and continuing through the establishment of the Regulatory Authority on Telecommunications, effective January of 1998. While the challenges Germany has faced in this fast-changing sector have been significant, the telecommunications maker in Germany has adapted quickly to globalized competition, assessing experiences of other countries, including the United States. In order to shed light on the lessons of telecommunications reform, AICGS organized a conference on November 20, 1997 in Bonn during which several presentations were made on the central issues revolving around telecommunication regulatory arrangements on both sides of the Atlantic. The conference was attended by telecommunications policy officials and industry executives as well as research experts from the United States and Europe. The result of this conference were incorporated into this publication. We are grateful to the eight authors who provided us with their assessments of the agenda in the ongoing developments in telecommunications reform. We also wish to express our deep appreciation to Prof. Juergen Mueller of the Berlin School of Economics (FHW) who provided both the intellectual leadership and the organizational assistance in making both the conference and the publication possible. This publication was supported by a grant from the German Program for Transatlantic Relations and the German Marshall Fund of the United States.
Jackson Janes Executive Director December 1998
v vi INTERCONNECTION AND UNBUNDLING POLICY IN NORTH AMERICA Richard Simnett
1. INTRODUCTION
This short paper is intended to highlight some of the key elements of regulatory policy in the U.S. and Canada in order to provide a perspective for European regulators and other interested parties. I have drawn upon several regulatory documents and rate filings to show that the context of rate setting in both the U.S. and Canada is quite different from that in Europe, and that, unless the differences are understood, apparently similar policies (from verbal descriptions) can turn out to have radically different consequences.
2. THE POLICY CONTEXT IN U.S. AND CANADA
The U.S. and Canadian telecommunications markets have been dominated by government-regulated private monopolies for nearly all of the twentieth century. Similar regulated rate structures evolved, with long distance charges substantially higher than costs providing the funds for carriers to sustain residential basic service rates at rates below their accounting costs, in many cases including unlimited free local calling. Business rates are higher, generally covering their accounting costs. Both the U.S. and Canadian authorities have introduced competition into the telephone industry, and have responded in different ways to the needs for reform. Both sets of regulators recognize the need to reform the distorted price structure so that efficient price signals are sent to entrants, and incumbents have a chance to compete. Residential rate rebalancing to bring rates more into line with economic costs (as required for equitable treatment of the regulated firm in a competitive market) has been very cautiously approached with extended (five years or more) transition periods for any substantial change in residential line rates. The policy context also differs from what Europeans might assume. The U.S. Telecommunications Act of 1996 imposes obligations on incumbent local exchange carriers (ILECs) specifically, and on Bell Operating Companies (BOCs) as a special class within the ILECs. ILECs must offer unbundled network elements, wholesale services for reseller competitors to use, and ordinary retail and long distance carrier access services. Currently there are several different costing and pricing standards in effect for these different services, creating potential arbitrage opportunities. The U.S. legislative focus on ILECs is different from one focusing on dominant firms with market power Telecommunications Reform in Germany and the ability to abuse it, and Federal Communications Commission (FCC) proceedings have not yet reached the issue of under what conditions ILECs might be deregulated. One state commission (Colorado) notified entrants that they too would become incumbents a number of years after they commenced service. Entrants are almost wholly unregulated. In Canada regulators have focused instead on the essential facilities doctrine, drawn from antitrust law, and have decided to impose only those requirements which they believe will encourage long term facilities-based competition and whose benefits will outweigh their costs. Some of these obligations are to be applied to entrants too, since they may attain local dominance or might be able to leverage dominance of one relationship into excess profits in another. In particular, a customer selecting carrier A as his provider of access lines and local calling gives Carrier A the opportunity to set high call termination charges for callers (and their carriers) trying to reach that customer. The Canadian Radio-Television and Telecommunications Commission (CRTC) has imposed interconnection obligations on entrants, and also retained its powers to regulate these rates, terms and conditions. Canadian entrants are also required not to discriminate among other carriers for interconnection and long distance services.
3. UNBUNDLED RATE STRUCTURES
In both the U.S. and Canada there is a substantial degree of geographical rate variation, with access line charges varying inversely to the density of the area in which the service is provided. It costs much more to serve areas with low numbers of access lines per square mile than dense urban and suburban areas or high density buildings (and this is so whether average historic or incremental forward-looking cost measures are used). Some of these cost differences have been passed on in retail rates, but social policies have kept residential rate differences within bounds, given universal telephone service goals. The cost differences have been more fully passed on in the rates for unbundled access lines in the U.S. The initial FCC order on unbundling contains a table of upper bound rates for loops in each state, but readers who assume that this actually indicates the rates which have gone into effect following state commission proceedings will have made a substantial mistake. This is shown in the table below. The table contains unbundled two wire access line rates of large local exchange carriers in the U.S., excluding BellSouth, SNET and Sprint, and as can be seen the rates can be as low as U.S.$3.72 per month in Illinois and as high as U.S.$135 per month in Hawaii. In general the rates based on state cost studies are higher than
2 Lessons and Priorities the FCC proxy cost model estimates. Most of these rates have been calculated based on incremental cost studies.
Table 1. Unbundled Access Line Rates in the USA, 1997
State FCC State Approved Rate upperbound (2wire loop) Alabama 17.25 28.15 GTE Arizona 12.85 21.76 Arkansas 21.18 19.25, 32.50, 73.05 Varies by density California 11.10 16.81 GTE Colorado 14.97 17.00-82.00, average 20.65 Varies by density Delaware 13.24 10.07, 13.13, 16.67 Varies by density, under appeal DC 10.81 10.81 Florida 13.68 20.00 GTE Hawaii 15.27 14.55 Oahu, 25.38 Maui, 28.78 Kauai 10.88 Hawaii, 43.84 Lanai 135.20 Molokai Illinois 13.12 3.72, 10.02, 11.53 Varies by density; Ameritech rates Indiana 13.29 12.19 Ameritech rates Iowa 15.94 28.12 GTE 12.72 USW Kansas 19.85 19.65, 26.55, 70.30 Varies by density Kentucky 16.70 19.65 GTE Maine 18.69 17.53 BA Maryland 13.36 11.87, 12.09, 16.13, 19.38 Varies by density Massachusetts 9.83 7.54, 14.11, Varies by density; TELRIC 16.12, 20.04 study filed 14 Feb 1997 Michigan 15.27 9.31, 11.84, 14.67 Varies by density Minnesota 14.81 28.60 GTE 12.03 USW Missouri 18.32 10.50/11.54, 16.92/ 19.78, Varies by density 27.63/ 32.07 and interconnector Montana 25.18 27.41 New Hampshire 16.00 12.67, 15.59, 23.00 Varies by density New Jersey 12.47 11.95, 16.02, 20.98, 16.21 average Varies by density New Mexico 18.66 19.49, 21.30, 26.74, 21.21 average Varies by density New York 11.75 12.49, 19.24 Varies by density, PUC order April 97 Ohio 15.73 15.73 GTE, 8.36 11.68, 13.73 Ameritech Varies by density Oklahoma 17.63 20.70, 27.75, 49.30 Varies by density Oregon 15.44 15.00 GTE 16.00 USW Pennsylvania 12.30 11.52, 12.71, 16.12, 23.11 Varies by density
3 Telecommunications Reform in Germany
Rhode Island 11.48 17.53 BA Texas 15.49 25.49/30.00 GTE Varies by line 15.00/ 17.00 SBC quality (signal loss) Utah 15.12 22.97 Vermont 20.13 17.53 BA Virginia 14.13 10.16 GTE, 9.52 13.31, 19.54 BA Varies by density Washington 13.37 13.62 GTE 11.33 USW W. Virginia 19.25 14.49, 22.04, 43.44, 24.58 average Varies by density Wisconsin 15.94 8.10, 12.80, 13.84 Varies by density; Ameritech rates
Additional charges are needed for interconnecting carriers to actually use these loops: there are non-recurring charges per order and per line, charges for central office space, line terminations, and links to these lines, among others.
Other U.S. Services for Carriers The U.S. has several different rate regimes which to European eyes may fall into the area of unbundling or network interconnection. Any retail service offered is subject to resale by other carriers, and in addition, wholesale service discounts for resellers apply to any LEC retail services. There has been much regulatory dispute about the proper level of these discounts, which are supposed to be calculated to reflect the avoided cost of retailing by the incumbent. Entrants, by and large, have found that the discounts are insufficient for them to make a profit in competition with the incumbents’ retail services, and not much resale has taken place. The wholesale rate structure is thus pegged to the retail rate structure, with all of its cross-subsidies and non-economic features intact. The third set of services for carriers is carrier access, offered for long distance carriers to complete their services by using local carrier networks. These rates were based on 25 percent of the total fully distributed historic cost of providing local exchange service before price caps were applied, and include the toll subsidy to local service (or the old implicit universal service fund and recovery of residential access deficits) by being set at rates well above incremental costs. The FCC has reduced the economic distortion this involves by two separate rebalancing proceedings over the years. The first was the creation of subscriber line charges (flat rate per month, paid by the retail customer) which were increased over a number of years and capped at $3.50 per month for residential customers to avoid “rate shock.” These are to be increased for lines beyond the first line per household, and other measures are also to be taken to rebalance access charges. Second, flat rate presubscribed line charges (to be paid by the long distance carriers) are also to be introduced over a number
4 Lessons and Priorities of years. Gradualism in adjusting rate structures is thus the order of the day. Most of the implicit subsidies are going to be made explicit by the new universal service fund and access charge regimes.
Canadian Services for Interconnection Deaveraging of unbundled access line rates is also found in Canada. The CRTC Decision 97-08 provides a table of unbundled loop rates in Appendix 1. The monthly and non-recurring charges are presented below, but there are additional charges for space, links and so on.
Table 2. Unbundled Loop Rates in Canada
Company Monthly Rate, Non-recurring Non-recurring $C Charge per order Charge per loop BCTel 17.40-32.35 166.00 82.50 Bell Canada 24.30-53.65 152.00 171.00 Island Tel 17.30-34.35 140.00 114.00 MTS 13.90-26.55 98.25 141.00 MT&T 20.40-38.20 145.00 118.00 NBTel 36.45-48.05 145.00 132.00 NewTel 34.70-48.85 153.00 76.50 TCI 16.00-23.55 27.75 79.25
Canadian unbundling policy contains a feature not found in the U.S. The CRTC has found that there is a presumption in favor of competitors building their own networks so that competition will reach all parts of the business. They also recognize that there are areas (particularly of low density) where there is little likelihood of competing infrastructures, and in these areas the incumbents’ network access lines may properly be treated as “essential facilities.” The test applied is whether other carriers could build their own facilities to compete. In higher density areas it is clear that rivals can build, and are, particularly to serve business customers and high density housing developments. Incumbents’ networks are thus not, strictly speaking, essential facilities. Nevertheless, the CRTC imposed a duty to offer these for sale as unbundled lines but for only a five-year transitional period to allow time for entrants to build their own networks without complete reliance on the incumbent. These are the cheaper rates from each company in the table above. The CRTC considered the introduction of wholesale services, but concluded that there would be little if any cost saving from selling to carriers rather than to retail customers and did not order that they be introduced. They
5 Telecommunications Reform in Germany did order that local services (including term and volume discounts) be subject to resale, with the restriction that cross-subsidized residential service may only be resold to residential customers. The CRTC also found that access by entrants to the incumbents’ operations systems (for service provisioning, network operations and so on) would not be in the public interest given that its costs would be high. Access to these systems is required in the U.S. by FCC order. Canadian toll services will continue to subsidize local services through an explicitly identified “contribution” charge. This is basically a flat-rate monthly charge per trunk connected to the local network, levied to support the local network and separate from incremental-cost-based charges for the use of the local network. Canadian regulators have also taken steps to rebalance rates, with an approved annual increase of C$2 per month per line for a number of years. This is similar to the U.S. FCC’s gradual introduction and increase of new residential flat rate charges, and quite different from the German regulator’s disallowance of continued long distance service support of low monthly line charges by interconnection rates.
4. RETAIL RATE STRUCTURES
Both the U.S. and Canadian retail rate structures contain a substantial degree of cross-subsidy, both from long distance services to local service, and from local business rates (which are generally at or above cost) to residential service which generally is priced below cost. Long distance rates are themselves geographically averaged within U.S. states and on all interstate services, but volume, term and contract discounts are generally available. The tables below are from the most recent FCC reference book on telephone service, issued in March 1997 and reporting the results of October 1995 surveys. Since that time no major changes in local rates have been made. Table 3 shows the company-wide averages for major companies, while tables 4 and 5 show basic residential and business flat rate service charges. Table 3 shows, by comparing the residential and business rates with each other and the average, the degree of cross-subsidy sent to residential service: the national average is more than $15 per month lower than business rates, and this is before usage charges are considered.
Table 3. Average Basic Rates by Company, October 1995
Ameritech Bell Bell-South NYNEX Pacific SBC U.S. West Inde- Total Atlantic Bell pendents Residential $16.29 $16.66 $17.44 $21.35 $14.37 $14.93 $17.51 $16.77 $16.93 Single-Line
6 Lessons and Priorities
Business $32.72 $31.60 $38.12 $37.20 $24.85 $27.57 $36.00 $31.79 $32.76 Multi-Line Business - Key $34.16 $30.52 $55.89 $37.28 $25.31 $33.70 $42.45 $36.94 $37.72 Multi-Line Business - PBX $35.35 $36.23 $62.89 $40.80 $25.31 $38.29 $45.81 $43.41 $41.89 Weighted Averages For access line $22.38 $22.36 $28.66 $28.35 $18.33 $21.15 $24.70 $22.09 $23.81 Additional for touch-tone $0.77 $1.40 $0.98 $0.88 $0.00 $0.33 $0.23 $0.62 $0.66
Tables 4 and 5 show the results by the 100 sampled cities reported by the FCC, and while none of these is a rural area they give some idea of the geographic variation in retail rates for access lines. This is also in marked contrast to the situation in Europe where national rates available to both business and residential customers are more common. Both of these implicit differences in background situation need to be borne in mind when assessing North American policy statements or literature for possible application to Europe. In particular, the idea that non-discrimination in rates requires the same rate for all customers cannot be supported from North American practice. A contrasting definition has gained some currency with regulators: that it is discriminatory to treat differently situated customers the same, as well as sending economically inefficient market signals to potential entrants. The issue of discrimination becomes one of showing cost differences or satisfying the Burden Test: that a lower rate for some set of customers produces more profit than higher rates, and thus enables lower rates than would otherwise be possible for the apparently discriminated-against class of customers.
Table 4. Residential Rates in the U.S., October 1995
State City Generally available Generally available unlimited calling rate, touchtone rate, with rotary dial inside wire maintenance
AL Huntsville $23.01 $24.51 AK Anchorage $14.47 $15.97 AZ Tucson $19.17 $20.42 AR West Memphis $28.42 $30.67 Pine Bluff $21.96 $24.21 CA Anaheim $15.49 $15.99 Bakersfield $15.49 $15.99 Fresno $15.49 $15.99 Long Beach $23.53 $24.48 Los Angeles $16.97 $17.47 Oakland $16.60 $17.10 Salinas $16.38 $16.88 San Bernadino $23.21 $24.16 San Diego $15.49 $15.99
7 Telecommunications Reform in Germany
San Francisco $15.49 $15.99 San Jose $16.23 $16.73 CO Boulder $21.61 $23.56 Col. Springs $19.78 $21.73 Denver $21.21 $23.16 CT Ansonia $18.70 $20.05 Norwalk $17.60 $18.95 DC Washington $19.50 $21.45 FL Miami $16.96 $19.46 Tampa $17.61 $18.61 W. Palm Beach $15.65 $18.15 GA Albany $19.15 $22.45 Atlanta $23.32 $26.62 HI Honolulu $19.58 $22.73 IL Chicago* $17.21 $19.71 Decatur $20.19 $22.69 Rock Island $20.76 $23.26 IN Indianapolis $19.77 $21.77 Terre Haute $22.13 $24.43 IA Fort Dodge $14.03 $15.28 KY Louisville $22.65 $25.65 LA Baton Rouge $20.99 $23.08 New Orleans $20.02 $22.11 ME Portland $17.99 $18.74 MD Baltimore $24.88 $25.73 MA Boston $22.01 $23.94 Hyannis $22.01 $23.94 Springfield $22.01 $23.94 MI Detroit $16.71 $21.39 Grand Rapids $15.40 $20.08 Saginaw $16.19 $20.87 MN Detroit Lakes $18.57 $21.72 Minneapolis $20.39 $23.54 MI Pascagoula $24.93 $28.23 MO Kansas City $18.12 $21.12 Mexico $16.91 $19.91 St. Louis $18.18 $21.18 MT Butte $18.22 $20.17 NE Grand Island $21.81 $23.76 NJ Phillipsburg $11.96 $14.20 NM Alamogordo $20.77 $22.72 NY Binghamton $26.22 $26.74 NY Buffalo $30.88 $31.40 Massena $23.60 $24.12 New York City* $25.28 $25.80 Ogdensburg $24.26 $24.78 Rochester $16.81 $18.80 NC Raleigh $17.21 $20.21 Rockingham $15.67 $18.67 OH Canton $19.18 $21.98 Cincinnati $20.28 $22.60 Cleveland $19.18 $21.98 Columbus $19.18 $21.98 Toledo $19.18 $21.98 OR Corvallis $18.84 $18.84
8 Lessons and Priorities
Portland $22.12 $22.12 PA Allentown $16.62 $18.81 Ellwood City $15.75 $17.94 Johnstown $20.05 $23.05 New Castle $14.00 $16.19 Philadelphia $18.87 $21.06 Pittsburgh $17.71 $19.90 Scranton $16.62 $18.81 RI Providence $23.47 $24.42 SC Beaufort $19.76 $21.01 TN Memphis $18.66 $21.41 Nashville $17.72 $20.47 TX Brownsville $15.05 $17.73 Corpus Christi $15.59 $18.27 Dallas $17.66 $20.34 Fort Worth $16.46 $19.14 Houston $18.15 $20.83 San Antonio $16.29 $18.97 UT Logan $15.96 $17.91 VA Richmond $23.96 $24.81 Smithfield $14.64 $18.14 WA Everett $18.91 $20.41 Seattle $16.45 $18.40 WV Huntington $27.15 $29.50 WI Milwaukee* $15.90 $18.40 Racine* $15.86 $18.36
* The measured service rate plus 100 five minute, same zone, business day calls is shown because unlimited local service is not offered. Source: FCC Reference Book, March 1997
Table 5: Business Rates in the U.S., October 1995
State City Single PBX Line Single Business PBX Line Business Line With wire With wire Line maintenance maintenance
AL Huntsville $56.01 $73.60 $57.51 $75.10 AK Anchorage $31.05 $41.13 $32.55 $42.63 AZ Tuscon $41.69 $59.98 $43.69 $61.98 AR West Memphis $53.42 $65.68 $56.17 $68.43 Pine Bluff $40.72 $51.01 $43.47 $53.76 CA Anaheim** $30.35 $32.04 $31.35 $33.04 Bakersfield** $30.98 $32.67 $31.98 $33.67 Fresno** $30.98 $32.67 $31.98 $33.67 Long Beach** $43.93 $52.24 $45.88 $54.19 Los Angeles** $33.25 $35.10 $34.25 $36.10 Oakland** $32.53 $34.33 $33.53 $35.33 Salinas** $32.87 $34.65 $33.87 $35.65 San Bernadino** $43.34 $51.54 $45.29 $53.49 San Diego** $30.35 $32.04 $31.35 $33.04 San Francisco** $32.53 $34.33 $33.53 $35.33 San Jose** $31.80 $33.57 $32.80 $34.57 9 Telecommunications Reform in Germany
CO Boulder $47.26 $58.73 $50.01 $61.48 Col. Springs $43.82 $54.56 $46.57 $57.31 Denver $46.79 $58.23 $49.54 $60.98 CT Ansonia $43.70 $49.53 $46.35 $52.18 Norwalk $40.86 $46.69 $43.51 $49.34 DC Washington** $33.61 $34.21 $36.61 $39.27 FL Miami $40.74 $81.59 $43.24 $84.09 Tampa $37.83 $65.38 $38.83 $66.38 W. Palm Beach $37.43 $75.16 $39.93 $77.66 GA Albany $39.67 $63.03 $41.67 $67.33 Atlanta $58.76 $93.28 $60.76 $97.60 HI Honolulu $44.40 $69.15 $46.15 $73.06 IL Chicago** $32.04 $32.75 $33.54 $34.25 Decatur** $35.98 $36.69 $38.48 $39.19 Rock Island** $36.55 $37.26 $39.05 $39.76 IN Indianapolis $55.92 $62.49 $57.42 $63.99 Terre Haute $44.16 $65.88 $45.66 $68.98 IA Fort Dodge $22.42 $37.29 $23.27 $38.14 KY Louisville $61.12 $93.47 $63.12 $98.56 LA Baton Rouge $47.68 $73.56 $49.68 $75.74 New Orleans $48.17 $73.83 $50.17 $76.01 ME Portland $38.63 $62.35 $40.58 $64.30 MD Baltimore** $43.50 $46.12 $44.50 $47.12 MA Boston** $42.81 $47.99 $44.76 $51.40 Hyannis $46.91 $72.87 $48.86 $76.28 Springfield** $38.92 $44.09 $40.87 $47.50 MI Detroit** $37.30 $40.66 $39.55 $45.41 Grand Rapids** $35.57 $38.79 $37.82 $43.54 Saginaw** $37.47 $40.69 $39.42 $45.14 MN Detroit Lakes $42.40 $51.63 $44.40 $55.83 Minneapolis $54.96 $64.91 $56.96 $69.11 MI Pascagoula $56.21 $82.55 $58.21 $87.55 MO Kansas City $45.48 $60.66 $48.73 $63.91 Mexico $35.55 $47.93 $38.80 $51.18 MO St. Louis $45.15 $60.22 $48.40 $63.47 MT Butte $43.82 $54.63 $46.57 $57.38 NE Grand Island $47.80 $68.17 $49.80 $70.17 NJ Phillipsburg** $27.60 $27.42 $28.55 $30.36 NM Alamogordo $56.15 $68.13 $58.90 $70.88 NY Binghamton** $49.99 $53.21 $55.70 $60.29 Buffalo** $50.87 $54.16 $56.58 $61.26 Massena** $49.70 $52.90 $55.41 $59.99 New York** $51.23 $54.54 $56.94 $61.65 Ogdensburg** $51.08 $54.37 $56.79 $61.46 Rochester** $48.44 $54.39 $50.94 $60.76 NC Raleigh $41.53 $72.75 $44.03 $76.75 Rockingham $36.09 $62.75 $38.59 $66.75 OH Canton** $44.25 $54.26 $46.25 $56.26 Cincinnati $52.99 $70.26 $55.49 $74.45 Cleveland** $43.22 $53.23 $45.22 $55.23 Columbus** $43.22 $53.23 $45.22 $55.23 Toledo** $44.25 $54.26 $46.25 $56.26 OR Corvallis $37.10 $45.33 $39.10 $47.33 Portland $42.84 $51.79 $44.84 $53.79 PA Allentown** $37.28 $38.77 $38.23 $41.52
10 Lessons and Priorities
Ellwood City** $36.54 $40.22 $38.04 $43.62 Johnstown** $37.28 $41.99 $38.78 $45.97 New Castle** $38.84 $40.22 $40.34 $43.62 Philadelphia** $30.64 $32.02 $32.14 $35.42 Pittsburgh** $31.67 $33.05 $33.17 $36.45 Scranton** $36.00 $37.49 $37.50 $40.79 RI Providence** $43.59 $45.17 $45.54 $47.12 SC Beaufort $38.04 $66.61 $39.29 $67.86 TN Memphis $54.84 $92.81 $56.09 $97.21 Nashville $52.30 $88.46 $53.55 $92.71 TX Brownsville $31.13 $47.76 $33.88 $51.81 Corpus Christi $31.74 $48.36 $34.49 $52.41 Dallas $38.35 $60.02 $41.10 $64.07 Fort Worth $34.39 $53.00 $37.14 $57.05 Houston $41.22 $65.41 $43.97 $69.46 San Antonio $34.03 $52.45 $36.78 $56.50 UT Logan $32.13 $58.35 $34.88 $61.10 VA Richmond $75.13 $119.35 $78.13 $124.26 Smithfield $29.97 $60.76 $31.72 $64.51 WA Everett $39.92 $59.48 $41.67 $61.23 Seattle $37.23 $55.38 $39.23 $57.38 WV Huntington $73.37 $114.59 $76.37 $120.34 WI Milwaukee** $37.50 $39.05 $39.25 $40.80 Racine** $39.14 $40.68 $40.64 $42.18
** The measured service rate plus 200 five minute, same zone, business day calls is shown because unlimited local service is not offered.
Source: FCC Reference Book, March 1997
11 Telecommunications Reform in Germany
INDEPENDENCE AND THE REGULATORY ARRANGEMENT ISSUES IN INSTITUTIONAL DESIGN Richard J. Schultz
All countries that seek to transform their telecommunications industry from the traditional monopolistic structure to one based on competitive markets must confront complex questions about the appropriate forms of alternative public control institutions to guide and supervise the restructuring. This is particularly true in the case of countries which have traditionally relied on public ownership of telecommunications enterprises to accomplish public policy objectives, but is no less the case for countries, such as Canada and the United States, whose tradition has been to permit private ownership of the telecommunications system subject to public regulation. In the latter case traditional regulation, which was premised on monopoly provision, has had to be revisited so as to ensure that the goals and instruments of the regulatory system are appropriate for contemporary needs. As a result in these countries there have been substantial revisions made in recent years to the basic regulatory statutes and set of institutions and instruments. The design of telecommunications regulatory institutions is a complex undertaking that must respect national administrative and legal cultures while simultaneously responding to domestic and increasingly international pressures as a result of the General Agreement on Trade in Services and the creation of the World Trade Organization. This paper will concentrate on only one set of issues associated with the nature of the regulatory system, although it is one that is paramount for all countries. In particular, the paper adopts as its organizing theme the comment from one of the participants, Robert Crandall of The Brookings Institution, at the Washington workshop on “Telecommunications Reform In Germany: Lessons from North America” that “there is no such thing as an independent regulatory agency.” While this is undoubtedly true in the sense that no regulatory agency is completely or totally independent of political control, it nevertheless ignores the importance that both traditionally and currently is placed on the concept and belief that regulatory agencies must have some degree of independence if they are to perform the functions assigned to them. As a generalization, however, Crandall’s statement raises some important issues that go the heart of the current attention being paid to the design of regulatory arrangements by individual countries. The issue of regulatory independence can be summed up in three interrelated questions: Independence for whom? Independence from whom? Independence for what purposes?
12 Lessons and Priorities
Inasmuch as both Canada and the United States have experience, as indicated, with independent regulatory agencies, this paper will review the debates and answers to these questions based on that experience.
1. INDEPENDENCE FOR WHOM?
This is the easiest of the three questions to answer. Members of the regulatory agency, or in the case of the recently-created British agencies such as the Office of Telecommunications (OFTEL), the Director-General, are appointed for fixed terms such as five or seven years and as such are given tenure during that period. The significance of this tenure is that they serve during “good behavior” and not at the pleasure of those who appointed them (Sommer 1987). Such tenure is presumed to give them independence to make regulatory determinations free of concern for their positions, although the specified nature of their tenure may, as some have suggested, make them somewhat more responsive, nearer the end of their term, to the interests of those who appointed them. In the case of the American independent agencies, such as the Federal Communications Commission, the independence of the regulators is supposedly reinforced by the bi-partisan composition of the Commission and the staggered terms of the Commissioners. As a sign of both the possible turbulence within regulatory arrangements that will be discussed below and the conditional nature of the independence of the regulators, the Canadian Government limited its most recent appointments to the Canadian Radio- Television and Telecommunications Commission (CRTC) to three year terms instead of the statutory and traditional term of five years. Presumably the objective of such shortened terms was to remind such appointees that they were not to be too independent but were to be held to a short leash.
2. INDEPENDENCE FROM WHOM?
This question is also relatively easy to answer. Regulators were given independence through security of tenure for a set period in order to provide them with a degree of protection from political interference, legislative or executive (Cushman 1941; Willis 1941). Here it is important to recall the circumstances under which the first independent regulatory agencies were created in North America, whether it be the Interstate Commerce Commission, which was the first American national independent agency created in 1887, or the Board of Railway Commissioners in Canada, which was created in 1903 and assumed responsibility for telephone regulation in 1906. In both countries, regulation was a relatively novel function of government and the concern,
13 Telecommunications Reform in Germany backed in the United States by the “no takings” constitutional protection in the Fifth Amendment, was that private investors should be protected from arbitrary or political interference. If governments were to assume the power to control some aspects of corporate behavior, they should be insulated against political opportunism. In contemporary language, corporate interests were insistent on the need for regulatory commitment and a relatively accurate understanding of the future policy environment (Levy & Spiller 1996). It should also be recalled that independent, specialized agencies were created in part because of the presumed inadequacies of existing public institutions such as the courts and executive or public service institutions for the performance of the new regulatory functions of government. In the United States, the concern for regulatory independence was reinforced by the fear that the president should not be able to control the new agencies; hence the requirements that appointments had to be bipartisan in nature. This meant that the president could only nominate a bare majority of the commissioners on any designated independent regulatory agency from his party while the remainder came from the other party. Furthermore appointments were subject to Senate confirmation. These provisions were not meant to produce “partisan” regulators but merely to prevent either executive or legislative control. In Canada the concern that regulators should be insulated and protected from political interference in the course of their decisionmaking led the government approximately twenty years ago to issue instructions prohibiting political authorities, specifically cabinet ministers, from contacting regulators during the exercise of their regulatory responsibilities for individual cases (Kane 1980). The prime minister of the day likened regulatory independence to judicial independence and made the penalty for breaching this convention similar to that for approaching a judge during the exercise of a judicial function, namely resignation from the Cabinet. The situation in the United States is less clear-cut inasmuch as both members of the executive and particularly Congress have over the years insisted on their right to discuss even current cases before regulatory agencies with regulators (Krislov & Musolf 1964). Given Robert Crandall’s comment cited above that “there is no such thing as an independent regulatory agency,” it is worth noting the qualifications on regulatory independence that do exist. In both Canada and the United States, the budgets of the regulatory agencies are subject to political scrutiny and control in ways that those of traditional judiciary are not. In the former this has been an important tool to control some aspects of regulatory behavior while in the United States the appropriations process is an ongoing and direct instrument for political control of the agencies, especially at the macro level of the agency but
14 Lessons and Priorities also with respect to individual policy initiatives and on occasion even specific decisions (United States Senate Committee on Government Operations 1977; Davidson & Vietor 1985). Certainly budget approval is a way in both countries to “send messages” to the regulatory agencies. In the United States, the congressional oversight function is also an important check on the independence of the agencies. More importantly over the past two decades there have been repeated attempts to subject regulatory agency rule-making to both legislative vetos or executive direction (Cutler & Johnson 1975; Kaiser 1980; Saks 1984). Another check on the independence of American regulatory agencies is the fact that the chair of each agency serves in his or her capacity as chair but not, it is important to note, as member of the agency at the pleasure of the president. Selection of the chair, or alternatively removal, is deemed to be an important instrument for sending policy signals to agencies. In Canada, one of the most important limitations on regulatory independence is the provision for appeals to the Cabinet against regulatory decisions; in addition, in some cases the Cabinet may on its own initiative review such decisions (Schultz 1977). There is no standardized system inasmuch as in some cases the Cabinet is limited to sending decisions back for regulatory review or setting them aside while in others, notably in the telecommunications sector, the Cabinet can change or vary the decision in question. We shall return to this political override power below because for some it constitutes a denial of the independence of the regulatory agency while more importantly for others the process of political appeals which are highly confidential in nature would appear to violate the transparency requirements of the telecommunications annex of the General Agreement on Trade in Services. Although there is no political appeal mechanism per se available to either the Executive or Congress in the United States, Congress does have the power through legislative action to override individual regulatory decisions. Over the past two decades such a power has been used. Perhaps more significantly the invocation of the threat to do so, as for example in the case of the FCC’s initial attempt to introduce a subscriber line charge in the early 1980s, can be an effective instrument to communicate congressional wishes to independent agencies. As the preceding suggests it is important to emphasize that regulatory agencies in Canada and the United States do not have complete or absolute independence from political authorities. In other words, to expand on Crandall’s comment, “there is no such thing as an absolutely independent regulatory agency.” That said, the relative independence of such agencies should be recognized both conceptually and empirically. Regulators in the
15 Telecommunications Reform in Germany exercise of their regulatory decisionmaking, or more precisely for the exercise of that power, have judicial-like security and cannot be removed from their offices. Such security of tenure is what distinguishes so-called regulatory agencies from other executive bodies in both countries whose members serve at pleasure and thus can be removed for whatever reason or impulse that those who made the appointments in the first instance choose to invoke to justify such actions. It is worth noting that in both countries prior to recent decades telecommunications regulatory authorities were, and were seen to be, independent. In the case of Canada, for example, notwithstanding the broad- based nature of the power of Cabinet to overturn individual regulatory decisions, no such action was taken between 1906 and 1973. Political authorities in both countries appeared to value the importance of the “arm’s- length” relationship that existed between them and their regulatory agencies. It is only in the last two or three decades in both Canada and the United States that debates have emerged over the proper scope of regulatory independence and to understand why we must turn to our third question.
3. INDEPENDENCE FOR WHAT PURPOSES?
No one would challenge the argument that there is today a continuing debate over the merits and appropriate extent of regulatory independence. On the one hand, there are those who argue that regulators must be given the maximum amount of independence possible in order to give service providers and investors, whether domestic or foreign, assurance that they will not be subject to arbitrary and/or unpredictable political interference. Advocates of this position seek, if anything, to enhance regulatory independence. On the other hand there are those within individual countries who maintain that telecommunications regulation is far too important, given the ongoing telecommunications and information revolution, to be left to the control of arm’s length, independent regulatory authorities. Their prescription is to subject regulatory authorities to more and more political constraints and controls. At its heart this is a debate, however, not about independence per se but of the fundamental purposes of regulatory agencies. This is a debate that rages in both Canada and the United States where there has been a traditional reliance on independent agencies as well as in those countries which are creating such agencies to cope with the imperatives of sectoral restructuring and international trade constraints. To appreciate the controversies that have ensued it is important to understand the traditional purposes of independent regulatory agencies in
16 Lessons and Priorities comparison with contemporary rationales for such agencies. Traditionally in Canada and the United States, telecommunications regulation, like its counterparts in other sectors, was narrowly construed (McManus 1973; Armstrong & Nelles 1986). The emphasis in institutional design debates was on impartiality, non-partisanship and the maximum avoidance of politics possible to minimize corruption, abuse and favoritism. Regulators had a reactive, proscriptive function. They were to be society’s economic policemen to correct unacceptable behavior by regulated firms. They were not to be sectoral managers. Rather they were largely irrelevant, and to a large extent uncontroversial, because the private firms were the primary decisionmakers both for the design of the system, its development or extension and for such things as the pricing and costing of services. Regulators were largely adjudicators of disputes enjoined to balance the interests and demands of telecommunications firms on the one hand and their subscribers on the other. Starting in the 1930s, particularly with the American New Deal, a new conception of the role of regulatory agencies was adopted in some sectors, of which transportation is perhaps the most striking example. The state’s role, and that of its primary institutional agent, the independent regulatory agency, as economic policeman was no longer perceived in some circles to be sufficient. The reactive, case-specific, corrective focus was found to be wanting in the face of economic turbulence, or partisan claims of such turbulence. The result was a debate about the appropriate role of regulation and regulatory agencies. The debate about independent agencies as the “headless fourth branch of government” has its roots in this period in the United States. In Canada there was far less controversy in part because there traditionally had been an acceptance of a more activist economic role for the state. This was manifested both in the employment of public enterprises in major sectors as well as a more prominent role for regulatory agencies. In any event the function of regulation in both countries was to be one that stressed not reaction and correction for unacceptable economic behavior by monopolies but anticipation and direction by state actors at the sectoral level (Jaffe 1956). Regulation in particular was to be less concerned with “policing” individual firms rather than promoting and indeed planning the activities of both firms and sectors (Landis 1938; Schultz & Alexandroff 1985; Eisner 1993). As importantly in the aspirations of American proponents and in the actual design of Canadian decisionmakers, the independent, specialized, impartial regulatory agency was to be the central state actor to fulfill the promotional and planning roles of regulation. It is important to note that in both countries the debate just summarily described did not extend to the telecommunications sector, for reasons that we
17 Telecommunications Reform in Germany need not address here. In both countries well into the 1960s, although there were periodic disputes about the performance of the telecommunications regulator, more so in the United States than in Canada, overall the agencies did not become embroiled in the extensive conflicts typical, for example, of the transportation sector. In large part, in the United States this was because the courts, through the anti-trust system, played a major preemptive role. In Canada, telecommunica- tions was unique among industrial sectors in not being given a governmental embrace, at least not by the federal government, until the late 1960s largely because of the divided jurisdiction for the sector combined with the success of the private sector in meeting Canada’s telecommunications service needs without overt, extensive political direction. There is no need here to recount the turbulence that has embroiled the telecommunications sector throughout the world. For our purposes the significance rests in the implications for regulation and regulatory agencies. As a result of the turbulence of restructuring, regulatory agencies in the telecommunications sector throughout the world today are expected to be “agents of change.” Regulators have been, as indicated with few national exceptions, assigned the role to help make (in some cases to be the primary actor) the transition from monopoly to competition. At the same time, it is important to emphasize, regulators are expected to protect and promote the traditional social interests such as consumer protection and universal service. This new positive role for regulatory agencies carries with it considerable tension and conflicts. Those who are forced to change may not appreciate either the speed or direction of change. Others seek to benefit from the changes or to channel them in favorable directions. A central controversy characteristic of almost all countries is to what extent regulators as appointed public officials, with specified degree of tenure, should be the primary agents of such change; hence the ongoing debates over regulatory independence. It is important to note that this is an unresolved set of conflicts and that no country has really gotten it right—at least not to the complete satisfaction of the central participants. Recent experience in Canada and the United States can be cited usefully to illustrate the tensions and the ongoing search for new solutions to demarcate the appropriate limits of regulatory independence and the concomitant legitimate political controls. In Canada, which has seen fundamental conflicts between the regulatory agency and political authorities over the past decade or so, new legislation has been enacted (Schultz forthcoming). This legislation, however, takes a rather indirect route to establishing the primacy of political authorities in goal-setting and limiting regulators to a goal implementation role. The problem springs from the fact that rather than making the hard choices in the legislative process between conflicting and ambiguous policy goals, Canada
18 Lessons and Priorities opted for a rather open-ended, multiple statement of legislative objectives that offers the regulator little in the way of concrete policy guidance. The result in the first instance is that the regulator becomes responsible for making what are essentially and unavoidably political compromises and tradeoffs; hence the redress to indirect political controls such as policy directives and political appeals against regulatory decisions, especially after the fact. As indicated, these appeals, although now subject to some procedural constraints such as due notice to all parties, are still subject to a non-transparent political process at the highest political level. As such it is arguable that the appeal mechanism is in contravention of the GATS transparency requirement. In addition, the recent short term appointments of a number of regulators suggests that Canada’s political authorities have decided that one solution to the question of regulatory independence is a temporal short leash for the regulators. The always impending need for reappointment may concentrate the mind of the regulators as to who their masters are. In the United States, reflecting their different political traditional and institutional system, Congress and the Administration have taken a different route in the 1996 Telecommunications Act. This legislation reflects the lack of trust that has ensued over the years between both members of Congress and the Executive Branch as well as between the FCC and Congress, and the fear on the part of various parties that an independent regulator may not respect the various commitments and agreements made by the members of the legislative branch. These have resulted in one of the most detailed pieces of legislation in recent years. The FCC is subject to detailed legislative instructions not only on the outcomes to be pursued but the actual regulatory process to be employed, including rigidly specified deadlines. Congress, to ensure regulatory commitment and respect, has legislated for itself a role in continuing surveillance and participation in implementation. The irony, of course, is that some of the parties have employed the judicial process to derail some of the hard-fought compromises that Congress and the FCC had sought to implement (Bartlett 1997). To return once again to Robert Crandall’s comment, it is true that there is no such thing as, and one could add, should not be, a totally independent regulatory agency. Political authorities must make the difficult political choices in order to direct effectively the regulators in their concrete decisionmaking. They cannot simply pass laws that in effect say “here is a problem, or complex set of problems, you deal with it.” To do so is an abdication of responsibility and when it happens, as it does all too frequently, one should not be surprised that a political maelstrom ensues with the regulatory agency at the eye of the storm. Of course, not all policy requirements can be anticipated and not all ambiguities
19 Telecommunications Reform in Germany and inconsistencies avoided. Consequently, secondary instruments, subject to effective public scrutiny through legislative and disclosure requirements such as policy directives (or ordinances as they are called in the German telecommunications legislation) are an appropriate political control mechanism. With these two prior constraints on regulatory behavior, regulatory independence for individual decisions, free from direct political control or interference, is both appropriate and indeed necessary for contemporary telecommunications restructuring. Finding that balance between political control over major policy determinations and regulatory independence for individual decisions and applications is perhaps one of the most difficult challenges confronting all countries today.
REFERENCES
Armstrong, C. & Nelles, H. Monopoly’s Moment: The Organization and Regulation of Canadian Utilities 1830-1930 (Philadelphia, Temple University Press), 1986.
Bartlett, H. H. The Public Interest and the Introduction of Competition into Local Telephone Networks, Commlaw Conspectus (Summer), 1997.
Cushman, R. E. The Independent Regulatory Commissions (New York, Oxford University Press), 1941.
Cutler, L. & Johnson, D. R. Regulation and the Political Process, Yale Law Journal, 1941, 84.
Davidson, D. & Vietor, R. Economics and Politics of Deregulation: The Issue of Telephone Access Charges, Journal of Policy Analysis and Management, 5 (Fall), 1985.
Eisner, M. A. Regulatory Politics in Transition (Baltimore, The Johns Hopkins University Press), 1993.
Jaffe, L. L. The Independent Agency: A New Scapegoat, Yale Law Journal, 65 (June), 1956.
Kaiser, F. M. Congressional Action to Overturn Agency Rules: Alternatives to the Legislative Veto, Administrative Law Review, 32 (4), 1980.
Kane, T. G. Consumers and the Regulators (Montreal, Institute for Research on Public Policy), 1980.
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Krislov, S. & Musolf, L. D. (eds.) The Politics of Regulation (Boston, Houghton Mifflin Co.), 1964.
Landis, J. The Administrative Process (New Haven, Yale University Press), 1938.
Levy, B. & Spiller, P. T. (eds.) Regulations, Institutions and Commitment (New York, Cambridge University Press), 1996.
McManus, J. C. Federal Regulation of Telecommunications in Canada, in: H. E. English (Ed) Telecommunications for Canada (Toronto, Methuen), 1973.
Saks, M. Holding the Independent Agencies Accountable: Legislative Veto of Agency Rules, Administrative Law Review, 36 (1), 1984.
Schultz, R. J. Regulatory Agencies in the Canadian Political System, in: K. Kernaghan (Ed) Public Administration in Canada 3rd Ed. (Toronto, Methuen), 1977.
Schultz, R. J. Still Standing: The CRTC 1976-1996, in: G. Doern, et al. (Eds.) Canadian Regulatory Institutions: Globalization, Choices and Change (Toronto, University of Toronto Press), (forthcoming) .
Schultz, R. J. & Alexandroff, A. Economic Regulation and the Federal System (Toronto, University of Toronto Press), 1985.
Sommer, S. Independent Agencies as Article One Tribunals: Foundations of a Theory of Independence, Administrative Law Review, 39 (1), 1987.
United States Senate Committee on Government Operations, Congressional Oversight of Regulatory Agencies Vol II, Ist Session 95th Congress (Washington, U.S. Printing Office), 1977.
Willis, J. (ed.) Canadian Boards at Work (Toronto, Macmillan), 1941.
21 Telecommunications Reform in Germany
LONG RUN INCREMENTAL COSTS AND THE REGULATION OF INTERCONNECTION CHARGES IN THE UK1 Geoffrey Myers
SUMMARY
Since October 1, 1997 the regulation of British Telecommunications’ (BT) interconnection charges has moved into a new phase. The network charge controls involve several key changes in the regulatory regime: the move away from detailed and intrusive regulation (e.g., annual determinations) to allow BT to set its own interconnection charges within appropriate limits; relating the type of charge control to the competitiveness of the service; the move to RPI- X for non-competitive services to sharpen incentives for BT to reduce its network costs. Another key difference in the network charge controls is the change in the cost base from historic cost accounting fully allocated costs (HCA FAC) to forward looking long run incremental costs (LRIC) plus equal proportionate mark-ups. Estimates of incremental costs have been derived from a process involving three essential elements:
(a) top-down model (developed by BT); (b) bottom-up model (developed by an industry working group); (c) reconciliation of top-down and bottom-up outputs and the production of hybrid results - the best available measure of BT’s relevant incurred incremental and common costs.
The top-down and bottom-up models have different strengths and weaknesses. The top-down model has significant articulation especially of operating and indirect costs, but includes any inefficiencies that are present in BT’s operations and suffers from a lack of transparency, because it contains commercially sensitive data and cost functions. The bottom-up model has clarity of the key cost drivers especially for capital costs, but has no “audit trail” and could omit relevant costs. The reconciliation enables interconnecting operators to have confidence that costs have not been artificially inflated and gives BT the comfort that the cost base can be reconciled back to its accounts. The charges based on incremental costs now in place in the UK can be compared to other measures of costs, such as fully allocated costs, and also to charges in other countries. BT’s interconnection charges are comfortably the lowest in Europe and are comparable to the charges for network components of
22 Lessons and Priorities the lowest charging Local Exchange Carriers in the U.S. (and substantially lower, once access charges are included in U.S. interconnection charges).
1. INTRODUCTION
The regulation of interconnection charges in the UK has recently moved into its third distinct phase since the privatization of British Telecommunica- tions in 1984 with the introduction of the “network charge controls” on October 1, 1997. An essential element of the network charge controls is the introduction of long run incremental cost (LRIC) as the cost base for interconnection charges. This paper addresses the following topics:
- the background to the regulation of interconnection charges in the UK;
- the changes in the regime that have resulted from the introduction of network charge controls;
- the derivation of estimates of long run incremental cost, using top-down and bottom-up models; and
- comparisons of the resulting costs and interconnection charges with those derived from other cost bases and with costs and charges in the rest of Europe and the U.S.
The paper discusses the arrangements for regulation of BT’s interconnection charges, but does not address local loop unbundling (also known as Direct Access to the Local Loop, DACL), since BT is not required to supply DACL in the UK.
2. REGULATION OF INTERCONNECTION CHARGES
There have been three distinct phases of the U.K. Office of Telecommunications’ (OFTEL) regulation of BT’s interconnection charges:
(1) up to 1994, regulatory intervention only in the event of a failure to reach agreement in commercial negotiations;
(2) introduction in 1995 of Standard Charges—automatic annual determinations by OFTEL of the vast majority of BT’s interconnection charges; and
23 Telecommunications Reform in Germany
(3) from October 1, 1997 the introduction of network charge controls.
Phase 1: Determination in Case of Failure to Agree In the initial years following privatization the only fixed wire competitor to BT was Mercury. OFTEL was only required to make determinations relating to interconnection if called upon by one of the parties, in the case of a failure to reach an agreement. In practice, BT and Mercury never reached agreement on interconnection charges and OFTEL was called upon to make determinations in 1985 and 1993 (indexation of the 1985 prices was used to set charges in the intervening years). The cost base used for such determinations was fully allocated costs (FAC) using the historic cost accounting (HCA) convention. In contrast to charges, in general, agreement was reached between the interconnecting operators on a range of other matters, such as points of interconnection, technical interfaces etc.
Phase 2: Standard Charges Following the duopoly review (see DTI (1991)), the UK government decided to operate a far more liberalized licensing regime and a large number of new entrants came into the industry operating in a wide range of markets. The operators fall into a number of broad categories:
Operators with both local and long-distance networks, such as CWC and NTL.
Cable operators, providing both telecoms and cable television networks in more than one hundred franchise areas in the UK. As at July 1997 cable operators had passed approximately 9.4 million premises (about 40%) and provided almost 2.5 million residential lines (11%) and 0.3 million business lines (4%). By the year 2000 it is expected that about 70% of UK households will be able to take service from a cable operator.
Radio fixed access providers, offering direct access to customers. Ionica launched service late in 1996. By 2001 it is expected to have coverage of 75% of the UK population. Other operators with licences for fixed radio access include Atlantic Telecom and, in rural areas, BT and RadioTel.
Other local access providers in particular regions, such as Scottish Telecom and Torch.
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High bandwidth networks aimed at large business customers, such as COLT and MFS in the City of London.
Operators with long distance networks, such as Energis and Racal.
Providers of international services, both international facilities licensees (almost 50 licences issued since liberalization in 1996) and international simple resellers.
With the proliferation of operators requiring interconnection with BT, it was felt that a more regular determination of BT’s interconnection charges was required to avoid repeated and uncoordinated requests for determinations from Other Licensed Operators (OLOs). This precipitated the introduction of the Standard Services regime, under which BT was required to offer to OLOs a range of services at charges determined annually by OFTEL. The list of Standard Services covered a wide variety of interconnection services, such as inland conveyance and transit, international conveyance, interconnection circuits, directory assistance, operator assistance, emergency operator, and data management amendments. Interconnecting operators paid only for the elements of the network that they used and charges did not vary with end-use. Determinations occurred automatically without the trigger of a request from an OLO or BT. First, OFTEL made a determination of Interim Charges, based on a forecast of the HCA fully allocated costs of services for the coming financial year. During the year interconnect payments were based on these interim charges. The charges were adjusted retrospectively (including interest payments) following the Final Charges determination, which was based on the out-turn HCA fully allocated costs after the financial year end. The other key element of the ICAS regime was the introduction of Accounting Separation (AS), the production by BT of audited regulatory accounts for separated businesses (Access, Network,2 Retail Systems Business, Supplemental Services, Apparatus Supply, and Residual) in accordance with a published documentation of allocation principles and methodology—see BT (1997c,d). The AS accounts have provided a more soundly based and rigorous division of costs between retail and network; they facilitate the identification of cross-subsidies between BT businesses; and they provide confirmation of non- discrimination in interconnection charges, i.e., that BT Retail pays transfer charges to BT Network on the same basis as interconnecting operators.
25 Telecommunications Reform in Germany
Traffic Sensitive Costs Following the Duopoly Review, Access Deficit Contributions (ADCs) were introduced into interconnection charges to “compensate” BT for its access deficit, arising from the explicit regulatory constraints on rebalancing (a sub- cap of RPI+2% on the exchange line rental within the overall retail basket). ADCs can also be seen as derived in a broad sense from the principles of the Efficient Component Pricing Rule (ECPR)3, though with some significant differences (see Armstrong and Doyle (1994)). For example, the size of the ADC increased with BT’s profitability of the end-use call for which the interconnection service was used. But ADCs were associated with a complex series of arrangements including ADC waivers (related to market share thresholds) and ‘reverse ADCs’ (for competing local access providers). In February 1996 the sub-cap on the exchange line rental was removed leading to the abolition of the system of ADCs. BT, therefore, has freedom to rebalance between line rental and call charges as it sees fit, subject to the overall price cap. With the abolition of ADCs, interconnection charges relate only to traffic sensitive costs of the network—all non-traffic sensitive costs, including the local loop and the line card in the local exchange, are recoverable by BT from retail prices.
3. NETWORK CHARGE CONTROLS
Some aspects of the Standard Charges regime remain important underpinnings of the network charge controls, such as the list of Standard Services, non-discrimination between operators (though differential charging by end-use is possible), and separated accounts. But there have been a number of important changes to the regulation of BT’s interconnection charges:
- deregulation: degree of regulation appropriate for each of BT’s interconnection services depends upon the competitiveness of the market in which it competes;
- incentive regulation with the move from determinations (rate of return regulation) to charge caps for those services that require continuing regulation of charges;
- change in the cost base from fully allocated costs (FAC), using historic cost accounting (HCA), to forward looking long run incremental costs (LRIC);
26 Lessons and Priorities
- BT given flexibility to set charges, but with a responsibility to demonstrate that charges are reasonably derived from costs (e.g., between incremental cost floors and stand-alone cost ceilings); and
- charges known contemporaneously with the removal of retrospective determinations.
Structure of the Controls BT faces competition from OLOs in a number of interconnection markets. Such competition will increase over the coming years with the entry of new operators and the further establishment of existing players. OFTEL carried out an assessment of the competitiveness of the markets in which BT’s services compete. It defined three categories—competitive, prospectively competitive (i.e., expected to become competitive during the control period, 1997-2001), and non-competitive—with a different regulatory treatment for each category, as shown in Table 1.
Table 1: Categories of Interconnection Services
Classification Charge control treatment
Competitive No charge controls
Prospectively competitive RPI+0% individual (“safeguard”) caps (Cap on each individual charge)
Non-competitive RPI-8% basket control (3 separate baskets: Call termination basket; General network basket; and Interconnect specific basket)
Very few services were considered competitive by the start of the controls—only operator assistance services provided by BT to other operators on an agency basis and new services, which will be initially treated as competitive. Inter-tandem or long distance conveyance was classified as prospectively competitive because of the competition that BT will increasingly face from other operators acting as “carrier’s carriers,” such as Mercury, Energis and Racal (though these operators also have retail customers). International Direct Dial (IDD) conveyance was also prospectively competitive, given the liberalization of international facilities by the UK Government. To include the charges for these services in the baskets would be undesirable, because BT would tend to focus price cuts on these services, where it faces increasing competition, rather than on the non-competitive services.
27 Telecommunications Reform in Germany
The use of safeguard caps allows these services to be excluded from basket control, but with a fallback control on prices to protect customers. However, the expectation is that competition will force BT to set prices below the limit set by the safeguard cap, i.e., that the safeguard caps will become non-binding constraints. If, during the control period, the market for a service is found to be competitive, the safeguard cap will be removed. The non-competitive services are those associated with the local exchange: conveyance from (to) the local exchange to (from) the customer, i.e., call termination (origination), and conveyance from (to) a tandem switch to (from) the local exchange. The diagram at Annex C illustrates the network components used in BT’s main inland conveyance interconnection services and the type of charge control they face. A full list of interconnection services and their regulatory treatment under the network charge controls is set out in OFTEL (1997c).
Call Termination One of the new aspects in the classification of services is the distinction between call termination and call origination. Both are considered non- competitive, but call termination gives rise to particular regulatory concern because it may be a long-term bottle-neck and so has been placed in its own separate basket. The distinction between termination and origination arises from the externality associated with the former, which arises because it is the caller (and her operator) that pays the call termination charge, whereas the choice of network and influence over the call termination charge is exercised by the call recipient. Operators face weak incentives to minimize call termination costs, because they are not borne by their own customers. They also have incentives to inflate termination charges, because this may serve to raise rivals’ costs when competing in retail markets. Call termination is defined from the lowest switch in the hierarchy at which interconnection can occur to the customer, i.e., from the local exchange (the interconnection service, local exchange segment). The term “call termination” is therefore restricted to the bottle-neck—there may be competition between operators for delivery to the local exchange, but competition in call termination cannot be expected (unless the customer takes access lines from more than one operator). A related issue is the appropriate level of the charge to be paid by BT to OLOs for call termination on OLO networks. OFTEL’s close interest in charges for call termination on OLO networks arises for two reasons:
- to protect against abuse of market power and exploitation of customers; and
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- to ensure no distortion of competition between operators. A full analysis of the difficult issue of call termination payments between operators competing in retail markets is beyond the scope of this paper—for OFTEL’s views, see Annex C of OFTEL (1997c). The agreement reached between BT and OLOs specifies (in accordance with OFTEL’s analysis) that the charges levied by OLOs will be based on BT’s charges for delivering calls: local exchange segment and single tandem. Therefore, the starting charges and the floors and ceilings for BT’s services, derived from the calculation of incremental costs, will influence not only the charges paid by OLOs to BT, but also the reciprocal charges paid by BT to OLOs.
Role of Long Run Incremental Costs The objective of moving to LRIC is to provide improved signals for entry, exit and investment. The “forward looking” element of LRIC is the use of Current Cost Accounting (CCA) for asset valuation, i.e., using the replacement costs of assets rather than their historic cost at time of purchase. In particular, replacement should generally be assumed to be by the Modern Equivalent Asset (MEA), the lowest cost, proven technology that performs the same function as the asset under consideration (e.g., all switches valued as if digital, even if some analogue switches remain in place4). The methodology developed in the UK to calculate LRIC for BT and the resulting cost estimates are discussed below. In the context of the network charge controls there are two distinct uses of the LRIC information. The first use is to set the starting charges (or initial levels) of the network baskets. Second, since over time BT will be able to vary the charges of individual services, the initial assessment of the legitimacy of the cost orientation of the charge set by BT will be whether it lies between the floor based on LRIC and the ceiling based on stand-alone cost (SAC).
Level of Charges: Mark-ups OFTEL has set the starting charges for all of the services in the call termination and general network baskets at long run incremental cost plus equal mark-up. These charges will apply from October 1, 1997 until BT announces changes in network charges, giving 90 days’ notice. In using LRIC as the cost basis to set the level of charges, OFTEL considers that it is necessary to add a mark-up. The common costs between the access network and the conveyance network are a relevant element of BT’s total costs and it should be given the opportunity to recover those costs. The key question is how the burden of recovery of the common costs should fall upon access and conveyance.
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In extensive consultation OFTEL gave consideration to a number of different possible mark-up regimes, such as the Efficient Component Pricing Rule and Ramsey mark-ups, but concluded that whilst each of these regimes has some theoretical attractions they would be problematic to implement and could have undesirable implications.5 The highly pragmatic approach of equal proportionate mark-ups was chosen, in which the common costs are apportioned for recovery from access (through the line rental and other retail prices) and conveyance (through interconnection charges, including BT Retail’s transfer charges) in proportion to the incremental cost of access and conveyance. This simple rule can be illustrated using incremental cost figures for interim 1996/97 (i.e., the first six months of the financial year, April- September 1996), shown in Table 2.
Table 2 Equal Proportionate Mark-ups: Figures for Interim 1996/97
£ million Incremental Cost Common Cost Cost including (multiplied by two to before mark-up apportioned mark-up give full year estimates) Inland Conveyance 996 104 1,100 Inland Private Circuit (conveyance related costs) 318 32 350 Access 3,220 334 3,554 Common Costs between Conveyance and Access 470 Total 5,004 470 5,004
Note: The equal proportionate mark-up rate is 10.3%.
LRIC plus the equal mark-up for inland conveyance is the cost base for the level of the baskets but, in principle, BT has freedom to set the structure of prices within the basket subject to meeting the RPI-8% constraint and controls on anti-competitive behavior.
Structure of Charges: Floors and Ceilings The key cost concepts in the network charge control regime will be incremental cost and stand-alone cost. In the first instance, whether or not a charge is excessively low and potentially anti-competitive, or excessively high and exploiting customers will be judged relative to floors and ceilings. There is an argument that anti-competitive behavior can be expected where the firm sets prices generating revenues that are insufficient to cover incremental costs. Only if revenues exceed the incremental cost of the service is the firm’s profitability
30 Lessons and Priorities improved by providing the service. The stand-alone cost (of an efficient operator) can be argued to set the upper bound on the charge for a service, because a price above this level can only be maintained by the incumbent if the market is uncompetitive—otherwise the price could be undercut even by a single product firm, i.e., one that benefits from no economies of scope. OFTEL does not propose to implement floors and ceilings mechanically— the key is the effect of the charge in the relevant market. Floors and ceilings provide a useful general guideline when examining whether a charge can be expected to have anti-competitive effects or exploit customers, but there will be exceptions. These may be related to the particular features of the case under investigation, but may also reflect different approaches to the analysis of anti- competitive behavior, such as the relevance of net revenue tests to the identification of predatory behavior—see, for example, Myers (1994). The particular construction of floors and ceilings and the relevance of combinatorial tests is discussed below under the definition of the increments and in Annex A.
4. INCREMENTAL COST METHODOLOGY
The robust methodology to calculate incremental costs was developed by OFTEL and operators in the UK industry over a period of more than two years. The heart of the work was a three-pronged approach:
- Top-down model, developed by BT;
- Bottom-up model, developed by an industry working group; and
- Reconciliation of the results of the top-down and bottom-up models.
The top-down and bottom-up models have different strengths and weaknesses and each provides a powerful and, in some cases, very detailed cross-check on the other. The process of developing the two models in parallel over a period led to substantial improvements to both models.6
Key Methodological Assumptions Definition of the Increments The increments could be defined in a number of different ways. Interconnection services would be the most theoretically pure approach, because services are the units purchased by interconnecting operators. However, incremental costs on this basis would be the most complex to derive. Taking components as the increments would be the approach most similar to
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Total Element Long Run Incremental Cost (TELRIC) in the U.S. The approach taken in the UK has been to define the increments in a more aggregated manner, because of its pragmatic advantages. Hence, the increments assumed in the methodology are the whole of the conveyance (or core network)—traffic sensitive costs, both switching and transmission—and the whole of the access network—non-traffic sensitive costs, both local loop and line card. Three elements of cost are identified: the incremental cost of conveyance, the incremental cost of access, and the common costs between conveyance and access. The incremental cost of conveyance is then broken down into the costs of the network components; the costs of interconnection services are derived using routing factors applied to the component costs. The characteristics of this approach to defining the increments in contrast to services or components is discussed in Annex A.
Definition of the Long Run The long run was taken to be the period over which all assets are replaced. It is assumed that there are no sunk costs in the long run.
Degree of Network Optimization There are two main options: “scorched earth,” under which an attempt is made to optimize the number and location of the incumbent’s switching nodes; and “scorched node,” under which the network is optimized, but taking the nodes as given. In principle, the scorched earth approach is desirable, if the intention is to measure the fully efficient level of costs. However, the optimal number and location of nodes are matters of considerable controversy. Therefore, the scorched node approach has significant pragmatic advantages, because it reduces the modeling complexities, even though it will lead to an overstatement of efficiently incurred costs to the extent that the incumbent’s nodes are not optimally situated.
5. TOP-DOWN MODEL
The top-down model starts from the cost information captured in BT’s current cost accounting systems and processes it to remove those costs that are not incremental. The top-down model analyses cost information in some 485 cost categories derived from BT’s Accounting Separation system (which carries out the split into network and retail costs). Each cost category has an associated cost-volume relationship that shows the way in which that type of cost would decline in the long run with reductions in the volume of the
32 Lessons and Priorities identified cost driver. The operation of cost-volume relationships is illustrated in the diagram at Annex D. The top-down model is structured to derive a “decremental” (or avoidable) cost.7 The definition of the increment implies the volume of the cost driver associated with the increment. The level of cost resulting from the removal of that volume can be read off the cost-volume relationship, starting from the recorded CCA cost and cost driver volume level. This cost is subtracted from the recorded cost to give the contribution to the incremental cost arising from the cost category under consideration. The total incremental cost is derived by summing over all the cost categories. BT has derived the cost-volume relationships from a variety of sources: e.g., based on engineering studies, past experience, statistical relationships. Full details of the top-down methodology and descriptions of the cost-volume relationships in the model are set out in BT (1997a,b). Recent top-down model results have been audited to a “fairly presents” standard in accordance with the documentation of the model set out in these documents. Depreciation in the top-down model uses the principle of Financial Capital Maintenance (FCM). It is the sum of Operating Capital Maintenance (OCM) depreciation, computed on a straight line basis, and a holding loss (or gain) reflecting changes in the price of the modern equivalent asset during the year. The derivation of operating costs has significant articulation and typically involves several levels of cost-volume relationships (e.g., the cost of personnel depends on the number of employees, which in turn depends upon the volume of calls and lines). Further details of the top-down model are set out in Annex B.
6. BOTTOM-UP MODEL
The bottom-up model involves a collection of engineering and other models that explicitly build up the annual costs of switches and transmission from the dimensioning capacities required to serve busy hour demand. Given the unimportance of the costs of access in UK interconnection charges (their only impact is on the equal mark-up calculation), the bottom-up model focuses on deriving the incremental cost of conveyance. The strength of the model is in developing the costs of capital equipment. Operating costs, however, are not built up from explicit cost drivers, because of the difficulty and complexity of the modeling that would be required—instead, operating costs are computed as a proportion of capital costs by asset type, calibrated using information from a range of operators. The bottom-up model comprises the following constituent models:
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- Network model, which derives the costs of local switches, concentrators and tandem switches and presents the costs of switches and transmission in pence per busy hour minute and pence per minute terms;
- Transmission model, which builds up the costs of remote-local, local- tandem and inter-tandem transmission per 2 Mbit/s, using provisioning rules;
- Erlangs per circuit model, which uses provisioning rules to derive the utilization of transmission circuits; and
- Economic depreciation model, which produces profiles of capital cost (depreciation plus return on capital employed) for switches, transmission electronics, fibre cable, duct and the major indirect assets (accommodation, computers and motor vehicles) over their economic asset lives—these are used in the network model to convert the investment costs into annual capital costs.
A detailed description of the bottom-up model, including print-outs of model workings and results, is set out in OFTEL (1997a).8 A further description of the modeling is included at Annex B.
7. RECONCILIATION
From the outset OFTEL regarded the reconciliation as an essential element of the methodology. The top-down and bottom-up models each have strengths and weaknesses. For example, the top-down has the advantage of an “audit trail” and significant articulation, especially of operating costs, but it suffers from a lack of transparency, because it contains information that is commercially confidential and reflects any inefficiencies in BT’s network operations. The bottom-up model is transparent and has clarity in the derivation of capital costs, but is relatively weak in developing operating costs and may exclude relevant costs (e.g., those associated with more indirect functions, such as personnel and finance). The object was not to choose one model over the other but to draw on the strengths of both to derive hybrid results, the best available measure of incremental costs. The concept of the hybrid results is that they could be calculated using either model by applying a specified set of adjustments. This gives BT the comfort that the hybrid figures can be traced back to its accounting
34 Lessons and Priorities information. OLOs can see how the figures were derived and have the confidence that costs are not artificially inflated. Of course, both BT and the OLOs may disagree that the hybrid figures are the most appropriate measure of incremental costs, preferring the top-down or bottom-up model respectively. However, both will know how and why the costs were derived. The reconciliation process identified the differences in the results of the two models, explained the reasons for those differences and so led to the specification of the hybrid adjustments. The results of the models differed for a variety of reasons, such as differences in:
- input costs
- parameter assumptions (e.g., the cost of capital)
- annualization of capital costs (the top-down model uses straight line depreciation plus holding loss, whereas the bottom-up model uses economic depreciation)9
- modeling approaches (e.g., the bottom-up model assumes point-to-point transmission, whereas BT’s transmission network uses intermediate multiplexing)10
- routing assumptions (e.g., the bottom-up model assumes no direct routes between local switches, although such routes do exist in BT’s network)
- equipment utilization and efficiency
Details of the reconciliations for the 1993/94 and 1994/95 models are set out in NERA (1996b,c). Switching costs were reconciled at a disaggregated level. Transmission costs were reconciled at a more aggregated level, because of the difficulties of disaggregated comparisons due to the different classifications of transmission (junction and trunk in the top-down model; remote-local, local-tandem and inter-tandem in the bottom-up model) and the different modeling approaches (intermediate multiplexed versus point-to- point). OFTEL made a decision to base the starting charges for the network charge caps on BT’s incurred incremental costs, not the costs of an efficient operator (with the degree of inefficiency reflected in the value of X). This allowed the top-down model after the hybrid adjustments, which were derived following the reconciliation, to be used to generate incremental cost information in the years
35 Telecommunications Reform in Germany following the reconciliation work. OFTEL used the incremental cost data for 1995/96 and interim 1996/97 as the basis for deriving the starting charges (by forecasting costs forward to 1997/98).
8. COST AND PRICE COMPARISONS
BT has been required in recent years to produce both HCA and CCA fully allocated costs Accounting Separation financial statements. These can be compared to the latest available audited incremental cost figures (for interim 1996/97). Table 3 shows this comparison for the local exchange segment, the interconnection service used for call termination or call origination (see Annex C). As can be seen, the LRIC figure, including mark-up, for the local exchange segment is almost identical to the CCA FAC figure, although there are some minor differences at the level of component costs. HCA FAC is significantly higher than LRIC plus mark-up. The main reason is the difference in the cost of the local exchange, arising from the gap between asset valuations under HCA and CCA.
Table 3: LRIC, HCA and CCA Costs of Local Exchange Segment in Interim 1996/97
Component/ Routing factor LRIC LRIC HCA FAC CCA FAC Service for local exchange plus segment mark-up Local exchange 1.00 0.189p 0.215p 0.274p 0.210p Junction link 0.66 0.056p 0.059p 0.070p 0.058p Junction length 10.11 0.0053p 0.0056p 0.0062p 0.0063p Local exchange segment 0.279p 0.312p 0.384p 0.313p % difference -11% 23% 0%
Despite the similarity between LRIC plus mark-up and CCA FAC, the great advantage in deriving LRIC information is that it allows floors and ceilings to be computed. It will be essential to have this kind of information in the network charge controls, since it will be BT that sets the charges for individual services, subject to the charge caps and controls on abuse of a dominant position. Table 4 shows the floors and ceilings derived for the local exchange segment.
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Table 4: Floors and Ceilings for Local Exchange Segment in Interim 1996/97
Component/ Routing factor for Floor (LRIC) Ceiling Service local exchange segment Local exchange 1.00 0.189p 0.289p Junction link 0.66 0.056p 0.069p Junction length 10.11 0.0053p 0.0067p Local exchange segment 0.279p 0.403p % difference compared to floor 44%
International Comparisons Comparisons between interconnection charges can be problematic for a number of reasons. It may be difficult to ensure that a strict like-for-like comparison has been carried out, because interconnection services in different countries may not be strictly analogous, or because the structure of charges differs somewhat (e.g., different time of day structures; per set-up as well as per minute charges in some countries). Depending upon the purpose, different types of comparison may be preferable, e.g., constructing an average charge from a basket of services or comparing charges for specific services. Furthermore, the comparisons vary with the particular exchange rates used to convert into the same currency. The attempt in this section is not to provide a comprehensive series of comparisons, but to illustrate the relative level of UK interconnection charges against charges in the rest of Europe and the U.S. Set out below are some comparisons, which will not capture all dimensions of variation between charges in different countries. For example, in some countries interconnect switch ports are charged on a rental, not per minute basis—to compute an average overall pence per minute charge, a particular number of minutes of use of the switch port needs to be assumed. Also, although the effect of different peak-off peak charge ratios can be captured to some extent by computing an average charge across times of day, the definition and duration of the peak differs between countries and this may itself reflect differences in calling patterns.
European Union BT’s interconnection charges are comfortably the lowest in Europe. Table 5 shows charges in seven European Union countries for the three main interconnection services (or equivalent)—local exchange segment, single tandem and double tandem. Single tandem is likely to be the most commonly
37 Telecommunications Reform in Germany purchased service. In this table the charges are averaged across times of day (making a consistent assumption about the proportion of traffic in peak periods, namely 50 percent). The charges shown are for the incumbents in UK, Denmark, Germany, France, Sweden, the Netherlands, and Italy.
Table 5: Comparison of EU Interconnection Charges
pence per minute, Local exchange Single tandem Double tandem11 average across times of day segment BT (October 1, 1997) 0.33 0.47 0.76 Tele Danmark 0.45 0.85 1.02 Deutsche Telekom 0.53 0.88 1.22 France Télécom12 0.60 1.25 1.71 Telia 0.77 0.97 1.33 KPN n/a 1.16 1.45 Telecom Italia 0.96 1.57 n/a
Notes: Exchange rates used to pence per minute are purchasing power parities for 1996—see OECD (1997).
Deutsche Telekom’s interconnection services are defined by the distance of transmission, not by the network elements used in interconnection (e.g., for the same distance there is the same charge whether the point of interconnection is at a local switch or a tandem switch). However, there is likely to be a correlation between the transmission distance and the number of switching stages, so Deutsche Telekom services have been mapped onto the services shown in Table 5 as follows: City Zone = local exchange segment, Regio 50 = single tandem, Regio 200 and Fernzone = double tandem. Tele Danmark, Telia and KPN have two-part interconnection charges: per set-up and per minute. Two-part charges have been offered in Denmark for four years or more; in Sweden and the Netherlands they are more recent developments. Tele Danmark charges per set-up, but KPN’s and Telia’s charges are levied only on successful calls. The figures in Table 5 make no adjustment for this factor, so Tele Danmark’s charges are understated, because payments will also be made on unsuccessful call attempts (except when due to network failure). This factor is likely to understate charges by about 10 percent at peak times and 15 percent at off-peak times. Telia’s charges may contain a small relative overstatement for a different reason—Telia’s charges include the cost of interconnection circuits, whereas in other countries there are typically separate connection and rental charges for such circuits.
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Table 5 understates the difference between the charges that will actually be paid in UK and France, because in addition to the charge shown, interconnecting operators in France will also have to pay universal service contributions and make access deficit payments, amounting to about 0.18 pence per minute (1.8 centimes per minute13) in 1998. On the other hand, the size of the difference in single tandem charges could be exaggerated, because in France the single tandem service gives the interconnecting operator access to about 2m subscribers, more than double the number in the UK (because BT has a larger number of tandem switches that are, on average, smaller than France Télécom’s) . As yet KPN does not offer interconnection at local exchanges. Hence KPN’s interconnection service “Local Terminating Access” corresponds in the UK to single tandem, not local exchange segment. Neither access charges nor universal service contributions will be paid on call termination in the Netherlands.14 The prices shown are preliminary—they could be subject to retrospective downward adjustment following the completion of the investigations by OPTA, the Dutch regulator. In a similar vein, the charges of Telecom Italia have yet to be approved by the national regulator. The interconnection charges in these countries can also be compared to the “best current practice” benchmark ranges recommended by the European Commission (1997). As shown in Table 6, most but not all of the charges fall within the recommended ranges. However, whilst BT’s charges are at the bottom end of the ranges, the charges in other EU countries tend to be close to the upper bound.
Table 6: Comparison of EU Interconnection Charges with DGXIII Recommended Ranges
ECUs/100 per minute, Local Metropolitan National peak rate charges (> 200 km) DGXIII - lower bound 0.60 0.90 1.50 - upper bound 1.00 1.80 2.60 BT (1 October 1997) 0.64 0.91 1.74 Tele Danmark 0.97 1.81 2.21 Deutsche Telekom 1.00 1.70 2.60 France Télécom 1.00 2.12 2.93 Telia 1.66 2.12 2.93 KPN n/a 1.99 2.50 Telecom Italia 1.53 2.50 n/a
Notes: Exchange rates used to pence per minute are current exchange rates (in November 1997).
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The basis of the comparison shown in Table 6 differs from Table 5 for three reasons (following the approach used by the Commission):
- peak rate charges are used, not average charges across times of day;
- conversion into a common currency uses current exchange rates, not purchasing power parity rates; and
- the “national” interconnection service is specified as the service with distance greater than 200 km, not the average across double tandem services for BT and Deutsche Telekom. The charges that fall within the recommended ranges (or are very close to the upper bound) are shown emboldened in Table 6. Telia’s charges for single tandem and double tandem are shown in italics, because these charges would be very close to or just below the upper bound of the recommended ranges if purchasing power parity exchange rates were used instead of current exchange rates. On the other hand, Telecom Italia’s charges would look significantly higher if purchasing power parity exchange rates were used.
United States Charges in the U.S. can differ greatly between local exchange carriers (LECs). No attempt is made here to provide a comparison against a comprehensive cross-section of LECs, but Table 7 shows charges for the local exchange for three LECs in Illinois and Massachusetts, two states that have broadly similar characteristics to the UK. (Illinois is one of the lowest charging states in the U.S.) These charges can be compared to BT’s charge for the local exchange component or for the local exchange segment. In the U.S. use of remote concentrators is generally less common than in the UK and the costs of transmission between remote concentrators and local switches, where incurred, are included in access network costs (even though such costs are traffic sensitive). On this basis the like-for-like comparison would be with BT’s charge for the local exchange component. BT’s charges for the local exchange appear to be lower than current U.S. charges and, even where the local exchange segment is used as the comparator, they are similar to the level of charges of the lowest charging U.S. LECs, if the CCLC (carrier common line charge) and RIC (residual interconnection charge) are excluded, as in Table 7. Together these elements of U.S. charges comprise around 1 cent per minute or more (varying by LEC). There are no corresponding elements to the CCLC and RIC in the UK, so to the extent that these are or continue to be paid,15 BT’s charges are substantially lower. Charges
40 Lessons and Priorities for the local exchange for LECs other than those shown can be in excess of 1 cent per minute, even before the CCLC and RIC are added.
Table 7: Comparison of BT’s and Selected U.S. LEC’s Charges for Local Exchange Segment (in cents per minute)
UK Component/ Routing BT U.S. Assumed Ameritech Sprint/ NYNEX/ Service factor Starting com- routing (Illinois) MFS C-TEC charges ponent factor (Illinois) (Mass) cents/min cents/min Local exchange 1.00 0.298 End 1 0.5 0.4 0.8 office local termi- nation % difference 67% 34% 167% Junction link 0.66 0.082 Tandem 0 0.019 transport termi- nation Junction length 10.11 0.0082 Tandem 0 0.0012 (km) transport facility mileage PPP 1 0.058 Local exchange 0.493 0.5 0.4 0.8 segment % difference 1% -19% 62%
Note: Exchange rate used is £1=$1.49, purchasing power parity for 1996—see OECD (1997).
A process of reform of U.S. interconnection charges is underway, following recent Orders by the FCC. Interconnection charges are expected to fall, the RIC is to be removed and the access charge regime is to be reformed. Default price ranges for various elements of interconnection charges, based upon the TELRIC approach were proposed in FCC (1996). These are lower than BT’s charge for the local exchange segment but consistent with BT’s charge for the local exchange component, as shown by the figures in Table 8. It should be noted, however, that the BT figure is an actual charge whereas it remains to be seen how U.S. charges reflecting TELRIC will compare to the FCC default prices.
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Table 8: BT’s Charges and FCC Default Prices for Local Exchange (in cents per minute)
UK Service BT floor BT Starting U.S. FCC default (OFTEL charge component price range forecast) cents/min cents/min cents/min Local exchange component 0.261 0.298 End office local termination 0.2 - 0.4 % difference compared to component -12% -33% to +34% Local exchange segment 0.442 0.493 % difference compared to segment -10% -19% to -59%
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ANNEX A: DEFINITION OF THE INCREMENT, FLOORS AND CEILINGS
Since, in the UK methodology, component costs are derived on the assumption that the increment is the whole of the conveyance (or core) network, by construction the sum of the costs of the network components equals the incremental cost of conveyance. One alternative approach would be to take each of the components as an increment in its own right (roughly in line with the use of Total Element Long Run Incremental Cost (TELRIC) in the U.S.). The incremental cost of conveyance could then be broken down into the incremental costs of the component and the common costs between components (also referred to as intra-core common costs). But a question would then arise of how to deal with intra-core common costs when setting the level of charges.16 A consequence of defining the increment as the whole core network is that the cost floors thereby derived for components are at least as large as the incremental cost of the components, because they include an element of the common costs between components.17 However, component incremental costs would not give the theoretically correct floors, since the units purchased by interconnecting operators are services, not individual components. The theoretically pure approach would be to define interconnection services as the increments and derive incremental and stand-alone cost on this basis for each service and for each combination of services (since combinatorial floor and ceiling tests are also relevant). This information would be substantially more difficult to derive, because it would rely upon the shape of the cost functions for components. Moreover the results could be quite sensitive to the particular modeling assumptions and simplifications made. Substantial further work would be needed to develop a model to produce robust results along these lines. The definition of the increment as the whole conveyance network has the attraction of relative simplicity. The floors and ceilings at component level are only a means to an end, since the floor and ceiling tests will be carried out at interconnection service level. The OFTEL approach allows the service floors and ceilings to be derived in a straightforward manner from the component floors and ceilings (using routing factors). Alternative approaches might require the construction of complex matrices showing incremental and stand- alone costs for different combinations of components and services, depending upon which intra-core or inter-service common costs were relevant to each combination. A feature of deriving the floors and ceilings from the definition of the increment of the whole core network is that it yields floors and ceilings that, by construction, will satisfy the combinatorial tests (to the level of the core network). 43 Telecommunications Reform in Germany
ANNEX B:MODELING OF THE LOCAL EXCHANGE SEGMENT
For ease of exposition the descriptions of the top-down and bottom-up modeling below focus upon the local exchange segment, the interconnection service used for call termination or call origination.
Top-down Model Currently, BT’s local exchange component covers the costs of both local switch (processor) and concentrator. The cost-volume relationships for the local exchange are based on detailed engineering models for System X and AXE10 exchanges. BT does have other types of local exchange in its network (UXD, TXE), but these are not modern equivalent assets and so are valued as if they were System X or AXE10. Local exchanges have two cost drivers: calls (conveyance) and lines (access). This results in a cost function that is a three- dimensional function. Some elements of the exchange vary only with calls, such as the local switch processor. Some vary only with lines, such as miscellaneous line auxiliaries on the concentrator. Some vary with both conveyance and access and give rise to common costs, such as concentrator core equipment, rack equipment and DC power equipment. The cost function is simplified into two two-dimensional cost-volume relationships corresponding to the two cost drivers (the function for calls assumes that lines are maintained at existing volumes and vice versa). The cost- volume relationships are derived from engineering models that use provisioning rules to derive optimal switch configurations for specified volumes of calls and lines. The shape of each function depends upon the nature of the optimal re-dimensioning of the switch as volumes are allowed to vary. The functions derived by BT are piecewise linear (with declining slope) plus a fixed cost element. The other element of the local exchange segment is transmission between remote concentrator and local switch (“R-L transmission”). In BT’s current classification of transmission, there is no separate component for R-L transmission - its costs are averaged with local-tandem transmission in junction transmission. The top-down model has separate cost-volume relationships to develop the capital costs of electronics, cable and duct, as well as a variety of relationships relating to operating and more indirect costs.
Bottom-up Model The costs of the concentrator and local switch are developed separately. Dimensioning capacities for each in terms of ports and busy hour call attempts are derived within the model. The investment cost of this size of switch is split
44 Lessons and Priorities into port, processing, unattributed (i.e., costs that are incremental to conveyance but are not specifically driven either by busy hour erlangs or call attempts), and common costs (relevant to the concentrator, but not the local switch). The costs per unit of capacity are progressively developed into costs per busy hour minute and ultimately costs per minute, using a number of parameter assumptions, including erlangs per circuit and the proportion of traffic that occurs in the busy hour. These calculations and the results for the bottom-up model in 1994/95 are shown in the print-out below. The costs of R-L transmission are modeled separately from the costs of other types of transmission (unlike the top-down model). The transmission model builds up the costs of electronics (end equipment and repeaters), cable and duct on the assumption of a point-to-point transmission network, i.e., each logical route is assumed to have a dedicated line system and fibre pair. The electronics cost per 2 Mbit/s is computed, starting from a busy hour traffic distribution and applying provisioning rules to derive the cost minimizing choice of line system size. Three different sizes of line system are considered: 34, 140 and 565 Mbit/s. The transmission model derives a mix of system sizes for R-L routes and determines endogenously the utilization of electronics. The duct and cable costs per 2 Mbit/s depend upon the average route length, the amount of duct sharing between logical routes, the amount of physical diversity allowed for, and the number of line systems per logical route (derived in the optimization of electronics). Different sizes of cable are considered and the lowest cost size is selected, given the input cost assumptions.
45 Telecommunications Reform in Germany Component cost in pence per minute 0.025 0.052 0.000 0.034 0.111 Component cost in pence per minute 0.051 0.082 0.133 Routing factors 0.9 1.1 0.0 1.0 Routing factors 1.0 1.0 Pence per minute 0.028 0.047 0.039 0.034 Pence per minute 0.051 0.082 Proportion of traffic in busy hour 9.2% 9.3% 11.2% 9.2% Proportion of traffic in busy hour 9.3% 11.0% Pence per busy hour minute 0.30 0.50 0.34 0.37 Pence per busy hour minute 0.54 0.74 Annualisation rate 26.6% 26.6% 26.6% 28.5% Annualisation rate 28.5% 28.5% Erlangs per circuit 0.59 0.35 0.51 Erlangs per circuit 0.35 Investment cost pe unit 2,946 2,946 2,946 5.17 Investment cost per unit 97 2,993 10.73 Tandem facing Access facing OLO facing Local switch facing costs (which are part of the access). For full details of the calculation method, see OFTEL (1997e). The units in the investment costs per unit are busy hour erlangs for port costs, call attempts processing and lines line BOTTOM-UP NETWORK MODEL RESULTS FOR LOCAL SWITCH AND CONCENTRATOR, 1994/95 Local switch Port costs Processing costs Total Concentrator (average of host and remote concentrator switching costs) Line costs Port costs Processing costs Total Notes:
46 Lessons and Priorities
Annex C
47 Telecommunications Reform in Germany
Annex D
48 Lessons and Priorities
REFERENCES
Armstrong and Doyle (1994) Access Pricing, Entry and the Baumol-Willig Rule, August 1994
ART (1997) What do new entrants have to pay for interconnection in France, Press Release, 10 April 1997
BT (1997a) Long Run Incremental Cost Methodology, May 1997
BT (1997b) Long Run Incremental Cost Model: Relationships and Parameters, May 1997
BT (1997c) Accounting Documents, July 1997 (HCA) and September 1997 (CCA)
BT (1997d) Detailed Attribution Methods, September 1997
DTI (1991) Competition and Choice: Telecommunications Policy for 1990s, Department of Trade and Industry, HMSO
European Commission (1997) Working Document on Interconnection Pricing in a Liberalized Telecommunications Market, Directorate General XIII, 6 August 1997
FCC (1996) Implementation of the Local Competition Provisions in the Telecommunications Act of 1996, CC Docket No. 96-98, First Report and Order, August 1996
Myers (1994) Predatory Behavior in UK Competition Policy, Office of Fair Trading Research Paper Number 5, November 1994
NERA (1996a) The Methodology to Calculate Long Run Incremental Costs, March 1996
NERA (1996b) Reconciliation and Integration of Top Down and Bottom Up Models of Incremental Cost, June 1996
NERA (1996c) Reconciliation of Top Down and Bottom Up Models, December 1996
NERA (1997a) An Assessment of the 1995/96 Top Down Model, May 1997
NERA (1997b) An Assessment of the Interim 1996/97 Top Down Model, August 1997
OECD (1997) Main Economic Indicators, Statistics Directorate, February 1997
49 Telecommunications Reform in Germany
OFTEL (1994) A Framework for Effective Competition, Consultative Document, December 1994
OFTEL (1995a) Effective competition: Framework for Action, Statement, July 1995
OFTEL (1995b) Pricing of Telecommunications Services from 1997, Consultative Document, December 1995
OFTEL (1996a) Pricing of Telecommunications Services from 1997, Consultative Document, March 1996
OFTEL (1996b) Pricing of Telecommunications Services from 1997, Statement, June 1996
OFTEL (1996c) Network Charges from 1997, Consultative Document, December 1996
OFTEL (1997a) Long Run Incremental Costs: the Bottom-up Network Model, March 1997
OFTEL (1997b) Network Charges from 1997, Consultative Document, May 1997
OFTEL (1997c) Network Charges from 1997, Statement, July 1997
OFTEL (1997d) Guidelines on the Operation of the Network Charge Controls, October 1997
OFTEL (1997e) Long Run Incremental Costs: the Bottom-up Network Model, March 1997
U.S. Charges in Table 8 Taken from Interconnection Agreements: Ameritech Illinois/AT&T of Illinois, January 14, 1997 Ameritech Illinois/TCG Illinois and TCG Chicago, January 7, 1997 Central Telephone Company of Illinois/MFS Intelenet of Illinois, September 20, 1996 New England Telephone and Telegraph Company/U.S. ONE Communications Services, March 6, 1997
50 Lessons and Priorities
COST AND PRICING OF INTERCONNECTION SERVICES IN A LIBERALIZED EUROPEAN TELECOMMUNICATIONS MARKET Günter Knieps18
INTRODUCTION AND EXECUTIVE SUMMARY
With the beginning of 1998 market entry will be permitted in all subparts of telecommunications networks, including cable-based infrastructure as well as telephone services, in nearly all European countries. As a consequence, problems of network access as well as network interconnection gain increasing importance. Global entry deregulation, however, does not automatically imply the abolishment of all sector-specific regulation. In the first place, a long-term proper role of government intervention with respect to technical regulations, for example the coordination and allocation of radio frequencies, the organization of number portability, the design of standards etc., remains in order to guarantee an adequate framework for a competitive telecommunications sector. Secondly, politically desired universal service objectives remain to be organized by entry-compatible instruments—like, for example, a universal service fund. Thirdly, remaining network-specific market power needs to be disciplined by regulatory instruments or competition policy respectively. Future regulation dealing with costing and pricing of interconnection services is under debate within the individual European Union (EU) countries as well as on the level of the EU as a whole. The purpose of this paper is to focus on the role of market power where interconnection and network access problems are involved.19 The controversy about the pros and cons of obligations for network interconnection, detailed regulation of tariffs, including the control of the underlying cost conditions, is very topical all over the world. The recent “Working Document On Interconnection Pricing In A Liberalized Telecommunications Market,” issued by the European Commission, Brussels, August 6, 1997 (Working Document), provides a paradigm change in the current debate on costing and pricing of interconnection services. Until now the EU regulatory framework for interconnection remained rather vague, only pointing out the necessity of non- discriminatory, transparent and cost-oriented interconnection tariffs. In contrast, the Working Document contains very concrete and detailed costing and pricing prescriptions which, after acceptance, may have a strong impact on the competition process of European telecommunications markets in the future. The purpose of this paper is therefore to provide a critical appraisal of this Working Document as well as to develop alternative proposals better suited to benefit the liberalized European telecommunications market.
51 Telecommunications Reform in Germany
The paper is organized as follows: Part A sketches the EU history with respect to open network provision (ONP) policy in order to demonstrate the paradigm shift represented by the recent Working Document. In part B the market-share concept of market power applied within the Interconnection Directive (Council Directive 97/33, EC on Interconnection in Telecommunica- tions, June 30, 1997) is criticized as an important source for an oversized regulatory basis. Instead, the criteria for an economically justified disaggregated regulatory framework for the ONP concept are pointed out in order to localize the proper regulatory basis. It is shown that the regulatory basis should be restricted to monopolistic bottleneck areas (local cable based networks). Part C provides a detailed analysis of costing and pricing of interconnection services within the ONP concept. Section C. I deals with the role of long-run incremental costs (LRIC) in determining interconnection prices. The Working Document assumes that interconnection prices should be equal to LRIC because this would enable a firm to recover all of its costs related to providing interconnection. In contrast we indicate that LRIC can only serve as a (long- run) lower boundary. Moreover, mark-ups are necessary to guarantee the long- run survival of the incumbent firm and to provide adequate incentives for future investments. There should be no ex ante regulatory allocation of mark-ups; instead carriers should be allowed to determine market-driven mark-ups in order to cover the total costs of interconnection. Section C. II deals with top-down versus bottom-up approaches to determine long-run incremental costs (LRIC). Whereas the Working Document is strictly in favor of bottom-up approaches, we conclude that engineering- economic models are inadequate for calculating decision-relevant incremental costs for the established carriers. In particular, the various sources which lead to an underestimating of the real incremental costs are laid open. As a prominent example the Local Exchange Cost Optimization Model (LECOM) will be discussed. In contrast, top-down approaches based on the cost accounting systems of established carriers should be applied to derive decision-relevant incremental costs. Section C. III deals with principles of interconnection pricing, focussing on the relationship between price-differentiation and price-discrimination. The Working Document for example argues that a dominant incumbent operator will be in a better position to bear the economic risk of predicting and investing in additional capacity, and subsequently, that it would be inappropriate for new entrants to pay according to capacity-based interconnection charges. Furthermore, the linking of interconnection charges to retail prices would lock the new entrant into the same retail tariff structures as those chosen by the
52 Lessons and Priorities incumbent. In this section it is shown that the regulatory enforcement of such pricing rules would entail price discrimination to the disadvantage of established carriers which would subsequently hamper welfare-improving price-differentiation. In particular, it is argued that regulatory restrictions with respect to flexible pricing on interconnection tariffs not only unduly restrict the established carrier’s pricing behavior but are also undesired from a welfare economic point of view. Section C. IV provides an economic evaluation of the “best-practice approach” taken within the Working Document. “Best current practice” interconnection charges using the three lowest-cost member states are planned to be progressively reduced in the future, towards a level compatible with a bottom-up LRIC based approach. In this section several arguments are given why this “best current practice” approach cannot be supported from the economic point of view.20 There is a tendency towards overregulation (e.g., tariffs for interconnection in long-distance networks should not be regulated, due to the absence of network-specific market power). Large cost differences for providing interconnection services may be due to differences in costs between different local networks within a country or between countries. “Best current practice” interconnection charges do not take into account the differences between countries in the recovering of subscriber-specific (non- usage-sensitive) costs. Their informational value is also hampered to the extent that they already reflect rate regulation on the country level. After all, the reference point is chosen inadequately. LRIC must be calculated on the basis of real cost data of established carriers (“top-down”). Moreover, LRIC can only serve as a (long-run) lower boundary of individual interconnection charges. In order to be able to survive, the established carriers must cover the stand-alone costs of all interconnection services. Remaining market power in monopolistic bottleneck areas should not be regulated by regulation of pricing structures. Instead, the instrument of price-cap regulation should be applied for regulating the level of prices.21 The concluding Section C. V points out that the paradigm shift of the Working Document—which contains very concrete and detailed costing and pricing prescriptions for the member countries—is also reflected within the Commission Recommendation on Interconnection in a liberalized telecommu- nication market, issued by the European Commission, Brussels, October 15, 1997. It can be expected that the debate on the proper role of costing and pricing of interconnection services will continue.
53 Telecommunications Reform in Germany
A. EUROPEAN ONP HISTORY IN TELECOMMUNICATIONS
I. The Concept of ONP in Partially Entry-deregulated Markets In 1990 the EU took the first step towards liberalizing telecommunications services by opening the market for value-added network services (VANS). Voice telephone service as well as public telecommunications infrastructure networks still remained legal monopolies owned by state-owned enterprises. Establishment of the internal market for these liberalized services within Europe required harmonizing conditions for access to and use of public telecommunications networks and services. The ONP concept was introduced in the Commission’s 1987 Green Paper on Telecommunications Services and given substance in Council Directive 90/387/EEC of June 28, 1990 on the establishment of the internal market for telecommunications services through the implementation of open network provision. Subsequent specific Directives and Recommendations applied the principles of open network provision to leased lines, voice telephony, packet switched date services and integrated services digital networks (ISDN).22 The purpose of the ONP-policy during the period of partial entry deregulation was to stimulate entry into the VANS market and to ensure “fair” competition between VANS suppliers and the VANS operations of the existing telecommunications organizations. Article 3 of the Council Directive 90/387/ EEC of June 28, 1990 therefore laid down several basic principles ONP conditions must comply with. These principles are as follows:
- conditions must be based on objective criteria; - conditions must be transparent, and published in an appropriate manner; - conditions must guarantee equality of access, and must be non- discriminatory, in accordance with Community law.
Furthermore, it was explicitly stated that ONP conditions must not restrict access to public telecommunications networks or public telecommunications services except for reasons based on essential requirements (e.g., security of network operations, maintenance of network integrity). Focussing on the preconditions for competition on the VANS market, only a minimally harmonized offering of those public telecommunications networks and public telecommunica- tions services identified as being in the European interest were required. EU’s ONP policy may also have been pursued as an instrument to avoid structural separation between the VANS activities of the existing telecommunications organizations and their traditional network activities.23 Since the established carrier was (correctly) considered to be a monopolist on
54 Lessons and Priorities a large part of the market, global regulation of market power was still considered to be necessary, but left to the national regulatory authorities.
II. The Concept of ONP in Globally Entry-deregulated Markets Commission Directive 96/19/EC (the Full Competition directive) of March 13, 1996 changes the Directive 90/387/EEC by abolishing all legal entry barriers including free entry into the markets for telecommunications services as well as the set-up and provision of telecommunications infrastructure networks. Since the future telecommunications infrastructure in Europe is developing towards a set of interconnected networks, owned and operated by many different organizations, the importance of interconnection is strongly increasing. Interconnection may take place among different providers of long distance networks, among providers of mobile or satellite networks and public cable-based long distance networks, interconnection also takes place between long-distance telecommunications service providers to local networks etc. This changing role of interconnection also led to a revision of ONP-principles. The basic philosophy behind the EU ONP policy seems to be that the infrastructure should be open to all users in the EU, open to any service provider, and open to any provider of elements of the overall infrastructure. The Full Competitive Directive (sections 4a-4d) extends ONP-principles to the new fully entry- deregulated environment, focussing on interconnection and public switched networks. In addition to the well known criteria of non-discriminatory, reasonable and transparent conditions, the criterion of cost-orientation was explicitly introduced. Priority was given to commercial negotiations between the interconnecting parties involved. Council directive 97/33 EC on Interconnection in Telecommunications (the Interconnection Directive) which was adopted in June 1997 and is to be implemented into the member states’ national laws by December 31, 1997, goes further than the “Full Competition” Directive by introducing a two-tiered approach to ONP-regulation. Providers of public telecommunications networks or public telecommunications services which are classified as possessing significant market power are subjected to more restrictive ONP-regulation. This entails the general obligation to provide network access (section 4 (2)), the burden of proof that interconnection charges are cost-based and the possibility of ex ante regulation of interconnection charges (section 7 (2)), as well as principles for cost accounting systems (section 7 (5)). According to the Interconnection Directive, an organization with a market share of over 25 percent in a given telecommunications market is considered to possess significant market power (section 4 (3)). Nevertheless, the major responsibility with regard to ONP-regulation still has been left in the hands of
55 Telecommunications Reform in Germany the national regulatory authorities. National regulatory agencies have the authority to determine whether an organization has significant market power. According to section 4 (3) they are free to decide whether an organization with more or less than 25 percent is to be classified as possessing market power. Moreover, principles for interconnection charges and cost accounting systems (section 7), including the control whether tariffs are cost-based etc., are considered under the responsibility of the national regulatory authorities. Thus, the Interconnection Directive laid down the general principles of future ONP regulation but left the responsibility for the concrete regulation of interconnection to the regulatory authorities of the individual Member Countries (section 9). The first (and nearly unchanged) version of the Working Document on Interconnection Pricing in a Liberalized Telecommunications Market, which was distributed only one week after the publication of the Interconnection Directive (see ONP COMMITTEE, ONPCOM 97-29, Brussels, July 7, 1997), leaves one wondering which role EU-ONP policy will play in the future. In contrast to the Interconnection Directive, the Working Document advocates very concrete regulatory measures that will strongly impede the search of the individual national regulatory authorities for a solution for the remaining regulatory problems with respect to interconnection. Given the extensive debate on the “correct” interconnection regulation, this EU initiative must be considered with caution. The Working Document contains the following detailed costing and pricing prescriptions for the Member Countries:
(1) Interconnection prices should be calculated according to forward looking long-run incremental costs:
“The forward looking long-run incremental cost represents the lowest price which enables a firm to recover all of its costs related to providing interconnection and call termination. Any price higher than this will on average pay more to owners and investors than they could earn by investing in any alternative but similar risky investment.” (Working Document, p. 4)
(2) Long-run incremental costs should be calculated with “bottom up” models:
“This involves building ‘bottom up’ models whereby an economic/ engineering model of an efficient network is developed, from which
56 Lessons and Priorities interconnection costs can be calculated by aggregating the costs of individual network elements . . .” (Working Document, p. 4)
(3) Reconciliation of “top-down” and “bottom-up” models works:
“Reconciliation of the results of these models with the results obtained from ‘top down’ models...serve to demonstrate that the calculated interconnection costs are broadly accurate.” (Working Document, p. 4)
(4) Asymmetric criteria with respect to interconnection pricing:
“Although the dominant incumbent faces mostly one-off capacity costs as a result of terminating interconnected traffic, the individual uncertainty of new entrants about their demand for interconnection, and the informational (transparency) problems and associated transaction costs relating to determining each operator’s utilization of peak capacity, make it inappropriate for new entrants to pay according to capacity based interconnection charges.” (Working Document, p. 17)
“Furthermore, the linking of interconnection charges to retail prices tends to lock the new entrant into the same retail tariff structures as those chosen by the incumbent. This will hinder and in some cases prevent the development by new entrants of innovative retail tariff schemes targeted at different types of user. Thus interconnection charges based on retail tariffs may be incompatible with the requirements of Community law.” (Working Document, p. 18)
(5) “Best current practice” interconnection charges:
“Where actual ‘bottom-up’ cost calculations based on forward-looking long run incremental costs are not available, interconnection charges based on ‘best current practice’ as given in this Recommendation provide guidance to NRAs when assessing the interconnection charges proposed by incumbent operators.” (Working Document, p. 13)
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B. THE APPLICATION OF THE DISAGGREGATED REGULATORY FRAMEWORK TO THE ONP CONCEPT
The Interconnection Directive introduced the criterion of significant market power into the ONP regulatory debate for the first time. It seems obvious that the criterion of 25 percent market share is rather arbitrarily chosen. However, the national regulatory authorities are currently engaged in the search for sound economic criteria to localize network-specific market power as a starting point for remaining sector-specific regulation.
I. The Necessity of a Symmetric Regulatory Approach Symmetric regulatory conditions should neither advantage nor disadvantage the former network monopolist. On the one hand, all monopoly privileges must be abandoned, on the other hand, all one-sided regulatory obligations (e.g., to cross-subsidize universal services) must end. “In general terms symmetric regulation means providing all suppliers, incumbents and new entrants alike, a level playing field on which to compete: the same price signals, the same restrictions, and the same obligations . . . But all forms of asymmetric regulation contain an intrinsic bias toward some firms or technologies. . .”24 Even if one accepts criteria like relative market share, financial strength, access to input and service markets etc. as a starting point in order to evaluate the existence of market power, nevertheless the development of an ex ante regulatory criterion creates a need for a more clear-cut definition of market power. This is even more important, because “Vermutungskriterien” on the basis of market shares can lead to wrong criteria for government intervention in the telecommunications sector. Therefore it is important to develop and apply a disaggregated approach of market power regulation. It is necessary to differentiate between those areas in which active and potential competition can work and other areas, so-called monopolistic bottleneck areas, where a natural monopoly situation (due to economies of bundling), in combination with irreversible costs, exists. It can be demonstrated that the regulation of market power is only justified in monopolistic bottleneck areas. In all other cases, the existence of active and potential competition will lead to efficient market results (see figure 1). The pressure of potential competition can already create incentive for the active supplier to improve the quality and variety of services as well as to produce more efficiently. These networks are therefore called contestable.25 An essential condition for the functioning of potential competition in order to discipline firms already providing network services is that the incumbent firms do not have asymmetric cost advantages in comparison with potential entrants.
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Figure 1: A Disaggregated Approach to Market Power Regulation
sub-market with sunk costs without sunk costs natural monopoly (1) (2) (bundling advantages) regulation of market potential competition power (non-contestable (contestable networks) networks)
no natural monopoly (3) (4) (bundling advantages) competition among competition among active providers active providers
An important example for contestable networks are the markets for telecommunications services, which are often provided via service networks. Even the market for public telephone services is contestable, because suppliers of value added services are also prepared to offer telephone services (after legal entry barriers disappear). An important condition, however, is the guarantee of number portability. The term “number portability” means the ability of users of telecommunications services to retain, at the same location, existing telecommunications numbers without impairment of quality, reliability or convenience when switching from one telecommunications carrier to another. Even if market shares of incumbent firms are large, inefficient suppliers would then be immediately confronted with rapidly decreasing market shares. But contestable subareas can also be localized in the area of telecommunications infrastructure. The pressure of potential competition in wireless networks, for example satellite, microwave systems, mobile communication, is guaranteed as long as symmetric access to complementary inputs, for example right of way, radio spectrum etc., is ensured. More generally, an important condition for the effectiveness of actual and potential competition is that all (active and potential) suppliers have equal (symmetric) access to the complementary monopolistic bottleneck. In contrast, in local cable-based networks, where sunk costs are relevant, consumers, who would intrinsically be willing to switch immediately to less costly firms, cannot do this. Market entry therefore cannot be expected easily, if sunk costs are sufficiently high and very relevant. Therefore we can conclude that sector-specific ex ante regulatory intervention in order to discipline market power can only be justified in non-contestable networks (monopolistic bottleneck areas), i.e., where bundling in combination with irreversible costs is relevant. Sunk costs are no longer decision-relevant for the incumbent monopoly, whereas the potential entrant is confronted with the decision whether to build network infrastructure and thus spend the irreversible costs. The incumbent firms therefore have lower decision-relevant costs than the
59 Telecommunications Reform in Germany potential entrants. This creates scope for strategic behavior of the incumbent firms, so that inefficient production and monopoly profits will not necessarily result in market entry. The aim of future regulatory policy should, however, not be the global regulation of markets. Instead, only a disaggregated regulation of non- contestable networks is justified. The aim is then to localize the market power in monopolistic bottleneck areas and discipline this market power by regulatory intervention. Asymmetry of market power due to monopolistic bottleneck facilities, however, does not by itself require asymmetric regulation. Instead, the symmetry principle requires that all firms have access to local telecommunications networks on terms identical to those of the incumbent (nondiscriminatory access). The symmetry principle demands that only bottleneck facilities are regulated, irrespective of whether the owner is the incumbent or a newcomer. The disaggregated location of market power is summarized by figure 2.
Figure 2: A Disaggregated Location of Market Power in Telecommunications Systems
Competitive/ Noncontestable contestable (monopolistic bottleneck) Terminal equipment X --- Telecommunications services (including voice telephone services) X --- Satellite/mobile networks X --- Long-distance cable based networks X --- Local cable based networks --- X
I. The Fallacies of Asymmetric Regulation Symmetric regulatory conditions should neither advantage nor disadvantage the former network monopolists. There is a wide range of possible asymmetric regulation. Whereas in the past monopolistic carriers were protected by legal entry barriers, the regulatory pendulum now seems to swing in the opposite direction. Asymmetric regulation in favor of newcomers is motivated by the conviction that even after the abolition of the legal monopoly the incumbent carrier would still possess a factual monopoly position on the network infrastructure and the normal voice telephone service. Therefore initial support of newcomers—at least for a sufficient transition period—has been
60 Lessons and Priorities recommended recently in national regulatory debates,26 as well as on the supranational level. For example, the OECD, which argued in favor of regulatory symmetry (competitive neutrality) in their Working Party on Telecommunication and Information Services Policies in April 1997 (p. 11),27 issued an amendment in September 1997 in favor of asymmetric regulation (p. 3): “This does not ignore the need and the importance of having asymmetrical regulation, even in liberalized markets, while effective competition is not widely established.”28 However, all asymmetric regulation runs the risk of the regulators preserving existing competitors rather than the competition process.
II. Symmetric Regulation of Monopolistic Bottlenecks A symmetric framework of regulation can be created by designing a disaggregated regulatory approach focussing on network-specific market power.29 Applying this theory to the ONP concept the following lessons can be drawn:
(1) Stable, network-specific market power in telecommunications systems can only be localized in local cable based networks. In all other areas, including telephone services, satellite/mobile networks or long distance cable based networks, active and potential competition does not allow for excessive profits. Even if market shares of incumbent firms are large, inefficient suppliers would lose their customers.
(2) As long as monopolistic bottlenecks are not involved, private bargaining solutions on interconnection conditions are not only beneficial to the carriers themselves, but also improve the market performance of the network services provided to the customers. Irrespective of the market size of the carriers involved, inefficient suppliers of interconnection services are rapidly confronted with strongly decreasing market shares, due to the pressure of alternative (potential) network service providers.
(3) Regulation of ONP conditions should be strictly limited to monopolistic bottlenecks. The market power involved in monopolistic bottlenecks may seriously disturb the bargaining over access conditions.
As an immediate consequence of this disaggregated regulated framework it follows that the “best current practice” interconnection charges at the national level (Working Document, p. 8) can only be considered as overregulation. Due
61 Telecommunications Reform in Germany to the absence of significant market power there simply is no need for regulatory intervention. Instead, bargaining on interconnection conditions will lead to efficient results. A similar reasoning holds for the competitive parts of interconnection on a metropolitan level.
C. COSTING AND PRICING OF INTERCONNECTION SERVICES WITHIN THE ONP CONCEPT
I. The Role of Long-Run Incremental Costs in Determining Interconnection Prices The Working Document argues that the lowest price which enables a firm to recover all of its costs related to providing interconnection is equal to the long-run incremental costs (LRIC). This cost concept became quite popular in topical regulatory debates as new entrants were arguing for low interconnection charges or asymmetric regulation respectively in an attempt to gain starting advantages. Nevertheless, pricing according to LRIC is not compatible with competitive telecommunications markets which require that no specific type of firm, neither incumbents nor entrants, and no specific form of competition, neither infrastructure nor service competition, is given preferential treatment. It is well known that even after complete entry deregulation economies of scale and economies of scope create common costs which cannot be directly attributed to the individual network services. Although activity-based costing can help to identify the directly attributable costs to specific products it is still not possible to declare all costs as incremental costs without applying economically unjustified allocation of common costs. Provided the established network carrier is determining incremental costs based on decision-oriented accounting methods it becomes immediately clear that the sum of the incremental costs does not allow survival. In fact the established firm must also cover its product-group specific costs as well as the firm-specific overhead costs by means of mark-ups on the LRIC. In order to avoid inefficient bypass activities of entrants, market-driven mark-ups should be raised by the established carriers. An obligation to provide the services according to LRIC, however, would disturb the symmetric treatment of infrastructure owner and service provider. Incentives to be the owner of infrastructure for interconnection and network access would disappear, because it would be cheaper to use the infrastructure of the competitors and avoid a contribution to the common costs. Symmetric treatment of owners and users of infrastructure therefore requires that the stand-alone costs of network infrastructure must be covered.
62 Lessons and Priorities
Applying these general principles to the network termination problems dealt with in the Working Document the following lessons can be drawn:
- The Working Document (at least implicitly) rests on the Total Service Long-Run Incremental Costs (TSLRIC). As service call termination either the local, the metropolitan or the national level is considered (p. 8). Nevertheless, in future competitive telecommunications markets the concept of Total Element Long-Run Incremental Costs (TELRIC) becomes the most important incremental cost concept. The incumbent’s offers to be priced using this methodology generally will be “network elements” rather than telecommunications services, defined by regulation. TELRIC-based pricing of discrete network elements or facilities such as local and tandem or transit switching functions or local loops is more economically rational than TSLRIC- based pricing.30
- As pointed out by Haring and Rohlfs there could be separate prices for each switching occurrence and for inter-office transmission.31 The provision of (unbundled) network components is only viable if the stand-alone costs of the different components are covered, because cross-subsidization among components becomes unstable under competition.
- Pricing the (non-traffic-sensitive, subscriber-dedicated) local loop for interconnection purposes has been explicitly rejected in the Working Document (pp. 18f.). Nevertheless, not only the incremental cost of the final link between the customer and the local exchange but also the stand-alone costs must be covered for the economic position of the provider of the local loop to be viable and for economic incentives for future investments to exist.
II. Top-down Versus Bottom-up Approaches to Determining Long-run Incremental Costs 1. The Obsolescence of Historical Cost Accounting According to the Working Document (p. 4), identifying the long-run incremental costs (LRIC) of telephone networks, or parts of telephone networks, involves building “bottom-up” models whereby an economic/ engineering model of an efficient network is developed. The general purpose behind this requirement seems to be that on competitive European telecommunications markets historical cost data—based on the purchase price
63 Telecommunications Reform in Germany of durable assets and (historical) accounting depreciation practices—cannot provide decision-relevant information on “forward-looking” interconnection costs, based on the economic value of the network components. In competitive industries the value of the firms’s productive assets is equal to the discounted (present) value of the anticipated net cash flows earned by the assets over their remaining useful life. These net cash flows are determined by competitive market forces and the firm’s actions, but are not influenced by book asset value. In regulated industries, however, the value of the firm’s assets in place, the rate base has been strongly influenced by regulated depreciation charges. Since the regulatory agencies were under political pressure to keep down the local rates, and therefore also the capital costs of local networks, artificially low depreciation charges and a too long life time were prescribed (not sufficiently taking into account technical progress, changed substitution possibilities etc.). Nevertheless, the Working Document points in the wrong direction as regards the question of how to design and implement the necessary reform. Although it is true that historical cost accounting is obsolete, the reform towards decision-relevant costing should still be based on management and financial accounting data. “Top-down” approaches are based on real costing data, observing the relationship between input-prices, outputs and the costs of production. In contrast, “bottom-up” models develop (pseudo-) cost-data by engineering approaches. After describing the production function from engineering data, the cost-output relationship is then derived as a result of assumed global optimization behavior. It shall be shown in the following section that, instead of “bottom-up” engineering models, an adequate reform of “top-down” approaches is needed, based on forward-looking cost accounting methods. Moreover, it should become clear that the concept of an “efficient” network needs much further elaboration than indicated in the Working Document. Whereas current-cost accounting methods take into account, by their very nature, the path-dependency of network evolution (as long as it is efficient from a forward-looking perspective) bottom-up models usually ignore the strategy of successive upgrading of networks.
2. The Fallacies of Bottom-up Approaches in Determining Long-run Incremental Costs According to the Working Document (p. 4), “bottom-up” models through which an economic/engineering model of an efficient network is developed should be applied, from which long-run incremental costs of interconnection could be calculated. In the following we shall argue that bottom-up approaches
64 Lessons and Priorities are inadequate for determining the long-run incremental costs of interconnection services of established carriers. Bottom-up models are characterized by process analysis in that the emphasis is placed on simulating the production function from engineering data. After describing the production function, the cost-output relationship is then derived as a result of assumed optimization behavior. Instead of real accounting data, the cost-data developed by engineering models are simulated (pseudo) data with their informational value strongly dependent on the quality and the characteristics of the underlying process model. Although the process analysis approach was not very popular for a long time,32 it has also been applied in the field of telecommunications.33 Gabel and Kennet developed the so-called LECOM (Local Exchange Cost Optimization Model) in order to generate data to address the issue of economies of scope in local telephone networks. With LECOM it became possible to solve the problem of selecting the combination and location of facilities that minimized the costs of satisfying varying levels of demand.34 The three types of facilities within the local exchange carrier’s network are the local loop, switching and trunking. The local loop is composed of facilities that provide signaling and voice transmission path between a central office and the customer’s station. The central office houses the switching computer that connects a customer’s line to either another customer who is served by the same switch, or to an interoffice trunk. Calls between central offices are carried on trunks. The model takes as data a city’s dimensions and customer usage level. LECOM then searches for the technological mix, capacity and location of switches that minimizes the annual cost of production. The location of the switches are optimized by the non-linear optimization model. In principle, there are an infinite number of possible configurations to be considered. For each economically and technically feasible combination of switches, a certain number of possible iterations are allowed. An iteration involves the calculation of the cost of service at one or more alternative locations for the switches. For each market, and a given level of demand, LECOM evaluates a number of different switch combinations. In other words, LECOM has been designed to develop a green-field approach. Gabel, Kennet (1994, pp. 390ff.) already pointed out important limitations of engineering optimization models. In the first place, optimization models typically are not designed to quantify the less tangible costs of providing service (administrative costs). Secondly, LECOM is limited by bounded rationality. Since global optimization is not feasible, only a reasonable number of possible solutions are examined. It is obvious that a great degree of freedom exists in the search for “plausible” solutions. Thirdly, the value of the pseudo-data approach ultimately
65 Telecommunications Reform in Germany rests on the quality and completeness of the underlying process models. Measurement errors and behavioral errors still persist, even in the best model.35 Beyond this immanent critique of engineering-economic models the most important point is that bottom-up models are simply the wrong tool for deriving the LRIC of established carriers. Even if the analysis is based on a “scorched node” assumption, which implies that the incremental cost estimate reflects the current network topology, bottom-up models—by their very nature—are not able to derive the LRIC of the efficient network of the established carrier. The reason is the path-dependency of networks. This means that the gradual upgrading is efficient (given the network history), if the additional costs of upgrading are lower than the costs of building new network facilities. This implies that the economically efficient incremental costs must be calculated on the basis of the factual costs of the incumbent’s network in place (including its history of upgrading). As long as the incremental costs of upgrading of the established carrier are lower than the stand-alone costs of a hypothetical new network of an entrant, the required network capacity should be provided by the historically grown network of the established carrier. This is true because entry would replace the service of the incumbent firm over its existing network, not the service of a hypothetical efficient provider. Path-dependent costs of gradual upgrading are then economically efficient and are also relevant from a forward- looking costing perspective.36 It is simply not in the spirit of the bottom-up optimization models to take into consideration the network history. Even under the scorched node assumption engineering models use the high degree of freedom of simulation models to find cost-minimizing solutions by ignoring the historically-grown network infrastructure already in existence. Beyond this fundamental critique of the usefulness of bottom-up approaches for determining the LRIC of the established carriers, other points of criticism have already been indicated in NERA’s studies for OFTEL.37 In particular, the insufficient determination of the factual usage of network capacities, and of the factual routing patterns have been stated.
3. The Necessity of Reforming the Top-down Approaches: from Historical Cost Accounting to Current Cost Accounting The Working Document suggests that the necessary and overdue departure from historical cost accounting (HCA) in a competitive environment can only be accomplished by introducing a bottom-up engineering approach. This is particularly misleading because the necessary reform should still be based on top-down accounting approaches. In the following we shall argue that a transition from historical cost accounting to forward looking current cost accounting (CCA) is unavoidable. Under competitive conditions the valuation
66 Lessons and Priorities of the assets and the depreciation-charges must reflect their economic values. The true economic value of any productive asset is the discounted present value of the anticipated stream of net earnings it is capable of producing. Thus the economic depreciation of a productive asset during a time period is the decrease in its economic value during this period. It should be noted that historical book values and historical depreciation patterns typically reflect neither capital market valuation of assets in place nor economic depreciation. A transition from historical cost accounting to current cost accounting thus necessarily poses the problem of phantom costs (“Altlastenproblem”) due to overvaluation of existing network equipment.38 However, phantom costs should not be confused with economically efficient forward looking costs of upgrading existing network (path-dependency). A periodical reevaluation of the assets as well as an adaptation of economic depreciation rates seems unavoidable, especially in such dynamic markets as telecommunications. There was an extensive debate, especially in Great Britain, to what extent top-down and bottom-up models could be reconciliated. Although the expectations were different in the beginning of this costing project, NERA finally concluded that significant differences between cost estimation of interconnection services based on top-down or bottom-up models remained. Given the serious flaws of bottom-up models in determining the decision- relevant forward looking costs of established carriers, this result seems no longer surprising. The established carriers thus need to reform their accounting systems, starting with a reevaluation of their assets and introducing economic depreciation rates. Moreover, modern accounting systems should be developed further. Contribution margin analysis serves to determine which services should be offered within a given network, which services should be expanded and which services should be scaled down in the light of the prevailing price situation. It is a very flexible tool, as it can apply current replacement costs (“Wiederbeschaffungsneuwerte”). Moreover, contribution margin analysis can be employed to determine long-run incremental costs by means of a “top- down” approach. Such an approach is methodically accurate if depreciation, imputed interest, and overhead costs of indirect services are established in such a way that they correspond to the economic depreciation and interest, as well as the outlays for jointly used services.
III. Principles of Interconnection Pricing The ONP-principles laid down in the Council Directive of 1990 already required non-discriminatory equality of access conditions. The Interconnection Directive of June 1997 goes further by introducing a two-tiered approach to
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ONP regulation. Carriers of public telecommunications networks or public telecommunications services that are classified as possessing significant market power bear the burden of proof that their interconnection charges are cost-based; moreover, there is the possibility of ex ante regulation of interconnection charges. According to the Interconnection Directive, the major responsibility for ONP-regulation still has been left in the hands of the national regulatory authorities. Nevertheless, the Working Document (pp. 16ff.) provides very detailed recommendations with regard to interconnection pricing. Because of this, its influence on future interconnection pricing policies within European telecommunications should not be underestimated. Therefore, the following provides a critical appraisal of the Working Document’s proposals with respect to interconnection pricing. It is obviously not the purpose of the Working Document to provide a thorough analysis of interconnection pricing principles on liberalized European telecommunications markets. Nevertheless, the Working Document (p. 17) makes clear-cut statements in favor of asymmetric interconnection prices to the disadvantage of established carriers. The Working Document (p. 17) argues that a dominant incumbent operator will be in a better position to bear the economic risk of predicting and investing in the additional capacity, and subsequently, that it would be inappropriate for new entrants to pay according to capacity-based interconnection charges. Furthermore (p. 18) it is argued that the linking of interconnection charges to retail prices would lock the new entrant into the same retail tariff structures as those chosen by the incumbent. The purpose of this section is to show that those views are inadequate from an economic point of view. In particular, it is shown that regulatory restrictions with respect to flexible pricing on interconnection tariffs not only unduly restrict the established carrier’s pricing behavior but are also undesired from a welfare economic point of view.
1. Price Differentiation Versus Price Discrimination It is important to note that strategies of price differentiation are not only beneficial from a welfare point of view, but are also compatible with the principle of non-discriminatory access conditions. Moreover, the principle of price differentiation does not contradict the criterion of cost-orientation of interconnection prices. In order to cover stand-alone costs of network services market-driven mark-ups on incremental costs are unavoidable in order to take into account product-group-specific as well as enterprise-specific common costs. In order to apply principles of price differentiation it is important to differentiate between capacity-based (traffic sensitive) costs of shared
68 Lessons and Priorities equipment (e.g., switching equipment), where opportunity costs of usage are depending on the factual loading of capacity on the one hand, and the costs of subscriber-dedicated non-traffi- sensitive local loops (the final link between the customer and the local exchange). There is no doubt that the concept of opportunity costs shall gain particular importance in future interconnection pricing. Direct rivalry for usage of scarce network capacities requires an efficient allocation procedure so that those demanders with the highest preference (willingness to pay) for usage can be served. In other words, (marginal) opportunity costs of supplying a single customer with an additional unit of (scarce) capacity reflect what the next customer (the first one not served) would (nearly) have been willing to pay for that last unit. Since this principle not only holds for the final service market but also for interconnection inputs, the prices for interconnection services must reflect the scarceness of capacities and therefore include opportunity costs (the most valuable foregone alternative, including opportunities foregone in the same market).
(a) Symmetric Peak-Load Pricing Capacity-based (traffic-sensitive) interconnection costs should be covered by peak-load pricing reflecting the factual scarceness (opportunity costs) of capacity.39 Interconnection services must be considered as derived demand for non-storable network services. They must therefore also reflect the varying scarceness of usage-sensitive infrastructure capacity over time. In contrast, uniform, undifferentiated interconnection charges would not be compatible with usage-sensitive tariffs for final network services. Moreover, it is important that all market participants irrespective of whether they are entrants or incumbents are confronted with the same efficient pricing signals. The statement of the Working Document (p. 17) that it would be inappropriate for new entrants to pay according to capacity-based interconnection charges therefore points in the wrong direction, because it entails discrimination against the owner of the capacity. If, for example, the established carrier’s interconnection charges were regulated in such a way that entrants had to pay less than the factual opportunity costs, incentives for discriminatory behavior on the part of the established carrier, such as using his scarce capacity for his own purposes, would be created. As a consequence, asymmetric pricing rules intended to benefit some specific entrants finally create incentives for discriminatory behavior and subsequently impede the competition process. As a further consequence the (implicit) linking of interconnection charges to retail prices should not be surprising, although opposed by the Working Document (p. 18) as incompatible with the requirements of Community law. As derived demand prices for
69 Telecommunications Reform in Germany interconnection services should reflect similar time patterns of capacity-usage as compared with final network services, even the most innovative retail scheme, targeted at different users, must take into account this cost-based characteristic of network usage reflected in peak-load pricing structures.
(b) Symmetric Optional Tariffs It is important to note that strategies of price differentiation usually lead to an increase in market size and therefore not only improve the economic situation of the providers but also of the purchasers of interconnection services. It is to be expected that in the liberalized telecommunications markets of the future so-called optional tariffs will become important. Given that a uniform tariff for usage-sensitive interconnection services cannot be higher than marginal costs (in order to cover fixed costs) it is always possible to improve the individual welfare of all market participants (“pareto improvement”) by means of price differentiation.40 Examples are optional two-part tariffs, where a choice is provided between a low fixed “entry fee” and a high usage charge (for small interconnections demanders), or one with a high fixed “entry fee” and a low usage charge (for large interconnection demanders). Since the small demanders have the option to stick to the uniform tariff or to opt for the two-part tariff (with low “entry fee”) and the big demanders are preferring the two-part tariff (with high “entry fee”), these non-linear pricing schedules are in fact welfare improving. Moreover, as long as such non-linear pricing schedules are offered symmetrically to all market participants, access conditions are non- discriminatory. Pricing regulation which would forbid such price differentiation would therefore be detrimental. It can be expected that the role of multi-part tariffs shall increase under the future competitive environment. Although pricing the subscriber-dedicated local loops for interconnection purposes has been explicitly rejected in the Working Document (pp. 18 f.), the problem nevertheless remains of how to cover their costs. In particular, not only the incremental costs of the final link between the customer and the local exchange but also the stand-alone costs must be covered for the economic position of the provider of the local loop to be viable and for economic incentives for future investments to exist. A first-best economic solution would require a non-traffic-sensitive (flat) subscriber access charge considering access as a separate product with identifiable costs associated causally with providing it and an identifiable demand for the option to receive or make telephone calls.41 Nevertheless, to the extent that a rebalancing of tariffs seems not politically feasible in the short-run, traffic-based allocation of subscriber line costs can be applied. In a recent article, Henriet and Moulin have developed a theoretical/axiomatic approach to cost-allocation, sharing the connecting
70 Lessons and Priorities costs of subscriber I among all of his correspondents in proportion to their traffic with subscriber I.42 Although this is not a first-best solution, at least incentives for inefficient network bypass are avoided. To the extent that interconnection charges entail parts of the costs of the subscriber-dedicated components of the local loop (for a transition period) non-discriminatory access conditions at least require application of symmetric interconnection charges (not discriminating between incumbents and entrants).
IV. Evaluation of the Best-practice Approach The approach taken within the ONP Committee Working Document is to use the interconnection charges in the three lowest cost member states as a starting point. “Best current practice” interconnection charges are planned to be progressively reduced in the future towards a level compatible with a bottom- up LRIC based approach (p. 12). In the following, several arguments are provided why this “best current practice” approach cannot be supported, neither from the standpoint of established carriers nor from the economic point of view.
- Price-regulation of interconnection charges at the “national level” (as proposed on p. 8, Working Document) is completely superfluous and impedes the competition process. Tariffs for interconnection in long- distance networks should not be regulated because they cannot be considered as monopolistic bottlenecks. In its report on network charges of 1997,43 OFTEL already introduced the economically sound principle that for competitive services the established carrier will be free to set his own charges.
- The approach taken in the Working Document (pp. 6ff.) is to compare interconnection charges around the world and to use the interconnection charges in the three lowest cost member states to derive a set of “best current practice” figures, at which to aim in the short term. Such a “best current practice” approach cannot be supported from the economic point of view. Large cost differences for providing interconnection services may be due to differences in costs between different local networks within a country or between countries. Moreover, costs, even nowadays, are dictated to varying degrees by the regulatory provisions of the various regulatory authorities by administrative action. Therefore the allocation procedures, premiums to cover overhead costs, service lives of equipment, and methods of depreciation vary considerably. Moreover, international cost and price comparisons that ignore the capacity
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utilization factors in networks do not provide reliable information. It is also not possible to compare the costs of network usage or network access in different countries without considering the influence of the existing, heterogeneous network architectures and topologies.
- Prices are distorted by subsidies. To varying degrees, regulatory authorities have allowed cross-subsidies to keep local calling charges as well as monthly subscriber line charges low. “Best current practice” interconnection charges do not take into account the differences between countries in the recovering of subscriber-specific (non-usage sensitive) costs. Their informational value is also questionable because they already reflect rate regulation on the country level. In particular, the welfare improving potentials of price-differentiation principles for interconnection pricing are obviously not exhausted. To the extent that—to different degrees in different countries—interconnection charges still have to cover part of the “access deficits,” price comparisons completely fail to provide reliable information on the efficiency behavior of established carriers.
- The Working Document considers the “best practice” approach as transitional, until “bottom-up” LRIC-based costs are available. An immediate consequence of the results reached in this paper is that the “bottom-up” approach would provide an inadequate reference point. Instead, LRIC must be calculated on the basis of real cost data of established carriers (“top-down”). Moreover, LRIC can only serve as a (long-run) lower boundary of individual interconnection charges. In order for the established carrier to be able to survive, the stand-alone costs of all interconnection services must be covered, including product-group specific costs of all interconnection services.
V. The Working Document as Basis for Commission Recommendation on Interconnection in a Liberalized Telecommunications Market
Although the Commission’s Recommendation44 has given broad support to the Working Document, some progress on the level of detailed recommendations can be found within the Recommendation. For example, in meantime the necessity of mark-ups has been stated (Commission’s Recommendation, p. 9). Interconnection charges which are based on forward- looking long average incremental costs may include justified mark-ups to cover
72 Lessons and Priorities a portion of the forward-looking joint and common costs of an efficient operator, as would arise under competitive conditions (Commission’s Recommendation, p. 23). Activity-based costing systems, in which costs are allocated to each product and/or service on the basis of the underlying cost drivers and activities of an efficient operator, are recommended in order to minimize the joint and common costs that cannot be directly allocated (Commission’s Recommendation, pp. 24 ff.). Top-down cost accounting systems based on current costs rather than historic costs are no longer rejected, although strong emphasis is laid on a “top-down” check through reconciliation with interconnection costs calculated according to “bottom-up” forward looking long run average incremental costs (Commission’s Recommendation, p. 9). Unfortunately, similar to the Working Document, strong emphasis is laid on the transitional use of “best current practices” prices during the transition to long run average incremental cost-based systems. Nevertheless, it is important to recognize that the paradigm shift of the Working Document, which contains very concrete and detailed costing and pricing prescriptions for the member countries, is also reflected within the Commission’s Recommendations. Although the Commission’s Recommenda- tions are legally non-binding, their influence should not be underestimated. Firstly, they back up on EU law that requires interconnection prices to be based on costs. Secondly, the Commission could ultimately take a government to the European Court of Justice if it refused to rein in prices without adequate justification. Thirdly, the Commission’s Recommendations may be abused by national regulatory commissions to overregulate the market for interconnection services by detailed inadequate costing and pricing prescriptions.
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COST AND PRICING OF INTERCONNECTION CHARGES IN THE U.S.: LESSONS FOR GERMANY? Ingo Vogelsang
1. THE INTERCONNECTION PROBLEM: WHY REGULATION?
The largest segments of telecommunications markets are not contestable. In fact, local loops and many other portions of the local network are bottlenecks that cannot reasonably be duplicated by entrants. Many other parts of the network (network elements) can be duplicated in principle but they nevertheless represent entry barriers because of sunk costs and economies of scale or because of economies of scope with bottlenecks.45 Also, for cost and demand reasons, telecommunications competition can only work if all competitors can interconnect with each other. Thus, interconnection is the key to telecommunications competition. This has been expressed in the UK as the any-to-any principle and is incorporated in the 1996 Telecommunications Acts of both the U.S. and Germany. Largely because of the interconnection problem, competition has not resulted in worldwide deregulation on a larger scale. On the contrary, competition has tended to increase regulation in most countries. Why does interconnection have to be regulated? Couldn’t antitrust policy solve the problem? Doesn’t the example of New Zealand show that almost total reliance on competition policy can replace telecommunications regulation? Interconnection involves essential facilities that incumbent dominant operators (DOs) do not like to offer entrants voluntarily and at competitive rates. This is also the essence of the New Zealand experience.46 In the U.S. the essential facility doctrine in antitrust might have been invoked instead of regulation to solve the bottleneck problem. However, as explained by Areeda (1990) and Hylton (1991), this doctrine does not work well and, for its implementation, actually requires regulation. Regulatory interconnection policy can, in principle, help to solve the bottleneck problem. What should interconnection regulation achieve in a regime that has abolished legal entry barriers? The first goal is efficient entry, meaning that the efficient market structure in terms of number and size distribution of firms should result. At the same time it means efficient investment, neither wasteful duplication nor under-investment. Production should be cost-minimizing and retail prices efficient in the sense that economic profits vanish and retail prices either approach marginal costs or follow a Ramsey optimal pattern (in case of economies of scale and scope).
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2. INTERCONNECTION PRICING AND RETAIL PRICES
2.1. Objectives Interconnection conditions and prices shape the amount and type of competition in telecommunications markets • by moving retail prices to efficient levels (toward marginal cost prices or Ramsey prices) • by providing incentives for the right type and amount of infrastructure investment. In the presence of network externalities, interconnection is a necessary tool to achieve these objectives. The conditions of interconnection have to follow a delicate balancing act between providing too much incentive for bypass of the incumbent provider’s network (and thereby too little incentive for competition) and providing too little incentive for investment by the incumbent network provider (and thereby too much incentive for competition). If interconnection conditions are too restrictive and charges too high for potential interconnectors there will be too much incentive for bypass of the incumbent provider’s network and, at the same time, too little incentive for competitive entry by interconnectors. If conditions are too liberal and charges too low there will be too little incentive for investment by the incumbent network provider and by entrants, with too much incentive for non-facilities-based entry by interconnectors. The goal of the regulator is to find interconnection conditions and pricing rules that are at the same time approximately optimal and sufficiently robust to perturbations of the relevant business parameters.
2.2. Pricing Rules 2.2.1. The Efficient Component Pricing Rule (ECPR) The interconnection-pricing rule most hotly discussed in the literature is known as the efficient component pricing rule (ECPR).47 It says the DO should charge an interconnection price equal to the incremental resource costs of interconnection plus the so-called “opportunity cost” of interconnection. This opportunity cost is the foregone profit contribution of the DO by providing interconnection to a competitor who might use interconnection to displace services provided by the DO. Thus, the ECPR is driven by the DO’s retail prices. If (a) interconnection and final outputs are generated in fixed proportions and if (b) the DO’s and the entrants’ final outputs are perfect substitutes and if (c) entrants take the DO’s price of the competing final output as given, then the opportunity cost is simply the profit contribution or quasi-rent generated by the DO’s final output (simple ECPR). Otherwise, the opportunity cost may be a fairly complicated term, reflecting cross elasticities of final
75 Telecommunications Reform in Germany demands, technical substitution and types of competition (sophisticated ECPR). The main peculiarity in approach taken by the proponents of the ECPR is the assumption that the price for the final output is given (and chosen optimally) and that the only function of competitive entry is to provide part of the network service at lower cost than the DO. The ECPR is therefore a partial rule that deals only with a specific aspect of network pricing and competition. It has nevertheless proven to be highly policy-relevant. The reasons are that, with the simple version of opportunity cost:
• it is easily understood and practiced, • it is usually embraced by incumbents, • it does not require a change in (regulated) prices of final services and does not interfere with politically popular cross subsidies.
With the more sophisticated version of opportunity costs the ECPR is also theoretically quite attractive but much more demanding on the regulator (see Armstrong, Doyle and Vickers, 1996).
2.2.2. Ramsey Prices Theoretically optimal interconnection prices can be determined under the Ramsey pricing approach taken by Laffont and Tirole (1993 and 1994). This approach simultaneously determines optimal interconnection and final goods prices, and it makes no a priori assumptions about demand relationships, technology and type of competition. Rather, the assumptions vary, as they do in oligopoly models in general. Depending on which assumptions are made, the approach leads to different results. In general, these results are complex in that they have to deal with the DO’s budget constraint, demand relationships, cost relationships and types of competition. This complexity reflects complicated relationships that need to be dealt with and is the price to be paid for general rather than partial optimization.48 Also, the optimal final goods prices themselves obey a complicated markup formula. In reality, a regulator cannot hope to capture all these effects at the same time.49
2.2.3. Cost-based Prices The third approach in the literature is to base interconnection prices plainly on costs. In the form of marginal-cost-pricing the cost-based approach to public utilities was dominant among economists for the better part of this century. It is thus not surprising that cost-based pricing resurfaces, as public utilities enter the competition age. Instead of marginal costs, it is incremental costs that have
76 Lessons and Priorities taken center stage now. Incremental costs equal marginal costs for small output changes but may differ substantially from marginal costs if they include large output changes up to entire services or network components. In addition, stand- alone costs play an important role. They are the costs of a single-product entrant for providing that single service. Under a cost-based approach the stand-alone costs of a (hypothetical) wholesale network operator would be an upper limit for interconnection prices charged by an integrated incumbent. This holds because prices above stand-alone costs would be unsustainable under (hypothetical) competitive conditions. Usually, the lower limit would be incremental costs. Otherwise, the interconnection service would be cross- subsidized.50 While stand-alone costs are always an upper bound for competitive prices, there usually exist smaller upper bounds that would be relevant. Imposing stand-alone costs as an upper-bound constraint on interconnection charges is therefore adequate, while setting them at stand-alone costs would often be too high. For example, a bottleneck is defined by the fact that duplication of the facility by an entrant would not be economical, meaning precisely that supplying the entrant at stand-alone costs would not be feasible. There are good reasons to price interconnection services close to or at the lower bound rather than at the upper bound. As is well known, pricing at incremental costs can only be optimal under specific conditions. In particular, there should be no regulatory incentive problem and the technology should exhibit no economies of scale and scope. Under these assumptions, however, the interconnection problem would be trivial to begin with. There would simply be no bottleneck. So, why have I been among those who have advocated basing interconnection pricing on incremental costs with limited markups (usually staying below stand-alone costs)?51 The first reason is the presumption that economies of scale and scope in the telecommunications industry are no longer very pronounced. This is the basis for allowing competition in the first place. Econometric cost estimates are fairly ambivalent on the prevalence of economies of scale and scope in telecommunications networks.52 At the same time economies of scale and scope appear to prevail at least in parts of networks. However, service-specific economies of scale can be captured in the average incremental costs of those services. Thus, all that would be left are true common costs that do not relate to service-specific scale. As observed by Burton, Kaserman and Mayo (1997), in practice, the size of such common costs tends to be overestimated. The second reason is that interconnection provides for particularly large network externalities (conditional upon entry of other firms) that justify reduced markups of interconnection prices on costs. These network
77 Telecommunications Reform in Germany externalities and the accompanying reciprocity of calling have even generated proponents of a so-called “bill-and-keep” approach under which interconnection would be implemented with zero interconnection charges. If traffic is symmetric and transaction costs of interconnection charges are high, bill-and-keep may be a desirable approach. The third reason is that information about the relevant technological and demand properties necessary to derive Ramsey prices or the ECPR is either unavailable or squarely rests with the DO. This makes it virtually impossible to directly implement the Ramsey approach and the ECPR.53 One could argue that asymmetric or lacking information can be captured in Bayesian incentive schemes using subjective probability distributions. However, such schemes lose much of their power if uncertainty parameters are too vague and too many. Without specific information about demand relationships and the state of competition, uniform markups on incremental costs are an appropriate upper bound for interconnection charges. This holds, among others, because competition makes firm demands more elastic. The fourth reason is that markups over marginal/incremental costs for intermediate inputs create inefficiencies known as double marginalization. Since entrants have their own overhead and other common costs, they have to charge a markup on top of the interconnection prices they pay. Thus, viable competition in the retail market cannot be of the Bertrand type (unless the retail market is sufficiently differentiated). Rather, retail competition itself entails markups and quantity adjustments that reduce the optimal interconnection charge (possibly below incremental cost). The fifth reason is that high interconnection charges are the best instrument for collusion between competing telecommunications carriers. Sixth, high interconnection charges would invite possibly inefficient bypass investments by entrants. Our suggestion therefore has been to impose a burden of proof on the DO. We start out with interconnection prices at average incremental cost of the interconnection service and let the DO justify any markups over and above average incremental costs (Arnbak et al., 1994, Mitchell et al. 1995, Mitchell and Vogelsang, forthcoming). In using this approach, we have deliberately not given the regulator the task to optimize over the whole set of markets, as done by Laffont and Tirole (1993 and 1994). At the same time, in contrast to the ECPR, we do not take the final goods price as given (by regulation or the DO’s market power). Rather, in the short and intermediate term we suggest retail price caps with full rebalancing, while ultimately we want to leave it to competition to determine the optimal prices for the final goods. The philosophy behind this approach is that interconnection and final goods can be sufficiently
78 Lessons and Priorities separated so that (for some time) interconnection can be regulated while the retail services produced with interconnection as an input can be left to market competition. Foreclosure incentives of the DO’s simultaneous pricing in the interconnection market and in the retail markets can be curtailed with the requirement of imputation. Imputation means that the incumbent may not price interconnection (resale, network elements) at a lower price to itself than to others. While internal prices, in contrast to external transaction prices, do not usually have direct allocative effects (because internal payments cancel each other out), they can be used as an accounting device to discover cross-subsidies. The imputation requirement shall thus guarantee that the retail stage is not cross-subsidized. Imputation is a minimum principle to make sure that the incumbent uses no exclusionary practices.54 It still leaves the incumbent with all the benefits from economies of scope, if any, because, under imputation, the incumbent could charge stand-alone costs for the interconnection services and still beat the competition. For this it is important to remember that the total cost of a retail service equals the stand-alone cost of the intermediate input plus the incremental cost of the retail stage. If an entrant has no economies of scope (and no other cost advantage over the incumbent) the entrant could not break even at an interconnection charge equal to the incumbent’s stand-alone cost unless the incumbent makes economic or excess profit. I conjecture the best practical interconnection pricing rule to be cost-based but that the retail prices resulting under competition will ex post yield the ECPR (in the sense that the interconnection charge will equal the incremental cost of interconnection plus the foregone profit contribution). This is trivial for homogeneous Bertrand competition. In cases of heterogeneous goods and other types of competition it would mean that the incumbent would expand in the retail market up to the point where the marginal profit contribution from more retail sales equals that from more sales to interconnectors. Thus, the ECPR is conjectured to appear as an equilibrium result of competition rather than as a starting point of interconnection price setting by an incumbent with market power.
2.3. Price Caps Since the determination of costs is tedious and contentious and always lags behind cost developments, it is advisable to adjust interconnection charges over time under price-cap formulas rather than through new cost determinations.55 The possibility of rebalancing within the set of interconnection services also potentially reduces the issue that interconnection is unbundled into many services with possible economies of scale and scope within the set of
79 Telecommunications Reform in Germany interconnection services. For example, economies of scale and scope may be imperfectly captured under the cost-based approach with initially uniform markups for common costs. These common-cost issues could have justified a separate Ramsey pricing approach within this unbundled set. The main characteristic of the approach taken here is that this Ramsey pricing problem can be seen as separate from the full Ramsey pricing problem that involves the interaction between interconnection prices and final goods prices and that has been treated by Laffont and Tirole (1993, 1994 and 1996). It deserves mentioning that any Ramsey approach that restricts itself to a subset of markets is theoretically inferior to one that includes more markets. However, this view does not take into consideration incentives for cost reduction and for information revelation that are associated with competition, even if it is restricted to a subset of the markets. The question is if the beneficial effects from competition in such markets can compensate for the mistake of not including all markets under a single regulatory constraint relative to the effects from modeling and estimation errors in solving the Ramsey problem. We are confident that it can.
3. U.S. PRICING OF INTERCONNECTION
3.1. Network Interconnection in the U.S. Long-distance competition in the U.S. has been highly successful.56 Interconnection with local networks and equal access were at the heart of this success. After establishment of equal access it was the reduction in interconnection charges that was responsible for most of the price reductions enjoyed by long-distance customers. In contrast, local network competition in the U.S. is still in its infancy. It is, however, starting with a number of large, experienced and financially strong new competitors that include the interexchange carriers (AT&T, MCI, Sprint, and WorldCom), the mobile carriers, cable TV companies, electric utilities, and incumbent local exchange carriers (ILECs) outside their traditional territories. All of these have networks in place that already are complementary to those of the ILECs. In addition, there are the small but fast growing competitive access providers (CAPs), who own broadband fiber rings in business centers and cities and most of whom have by now been acquired by long-distance carriers or cable networks. These companies have for some time been actively engaged in local network competition, and some of them have big plans in this market. However, competition is actually penetrating very slowly. Part of this slowdown is due to continuing disputes about the best interconnection policy, something that has not been fully resolved at this time.
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While local competition has started to emerge in several U.S. states over the past few years, it was supposed to receive a really big push only very recently, from the U.S. Telecom Act. This act is the first major reform of federal telecommunications regulation in over sixty years. Unlike the Communications Act of 1934, the U.S. Telecommunications Act of 1996 (hereafter the U.S. Telecom Act) takes competition (rather than regulation) to be the principal mode of governance for telecommunications markets. The main objective of the U.S. Telecom Act is to further open telecommunications markets and to protect competition against the market power of incumbent dominant carriers. In principle, the new act eliminates barriers to entry and provides substantial entry help to the new competitors of the dominant ILECs. However, in line with a famous proposition by Owen and Braeutigam (1978), according to which the administrative process of regulation slows down change, much less is happening than was expected at the time of passage of the act. Almost two years after passage of the act, the ILECs still control 98-99 percent of the local networks, although local competition through CAPs had already started ten years earlier.57 In contrast, once allowed, entry into long-distance markets today has become much quicker, as shown by GTE’s and SNET’s success in gaining 10 percent market share in their regions within less than two years. A number of the U.S. Telecom Act’s provisions are designed to create opportunities for new local exchange competitors. First, state and local regulations restricting entry into telecommunications markets are to be abolished or declared invalid. Second, the U.S. Telecom Act foresees three entry paths into telecommunications markets that go along with three types of services provided by one telecommunications carrier for another:
1. The first is full-scale network entry. In this case the any-to-any principle requires that calls generated on one network can be completed on another network. Thus, there has to be interconnection for transporting and completing calls. Therefore, all ILECs must allow others to interconnect at all feasible points of their networks. Physical collocation is the rule. ILECs and entrants must transport and terminate calls from each other’s subscribers and compensate each other for this service. Pricing is to be at ILEC’s cost in both directions. This path is fairly uncontroversial, except for the possibility of bill-and-keep pricing arrangements, which entrants like but which are vehemently opposed by ILECs.
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2. An entrant can build partial networks that lack certain facilities, such as local loops. For this purpose, ILECs must offer unbundled network elements that allow entrants to pick and choose. The elements have to be priced to approximate economic costs with allowance for a reasonable return. This path is highly controversial: • because of the types of elements to be included. For example, unbundled local loops are both quite feasible and in high demand. In contrast, unbundled switching has been hard to define and is not demanded much. The most controversial issues are the quality of the operations support system (OSS) to be supplied with unbundled network elements and the question whether entrants should be allowed to rebundle by building whole networks from combining unbundled elements. While the FCC expressly obliged ILECs to allow this, a recent federal court decision denied it. If allowed it could force state regulators to rebalance ILEC retail rate structures wherever they are not cost based.58 • because of the FCC’s pricing requirement that makes entrants share in the economies of scale and scope of the ILECs.
3. Entry can occur via resale of the ILEC’s services. Here, entrants can make use of quantity discounts available under ILEC tariffs and, more importantly, of wholesale discounts. ILECs must offer resale of all their retail services at wholesale prices with a discount equal to their cost savings from not selling at retail prices themselves. This is the simple ECPR applied to the wholesale price.
The pricing methods for unbundled network elements and resale are in some conflict if not all retail prices reflect competitive conditions. Thus, this conflict is one that is most virulent as long as ILECs’ retail prices are regulated under an unbalanced rate structure. In all three cases of envisaged entry, ILECs must offer number portability, allowing a new competitor to take an existing subscriber with her/his telephone number, and dialing parity, allowing subscribers of new competitors to dial without special access codes and without delays. Finally, new entrants must be given access to network infrastructure such as rights of way, ducts and poles, as well as telephone numbers, databases and directories. In order to make these things happen, the telecommunications companies must negotiate in good faith. If agreements are not reached quickly, state regulatory commissions can be asked to mediate or arbitrate. If this doesn’t occur in a timely manner, the FCC becomes the arbiter of last resort. During the
82 Lessons and Priorities first year after passage of the Telecom Act, reaching agreements between ILECs and new competitors has been contentious and has involved many complicated arbitration proceedings. For example, the Massachusetts Department of Public Utilities issued an order in the arbitration between NYNEX and several new competitors on December 4, 1996, but even six months later none of the interconnection agreements under arbitration had been signed. In addition to the provisions cited, the Modified Final Judgment (MFJ) line- of-business restriction barring the regional Bell operating companies (RBOCs) from long-distance services is softened. As a “carrot” to induce the RBOCs to open their local markets to competition, they must first convince their state regulatory commissions, the Department of Justice and the FCC that local competition is developing in its territory. By November 1997 no RBOC had been able to convince the FCC that its local markets were sufficiently open to competition to drop the restriction on long-distance services. The FCC has devised average long-run incremental costs for entire services (TSLRIC) and for entire elements (TELRIC) as cost bases for interconnection prices and prices for unbundled network elements. This means that ILECs would receive the costs (inclusive of cost of capital) for these items including service-specific or element-specific fixed or setup costs (that the incumbent or entrant would incur). In line with the above arguments, the FCC also provided for a limited amount of common costs so that effects of economies of scale and scope were largely included. Katz (1997, p. 22) argues that the resulting interconnection prices might be too high and could encourage inefficient bypass investment by entrants. In contrast, ILECs complained that the resulting prices would not cover their general overhead costs. While state regulators, by a federal court decision, were not obliged to follow the FCC’s pricing rules, many of them did. However, typically, interconnection charges differ from proxies provided by the FCC. At this point in time, the U.S. has refrained from using price caps to interconnection charges in the area of local competition. There is ample experience with price caps for long-distance access to local networks. However, this approach has deliberately not yet been extended, for example, to unbundled network elements. This issue is certain to arise, though, when it comes to renegotiating initial prices.
3.2. Cost Measurement in the U.S. Firms have always measured some form of their costs.59 The measurement of economic costs of individual services or network components (elements) in telecommunications, however, is a difficult undertaking because economic
83 Telecommunications Reform in Germany costs are forward-looking, because of rapid technical progress and because of economies of scale and scope, resulting from the use of long-lived assets. There is consensus today that cost measurement requires three sources or techniques to be used in combination. Bookkeeping is essential for providing most of the quantity and price data for inputs and outputs. Statistical/econometric analysis is important for establishing empirical regularities between variables. Engineering analysis is needed to establish technical relationships that are the basis for functional forms, for example, for economies of scale and scope and for deriving forward-looking cost data. In the U.S. and the UK, cost models are being used to establish universal service costs, costs of interconnection and retail services and costs of individual network elements and the retail function. Measurement of local network costs was pioneered by Mitchell (1990) and is now done by all large ILECs. Most of them have their own cost models which use modules that are often provided by Bellcore (until recently the common research unit of the Bell operating companies). The advantage of these firm-specific models is that they can, in principle, best reflect local geographic and market conditions. At the same time, they and their data inputs are less open to outside scrutiny than models developed and run by independent institutions. However, to the extent that firm-specific models are used in regulatory proceedings, they are getting scrutinized by regulators and adverse parties. For this purpose, other cost models have been developed on behalf of firms competing with the ILECs (the Hatfield Model), of the National Association of Regulatory Utilities Commissioners (the Gabel/Kennet Model) and of a mixed industry group (the Benchmark Cost Model and its derivatives). Most of these latter models are so- called proxy models that, without modifications, can be applied to all regions of the U.S. Only the data input changes from locality to locality. Proxy models tend to depend on a smaller number of data than firm-specific models for which all necessary data are available to the ILECs (but are proprietary). They can be used to check the accuracy and dependability of firm-specific models. In the UK, British Telecom and an industry group (that included BT) developed competing models (BT a top-down model and the industry a bottom-up model) that were reconciled by the Office of Telecommunications with the help of a consulting firm (NERA). In all these processes, a fairly strong consensus across models and jurisdictions emerged about the long-run incremental costs of some network elements, switching and transport in particular. In contrast, the cost measurement for local loops and for operating costs remains contentious. Measuring costs has been an ongoing and controversial issue. Cost measurement problems arise for a number of reasons.
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• There can be conflict about the appropriate economic cost category to be measured. The candidates are marginal costs, incremental costs, stand-alone costs (and fully allocated costs).
• Once agreement has been reached on the cost category, a method of measurement has to be chosen. At stake are the proper mix of bookkeeping, engineering and econometric methods as well as bottom- up versus top-down and firm- or location-specific versus general (proxy) model.
• Last, the data inputs for the models have to be collected. These can be actual purchase and consumption data, which are often proprietary and therefore unavailable, or they can be publicly available data from statistics and the trade press.
Cost measurement based on actual data appears to be naturally superior to measurement based on estimated or average data. For that reason actual data should be made available to the regulator. An incumbent TO cannot complain that data used by outsiders are incorrect but at the same time withhold the correct data. But the stated superiority of actual data may not hold at all, for the following reasons:
• Future and efficient costs are being measured, and the actual data may reflect cost inefficiencies. These could include waste, old technologies, excess capacities and more. For example the loop costs in the former East Germany may be exaggerated because not all households are connected yet or because capacity leap-frogging has occurred.
• The way data are presented may distort cost measurement. For example, Burton, Kaserman and Mayo (1997) argue that regulated monopolists in the U.S. have an incentive to overstate common costs relative to directly attributable costs.
The use of actual cost data in regulation (and long-term contracts) is known to provide weak incentive effects. In contrast, because proxy models are built on (price and quantity) data that are not firm specific and location specific, they can function as benchmarks with strong incentive effects. Thus, it is not clear that, for pricing purposes, firm-specific models are superior to proxy models. For the purpose of determining universal service costs, the FCC is now trying to reconcile various cost models.
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The FCC, in its Local Competition Order, developed a cost methodology that closely resembles the one suggested above in Section 2.2.3. The FCC derived proxy cost data from cost models used in state regulatory proceedings that had used similar methodologies. The prescription of these numbers and the methodology for state regulatory proceedings has, however, (until now) successfully been challenged before the courts. Thus, at this point, there does not exist an official U.S. costing methodology, although most states have adopted the FCC methods, though not necessarily the FCC’s numbers. No good models currently exist for operating costs and for the costing of the retail stage. In these cases, bookkeeping costs have been used at least as the starting point. This is not so bad because, in this case, most of the costs are incurred simultaneously with their expenses so that depreciation and valuation issues hardly arise. However, they may still be inefficient. What could, in principle be done is the estimation of the frontier cost function for these items from the standardized bookkeeping data of all ILECs.
4. U.S. SOLUTIONS TO GERMAN PROBLEMS?
4.1. Cross-country Learning? Learning from other countries’ experiences is always difficult, especially if countries differ substantially. Many past differences between the telecommunications sectors of the U.S. and Germany have shrunk or vanished recently. No longer is Deutsche Telekom a fully state-owned monopoly. Rather, it is a regulated, partially privatized firm facing competition in all its markets from 1998 onwards. However, the U.S. and Germany continue to differ in at least four areas. First, Germany lacks some of the regulatory problems encountered by the U.S. division of labor between federal and state regulation, although one can argue that similar problems arise for Germany relative to the European Commission. As a result of the U.S. federal system, U.S. telecommunications regulation has a complicated and sometimes inefficient two-tier structure and varies substantially between the fifty states of the union. As is only too obvious right now, the two-tier U.S. structure leads to disputes about the correct regulatory level to apply, and these disputes retard regulatory reform efforts. Thus, for example, not so much can be learned from the experience with the U.S. Telecom Act because much of it is in the hands of the courts and not yet implemented.60 Second, as a result of the 1984 AT&T divestiture that followed the 1982 consent decree (known as the Modified Final Judgment or MFJ), most of the U.S. telecommunications markets have been vertically separated into local and
86 Lessons and Priorities long-distance providers. While reintegration occurs at this time, vertical separation is still dominant among ILECs. Third, the U.S. has the much larger land area that, on average, is as thinly populated as the least populated areas in Germany (the 5 percent of Germans living in the least populated areas still experience twice the population density of the forty-eight contiguous U.S. states.). Population density is a main determinant of telephone line density which, in turn, is highly correlated with loop costs, transport costs and, to a lesser extent, switching costs. Nevertheless, the U.S. has several more densely populated states and population centers that are quite comparable to Germany. So, careful cost inferences can be drawn. A major implication of the different population densities (and the more unequal U.S. income and wealth distribution) is that the universal service problem in the U.S. is and has for a long time been much more pronounced than in Germany. Fourth, the U.S. has much more experience than Germany with regulation of private firms and with competition in the telecommunications sector. This last difference is, however, the main reason why Germany may have something to learn from the U.S. At the same time, some of the consequences of a long history of regulation do not apply to Germany. One can argue that the long history of regulation has resulted in some property rights in the status quo of regulation and that therefore some practices required to facilitate competition could represent regulatory takings in the U.S. (Sidak and Spulber, 1996). Aside from the fact that this view is highly controversial,61 it would not apply to Germany because of its lack of regulatory history. This does not, however, totally preclude takings claims in Germany that could be based on a violation of the German Telecommunications Act of 1996 (hereafter German Telecom Act), which itself was fully known at privatization of Deutsche Telekom.
4.2. German Problems 4.2.1. Interconnection/Bottlenecks History sometimes repeats itself. Worldwide, incumbent DOs tend to drag out interconnection negotiations with new rivals by demanding high interconnection charges and by raising technical feasibility issues. This has happened, for example, in the UK between BT and Mercury in 1984/85 and in the U.S. between ILECs and new entrants in the early 1990s. It has most recently happened between Deutsche Telekom and various entrants. By refusing to interconnect, the incumbent DO can prevent a competitive entrant from having its subscribers complete calls to subscribers on the DO’s network. This hurts the entrant much more than the DO because only few calls need to be completed in the opposite direction. This asymmetry of interests provides the incumbent DO with incentives to drag out interconnection negotiations,
87 Telecommunications Reform in Germany provide poor interconnection services and charge high interconnection prices. Thus, it appeared to be clear that the incumbent DO can only win by delay because the DO has little to gain from quick interconnection while the entrant’s very existence depends on it. However, in all three of the above cases the incumbents’ approach backfired and they missed out on the opportunity to settle at mutually acceptable negotiated conditions. Instead, regulators were called in. In the UK this resulted in speedy interconnection at rates that (initially) favored Mercury. Similarly, in the U.S. interconnection conditions and rates as stipulated by the U.S. Telecom Act did away with advantages that ILECs probably could have maintained in voluntary negotiations.62 Now Deutsche Telekom finds itself in a similar position. The UK and U.S. experience should be sufficiently powerful to prove (a) that various interconnection arrangements (including unbundling) are technically and economically feasible and (b) that cost-based interconnection charges do not cripple incumbent DOs. Because competition in Germany is just starting, there are likely to be more bottlenecks than in the U.S. and UK where duplicate facilities often already exist. The current bottlenecks in German telecommunications appear to be the following:
• network access to single-line subscribers (local loops) • local switches • telephone numbers • access to network intelligence and to certain databases.
Will they go away? Have bottlenecks gone away in the past? Long-distance competition may look like a good example. Long-distance networks today are not considered bottlenecks. However, in the U.S., there were no bottlenecks even twenty years ago. There are likely to be no bottlenecks in Germany as well.63 So, the absence of bottlenecks in the long-distance parts of networks cannot be used as an argument that all bottlenecks will eventually disappear. Any reduction in bottlenecks will depend on a number of developments, such as the density of networks, growth of markets (geographic and otherwise), available capacities, and new technologies with less sunkness. The U.S. experience with interconnection of bottleneck services and network components started with MCI’s entry in long-distance services that required access to local networks. Then came the interconnection of information service providers in the so-called ONA (open network architecture) proceedings that started to open the network components themselves to firms other than incumbent local exchange carriers. Although
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ONA was not a very successful undertaking, it lay the groundwork for physical access to local networks in the Expanded Interconnection proceedings that promoted physical and virtual collocation of other firm’s interconnection equipment at ILEC network nodes.64 At the time of these proceedings, in 1993, Ameritech offered to provide unbundled network components to competing carriers (in exchange for the permission to offer long-distance services) and Rochester Telephone offered to split itself into a wholesale provider and a retail service provider. All these developments are the predecessors on which the U.S. Telecom Act builds. The act establishes the interconnection requirements mentioned above. Since the German Telecom Act has fairly similar requirements, the U.S. experience would be highly relevant. The U.S. provisions have, however, not all been fulfilled yet, as expressed by the fact that the FCC and Justice Department have so far rejected all RBOC applications for permission to enter long-distance services in their territories on the grounds that local competition has not yet been established. Nevertheless, experience demonstrates the feasibility of providing resale of local services and of providing a number of unbundled network elements, local loops in particular. By spring 1997, Ameritech Michigan, for example, had provided 70,000 unbundled loops to competitors. At the same time, unbundled switching had not been provided at all. Problems have appeared with the provision of support services, such as repair and maintenance, that go along with unbundled elements. Also, the speed of transfer of loops has been an issue. Thus, the experience is that most elements can be unbundled but perfect and seamless unbundling (under which customers do not detect that they continue to be served by the ILEC) remains elusive. So, while the U.S. experience with bottleneck services is positive, it is worth observing whether the price for perfection is not too high.
4.2.2. Incumbency Burdens (Altlasten) Incumbents often claim that they face burdens relative to entrants. The most common of these claimed burdens are sunk in the sense that they are not influenced by current decisions. This could hold for ongoing costs of assets that were purchased in the past at high historic costs and have not been depreciated sufficiently to reflect their current market value. Deutsche Telekom, for example, claims that its DM45 billion investment in the former East German infrastructure is such a burden.65 It also faces pension costs for civil servants formerly employed by its predecessors. (For the next few years these costs are predetermined payments per annum which Deutsche Telekom has to pay into a government fund.) Incumbents also may face future expenses (or reduced revenues, see below) imposed on them by past or current regulatory restrictions
89 Telecommunications Reform in Germany but which depend on current decisions of the firm. For Deutsche Telekom the main future expenses are the costs of reducing its workforce. There appear to be three reasons why incumbency burdens might give incumbents an excuse to charge higher prices or to receive subsidies. The first is that fairness may require compensating the incumbent for burdens that other firms (entrants) are not facing. At first blush, this seems to be entirely reasonable. However, two other fairness considerations counter it:
• Usually, the incumbent enjoyed past privileges that others were cut off from (through entry prohibitions). These privileges enriched the incumbent. However, as the downside, the incumbent may have invested or made commitments beyond the time when the privileges would expire. The question therefore is if the incumbent could have trusted that privileges would persist. This can only be a valid excuse if the incumbent made irreversible decisions with the assurance that there would be no competition. In the U.S. this is a much-debated issue because competition had cast its shadows for a long time. In Germany, the question is if such expectation could have existed at the time of Deutsche Telekom’s partial privatization in late 1996. Until that point in time all decisions regarding Deutsche Telekom and its regulation were internal to the federal government so that no outside owners had committed funds that would have been adversely affected by regulatory decisions. Expectations at the time of privatization and thereafter would be relevant, though. Such expectations could be based mainly on the German Telecom Act and, to some extent, on Deutsche Telekom’s prospectus for the sale of shares (which partially includes the government’s interpretation of the Act).
• The stronger counter-argument against accepting incumbency burdens under the fairness argument, however, is that incumbents enjoy present incumbency advantages in the form of unmatched name recognition, know-how, infrastructure, etc., for which, in turn, the entrants would have to be compensated. These advantages have been accumulated under monopoly in part because entrants have been kept out. Such advantages usually by far outweigh the incumbency burdens (in the case of Deutsche Telekom probably by a 10:1 margin).
A fairness (or equity) reason for providing relief from a burden is rooted in some popular consensus that may allow for some sacrifice of efficiency. We have not found sufficient reason for such a consensus. However, there may
90 Lessons and Priorities actually exist efficiency reasons for granting such relief. The argument here would be that, without the relief, the DO (or entrants) would make decisions that would hurt either static or dynamic efficiency.66 The second reason is thus one of static efficiency. It relates to two cases:
• The first case involves historic decisions by the incumbent that lead to future outlays that entrants do not face because they start with a clean slate. This holds, for example, for Deutsche Telekom’s payments into a fund for pensions and other expenses for the civil service status of some of its employees. However, these are adjustment costs that arise on account of technical, market and organizational change rather than through competition per se.
• The second case relates to assets etc. that become obsolete because competition reduces or otherwise changes the demand for the incumbent’s products. Clearly, under competition the incumbent DO loses market share. In principle, this argument holds for any dominant firm in any market if competition arrives. The main question from an efficiency perspective is whether the total costs in the market are increasing because competition is rendering some of the incumbent’s assets obsolete. This may occur precisely if the incumbent charges too high interconnection prices to competitors who therefore build their own facilities. Thus, to prevent this inefficiency, interconnection charges have to be set such that duplicative investment is avoided if it increases total costs.
The third reason is one of dynamic efficiency. It says that the incumbent has had a regulatory contract that, for example, required a large workforce in the past or disallowed market-based depreciation of assets. If the firm receives no full compensation for these incumbency burdens it cannot or will not invest efficiently in the future (nor will others that may one day be in a similar position). This is actually an argument about the lack of commitment by a regulator that may lead to long-run inefficiency. Here are again two cases:
• The first is that, because of the financial hardships (reduction in cash flow) caused by incumbency burdens, the incumbent may be unable to raise the funds necessary for investments. Thus, even an efficient incumbent may be precluded from efficient investment.
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• The second case relates to the reputation effect from breach of regulatory commitment. Even if the incumbent DO generates enough cash flow, new investments may appear to be unprofitable because of the danger that the regulator will in the future “expropriate” the assets by not allowing the firm to recover its investment. This argument can spill over to other industries and countries where sub-optimal investments would be observed. This argument is unlikely to hold for a firm like Deutsche Telekom that has just been privatized and is subject to a new law and a new regulator, provided the German Telecom Act is applied correctly and public promises made by the government before privatization are kept. Then, no regulatory contract would be breached or reputation of regulatory commitment negatively affected. The reputation argument may hold for an evolutionary situation, like in the U.S., but even here the question is to what extent the change could have been reasonably anticipated at the time of investments or at the time of entering into employment contracts.
Again, on the efficiency side we found little reason in favor of granting relief for incumbency burdens. The case is weakened further by the fact that the relief itself would consist in price increases that would hurt competition and efficiency. In the U.S., incumbency burdens are usually invoked with respect to depreciation provisions (stranded investments) and services provided in low- density areas. ILECs have generally dealt with excessive workforces in a more quiet way. Most of them are now slim, in part due to incentive regulation, in part due to the threat of competition. ILECs also have generally adjusted the bookkeeping valuation of their assets to current market values. By far the largest issue is that of low-density service areas; this is currently attacked under the universal service provisions discussed below. In conclusion, the argument of incumbency burdens has only a weak basis in equity and efficiency. This holds for Deutsche Telekom in particular because of strong continuing incumbency advantages and because no regulatory contract would be breached by denying incumbency burdens.
4.2.3. Access Deficits The access deficit issue refers to incumbency burdens on the pricing side. In particular, charges for retail subscriber access (connection fees and monthly fees) may be underpriced relative to usage fees. As in the case of cost burdens, questions of equity and efficiency arise. Contrary to the case of cost burdens, however, price burdens are more easily resolvable, provided the regulator
92 Lessons and Priorities allows the incumbent DO to rebalance its rate structure. This is something that U.S. ILECs may have a harder time with than Deutsche Telekom. U.S. local rates continue to be regulated by state PUCs that are under political pressure to keep residential local rates down. My interpretation is that Congress, through the pricing provisions of the U.S. Telecom Act on the unbundled network elements and wholesale discounts, wanted to force states to allow rebalancing of local tariffs between and within states. However, that has not yet happened. The German Ministry of Posts and Telecommunications recently decided not to allow access deficit contributions as part of Deutsche Telekom’s interconnection charges. The regulator expressly reiterated that the firm may rebalance its price structure, and Deutsche Telekom had previously publicly acknowledged that it does not feel constrained by the regulator (Deutsche Telekom, 1996, p.26). Thus, Deutsche Telekom must have some preference for its current rate structure. I have argued elsewhere (Vogelsang, 1996) that Deutsche Telekom’s rate structure does not appear to be cross-subsidized. One- time and monthly subscriber payments are at least as high as in the UK and in those U.S. states that have comparable population densities. However, for the sake of argument, let us assume that Deutsche Telekom had priced consumer access below its cost. Would that be a sign of a regulatory constraint? Not necessarily, since a monopoly firm may well maximize its profits (in a two-part pricing arrangement) by pricing access below cost, as shown, for example, by Schmalensee (1981) in a constant-returns-to-scale framework. This can happen even without income effects and network externalities, simply because lower end-user subscription charges lead to more subscribers which, in turn, increase demand for usage. Thus, an incumbent monopolist or DO could have a long-run interest in a cross-subsidized rate structure. However, with the advent of competition and (coincidentally) with full telephone penetration, the incumbent’s interest in low access/high usage prices is likely to fade. At the same time, rebalancing may entail a rate shock that could prove unpopular and reduce Deutsche Telekom’s goodwill. Thus, Deutsche Telekom definitely prefers high interconnection charges to higher fixed subscriber tariffs.
4.2.4. Cross-Subsidies and Universal Service Although a pricing policy that is financed within the industry can affect “universal service” only if it has some focus on marginal consumers, virtually all past universal service policies have involved such broad-based cross- subsidies that almost every user was both a payer and a receiver of the subsidies. This is usually inefficient but can be politically desirable, especially under incomplete and asymmetric information about the consequences of price
93 Telecommunications Reform in Germany structures. If a universal service policy is maintained in the long run it will require some form of regulation that may, at the same time, impede deregulation of competitive aspects of the industry. Is a universal service policy therefore really required in the long run? Universal service policies are so popular because telecommunications has a broad user base that includes almost the total population. Universal service is a catchword similar to the “security of energy supply” that can be used by politicians to channel subsidies and reduce competition. In the U.S., this has worked for a long time during which implicit and explicit subsidies to rural areas have increased substantially. Regulation-induced cross-subsidies are a major tool of regulatory interest group policy. They totally interfere with competition. Such cross-subsidies have been substantially reduced in the UK in a twelve-year process that started with the first price-cap regime. In the U.S., rate rebalancing progresses at various speeds, depending on state public utility commissions. As a rule, rate rebalancing is more advanced the more progressive a commission is in implementing competition. Forerunners in rebalancing are Illinois and California. Major rebalancing can be expected from the ongoing U.S. universal service reform and is part of the recent access charge reforms. It will also likely be forced upon state regulators by the implementation of the competition rules of the U.S. Telecom Act. Can such rebalancing be expected in Germany? Not likely. As argued below, the cost of universal service in Germany is much lower than in the U.S. where vast rural areas are subsidized. Deutsche Telekom has not threatened rebalancing for the near future.67 Regulation-induced cross subsidies tend to vanish only slowly and may require a conscientious policy of dealing with large rent transfers and remaining equity issues in the form of an explicit universal service policy. In that sense, independent of its long run economic justification, a universal service policy may be necessary to overcome resistance (of DOs and affected user groups) against competition, free entry and deregulation of retail (and possibly wholesale) rates. Opposition of the DO against incremental-cost-based interconnection prices can be overcome much more easily if funds from a universal service pool can be used to support high-cost or low-revenue endusers. In fact, universal service policy may help to make the introduction of competition a Pareto improvement. In the U.S., universal service has a long tradition, although most of the universal service policy has in the past been implicit, in the form of broad cross- subsidies, rather than explicit (lifeline and link-up programs). Germany’s waiting lines for telephone services that persisted well into the 1970s would have been politically unacceptable in the U.S. The U.S. Telecom Act has just widened the scope of universal service to include enhanced telecommunica-
94 Lessons and Priorities tions services for health care providers, schools and libraries. The universal service provisions were required to get approval to the law by representatives from rural states. The law also allows for the definition of universal service to be adapted by the FCC to new circumstances. Given that the U.S. has vast low- density and remote areas, universal service is soon officially going to become a multibillion-dollar industry. Abolishing universal service or reducing it to a welfare program is likely to be extremely difficult here. Countries, such as the UK and Germany, that start out universal service with a more limited approach and have denser and more homogeneous populations are more likely to be able to deregulate universal service should it become obsolete or dwindle. In contrast to the U.S., calculations of universal service costs in the UK indicate that, from a financing perspective, universal service could be a nonexistent problem.68 That does not mean that specific user groups in remote areas or with low income would not be harmed without access to low subscription rates. The empirical question is if the market without such policies would not provide those rates. To what extent would, without universal service obligations (and/or subsidies), a dominant or competitive telecommunications operator deaverage geographic rates or charge high rates to low users? This is an empirical question. Evidence from other competitive service markets (e.g., airlines) suggests that price differentiation often works in favor of users with low willingness to pay who are content with lower quality service. Thus, complete cutoff of users may be an exceptional problem precisely because competition generally results in increased and even excess capacities. The remaining universal service issue could then be dealt with as an annex to other, welfare-type programs that are user-specific and require no interference in the telecommunications industry. In the U.S., foodstamps would be the analogy. They certainly do not make the food retail sector a regulated industry. While the German Telecom Act provides for a universal service policy, this is not triggered automatically. Rather, invoking universal service policy first requires a threat by the incumbent DO(s) to abandon service in an area. Holding back on universal service policy makes sense in a country with no specific universal service policy tradition, high telephone penetration, fairly small income disparities and fairly small disparities in population density. At the same time, the costs of universal service are likely to be as small in Germany as in the UK. If that is true, then the real economic costs of a universal service policy are its administrative burdens and its potential interference with competition.69 The real danger of universal service policies is that they prevent competition from fully effecting prices. That is why universal service policies have to be restricted to a small set of deserving subscribers. If there is anything to be learnt from the U.S. it is not to emulate their universal service policy.
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4.2.5. Collusion The current contentious relationships between incumbent DOs and entrants do not raise the imminent specter of collusion. The telecommunications sector is probably subject to most of the same collusion problems as other concentrated industries. On top of those, however, telecommunications may become particularly prone to collusion for reasons similar to those that favor integration of telecommunications companies. In addition to competing with each other telecommunications firms have to collaborate with each other in the form of interconnection, provision of unbundled network elements and in the resale of services. All these collaborations occur, in principle, between all competing firms in the industry and on an ongoing basis. The collaboration is also sufficiently complex that it requires close relationships. Such collaboration between multiproduct firms in the form of reciprocal dealings has, in the past, been viewed as one of the reasons for reduced competition in some other sectors, such as the oil industry. We have little experience in this respect with the telecommunications industry. Due to the antagonistic political process that jump-starts competition, initially the problem of collusion will be minor. However, over time it may well increase significantly. This is further enhanced by merger activities among new competitors in local networks. Such consolidation has occurred in both countries but may be more of a problem in Germany than in the U.S., since in Germany the number of interacting competitors is likely to remain smaller. Collusion then need not occur in explicit forms but will be more subtle and therefore less subject to antitrust scrutiny. The question then arises if intermediation in collaborations between competitors by regulators could help reduce the incentive to collude.
4.2.6. Determination of Costs One might think that, if at all, measurement of its network costs is Deutsche Telekom’s problem. However, if interconnection charges are to be based on costs, cost measurement becomes a general problem for the telecommunica- tions sector. In terms of costing, Germany could, in principle, learn from the U.S. experience about cost models. I have alluded to some of these lessons in an earlier study, which resulted in a substantial dispute.70 I do not want to repeat those arguments and numerical conclusions here. However, there are meta- conclusions for interconnection costing and pricing suggested by this episode. The first is that costing itself is such a controversial issue that the incumbent DO and the entrants are unlikely to agree on the types of costs to be applied and on cost figures corresponding to each cost type. The confidentiality with which Deutsche Telekom treats its cost data exacerbates this problem. Thus, it is
96 Lessons and Priorities important to find a way to bridge the gaps. What the U.S. (and UK) experience suggests is that the regulator should function as a mediator for cost modeling efforts by the industry. Since Deutsche Telekom by law has to reveal cost data to the regulator but not to its competitors, the regulator is the only institution that can question Deutsche Telekom’s cost data. That does not, however, preclude others, such as the entrants and researchers, from developing alternative cost models (and their own cost data). It also does not preclude the regulator from sharing the cost modeling efforts with the industry and experts. Something that definitely has to be avoided is that Deutsche Telekom uses its proprietary data and a proprietary cost model that cannot be critiqued by outsiders. Rather, the model should be transparent and available so that it can be analyzed and can be fed with cost data supplied by others. In order to agree on such a model, the regulator should establish a group of experts representing the licensed telecommunications operators, the regulatory body and independent experts (such as the WIK).
5. CONCLUSIONS
The lessons from the U.S. on interconnection policy are a mixed bag. Interconnection and equal access were at the heart of successful competition in the U.S. long-distance markets. After establishment of equal access, the reduction in interconnection charges was responsible for most of the price reductions enjoyed by long-distance customers. Using interconnection policy to open local telecommunications markets to competition appears to be substantially more difficult because it is here where bottlenecks have to be made accessible to competitors. This is a contentious and complex task. Paramount among the competitive provisions of the U.S. Telecom Act are the duties of the ILECs to provide unbundled network elements and to provide wholesale rebates to resellers of all their services to end-users. As a result, new competitors can, in principle, start offering local services anywhere, without necessarily having to invest in their own networks. In addition, they have a right to interconnection with the ILECs, to nondiscriminatory access to rights-of- way, and to number portability. At the same time, most of the largest ILECs will receive the long-awaited permission to offer long-distance services in their regions only if they can demonstrate that local competition is happening there. Although the new competitors and the ILECs are free in principle to reach voluntary agreements about their mutual cooperation, the regulators are always the arbitrators of last resort. As a result, in the short run, regulation actually has been increasing. In addition, traditional cross subsidies will soon have to be replaced by an explicit universal service policy, and a reform of interexchange
97 Telecommunications Reform in Germany carrier access charges is being implemented. In principle, the arbitrage possibility of long-distance carriers to substitute ILEC access charges with unbundled network elements may force ILECs to lower long-distance access charges even more quickly. Similar forces may be at work with regard to ILEC end-user tariffs. However, as long as local competition is not well established, ILECs are not forced to rebalance their retail prices. On the contrary, state public utilities commissions, by setting maximum prices for basic services, often prevent ILECs from rebalancing. At this point in time, U.S. policy on local competition has been frustrated by technical difficulties and by legal battles before courts and regulatory commissions. The U.S. experience shows that:
• Resale of local services is important for entrants but hard to provide in such a way that quality equal to the incumbent’s service can be guaranteed. • Unbundled network elements vary in importance, the most important being unbundled local loops. Again, quality is important, in particular, when it comes to the quality of repair and maintenance. Instead of opting for elusive perfection price discounts (like for unequal access) may be in order. These could decline as quality improves over time. • The U.S. carries some historic ballast, for example, fairly high long- distance access charges. It is now recognized that interconnection charges for the same service should not be differentiated by use. • The U.S. overemphasis on universal service is motivated largely by distributional and political concerns that do not hold in a similar way in Germany. • The U.S. and the UK have experience with cost measurement that would be useful for Germany.
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Albach, Horst, Günter Knieps, John Panzar und Bell Communications Research, Costing und Pricing in wettbewerblichen Telekommunikationsmärkten, Study for Deutsche Telekom, January 1997.
Areeda, Philip, “Essential Facilities: An Epithet in Need of Limiting Principles,” Antitrust Law Review 58, 1990, pp.841-869.
Armstrong, Mark, Chris Doyle and John Vickers, “The Access Pricing Problem: A Synthesis”, Journal of Industrial Economics 44, 1996, pp.131-150.
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Brunekreeft, Gert, “Local versus global price cap: A comparison of foreclosure incentives,” Discussion paper #36, Institut für Verkehrswissenschaft und Regionalpolitik, Albert-Ludwigs-Universität Freiburg/Breisgau, June 1997.
Arnbak, Jens, Bridger M. Mitchell, Werner Neu, Karl-Heinz Neumann, and Ingo Vogelsang, “Network Interconnection in the Domain of ONP,” Final WIK/EAC Report of Study for the European Commission, Brussels, November 1994.
AT&T (1996), “Reply Comments of AT&T Corp.,” CC Docket 96-98, May 30.
Baumol, William J., “Some Subtle Issues in Railroad Regulation,” Journal of Transport Economics 10, 1983, pp.1-2.
Baumol, William J., and J.Gregory Sidak (1994), Toward Competition in Local Telephony. Cambridge, Mass.: MIT Press and American Enterprise Institute Press.
Brock, Gerald W., “Local Competition Policy Maneuvers,” in G.L. Rosston and D. Waterman (eds.), Interconnection and the Internet, Selected Paper from the 1996 Telecommunications Policy Research Conference, Mahwah, NJ: Lawrence Erlbaum Associates, 1997, pp.1-14.
Burton, Mark L., David L. Kaserman and John W. Mayo, “The Economics of Common Costs: Lessons from (and for) Regulatory Policy,” Paper Presented at AEI Conference “Pricing and Costing a Competitive Local Telecommunications Network,” Washington, November 4, 1997.
Deutsche Telekom AG Bonn, “Unvollständiger Verkaufsprospekt,” 3. Oktober 1996.
“Deutsche Telekom mit Gewinnsprung und deutlichem Umsatzplus im 1. Halbjahr 1997,” www.dtag.de/aktuell/presse/archiv/091897.htm.
FCC, Implementation of the Local Competition Provisions in the Telecommunications Act of 1996, First Report and Order, CC Docket 96-98, FCC 96-325, issued August 8, 1996.
Gabel, David, and Richard Gabel, “The Application of Cost Data in the Telecommunications Industry,” Paper Presented at the 25th Telecommunications Policy Research Conference, Alexandria, Virginia, September 27-29, 1997.
Hylton, Keith H., “Economic Rents and Essential Facilities,” Brigham Young University Law Review, 1991, pp.1243-1291.
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Johnson, Leland L., “Telephone Assistance Programs for Low-Income Households: A Preliminary Assessment.” Technical Report R-3603 NSF/MF, RAND Corpora- tion, Santa Monica, February 1988.
Katz, Michael L., “Economic Efficiency, Public Policy, and the Pricing of Network Interconnection Under the Telecommunications Act of 1996,” in G.L. Rosston and D. Waterman (eds.), Interconnection and the Internet, Selected Paper from the 1996 Telecommunications Policy Research Conference, Mahwah, NJ: Lawrence Erlbaum Associates, 1997, pp.15-32.
Knieps, Günter, “Phasing out Sector-Specific Regulation in Competitive Telecommunications,” KYKLOS, Vol.50, 1997, Fasc.3, pp.325-339.
Kress, Carl B., “The 1996 Telekommunikationsgesetz and the Telecommunications Act of 1996: Toward More Competitive Markets in Telecommunications in Germany and the United States,” Federal Communications Law Journal 49(3), April 1997, pp.551-619.
Laffont, Jean-Jacques, and Jean Tirole, A Theory of Incentives in Procurement and Regulation, Cambridge, MA: MIT Press, 1993.
Laffont, Jean-Jacques, and Jean Tirole, “Access Pricing and Competition,” European Economic Review 38, 1994, pp. 1673-1710.
Laffont, Jean-Jacques, and Jean Tirole, “Creating Competition Through Interconnec- tion: Theory and Practice,” Journal of Regulatory Economics 10, 1996, pp. 227- 256.
MacAvoy, Paul W., The Failure of Antitrust and Regulation to Establish Competition in Long-Distance Telephone Services, MIT Press and AEI Press, 1996.
Masmoudi, Hautam, and Francois Prothais, “Access Charges: An Example of Application of the Fully Efficient Rule - Mobile Access to the Fixed Network,” mimeo, April 1994.
Mitchell, Bridger M., “Incremental Costs of Telephone Access and Use,” Report R- 3909-ICTF, RAND Corporation, Santa Monica, July 1990.
Mitchell, Bridger M., Werner Neu, Karl-Heinz Neumann, and Ingo Vogelsang, “The Regulation of Pricing for Interconnection Services,” in Gerald Brock (ed.), Toward a Competitive Telecommunication Industry - Selected Papers from the 1994 Telecommunications Policy Research Conference, Mahwah, NJ: Lawrence Erlbaum, 1995, pp. 95-118.
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Mitchell, Bridger M., and Ingo Vogelsang, “Markup Pricing for Interconnection: A Conceptual Framework,” in David Gabel (ed.), Opening Networks to Competition: The Regulation and Pricing of Access, Boston: Kluwer Academic Publishers, 1998.
Oftel, “Universal Telecommunication Services: Proposed Arrangement for Universal Service in the UK from 1997,” Consultative Document, London, 1997.
Perl, Lewis, and Jonathan Falk, “The Use of Econometric Analysis in Estimating Marginal Cost,” in Telecommunications Costing in a Dynamic Environment, Proceedings of the Bellcore – Bell Canada Conference on Telecommunications Costing, Held 5-7 April 1989 in San Diego, pp. 825-846.
Schmalensee, Richard, “Monopolistic Two-Part Tariff Arrangements,” Bell Journal of Economics 12, 1981, pp.445-466.
Shin, Richard T., and John S. Ying, “Unnatural Monopolies in Local Telephone,” RAND Journal of Economics 23, 1992, pp.171-.
Sidak, J. Gregory, and Daniel F. Spulber, “Deregulatory Takings and Breach of the Regulatory Contract,” New York University Law Review 71, 1996, pp. 851-999.
Vogelsang, Ingo, “Kosten des Ortsnetzes,” Studie des VTM, Mai 1996.
Vogelsang, Ingo, “Die DTAG-Studie ‘Costing und Pricing in wettbewerblichen Telekommunikationsmärkten’: Ansätze, aber keine Antworten,” mimeo, Boston University, August 15, 1997.
Vogelsang, Ingo, and Bridger M. Mitchell, Telecommunications Competition: The Last 10 Miles, MIT Press and AEI Press, 1997.
Williamson, Oliver E., “Deregulatory Takings and Breach of the Regulatory Contract: Some Precautions,” New York University Law Review 71, 1996, pp. 1007-1020.
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INFRASTRUCTURE COMPETITION AND LOCAL-LOOP UNBUNDLING Martin Cave & Peter Crowther
1. INFRASTRUCTURE VERSUS SERVICE COMPETITION
The debate about the effectiveness of infrastructure and service competition has occupied the telecommunications industry and its regulators in Europe for some time. Proponents of infrastructure competition argue that it is necessary to replicate networks over a substantial area in order to get the benefit of full cost reduction and innovation made available by competitive markets. They argue that the telecommunications industry, in which most providers rely for most of the time upon the network provided by the historic operator, will limit customer choice and condemn the sector to perpetual and stifling regulation. When taxed with the argument that duplication of infrastructure imposes avoidable costs on the network, because it prevents the full exploitation of economies of scale and scope, they argue that in practice second networks either benefit from an economy of scope—being provided, for example, in conjunction with cable television or other utilities such as electricity transmission or distribution—or that they rely upon a new technology such as wireless, which imposes lower capital demands. Proponents of infrastructure competition also invoke, with good reason, the spur to innovation which infrastructure competition generates. This relates not only to new methods of delivery as discussed above, but also to new technological capacity, such as wider band width. Infrastructure competition also provides a stimulus to efficiency, by two routes. First and most obviously, the incumbent is in head-to-head competition with entrants for customers and must match their offerings in price and quality. Secondly, data from entrants provide the regulator with a crucial check on the incumbent’s reported cost data. Unsurprisingly, proponents of service competition attach considerable weight to the avoidable cost of network duplication and argue, particularly in relation to broadband delivery systems, that it is more efficient to have a single broadband pipe passing all customers’ homes. Within Europe, the United Kingdom in particular has favored infrastructure competition, through a variety of measures sustained over more than a decade designed to create incentives to build alternative infrastructure. The first of these was the duopoly policy, from 1984 to 1991, which confined new entry to a single operator, Mercury. In return for this advantage, Mercury had to commit itself to network roll-out targets. This approach is now generally regarded as
102 Lessons and Priorities conservative and ineffective. Subsequently, entrants received a benefit in the form of relief from access deficit contributions for a limited period. It is impossible to evaluate the effects of this second measure, which were probably small. In any event, the objective of infrastructure competition in the UK has in large measure been achieved, to the extent that there are a large number of providers of network services for long-distance conveyance, a growing number of infrastructure-based providers of international telecommu- nications services, and a growing cable sector which is licensed to pass 65 percent of UK homes and already passing two-thirds of them. However, significant infrastructure building has taken place in a number of other countries which have not relied upon the explicit entry promoting measures adopted by the UK company. The European Commission has attempted to adopt a neutral position over the question of infrastructure or service competition, favoring neither. Defining such a regime in terms of regulatory policy creates, however, considerable difficulties. This can be illustrated with particular clarity in relation to local loop unbundling. This involves the unbundling of local switching and access through an arrangement in which a competitor leases the copper wire connecting a subscriber’s premises to the switch to the boundary of the access network (the remote concentrator or local switch) and “hardwires” the copper wire into a switch of its own, located on the incumbent’s premises (co-location) or elsewhere. Local-loop unbundling is thus a special case of the more general phenomenon of network unbundling, in which the nature of the cost of the service provided makes leasing the appropriate charging mechanism. In practice, any operator might choose voluntarily to introduce local-loop unbundling. In practice, the term normally signifies that the unbundling occurs at the regulator’s behest. It is widely observed that infrastructure competition is particularly slow to take hold in the local-loop. The reasons for this are not hard to find. First, the local-loop is very capital intensive, and requires in particular up-front sunk investment. Second, the normal pattern of prices observed in European telecommunications generate high returns to long distance and international calls, but low returns to the local-loop and local calls. Where this lack of balance in the tariff is the result of regulatory intervention, the situation is sometimes corrected by access deficit contributions or the like. Where it arises from commercial decisions on the part of the incumbent operator, perhaps based upon a reluctance to introduce rapid changes in the structure of the tariff, the incentive to build a competing local-loop is substantially reduced.
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Local-loop unbundling could, at a stroke, solve for a competitor the problem of acquiring local-loop assets without making a significant sunk investment. The decision whether to build a rival local-loop, whether to lease the incumbent’s or whether to buy the local-loop and local switching from the incumbent in a bundled form depends upon the current and expected pattern of pricing. It would not be difficult to generate a set of prices which would make any of the three options preferred. In particular, making an unbundled local- loop available at exceptionally low prices—both current and expected—would have a major impact on the extent of infrastructure competition. We explore this crucial point below, after a further discussion of incentives to invest in infrastructure.
2. INCENTIVES TO INVEST IN THE LOCAL-LOOP
The standard way of appraising an investment proposal is to apply the net present value (NPV) approach, that is, to project the constant revenues associated with the investment, discount them at a rate equal to the cost of capital and establish whether the resulting net present value is positive or negative. However, as Dixit and Pindyck have pointed out, “the net present value rule is based on some implicit assumptions that are often overlooked. Most important it assumes that either the investment is reversible, that is it can somehow be undone and the expenditures recovered should market conditions turn out to be worse than anticipated, or, if the investment is irreversible, it is a now or never proposition, that is, if the firm does not undertake the investment now, it will not be able to.”71 Yet many investments, including investments in the local-loop have neither of these two characteristics. An investment in the local-loop is irreversible, in the sense that much of the expenditure is not recoverable in the event that the company ceases to operate, and potential investors are not faced with now or never propositions: they can adjust the start date and speed of construction of the loop to any desired level. In these circumstances, a firm with an opportunity to invest possesses something equivalent to a call option on a financial instrument. The holders of a call option can exercise that option at a time of their choosing, but do not have to do so (and obviously will not do so if the market price is less than the option price). But the observation that the market price exceeds the option price is not enough to trigger the use of the option. The holder may choose to wait until further information arrives concerning the value of the underlying security. Similarly, a potential new investor in the local-loop can predict fairly accurately the cost of making an investment, which is fairly constant from one
104 Lessons and Priorities period to the next. Its value, however, is changing all the time as market projections change. By undertaking the investment the firm gives up the possibility of waiting for new information to arrive. As Dixit and Pindyck put it, “this lost option value is an opportunity cost that must be included as part of the cost of the investment. As a result, the NPV rule ‘invest when the value of a unit of capital is at least as large as its purchase and installation costs’ must be modified. The value of the unit must exceed the purchase and installation cost, by an amount equal to the value of keeping the investment option alive.”72 This way of viewing the investment decision, from the standpoint of so- called “real option theory” is helpful in understanding investment in the local- loop. A firm estimate of the NPV of such an investment is constantly changing as new information arrives from the market and from the regulator. A momentarily positive NPV is not enough by itself to trigger investment. Moreover, the availability of an option to lease capital equipment (the “buy” option) is an alternative which influences the NPV of the investment decision (the “make” option). This new way of thinking about the investment decision applies to the incumbent too. Its investments are irreversible but it can modernize the network at a time of its choosing. If entrants can immediately lease the modernized network that may well chill the incumbent’s incentives to invest. Although Dixit and Pindyck and their successors have made considerable progress in applying real option theory both to a monopoly and a perfectly competitive market, employing the technique to the case of an oligolopy has presented hitherto insurmountable difficulties, derived from a combination of the smaller number of players and the stagastic nature of the events that unfold over time. Firms in such circumstances will be torn between a desire to “wait and see” and a desire the gain first mover advantages. The approach can, however, be useful in evaluating in an informal way the effects of policy towards local-loop unbundling. In general, its availability at a reasonable price is likely to chill investment in the local-loop because it provides a method of buying time, in the sense that an entrant can offer its services on the market without incurring the cost of an irreversible investment. This is particularly advantageous if customers are indifferent between having service provided to them by an entrant employing the incumbent’s unbundled loop or employing its own loop. This way of conceptualizing the investment decision also opens up the possibility of the regulator manipulating the option value by specific intervention. We return to the possibility below.
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3. IS LOCAL LOOP UNBUNDLING REQUIRED UNDER EC LAW?
Many EU member states are considering local loop unbundling, and it is therefore timely to consider how it is likely to be viewed under EC telecommunications regulation and competition law.
EC Telecommunications Regulation EC telecommunications law does not provide a definitive answer to the question of whether unbundled access to the local loop should be granted. Viewed from the perspective of the type of access which is being granted by the incumbent, it would appear that the nature of such access is not “interconnection” within the meaning of the Interconnection Directive.73 The better view would seem to be that the local loop cannot constitute a “transmission system,” although this is not defined in the Directive. The European Commission’s own view, set out in its Recommendation on Interconnection Pricing,74 is consistent with this analysis, that access to the local loop is not governed by the rules on interconnection. On the other hand, it may be that access to the local loop falls within the meaning of “special network access,” attention to which is given in Article 16 of the amended ONP Voice Telephony Directive.75 Article 16 provides that reasonable requests for special network access should be “dealt with,” and this obligation is only to be limited on a case by case basis, where two conditions are fulfilled: first, that technically and commercially viable alternatives to the requested access exist; and second, that the requested access is inappropriate in relation to the resources available to meet the request. It is difficult to see where justification in respect of access to the local loop might arise under the second limb. In the case of the first limb, clearly, “traditional” local access is a technically viable alternative, in terms of the objective sought by entrants, i.e., to gain access subscribers; whether this proves to be commercially viable will depend upon the pricing mechanism adopted by the local access provider, to which the ordinary rules of analysis apply.
Competition Law As is well known, Article 86 EC prohibits the abuse of a dominant position by a company. Viewed in the context of this Article, the question is whether a refusal to supply unbundled access to the local loop could be regarded as anticompetitive. Whilst space does not permit a complete analysis of this question, it is helpful to offer a number of observations. First, in general terms, the European Court of Justice has on a number of occasions found refusals to supply anticompetitive. However, in the present context, the question is
106 Lessons and Priorities perhaps more appropriately: is the provision of local interconnect (i.e., access to the local switch and the local loop etc) to be regarded as a form of anticompetitive tying. There is no clear answer to this question, but a preliminary indication may be obtained in the light of the fact that the secondary legislation and the competition provisions are, in principle, to be applied consistently. With this in mind, it should be emphasized that the secondary legislation, which imposes stricter obligations than does competition law, stops short of requiring unbundled local loop access. Therefore, although there may in principle be an argument that refusing unbundled local loop access may constitute an abuse, this may require some solid justification.
4. THE COST AND PRICE OF LOCAL-LOOP UNBUNDLING
I have referred above to the key role of the price charged for an unbundled local-loop in determining take-up and hence in influencing the rate of construction of the competitive local-loop. There are two generic approaches which might be employed toward pricing this particular unbundled service, whether within the framework of Competition Law or as part of a regulatory process. The first is based upon cost, while the second has its starting point in the incumbent’s retail tariff. The question of how the prices of interconnection services should be related to costs has been discussed exhaustively. Our discussion is based on the assumption that an appropriate starting point is average long-run incremental cost, supplemented by a mark-up to recover common costs between the conveyance network and the access network. Because the replacement cost of assets in the access network is likely to exceed their historic cost (because of relatively low rates of technical progress there), current cost estimates are likely to be higher than historic costs. This proposition is shown in BT’s financial accounts. The alternative approach is to base wholesale prices on the incumbent’s retail charges for similar services. This could be done by stripping out from the retail monthly payment costs associated with the provision of the retail service alone, on the assumption that marketing and billing costs associated with a wholesale client are sufficiently small to be ignored. The most persuasive argument for basing interconnect charges on retail prices starts from the proposition that the regulator is seeking to introduce efficient competition in circumstances where tariffs are unbalanced. This argument is encountered most frequently in connection with entry into profitable activities such as long- distance or international calls. If the regulator has set tariffs for these services at a high level in order to cross-subsidize access, then a less efficient operator
107 Telecommunications Reform in Germany than the incumbent may be able to cream-skim these markets. To prevent that occurring, it is argued that interconnection charges should be set at a level equal to the incremental cost of the service in question augmented by the “opportunity cost,” which can be defined as the profit foregone by the incumbent as a result of its loss of long-distance or international business to its competitor. Provided that the overall level of profits earned by the incumbent is controlled, and if other conditions apply, it can be shown that this so-called efficient component pricing rule (ECPR) will ensure that entry only occurs where the entrant is more efficient in providing the service than the incumbent.76 In relation to local-loop unbundling, the equivalent argument could be made that the service should be offered to entrants at the incumbent’s retail tariff, reduced by the incremental cost to the incumbent of providing the retail service associated with the provision of a line. In such circumstances, entrants will only come into the market if they can perform the retail functions more efficiently than the incumbent. If this argument is to be successfully applied, then two conditions must be fulfilled. Firstly, it must be the case that the structure of retail prices is determined by the regulator, in pursuit of public policy objectives, rather than by the operator, on commercial considerations. (Otherwise the interconnection pricing regime effectively causes competitors to conform with the incumbent’s pricing strategy.) Second, the principle must be applied to all interconnection services, both those used to provide profit-making and those used to provide loss-making services. In particular, if it applies only to loss-making services, and if the unbundled local-loop is loss-making at existing tariffs, then entrants are able to purchase the unbundled local-loop at a subsidized price, and can use it as a basis to attack profitable markets, without having to contribute to the cost of the local-loop subsidy. In other words, if retail prices are to be used as the starting point for charging for any interconnection service, they should be the starting point for charging for all such services, including cases where an entrant by-passes the incumbent’s facilities. In summary, price is obviously a key element in determining the impact of any policy of local-loop unbundling. The application of now quite widely established principles of interconnection pricing implies that a long-run incremental cost basis, with mark-up, is appropriate. Where the tariff is unbalanced, a change starting from the incumbent’s retail price (without further adjustments) carries significant risks of encouraging inefficient entry.
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5. REGULATORY POLICY TOWARDS LOCAL-LOOP UNBUNDLING
A telecommunications regulatory agency typically operates under sector- specific legislation which gives it different duties and usually greater powers than apply under general Competition Law. They can, for example, use these powers to promote particular competitors or particular forms of competitive entry. In the case of local-loop unbundling, the key instruments at their disposal are decisions about whether (or for how long) to mandate local-loop unbundling and the determination of the price at which it should be made available. The significance of the pricing issue was discussed in section 4 above. I emphasized there that, unless the regulator is pursuing an explicit policy of entry promotion, by tipping the playing field against the incumbent, regulatory pricing of interconnection services could reasonably be based upon the uniform application of one of two competing principles—long-run incremental cost (with mark-up) or charges based on the incumbent’s retail prices. The latter may be appropriate where there is a strong regulatory interest in maintaining a particular structure of retail prices. In the absence of such a motive, LRIC prices are more appropriate. The key point, however, is that, if distortions to competition are to be avoided, the same approach should be applied to all interconnection services, access or conveyance. We now address the question of whether it is appropriate as a matter of regulatory policy, rather than of competition law, to mandate local loop unbundling. This must depend on a variety of factors, including in particular the objectives of policy pursued by particular governments. I noted above the European Commission’s preference for neutrality between infrastructure and service competition, but, in my opinion, the task of defining and enforcing such neutrality during a period of transition to competition is in practice impossible. This leaves governments and regulators with considerable flexibility of how to proceed. On our reading of international experience of the development of competition in telecommunications, cases of significant infrastructure development have been observed, without local-loop unbundling. This suggests that such unbundling is not a necessary condition for competition to develop. At the same time, experience of lineside unbundling is so restricted that it is impossible to say whether it is a complement or precursor to the development of infrastructure competition or whether it is a substitute for it. (Nor will the issue be resolved soon, as the time required to set up such arrangements—let alone observe their effects—may be considerable.) In logic, a case can be made for either proposition. Local-loop unbundling might
109 Telecommunications Reform in Germany provide an entrant with a relatively quick means of gaining direct access to customers, who then transfer to the entrants own infrastructure. Alternatively, if local loop unbundling is available at a low price, incentives to build infrastructure are eliminated. As in the whole of this discussion, prices are of fundamental importance. There is, however, a position intermediate between mandating and not mandating lineside interconnection - mandating it for a limited period. This is the approach employed in Canada. It is sometimes represented as a means of “jump-starting” competition. The idea is that entrants acquire customers in the local-loop through leasing the incumbent’s facilities. This provides them with a sounder basis for their own investment positions in infrastructure. However, because local-loop unbundling is only mandated for a limited period, they have to take the plunge or risk losing their business. In terms of analysis set out in section 2 above, this policy is designed to increase the NPV of the investment when it occurs and to control its timing by raising the opportunity costs of delay. What is not clear, however, is the basis on which local-loop unbundling would be priced in the interim period. This would require considerable judgement. If it were set too low, there is a risk of entry by short-run cream-skimmers who have no intention of constructing their own local-loop. If it were set too high, the opportunity would not be taken up. A long-run incremental cost approach (with mark-up) might be most appropriate here, as it would confine entry assistance to bringing its timing forward, rather than offering an explicit subsidy. Questions remain, however, about whether this particular form of intervention, which is geared at managing the transition to competition, is necessary or desirable. Evidence from other countries suggests that it is not necessary. The question of its desirability is tied up with the general issue of entry promotion. In my judgement, now that entrants have established themselves in a number of countries and typically are supported by incumbents in other major markets, the burden of proof rests with those who favor explicit entry-promoting measures. There will also be effects on the incumbent’s investment decisions. In particular, the incumbent may choose to defer network modernization, so that it comes into effect only after the period of mandatory unbundling has expired. This possible or likely detriment should also be placed in the balance when the policy decision is made.
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6. CONCLUSIONS
This paper has reviewed a number of questions relating to local-loop unbundling, in particular, whether a dominant incumbent should be required to unbundle its local-loop, and if so, at what price. Inevitably, these issues are nested within a broader consideration of government policy towards infrastructure or service competition. At present there is insufficient evidence to judge whether economic and social welfare is better served by infrastructure competition or service competition. However, infrastructure competition has established itself in a number of countries without the availability of local loop unbundling. Moreover, because of the complexity of regulatory interventions in telecommunications markets, which embrace decisions about the level and structure of retail prices and the charges for and availability of wholesale services, it is impossible to define an entirely neutral approach towards infrastructure and service competition, and for this reason European governments have considerable and legitimate scope in deciding what policies to adopt. No conclusive case can be made for the proposition that local loop unbundling is mandatory under EU Competition Law, and no such case has been brought by the Commission. It is impossible to divorce the question of mandatory unbundling of the local loop from the price which is charged for it, but as with other interconnection services, consistent cases can be made either for pricing in relation to long-run incremental costs (to provide efficient entry signals) or in relation to the structure of retail prices (but only where these are fixed by regulators to meet social objectives). In order to avoid inefficient entry, a consistent approach must be taken to pricing access and conveyance services. Account should also be taken of the likely effect of local loop unbundling on discouraging the incumbent from investment in network modernization. A regulatory body with a remit explicitly to promote entry can use local-loop unbundling available at a low price to stimulate entry. Given the pattern of entry at present, such entry assistance is unnecessary or should in any case be short-lived. A temporary period of mandatory local-loop unbundling might bring competition forward, rather than distort its form over the long term. Such a policy does, however, carry with it the risks of promoting inefficient entry, and of (temporarily) reducing the incumbent’s investment incentives.
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In summary, a convincing regulatory case for local loop unbundling has not been made. But if it is adopted, it should be done at prices which do not distort the competitive process—i.e., normally LRIC prices with mark-up.
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UNIVERSAL SERVICE OBLIGATIONS: COMPARISON OF THE UNITED STATES WITH THE EUROPEAN UNION Barbara A. Cherry
Abstract. The United States (U.S.) and the European Union (EU) are both pursuing joint policies of liberalization of telecommunications service markets and universal service. As a matter of law, there are many similarities in their respective policies, such as the elimination of monopolies and the establishment of explicit universal service funding mechanisms. However, cultural and political differences as well as other dissimilar regulatory rules may yield differences in implementation. There are also some substantial differences in stated policy. For example, the U.S. views affordability of services in terms of uniformity of rates, whereas the EU approach is to mitigate the effects of mandatory rate rebalancing towards costs. In addition, unlike the EU, the U.S. mandates special rates for special groups of customers, namely, certain schools, libraries and health care providers. This latter requirement alone has resulted in creation of a $2.65 billion annual fund by the Federal Communications Commission, which is to be funded by contributions from telecommunications service providers. These important differences may likely provide telecommunications providers in the EU with competitive advantages over U.S. carriers in the international telecommunications service marketplace.
1. INTRODUCTION
Both the United States (U.S.) and the European Union (EU) have been pursuing policies of liberalization of telecommunications service markets while providing for universal service. For the U.S., these policies are codified in the Telecommunications Act of 1996 (TA96) [1]. For the EU, these policies are embodied in numerous directives, such as the Voice Telephony Directive [2], the Full Competition Directive [3], and the recently adopted Interconnection and Universal Service Directive (“IC/US Directive”) [4]. In TA96, Congress enacted legislation setting forth the regulatory framework for incumbent providers and new entrants in a competitive environment, with specific provisions on universal service. Consistent with the dual jurisdictional nature of regulation set forth in the Communications Act of 1934 [5], the new law continues to provide for regulation of interstate services by the Federal Communications Commission (FCC) and regulation of intrastate
113 Telecommunications Reform in Germany services by state regulatory commissions. In particular, section 254 of TA96 provides specific policies for the provision of universal service. Some aspects of universal service are to be implemented by the FCC, pursuant to which the FCC recently issued its Universal Service Order [6]. Other aspects are left to implementation by the States, subject to consistency with the Act and certain preemption powers granted to the FCC under section 253(d). Similarly, the EU’s directives establish policies for harmonization of the regulatory environment and standards for services and technologies among its member states. The member states have the authority to implement such policies on a national level, subject to consistency with the law of the European Community and the oversight authority of the European Commission (ECOM) as to implementation of numerous requirements by the national regulatory authorities. There are many similarities in the policy provisions of TA96 and the FCC’s Universal Service Order, on the one hand, and of the EU Directives and ECOM Communications [7] [8], on the other. Their provisions contain strikingly similar approaches by government to ensure universal service to customers, such as the elimination of monopolies, the establishment of explicit funding mechanisms for net costs arising from universal service obligations, and the possibility of multiple providers bearing universal service obligations. However, there are some important differences in policies between the U.S. and EU. These differences relate primarily to the relationship of rate rebalancing to the concept of affordability, as well as the greater scope in funding to be provided for certain educational institutions and health care providers in the U.S. A comparison of universal service policies between the U.S. and EU provides valuable insights as to the likelihood of success among the different nations in achieving the goals of universal service. Given my greater familiarity with the implementation process of universal service policy in the U.S., a comparison of policies reveals problems, which have arisen in the U.S., that I believe are less likely to be encountered in the EU. However, it also reveals problems that may arise in the EU if the experience of the U.S. is not taken into account. The purpose of this paper is to describe many of the similarities and differences in universal service policy between the U.S. and EU, and to explore some of the ramifications flowing from them. It is hoped that this may trigger further interest in sharing the successes and failures in policies among nations and in broadening the research endeavors of policy experts.
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2. SIMILARITIES IN UNIVERSAL SERVICE POLICIES
The similarities in universal service policies between the U.S. and the EU relate to some basic principles embedded in a regulatory framework of telecommunications services. These principles include the elimination of monopolies, a fairly narrow initial definition of universal service for general residential and business customers, the notion that the definition of universal service is an evolving one, the possibility of multiple carriers bearing universal service obligations in a given serving area, the lack of a presumption as to which carriers may bear universal service obligations, and the establishment of explicit funds to support universal service objectives. However, these similarities in policies may not necessarily lead to similarities in implementation of policy nor of performance within the telecommunications industry. For example, in the long run, cultural differences may lead to dissimilar evolving definitions of universal service. In the shorter run, the interlata entry barrier to Regional Bell Operating Companies in the U.S. will likely lead to more strategic behavior and creamskimming activities by new entrants in the U.S. compared to new entrants in EU member states. Furthermore, the combinatorial effects of other Federal and State regulatory rules with the collection mechanisms for universal service may pose greater competitive non-neutrality problems in the U.S.
2.1. Elimination of Monopolies In both the U.S. and the EU, monopolies for the provision of telecommunications services are required to be eliminated. Under section 253(a) of TA96, no state or local government statute, regulation or legal requirement “may prohibit or have the effect of prohibiting the ability of any entity to provide any interstate or intrastate telecommunications service.” To the extent that a state or local government action violates section 253(a), under section 254(d) the FCC shall preempt its enforcement to the extent that it is necessary to correct the violation. In the EU, Article 2 of the Full Competition Directive requires member states to withdraw all measures granting exclusive rights for the provision of telecommunications services by January 1, 1998. However, the Directive leaves open the possibility of additional implementation periods for full liberalization for member states with less-developed or small networks. In this regard, additional periods to implement full liberalization have been granted to Greece, Ireland, Luxembourg, Portugal, and Spain [9].
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2.2. Definition of Universal Service Yet, reliance on more competitive markets to provide telecommunications services may impede the ability of all individuals to have access to the public switched telecommunications network and the use of certain basic telecommunications services. Under section 254(c)(1), Congress states that the FCC shall establish, based on recommendations from a Federal-State Joint Board, the definition of services to be supported by federal universal service support mechanisms. It also provides that universal service is an evolving level of telecommunications services that the FCC shall establish periodically, given certain enumerated criteria.77 In its Universal Service Order, the FCC defined core services to receive universal service support with respect to residential and business users. The core services are: single party service; voice grade access to the public switched network; dual tone multifrequency signaling (DTMF) (i.e., touch tone); access to emergency services; access to operator services; access to interexchange services; access to directory assistance; and toll limitation services for qualifying low-income customers (par. 56). Universal service support is also to be provided for some amount of local usage, although at a level of usage yet to be determined (pars. 65-70). With respect to low income individuals, the Universal Service Order also provides for expansion of existing Lifeline and Linkup programs (pars. 346-382), the availability of toll limitation services (par. 385), prohibitions on disconnection of low service for nonpayment of toll charges (par. 390), and restrictions on use of service deposits (par. 398). Special needs of disabled individuals are handled in separate orders and proceedings. In the Voice Telephony Directive, the member states of the EU are required to ensure that end users can obtain upon request a connection to the fixed public telephone network (Article 3(a)). Furthermore, national regulatory authorities are to ensure, among other things, that DTMF, direct dialing-in, call forwarding, and calling-line identification are provided where technically feasible and economically viable (Article 9); that special tariffs may be available for emergency services, low usage users, or specific social groups (Article 14); that targets are set for the provision of itemized billing (Article 15); that directories of subscribers to voice telephony services are made available to users in either printed or electronic form, with public directory information available upon request (Article 16); and that public pay telephones be provided to meet the reasonable needs of users in terms of both numbers and geographical coverage (Article 17). Furthermore, member states are authorized to take measures to ensure that disruption of service is confined as narrowly as necessary for nonpayment of bills (Article 23).
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The recent IC/US Directive expands upon the Voice Telephony Directive by expressly defining the fixed public telephone network to support not only voice telephony but also certain facsimile communications and voice band data transmission via modems at a rate of at least 2400 bits/second (Annex I, Part 1). The fixed public telephone network is also to provide to end users access to emergency services and the ability to originate and receive national and international calls, as well as the provision of operator assistance, directory services, public pay phones, and special terms or facilities for customers with disabilities or special social needs (Annex I, Part 1). Furthermore, in its preamble, the European Parliament and Council state that the concept of universal service must evolve to keep pace with advances in technology, market development, and changes in user demand (par. (7)). From the preceding description, it is clear that, as a starting point for residential and business end users, both the U.S. and EU are still primarily concerned with the availability of voice telephony; although both jurisdictions include the requirement of access to certain technical functionalities—such as DTMF (touch tone services)—that make other uses of the network, such as facsimile and modems, possible. In addition, both require access to emergency services as well as services related to access to information, such as operator assistance and directory services. Special needs of certain groups, such as low income users and the disabled, are also addressed. However, as will be discussed in section 3.1, the overall regulatory framework within the EU permits a more targeted approach in setting rates for special groups. Yet, in the U.S. a controversy yet to be resolved is the amount of local usage to be included in the definition of universal service. This issue is to be determined at a later time by the FCC, for federal support purposes, and by the State commissions for state support, if any. This issue highlights conflict between those pushing for a more expansive definition of universal service and those desiring to keep universal service funding contained. Given that the EU has not specified local usage as a component of universal service, this issue is less likely to arise, as national universal service funding schemes can not be used to fund costs incurred outside the scope of universal service (see [8], p. 6). As to the future, both the U.S. and the EU contemplate the evolution of the meaning of universal service as technology, customer demands, and societal needs change. But, at this time, neither requires the availability of more advanced services requiring broad bandwidth to general residential and business end users. However, it is unclear whether the expansion of the meaning of universal service will follow similar paths in the U.S. and throughout the EU. The development of a truly global economy would encourage similar developments. But, cultural differences may prove significant impediments to
117 Telecommunications Reform in Germany common social goals. An example of such a difference is discussed in section 3.2 of this paper with respect to universal service to educational institutions and health care providers.
2.3. Imposition of Universal Service Obligations on Providers There are some basic elements of imposing universal service obligations (USOs) on providers of telecommunications network facilities and/or services in the U.S. and the EU that are essentially the same. In both jurisdictions, more than one provider may bear USOs and be eligible for funding. Furthermore, in neither jurisdiction is there a presumption that the incumbent local exchange providers (ILECs) are to bear USOs. In the U.S., carriers that bear USOs and are eligible for universal service support are called eligible carriers. In particular, section 214(e)(1) defines an eligible carrier as one that, throughout the service area for which the designation is received, offers the services supported by federal universal service support mechanisms (either using its own facilities or a combination of its own facilities and resale of another carrier’s services) and advertises the availability of and charges for such services using media of general distribution. State commissions are to designate eligible carriers, satisfying this definition, for a service area; more than one eligible carrier shall be designated for non-rural areas and may be designated for rural areas (section 214(e)(2)). However, under section 214 there is no presumption that any particular carrier, such as the ILEC, shall be an eligible carrier. In the EU, the IC/US Directive provides that national regulatory authorities are to notify to the European Commission by January 31, 1997, the names of those telecommunications organizations which have USOs (Article 18). More than one organization in a member state may bear USOs (par. (8) of preamble). However, according to the European Commission [8], the regulatory framework in the EU also provides no presumption that the incumbent (formerly monopoly) provider bears USOs (Annex D). Furthermore, similar to the definition of an eligible carrier in the U.S., USOs are to be imposed through consideration of geographic areas and service categories (see [8], Annex D). Despite these similarities in the regulatory frameworks for assigning USOs, there are major historical differences in the provision of telecommunications services between the U.S. and throughout the EU which give rise to dissimilar political issues. These differences in political forces may produce different outcomes as to bearers of USOs. For example, in the U.S., the Bell Operating Companies may not provide interlata interexchange services in areas where they provide local service until they convince the FCC that they satisfy the requirements contained in section
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271(C) of TA96. There is heated debate among industry players as well as regulators as to whether any of the Bell Companies have met such conditions. As to applications for interlata entry that have been filed before the FCC, interexchange carriers claim that certain items of the competitive checklist in section 271(c)(2)(B) have not yet been met. On the other hand, Bell Companies claim that interexchange carriers have strategic incentives to slowly enter local exchange markets and to greatly exaggerate problems with interconnection and operating system interfaces. In essence, the controversy on interlata entry has simply shifted from the legislative arena to the regulatory one. It appears that the FCC will not allow in- region interlata entry by any Bell Company for some time to come, and that local exchange entry by interexchange carriers will likely continue to be slow to better ensure no interlata relief. So long as this is the case, the present ubiquity of ILEC facilities, particularly of Bell Companies, in their service areas will likely require designation of ILECs as the providers bearing USOs. New entrants will then have the ability to choose those areas in which they will seek to bear USOs and be eligible for universal service funding. These choices of where to bear USOs may be motivated, in significant part, by creamskimming opportunities provided through arbitrage of averaged prices for interconnection and unbundled network elements and the deaveraged costs of serving customers within wire centers. In member states of the EU, there is also the history of incumbency by monopolists. However, monopolies were usually in the form of governmentally-owned or controlled entities compared to privately-owned entities in the U.S. Therefore, member states have been required to take steps that the U.S. has not, such as privatizing telecommunications providers and establishing national regulatory authorities. As privatization and implementa- tion of national policies through national regulatory authorities occur, the forces contributing to the development of local competition may be greater at least in some member states of the EU. First, there is no EU edict, comparable to the interlata restriction in the U.S., barring entry by incumbent providers to a lucrative telecommunications market and inducing the associated strategic behavior of industry members. Given the U.S. experience, it would be wise for member states to also refrain from erecting any such artificial entry barriers (to the extent that it would even be permissible under European Community law). Second, local telephony competition by cable companies is already greater in some of the member states, such as the UK. This is due not only to some differences in regulation of cable service, but to the fact that many cable systems in the EU are being built at a later time than in the U.S. and specifically with the intent to provide both cable and telephony services. Third, by
119 Telecommunications Reform in Germany mandating rate rebalancing towards costs, as discussed in section 3.1 of this paper, the EU provides greater protections against creamskimming by new entrants. Therefore, throughout the EU, there may be: (1) less incentive for strategic behavior by new entrants both to burden ILECs with USOs and yet to accept USOs when access to universal service funding provides creamskimming advantages; and (2) a greater number of local telephony providers able to bear USOs in certain geographic areas.
2.4. Explicit Funding for Universal Service Obligations Both TA96 and the EU Directives provide for the establishment of explicit mechanisms to support universal service objectives, with funding based on contributions from telecommunications providers. The scope of entities required to make contributions is also similar. Furthermore, both jurisdictions are concerned with nondiscriminatory and equitable assessment of contribution burdens among providers. Under TA96, universal service principles established by Congress include “specific, predictable and sufficient Federal and State mechanisms to preserve and advance universal service” (section 254(b)(5)). Such mechanisms are to be funded by contributions from telecommunications carriers—of interstate services for Federal mechanisms and of intrastate services for State mechanisms—on an equitable and nondiscriminatory basis (sections 254(d) and (e)). In similar fashion, the Full Competition Directive (Article 4c) and the IC/ US Directive (Article 5) authorize member states to establish national schemes to share the net cost of the provision of USOs among organizations operating public telecommunications networks and/or publicly available voice telephony services. Contributions may be required as a part of an independent universal service fund or as unbundled, supplementary charges added to interconnection charges. Furthermore, in setting the amount of contributions, member states are to take into account the principles of transparency, nondiscrimination and proportionality.
2.4.1. Providers Which Pay Contributions In applying section 254(d), the FCC decided in its Universal Service Order that the definition of a carrier required to make contributions to a Federal fund be construed as broadly as possible, including wireless and wireline providers (pars. 779-791). However, certain providers are to be excluded, such as Internet and enhanced service providers, because they are currently considered to not be telecommunications carriers under federal law (par. 788), and private network operators which do not lease or sell excess capacity (par. 794).
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Likewise, in its Communication on assessment criteria for national schemes for costing and financing universal service [8], the ECOM states that organizations not liable to make contributions include private network operators offering corporate networking or closed user group services, providers of value-added data services, and providers of enhanced voice telephony services (guideline 15). In addition, Internet access providers can not be required to make contributions because voice telephony service via the Internet is not currently viewed as a publicly available voice telephony service (footnote 19). Yet, since universal service can be provided by wireline or wireless technology to a fixed location ([8], section 2.1; [4], Annex I, Part I), it appears that both wireline and wireless providers would also be required to provide contributions. In the U.S., a number of parties have claimed that exclusion of Internet and enhanced service providers from making universal service contributions is not competitively neutral, and that their exclusion will be more problematic as competing services, such as Internet telephony, become more widespread. The severity of the competitive advantage given to excluded entities will depend, of course, on the degree to which excluded entities’ offerings become substitutable services. The same structural problem is embedded in the framework of the EU. To the extent that excluded entities’ services become substitutes for those of included entities, a cost advantage will be conferred on excluded entities. In this way, a source of economic inefficiency will be introduced, and it will be more difficult to determine whether the diffusion of excluded entities’ services is due to innovation, changes in customer needs, or simply an artificial price advantage.
2.4.2. Differential Abilities to Pass Through Costs of Contributions But, a greater problem for both the U.S. and the member states of the EU is posed by the likelihood that the various providers required to make contributions will have differential abilities to pass through the cost of such contributions to customers. Such differential abilities pose not only competitive neutrality problems, but also potentially threaten the financial viability of incumbent providers in certain geographic areas and thereby the continued availability of universal service in such areas. In its Universal Service Order, the FCC requires contributions to be assessed against end user revenues of telecommunications services (par. 844). This revenue base was chosen in order to avoid double tax problems, as would occur with an assessment against gross revenues, and distortions in the incentives of new entrants to build their own facilities or purchase services for resale rather than buy access from incumbent providers (pars. 843-850).
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However, the coexistence of other Federal and State regulatory requirements reintroduce the distortionary effects meant to be avoided by choice of a revenue base of end-user revenues. First, the Universal Service Order itself prohibits ILECs from adjusting their rates for unbundled network elements to account for the universal service contributions (par. 851). Furthermore, ILECs are permitted to pass through their contributions to the Federal fund only onto interstate—which are primarily access—services. As a result, competitors will be induced to purchase ILEC unbundled elements, build their own facilities, or purchase services by resale, rather than purchase access services from ILECs. In this way, in actuality it will be more difficult for ILECs than new entrants to pass contributions through to customers rather than their shareholders. Second, many States have price caps or rate freezes which have the effect of prohibiting the pass through of ILECs’, but not new entrants’, contributions to customers. These rate restrictions also create a higher burden on the shareholders of ILECs compared to the shareholders of their competitors to finance the universal service contributions. To ensure that providers have the same ability to pass through their contributions in rates to customers, the FCC should have provided—although it declined to do so (par. 853)—an explicit mechanism to pass through the contributions, such as an end user surcharge. In the EU, the ECOM has also applied the principles of nondiscrimination and proportionality to require that member states implement national schemes for universal service support through a collection mechanism that prevents “double contributions,” as would occur with contributions based on gross revenues ([8], guideline 17.4). A number of indicators for determining the apportionment of contributions among providers might be used—such as revenues before tax, call minutes, number of subscribers, and overall profit—as long as criteria which unduly distort patterns of market entry, activity or investment by market players are avoided (guideline 17.3). As illustrated by the above scenario in the U.S., member states should also avoid a regulatory framework which would yield differential abilities among providers to pass through contributions in rates and the associated differential burdens of shareholders of such providers to finance the contributions. Such differential impacts may arise from the choice of criteria for apportionment among providers, or from the combinatorial effect of multiple, even seemingly unrelated, regulatory requirements. It deserves reiteration that the potential effects of such differential impacts create not only inequitable and discriminatory effects among providers and associated distortions to economic efficiency, but may also threaten the long term availability of universal service in some geographical areas.
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3. DIFFERENCES IN UNIVERSAL SERVICE POLICIES
Amid numerous similarities in universal service policies, the U.S. and EU have some important differences. A few will be discussed here. First, the U.S. and EU have differing concepts of how rate rebalancing relates to affordability of universal service to end users. The U.S. views affordability as requiring uniformity of rates among classes of customers, with particular emphasis on comparable rates between rural and urban areas. On the other hand, the EU views affordability as mitigating the impacts of mandated rate rebalancing towards costs. Second, the U.S. requires special rates, as a matter of law, for some special categories of customers, consisting of schools, libraries and health care providers. This has resulted in a substantial funding burden of $2.65 billion per year which is being placed on domestic telecommunications carriers. In the EU, there is no comparable universal service burden. Both of these differences in universal service policy will likely lead to competitive advantages for carriers in the EU as compared to those in the U.S.
3.1. Affordability and Rate Rebalancing Perhaps the most important difference in universal service policy between the U.S. and the EU is reflected in their respective approaches to the relationship of rate rebalancing to the affordability of universal service to end users. This is evident from a comparison of provisions of TA96 with those of EU Directives. In its Full Competition Directive, the EU specifically directs the member states to allow telecommunications organizations to rebalance their rates towards costs (Article 4c):
Member states shall allow their telecommunications organizations to re-balance tariffs taking account of specific market conditions and of the need to ensure the affordability of a universal service, and, in particular, member states shall allow them to adapt current rates which are not in line with costs and which increase the burden of universal service provision, in order to achieve tariffs based on real costs. Where such rebalancing cannot be completed before January 1, 1998 the member states concerned shall report to the Commission on the future phasing out of the remaining tariff imbalances. This shall include a detailed timetable for implementation.
Although member states may create an explicit fund to recover the net cost of USOs according to this Directive, such a fund may not be used to recover access
123 Telecommunications Reform in Germany deficit contributions attributable to unbalanced national tariff structures nor any other costs associated with activities outside the scope of universal service ([8], p. 6). To address such other costs, including any concerns of bypass or creamskimming by new entrants because incumbent providers may not have yet completed rebalancing of tariffs, member states must establish mechanisms separate from national schemes for funding universal service ([8], Annexes B & D). This overall approach was reaffirmed by the EU in its IC/US Directive, which provides the principles for calculating the net costs of USOs (Article 5) and states that such a calculation “should not hinder the on-going process of tariff rebalancing” (par. 8). In recognition that such rate rebalancing may make certain telephone service less affordable in the short term, member states are permitted under the Full Competition Directive, consistent with the principle of subsidiarity, to adopt special provisions to soften the impact of rebalancing (par. 21). This includes the ability of the member states to maintain uniformity of national prices or to allow deaveraging, providing that the overall affordability of the universal service is not called into question ([8], Annex D). This aspect of policy was left unchanged by the new IC/US Directive. Thus, other than the requirement to rate rebalance, and other requirements related to interconnection charges, pricing decisions are left to the member states. This approach is in stark contrast to that in the United States. In TA96, there is no mandate, as in the EU, that the FCC or the States rebalance end-user rates towards costs.78 On the contrary, rather than leave the issue to the FCC or the States, Congress mandates several forms of rate averaging in the name of universal service. For example, comparability of rates is generally required between rural and urban rates for all telecommunications and information services in section 254(b)(3):
Consumers in all regions of the Nation, including low-income consumers and those in rural, insular and high cost areas, should have access to telecommunications and information services, including interexchange services and advanced telecommunications and information services, that are reasonably comparable to those services provided in urban areas and that are available at rates that are reasonably comparable to rates charged for similar services in urban areas.
A similar requirement is imposed specifically on providers of interexchange services in section 254(g):
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[T]he Commission [FCC] shall adopt rules to require that the rates charged by providers of interexchange telecommunications services to subscribers in rural and high cost areas shall be no higher than the rates charged by each such provider to its subscribers in urban areas.
In addition, section 254(g) requires the FCC to adopt rules to “require that a provider of interstate interexchange telecommunications services shall provide such services to its subscribers in each State at rates no higher than the rates charged to its subscribers in any other State.” Thus, the same rates must also be provided for interstate interexchange services across states. These requirements, for comparability (in essence, averaging) of rates to consumers with no reference to costs, are an integral part of Congress’ vision of universal service. Implementation of the universal service provisions of section 254 by the FCC and the states must necessarily comply with these requirements. Thus, universal service mechanisms—including contributions by carriers to fund federal and state universal service funds authorized under subsections (d) and (f), respectively—necessarily include the costs of not being able to deaverage or rebalance rates towards costs among end users. Such inclusion, as previously discussed, is prohibited by the member states of the EU. These differing approaches highlight a fundamental difference in the concept of affordability between the U.S. and the EU. In the U.S., affordability is viewed, in large part, by uniformity of rates among classes of customers. In the EU, affordability is viewed as mitigating the effects of rate rebalancing through targeted and special tariff schemes. Although rate averaging may be an approach used by a member state, universal service funds may not be used for maintenance of such a tariff structure. In the long run, the EU’s concept of affordability may better position its member states, as compared to the U.S., to participate in a global economy. This is because, as competitive pressures grow in the telecommunications marketplace, rate structures in EU countries will be more cost-based due to rate rebalancing and less encumbered by artificial pricing restrictions as a matter of law. Policy makers in the U.S. should take note of the rate rebalancing policy of the EU, its compatibility with achieving universal service, and the international competitive advantage it is likely to confer.
3.2. Affordability for Special Categories of Users Arguably, the main focus of affordability discussed in section 3.1 relates to general concerns with residential and business consumers. In the U.S., unlike the EU, notions of affordability are also incorporated in legislative mandates for special telecommunications service prices to special categories of end users. In
125 Telecommunications Reform in Germany particular, as part of universal service, Congress specifies pricing requirements for certain educational institutions and libraries as well as health care providers. Section 254(h)(1)(B) of TA96 requires telecommunications carriers to provide services within the definition of universal service—which, under section 254(c)(3), may include additional services to those for other end users— to elementary schools, secondary schools and libraries at rates less than the amounts charged for similar services to other parties. In its recently issued universal service rules, the FCC has defined such services to include all commercially available telecommunications services (section 54.502). Carriers are to receive reimbursement for providing such discounts from universal service support mechanisms (section 254(h)(1)(B)(ii)). Section 254(h)(1)(A) pertains to services for health care providers and provides in relevant part:
A telecommunications carrier shall, upon receiving a bona fide request, provide telecommunications services which are necessary for the provision of health care services in a state, including instruction relating to such services, to any public or nonprofit health care provider that serves persons who reside in rural areas in that state at rates that are reasonably comparable to rates charged for similar services in urban areas in that state.
This is yet another instance in which Congress mandated comparable rates between rural and urban areas. In this section, Congress further specifies that an amount, equal to the difference in rates provided to health care providers for rural areas and the rates for similar services provided to other customers in comparable rural areas in that state, should be treated as a part of universal service obligations and mechanisms. In implementing these provisions, the FCC has ordered support for educational institutions and libraries in an amount of $2.25 billion per year ([6], par. 425). For provision of service to health care providers, an annual cap of $400 million has been set (par. 608). Thus, for these two groups alone, federal universal service funding of $2.65 billion per year is required. The EU has provided no comparable mandate for universal service to specific categories of consumers, such as educational institutions, libraries or health care providers. Instead, any special tariff schemes for targeted groups is left to the policy making of member states. Furthermore, as discussed earlier, any special schemes that are beyond the scope of universal service as defined in the EU Directives may not be funded by member states through the explicit universal service funding mechanisms that were initially authorized to be
126 Lessons and Priorities established under the Full Competition Directive. Rather, member states will have to develop some other means of implementing such a policy, such as by direct funding by national governments. In this way, the EU is avoiding imposition of the enormous price tag to support special service rates to educational institutions, libraries and health care providers, that has been created in the U.S. The U.S. policy of funding these special categories of users—as with failure to rate rebalance towards costs—is also likely to confer some international competitive disadvantage to U.S. telecommunications carriers. Since U.S. carriers must pay contributions to support services at special rates to schools, libraries and health care providers, such contributions constitute an increased cost of doing business. These increased costs will pose a competitive disadvantage to U.S. carriers in the market for international services, because, under the Universal Service Order, the international revenues of only domestic carriers will be included in the revenue base against which contributions are assessed (par. 779). Thus, with competition, U.S. carriers will not be able to simply pass through these costs to international customers.
4. CONCLUSION
The U.S. and EU are both pursuing policies of liberalization of telecommunications service markets and universal service. These policies are reflected in various legislative measures—in the Telecommunications Act of 1996 in the U.S. and in several Directives of the EU—with implementation by designated regulatory agencies. There are significant similarities as well as differences in the policies of these respective jurisdictions. Similarities include elimination of monopolies; initial definitions of universal service for general residential and business customers based on voice grade telephony and certain capabilities for facsimile and modems; the ability for multiple providers to bear universal service obligations; and no presumption that universal service obligations are placed on incumbent providers. Despite these similarities, there may be differences in implementation. For example, cultural differences may lead to differing, evolving definitions of universal service for customers. In addition, political differences reflected in policy, such as the interlata entry barrier placed on Bell Operating Companies, may lead to greater strategic behavior and creamskimming activities by new entrants in the U.S. In the long run, a higher incidence of creamskimming activities in the U.S. may lead to greater difficulties for incumbent providers in the U.S. to meet their universal service obligations in some geographic areas.
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Similarities in policies between the U.S. and EU also include the establishment of explicit funding mechanisms to support universal service, with contributions to be paid by telecommunications service providers and to be imposed in an equitable and nondiscriminatory manner. Both the U.S. and EU, however, will face challenges in actually assessing such contributions in a competitively neutral manner. This is due to the exclusion of providers of substitutable services, such as Internet and enhanced service providers, from making contributions, and the differential abilities among providers to pass through the costs of contributions to customers. There are also some important differences in universal service policies. The differences discussed in this paper relate to concepts of affordability. For residential and business customers in general, the U.S. policy of affordability is based, in large part, on uniformity of rates among classes of customers. Particular emphasis is placed on comparability of rates between rural and urban areas, as well as uniformity of interexchange rates across the states. By contrast, the EU mandates rate rebalancing toward costs for end users, and views affordability as the need to mitigate the effects of this rate rebalancing. Each member state is provided the authority to determine the degree of uniformity of rates among classes of customers, although failure to rate rebalance is not to be funded from universal service funds. Thus, the EU essentially creates a presumption of rate rebalancing towards costs, with deviations permitted for affordability purposes, whereas the U.S. specifically precludes such rate rebalancing in favor of uniformity of rates among various groups of customers. The U.S. concept of affordable rates is also reflected in special statutory provisions under TA96 with regard to rates to be provided to special categories of customers. More specifically, discounted rates are to be provided to certain schools and libraries, and urban rates are to be made available for health care providers serving rural areas. The burden of these requirements has been set in the amount of $2.65 billion per year by the FCC. The EU Directives have no comparable requirements. These differences in approaches to affordability may lead to competitive advantages in the international marketplace for telecommunications providers from the EU as compared to providers from the U.S. This is due to the greater flexibility afforded to member states of the EU to require cost-based rates by providers, as well as the greater financial burden to be borne by U.S. providers for provision of special rates to schools, libraries and health care providers. Overall, the differences in the regulatory frameworks for providing universal service in a more competitive telecommunications environment will likely confer competitive advantages for telecommunications providers in the EU, as well as greater success for achieving the underlying universal service
128 Lessons and Priorities goals. The probability of such advantages materializing increase if the member states avoid the mistakes made in the U.S., such as the creation of double taxation problems with respect to imposition of universal service contributions on providers. In order to mitigate the advantages naturally occurring in the EU’s regulatory framework, policy makers in the U.S. should consider adopting some elements of the EU approach, such as the EU’s view of the relationship between rate rebalancing and affordability of rates.
REFERENCES
[1] Telecommunications Act of 1996, Pub. L. No. 104-104, 47 U.S.C. Sec. 151 et seq. (West Supp. 1997). [2] Directive 95/62/EC, (March 12, 1995). [3] Directive 96/19/EC, (March 13, 1996). [4] Directive 97/ /EC, (June 11, 1997). [5] Communications Act of 1934, 47 U.S.C. sec. 151 et seq. (West 1991 & Supp. 1995). [6] In the Matter of Federal-State Joint Board on Universal Service, FCC Report and Order, CC Docket No. 96-45 (May 8, 1997). [7] European Commission Communication, Universal Service for Telecommunications in the Perspective of a Fully Liberalised Environment, COM(96) 73 (March 13, 1996). [8] European Commission Communication, Assessment Criteria for National Schemes for the Costing and Financing of Universal Service in Telecommunications and Guidelines for the Member States on Operation of Such Schemes, COM(96) 608 (November 11, 1996).
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RECENT DEVELOPMENTS IN THE REGULATION OF INTERNA- TIONAL TELECOMMUNICATIONS Dr. Andrea Huber
INTRODUCTION
The year 1998 is filled with expectations regarding changes in the regulation of telecommunications worldwide. From the effects of liberalization in the European Union (EU) to implementation of the World Trade Organization’s (WTO) Basic Telecom Agreement to the need for reform of the international accounting rate system, regulatory bodies the world over are called upon to meet the challenges of the fast-changing commercial environment. In most member states of the European Union, 1998 marks the liberalization of voice telephony and, thus, the abolition of the last remaining monopoly in these countries’ telecommunications markets.79 A large part of the EU Commission’s efforts is devoted to the creation of a level playing field between incumbent operators and new entrants in the Member states. In the United States, the implementation of the 1996 Telecommunications Act, which sought to introduce competition for local telephone service, is still in progress, especially with regard to the Bell Operating Companies’ (BOCs) entry into the long distance market and the corresponding opening of their local telephone markets to competition. In fact, the first weeks of 1998 have already seen significant activity in this area, especially with regard to the application of section 271 of the Telecommunications Act, that is, the provision stating the requirements for BOC access to the long-distance market. On a larger scale, the WTO Basic Telecom Agreement that was signed on February 15, 1997, became effective on February 5, 1998. It provides for market access for foreign telecommunications carriers and for adherence to a basic regulatory framework by the signatory states. Thus, the Agreement enables operators to enter the markets of the signatory states with some degree of certainty regarding the regulatory environment. Finally, the system of international settlement rates is in the process of being reviewed, not only by the Federal Communications Commission (FCC) which issued an order containing benchmarks for international settlement rates last year,80 but also by the International Telecommunications Union (ITU). The ITU World Telecommunications Policy Forum (WTPF) in March 1998 addressed developments in world trade in telecommunications and the reform of the international settlement rate system. The 3-point opinion adopted by the WTPF is expected to improve the relationship between the ITU and the WTO,
130 Lessons and Priorities support developing countries in their transition to competitive markets, and accelerate the pace of accounting rate reform.81 One of the most important issues in the context of the liberalization of telecommunications markets worldwide is network access and interconnection. The introduction of competition can only be successful if it is guaranteed, on the one hand, that new entrants do not have to duplicate existing facilities but can gain access to existing networks. On the other hand, to avoid inefficient market entry and subsidization of new entrants by incumbent network operators, the operators of existing networks must be able to recover the costs for interconnection from the new entrants. Implementing a fair and efficient interconnection regime is one of the most significant challenges in markets currently opening to competition. Thus, not surprisingly, it is one of the focal points of the EU Commission and national regulators throughout the member states. At the same time, the EU Commission is discussing the relation between international settlement agreements and cross-border interconnection. In the United States, controversial questions on the implementation of the Telecommunications Act, including the introduction of competition in local markets and network access for competing local exchange carriers (LECs) will likely be decided by the U.S. Supreme Court. In discussing the issues surrounding network access for new entrants, it is helpful to keep in mind the international regulatory environment in telecommunications and to look at the approaches chosen in different countries. To provide a framework for the contributions from individual countries this article will now describe and analyze the recent developments in the regulation of international telecommunications that were already briefly mentioned above. This article examines the most recent of these developments in the area of international telecommunications regulation. Part of the analysis is devoted to international agreements and initiatives such as the WTO Basic Telecom Agreement and the current attempts at a reform of the international settlement rate system. Also emphasized, because of their significant impact around the world, are the developments in the United States and the European Union. A focal point of this analysis is on the use of asymmetric regulation in the liberalization of telecommunications markets.
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DISCUSSION
A. International Agreements 1. WTO Basic Telecom Agreement The WTO Basic Telecom Agreement was signed by sixty-nine states on February 15, 1997, in Geneva, Switzerland. The Agreement, which could have the widest impact of any other development for some time to come, followed a lengthy period of negotiations within the so-called Group on Basic Telecommunications. Originally, the Agreement had been scheduled for signature in April 1996. However, at that time the United States argued that there was no “critical mass” of countries that were willing to sign the Agreement. Therefore, it was argued, signature of the Agreement would lead to negative consequences for those countries that would open their markets. In the months following April 1996 more countries decided to join the negotiations and sixty-nine of them finally signed the Agreement in early 1997.82 The Agreement required implementation by the signatory countries by November 30, 1997. Its entry into force was scheduled for January 1, 1998. However, in November 1997 it became clear that not all signatory countries would be able to implement the Agreement in time to meet the deadline. For some countries this failure was caused only by administrative or bureaucratic impediments. However, the United States contended that the lack of implementation especially in signatory states from Latin America would seriously impede the success of the WTO Basic Telecom Agreement. Therefore, after further discussions the signatory states agreed in January 1998 to extend the deadline for ratification until July 31, 1998. The Agreement was to become effective by February 5, 1998, for those states that had already ratified it. For the twelve signatory states that had not ratified the Agreement by January 31, 1998, the Agreement will become effective with the date of ratification.83 a) Contents What is usually referred to as the “WTO Basic Telecom Agreement” takes the form of the Fourth Protocol to the General Agreement on Trade in Services. To this protocol are attached the schedules of commitments and lists of Most Favored Nation (MFN) exemptions undertaken by the signatory countries. Each schedule contains that country’s commitments with regard to market access and national treatment, as well as any additional commitments the country wishes to make. Further, the schedules contain descriptions of the services for which commitments are made.
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An additional commitment that a majority of the signatory countries entered into is the Reference Paper on regulatory principles. Under the Reference Paper, countries are obliged to prevent major suppliers from engaging in anti-competitive practices. The Paper particularly proscribes cross-subsidization, use of information obtained from competitors, and the withholding of necessary technical and commercially relevant information from other service suppliers. Consequently, the signatory countries must introduce or maintain appropriate competitive safeguards. Second, the Reference Paper requires major suppliers to ensure interconnection at any feasible point of the network. In most WTO member countries the term “major supplier” will apply to the monopolist or former monopolist incumbent operator. Further, interconnection must be provided (1) under non-discriminatory terms and conditions; (2) at transparent, reasonable, and cost-oriented rates; (3) sufficiently unbundled, and (4) upon request, at points in addition to the network termination points. The Reference Paper provides for the public availability of interconnection procedures and arrangements by major suppliers, that is, a reference interconnection offer must be available to any party interested in entering into an interconnection agreement. Finally, the Reference Paper requires that a dispute settlement procedure administered by an independent regulatory body shall be made available to suppliers requesting interconnection. There are also guidelines with regard to universal service obligations, public availability of licensing criteria, independence of regulators, and the allocation of scarce resources. An important consequence of the adoption of the WTO Basic Telecom Agreement is the recourse to the WTO Dispute Settlement Body which it provides. Under Article III(3) of the WTO Agreement and the annexed Understanding on Rules and Procedures Governing the Settlement of Disputes, each WTO Member has the right to request a dispute settlement procedure to address alleged violations of the WTO Agreement, including the WTO Basic Telecom Agreement. If a WTO Member brings a case before a Dispute Settlement Body, the panel will examine the case, hear the parties and then come to a decision within six months. b) Assessment The WTO Basic Telecom Agreement is a comprehensive market opening undertaking that, for the first time, offers enforceable mechanisms to enter a foreign telecommunications market.84 The Reference Paper provides basic regulatory tools on an international level that will allow telecommunications operators to assess the chances and risks of entering a foreign market. To
133 Telecommunications Reform in Germany achieve this goal of making market entry easier for foreign carriers, the Reference Paper relies mostly on asymmetric regulation and the existence of a national regulatory authority. Under the Reference Paper, major suppliers must provide interconnection, competitive safeguards against the abuse of a dominant market position are requested, and universal service obligations must be imposed in a competitively neutral way. Consequently, those WTO members that do not have an interconnection regime in place will have to introduce one in order to comply with the WTO Basic Telecom Agreement. Interconnection is one of the most important prerequisites for a functioning competitive environment. Without effective interconnection, market entry will become extremely difficult to foreign carriers as the creation of a new network is often prohibitively expensive and time consuming. Furthermore, duplication of an existing network is not an economically reasonable allocation of resources. Therefore, interconnection and access to an incumbent’s network is generally the most intensely fought over issue in the course of liberalization of a monopolist market. This is true for those EU member states that have opened their voice telephony markets on January 1, 1998, as well as for local services in the United States. An example are the ongoing disputes between several BOCs and the FCC about fulfillment of the competitive checklist contained in section 271 of the Telecommunications Act. The Reference Paper now transfers the lessons from these experiences to an international level. By granting foreign carriers the right to interconnect with a country’s major supplier, there should now be effective access to each signatory country’s telecommunications market. However, it also opens the door to the disputes we know from earlier-liberalized markets in Europe and the United States. Interconnection cannot be provided for free, nor are the technical parameters always undisputed. Thus, the judicial and regulatory challenge in the next few years will be a task that would have challenged Salomon: to try to fairly balance the competing interests of incumbent, new entrants, and customers. A similar challenge is the Reference Paper’s provision for transparent, non-discriminatory, and cost-oriented interconnection rates. It must be borne in mind, though, that the methods used for determining interconnection costs have been hotly debated in the earlier-liberalized markets. The better part of the FCC’s Interconnection Order,85 for example, deals with the comments and reply comments filed in the course of the Rulemaking Proceeding. Therefore, it can be expected that these same issues will surface in newly-liberalized countries when a foreign carrier claims interconnection rights pursuant to the Reference Paper.86
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Does this mean, in the end, that a WTO Dispute Body will be required to determine cost-orientation of interconnection rates in markets such as Argentina, Germany or the United States? Likely not. It is to be expected that the WTO, in such disputes, would rely heavily on the expertise of the national regulatory authority. In fact, this is another reason why the Reference Paper strongly emphasizes the existence of independent national regulatory authorities. Consequently, without an independent national regulatory authority and its commitment to market opening and liberalization, the provisions of the Reference Paper will not be sufficient to grant efficient market access to foreign operators.
2. ITU For several years, one of the ITU’s focal points has been the reform of the International Accounting Rate System. Under the existing system carriers bilaterally negotiate accounting rates for the termination of international telephone traffic. However, in a major part of the world, monopolist carriers are able to set accounting rates which substantially exceed the costs of call termination. The resulting imbalances between liberalized and non-liberalized countries have resulted in increasing calls for a cost-oriented accounting rate regime over the past years. With its widespread membership of developed and developing countries, the ITU has been so far the most prominent forum to discuss options for a reform of the existing system. Current developments in international telecommunications, most prominently the implementation of the WTO Basic Telecom Agreement, mandate a reform of the international Accounting Rate system. Implementation of the WTO Basic Telecom Agreement will result in increasing liberalization in the 69 signatory countries representing approximately 90 percent of the world’s telecommunications markets. The existing Accounting Rate system, on the one hand, is tailored for bilateral settlement agreements between two monopolist operators. Increasing liberalization, on the other hand, will result in competitive markets and the abolition of existing monopolies. Therefore, it is necessary to adapt the accounting system for the termination of international calls to this new, competitive environment. In the ITU-T Study Group 3, experts from country and sector members analyze the future of accounting rate and settlement systems in increasingly competitive markets. The basis of the discussion within Study Group 3 is ITU- T Recommendation D.140 under which accounting rates must be cost-oriented, transparent, and non-discriminatory.87 This Recommendation has now been endorsed by most countries represented in Study Group 3.88
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The ITU’s goal in reforming the international accounting rate system is to introduce cost-based, non-discriminatory, and transparent termination charges. These charges would have to be set based on the following elements: (1) the international circuit; (2) the international exchange; and (3) the national extension. However, as the Secretary-General points out in his report to the ITU Policy Forum, the introduction of cost-based termination charges requires a general “multilateral agreement on costing methodologies and on which cost elements can be legitimately included in the calculation of the charges.”89 Existing studies, such as case studies commissioned for the Policy Forum, best practice rates, e.g., from the European Union, or benchmarks set by other regulators, particularly by the FCC in its Benchmark Order,90 could provide guidance for the necessary transition.91 Further, in December 1997, Study Group 3 discussed possible means to encourage the transition from the existing accounting rate system to cost- oriented mechanisms.92 As a result, the Group agreed on several recommendations which, upon approval by the ITU’s member countries, will become part of a revised Recommendation D.140.93 Under the Study Group’s recommendations, national administrations or recognized operating agencies (ROA) should aim for a total accounting rate level of 1 SDR per minute by the end of 1998.94 By the end of 1999, national administrations/ROAs should have in place an appropriate costing methodology to determine their relevant costs. Finally, as a result of the WTPF a Focus Group will be established which has the task to develop a proposal how to further reduce accounting rates as a transitional measure on the road to cost-oriented rates. The Focus Group will report on the results of its work to Study Group 3 by November 6, 1998. In the long run, the introduction of cost-based termination charges is certainly the best method to account for the termination of international calls. It is in line with the general development towards more transparency and cost- accounting in telecommunications displayed, for example, by the EU Commission’s activities in the field of cost-based interconnection pricing and accounting separation. Also, accounting rates which exceed costs are not sustainable in a global competitive environment. Rather, their existence encourages carriers to by-pass the existing system using, for example, refiling or call back methods. Thus, even more of an imbalance is created. However, two things need to be considered when discussing the introduction of cost-based termination charges for international call termination. First, it must be ensured that a sufficient number of countries agree to apply termination charges in place of the existing accounting rates. Otherwise, low termination charges between already liberalized countries invite countries with high accounting rates to refile their traffic and, thus, even
136 Lessons and Priorities increase the payments they receive as settlements. Thus, a severe imbalance would be created to the advantage of non-liberalized countries. In particular, developing countries with high accounting rates need to be convinced to implement cost-based termination charges. While a certain percentage of free riding can, most likely, not be avoided, a balance has to be struck between the general interest in reforming the Accounting Rate system and the economic interests of operators in liberalized countries. Second, agreeing on and implementing a costing methodology for termination charges will be, in all likelihood, an extremely complicated process. Over the past two years, both the European Union and the United States have introduced a long run incremental cost methodology to determine cost-based interconnection charges. However, in the United States and in the EU member states the application of this methodology has led to disputes and extended court proceedings. The telecommunications markets in the United States and the EU member states are highly developed markets with efficient operators. One can easily imagine how much harder it will be to introduce an cost accounting methodology that is acceptable to both developing and developed countries with highly different market structures and infrastructure needs. Therefore, the challenge and the hope is that the lessons learned from these early experiences can be effectively and efficiently applied so that cost- based accounting will become standard world-wide.
B. Recent Developments within the European Union and the United States 1. European Union As mentioned above, most EU member states liberalized their voice telephony markets by January 1, 1998. The introduction of competition for voice telephony was the last step in the liberalization of the EU’s telecommunications market that began with the adoption of the Green Paper on the Liberalization of the Telecommunications Sector in 1987.95 In the years since, the EU has adopted various directives designed to open the telecommunications markets in the member states, including the Competition and the Full Competition Directives,96 the ONP Framework Directive,97 the Interconnection Directive,98 and the Voice Telephony Directive.99 In order to promote a functioning competitive environment, the EU has, on the one hand, abolished market access barriers such as monopoly rights for state-owned telecommunications operators. On the other hand, it has created a regulatory framework designed to enable new competitors to enter the former monopoly markets. In this context, the EU Commission has, in the course of the past year, particularly focused on interconnection and network access including pricing and accounting separation.
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The right of new market entrants to interconnect with the network of a dominant provider is one of the cornerstones of EU telecommunications regulation. Various directives lay out the ground rules for this right. For example, under the ONP Interconnection Directive, organizations that provide public telecommunications networks or services must negotiate interconnec- tion terms with each other. Other organizations, i.e., organizations that do not provide public telecommunications networks or services, have the right to request access to a dominant telecommunications provider’s network under the ONP Voice Telephony Directive. Charges for both interconnection and access have to be cost-based and transparent. In order to ensure availability of an incumbent’s standard interconnection offer to new entrants, national regulatory authorities were required to ensure publication of a reference interconnection offer by July 1, 1997, under the Full Competition Directive. Finally, with respect to the inevitable disputes that can be expected in the area of interconnection and access, the ONP Interconnection Directive provides for dispute settlement procedures for interconnection disputes. As to cost orientation of interconnection or access charges, there is still discussion about the adequate methodology within the EU. This past September, the European Commission published the first part of a recommendation on interconnection pricing and cost accounting for interconnection pricing.100 Therein, the Commission recommends a best current practice approach for the time being. This approach examines peak rate interconnection charges to an incumbent’s fixed public telephone network under three different scenarios: (1) local level interconnection, (2) metropolitan level interconnection, and (3) national level interconnection. Based upon the interconnection charges in the three lowest priced member states, the Commission then recommends best current practice prices for interconnection. However, the Commission states in the Recommendation that, once the necessary studies are concluded, it will favor a methodology based upon long run average incremental costs (LRAIC) to determine interconnection costs. As a next step in creating a basis for the determination of cost-based interconnection charges, this past November the European Commission published a Working Document on cost accounting and accounting separation principles.101 This proposal is designed “to provide practical guidance to National Regulatory Authorities on how the requirements on cost-accounting and accounting separation in the interconnection directive can be implemented.”102 With reference to operators with significant market power103, the Commission suggests separating operating costs, capital employed, and revenues into four business lines: core-network, local access-network, retail, and other activities.104 Thus, operators should be able to make transparent their
138 Lessons and Priorities costs, revenues, and capital employed to regulatory authorities and competitors. In the Commission’s opinion, this will serve to give regulators and competitors “confidence that no anti-competitive cross-subsidies exist.”105 Another issue that the European Commission is currently looking at is interconnection for carriers from EU member states in non-EU member states. This issue gains increasing significance in the EU because, under EU regulation, a foreign carrier has the right to terminate its cross-border traffic in any EU member state by means of interconnection. However, unless there is reciprocity with regard to the right to cross-border interconnection, this may cause imbalances in the processing of incoming and outgoing calls in EU member states. Therefore, under Article 22 of the Interconnection Directive, the Commission must report to the European Parliament and the Council “on the availability of rights to interconnect in third countries for the benefit of Community organizations.”106 A draft of this report was made public by the ONP Committee this past December.107 Therein, the Commission states that the existing accounting rate system is no longer appropriate for charging cross- border calls between liberalized countries.108 Instead, the Commission considers cost-oriented termination charges, pointing out that this mechanism is best suited to a competitive market. Therefore, it is to be hoped that the Commission will closely watch the issue of accounting rates versus cross- border interconnection charges in the course of this year to determine possible impacts on the EU telecommunications industry and ensure a balance between introduction of an EU-wide interconnection regime and application of the existing Accounting Rate system.
2. United States In the United States, several important aspects of the legal and regulatory framework have been subjected to challenges and will be subjected to the scrutiny of the highest court in the land. The Telecommunications Act of 1996 was designed to introduce competition in the local telephone markets where, so far, the local Bell Operating Companies (BOCs) had a monopoly to provide local telephone service. In order to compensate the BOCs for the loss of their status as sole provider of local services, the Telecommunications Act allows them to enter into the long-distance market, provided that competition exists in their local markets. Under section 271 of the Telecommunications Act, a BOC may only offer long-distance services in its local services market if it has entered into an interconnection agreement with a facilities-based competitor or, if there are no interested competitors, if it has an approved standard interconnection agreement available.109 Consequently, interconnection has
139 Telecommunications Reform in Germany become one of the dominant issues regarding the introduction of competition in local telephone markets in the United States. In its Interconnection Order, the FCC decided that cost-based interconnection rates should be determined using a total element long run incremental cost methodology (TELRIC).110 This decision was widely criticized, especially by local exchange carriers arguing that the FCC did not have jurisdiction to determine an interconnection pricing methodology. Rather, this determination should be left to the states. In the course of the ensuing lawsuit, the Interconnection Order was stayed by the court of appeals for the Eighth Circuit for jurisdictional reasons.111 The court followed the arguments brought by the local exchange carriers, which was essentially that the FCC did not have jurisdiction over the issue of interconnection pricing in local markets. The court held that jurisdiction over this issue lies with the state regulators. The case is now before the U.S. Supreme Court, which is expected to issue an opinion by the end of 1998. However, at this point most state regulators are using either TELRIC or a similar methodology when deciding interconnection pricing disputes. Another question that should be decided by the U.S. Supreme Court this year is the BOCs’ obligation to recombine unbundled network elements. In order to further competition in the local telephone markets, the FCC had decided that BOCs were obliged to not only offer unbundled access to competitors but also to recombine the unbundled network elements according to a competitor’s demands.112 However, this obligation was also stayed by the court of appeals for the Eighth Circuit.113 Until the Supreme Court decides this issue, BOCs are not being required to recombine unbundled network elements. The latest development with regard to the opening of the local telephone markets to competition in the United States is the decision of the District Court in Wichita Falls, Texas, declaring section 271 of the Telecommunications Act unconstitutional.114 In a lawsuit filed by SBC in 1997, the Court found that section 271 and, in particular, the so-called competitive checklist BOCs have to fulfill before they are allowed to provide long-distance services in their local service areas, give an unfair advantage to those local exchange carriers that do not have to comply with section 271. With this decision, the BOCs would have been able to offer long-distance service within their local service areas without any restrictions. However, the U.S. Department of Justice and several long- distance carriers appealed the decision and obtained a stay from the district court, which means that the court decision is ineffective until review by a higher court is completed. Although this latest decision is not in effect, it may have had some influence on the FCC’s policy with regard to BOC entry into the long-distance market.
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For example, the FCC recently announced that it will use a more cooperative approach when judging BOC application for entry into the long-distance market. Thus, a speedier granting of applications may be facilitated. This is a change from the previous procedure where only after lengthy reviews and several rejected applications a set of FCC precedences were formed which could serve as criteria for following applications. Clearly, the implementation of the Telecommunications Act and the corresponding changes in the U.S. telecommunications market are by no means completed. As in Europe, the opening of formerly monopolist markets to competition creates friction between market players and regulators and gives rise to arguments which will, in the end, be decided by the courts.
CONCLUSION
So far, the expectations regarding the year 1998 have only been partly fulfilled. On one hand, the liberalization of global telecommunications markets has made a great leap with the implementation of the WTO Basic Telecom Agreement. In particular, implementation in the EU member states and the United States have led to improvements regarding market access for foreign telecommunications companies. On the other hand, much remains to be done before a truly global and liberalized telecommunications market will become reality. Effective implementation of the WTO Basic Telecom Agreement in all signatory countries must be monitored and ensured in order to encourage investment and participation in foreign markets. Also, the liberalization of telecommunications markets must play a significant role in negotiations for accession to the WTO, e.g., with Russia or China. The international accounting rate system must be reformed to gradually adapt the cost of international call termination to the cost of national call termination. In this context, incentives and support must be provided for developing countries that will suffer from a decrease in foreign currency income as a result of accounting rate reform. Finally, in the domestic arena in both the United States and EU member states, a functioning competitive environment must be ensured—one that considers both the concerns of incumbent operators and new entrants.
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ENDNOTES
1. This is an amended and updated version of a paper presented at the Telecommunications Policy Research Conference, Alexandria, Virginia, USA on September 27-29, 1997. 2. Access covers non-traffic sensitive costs - local loop plus line-card; Network covers traffic sensitive costs, including the components used to build up interconnec- tion charges (referred to below as “conveyance”). 3. Under the ECPR interconnection charges are given by the sum of the incremental cost and the opportunity cost (foregone profit) on retail calls. 4. BT has a few remaining analogue local switches, which are to be replaced with digital equipment by early 1998. 5. A discussion of the pros and cons of different mark-up regimes is beyond the scope of this paper—for OFTEL’s views on mark-ups see OFTEL (1994, 1995a). 6. See, for example, the series of reports prepared for OFTEL by NERA. 7. With the assumption that there are no sunk costs in the long run, this is identical to the incremental cost. 8. Copies of the bottom-up model on diskette are also available from OFTEL. 9. In practice, this was found to lead to some differences between the models, asset by asset, but the differences were not systematic and were in both directions. Consequently, this was not a major source of difference. 10. Point-to-point and intermediate multiplexed networks will have a different balance of costs between electronics and fibre. 11. There are three double tandem services offered by BT and two by Deutsche Telekom, differing by distance band. To compute the average double tandem charge, a simple average has been taken of these charges. 12. Switch port rental costs are included on a per minute basis assuming 1.8 million minutes per annum per 2Mbit/s connection. 13. Unbalanced tariffs (a type of access deficit calculation) account for about 0.8 centimes per minute, and the universal service cost of geographically averaged tariffs accounts for about 1 centime per minute. 14. Access charges, however, will be paid on call origination. Consequently the price of “Local Carrier Select” is roughly double the price of “Local Terminating Access.” 15. They are paid on inter-LATA toll calls, but not local calls (even though the network components used in each case may be identical). 16. The FCC commented that a consideration in determining the definition of the increments in TELRIC, was to minimize the common costs between elements—see FCC (1996). 17. Similarly, by construction, the sum of the component ceilings equals the stand-alone cost of conveyance. The component ceiling is therefore generally lower than the stand- alone cost of the component. Further details are set out in Annex C of OFTEL (1997d).
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18. The author is indebted to G. Brunekreeft, W. Groß, M. Kunz, J. Merkt, H.-J. Weiß and the participants of the research seminars at the Government Institute for Economic Research in Helsinki and the University of Freiburg and the participants of the AICGS Conference in Bonn for helpful comments. 19. For the analysis of technical regulations, the reader is referred to Knieps, G., Die Ausgestaltung des zukünftigen Regulierungsrahmens für die Telekommunikation in Deutschland, Diskussionsbeiträge des Instituts für Verkehrswissenschaft und Regionalpolitik, Nr. 22, Universität Freiburg, Juli 1995; the analysis of an entry- compatible alternative to cross-subsidization, the so-called universal service fund, has already been provided in Blankart, Ch. B., Knieps, G., What Can We Learn From Comparative Institutional Analysis? The Case of Telecommunications, in: Kyklos, Vol. 42, Fasc. 4, 1989, S. 579-598 . 20. A separate critique of the best current practice interconnection charge at the local level is provided in part C.IV, although in local networks regulation still seems to be necessary. 21. See Knieps, G., Phasing out Sector-Specific Regulation in Competitive Telecommunications, in: Kyklos, Vol. 50, Fasc. 3, 1997, pp. 328ff. 22. Similar ONP-policies could also be observed in other network industries, e.g., railroads and airlines (e.g., Knieps, G., Wettbewerb in Netzen? Reformpotentiale in den Sektoren Eisenbahn und Luftverkehr, Tübingen, 1996). 23. Similar ONP-policies could also be observed in other network industries, e.g., railroads and airlines (e.g., Knieps, G., Wettbewerb in Netzen? Reformpotentiale in den Sektoren Eisenbahn und Luftverkehr, Tübingen, 1996). 24. Shankerman, M., Symmetric regulation for competitive telecommunications, in: Information Economics and Policy, Vol. 8, 1996, pp. 5f. 25. Baumol, W.J., Panzar, J.C., and Willig, R.D., Contestable Markets and the Theory of Industry Structure, New York, 1982. 26. The argumentation in favor of asymmetric regulation in Germany is illustrated for example in: Mestmäcker, E.-J., Witte, E., Gutachten zur Zuständigkeit für die Verhaltensaufsicht nach dem dritten und vierten Teil des Referentenentwurfs für ein Telekommunikationsgesetz (TKGE), Hamburg und München, 22. November 1995, p. 12, and in: Picot, A., Burr, W., Regulierung der Deregulierung im Telekommunikationssektor, in: ZfbF (Schmalenbachs Zeitschrift für betriebswirtschaftliche Forschung), Vol. 48, Heft 2, 1996, p. 192. 27. OECD: Working Party on Telecommunication and Information Services Policies— Universal service and public access in the technologically dynamic and converging information society. OECD, Paris, April 10-11, 1997. 28. OECD: Working Party on Telecommunication and Information Services Policies— Corrigendum to “Universal service and public access in the technologically dynamic and converging information society.” OECD, Paris, September 15-16, 1997.
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29. See Knieps, G., Phasing out Sector-Specific Regulation in Competitive Telecommunications, in: Kyklos, Vol. 50, Fasc. 3, 1997, pp. 325-339. 30. Final Report and Order on the Local Competition Provisions of the Telecommunications Act, FCC-96-325, August 8, 1996, pp. 329ff. 31. See Haring, J., Rohlfs, J.H., Efficient competition in local telecommunications without excessive regulation, in: Information Economics and Policy, Vol. 9, No. 2, June 1997, pp.119-131. 32. See Griffin, J.M., The Process Analysis Alternative to Statistical Cost Functions: An Application to Petroleum Refining, in: American Economic Review, Vol. 62, 1972, p. 47. 33. See Gabel, D., Kennet, D.M., Estimating the Cost Structure of Local Telephone Exchange Network, Columbus, OH: National Regulatory Research Institute at Ohio State University, 1991. 34. See Gabel, D., Kennet, D.M., Economies of Scope in the Local Telephone Exchange Market, in: Journal of Regulatory Economics, Vol. 6, 1994, pp. 386 ff. 35. See Griffin, J.M., Long-run production modeling with pseudo-data: electric power generation, in: Bell Journal of Economics, 1977, p. 125. 36. As long as upgrading is an efficient strategy its costs should not be confused with phantom costs due to overvaluation of installed investment (based on differences between economic and historical depreciation patterns (see next section)). 37. The reader is referred to a series of studies NERA provided to OFTEL: The Methodology to Calculate Long-Run Incremental Costs, March 1996; Reconciliation and Integration of Top Down and Bottom Up Models of Incremental Costs, June 1996; Reconciliation and Integration of Top Down and Bottom Up Models of Incremental Costs, Final Report, December 1996. 38. See also H. Albach, G. Knieps: Kosten und Preise in wettbewerblichen Ortsnetzen, Baden-Baden 1997, p. 31. 39. The peak-load pricing principle is already developed in: Steiner, P.O., Peak load and efficient pricing, in: Quarterly Journal of Economics, Vol. 71, 1957, pp. 585-610. 40. See the article by Willig, R.D., Pareto-Superior Nonlinear Outlay Schedule, in: Bell Journal of Economics, 1978, Vol. 9, pp. 56-69. 41. See e. g. Kahn, A.E., Shew, W.B., Current Issues in Telecommunications Regulation: Pricing, in: Yale Journal on Regulation, Vol. 4 (2), Spring 1987, pp. 191-256. 42. See Henriet, D., Moulin, H., Traffic-based cost allocation in a network, in: Rand Journal of Economics, Vol. 27, No. 2, Summer 1996, pp. 332-345. 43. See OFTEL: Network Charges from 1997, London, May 1997. 44. Commission of the European Communities: Commission Recommendation on Interconnection in a liberalized telecommunications market - Part 1 - Interconnection Pricing, Brussels, October 15, 1997 (Provisional text). 45. For different views, see Brunekreeft (1997) and Knieps (1997) according to whom telecommunications markets either represent bottlenecks (local networks) or are 144 Lessons and Priorities contestable (the service and long-distance markets). This contrasts, for example, with MacAvoy (1996), who maintains that there is a lack of competition in the U.S. long- distance market, something that would not be sustainable under contestability. 46. In New Zealand, the incumbent DO is regulated “only” by a price moratorium on basic services. 47. The ECPR is widely attributed to Willig (1979) and Baumol (1983). For an extensive discussion, see Baumol and Sidak, 1994, and the Winter 1994 edition of The Yale Journal on Regulation and in the Fall 1995 issue of the Antitrust Bulletin. 48. The relationship between the ECPR and the Ramsey approach is akin to the one between partial and general equilibrium analysis. However, in the case of interconnection the legitimacy of partial analysis is called into question because interactions between the relevant markets are bound to be very strong. 49. These effects do not yet include incentive effects as discussed in Laffont and Tirole (1993). The absence of incentive effects can be justified if the incentive-pricing dichotomy holds. 50. We are here neglecting the possibility that network interconnection may efficiently be priced below marginal/incremental costs because of network externalities or because of lack of competition in the retail market. 51. See, for example, in Arnbak et al., 1994, Mitchell et al., 1995, Mitchell and Vogelsang, forthcoming. 52. See, for example, Perl and Falk (1989) or Shin and Ying (1992). 53. Similarly, calculating stand-alone costs is harder than calculating incremental costs. In particular, stand-alone costs of various output combinations need to be calculated in order to derive the relevant upper bound, because the DO’s revenues should not exceed stand-alone costs for any output combination. 54. Laffont and Tirole (1996) equate the imputation requirement with the ECPR. However, imputation implies upper bounds for interconnection charges (or, minimal internal transfer prices), while the ECPR declares these upper bounds to be optimal. 55. Price adjustment formulas of similar kinds would even be advisable for privately negotiated interconnection agreements. 56. For a different opinion, see MacAvoy (1996). 57. The slow pace obviously suits the ILECs. However, it may also suit some others, such as cable TV companies, who want to be full network entrants and who take time to develop their network technology and infrastructure. 58. In principle, the sum of network element costs properly weighted should equal total network costs. However, elements may include setup and collocation costs that would not be needed for a stand-alone network. 59. See, for example Gabel and Gabel (1997) for a history of cost measurement in the U.S. telephone industry.
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60. Brock (1997) believes that the ambiguity in the U.S. Telecom Act about the FCC’s authority to interfere with intrastate matters was intentional, in order to get the act passed. 61. See Williamson’s (1996) comment to Sidak and Spulber. Williamson’s main counter-argument against a construction of takings under Sidak’s and Spulber’s view of regulation as a long-term contract is that long-term contracts are always incomplete and have to be adapted. In regulatory contracts, in particular, issues of opportunism arise on both sides (e.g., regulatory capture, not prudently incurred investments, entry deterrence and other moral hazard issues). As a result, there cannot be guarantees on either side. According to Williamson, a guarantee to compensate for stranded investment would lead to wasteful investment. 62. However, the influence of state regulators mitigates part of the strong language of the U.S. Telecom Act, as interpreted by the FCC. 63. As noted in Kress (1997), the U.S. Telecom Act concentrates on issues specific to local telecommunications (except for Sections 271/272) because long-distance telecommunications had been experiencing competition for more than two decades already. In contrast, the German Telecom Act had to include local and long-distance networks. However, the U.S. Telecom Act did trigger a long-distance access charge reform for interstate access. 64. For an extensive analysis of these developments see Vogelsang and Mitchell (1997). 65. See Deutsche Telekom (1997). 66. Under an efficiency approach we may define the presence of incumbency burdens by the fact that, without its fault, the incumbent as a firm (or a well-defined part of the firm) is valued lower by the (financial) markets than it would cost to replace its assets (by modern assets, age adjusted). This means that, for the firm, Tobins ‘q’ < 1. 67. See Deutsche Telekom (1997). Based on the low telephone density of some former East German districts, Deutsche Telecom could actually try to claim universal service subsidies under the German Telecom Act. 68. See Oftel (1997). Note that the issue of universal service costs is related to but not identical with that of access deficits. 69. See Johnson (1988) for the high administrative costs of U.S. lifeline and link-up programs. 70. See Albach et al. (1997) and Vogelsang (1996 and 1997). 71. Dixit, Avinash K. and Pindyck, Robert S., Investment Under Uncertainty, Princetown University Press 1994, p. 6. 72. Ibid 73. Defined in Article 1(a) as “the physical and logical linking of telecommunications networks used by the same or a different organization in order to allow the users of one organization to communicate with the users of the same or another organization, or to access services provided by another organization. Services may be provided by the parties involved or other parties who have access to the network.”
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74. Commission Recommendation on Interconnection in a Liberalized Telecommunica- tions Market. January 8, 1998 75. Directive 98/10/EC of the European Parliament and of the Council of 26 February 1998 on the application of open network provision (ONP) to voice telephony and on universal service for telecommunications in a competitive environment. 76. See William J. Baumol & Gregory Sidak, Toward Competition in Local Telephony, MIT Press/AEI, 1994 Ch 7. 77. The criteria are the extent to which telecommunications services: (A) are essential to education, public health or public safety; (B) have, through the operation of market choices by customers, been subscribed to by a substantial majority of residential customers; (C) are being deployed in public telecommunications networks by telecommunications carriers; and (D) are consistent with the public interest, convenience and necessity. 78. However, in section 252, Congress does mandate cost standards for pricing of certain elements, such as interconnection and unbundled network elements, between carriers. 79. Of the fifteen member states, the following were granted deferments ranging from six months to three years with regard to the liberalization of voice telephony: Greece, Ireland, Luxembourg, Portugal, Spain. 80. International Settlement Rates, IB Docket 96-261, Report and Order, FCC 97-280. 81. ITU World Telecommunications Policy Forum, Trade in Telecommunications, Report by the Chairman, March 18, 1998, available at http://www.itu.int/wtpf/sg_rep/ chairman/english.doc. 82. For a brief overview over the signatory countries and their individual commitments, see William J. Drake & Eli M. Noam, The WTO deal on basic telecommunications, 21 TELECOMMUNICATIONS POL’Y 799, 803 [hereinafter Drake & Noam]. 83. In the following countries the Agreement was not ratified as of January 26, 1998: Argentina, Belgium, Bolivia, Brazil, Chile, Dominica, Dominican Republic, Ghana, Guatemala, Papua New Guinea, Philippines, Poland. 84. Drake & Noam at 809. 85. Implementation of the Local Competition Provisions in the Telecommunications Act of 1996 and Interconnection between Local Exchange Carriers and Commercial Mobile Radio Service Providers, First Report and Order, 11 FCC Rcd 15499 (1996), Order on Reconsideration, 11 FCC Rcd 13042 (1966), petition for review pending and partial stay granted, sub nom. Iowa Utilities Bd. v. FCC, 109 F.3d 418 (8th Cir. 1996), pricing rules vacated, 1997 WL 403401 (8th Cir. July 18, 1997) (“Interconnection Order”). 86. Drake & Noam at 806. 87. International Telecommunications Union, Telecommunications Standardization Sector. ITU Recommendation D.140, Accounting Rate Principles for International Communications Services (Geneva 1992, revised 1995).
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88. See Third Draft of the Secretary-General’s Report to the Second World Telecommunications Policy Forum on Trade in Telecommunications, available at http:/ /www.itu.int/wtpf/sg_rep/3_draft/002v3e2.doc (“Third Draft”) at para. 44. 89. Third Draft at para. 47. 90. International Settlement Rates, IB Docket 96-261, Report and Order, FCC 97-280. 91. Third Draft at para. 47. 92. Id. 93. Id. at ¶ 45. 94. Approximately $1.35. 95. Towards a Dynamic European Economy: Green Paper on the Development of a Common Market for Telecommunications Services and Equipment, COM(87)290 final. 96. Commission Directive 90/388, 1990 O.J. (L 192) 10; Commission Directive 96/19, 1996 O.J. (L 74) 13. 97. Council Directive 90/387, 1990 O.J. (L 192) 1. 98. Parliament and Council Directive 97/33, 1997 O.J. (L 199) 32. 99. Parliament and Council Directive 95/62, 1995 O.J. (L 321) 6 (A revision of the 1995 ONP Voice Telephony Directive has been adopted on January 29, 1998, by the Council and will have to be implemented by the Member states by mid-1998). 100. Commission Recommendation on Interconnection in a liberalized telecommunica- tions market, Part 1 - Interconnection Pricing of 15 October 1997, 1997 O.J. (C 3148). 101. Interconnection in a liberalized telecommunications market: Working document on Cost Accounting and Accounting Separation of 6 November 1997, XIII/A/1. 102. Id. at 2. 103. An operator is “presumed to have significant market power when it has a share of more than 25 percent of a particular telecommunications market in the geographical area in a Member State within which it is authorized to operate.” Parliament and Council Directive 97/33, 1997 O.J. (L 199) 32, Article 4 (3). 104. Interconnection in a liberalized telecommunications market: Working document on Cost Accounting and Accounting Separation of 6 November 1997, XIII/A/1 at 5. 105. Id. at 2. 106. Parliament and Council Directive 97/33, 1997 O.J. (L 199) 32, Art. 22 para.1. 107. ONP Committee Draft Report on the availability of rights to interconnect in third countries for the benefit of Community telecommunications organizations of December 23, 1997, ONPCOM98-01. 108. Id. at 8. 109. Telecommunications Act 47 U.S.C. § 271 (1996). 110. Interconnection Order at paras. 690-693. 111. Iowa Utilities Bd. v. FCC, 109 F.3d 418 (8th Cir. 1996).
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112. Interconnection Order at paras. 292-294. 113. Iowa Utilities Bd. v. FCC, 120 F.3d 753 (8th Cir. 1997), cert. granted by AT&T Corp. v. Iowa Utilities Bd. 114. SBC v. FCC, 981 F. Supp. 996 (D.C.N.D. Texas)
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CONFERENCE AGENDA
Telecommunications Reform in Germany: Lessons and Priorities
Wednesday, November 19, 1997
Opening Dinner Speaker: Arne Börnsen, MdB, Chairman, Committee for Post and Telecommunications
Thursday, November 20, 1997
Panel I: The Role of Regulatory Arrangement Chair: Richard Simnett, Bellcore Applied Science Speakers: Michael Riordan, Federal Communications Commission Richard Schultz, McGill University Jörg Sander, German Ministry of Post and Telecommunications
Panel II: Access to the Dominant Network: Interconnection and Unbundling Chair: Marc Harold Scanlan, European Commission Speakers: Geoffrey Myers, OFTEL Peter Quander, German Ministry for Post and Telecommunications Thomas Mellewigt, o.tel.o communications GmbH & Co. Martin Schlieker, Deutsche Telekom AG
Panel III: Setting Interconnection Charges: Costing and Pricing of Competitive Telecommunications in Germany Chair: Martin Cave, Brunel University Speakers: Günter Knieps, University of Freiburg Ingo Vogelsang, Boston University Werner Neu, Institute for Communications Research (WIK)
Panel IV: Panel Discussion: Lessons and Priorities Chair: Jürgen Müller, Berlin School of Economics (FHW) Speakers: Martin Cave, Brunel University Barbara Cherry, Northwestern University Andrea Huber, Deutsche Telekom AG
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Karl-Heinz Neumann, RWE Alliance AG Luigi Prosperetti, University of Milan David Sevy, France Telecom
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American Institute for Contemporary German Studies AICGS Conference Reports
Gibowski, Wolfgang, Dieter Roth, and Hans Herbert von Arnim. Whose Party is This? Transitions in the German Political Party System. Washington, D.C.: AICGS, November 1996.
Janes, Jackson and Charles C. Loveridge. The Future of Telecommunica- tions: A German-American Dialogue. Washington, D.C.: The Center for Strategic and International Studies and AICGS, November 1996.
Culpepper, Pepper. Skills for the 21st Century. Washington, D.C.: AICGS, January 1997.
Westin, Alan. Data Protection in a Global Society. Washington, D.C.: AICGS, May 1997.
Cowles, Maria Green. The Limits of Liberalization: Regulatory Cooperation and the New Transatlantic Agenda. Washington, D.C.: AICGS, July 1997.
Rahr, Alexander, Sherman Garnett and Zbigniew Brzezinski. The Future of Ukraine: Challenges to German and American Foreign Policy. Washington, D.C.: AICGS, July 1997.
Rudolf, Peter and Geoffrey Kemp. The Iranian Dilemma: Challenges to German and American Foreign Policy. Washington, D.C.: AICGS, July 1997.
Gibowski, Wolfgang, Josef Joffe and Dieter Roth. The Road to Germany’s National Elections. Washington, D.C.: AICGS, February 1998.
The Parameters of Partnership: Germany, the U.S. and Turkey. Challenges for German and American Foreign Policy. Washington, D.C.: AICGS, April 1998.
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Pavliuk, Oleksandr, Alexander Rahr and John Tedstrom. Ukraine in Transition and Western Strategy: Challenges to German and American Foreign Policy. Washington, D.C.: AICGS, August 1998.
MacDonald, Duncan. Protecting Privacy: The Transatlantic Debate Over Data Protection. Washington, D.C.: AICGS, September 1998.
Harris, Martha Caldwell, Kay Möller, Margot Schüller, and David Shambaugh. Managing Conflict, Building Consensus: Germany, the United States and the People’s Republic of China. Washington, D.C.: AICGS, November 1998.
Telecommunications Reform in Germany: Lessons and Priorities. Washington, D.C.: AICGS, December 1998
153 Telecommunications Reform in Germany
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