Global Telecommunications Regulation TCOM 5173

(c) 2004 Charles G. Gray 1

Global Telecommunications Regulation

TCOM 5173

Universal Service in the

United States28 January 2004

Charles G. Gray


Universal Service - General• Concept did not flow from the goodness of

the human heart

• Groups involved supported it because it forwarded their private agendas– Telegraph– Education

• Immigration

• Universal suffrage

• Better than political action

– Telephone service


Early Concepts - Telegraph• “Universal communication”

• Promised “unity of interest”

• Men linked by a “single mind”

• Worldwide victory of Christianity

• 1857 America linked to Europe– “Kinship of humanity” (Scientific American)– “A loving girdle around the earth”– “Electric utopianism”


“Dual Service” Telephony

• 1894 Bell’s patents expired

• 1894-1924 – 45-59% of all US cities larger than 5,000 had a Bell and an Independent– 1904 Bell had 1.3 M subscribers and

Independents had 1.1 M

• Independents had automatic dialing, better service and lower prices


Plight of the Independents• No access to Bell’s long distance network

• Unable to match WECo’s at-cost pricing

• Bell’s short-run strategy of pricing below cost to gain market share

• Bell purchased controlling interest (stock) in many independents– Leveraged minority stockholders

• Suspend dividend, divert funds to “maintenance”

– Adverse “propaganda” about a company


Financial Situation• Bell moved from Boston to New York for

better access to financial markets and changed name to AT&T

• Sales increased from $6.0M in 1896 to $630M in 1906

• J. P. Morgan quashed any efforts to organize any company (e.g., Erie T&T) competing with AT&T

• Investors persuaded Theodore Vail to come out of retirement in 1907


Theodore Vail• General Manager of Bell 1878-1889

– Came from the Railway Postal Service

– Oversaw the first long distance line from Providence to Boston in 1881

– Left to make money in Argentina in mining, railways and power plants

• Lured back to AT&T by fearful investors• Intent on establishing a “natural monopoly”

– Committed to a nation-wide long distance system

– Established Bell Laboratories

– Viewed Independents as a deterrent to anti-trust actions


“The Vail Doctrine”

“One Policy”

“One System”

“Universal Service”

An enlightened business philosophy?


“Unified” vs. “Universal” Service

• Need for a monolithic, completely interconnected system

• Every subscriber able to talk to every other subscriber

• No mention of a “phone in every home”• No provision for, or even mention of, cross-

subsidies• Connectivity – not social ubiquity was the

goal


The AT&T “De facto” Monopoly

• Many new patents – both internal and purchased

• Control of long distance (98%)

• Backing from major financial markets

• Immense political influence

• Huge size


The “Kingsbury Commitment”

• Driven by legal action against AT&T in several states and the DOJ

• Signed 19 December 1913– Bell would stop buying independent phone

companies– Sell its controlling interest in Western Union– Permit Independents to connect to its long

distance system• Provided that their equipment met Bell’s operating

standards (The “fine print”)


The “Kingsbury Commitment”

• Interconnection applied only to exchanges more than 50 miles apart– No real effect on toll interconnection– Primary intention to leave dual-service intact– Independent had to construct the line to Bell,

and pay 10 cent fee per call– Entire toll circuit had to be via Bell lines– One-way only – Independent subscriber to Bell

– no calls from Bell to an independent


Bell Interconnection Policies• A way to expand the network without

having to invest in local facilities

• Could use non-WECo equipment if it was “first class”

• Great efforts to attract farmer and mutual companies

• Cut toll rates to strangle the movement toward independent networks – US Telephone sold out to J. P. Morgan & Co.


Consolidations and “Swaps”

• Dual service remained in 1,864 places (13% of the total number of exchanges)

• State PUCs pushing for a regulated monopoly

• Users tired of two telephones

• DOJ turned a “blind eye” when asked for waivers – IF dual service was eliminated by swapping territories– Voters, city councils, and PUCs approved


“Kingsbury” Results

• Halted Bell’s acquisition of Independents for four years

• Deflected antitrust pressures, but did not undermine the company’s superior market position

• Allowed city, state, and federal regulators time to work on a coherent policy


Unification – 1914-1921

• Methods employed– Interconnection– Consolidation– Municipal buy-out

• Bell proceeded cautiously– Referendums– Business and civic leader support– Careful rate reviews


Access Competition

• By 1920 virtually all settled areas in the US had telephone service

• Household penetration rates around 50% where independent competition was strong

• 1920 - Census – 15,692 “incorporated places”, AT&T reported 19,550 places with telephone exchanges

• 1990 – FCC reported 15,227 exchanges


Telephone Penetration• 1920 – 39% rural, 30% all households

– Kansas & Nebraska 60-80%, Iowa had 86%

• Extremely wide variations between south and north central states

• Independents catered to residences– Residential lines passed business by 1910– Many communities reached more than 50% by 1910

• By 1920 market processes made the phone ubiquitous first, followed by government policy


The Willis-Graham Act - 1921• At the end of WWI there were still 1,000 cities with

dual service – including 12 major cities• Willis-Graham Act superseded the Kingsbury

Agreement• Allowed consolidation of all remaining dual service

systems • Gave Congressional approval to elimination of any

competition• Established the concept of geographical monopoly

– Regulated by the ICC and PUCs


The Problem of Rate Setting• Rate base regulation based on:

– Book cost of facilities (physical plant)– Expenses– Reasonable rate of return (ROI)

• Regulation brings an “obligation to serve”, including remote and sparsely settled areas

• Restrictions on a firm’s freedom to exit

• Rates based on sustaining the system as a whole – not the individual parts


Jurisdictional Separations• Separate costs for LEC and LD service

– Board-to-board method (supported by AT&T)– Station-to-station method

• Difficult to apportion costs between intra- and inter-state usage

• US Supreme Court upheld the station-to-station method in 1930 and 1933 – Not fully implemented until 1949/50– No impact on “universal service” or penetration

rates


Telecommunications Act of 1934• The terms “universal service” or “unified

service” do not appear in either the Act or the legislative history leading up to it

• Purposes of the Act:– Consolidate all related legislation (mainly radio)– Centralize authority (FCC)– “National defense”– Promote safety of life and property– Regulate interstate and international commerce


TA 34 - Preamble“. . . To make available, so far as

possible, to all the people of the United States a rapid, efficient, Nation-wide, and world-wide wire and radio communication service with adequate facilities at reasonable charges . . .”


The FCC 1934-1945• Made no effort to shift revenue from LD to

support local service

• Extracted several LD cost reductions from AT&T

• The Bell System lobbied for (and received) higher local exchange rates– Did not diminish demand for service

• AT&T finally accepted the station-to-station accounting method


Cross-subsidies and Local Service• After 1950 – formula for allocating costs was

“subscriber line use” or SLU– Average proportion of in-state to interstate calls– Interstate SLU was still only 3% (up from 2% in

1934)

• AT&T wanted to shift more SLU to interstate– FCC objected– Senator McFarland overruled the FCC– 1953 SLU changed from 3% to 5%– Result was using LD to subsidize local service


Local Service Rates• Average rate in 1953 = $14.25*

• Average rate in 1955 = $15.86*

• Average rates remained higher than the 1952 average until 1965

• However, household penetration rates continued to grow rapidly

*In constant 1980 dollars


The “Ozark Plan” - 1970• New edition of the “Separations Manual”

• Used formulas to adjust how subscriber plant costs were allocated to interstate service – built-in escalation factors

• Separations Manual adjusted rates from 5% in 1953 to 16% in 1970

• Ozark Plan moved the allocation from 16% in 1970 to 27% in 1982

• Driven by ideology, politics and regulation


Universal Service-Redefined• 1970s – MCI and Sprint exempt from the

“Ozark Plan” – built-in cost advantage• AT&T and PUCs needed a rationale for the

regulated monopoly• “Universal Service” was redefined by

linking it to the practices of regulated monopoly

• “Separations” were retroactively credited with making telephone service universally available and “affordable”


Three Milestones

• 1973 - John DeButts (AT&T CEO) speech at NARUC– Strong stance against competition, favoring

regulated monopoly

• 1975 – Report to Congress by Eugene V. Rostow (former Undersecretary of State) on behalf of AT&T

• 1976 – AT&T proposal to reform the TA of 1934 to preserve regulated monopoly


AT&T Lobbying Efforts• 1974 – DOJ antitrust suit against AT&T

• 1975 – MCI Execunet Decision– Threatened to subvert the whole separations system

• 1975-Rostow testimony to Congress - ”The Case For Congressional Action to Safeguard the Telephone Network as a Universal and Optimized System”– Claimed that a monopoly system devoted to universal

service was part of the TA of 34


The “Bell Bill”• AKA “Consumer Communications Reform

Act of 1976”– Claimed that the existing rate structure (and

separations) was the driver behind “universal service”

• “Universal Service” became a political weapon for defenders of the status quo

• AT&T’s attempt failed, but it did manage to totally confuse the historical and contemporary definitions of “universal service”


The “New” Universal Service• Codified in Section 254 of the TA of 1996• Identified as the “cornerstone” of the

Nation’s communications system• Gives the FCC and states explicit authority

– “Evolving level of services” based on input from:• The public• Congress• Federal-state joint Board

• Definition to be revised periodically• Any service subscribed to by “a substantial

majority” of the population


Universal Service Mandates• Quality services at just, reasonable, and

affordable rates

• FCC must decide on “affordability”– Explicit mandate that regulators can depart

from cost standards

• Supply subsidies for providers in high-cost or low density areas

• “All” carriers contribute to fund, but only “some” carriers can draw from it


Who Pays?• All telecommunications carriers

– Cell phone companies pay, but cannot receive

• Based on percentage of end-user retail revenues

• Payments calculated on 6-month ago revenues, paid out of current revenues

• FCC determines the “contribution factor”

• Billing, collection, disbursements and reporting by the USACC


Who Receives?• Only carriers designated by their state PUC

– Only in the geographical areas designated

• Must offer all universal services throughout their area through own facilities or combination with resale– No pure resale services eligible for funding– Duty to advertise service availability and cost

• Lots of fraud involving third-parties


Subsidized Services• Elementary and secondary schools

– Movement to wire “every classroom”– Subsidy amounts tied to school lunch program

• Healthcare providers (multiple definitions)• Libraries• Lifeline/low income services• Rural/urban rate parity• States can establish their own rules for

intrastate subsidies


Four Flawed Assumptions – TA 96

• Inappropriate to rely on the market to promote the spread of basic and advanced services

• Local access must be subsidized if it is to become universally affordable

• It is both possible and desirable to designate a particular service as the “universal service”

• It is possible to reconcile the goal of a competitive, deregulated marketplace with universal service subsidies


Section 254 Analysis

• Everybody who could have a phone doesn’t necessarily want one

• Customization, not uniformity will be the rule going forward

• No single form of communications is absolutely necessary for all people

• What is an “affordable rate”?• How to price each network component on a

stand-alone basis, and still support rate averaging and universal service subsidies??


Where are we Now?• Universal Service Administrative Company

– Non-profit company set up by the FCC• High Cost Program

• Low Income Program

• Rural Health Care Program

• Schools and Libraries Program

• Fund is now about $5.5B annually– IXCs contribute 63% (7.28% of revenues)– LECs and wireless contribute 37%– Carriers are free to pass on charges as they like


Some Changes in the Wind

• FCC NPRM in February 2002– RBOCs entering the LD market– Wireless minutes growing– Interstate LD revenues declined in 2000– Bundled services make separations difficult

• Calculations based on last year’s revenue, but this year’s stream is depressed

• Should contributions be based on revenues or number of connections?


Most Recent Change• Information service providers are exempt

from universal service contributions

• Voice over IP (VoIP) ruled to be an information service (Minnesota)– Net-to-phone – Skype– Vonage– AT&T

• FCC promising to act “soon” (early 2004)


An Uncertain Future?• IXCs can “escape” contributions IF VoIP is

ruled to be an “information” service– Exempt under current rules (same as for ISPs)

• Continuing contributions by “carriers”– ILECs– CLECs– Cell phone carriers– Cable providers (e.g. Cox cable)

• Fund universal service from general taxes?


Bottom Line

It is hard for me to see how mandatory contributions to the universal service fund will ever achieve the truly competitive marketplace that the TA of 1996 envisioned, and has as its stated purpose.

Global Telecommunications Regulation TCOM 5173

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