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WHO CREATES TELECOMMUNICATIONS POLICY?

Some of players who create telecommunications policy include:

  AT&T.
  The Baby Bells.
  MCI, Sprint, and other IXC.
  Competitive access providers.
  The FCC.
  The courts.
  State regulatory commissions.
  Consumer groups (i.e., lobbyists).
  Congress.
  Cable companies.
  Cellular companies and wireless services.
  Bellcore.
  Large institutional users.

THE RATE-SETTING PROCESS: WHO SETS THE PRICE?

For a company to take advantage of all the unique opportunities happening right now, it needs to understand the basics of how rates are constructed. Rate cases are divided into two parts:

  Revenue. Revenue determines how much money the telephone company should be allowed to earn.
  Rate design. Rate design determines who has to pay. In most rate cases, it is the utility vs. everyone else in the revenue portion of the case, because everyone believes that holding rates down in general will help their special interest when it comes to rate design.

In determining how much revenue the utility is entitled to, the commissions are restricted by court decisions that say that the return must be high enough to attract investors into the enterprise. The components of the revenue requirements part of the rate case can be broken down into the formula:

RR = (v - d)*r&$43;e

where:

RR = revenue requirement
v = the value of the rate base
d = the amount of depreciation of the rate base
r = the rate of return
e = expenses

This is a “cost plus” formula, in which the telephone company is granted the opportunity to recoup all of its expenses and get a return on its investment. In a major rate case, virtually every element and subelement of this formula is hotly contested. It can be expected that cost will be an overriding factor in any new custom network integrating advanced and emerging network services that a company designs and requests.

The Rate Base

The “v” in the “cost plus” formula is the value of the rate base. The rate base is the investment made by the utility in the plant that serves the customer. Thus, items such as telephone poles, wires, switches and buildings are in the rate base. To be included in the rate base, the plant must be “used and useful.” For example, if there is an old switch being kept in a switch building, but it is only used perhaps once every two years, it would not generally be considered used and useful. In most commissions, the evaluation of the rate base is made on an original cost basis — in other words, how much the company paid for the copper wire at the time of purchase.

Depreciation recognizes that as rate base equipment is used, it loses its value. The utility has to account for that loss in value and recover enough revenues so that the plant can be replaced at the appropriate time. In a time of rapidly changing equipment, depreciation has to recognize that the plant may still be able to function, but have very little market value. For example, as the telephone companies move from copper to optical fiber, depreciation also has to recognize that it may be cheaper simply to write off the copper wire in the ground. Depreciation is a very complex area in a rate case and should be handled by a highly qualified expert.

RATEMAKING

Once the regulators determine how much revenue the regulated company should earn, they have to figure out who is going to pay that revenue. In telephone rate cases, there are literally hundreds of services that have to be priced, which can be unbelievably complicated. Moreover, companies that are not traditionally active in the regulatory process (unless they are telecommunications companies, of course) are almost always the ones who end up paying the most.

Ratemaking involves figuring up the costs of producing a service, including the profit for that service, and charging accordingly — this is the starting point for most regulators. However, the entire process is not that easy.

Many of the services that are offered by the telephone company are offered on an undivided basis. For example, a telephone company switch may be providing touch-tone service to one phone, business service to another phone, contacting the operator on yet another phone, and providing caller ID to another telephone. Yet each of these services needs to have a price determined out of the general cost of the switch. Thus, ways must be devised to split up the costs, which helps set the price.

Residual Ratemaking

To preserve universal service, regulators adopted a process known as residual ratemaking. For example, if a cost study demonstrates that the current rates for residential service only cover one-half of the cost, then a strict cost-based system would say that residential rates should therefore be doubled. In the real world, this is probably not a practical option. In addition to the political fallout of such a move, it would harm universal service. Regulators faced with this problem came up with the concepts of “value of service” and “residual ratemaking.”

Value of Service

There are some products, such as three-way calling or call waiting, that do not cost a great deal once they are placed in a switch. Those services are optional. Therefore, those services can be priced based on the perceived value (i.e., value of service) to the subscriber, which is another way of saying that the provider can charge what the traffic will bear.

If the services are priced too high, they will not contribute as much toward maintaining universal service. The revenues obtained from those services allow the telephone company to remain whole, while the favored classes of service — residential and small business — get small increases in their basic line. If households have call waiting, they may see a small increase on their total bill, but most people will not take the time to drop their optional services.

Access Charges

Possibly the largest contributors to residual ratemaking are the long-distance carriers (i.e., the IXC), who pay for residual ratemaking through their access charges. Access charges were devised at divestiture to make sure that the local companies were not harmed by the divestiture from AT&T. They were originally calculated on a revenue replacement basis, which included a hefty contribution to universal service.

Long-Run Incremental Cost (LRIC)

One of the ways of showing that a plan does not have a major impact on the concept of universal telephone service is by calculating the long-run incremental cost (LRIC) of service and including a contribution to universal service on top of that cost. That is how commissions do it. However, LRIC costs are very different when the dynamics of fiber optics are considered. In the world of fiber-optic transmission, there is no need to lay additional cable to provide additional capacity. The basic concept is to determine how much more one unit of output costs to produce.

For example, how much more does it cost to carry one more passenger on an airplane? There may be some cost associated with the additional fuel and the passenger’s meal, but assuming that all of the other passengers tickets have already paid for the flight, one additional passenger should have a very small cost. If a utility commission and potential network providers could be made to see such logic, consumers would all be better off.


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