L United State~‘Gene~al Accounting Office 13txiq6 Repo:fi to the Cong:ress b August 1986 TELEP’HONE COMMUNICATIONS Bypass of the Local Telephone Companies I IIIIllI II 130846 I , I cIIE3~sa.4 GAO/RCED-86-ij0 1/s I I $ ’ “1 , * I United States General Accounting Office GAO Washington, D.C. 20648 Comptroller General of the United States B-203706 August IS,1986 To the President of the Senate and the Speaker of the House of Representatives This report provides the results of our work on customers bypassing local telephone companies. We discuss the extent of and reasons for bypass, the impact that bypass may have on local telephone company revenues, and observations on some regulatory actions and proposals that address bypass. We conducted the review because of the concern that local telephone companies could lose billions of dollars if large-volume customers avoid or bypass local telephone company facilities. The report provides the Congress information that may be helpful in oversight and regulation of the nation’s telecommunications industry. We are sending copies of this report to the Director, Office of Management and Budget; the Chairman, Federal Communications Commission; and other interested parties. We will also make copies available to others upon request. Charles A. Bowsher Comptroller General of the United States Executive Summary Local telephone customers could face billions in rate increases if the Purpose local telephone companies lose their large-volume customers due to bypass. Bypass occurs when customers use available technologies, such as microwave and satellite transmission facilities, to avoid using certain local telephone company facilities. Increased local telephone rates could reduce the affordability of telephone service. This report provides the Congress with data that will be useful in its oversight and regulation of the nation’s telecommunications industry GAO’sreview relates to: l the extent of and reasons for bypass. The results are based on GAO'S interviews with 82 large-volume telephone users in Colorado and Massa- chusetts and review of 3 other bypass studies. l the impact that bypass may have on local telephone company revenues. GAOanalyzed two simulation models that can estimate nationwide bypass revenue loss associated with long-distance calls. l observations on current regulatory actions and other options available to policymakers for addressing bypass concerns. The Federal Communications Commission is concerned about bypass Background because it can affect the Commission’s ability to ensure that the nation’s telecommunications policy of reasonable charges, universality of ser- vice, efficiency, and innovation is met. Bypass occurs because the regulated rates of local telephone companies can exceed the costs and prices of unregulated competitive suppliers of telephone service Regulated prices can be higher because they include both the actual or economic costs of providing service and an allocated share of overhead or fixed costs of the local telephone company. I In 1982 the Commission changed its method for recovering certain inter- state telephone costs, in part, as a way of limiting bypass. This “access charge” decision provided for local telephone companies to recover a part of their costs from all customers rather than a previous method that recovered these costs only from those making interstate long- distance calls. Accordingly, local telephone companies were permitted to add to then- regular charges, a monthly charge for each telephone line. While the Commission has changed the amount since 1982, the current monthly charge can range up to $6. Page 2 GAO/RCED-86436 Telecommunications Executive Summary In changing its method for recovering telephone costs, the Commission stated that the access charge decision may deter customers from bypassing the local telephone company because the decision permits a reduction in interstate long-distance usage charges. Various groups have voiced concerns about the monthly line charge because it increases tele- phone bills for customers who do little or no interstate calling and reduces the affordability of telephone service. GAO'Ssurvey and 3 other studies indicate that 16 to 29 percent of large- Results in Brief volume telephone company customers are bypassing their local tele- phone companies. In addition, 19 to 53 percent of the large-volume cus- tomers are considering plans to initiate or increase bypass activity. These customers were bypassing to reduce their costs and improve ser- vice and will continue to bypass for these reasons. Bypassing could significantly reduce local telephone company revenues. For example, the Bell operating companies estimate that the loss of 1 percent of their business customer locations could represent from 14 to 48 percent (depending on the state) of their total long-distance revenues. GAO'Sreview of two simulation models showed that the two models over- estimated the actual amount of 1984 revenues that local telephone com- panies could have lost in interstate markets due to bypass. Despite their weaknesses the two models do indicate that substantial future revenue could be lost. The Commission initiated m June 1986 an evaluation of bypass issues and its access charge decision Because increased bypass could reduce telephone service affordability, GAOagrees with the Commission that a reassessment is needed which addresses specifically the relationship between bypass actions and national telephone goals, including um- * versa1 service and reasonable charges. GAO’s Analysis Extent of and Reasons for From its interviews, GAOfound that 20 out of 68 large-volume customers Bypass were usmg bypass systems. Of the 68 customers, GAOfound that 25 had future bypass plans, including the 14 who already had bypass systems and 11 others. These bypassers were continumg to use local telephone companies for more than 75 percent of their telecommunications use. Page 3 GAO/RCED-86-66 Telecommunications Executive Summary GAO also found that (1) bypass systems are being used for both voice and data transmissions, (2) several bypass technologies are being used, with the most popular being microwave, cable/wire, and fiber optics, and (3) the typical bypass system is owned and used by a single com- pany for mostly local or intrastate services. The customers reported that they were bypassing because the telephone company could not provide a particular type of service or could not pro- vide the same reliability, flexibility, and security that a bypass system can. The customers also said that bypass alternatives offer similar ser- vices at a lower cost and allow them to better control and budget for telecommunications service. Impact on Revenues GAOfound that no definitive studies are available to show the impact that bypass could have on local telephone company revenues. However, in late 1984 the Commission’s staff and Bell Communications Research developed simulation models that determine how interstate access rev- enue could decrease due to bypass in a fully competitive market. The two models suggest widely differing losses at current prices-the Com- mission model suggests $4 billion while Bell Communications Research suggests a S 10 billion loss per year. As a matter of perspective, local telephone company revenues were about S74 billion in 1984, of which S14.6 billion were from interstate access services regulated by the Commission. The two models contain estimates of revenue loss due to bypass. How- ever, the model results were not precise and should not be used as fore- casts of revenue loss. The models overestimate near-term bypass because they assume that all customers and long-distance carriers have fully adjusted to financial incentives to bypass. In practice, such aci)ust- ments may take some time, during which market conditions are changing so that the actual outcome can be expected to vary from the model results Observations on Current GAO'Sreview of survey and simulation model results demonstrates limi- Regulatory Options tations with the current bypass data available to address the question of how effectively the access charge decision will deter the undesirable consequences of bypass associated with long-distance calls. The decision has been criticized for its potential negative impact on two of the nation’s telecommunications goals-reasonable telephone charges and universal service In response, the Commission has reconsidered and Page 4 GAO/RCED-86-66 Telecommunications Executive S-a.ry modified its original decision, in part, to give local telephone companies more flexibility to set charges for interstate access services. In addition, the Commission initiated a review in June 1986 of the effect of its access charge decision, including bypass issues. Other regulatory options have been proposed by states and other interested parties that are available for further consideration by the Commission. These mclude reducing the regulatory control over local telephone companies and changing the pricmg structure for certain telephone services. Recommendations GAOis making no recommendations GAOrequested comments on a draft of this report from the Commission Agency and Industry and Bell Communications Research. The Commission’s Managing Cdmments Director stated that overall the report reflects the views of the Commis- sion The Director, Regulatory Policy Analysis of Bell South Corporation (previously Director of Governmental Affairs at Bell Communications Research and responsible for the bypass model), commented that the critique of