Communications and Society Program
Communications and Society Program
Regulating Wholesale Pricing by ILECs
Ironically, given its stated goals, one of the 1996 Act's major provisions was identified as creating a serious impediment to investment by the ILECs: requirements that they provide unbundled network elements (UNEs) and price them for resale at total-element long-run incremental cost (TELRIC pricing). Most participants agreed that the so-called UNE/TELRIC mandate discourages the incumbent from making large investments in the network. If they have to share the product of new investment with their competitors at prices that regulators may set at barely compensatory levels, why would ILECs take the risk? At the same time, in some participants' view, knowing they can gain access at regulated prices to any new ILEC facilities gives CLECs less incentive to build their own. The latter point was more controversial. But as CLECs do build their own systems, there will be a smaller collection of bottleneck facilities and more reason to seek alternatives to the UNE/TELRIC regime. The two proposals that received the most attention were (1) to end TELRIC pricing on a phased basis that would vary from place to place depending upon certain criteria, and (2) to end it by a time-certain termination. Drawing heavily upon a proposal offered by Dan Reingold of Merrill Lynch, this section discusses the two alternatives.
Reingold suggested that TELRIC pricing be phased out, in effect allowing UNE prices to reach, over time, the level where they would help compensate the ILEC for historical costs. TELRIC pricing initially offers new entrants a kick-start, enabling them to offer local service to customers faster and at lower cost than by constructing their own facilities. In this sense, new entrants can use the TELRIC prices (which some believe average 50 percent below current aggregate retail rates) to offer price-competitive services and thereby build up local customer bases prior to and during construction of their own facilities. Establishing a transition plan would provide new entrants the certain knowledge that such discounts would not last, and thus stronger incentives for investing soon in new facilities. At the same time, knowing they would be freed of TELRIC requirements once certain conditions were met, ILECs would receive encouragement to invest more in upgrading local facilities to offer innovative new technologies and services.
Reingold proposed specifically that TELRIC pricing be phased out over three years, beginning from the date that the ILEC in a particular state received FCC approval to offer long-distance service to in-region customers, that is, the date they achieved approval under Section 271 of the 1996 Act. The Act charges the FCC generally to grant Section 271 approval when the incumbent carrier faces facilities-based competition in the local exchange market (defined by the Act as having a competitor that exclusively or predominantly uses its own facilities to deliver business and residential service). The trigger date of three years after Section 271 approval was proposed in order to accommodate the differing paces at which local competition would develop across different geographical areas of the United States.
Several participants felt a more finely tuned geographic standard should be used for deciding when and where to phase out the TELRIC prices. Absent a distinction between, say, urban and rural markets within a state, some feared that the latter might be left without competitive facilities or improved incentives for ILEC investment once the state's urban areas became competitive. Moreover, David Turetsky of Teligent argued that Congress does not believe Section 271 approval is equivalent to effective competition, since the Act provides that for at least three years after such approval the ILEC must operate separate affiliates.
For this and other reasons, some participants felt that regulators should make even finer judgments about the competitiveness of specific network elements and customer categories (large versus small business versus residential) in particular places before eliminating the TELRIC rules. Among others, Bill Kennard, at the time general counsel of the FCC, Joel Lubin, regulatory vice president of AT&T, Gail Schwartz of TCG, and Larry Strickling of Ameritech seemed to find common ground in suggesting that the issue here as elsewhere is market power. All indicated regulators could find a workable standard for judging and containing an ILEC's market power, lifting the TELRIC pricing rules only when competition sufficiently diminishes that power. Lubin suggested requiring that ILECs make new investments through a separate subsidiary that would have to act in a technology-neutral and competitor- neutral way. To minimize the incumbent's ability to leverage any market power from its essential facility, Strickling said it might be appropriate to assess whether competitors have an alternative to the incumbent local exchange carrier. Thus TELRIC pricing for local switching might end before TELRIC pricing for local loops, since alternatives for the former likely will be available well before alternatives for the latter. Indeed, some note that switches are widely available for purchase from competitive suppliers right now, allowing a nearer-term phaseout of TELRIC pricing for local switching.
The notion of a switch phase-out was not specifically addressed or opposed, but this may well have been the consequence of the discussion moving to a more general plateau. Thus, several participants countered the above ideas, arguing that requiring regulators to make such fine judgments would likely deepen the morass of legal wrangling, political gamesmanship, and government gridlock, in effect postponing the incentives for years. In their view, state-wide termination of TELRIC pricing three years following fulfillment of the 1996 Act's competitive checklist and facilities-based provider conditions serves as a reasonable compromise. In response, the other side maintained that analysis of competitiveness by place and service would work, and even if causing some delays would mark a major improvement over the current version of gridlock. Almost everyone seemed to agree that it would be both desirable and feasible to retain some kind of regulation to set wholesale prices at incremental costs for local loop transport and termination, the segment of the network least likely to see vigorous competition in the near future.
This last agreement extended to advocates of the other major proposal, which was to set a definite date to end UNE and wholesale pricing rules, with five years being the most commonly accepted time frame. Alternatively, Noam of Columbia Institute of Tele-Information suggested that rather than enforcing termination of TELRIC pricing, the policy might apply a sunset, which would allow policy makers to renew the TELRIC regime if officials felt competitive conditions warranted.
This second alternative aroused significant opposition. Most importantly, argued Sallet of MCI, a time-certain termination creates incentives for delay by the ILEC. The ILEC would know that by staving off competition for five years it could win big, gaining freedom from TELRIC rules while undermining competition in its local market. And the ILEC might still refrain from much new investment during those five years. Moreover, several participants suggested, whatever the effect on the ILEC's incentives, TELRIC prices do not delay facilities investment by important new competitive carriers like fixed wireless and cable television. Lubin of AT&T asserted that these firms would not make investment decisions based on TELRIC rates but "on the basis of retail prices today." Even if TELRIC prices are set at 50 percent of current retail revenue, such a discount does not provide the unfair bonanza to new entrants that some might believe, in Lubin's view. Competitors have to bear high costs for marketing, customer acquisition, and customer care and service. And as Binz of the Competition Policy Institute argued, "a competitive carrier would be foolish to stake the future on permanent TELRIC pricing," since it would assume the end of that regime at some point. Given Their view that TELRIC rules do not appreciably reduce incentives for investment by CLECs, these participants felt the benefits of time-certain termination of TELRIC pricing would not be worth the risk of ILECs exploiting the situation.
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