ORDER NO. 96-021

ENTERED JAN 12 1996

THIS IS AN ELECTRONIC COPY

BEFORE THE PUBLIC UTILITY COMMISSION

OF OREGON

CP 1, CP 14, CP 15

TABLE OF CONTENTS

EXECUTIVE SUMMARY

The Applications

Procedural Background

Statutory Basis

Stipulations

Disposition of Stipulations

 CONTESTED ISSUES

ISSUE I:

How will the application affect rates for local exchange telecommunications customers within and outside the competitive zone?

(a) What is the financial impact on LECs if the application is granted?

Commission Findings and Decision

ISSUE II:

How will the applications affect competition within the local exchange service area?

(a) Will the applicants' proposed service stimulate competition?
(b) How will local exchange providers respond to the presence of competitive local service providers?

Commission Findings and Decision

ISSUE III:

How will the application affect access by customers to high quality, innovative telecommunications service in the local exchange service area?

(a) What new or improved services will be offered by the applicants or the LECs?
(b) Will the applicants' application affect the quality of service offered by the LECs?
(c) What effect will the application have on economic efficiency?

Commission Findings and Decision

ISSUE IV:

Other Considerations

(a) Should the Commission authorize the applicants to provide service within the entire area designated in the application?
(b) If the application is approved, under what circumstances may the applicants deny service to a potential customer within the competitive zone?
(c) Should the Commission impose requirements on the applicants in addition to those in OAR 860, Ch. 32?
(d) Should the applicants be subject to the Oregon CustomerAccess Plan?
(e) What ancillary services should the applicants be required to provide?
(1) How will the applicants supply such services?
(2) What ancillary (direct access) services, features, and functions should the LECs be required to make available the applicants?

(f) What intercompany compensation arrangements are needed for calls placed within an exchange and calls placed between exchanges within the competitive zone?

Summary of Positions
Reciprocal Usage-Sensitive Compensation

Opposing Arguments

Price Squeeze
Impact on Local Rates
Lack of Reciprocity
Measurement-Related Costs
Cost Causation
Traffic Patterns
Network Architecture

Interim Universal Service Charge

Opposing Arguments

Flat Rate Compensation

Opposing Arguments

One Way Compensation

Opposing Arguments

Bill and Keep Compensation

Opposing Arguments

Commission Findings and Decision

Issue IV:

(f)(1) What arrangements are necessary to accommodate existing extended area service (EAS) routes?

Commission Findings and Decision

(g) Is the applicants' proposed service compatible with the existing network configuration and other requirements associated with providing enhanced 911 service?

Commission Findings and Decision

(h) What interconnection arrangements between the applicants and LECs should be provided?

(1) What should be the conditions of such arrangements?
(2) What technical issues must be resolved?

Physical Interconnection Issues

Commission Findings and Decision

Unbundling and Resale Issues

Commission Findings and Decision

(i) What arrangements are necessary for the assignment of telephone numbers to the applicants?

Commission Findings and Decision

(j) What arrangements are necessary to ensure adequate number portability?

Database Number Portability
Interim Portability

Commission Findings and Decision

(k) If the applications are granted, should the Commission impose any limits on LEC pricing flexibility?

Commission Findings and Decision

CONCLUSION

ORDER

Appendix A: The Applications

Appendix B: Parties' Representatives

Appendix C: Stipulation

Appendix D: Partial Stipulation

Glossary

EXECUTIVE SUMMARY (BACK)

These applications were filed pursuant to ORS 759.050, which authorizes the Commission to certify additional providers of local exchange telecommunications services in the existing service areas of telecommunications utilities if the proposed service is in the public interest. In making this determination, the Commission must consider the effect on rates for local exchange telecommunications service customers both within and outside the competitive zone; the effect on competition in the local exchange telecommunications service area; the effect on access by customers to high quality innovative telecommunications service in the local exchange telecommunications service area; and any other facts the Commission considers relevant.

The issues listed below reflect the factors that ORS 759.050 requires the Commission to consider. After considering these factors, the Commission finds that the applications of Electric Lightwave, Inc., MFS Intelenet of Oregon, Inc., and MCI Metro Access Telecommunications Services, Inc., for authority to provide local exchange service in the service territories of USWC and GTE are in the public interest and should be granted. Pursuant to this finding the following telephone exchanges are designated as competitive zones under the statute: Burlington, North Plains, Lake Oswego, Milwaukie-Oak Grove, Oregon City, and Portland (USWC exchanges); and Beaverton, Forest Grove, Gresham, Hillsboro, Scholls, Sherwood, Stafford, and Tigard (GTE exchanges).

Issue I: How will the application affect rates for local exchange telecommunications customers within and outside the competitive zone?

(a) What is the financial impact on LECs if the application is granted?

In the long term, the Commission believes that competitive entry will cause downward pressure on rates for the telecommunications services, but the effect of the market presence of the new entrants cannot be quantified at this time. The Commission finds that competition will develop gradually, and that the initial beneficiaries of competition will mainly be business customers. Business rates will fall over time, but because firms will compete in terms of service quality and services offered as well as price, we cannot presently quantify the potential drop in rates. If the LECs lose revenues to competition within the competitive zone, there will be upward pressure on residential rates outside the zone to offset the lost revenues.

It is not certain, however, that local exchange competition will cause the local exchange companies (LECs) to lose revenue. They may lose market share to the new entrants, but the market is likely to grow through an increase in consumption of lines and services. Net revenue loss could also be contained through cost-cutting and use of more efficient technologies.

The financial impact on the LECs will also depend on the extent of market penetration by the alternative exchange carriers (AECs) and their pattern of entry. It will also depend on the LECs' response to competition and on the regulatory policies adopted by the Commission.

II. How will the applications affect competition within the local exchange service area?

(a) Will the applicants' proposed service stimulate competition?

(b) How will local exchange providers respond to the presence of competitive local service providers?

Competitive entry will increase the quality and variety of service and decrease price for telecommunications customers. Entry should also promote deployment of new technology and foster innovation. Over time, benefits from new technology and innovation will flow to all users. In the short term, the main beneficiaries are likely to be business customers.

The development of competition depends on appropriate conditions being established by the Commission. These conditions include elimination of entry restrictions, equal access to rights of way, local number portability, dialing parity, unbundling the monopoly local exchange network, comprehensive interconnection, cost-based pricing by the incumbents, imputation, elimination of resale restrictions, and open technical standards. These issues must be resolved as we move forward into a competitive environment.

The incumbent local exchange providers will respond to competition by lowering prices, increasing efficiency, and creating new service packages. In the longer term, they are likely to respond by improving the quality of their service.

III. How will the application affect access by customers to high quality, innovative telecommunications service in the local exchange service area?

(a) What new or improved services will be offered by the applicants or the LECs?

(b) Will the applicants' application affect the quality of service offered by the LECs?

(c) What effect will the application have on economic efficiency?

The applicants' initial service offerings will be similar to those already available. Incumbents and new entrants will also compete on the basis of customer service. At the very least, competition will improve the quality of service and enhance the economic efficiency of participants in the local exchange market. In the long term, the competitive environment should promote new products, innovation, and the deployment of existing technologies not yet in widespread use.

IV. Other Considerations

(a) Should the Commission authorize the applicants to provide service within the entire area designated in the application?

In accordance with the parties' stipulation, the Commission authorizes the applicants in all three dockets to provide service within the entire geographic areas designated in their respective applications.

(b) If the application is approved, under what circumstances may the applicants deny service to a potential customer within the competitive zone?

It is unnecessary to regulate the conditions under which the entrants may deny service to potential customers. It would be unreasonable to require that new entrants serve all customers, business and residential, within a given geographic area until such time as their networks are in place. Once their networks are developed, the AECs should have no incentive to refuse service to any customer. If denial of service by AECs creates a problem in the future, the Commission has statutory authority to impose conditions on the AECs and could impose conditions similar to those under which the LECs operate.

(c) Should the Commission impose requirements on the applicants in addition to those in OAR 860, Chapter 32?

Consumer protection measures are critical when captive rate payers are forced to use monopoly service providers. The presence of alternatives helps protect consumer interests. Requirements in addition to those in OAR 860, Chapter 32 are thus unnecessary at this time. Once competition is established, we will consider whether consumer protection requirements imposed on LECs should be relaxed.

(d) Should the applicants be subject to the Oregon Customer Access Plan?

(1) If so, what conditions or procedures are necessary to facilitate compliance with the Plan?

Under the Partial Stipulation, the applicants will contribute to the Oregon Customer Access Fund. AECs will also have to comply with the 1994 Oregon Customer Access Plan, Parts V.D, VI.C, IX.D, and XI.F. AECs should not participate in pooling arrangements.

(e) What ancillary services should the applicants be required to provide?

(1) How will the applicants supply such services?

(2): What ancillary services, features, and functions should the LECs be required to make available to the applicants?

The only ancillary service the AECs must provide is E-911 service. Public health and safety concerns justify that requirement. We expect, however, that the AECs will also offer other ancillary services because their customers will demand them. We prefer to let the market dictate what services AECs offer. Applicants will supply ancillary services with their own equipment or through arrangements with the LECs.

The Commission can consider on a case by case basis relaxing the consumer protection and service requirements imposed on the LECs. Until competition has become established, however, we will not consider lifting the ancillary service requirements on the LECs.

Issue IV(e)(2) was resolved by stipulation. The LECs agree to treat the AECs as they treat independent local exchange carriers (ILECs) for purposes of making ancillary services available. The resolution of this issue is consistent with our decision that AECs should have co-carrier status with other local exchange service providers. Throughout this order, we have mandated treatment for the AECs that is analogous to the treatment the ILECs receive from the LECs.

(f) What intercompany compensation arrangements are needed for calls placed within an exchange and calls placed between exchanges within the competitive zone?

The Commission finds that compensation arrangements for the exchange of local and Extended Area Service (EAS) traffic should be based on bill and keep arrangements for an period of not more than 24 months. We are persuaded that bill and keep has fewer shortcomings than other compensation proposals in this case and will function as a reasonable compensation mechanism during the initial stages of competitive entry into the local exchange market. At the same time, we recognize that bill and keep is only a temporary means of accommodating local exchange competition and that a more permanent intercarrier compensation mechanism must be developed as competition progresses.

We order a work group to study intercompany compensation issues and to formulate proposals for implementing a reciprocal interconnection rate structure applicable to all switched telecommunications traffic. The interconnection compensation work group shall consist of representatives from USWC, GTE, Staff, MFS, ELI, MCImetro, and other interested parties, including consumer groups, ILECs, IXCs, and other competitive providers. Staff shall submit a report to the Commission every six months detailing the progress of the work group. In addition, applicants, USWC and GTE shall conduct and submit traffic studies of local and EAS traffic exchanged with other carriers. The first study shall be submitted within six months from the date of this order. Additional traffic studies shall be submitted every six months thereafter. This information can be used by the work group to develop its recommendations regarding reciprocal compensation arrangements for terminating traffic.

(1) What arrangements are necessary to accommodate existing Extended Area Service routes?

Because we have decided to adopt bill and keep as the form of intercompany compensation for local traffic, it would create an anomaly to impose a different form of compensation on the AECs within the EAS region. Also, there is no cost justification for treating incumbent LECs and AECs differently for EAS purposes. Current EAS routes are established based on criteria that consider community calling areas of interest. In the case of AECs, calls between exchanges reflect end users' calling areas of interest between two neighboring exchanges just as if calls were handled by the incumbent LECs. The identity of the companies involved is irrelevant. The proposal to treat LECs and AECs differently within the EAS region would severely disadvantage the new entrants and hamper competition.

Until otherwise ordered by the Commission, existing local exchange boundaries and EAS routes shall apply to AECs as well as incumbents for the purpose of distinguishing between local and toll calling and for intercompany compensation. Thus, traffic originated by any authorized local carrier that crosses exchange boundaries within the Portland EAS region shall be treated as a local call and compensated on a bill and keep basis.

(g) Is the applicants' proposed service compatible with the existing network configuration and other requirements associated with providing enhanced 911

(E-911) service?

The AECs' proposed service will be compatible with the existing network configuration and other requirements associated with providing E-911 service. The AECs have primary responsibility to work with the E-911 agencies to make certain that all users of their services have access to the emergency system.(h) What interconnection arrangements between the applicants and the LECs should be provided?

(1) What should be the conditions of such arrangements?

(2) What technical issues must be resolved?

Physical interconnection. The Commission finds that the applicants should be permitted to interconnect with incumbent providers on the same terms and conditions that LECs have used to interconnect their telecommunications networks. This process contemplates that the interconnecting parties will negotiate mutually acceptable locations where network facilities can be joined. We find that the parties will bargain on more equal terms and have a greater incentive to agree upon the most efficient interconnection if all costs associated with the construction of facilities are shared equally.

The Commission declines to adopt recommendations that would give either the LECs or the AECs the power to unilaterally designate interconnection meet points. In a competitive environment, carriers should not have an opportunity to select interconnection locations that may disadvantage competing providers. The applicants shall not take any action that impairs the ability of the incumbent LECs to meet the service standards specified by the Commission.

Where parties are unable to agree on mutually acceptable interconnection arrangements, the Commission should be notified within three days so the dispute can be resolved on an expedited basis.

The applicants have indicated that they intend to abide by existing protocols and procedures and install equipment that complies with network standards. We therefore have no reason to believe that technical problems will occur.

Unbundling and Resale. These issues will be addressed in docket UM 351. An order is expected shortly in that docket.

(i) What arrangements are necessary for the assignment of telephone numbers to the applicants?

The AECs cannot compete in the local exchange market unless they have nondiscriminatory access to telephone number. Competitive entrants are entitled to receive central office code assignments according to the same rates, terms, and conditions as any LEC. Guidelines for the assignment of numbers are in place. USWC, as the Numbering Plan Administrator, shall apply these guidelines in a nondiscriminatory manner.

(j) What arrangements are necessary to ensure adequate number portability?

Number portability is essential to the development of effective local exchange competition. It is therefore important for the telecommunications industry to produce a database solution as soon as possible. At the same time, the Commission does not want to duplicate efforts now underway to arrive at a national solution to portability issues. A work group is established to monitor developments in this area, including the results of database number portability trials in other states. The work group shall submit periodic reports evaluating the progress of database portability trials and include recommendations regarding the timing and implementation of a database number portability solution. The first report shall be filed with the Commission no later than July 1, 1996.

Interim number portability shall be offered by allowing AECs to use remote call forwarding or directory number route indexing technology. The evidence indicates that these methods have technical limitations, but there appears to be general agreement that they will function reasonably well as an interim solution. USWC and GTE shall file tariffs within 30 days from the date of this order offering both the remote call forwarding and directory number route indexing functions at a price equal to total service long run incremental cost. The tariffs may include a nonrecurring service provisioning charge, which should also be set at cost.

(k) If the application is granted, should the Commission impose any limits on LEC pricing flexibility?

LECs should be afforded pricing flexibility under ORS 759.050(5) once (a) the applicants have received certificates of authority to provide local exchange service consistent with the terms of this order; (b) the Commission approves the tariffs filed by USWC and GTE in compliance with this order; and (c) USWC and GTE certify that interconnection arrangements are in place and a mutual exchange of traffic exists with an authorized AEC. These conditions will ensure that a competitive alternative is present at the time LECs receive the pricing flexibility contemplated by ORS 759.050. We also find that the pricing flexibility authorized in USWC's Alternative Form of Regulation plan should not be restricted in this proceeding.

ORDER NO.

ENTERED

BEFORE THE PUBLIC UTILITY COMMISSION

OF OREGON

CP 1, CP 14, CP 15

DISPOSITION: APPLICATIONS GRANTED

The Applications (BACK)

Docket CP 1: Electric Lightwave, Inc. On November 14, 1994, Electric Lightwave, Inc. (ELI) filed an application with the Commission for certification to provide telecommunications service in Oregon as a competitive provider. ELI seeks authority to provide intraexchange switched service in areas coextensive with the Lake Oswego, Milwaukie, Oak Grove, Oregon City, and Portland local exchanges of

U S WEST Communications, Inc. (USWC), and the Beaverton, Gresham, Hillsboro, Sherwood, Stafford, and Tigard local exchanges of GTE Northwest, Incorporated. (GTE).

Docket CP 14: MFS Intelenet of Oregon, Inc. On December 14, 1994, MFS Intelenet of Oregon, Inc. (MFS), filed an application with the Commission for certification to provide telecommunications service in Oregon as a competitive provider. MFS seeks authority to provide intraexchange switched services in areas coextensive with the Burlington, Lake Oswego, Milwaukie, North Plains, Oak Grove, Oregon City, and Portland (local exchanges of USWC, and the Beaverton, Forest Grove, Gresham, Hillsboro, Scholls, Sherwood, Stafford, and Tigard local exchanges of GTE.

Docket CP 15: MCI Metro Access Transmission Services, Inc. On December 20, 1994, MCImetro Access Transmission Services, Inc. (MCImetro) applied for authority to provide telecommunications service in Oregon as a competitive provider. MCImetro seeks to provide intraexchange switched telecommunications services in the Portland metropolitan area, including portions of Multnomah, Clackamas, and Washington counties. Service will be provided in areas coextensive with the Lake Oswego, Milwaukie, Oak Grove, Oregon City, Portland exchanges of USWC, and the Beaverton, Forest Grove, Gresham, Hillsboro, Scholls, Sherwood, and Stafford local exchanges of GTE.

The applications are described more fully in Appendix A.

Procedural Background (BACK)

On January 26, 1995, dockets CP 1, CP 14, and CP 15 were consolidated for purposes of hearing and decision. Protests to the applications were filed by USWC, GTE, Oregon Cable Telecommunications Association (OCTA), Oregon Exchange Carriers Association (OECA), Oregon Independent Telephone Association (OITA), PTI Communications Inc. (PTI), Teleport Communications Group, Inc. (TCG), and Mr. R. Rose. Petitions to intervene were filed by AT&T Communications of the Pacific Northwest, Inc. (AT&T), McCaw Cellular Communications, Inc. (McCaw), MCI Telecommunications Corporation (MCI), Sprint Communications Company L.P. (Sprint), United Telephone Company of the Northwest (United), OCTA, and PTI. The Citizens' Utility Board (CUB) filed a notice of intervention. All petitions to intervene were granted.

On July 10-15, 1995, an evidentiary hearing was held in these matters in Salem, Oregon, before Samuel J. Petrillo and Ruth Crowley, Administrative Law Judges. Appearances were entered on behalf of ELI, MFS, MCImetro, GTE, USWC, AT&T, OCTA, OECA, OITA, Sprint, TCG, and the Commission Staff. Party representatives are listed in Appendix B.

On August 18, 1995, the parties submitted simultaneous briefs and the record was closed.

Statutory Basis (BACK)

The telecommunications policy goals established by the Oregon Legislature and administered by the Commission are found in ORS 759.015. That statute provides:

The Legislative Assembly finds and declares that it is the goal of the State of Oregon to secure and maintain high-quality universal telecommunications service at just and reasonable rates for all classes of customers and to encourage innovation within the industry by a balanced program of regulation and competition. The commission shall administer the statutes with respect to telecommunications rates and services in accordance with this policy.

These applications to provide local exchange telecommunications services are filed pursuant to ORS 759.050, the "competitive zone law." Under ORS 759.050(2)(a), the Commission may:

certify one or more persons, including another telecommunications utility, to provide local exchange telecommunications service within the local exchange telecommunications service area of a certified telecommunications utility, if the commission determines that such authorization would be in the public interest. For the purpose of determining whether such authorization would be in the public interest, the commission shall consider:

(A) The effect on rates for local exchange telecommunications service customers both within and outside the competitive zone.

(B) The effect on competition in the local exchange telecommunications service area.

(C) The effect on access by customers to high quality innovative tele-communications service in the local exchange telecommunications service area.

(D) Any other facts the commission considers relevant.

Under ORS 759.050(2)(c), the Commission may establish reasonable conditions or restrictions on the certificates of telecommunications providers to provide local exchange service. Conditions may be imposed by the Commission at the time of issuance or thereafter.

Stipulations (BACK)

The parties in these proceedings engaged in a number of settlement conferences, which resulted in the submission of a Stipulation and a Partial Stipulation. These documents are attached to this order as Appendices C and D.

The Stipulation addresses Issue IV(e)(2), regarding ancillary services, features, and functions that the local exchange carriers (LECs) should be required to make available to the applicants. Under the terms of this document, GTE and USWC agree to offer a number of ancillary services to the applicants on a nondiscriminatory basis and on the same terms and conditions, other than price, that are offered to other LECs in Oregon:

• White Pages Custom and Customer listings.
• Directory Assistance.
• IntraLATA Directory Assistance Operator Service.
• 911 service. LECs and the applicants will negotiate in good faith regarding the use of LEC standard procedures, obligations, arrangements, and delivery of 911 calls originated by the applicants' customers.
• Access to Centralized Message Distribution System for facilitating collect and third party billing.
• Operator Assistance Services, including Busy Line Verification/Interrupt.
• Mutual Repair Referral.

In addition to the above, the Stipulation provides that GTE will offer the applicants and their customers with Yellow Pages advertising, basic Yellow Pages listings, White Pages information listings, and directory distribution in GTE directories on a nondiscriminatory basis and on the same terms and conditions, other than price, as it offers to other LECs in Oregon.

The Stipulation also provides that the applicants may request Commission relief to obtain ancillary services not listed above, and that USWC and GTE may oppose such requests. The signatories to the Stipulation are AT&T, ELI, GTE, MFS, OCTA, OECA, Sprint, TCG, and USWC. OITA does not oppose the Stipulation.

The Partial Stipulation is separated into five different Items, each of which has been agreed to by different parties.

Item 1 of the Partial Stipulation is an agreement that it is in the public interest to grant the applications and to designate the exchanges listed in the applications as competitive zones. The signatories are ELI, MFS, AT&T, Sprint, TCG, OCTA, and OECA. OITA and USWC are not opposed.

Item 2 addresses Issue IV(a). ELI, MFS, AT&T, Sprint, TCG, OCTA, OECA, GTE and USWC agree that the applicants in all three dockets should be authorized to provide service within the entire geographic areas designated in their respective applications. They also agree that the Commission should acknowledge the concerns of USWC and GTE that LECs and alternative exchange carriers (AECs) do not have an equal obligation to serve customers. OITA is not opposed.

Item 3 deals with Issue IV(d). It first provides that ELI, MFS, and the LECs will terminate all intrastate traffic originating on one another's network. The signatories to this agreement are ELI, MFS, AT&T, Sprint, TCG, OCTA, GTE, and USWC. OITA and OECA are unopposed.

In addition, ELI, MFS, AT&T, Sprint, TCG, OECA, GTE, USWC agree to contribute to the Oregon Customer Access Fund (OCAF) and to comply with specific provisions of the Oregon Customer Access Plan (OCAP). Where an AEC terminates long distance traffic directly or indirectly from interexchange carriers (IXCs) or from its own toll network to its own end office and end user customers, the AEC will charge an OCAF and Oregon Universal Service Fund (OUSF) rate element, in addition to switched access charges, on all intrastate terminating carrier common line access minutes or their equivalent. The revenues collected from the OCAF and OUSF charges paid by AECs will be turned over to OECA for OCAF pool distribution. The agreement is intended to coincide with Order No. 93-1133, which funds OCAF and OUSF by a cents per minute charge on all intrastate terminating rated CCL switched access minutes.

The signatories indicated above also agree that the AECs, as contributors to OCAF, shall comply with OECA's informational and operational needs. Specifically, the AECs will comply with Parts V.D, VI.C, IX.D, and XI.F of the 1994 OCAP. AECs will not participate in the OCAF/OUSF pooling arrangements because of the extensive regulatory oversight that would be required.

Item 4 of the partial stipulation deals with Issue IV(j). ELI, MFS, AT&T, Sprint, OCTA, TCG, OECA, and GTE propose that the Commission open a docket no later than January 31, 1996, to consider and resolve the issue of permanent number portability. In the meantime, the applicants, OECA, USWC, and GTE and other interested parties shall develop a work group to evaluate the results of number portability trials in other states. OITA is not opposed to this agreement.

Item 5 was signed by ELI, MFS, Sprint, AT&T, OCTA, TCG, GTE, and USWC. These parties recommend that the following issues should be addressed in other Commission dockets:

• Issues relating to network access channel unbundling and line side interconnection should be considered in docket UM 351;

• Virtual and physical collocation issues should be considered in dockets UT 119 and UM 351;
• Universal service issues should be considered in docket UM 731.

Disposition of Stipulations (BACK)

The Commission has reviewed the stipulations in light of the record in this case. We adopt the Stipulation in its entirety. That agreement resolves Issue IV(e)(2) regarding the ancillary services the LECs will offer to the AECs.

The Commission also adopts Items 2, 3, and 5 of the Partial Stipulation, thereby resolving Issue IV(a) relating to the geographic scope of the applications, and Issue IV(d) relating to OCAF/OCAP issues. We do not adopt Item 1 because it relates to the public interest determination required by ORS 759.050(2)(a), and must be decided based on the record in this case. We adopt Item 4 in part. Specifically, we mandate establishment of a work group on permanent number portability, but decline to open a docket on that issue at present. Number portability is discussed at Issue IV(j) below.

CONTESTED ISSUES

Issue I: (BACK)

How will the application affect rates for local exchange telecommunications customers within and outside the competitive zone?

(a) What is the financial impact on LECs if the application is granted?

Positions of the Parties

Staff states that the AECs' entry will cause downward pressure on rates for the telecommunications services they offer, particularly to business customers. Staff argues that prices are also likely to decline as competition motivates the applicants and the incumbent LECs to develop more efficient, less costly methods of supplying telecommunications services. Staff argues that competition may also cause the LECs to seek rate rebalancing within and outside the competitive zones to bring rates more in line with the underlying economic costs of providing telecommunications services. A possible consequence of rebalancing is higher rates for high cost, rural service areas and for residential services generally.

If the applications are granted, Staff maintains that the LECs will lose customers and revenue. The extent of these losses in the Portland metropolitan area depends on a number of factors, including AEC market penetration; the expansion of telecommunications service markets as a result of competition and additional demand caused by price reductions; LEC cost savings from not serving customers lost to AECs; and terms and conditions established by the Commission for local competition

(Issues IV a-k).

Staff acknowledges the arguments of the applicants and others, that potential LEC revenue losses may be offset by new revenues from expanded telecommunications services markets. However, Staff notes that no party provided a quantitative analysis of the potential financial impacts of market stimulation due to new entrants.

Regarding market stimulation due to reduced prices, Staff challenges comparisons between local exchange competition and competition in the interLATA toll market, where price reductions stimulated the market for long distance services. Staff argues that the local exchange and long distance markets are fundamentally different. Many of the price reductions in the interLATA toll markets resulted not from competition, but from regulatory decisions to shift LECs costs from toll and access services to local exchange services. Thus, the cost of access declined for IXCs.

Staff also maintains that market demand for local exchange services is less price elastic than demand for toll services. Estimates of price elasticity of demand for local exchange services are about -.05 to -.10. That is, a 10 percent decrease in price would increase market demand by only .5 to 1.0 percent. Toll, on the other hand, has a price elasticity in the range of -.36 to -.58; a 10 percent decrease in price would stimulate market demand by 3.6 to 5.8 percent. Finally, toll services are sold on a measured usage basis, whereas most local exchange service is sold on a flat rate basis. Thus, greater usage will increase IXC revenues but not LEC revenues from flat rate service. LEC revenues are increased by stimulating demand for more access lines.

To the extent that the LECs lose customers to the AECs, they may avoid certain costs associated with serving those customers. Staff argues that any potential cost savings due to the LECs' serving fewer customers would be consumed by increased advertising and marketing expenses and potential increases in depreciation expenses as LECs attempt to adjust to a more competitive environment.

Using ELI and MFS forecasts of local exchange customer and revenue growth in the Portland area in the next several years, Staff projected the AECs' penetration of the Portland metropolitan area business market. Based on these forecasts, Staff concluded that there is a reasonable possibility that the three applicants could attain a 20 percent penetration rate in that market by the year 2001.

Staff performed quantitative analyses to estimate the possible financial impacts of local competition on LEC revenues if the applications are granted. Staff assumed that the AECs would attain either a 10 percent or 20 percent share of the business market in the Portland metropolitan area by 2001. Staff believes that the 10 percent estimate is conservative.

For each of these scenarios Staff developed a mild and a severe case. In the mild case, for USWC, Staff assumed that:

• In addition to lost revenue from basic local exchange service and EAS, USWC will lose $20.77 per month in vertical service and ancillary revenues (toll, carrier access, miscellaneous) per business line lost and $17.19 per month in such revenues per residence line lost;
• USWC will experience an annual access line growth rate of four percent;
• USWC will reduce prices by 10 percent to its remaining business customers in the competitive zones;
• USWC price reductions in response to competition will stimulate demand for local exchange telecommunications services by a factor of -0.09

In the Staff's severe case, USWC is forced to reduce business rates in the competitive zones to total service long run incremental cost (TSLRIC). The table below shows USWC's revenue erosion per year and residential rate increase per month for the mild and severe case of each of Staff's scenarios:

USWC

Staff performed the same analyses for GTE, assuming loss of revenues from basic local exchange service and EAS, plus $27.30 per month in vertical service and ancillary revenues (toll, carrier access, miscellaneous) for each business line lost and $15.69 per month in revenues for each residence line lost. Staff made the same assumptions for GTE's severe case as it did for USWC. The following table shows Staff's projected revenue erosion and residential rate increase for GTE:

GTE

Staff believes that granting the applications carries the risk of significant adverse impacts on GTE and USWC. The projected revenue erosion could cause the LECs to seek rate rebalancing within and outside the competitive zones. Such rebalancing could erode internal LEC revenue support for higher cost service areas and for residential services generally. Revenues available for sharing under USWC's existing Alternative Form of Regulation (AFOR) plan could also decline.

USWC agrees with Staff. USWC emphasizes that the AECs will enter the urban business market, where services are overpriced relative to cost. Historically, regulatory pricing has kept business service rates, toll, and access charges much higher than residential rates. Competitive entry will force business rates down in the competitive zones and cause realignment of prices outside the zones, with significant impact on residential customers. Customers without a choice of carriers will be responsible for covering costs and making up for competitive losses as the incumbents' market share declines. Averaged rates, one of the traditional support mechanisms for affordable universal service, will come under severe pressure due to local exchange competition.

USWC foresees a significant financial impact on the LECs if the applications are granted, because the applicants will target those parts of USWC's market where revenues are most greatly concentrated. USWC prepared a confidential revenue impact analysis based on Staff's market penetration figures, using the same assumptions as Staff used, including the mild and severe cases. USWC anticipates that the AECs' market penetration will be even greater than Staff predicts, and that revenue losses will be even more severe. USWC bases its conclusion in part on its own experience in the United Kingdom. USWC witness Inouye also testified that USWC had experienced a downward trend in its market share for private line and special access services in the competitive areas of Denver, Minneapolis, Seattle, and Portland.

GTE argues that the effect of competition on rates and LEC revenues will remain unknown until the Commission decides how GTE and USWC may price their services in docket UM 351. The effect of competition on rates and the LECs will also depend on which services the applicants offer and how those services are priced. It is reasonable to assume that prices within the competitive zones will eventually decline and that prices outside the zones will increase.

According to GTE, the financial impact of competitive entry on the LECs also depends on whether GTE and USWC are permitted to rebalance their rates in response to competition. In the main, however, GTE believes that Staff's analysis presents a reasonable estimate of the magnitude of the impact of competition. Such an impact could materially affect residential service rates within and outside the zones and rates in general outside the competitive zones. GTE also asserts that rate restructuring costs will be incurred in order to gain the benefits of a more competitive market.

Applicants argue that local exchange customers are likely to see rate reductions and other benefits as a result of competitive entry. The applicants believe that the market for telecommunications services will expand with entry, and that loss of market share does not necessarily mean revenue loss for the incumbents.

The applicants argue that development of competition has been slow in other jurisdictions where alternative carriers are authorized to provide service and intercarrier arrangements are directed by the regulatory agency. The applicants maintain that incremental growth is the most likely scenario in Oregon as well. Even when it is relatively easy for consumers to change providers, as in the long distance market, experience has shown that change comes slowly. Moreover, networks take time to construct. Applicants note that it will also take time for the Commission to create the conditions for effective competition through costing, imputation, interconnection, unbundling, resale, number portability, collocation, and universal service policies.

The applicants contend that there is no basis to grant the incumbent LECs any immediate form of regulatory parity, such as rate rebalancing. The applicants state that AEC entry into the local exchange market will have little financial impact on the incumbent LECs and will not have a negative effect on residential rates within or outside the competitive zones. The applicants also contend that competition will cause the local exchange market to expand. Therefore, a decline in LEC market share does not necessarily mean a decline in LEC revenues or profits.

The applicants further contend that Staff estimates of market penetration and LEC financial impact are highly speculative and based on untested assumptions. Staff's market penetration figures are based on five year projections submitted by ELI and MFS, but Staff did not review the assumptions underlying these projections, such as the nature of intercompany compensation arrangements or the availability of unbundled loops or number portability. The applicants point out that Staff did not test its market penetration projections against the experience in other markets, such as the United Kingdom, New York, or Michigan, where local exchange competition has been introduced. Further, Staff did not compare its projections with experience in other market segments that have been opened to competition, such as long distance and competitive access provider services.

In addition, the applicants assert that there are other flaws in the Staff analysis. Staff assumes that 100 percent of local exchange market belongs to the incumbent LEC, so any revenues the applicants gain is necessarily the incumbents' loss. The applicants also argue that Staff did not take into account the potential market stimulation effect on access line growth and did not deal with offsetting factors like potential cost savings and efficiencies realized by the incumbents. Finally, Staff did not include the revenue that incumbents would receive from unbundled network access channels if they were provided by LECs to AECs.

The applicants also challenge USWC's reliance on market penetration data from the United Kingdom to support the claim that AEC entry will have serious financial consequences for the LECs. According to the applicants, the record is silent on the market conditions in the United Kingdom at the time of the study. For instance, it is not known whether basic telecommunications service was bundled with cable service, or whether service was priced on a usage basis. The level of market penetration for basic service prior to competition is also unknown. Moreover, the United Kingdom data is limited to the percentage of homes that the USWC affiliate had marketed to; the overall market was much larger. The applicants point out that, after 5 years, overall market penetration was only 5 percent.

The applicants state that, even if the market penetration estimates made by Staff and USWC are accepted, the projected revenue impact of a 10 to 20 percent penetration, based on USWC's figures, is only 2.3 to 3.4 percent of USWC's Oregon revenue. The applicants argue that this level of revenue impact is insignificant.

OCTA and Sprint are aligned with the applicants. AT&T notes that competition will drive prices to incremental cost over time. Telecommunications customers throughout the state should eventually benefit, but competition will develop gradually. AT&T states that its experience with long distance competition will not be repeated at the local level. In the long distance market, AT&T's facilities could be efficiently duplicated by new entrants, all AT&T services were available for resale, and AT&T owned no bottleneck facilities that competitors needed to provide service. Those conditions are not present in the local exchange market.

AT&T points out that competition in the long distance market has increased its revenues despite lower prices and vastly decreased market share. AT&T argues that the LECs should experience similar circumstances. The LECs have greater pricing flexibility than AT&T had until 1988. Loss of market share may not mean significant revenue loss because the market is expanding. Moreover, competitive shifts should be gradual, so the Commission can monitor and take appropriate remedial action.

Commission Findings and Decision: Issue I

Competition in the switched local exchange market is new and untested. Few jurisdictions have paved the way for competition; even fewer have seen competition take hold. There is insufficient experience elsewhere to allow us to draw conclusions about the course of development in our own state. Even the parties admit that market penetration and revenue loss figures are speculative. There are far too many unknowns in this area to predict the future.

We acknowledge that the LECs may lose market share and, possibly, revenues as well. That could result in a rate increase for residential customers. Overall, however, we are convinced of the benefits of competition: increased customer choice, provider diversity, improved service quality and technical and service innovations. We therefore conclude that the benefit from granting the applications outweighs the potential detriments.

Effect on Rates. We do not believe that it is possible at present to quantify the effect of entry by the AECs on rates inside or outside the zone. We are convinced of two facts regarding the effect of competition on rates, however. First, the AECs will not make major inroads into LEC revenues overnight; they will develop their networks only gradually. Development of AEC networks depends on a number of factors that have yet to be determined, most critically the availability and price of unbundled loop elements. These issues will be addressed in docket UM 351. Even after the UM 351 order is entered, it will take time to negotiate interconnection agreements.

Second, business customers are the most likely to benefit from competition in the short term because the applicants will target those customers first. Business rates will likely decline, but we cannot quantify the level of decline at this point. We do not know how the LECs will price their services in response to initial competition or as a result of decisions in UM 351. Nor do we know how the applicants will price their services. Aside from price competition, carriers will also compete on the basis of service quality and product offerings.

Over the long term, if the conditions for effective competition are met, competition will drive prices closer to incremental cost. Since business services are priced well above cost, those rates should fall considerably. If the AECs also target residential customers, those rates will fall within the competitive zones as well. Because residential rates are priced closer to cost, however, competition for residential customers will develop more slowly than competition for business customers. Competition is unlikely to reduce residential rates significantly in the short term.

USWC, GTE, and Staff foresee a possible rebalancing of LEC rates within and outside the competitive zones due to lost LEC revenues. If the LECs lose revenues due to competition in the zones, there will be upward pressure on residential rates to offset the lost revenues. The need for rate rebalancing will depend on a variety of factors including the extent of market penetration by the AECs and their pattern of entry. It will also depend on the unbundling, interconnection, pricing, number portability, and access rules adopted here and in UM 351, as well as LEC responses to competitive initiatives.

Staff attempted to quantify the impact on residential rates for USWC and GTE, but did not assume any growth in the local telecommunications service market. We are not persuaded that the market for new lines will be price inelastic. The telecommunications market is changing in ways that cannot be predicted. In the developing environment, new technology may create unforeseen demand for new lines. We also agree with MCImetro that businesses will use more lines if the price for access lines fell more than in Staff's analysis. Even without taking into account potential new services developed and offered by entrants, businesses might well switch from PBX to Centrex, or might add fax lines or dedicated computer modem lines. Moreover, reduced prices and competition in terms of service quality could well induce businesses to protect their information flows with redundant lines. Market growth could mitigate any LEC revenue loss due to competition and relieve the upward pressure on rates outside the zones.

Competition for high profit customers may cost the LECs some of the revenue that, as USWC claims, currently subsidizes service to less profitable residential customers. Although the LECs have an obligation to provide universal service, we have decided, in docket UM 731, that the AECs should also contribute to universal service support. Universal service issues are also addressed below under Issue IV(f).

Financial Impact on the LECs. It is probable that the AECs will, over time, capture a significant percentage of the local exchange market. The parties differ greatly in their estimates of AEC market penetration, however. Staff estimates a 10 to 20 percent penetration of the business market in the competitive zones by 2001. USWC argues that penetration will be on the high end of Staff's projections, with the greatest penetration in private line and special access services. These projections do not consider the possibility of a growing market for local exchange services. If competition stimulates the market, as we consider likely, the LECs could lose market share without losing revenues, similar to AT&T's experience in the long distance market.

Staff's projections do not consider the experience of competitors in other jurisdictions. In Washington State, for instance, new entrant market share is nearly zero. ELI and TCG Seattle have filed contracts with the Washington Commission to provide local exchange service to a total of 386 lines. In New York City, where local competition has been in operation for the longest period of time, the highest reported nonBell competitor's share of access traffic is only 3 percent.

It is difficult to extrapolate from these data with any certainty. As noted, we are looking at a small number of jurisdictions. Moreover, we know little about the conditions unique to each area. In the United Kingdom study, for example, the applicants have pointed out many areas of uncertainty that prevent us from drawing any definite conclusions about how local exchange competition will develop in Oregon. Finally, we cannot reliably compare figures on the share of access traffic, which are usage based, with Staff's figures on market penetration, which are expressed in terms of customers (who may have many lines) or with the Washington data, which is based on number of access lines.

Before AEC market share is able to increase substantially, the AECs and LECs must negotiate interconnection agreements, the AECs must construct the parts of their network that they do not purchase or lease from the LECs, and the Commission must resolve outstanding issues relating to competition. These things will all take time. Even if the applicants garner the market share predicted by Staff, USWC will experience a revenue loss equal to 2.3 to 3.4 percent of its Oregon revenues, without taking into account market growth or avoided costs.

USWC witness Inouye argued that USWC experienced a downward trend in its market share for private line and special access services in the competitive areas of Denver, Minneapolis, Seattle, and Portland. That claim is part of USWC's argument that it will suffer serious revenue consequences from competitive entry. We have information to the contrary. We take official notice of an exhibit entered into evidence in UM 351, AT&T Confidential Exhibit 9. Because the exhibit is confidential, we will disclose no specific figures. That exhibit demonstrates that USWC is losing market share to competitors in the high capacity telecommunications market in Portland, but that its revenues in that market are increasing due to overall market growth. Thus, the exhibit refutes USWC's claim that decline in market share necessarily entails revenue loss.

In view of these facts, we conclude that AEC entry into the local exchange market will not have a significant impact on the LECs in the near term. If competitive entry does significantly affect LEC revenue, the LECs may seek rate relief from the Commission, including interim relief. USWC may seek to have its AFOR plan modified if its equity return falls below the minimum level prescribed in the plan. Finally, the Commission may rebalance LEC rates or take other appropriate action if warranted.

Aside from the revenue impacts associated with competitive entry, the LECs also face the issue of whether competition will create stranded plant, and, if so, whether it should be recovered from the LEC monopoly customers. Commission treatment of stranded investment, if it occurs, may have a significant impact on the LECs' financial health. That issue is beyond the scope of this docket, but will have to be considered in the future. The Commission has opened docket UM 731 to consider the proper recovery of USWC plant.

Issue II: (BACK)

How will the applications affect competition within the local exchange service area?

(a) Will the applicants' proposed service stimulate competition?

(b) How will local exchange providers respond to the presence of competitive local service providers?

Positions of the Parties

Staff distinguishes between competition from facilities based carriers and competition from resellers. Facilities based carriers are those who, like the applicants, own their own switches and at least some loop components. Staff asserts that facilities based competition will provide customers in the competitive zones with more choices, and new approaches to configuring service offerings. Competition may also stimulate innovation, which will benefit immediate users of the services and ultimately all telecommunications users by providing greater access to more efficient technology. Competitive entry will also motivate the LECs to lower prices and improve efficiency for services comparable to those offered by applicants.

USWC expects that competitive entry will stimulate competition by offering alternatives to some customers. If properly regulated, competition will eventually produce lower prices, more choices, more innovation, and improved service quality. The applicants' facilities will allow them to compete not only for new customers, but also for USWC's existing market share. USWC intends to use the pricing flexibility under its existing AFOR and the competitive zone law to respond to competition. USWC will also develop new pricing options and increase advertising, marketing, and sales activities.

GTE contends that granting the applications will expand competition in the target areas. Even in the best case, however, competition would be "monopolistic," with multiple providers offering essentially the same services and competing through advertising and service packaging. The deployment of new technologies and new services would become more market driven.

GTE asserts that the Commission should not attempt to manufacture competition. The applicants seek significant levels of aid and support from the incumbent LECs, usually at incremental cost. The type and magnitude of market intervention these requests would entail is contrary to the notion of replacing a regulated monopoly system with a competitive market approach. If technological and economic developments have made state sanctioned monopolies obsolete, GTE believes that the market should develop on its own. If there are areas where telecommunications is a still natural monopoly, then the rationale for the current regulatory system still exists.

Applicants and AT&T believe that entry will stimulate competition, but stress that effective competition will not develop overnight or on its own. The development of competition depends on how the Commission resolves key policy issues in this and related dockets. The applicants argue that they need an appropriate economic costing analysis, a proper imputation test, a fair local interconnection policy, immediate unbundling, and true equal access. They also stress the importance of the Commission's collocation and resale policies for the development of competition.

If the applications are granted, the applicants assert that AECs will stimulate competition by providing better, more reliable service quality than the LECs. Competition on the basis of service quality has been a key factor in the success new entrants have experienced competing with incumbent LECs for nonswitched services.

The applicants argue that, if the Commission creates the right incentives, local exchange carriers should respond to competition by reducing costs and becoming more efficient. If LECs are not allowed to pass costs to other customers, the incumbents will have to become more efficient and more responsive to customers needs. The Commission should also not permit the LECs to recover their common costs from the AECs in the price of the interconnection elements. The full benefits of competition will be realized only if all costs of the incumbents are subjected to market pressures for greater efficiency. Finally, the applicants note that the LECs will also have to upgrade their networks and increase the quality and variety of their services in response to competition.

Sprint believes that local competition will create new market opportunities for both entrants and the incumbent LECs to expand their service territories and the range of service offerings, both of which create an opportunity to increase their revenue and earnings. According to Sprint, competition in the interexchange market has shown that an incumbent will respond to new market conditions by developing new services and reducing costs. How incumbent LECs respond to new entrants in the local market will depend on how they are regulated. If a LEC cannot pass costs on to its customers and still retain most of those customers, the LEC will have to become more efficient and responsive to its customers.

OCTA argues that competition offers improved service and greater access to diverse facilities that could enhance network reliability.

Commission Findings and Decision: Issue II

Our decision to approve these applications to provide competitive local exchange service is just the beginning in a long process. Over time, AEC entry will increase the quality and choice of service and decrease price for telecommunications customers. Competitive entry will also promote deployment of new technology and to foster innovation. In the long term, the benefits from new technology and innovation will flow to all users. In the short term, the main beneficiaries are likely to be business customers. The incumbents will likely respond to competition by lowering prices and creating new service packages. They will also have to improve the quality of their service.

GTE argues that local exchange competition will be limited to providers that offer the same services and compete through advertising and service packaging. We do not believe this will be the case. Even if it were, however, it is an initial stage in the development of competition. Having a choice of providers and service packages is a significant benefit to telecommunications customers.

The development of competition depends, as several parties have noted, on appropriate conditions being established by the Commission. These conditions include elimination of entry restrictions, equal access to rights of way, local number portability, dialing parity, unbundling the monopoly local exchange network, comprehensive interconnection, cost based pricing by the incumbent, imputation, elimination of resale restrictions, and open technical standards. Not all of these matters are addressed in these dockets, but must be considered as we move forward in a competitive environment.

Issue III: (BACK)

How will the application affect access by customers to high quality, innovative telecommunications service in the local exchange service area?

(a) What new or improved services will be offered by the applicants or the LECs?

(b) Will the applicants' application affect the quality of service offered by the LECs?

(c) What effect will the application have on economic efficiency?

Positions of the Parties

Applicants point out that, initially, their service offerings will approximate the services provided by the LECs. Competition is likely to hasten the introduction of new services, however. In other telecommunications markets, new and improved services have been offered over time, many of which could not have been predicted when the markets were first opened to competition.

New services are likely to result from deployment of existing technology as well as from technological development. MFS points out that much of the technology deployed by competitive providers, especially the use of fiber optics, had been available for years, yet without any significant deployment until competitive access providers entered various metropolitan markets throughout the country. Companies can also innovate by providing better service: quicker response times, redundant capacity, creative billing solutions, and customer options. The LECs will be forced to meet any service innovations that the AECs develop in order to remain competitive.

The frequency of LEC service quality problems suggests that the presence of AECs will encourage the LECs to upgrade their service as well as to introduce efficiencies. Customers may be unwilling to switch providers without a significant price differential unless the LEC product is disappointing. Poor service could seriously harm the incumbents. Thus competition will have a positive effect on LEC service quality.

The applicants also argue that competitive entry will improve economic efficiency in general. As markets move toward effective competition, prices will be driven closer to the cost of the most efficient service provider, improving static economic efficiency. Moreover, the competitive process will speed the deployment of new and better technologies in the most efficient way, improving dynamic efficiency of telecommunications. Competition will also increase the inflow of telecommunications capital into Oregon on the part of the incumbents and new entrants, which will benefit the economy of the state as a whole.

Finally, the applicants note that networks have properties that magnify as they are interconnected. Because information is a leading sector in the United States economy, an increase in the number of networks available to transfer information can lead to potentially greater economic gains than would increased competition in other sectors.

The applicants challenge the LECs' assumption that competition will result in decreased economies of scale and scope. According to MCImetro witness Dr. Nina Cornell, USWC cost studies do not reveal such economies except for the NAC. Moreover, the theoretical benefits of such economies do not matter unless they are passed on to the consumer in the form of lower prices, because the incumbent monopoly firm is inefficient and there is no competitive market incentive to keep costs in check.

The applicants contend that Staff ignores dynamic efficiency. Staff does not account for possible market stimulation from the greatly reduced prices it forecasts; nor does Staff acknowledge that it is possible for competitors to bring new services and new technologies to consumers more quickly and efficiently than the LECs have been willing to do. Sprint concurs with the arguments made by the applicants.

AT&T argues that competition will allow consumers to benefit from innovation because it ensures the ascendancy of the technology with the best service attributes and quality at the best prices. At present, monopoly providers decide what services will be offered in the local market. With effective competition, consumers will decide.

According to AT&T, evidence from the interLATA market also demonstrates that market forces drive application of the best available technology. Sprint's aggressive entry into the long distance market caused AT&T to accelerate deployment of fiber technology and improve its methods of informing customers about its fiber network. In the telephone equipment market, the black rotary dial instrument has given way to portable phones, answering machines, and fax machines, automatic re-dial, and a host of other features and functions.

Staff also argues that competitive entry will encourage the LECs to deploy newer technologies like optical fiber more rapidly in the competitive zones. Competition should also encourage LECs and applicants to invest in research, because any sustainable competitive advantage will come through innovation. Where profitable, the benefits of competition could be available to customers outside the competitive zones as well. But if applicants merely resell the incumbent LECs' services and do not build their own facilities, it will exacerbate LEC bottlenecks and hinder customer access to telecommunications services.

GTE states that moving to a market based system will necessarily change investment and service dynamics. Granting the applications will affect service provided inside and outside the competitive zones. According to GTE, the LECs will likely invest on a more deaveraged basis if the applications are granted. They will deploy new technologies in the competitive zones. Without contribution from the more lucrative urban areas, investments outside the zones would be based on the ability of those markets to generate revenue to cover the cost of and return on investments. Consequently, the implementation of a sound universal service support program will be crucial for investment dynamics.

As to whether competition will result in new or improved telecommunications services, GTE argues that the introduction of truly new services is driven by manufacturers' technological developments. New technology is available to GTE, USWC, and the applicants alike.

GTE believes that competition can result in improved quality and in selective quality reductions. Rivals will compete for some customers based on meeting high levels of performance and service quality. However, the competitive market should also accommodate those customers who will accept somewhat lower performance parameters in exchange for lower prices. If the applications are granted, GTE argues that all firms in competitive zones should be subject to the same minimal level of service regulation by the Commission, but the Commission should retain oversight of certain critical services such as 911.

According to GTE, the effect of entry on economic efficiency will be mixed. GTE and USWC have constructed ubiquitous networks with nonduplicative facilities. Granting the applications will result in duplicate, overlapping construction. The total cost of providing local exchange service in the state will increase. Moreover, replacing a regulated monopoly system with a competitive market system will increase the riskiness of investment in telecommunications utilities. That, in turn, will increase the utilities' revenue requirement by increasing the return demanded by investors. GTE states that if a change in paradigm from regulation to competition is to produce any real economic efficiency gains, competition must develop naturally, so firms are free to respond to each other's actions. GTE urges that there should be no government compulsion in the market.

Commission Findings and Decision: Issue III

In the near term, the applicants are not proposing the use of any technology not already in place or planned by LECs, especially in the Portland metropolitan area. When markets first open to entry, the initial offerings are usually similar to those already available; that will likely be the case here. As competition takes hold, incumbents and new entrants will likely compete on the basis of customer service. By their very presence in the market, AECs will provide customers with enhanced operational and strategic security, by serving as redundant carriers. The fact that customers will have a choice of service provider is also new. At the very least, competition should improve the quality of service and enhance economic efficiency of all participants in the local exchange market.

In the long term, competition should promote new products, innovation, and the deployment of existing technologies not yet in widespread use. ELI currently plans to offer intraLATA equal access and physical collocation, in addition to the services currently provided by the incumbents. MFS plans to offer the services offered by the incumbents as well as credit card calling, conference calling, voice mail, and E-mail, and specialized customer services. Other new services may depend on technological change, which is difficult to predict.

In a competitive environment, the LECs will be forced to increase the variety of their services. Competition will stimulate the LECs to provide new services, either in response to AEC service innovations or on their own, in order to generate new revenues. Effective competition will accelerate the rate of innovation, for both new entrants and the incumbent local exchange carriers alike. In response to competitive pressures, USWC, for example, has announced plans to develop a broadband network capable of offering customers multimedia services and ATM and frame relay based services.

Competitive pressure will provide service quality standards that are customer driven and market driven, and not dependent on regulatory monitoring. Because customers will have a choice of providers under a competitive regime, incumbent LECs will have to improve the service quality as well, in order to retain customers and market share. Service outages, repair delays, and delays in service connections become costly for the incumbents when customers can express dissatisfaction by changing carriers.

GTE points out that while competition will make high levels of service quality available, some customers might choose a lower level of quality or performance in return for a lower price. If the lower service quality/lower price option is chosen by informed consumers, the Commission has no objection to such a tradeoff.

"Economic efficiency" includes both allocative efficiency and technical or productive efficiency. Allocative efficiency refers to the situation in which prices act as appropriate signals for decisions that consumers and firms make. The signals allow consumers to purchase the appropriate amounts and kind of goods and services. Over time, competition will enhance allocative efficiency by pushing prices closer to the costs of providing a particular service.

Productive or technical efficiency refers to minimizing the cost of producing a given level and quality of goods or services. Cost containment may come from efficiency in internal operations or technological change. Competition enhances technical efficiency both by spurring technological innovation and providing an incentive for firms to reduce costs.

"Economic efficiency" may also be judged in terms of static and dynamic economic efficiency. Static efficiency is similar to allocative efficiency. As to dynamic efficiency, we agree with the applicants that competition will encourage the deployment of new and better technologies over time. We also agree that an increase in the networked properties of information technology could lead to major economic gains for the state as a whole.

GTE notes that granting the applications will result in duplicate, overlapping construction of facilities, which is economically inefficient. While this argument may have some merit, it is also the case that the applicants are introducing fiber optic based networks, while the incumbents' networks may include a mix of newer and older technology. The facilities are therefore not merely duplicative, but, to some extent, represent the replacement of an older technology with a newer one. To the extent that there is duplication, we find that the benefits of competition outweigh the disadvantage.

GTE claims that the utilities' cost of capital will increase because of the increased riskiness of investment associated with a competitive market system. That remains to be seen. If the utilities' revenue requirement increases as a result of competitive local entry, we can address the issue in appropriate rate proceedings. We are not convinced that such an increase is a necessary outcome of the applicants' entry into the local exchange market.

In theory, we agree with GTE that competition should be allowed to develop naturally and without government compulsion. At the same time, the incumbents have nearly 100 percent market share in the local exchange market. Until there is indication that competition will thrive on its own, it is not in the public interest for regulators to withdraw completely.

We also agree with GTE that a sound universal service support program is critical to telecommunications in Oregon. The Commission has adopted a program in Docket UM 731 that addresses GTE's concerns.

Issue IV: (BACK)

Other Considerations

(a) Should the Commission authorize the applicants to provide service within the entire area designated in the applications?

Issue IV(a) was resolved by stipulation.

Issue IV(b): If the application is approved, under what circumstances may the applicants deny service to a potential customer within the competitive zone?

Positions of the Parties

USWC asserts that AECs could effectively deny service to customers the AECs do not want to serve by setting prices to make the services unattractive. To require the AECs to serve all customers who request service in the competitive zones, the Commission would have to regulate the AECs' rates. The Commission should avoid such a course of action.

Ideally, USWC believes that an AEC should hold itself out to provide service to all customers within its authorized service area. But USWC recognizes that, unlike public utilities, competitive providers do not have an obligation to serve ubiquitously within their service territories. USWC also acknowledges that the AECs will need time to build their distribution networks. For the present, USWC recommends that AECs not be required to provide service.

MCImetro argues that the AECs should be permitted to deny service to any customer if the potential customer does not agree to reasonable conditions to ensure payment. The AECs should also be able to deny service if they cannot reach a customer. If the entrant does not have facilities that pass the customer and cannot obtain an economic resale product or nondiscriminatory unbundled network component from the incumbent LEC, there should be no obligation to serve that customer. Likewise, if the entrant has facilities that pass the customer but cannot get nondiscriminatory access to the customer's premises, there should be no obligation to serve. GTE, ELI, and Sprint take a similar position.

MFS states that it is prepared to serve any customer, including residential customers, within its license area. MFS' goal is to provide universal access to its network, whether by other service providers, subscribers, or competitors.

Staff argues that the Commission should leave it to the applicants to determine whom they will and will not serve. MCImetro did not apply for authority to serve residential customers. ELI and MFS intend initially to offer services targeted to the business customer market. The choice of all three applicants to begin by serving only business customers would deny service to potential residential customers within the competitive zones, but this is a legitimate business decision for AECs to make.

The Commission has authority to impose reasonable requirements on AECs pursuant to ORS 759.015, 759.020, 759.030(1), and 759.050. But the Commission has generally adhered to the policy of allowing market forces to determine prices and conditions of service offered by competitive telecommunications providers. In the long run, Staff believes that policy will best serve the public and should be continued.

AT&T agrees with Staff. The new providers need time to expand their networks. Once their facilities are in place, they will have every incentive to serve customers requesting service. Like all competitive companies, they will be guided by commercially reasonable practices in refusing or terminating service to customers.

Commission Findings and Decision: Issue IV(b)

We decline to impose denial of service criteria on the AECs at this time. We agree with Staff and AT&T that it is unnecessary to regulate the conditions under which the entrants may deny service to potential customers. The LECs have expressed concern that the AECs will deny service to customers whom they do not wish to serve by pricing their services too high for the relevant customers, by not providing information to potential customers about the availability of their services, or by imposing overly stringent credit requirements. LEC concern is apparently rooted in a perception that it is unfair for the entrants to deny service to some customers while the LECs are under the obligation to serve ubiquitously throughout their territory.

It would be unreasonable to require that new entrants serve all customers, business and residential, within a given geographic area until such time as their networks are in place to do so. Once their networks are developed, the AECs should have no incentive to refuse service to any customer. On the contrary, they will need to expand their customer base in order to spread their fixed costs over as many customers as possible. If denial of service by AECs creates a problem in the future, the Commission has statutory authority to impose conditions on the AECs and would likely impose conditions similar to those under which the LECs operate. Until competition is robust enough to warrant relaxing the service obligations of the incumbent LECs, however, we find the public interest best served by allowing market forces to work.

Issue IV(c): Should the Commission impose requirements on the applicants in addition to those in OAR 860, Chapter 32?

Positions of the Parties

GTE and USWC argue that all competitors and incumbents should be subject to equal regulatory treatment within the competitive zones. OAR Chapter 860, Division 32, contains limited requirements for competitive providers. Those rules were enacted when no competitive firms were providing local exchange service. If the Commission grants the current applications, it should declare that all Division 32 rules pertaining to the provision of local exchange service by utilities will also apply to applicants. Further, the Commission should open a rulemaking for the purpose of modifying Division 32 or creating a new chapter to establish a set of rules appropriate for competitive zones, which would apply equally to all firms.

Staff contends that the Commission should not impose additional consumer protection or reporting requirements on the applicants. Consumers who believe they have been poorly treated by an AEC can opt to take service from the incumbent LEC or possibly another competitive provider. Staff argues that the Commission should leave it to market forces to deal with AECs who provide poor service. If customers encounter special problems in the future, the Commission could consider adopting additional consumer protection rules or requirements for AECs. Staff does not know what additional reporting requirements might be useful for regulating AECs a the competitive market.

Staff notes that regulatory parity may be acceptable as a long range goal, but competition is not sufficiently robust throughout the service areas or even the proposed competitive zones to justify relieving the LECs of various requirements now imposed on them. Because most customers do not have effective alternatives to choose from, consumer protection requirements should continue to be imposed on the incumbent LECs. When the LECs present persuasive evidence that there is sufficient competition for local exchange services, then the Commission will consider relaxing the consumer protection requirements.

AT&T, ELI, MCImetro, MFS, OITA, and Sprint concur with Staff. They argue that a competitive market will regulate the behavior of entrants. The requirements in OAR 860, Division 32, are sufficient to monitor the progress of local exchange entry. If the Commission finds that existing requirements are inadequate after it gains experience with a competitive local exchange market, it may always impose additional requirements. These parties urge caution in this area, because unnecessary reporting requirements increase cost and may limit competitive entry.

Commission Findings and Decision-Issue IV(c)

Consumer protection measures are critical when captive ratepayers are forced to use monopoly service providers. To an extent, those safeguards become unnecessary once customers have a choice of carriers. Moreover, the AECs will also compete with the LECs on service, and cannot hope to succeed unless they are sensitive to consumer needs. Thus, the presence of alternatives helps to protect consumer interests. Requirements in addition to those in OAR Chapter 860, Division 32 are therefore unnecessary at this time. We will revisit the issue of consumer protection once competitive local exchange services have been more firmly established.

The LEC goal of regulatory parity requires effective competition for local exchange services. Once competition is established, we will consider whether the consumer protection requirements imposed on LECs should be relaxed.Issue IV(d): Should the applicants be subject to the Oregon Customer Access Fund Plan? If so, what conditions or procedures are necessary to facilitate compliance with the Plan?

Issue IV(d) was resolved by stipulation.

Issue IV(e): What ancillary services should the applicants be required to provide?

(1) How will the applicants supply such services?

OAR 860-35-020 defines "ancillary service" as "a service, such as billing and collection service" . . . "which is performed by a local exchange carrier to directly administer or support provision of the LEC's basic and enhanced services. [Ancillary services] do not include the provision of common administration such as human resources, accounting, purchasing, inventory control, or other similar functions." Ancillary services include, but are not limited to, E-911 service, directory assistance, operator services, operator assisted calls such as credit card and third party billing calls, and directory listings.

Positions of the Parties

Staff and OITA recommend that the Commission not require the applicants to provide any specific ancillary services except access to E-911 service. The Commission should leave it to market forces and the AECs to determine what ancillary services they will provide.

ELI believes that the AECs should provide ancillary services that benefit the health and convenience of customers in general and which customers expect to receive from their local service provider, including E-911 service, telecommunications relay services, operator and directory services. ELI will provide a number of other ancillary services, using a combination of its own resources and the resold services of the incumbent LECs.

MFS intends to provide ancillary services such as directory assistance, operator services, calling card, conference calling, and voice mail, but does not believe that the Commission should require the AECs to provide ancillary services.

MCImetro believes that the AECs should be required to provide access to operator service, directory assistance, and emergency services, as well as unified telephone directories. MCImetro will use a combination of its own resources and resold service of the LECs to provide these services.

AT&T contends that the Commission should rely on competitive market to determine what services the new entrants will provide. Consumers will probably demand such services, but the Commission should not require an AEC to provide them.

Sprint argues that the AECs should be required to provide operator services, directory assistance, and emergency services.

GTE argues that the principle of regulatory parity also applies to ancillary services. In the competitive zones, any requirement to provide ancillary services should be the same for all firms. In a market environment, the government should not set any requirements. On that principle, GTE argues that 911 service should be the only ancillary service that LECs and AECs are required to provide.

USWC maintains that the Commission should only mandate provision of essential services: a local telecommunications network facility, feature, or function that competitors cannot realistically duplicate or obtain from an alternative source, and to which reasonable access is necessary to enable competition. The only requirement the Commission should impose on AECs is terminating access on their networks.

Commission Findings and Decision: Issue IV(e)(1)

We agree with Staff that E-911 service is the only ancillary service that AECs should be required to provide. Public health and safety concerns support that requirement. We expect that the AECs will offer the remaining ancillary services because their customers will demand them. Again, we prefer to let the market dictate what services AECs offer. The record indicates that the applicants will supply ancillary services with their own equipment or through arrangements with the LECs.

GTE argues that if the Commission requires the AECs to provide only E-911 service, it should require no more from the LECs. OAR 860-32-020 allows tele-communications utilities to petition for authority to abandon service and permits the Commission to relax the LEC consumer protection and service requirements on a case by case basis. Until competition has been established, however, we will not consider lifting the ancillary service requirements on the LECs.

Issue IV(e)(2): What ancillary services, features, and functions should the LECs be required to make available to the applicants?

Issue IV(e)(2) was resolved by stipulation. The LECs agree to treat the AECs as they treat independent local exchange carriers (ILECs) for purposes of making ancillary services available. The resolution of this issue is consistent with our decision that AECs should have co-carrier status with other local exchange service providers. Throughout this order, we have mandated treatment for the AECs that is analogous to the treatment the ILECs receive from the LECs.

Issue IV(f): What intercompany compensation arrangements are needed for calls placed within an exchange, and calls placed between exchanges within the competitive zone?

The most controversial issue in this proceeding relates to the method for compensating carriers for costs associated with the termination of local exchange traffic. Because interconnection costs are a major cost component for new carriers, the terms and conditions of these arrangements are critical to the viability of entrants and the emergence of local exchange competition.

In evaluating the various intercompany compensation proposals, the Commission is guided by ORS 759.015, which requires, inter alia, a balanced program of regulation and competition. Toward that end, intercompany compensation should be nondiscriminatory, simple to administer, and neutral from a technological standpoint. It should also foster economic efficiency, create incentives for infrastructure development, and ensure that all carriers are fairly compensated.

Summary of Positions

• USWC and GTE recommend reciprocal usage sensitive compensation based on current switched access charges.

• MFS, ELI, MCImetro, OCTA, and AT&T recommend bill and keep arrangements as the appropriate method of compensating local service carriers for the exchange of traffic. Bill and keep is also referred to by the parties as mutual traffic exchange or payment in kind compensation.

• TCG recommends that interconnection compensation for local traffic be based on bill and keep for end office terminations and flat rate port charges for terminations made at a tandem switch.

• Staff and OITA propose nonreciprocal (one way) usage sensitive compensation based on existing switched access rates.

Reciprocal Usage Sensitive Compensation

USWC and GTE propose reciprocal compensation arrangements based on the access charge rate structure in effect for toll traffic. USWC recommends that AECs pay a switching charge and an interconnection charge for local and toll traffic terminating at a USWC end office switch or delivered to a USWC tandem for delivery to a USWC end office switch. These charges would be assessed for each minute of use and are reciprocal; that is, USWC will pay an AEC a switching and interconnection charge for each local and toll minute of use originated by USWC customers and delivered to an AEC switch.

USWC's proposal also contemplates that AECs will pay a carrier common line charge (CCLC) for all intraLATA and interLATA toll traffic terminated on USWC end office or tandem switches. The CCLC is part of USWC's current switched access rate structure and is assessed on a minute of use basis. Like the local switching and interconnection charges, the CCLC would be reciprocal. The CCLC would not apply to local traffic.

Finally, USWC proposes that the Commission approve a nonreciprocal Interim Universal Service Charge (I-USC) of 0.85 cents per minute for all local traffic delivered by an AEC and terminated on a USWC end office switch. The proposed I-USC is discussed more fully beginning on page 38 of this order.

USWC's proposed interconnection rates are as follows:

Local and EAS Calls Rate (Cents per Terminating Minute)

Local Switching 1.0881

Interconnection 0.0582

I-USC 0.8500

Total 1.9963

Toll Calls Rate (Cents per Terminating Minute)

Local Switching 1.0881

Interconnection 0.0582

Carrier Common Line Charge 2.0400

OR Carrier Access Fund Charge 0.4810

Total 3.6673

GTE also recommends reciprocal interconnection compensation based on the rates included in its switched access tariff. GTE does not recommend that the CCLC or an I-USC apply to the termination of local or "EAS-like" traffic. The interconnection rate paid by an AEC for terminating local exchange traffic on a GTE switch would be 2.05 cents per minute.

According to GTE witness Dr. Edward Beauvais, the interconnection compensation structure should not distinguish between calls that are intraexchange or interexchange within a competitive zone or interexchange outside of a competitive zone. However, such an approach requires eliminating the CCLC and rebalancing current rates. Dr. Beauvais recommends that the Commission consider repricing issues in docket UM 351. If switched local service competition is authorized before such repricing occurs, all interexchange interconnection traffic should be assessed the full switched access tariff rate, including the CCLC. Intraexchange traffic would not be subject to the CCLC under those circumstances.

Dr. Beauvais emphasizes-and most other parties concur-that the pricing structure in a competitive telecommunications environment must ultimately move away from arbitrary classifications such as toll, access usage, local usage, and EAS. These classifications would be replaced by a single integrated rate structure applicable to all switched traffic. As USWC points out:

[L]ocal interconnection is no different technically and conceptually from any other kind of interconnection. Compensation for the use of one carrier's network by another should be the same regardless of how the originating carrier rates the traffic to its customers. In the competitive world, there will be little distinction between local and toll at the state level.

Dr. Beauvais observes that an integrated price structure for interconnection avoids the enforcement and definitional problems inherent in current differential pricing structures, conveys proper economic signals to customers, and is simpler and more equitable to administer. In addition, it will provide the pricing flexibility necessary for telecommunications providers to succeed in an increasingly competitive environment.

Reciprocal Usage Sensitive Compensation-Opposing Arguments

ELI, MFS, MCImetro, AT&T, McCaw, OCTA, Sprint, and TCG criticize the proposal to use switched access charges as the compensation structure for interconnection. These parties argue that the proposed rate structure (a) imposes a price squeeze on entrants; (b) precludes opportunities for local exchange prices to decline;

(c) creates barriers to competition because of the lack of reciprocity; (d) requires traffic measurement capabilities that are unavailable and costly to implement; (e) is unrelated to underlying costs; (f) inhibits competition by skewing traffic patterns; and (g) forces entrants to imitate the network architecture of the LECs. These arguments are addressed below.

(a) Price Squeeze. According to Dr. Cornell, a "price squeeze" is a relationship between prices that can arise whenever a monopoly supplier of an input to other firms also competes to sell a retail service which incorporates that bottleneck input (or essential function). If the monopoly supplier sets the price of an essential function at a level such that the retail end user price does not recover both the price for the essential function and the remaining costs to produce the service, a price squeeze exists. Under a price squeeze, competitors who must purchase the essential function from the monopoly supplier face a barrier to entry because they cannot cover their costs at the price charged by the monopolist for the retail service.

ORS 759.050(5)(b) is designed to prevent price squeezes by establishing an imputation price floor for services sold by telecommunications utilities within competitive zones. It requires that the price for a service offered by a telecommunications utility may not be less than the TSLRIC of nonessential functions plus the price of the essential functions necessary to provide the service.

MCImetro and TCG presented evidence to demonstrate that the interconnection rates proposed by USWC and GTE will result in a price squeeze. Dr. Cornell and TCG witness Dr. Paul Teske compared USWC's proposed interconnection rate with measured usage rates available to USWC's retail business customers under various calling packages. Both analyses disclose that a USWC business customer subscribing to measured service pays less to originate and terminate a local call than an AEC would pay to USWC just to terminate a local call.

Dr. Teske also compared USWC's and GTE's proposed interconnection rates with the retail rates paid by customers for a number of other services. His analysis indicates that:

• USWC medium sized business customers now pay an effective calling rate that is .6 cents per minute (cpm) less than USWC's proposed interconnection rate at higher traffic volumes. Even if an AEC were to confine its market to customers with 900 minutes or fewer per month-less than one half the average usage for USWC PBX and Centrex users in Oregon-the AEC would still pay .14 cpm more to terminate calls than the effective calling rate now paid by USWC customers.

• USWC large volume business customers taking Digital Switched Service (DSS) service pay an effective calling rate of .529 cpm, compared with USWC's proposed interconnection rate of 1.9963 cpm.

• USWC residential customers taking measured service pay effective retail prices from 1.27 cpm to 1.33 cpm compared with USWC's proposed interconnection rate of 1.9963 cpm. In the case of flat rate residential service, the interconnection rate is lower than the effective calling rate only for customers making fewer than two calls per day.

• GTE flat rate business customers pay an effective calling rate less than GTE's proposed interconnection rate of 2.05 cpm once usage exceeds 644 local calling minutes per month.

• As in the case of USWC, GTE residential customers pay an effective calling rate less than GTE's proposed interconnection rate only if they make fewer than two calls per month.

Based on his analysis, Dr. Teske contends that the interconnection rates proposed by USWC and GTE create a classic price squeeze, which effectively precludes AECs from competing for local business and residential customers. In every instance, the rate that AECs would pay to terminate calls is greater than the effective calling rate that USWC and GTE customers now pay to receive retail service. Thus, AECs would experience negative operating margins even before incurring any of the costs associated with originating, switching, or transporting the call. These additional costs further exacerbate the substantial losses AECs would encounter. Dr. Teske concludes that local competition is not viable under such circumstances.

Several parties emphasize that the usage based interconnection rates proposed by USWC and GTE will create an underlying cost structure that is incompatible with the flat rate environment for retail local exchange service in Oregon. If usage sensitive charges are assessed for every minute of use, it is uneconomic for an AEC to serve customers beyond a given usage threshold. As demonstrated by Dr. Teske's analysis, the USWC and GTE proposals effectively create a price squeeze at higher usage levels, relegating AECs to serving low volume customers that are least likely to be interested in obtaining service from a competitive provider.

In its posthearing brief, GTE alleges that Dr. Teske's interconnection/retail rate comparison is misleading and inaccurate because it (a) hinges on assumed usage levels not based on actual traffic studies; (b) reflects only traffic flowing in one direction, and does not account for offsetting revenue; and (c) fails to take into account the mandatory EAS additive. GTE claims that, if the correct figures had been used, Dr. Teske's comparisons would have yielded positive margins at all assumed levels of usage. It further emphasizes that switched access rates are subject to change in the pending

UM 351 investigation, and that GTE has proposed reductions in its switched access rates that may extend to both local and toll traffic.

TCG disputes GTE's claims regarding the validity of Dr. Teske's price squeeze analysis. It maintains that a price squeeze still exists for a large segment of the relevant market even after the EAS additive is included in the comparison. TCG's calculations show that GTE business customers making more than 1182 minutes of calls per month will have an effective retail rate less than GTE's proposed 2.05 cpm interconnection charge. Likewise, GTE residential customers making more than 662 minutes of calls per month-4 to 5 calls per day-will have effective retail rates less than 2 cpm, resulting in negative margins for competitors. TCG maintains that anticipated reductions in rates generated by competition will only exacerbate the price squeeze by reducing the threshold level beyond which AECs cannot effectively compete.

USWC witness Dan Purkey performed a series of imputation analyses to demonstrate that USWC's proposed interconnection rate will not result in a price squeeze. Mr. Purkey conducted service specific imputation studies for flat rate simple business service, flat rate complex business service, business measured service, PBX trunk service, Centrex line service, DSS service, and Public Access Line Measured Service. A separate analysis was made for each service using the Average Direct and Shared Residual Cost (ADSRC) methodology and the Average Service Incremental Cost (ASIC) methodology. In addition, an imputation analysis inclusive of all USWC business services was performed using the ADSRC approach. In every case, the imputed price floors derived were significantly less than USWC's current tariff rates. According to Mr. Purkey, these results demonstrate that USWC's interconnection proposal will allow AECs to compete with USWC for local exchange business services.

ELI, TCG, and others maintain that USWC's imputation studies improperly manipulate cost and price data and ignore applicable imputation requirements in order to demonstrate that switched access compensation will not create a price squeeze. ELI states that USWC: (a) assumes incorrectly that certain inputs are nonessential instead of essential (and therefore improperly imputes USWC's cost instead of the tariff rate);

(b) fails to include certain essential functions and nonessential service specific costs; and (c) relies on hypothetical usage and price data. Furthermore, USWC's analyses do not reflect the actual telecommunications marketplace and disguise the fact that the proposed switched access compensation structures will render local competition uneconomic by barring entrants from creating profitable services.

To illustrate the alleged shortcomings in USWC's imputation analysis, ELI witness William Montgomery prepared a revised imputation study. Mr. Montgomery used the same general method as Mr. Purkey, but incorporated the following assumptions: (a) intraoffice traffic is included for imputation purposes;

(b) terminating transport is treated as an essential function and imputed at USWC's tariff rate; (c) number portability and directory listings are considered essential functions and imputed at $4.00 and $0.75 per line per month, respectively; (d) USWC is assumed to use its pricing flexibility to offer "Custom Choice" discounts of 30 percent to business customers;and (e) USWC's proposed I-USC is disallowed. Mr. Montgomery's imputation analysis included flat rate business service, Centrex/PBX/DSS usage, and all business services combined. His adjustments generally yield higher price floors, and therefore a smaller margin between the amount an AEC must pay for interconnection and the amount charged by USWC for the retail end user service. In several instances, the AEC margin is negative; that is, the imputation price floor exceeds the USWC tariff rate for the retail service. Dr. Montgomery contends that negative margins affirm the existence of a price squeeze, since AECs lose money on every minute of use.

(b) Impact on Local Rates. AT&T, ELI, OCTA and MCImetro contend that USWC's proposed interconnection rates will require it to raise local rates, resulting in an upward pricing spiral. Dr. Cornell explains how pricing interconnection above cost prevents competition from lowering retail prices:

Since interconnection is a service that cannot be self-supplied, the price paid, whether in cash or in kind, is a permanent part of the cost structure of each carrier. Thus if either carrier has to pay more than cost to the other carrier, the amount above cost remains permanently embedded in the cost of local exchange service. This is because what is a price to the carrier charging that amount is a cost to the carrier paying it.

Not only does USWC want to embed some amount above cost in local exchange rates permanently, but it also wants to impose a price squeeze. This means that USWC is trying not only to recover all of the "contribution" from local calling that it would have gotten had it provided the end to end call, but it is trying to recover some of the "contribution" that it would have gotten if it had supplied the access connection as well. Any policy that allows USWC to continue to collect "contribution" even when it does not provide the service from which the "contribution" is derived is a policy that directly hinders the achievement of greater efficiency in telecommunications. USWC loses a significant incentive to compete for the customer, given that it can retain the "contribution" even if it does not incur the costs to provide the service. If USWC is allowed to retain the "contribution" without performing the service, that portion of the total telecommunications bill can never fall due to competitive pressures.

Because of these circumstances, Dr. Cornell argues that USWC's interconnection proposal will not lead to competitive entry. If entry does occur, it will not be sustainable. Absent competitive pressure, Dr. Cornell observes that costs will not decline.

ELI further contends that there is no economic rationale for adopting switched access charges as the compensation structure for local exchange service. According to Mr. Montgomery, the primary rationale for using switched access charges is that LECs need contribution to compensate for universal service and carrier of last resort (COLR) obligations. In an emerging competitive environment, contributions to fund universal service should be collected in a competitively neutral manner, not through inefficient carrier access charges that limit or foreclose competition.

(c) Lack of Reciprocity. MCImetro maintains that USWC's compensation proposal is not reciprocal because AECs will not be able to charge as much as USWC for interconnection. According to Dr. Cornell, nonreciprocal compensation creates a barrier to entry because it requires entrants to absorb higher costs than incumbents. In order for AECs to attract customers, they must price below the rates of the incumbent LEC or offer a better service at the same price. If an AEC is forced to pay a higher interconnection price, it must be more efficient than the incumbent even to match the incumbent's price, let alone price below the incumbent. Therefore, a lack of reciprocity is similar to a price squeeze because it keeps equally efficient carriers out of the market.

Dr. Cornell also emphasizes that requiring a more efficient carrier to charge less for interconnection effectively forces that carrier to transfer its efficiencies to its competitors. In order for the market to send correct information to consumers about which firm is more efficient, the more efficient firm must be permitted to pass on the benefits of those efficiencies to its own customers, not the customers of its competitors.

(d) Measurement Related Costs. USWC witness Owens testified that the technological means for measuring terminating local exchange traffic was not available to that company at the time of hearing. USWC anticipated that it would develop a method to generate the necessary call records by the end of 1995. It argues that the additional investment in measurement capability is necessary to enable carriers to manage their networks in a competitive environment. Networks already have the capability to measure intercompany toll rated traffic, and the cost of adding local measurement is expected to be modest and incremental. USWC points out that existing LECs are already pursuing measurement arrangements. Also, much work has been done to accommodate GTE's entry as a primary toll carrier and to measure the integrated toll and local traffic exchanged with wireless carriers.

Until its measurement system is in place, USWC proposes to work with AECs to determine the local traffic exchanged between networks. Mr. Owens states that originating carriers can supply measurements of local traffic delivered to terminating carriers so that the latter can bill the traffic terminated on their systems. USWC is willing to rely on AEC measurements until a more precise measuring system is in place.

GTE, on the other hand, states that its existing systems can measure local traffic at relatively low cost. GTE can also carry mixed local and toll traffic on two way trunks, provided that the rate for terminating local traffic is the same as the rate for terminating toll. If the terminating rates for local and toll differ, it will be necessary to use separate trunk groups for the two types of traffic. The current industry practice for handling toll and EAS traffic is to use separate trunk groups.

Staff contends that measurement is necessary in a multiprovider environment. Because AECs will interconnect different types of traffic -including intrastate toll, interstate toll, local, and EAS-it is important to record the type of call and jurisdiction so that the appropriate intercompany compensation and end user billings can be made. Staff opposes allowing originating carriers to estimate the "percentage of local use" (PLU) in lieu of actual measurement because of the potential for carriers to misreport traffic.

Opponents of usage sensitive interconnection pricing contend that the costs associated with developing a system to measure intercarrier local traffic will compromise economic efficiency and unnecessarily increase the total cost floor for local exchange services. According to MCImetro and TCG, cost studies in the state of Washington disclose that adding measurement and billing costs more than doubles the cost of end office switching. Furthermore, USWC estimates that the cost of implementing its new measurement system in Washington will be more than three times the amount now spent to measure switched access minutes of use. Dr. Cornell emphasizes that it is inefficient for firms to develop measurement and billing arrangements that significantly increase the cost of doing business, especially since traffic between networks will tend to be in balance over time. TCG adds that, if traffic is roughly in balance and both carriers' interconnection rates are the same, the expense of measuring is wasted because both carriers are simply billing each other the same amount. Even if traffic is not in balance, the degree of imbalance must justify the costs of measuring and billing.

ELI, OCTA and MCImetro also observe that measured compensation will force new entrants to incur additional costs to audit and correct errors in measurement and billings. ELI witness Walter Cook and Dr. Cornell testified that the carrier access billings currently received by interexchange carriers contain many errors and must be amended on a regular basis. Audit costs are a significant expense for interexchange carriers and can be expected to increase the cost of providing local exchange service for AECs. Furthermore, AECs familiar with auditing procedures for switched access will not be able to rely on that expertise because the proposed measurement system for local exchange traffic differs from the system for switched access terminations.

Applicants further contend that measurement related costs will impose a greater relative burden on entrants than on incumbent LECs. In order to provide service, entrants either have to incur the expense of installing measurement equipment in their networks or absorb the cost of terminating intercarrier traffic. In addition, AECs will have smaller volumes of traffic over which to spread measurement, billing, and auditing costs for the foreseeable future. In contrast, the amount of local traffic delivered from LEC to AEC facilities will represent a much smaller percentage of the incumbent's total traffic.

(e) Cost Causation. ELI and TCG assert that usage sensitive compensation is inappropriate because the costs of facilities used to provide interconnection are largely a function of capacity. These arguments are addressed below.

(f) Traffic Patterns. TCG and MCImetro argue that the measured compensation proposals offered by USWC and GTE will distort local exchange competition by encouraging competitors to serve customers with higher volumes of incoming calls in order to equalize interconnection revenues. In a competitive market, new entrants may be expected to serve as many customers as possible, regardless of usage patterns, in order to maximize overall revenues. AECs are likely to evaluate potential customers not only on local exchange use, but on overall telecommunications usage, including toll and vertical services. Customers with high traffic volumes are most likely to be interested in exploring various competitive offerings in order to minimize their total telecommunications costs. MCImetro and TCG contend that measured compensation creates an incentive to avoid interconnection charges and encourages AECs to serve low volume customers and customers that rely heavily on inbound traffic. The problem is exacerbated by the fact that AECs would pay higher interconnection rates than incumbent LECs under the proposals forwarded by USWC and GTE.

(g) Network Architecture. Several parties argue that the switched access compensation structure proposed by USWC and GTE will skew the technology and architecture choices of entrants, thereby reducing or eliminating the benefits derived from competitive entry. At the outset, entrants can be expected to terminate a much higher percentage of their traffic onto the networks of the incumbent LECs. A switched access rate structure will force entrants to mirror as many of those rate elements as possible and will affect AEC decisions about the architecture to employ. According to Dr. Cornell:

Switched access charges are composed of a series of rate elements charged for the use of different piece parts of the incumbent's network to terminate a call. Except for the rate elements designed to pay "contribution," if a piece part is not used, then the rate element is not charged. The proposals to use switched access charges for compensation mostly include the same requirement. Thus, the entrant would only be allowed to charge for the same categories of costs that the incumbent claims are the costs of providing service.

Suppose an entrant placed only a single switch, using much more "loop" plant than the incumbent. The total cost to it to terminate a local call for the incumbent may or may not be less than the incumbent's costs, but those costs may be in different categories from those used by the incumbent. If the only costs the entrant can recover in its local interconnection tariff are switching and transport costs, however, it will be handicapped relative to the incumbent, and may be prevented from recovering all of its costs regardless of whether they are less than or equal to the incumbent's costs. Because of the inability to recover its costs using its preferred architecture it will face an incentive to try to mirror the architecture of the incumbent, even if it were not the most efficient architecture.

Interim Universal Service Charge

As noted previously, USWC proposes that the Commission approve a nonreciprocal Interim Universal Service Charge (I-USC) of 0.85 cents per minute for all local traffic delivered by an AEC and terminated on a USWC end office switch. USWC witness Jeffrey Owens explains the charge as follows:

The proposed interim universal service charge is a result of the substantial difference between USWC's residential and business exchange rates. USWC has been able to maintain this differential as a result of its historic role as a single provider of these services in its exchanges, wherein each business customer has provided support to roughly 2.43 residential customers. The advent of competition in the local exchange will ultimately require USWC to equalize the rates for residence and business exchange services-as competition inevitably will drive the prices of these services closer to cost. Initially, most AECs are likely to serve business exchange customers almost exclusively-although some AECs, who have access to the distribution networks of cable companies, are likely to serve a comparable mix of business and residential customers as USWC. If USWC is to maintain the differential between its business and residential rates during a transitional period, it is essential that the Commission impose an interim universal service charge on those AECs who choose to avoid the burdens associated with serving the residential market.

USWC contends that the I-USC is not a "keep whole" charge designed to protect it from competitive loss, but is required to maintain consumer equity and competitive neutrality. Mr. Owens emphasizes that the I-USC will only recover a portion of the support flow lost from business customers who will be served by AECs. It will not recover contribution provided by toll, access, and vertical services that are lost when a business exchange customer takes service from an AEC.

USWC proposes that the I-USC be discontinued if an AEC (a) has a sustained ratio of residential to business customers that is equal to or greater than USWC's comparable ratio; (b) provides a telecommunications service which has a demographic and geographic penetration similar to the relevant USWC exchange; (c) serves its residential and business customers using its own facilities; and (d) provides Federal Link-Up and Oregon Telephone Assistance Plan service to its residential customers.

USWC regards the I-USC as a temporary mechanism that cannot be sustained in a competitive environment. It states:

The monopoly era approach of allocating large amounts of revenue requirement to interconnection rates to keep all residential rates below cost is not viable going forward. There must be a transition downward in interconnection rates, as other rates are rebalanced commensurate with specific, identified universal service requirements. The current pure contribution rate elements of access should be replaced with targeted, competitively neutral funds to meet the affordability needs of low density and low income segments of the market. The industry and the Commission must use interconnection charges sparingly as needed to preserve universal service.

USWC envisions that the I-USC will be reduced over time as the company is able to rebalance its residential rates to levels that recover direct cost plus an appropriate level of shared and common overhead costs. It urges the Commission to rebalance rates, reduce the subsidies inherent in residential exchange rates and reapportion contribution levels among the company's services.

USWC acknowledges that the Commission is presently reviewing universal service issues in docket UM 731 and will likely entertain rate rebalancing proposals in docket UM 351. Nevertheless, it recommends that the I-USC be approved without delay. USWC contends that its competitors will quickly gain market share in the Portland metropolitan area where USWC business revenues are concentrated. If the

I-USC is not implemented, USWC states that it will be effectively deprived of the opportunity to earn a fair rate of return, because competitors will "strip off large portions of [business] revenues," leaving USWC to serve residential and rural customers at unprofitable rates.

Interim Universal Service Charge--Opposing Arguments

Applicants and several intervenor parties recommend that the Commission reject the proposed interim universal service charge proposed by USWC. Opponents of the

I-USC contend that the charge is not cost based and is unnecessary to compensate LECs for universal service obligations. These parties assert that USWC has not quantified the level of support necessary to protect universal service or demonstrated that the funds generated by the I-USC would be used for that purpose. They further maintain that, in a competitive environment, all support for universal service should be made explicit and collected in a manner that is competitively neutral.

MFS argues that there is no support in the record for USWC's claim that an implicit cross subsidy of residential service by business service exists, and consequently, no evidentiary foundation to justify adopting the I-USC. MFS notes that the TSLRIC cost data presented by Staff discloses that USWC provides both business and residential service above cost. In contrast, the ADSRC cost methodology used by USWC to demonstrate that residential rates are below cost includes additional common and overhead costs and differs from the cost methodology approved by the Commission in docket UM 351. Given the shortcomings in USWC's cost study, and absent evidence that Staff's TSLRIC calculations are incorrect, MFS asserts that there is no credible evidence to support the I-USC.

Sprint maintains that USWC's method of calculating the I-USC is "inherently suspect and faulty." Sprint claims that the I-USC is necessarily inflated because it presupposes that all AEC customers are former customers of USWC; i.e., that USWC will lose a business exchange line for every line obtained by a competitor. According to Sprint witness Dr. Richard Purkey:

this presumption of a static market (or "zero sum game") clearly ignores new growth, and as well ignores the fact that US West will undoubtedly collect an IUSC from AEC customers who were never customers of US West, but were rather, former customers of GTE or another independent phone company. Thus, the assessment of the IUSC obtains for US West not only compensation for alleged competitive losses, but a new and potentially large revenue stream as well.

ELI and TCG make similar arguments, emphasizing that USWC's approach assumes that all future, as well as current, business lines would be USWC customers.

In addition, several parties argue that the criteria proposed by USWC for reducing or eliminating the I-USC are arbitrary and subject to manipulation. TCG also observes that the conditions for waiving the charge permit USWC to impede competition by burdening new entrants with costs that will remain in effect for an indefinite length of time at USWC's discretion.

Opponents of the I-USC acknowledge that there are definable customer groups that may require a subsidy to remain on the network. Rather than have USWC administer such subsidies, however, the Commission or another independent entity should assume responsibility for determining the appropriate subsidy mechanism and the customer groups eligible to receive support. Generalized surcharges such as the I-USC are an inappropriate means of funding universal service. AT&T and ELI recommend that the Commission reject USWC's arguments regarding universal service and COLR until such time as USWC quantifies the level of support associated with those obligations. Mr. Montgomery states:

The policy question concerning whether and how much contribution is required to protect universal service is whether a particular group of customers would still be served at the option of the incumbent carrier, without any COLR obligation, even if some component of the ratepayer's service is below the piece part cost of that service. Piece part cost studies cannot answer this question. The answer requires looking at the overall cash flow derived from the customer, considering all sources of revenue.

* * * * * * * * *

The COLR concept assumes that being the provider of telephone service is a liability, when in fact the market shows that it is an asset. LECs like USWC claim that being a COLR is a liability wherever cost studies seem to indicate that access prices are below the costs of this specific "service." Telephone company cost studies treat "basic exchange access" as a separate service, when, in fact, access lines are what provide the economies of scope in telecommunications. Many services can be provided once access is available but not without it. LEC cost studies typically examine only some of the economic factors that would be needed in order to determine whether one class of users was subsidizing another class. Even if it were assumed that these piece part cost studies are completely accurate, they are not sufficient to set contribution policies with respect to competitive entrants.

Staff agrees with the I-USC in concept, but disagrees with USWC's method of computing the charge. Staff's approach incorporates different EAS rates and a different cost methodology. If the Commission approves an I-USC, Staff recommends that USWC and GTE file proposed I-USC rates and supporting cost data as separate tariffs.

Flat Rate Compensation

TCG proposes a compensation arrangement that allows local exchange traffic to be transferred to the terminating carrier at its last point of switching at no charge to the originating carrier. This arrangement would apply equally to AECs and incumbent LECs. Local exchange traffic transferred to the terminating carrier at locations other than the terminating carrier's last point of switching, however, would be terminated at a flat monthly charge that recovers only the terminating carrier's cost of transporting the traffic from the transfer location to the last point of switching (including any inter- mediate switching). In other words, TCG recommends bill and keep compensation for end office termination and a flat rate port charge for termination at the tandem switch.

Dr. Teske proposes bill and keep for end office terminations because AECs are unlikely to build facilities to an end office unless there are sufficient traffic volumes to warrant construction of those facilities. Under those circumstances, there is likely to be a community of interest in the calling area. Consequently, traffic flows between AECs and LECs will tend to be closer to equilibrium. Tandem interconnections, on the other hand, entail additional switching and trunking costs that justify a flat rate port charge until traffic reaches a rough equilibrium. This approach addresses concerns relating to traffic imbalance by providing a transition mechanism to bill and keep without incurring the problems associated with traffic measurement. In addition, the end office/tandem pricing differential is designed to encourage investment in and development of AEC facilities to the end office. Dr. Teske maintains that this investment will enhance network redundancy, leading to a more reliable "network of networks" and a more robust telecommunications infrastructure.

TCG's proposed flat rate charge would require carriers to make available DS1 capacity switch ports for terminating traffic at the tandem and end office levels. The ports would be priced on a flat monthly basis and would reflect differing end office and tandem functions. Carriers would measure the peak busy hour of each month to determine the relative traffic flow over the DS1 facility and allocate port charges using the deploying carrier's tariffed rate. By monitoring peak busy hour usage, carriers will be able to ascertain when traffic is balanced and can make the transition to bill and keep for tandem interconnections at that time. Dr. Teske calculates the capacity based rate for tandem ports by multiplying the per minute cost of tandem switching and (average) transport by an assumed DS1 usage of 216,000 minutes per month. In a recent interconnection compensation case in Washington State, this formula yielded a monthly flat rate charge of $130 for a tandem DS1 port.

Dr. Teske states that TCG's proposed compensation structure better reflects how interconnection related costs are incurred than does usage sensitive pricing. The bulk LEC interconnection related costs result from "lumpy" investments in switching and interoffice trunking capacity that are designed to meet peak usage requirements, while the cost of carrying off peak traffic is essentially zero. As a consequence, usage sensitive compensation schemes substantially overstate the cost of completing calls during most times of the day. Moreover, flat rate capacity charges are a more logical means of assessing call completion charges in a competitive market since competition forces price structures to match underlying cost structures.

ELI concurs with TCG's position regarding cost causation in telecommunications networks. Mr. Montgomery states:

The new technologies are less sensitive to call distances and to call usage. Whereas usage rate structures measure only these factors, the underlying costs are becoming relatively more sensitive to the capacity demanded, rather like the "demand charge" in kilowatts in an electric service pricing structure, compared with usage sensitive kilowatt hours. Fiber optics technologies are much less distance sensitive than the predecessor metallic, analog technologies. In the long distance market, all of the major carriers now offer optional postalized rates (i.e., rates that do not vary by the distance covered, as postage stamp rates), so that a call from Portland to Washington, D.C., costs the same as a call from Portland to Salt Lake City. These postalized rates recognize, among other things, the reduced sensitivity of the fiber optic transport technologies used by interexchange carriers. Local carrier networks are, of course, evolving so that most calls already transverse fiber optics technologies at some point, and the networks placed by entrants like ELI will be predominantly fiber optics. Likewise, switching and call control systems are also much less "traffic sensitive" and more "non-traffic sensitive" than outmoded costing models like jurisdictional separations rules currently recognize. Digital switches are predominantly "non-traffic sensitive" as are new call control systems like Signaling System 7.

TCG and ELI also point out that capacity based reciprocal interconnection compensation arrangements afford all carriers greater retail pricing flexibility than usage based compensation structures. Despite the fact that the retail telephone market in Oregon is dominated by flat rate local calling, AECs will be unable to offer flat rate local calling if they must pay per minute charges to terminate traffic. If usage sensitive pricing is adopted, AECs will be forced to choose between offering minute of use pricing and garnering little or no market share, or offering flat rate calling and losing money. Effective local exchange competition is unlikely under either scenario. Capacity based charges, on the other hand, permit all carriers to develop both flat rate and measured usage options for local calling, including time of day and volume discounts. This type of pricing flexibility is not possible in an environment where the dominant carrier imposes per minute interconnection charges, because those charges effectively establish a price floor for all carriers operating in the market.

Finally, Dr. Teske observes that flat rate capacity charges are simpler to administer because they entail only the monthly measurement of traffic and billing of a fixed charge. Per minute charges, on the other hand, require complex and costly measuring, recording and billing capabilities that few carriers now possess.

Flat Rate Compensation-Opposing Arguments

GTE argues that TCG's proposed flat rate charge for the switching component of interconnection is a departure from the cost methodology adopted by the Commission in Phase I of the UM 351 docket. GTE asserts that the UM 351 methodology develops switching costs on a per minute of use basis, and is incompatible with TCG's claim that interconnection costs are not usage sensitive. Dr. Beauvais notes that flat rate charges might be reasonable as a temporary step while measured compensation is put in place. However, incorporating the proper capacity and pricing assumptions is crucial to ensure that carriers receive proper compensation for their services.

MCImetro also disagrees with TCG's proposed flat rate port charge for terminating traffic at the tandem. It contends that the proposal will encourage providers to extend facilities to the end office instead of the tandem in order to avoid interconnection charges, without regard to the efficiency of a particular architecture for a given market. MCImetro asserts that TCG's proposal implicitly assumes that incumbent LECs have efficiently designed networks. It also distorts the market by sending signals that are unrelated to minimizing cost or maximizing efficiency.

One Way Compensation

Staff recommends a compensation arrangement that requires AECs to pay switching and transport access charges to LECs for EAS and local calls terminated on LEC facilities. AECs would not be compensated for any terminating traffic. OITA concurs with Staff's compensation proposal.

Staff witness Thomas Turner offers three reasons for opposing reciprocal compensation. First, the AECs, unlike the incumbent utilities, are not subject to extensive rate, service and cost regulations and do not have universal service or COLR obligations. Second, reciprocal compensation is not available to other entities that lease or own telecommunications facilities, including radio common carriers (RCCs), Shared Telecommunications Service (STS) providers, coin telephone providers, and private line networks. Last, Mr. Turner states that reciprocal compensation may create an incentive to "game the system" at LEC expense, by obtaining authority, leasing a few lines, and receiving compensation from the LEC for all incoming traffic. While such a scenario may seem unlikely, Staff believes it is prudent to anticipate that carriers might take advantage of such an opportunity.

Staff does not believe that AECs will be adversely impacted by the lack of compensation for traffic terminated on their networks. Mr. Turner observes that RCCs have experienced phenomenal growth despite the fact that they receive no compensation from LECs. In addition, AECs have a strong growth potential because they face few regulatory restraints and can become "one stop" telecommunications providers by integrating terminal equipment, radio communications, and long distance communications together with targeted local exchange services. Staff states that reciprocal compensation may be appropriate when the "regulatory landscape is equal," but recommends that the Commission proceed cautiously to avoid jeopardizing affordable service.

As a policy matter, Staff recommends that the interconnection compensation mechanism adopted in this proceeding should be interim in nature. It recommends that the Commission open an investigation to consider a permanent solution within a year after the first AEC is authorized to provide local exchange service. Staff proposes that AECs pay from 1.3 to 1.6 cpm to terminate traffic on USWC's network, depending upon local transport distance. Staff recommends that the Commission adopt the rate proposed by GTE for traffic terminated on that carrier's network.

One Way Compensation-Opposing Arguments

ELI, MCImetro, MFS, TCG, Sprint, McCaw, OCTA and AT&T oppose the one way compensation scheme recommended by Staff. They make the following arguments:

(a) Because Staff's proposal allows only LECs to charge for calls terminated on their network facilities, it will foreclose effective competition and perpetuate LEC domination of local exchange markets. Staff's proposed compensation structure attempts to achieve "regulatory symmetry" by denying AECs compensation for interconnection, but ignores the fact that the incumbent LECs possess 100 percent of the market for switched local exchange service. Dr. Cornell argues that regulation should acknowledge differences in market power. Moreover, to the extent that LEC rates incorporate cross subsidies to support universal service and ubiquity, the proper regulatory response is not to impose uneconomic costs on entrants in a manner that impedes competition. Rather, the appropriate response is to identify valid policy goals, quantify the level of support necessary to achieve them, and devise a competitively neutral means of funding. The pending universal service and unbundling/repricing dockets are the appropriate forums in which to consider these issues.

(b) According to MFS, Staff's one-way compensation approach is undermined by the cost evidence presented by Staff witness Turner. Mr. Turner's calculations disclose that residential customer rates paid by incumbent LEC customers are above cost. If LECs are in fact experiencing a positive margin on residential service, then universal service does not impose a burden on the incumbent, but rather conveys a benefit. MFS observes that Mr. Turner did not address, and could not quantify, how holding the incumbent LECs harmless from paying compensation relates in any direct, quantifiable manner to specific universal service costs. Nor did Staff discuss whether universal service support-to the extent such a subsidy exists-is being provided by the LECs in the most economically efficient manner. Consequently, there is no justification for denying AECs compensation for terminating local exchange traffic as a surrogate for universal service obligations.

(c) ELI, MCImetro and McCaw argue that Staff's attempt to compare AEC interconnection arrangements with the compensation structure paid by RCCs is misplaced. McCaw points out that FCC rules require mutual compensation for interconnection services established between wireless and wireline competitors. While current interconnection tariffs do not provide for mutual compensation for cellular carriers, this situation must change to advance the goal of competitive neutrality. Toward this end, several parties, including Staff and the LECs, advocate eliminating use and user restrictions and moving toward an environment where all interconnecting entities purchase network functionalities from the same unbundled tariffs. Staff's one way compensation scheme is incompatible with this objective and should be rejected.

MCImetro further argues that nonreciprocal compensation is a major reason why cellular carriers have traditionally been perceived as providing discretionary, high priced service rather than as a substitute for traditional local phone service. According to Dr. Cornell:

Cellular carriers were forced to be niche providers, serving a supplementary purpose only, because they were denied true co-carrier treatment, subjected to interconnection charges that priced them out of being able to effectively compete for local exchange service.

MCImetro and McCaw assert that, if the regulatory goal is uniform treatment of all local carriers without distinctions based on technology, the Commission should opt for mutual compensation instead of Staff's one way compensation proposal.

ELI contends that comparisons between AECs and RCCS are inapposite because cellular telephone service is not a direct substitute for the local dial tone services proposed by the applicants. Mr. Montgomery states that positive cross price elasticity does not exist between local dial tone and cellular service because the market demand served by cellular cannot be readily duplicated by fixed wireline alternatives. Rather than exhibiting positive cross elastic effects, the demand relationship between cellular and wireline service is complementary; that is, decreases in the price for cellular phones or cellular usage increase demand for wireline network. This condition explains why cellular services have enjoyed "phenomenal" growth, despite usage charges that far exceed local dial tone charges even where the wireline service is provided under usage sensitive rates. It also explains why cellular service has been relatively unaffected by the lack of reciprocal compensation for calls from wireline networks to cellular phones.

(d) Opponents of one way compensation also dispute Staff's claim that one way compensation is appropriate for applicants because providers of STS services, private coin operated telephone service, private lines and farmer lines are not compensated for traffic terminated on their equipment. ELI and TCG point out that the services mentioned by Staff differ from the facilities based local services proposed by the applicants in terms of cross price elasticity, the insignificance of call terminations (e.g., many coin phones do not permit inbound calling), and other specific economic characteristics. For example, the relationships between demand for local dial tone and the local service of STS services are not true cross elasticities between comparable products. Because the local component of STS is essentially resale of local dial tone, it represents arbitrage, not sustainable economic cross elasticity.

(e) Staff's compensation proposal is premised on the assumption that AECs will capture 10 to 20 percent of USWC's local exchange business market in the competitive zones by the year 2001. Opponents argue that Staff's analysis is flawed because it fails to consider actual market experience, underestimates line stimulation, uses outdated information, fails to take into account likely cost savings, and relies on faulty analogies between AECs and LECs. These arguments are discussed under Issue No. I.

Bill and Keep Compensation

ELI, MFS, MCImetro, AT&T, and OCTA recommend adoption of a "bill and keep" compensation arrangement for the exchange of local and EAS traffic, at least for an initial period to allow local exchange competition to take hold. TCG agrees that bill and keep offers many of the same advantages as its proposed flat rate approach. Under bill and keep, no explicit monetary compensation is required for the exchange of traffic terminated on each carriers network. The proposal, also known as mutual traffic exchange, or payment in kind, requires that each carrier absorb the cost of traffic originated and terminated on its own network.

Under a bill and keep arrangement, AECs and incumbent LECs will establish trunk groups between each other's networks with Signaling System 7 (SS7) interconnection. The AECs and incumbent LECs will terminate local and toll traffic over these trunk groups. Termination of local calls will be compensated on an

in kind basis. Compensation for terminating toll calls will be compensated based on tariffed switched access charges. The mix of traffic terminated over these trunks may be rated based on a percentage local usage factor (PLU), similar to the percentage interstate usage (PIU) factor that has been used for many years to rate interstate and intrastate traffic between interexchange carriers and LECs. Alternatively, separate toll and local trunks may be utilized.

Bill and keep is premised on the assumption that intercarrier traffic flows will be in balance. If traffic is not in balance, the carrier terminating more calls will incur higher costs. Proponents of bill and keep acknowledge that a new entrant will likely terminate a higher percentage of its originated calls on an incumbent's local network than the incumbent will terminate on the new entrant's network. This does not mean that traffic flows will be imbalanced in favor of the entrant, however. It is the absolute volume of calls terminated by each carrier, not the relative percentage of calls terminated, that is relevant for ascertaining whether traffic flows are in balance.

ELI witness Montgomery emphasizes that intercarrier traffic is likely to be balanced in a competitive co-carrier environment because AEC customers will exhibit calling patterns very similar to those of LEC customers in the same area. Moreover, unless an AEC's incentives concerning which customers to serve are artificially distorted by discriminatory compensation rules, traffic flows are more likely to be balanced than in the case of existing EAS routes. Applicants point out that there is no evidence in the record to support the claim that terminating traffic will not be in balance.

With respect to the issue of traffic balance, MFS witness Peter Schulz testified regarding the local traffic exchanged between MFS Intelenet of New York, Inc.

(MFS-NY) and NYNEX in New York City. New York is the only jurisdiction with any significant history relating to switched local traffic exchanged between an entrant and an incumbent LEC. Over the first five months of 1995, 54 percent of the local traffic exchanged between the two carriers was terminated on MFS-NY facilities, and 46 percent was terminated on NYNEX facilities. In every month, NYNEX terminated more traffic with MFS-NY than vice versa. Similarly, traffic balance studies conducted in Washington State disclose a 53:47 split in EAS traffic terminations, a difference of plus or minus three percentage points.

Proponents of bill and keep point out that it is the predominant compensation plan among LECs in the United States for terminating calls in EAS areas. InterLEC terminations of local calls typically occur when an EAS route is established between a calling area served by a regional Bell operating carrier and an area served by a nonBell, or independent, carrier. Bill and keep has worked because the revenue settlements are simple: Each LEC recovers the costs of call origination and termination from its own customers. EAS compensation can also involve division of costs between LECs for trunking and other facilities, but there is no per call compensation between carriers. A similar situation would prevail if bill and keep is applied to traffic exchanged between AECs and LECs. ELI witness Montgomery states that bill and keep will:

vastly simplify the Commission's new responsibilities in an environment of emerging competition, and it is highly compatible with new incentive forms of regulation. The Commission will not have to develop a new form of compensation for existing or future EAS routes, nor will it have to try to differentiate between EAS and directly competing LECs connections -a task which may be impossible economically. The most critical price squeeze issues go away with [bill and keep] and the Commission can devote its time and resources towards further rationalization of local, toll and access pricing without being continually embroiled in disputes among competitors.

In this context, MFS points out that cash compensation arrangements such as those proposed by the LECs and Staff will generate disputes concerning the rates LECs should impute for terminating traffic. The disagreements that have surfaced in this case regarding the imputation suggest that this issue is extremely contentious. Bill and keep compensation arrangements would eliminate the time and effort associated with resolving those disputes.

Aside from administrative simplicity, ELI points out that bill and keep avoids the possibility that incumbent carriers will use intercompany compensation as a means to leverage their market power to increase an entrant's cost structure. If applied on an interim basis, bill and keep permits regulators to observe the development of local compensation and take the time necessary to fashion compensation plans that may be feasible in the long term. As noted above, bill and keep for local call termination is compatible with the current switched access charge structure for toll calls. For example, if ELI hands a long distance call to USWC, ELI will pay the same switched access charges as any of the current long distance carriers such as AT&T.

Proponents also contend that bill and keep provides the correct economic incentive for LECs and AECs to design and operate their respective networks to achieve maximum possible efficiency over time. Bill and keep requires each carrier to absorb the cost of all traffic terminating on its network. Therefore, carriers have an incentive to become more efficient by using technology and network architecture to minimize interconnection costs. Usage sensitive compensation schemes, on the other hand, do not create the proper economic incentive to reduce termination costs because cost responsibility is shifted to the carrier originating the calls. Also, as noted above, usage sensitive compensation forces new entrants to mimic the technology and architecture of the incumbents, even though it may be inefficient.

MCImetro argues that bill and keep is the only compensation arrangement that creates incentives for incumbent LECs to cooperate in developing number portability. Without number portability, AECs will be unable to attract customers with a significant amount of incoming calls, creating a traffic imbalance that disadvantages LECs. Number portability will permit AECs to serve customers with incoming and outgoing calls, thereby ensuring that traffic remains in balance.

Dr. Cornell and others also emphasize that bill and keep eliminates the incentive for new entrants to solicit customers with specific calling patterns. If compensation arrangements for traffic termination impose a disproportionate cost burden on AECs, those carriers will have an incentive to attract customers with more incoming than outgoing calls in order to minimize termination charges. Effective competition will occur sooner if this distortion is not present.

Finally, proponents argue that bill and keep saves on transaction costs associated with traffic exchanged between carriers. Bill and keep is the least costly method of compensating carriers for terminating traffic because carriers are not required to incur costs associated with measuring, billing and collecting terminating access charges. Thus, bill and keep will result in a lower total cost floor and drive local exchange rates as low as possible.

Bill and Keep Compensation-Opposing Arguments

USWC, GTE, OITA and Staff all oppose bill and keep as a method of interconnection compensation. These parties argue that bill and keep is inappropriate in a competitive environment because it allows AECs to use the facilities of the incumbent LEC for free. According to Dr. Beauvais, bill and keep is uneconomic because new entrants are able to utilize the terminating facilities of an interconnecting carrier at a zero marginal price, creating both static and dynamic inefficiencies. Bill and keep is inefficient in a static sense because AECs will rely on the existing facilities of the incumbent LEC, rather than building out their own networks or seeking alternatives for the delivery of traffic from other potential suppliers such as cable TV companies or electric utilities. Bill and keep is also inefficient in a dynamic sense, because a zero price will cause over consumption of access services and reduce the incentive to employ new, lower cost technologies as they become available.

USWC, GTE and Staff also maintain that traffic between carriers will not be balanced. While bill and keep arrangements might be appropriate from a theoretical standpoint if traffic between carriers is in balance and terminating access charges are equivalent, USWC contends that these conditions are unlikely to occur in practice. As a consequence, one of the providers will not recover the full cost of terminating traffic from the other provider.

According to USWC witness Owens, interoffice traffic between LEC and AEC central offices will be out of balance because of two market realities - the fact that AECs can choose to serve particular types of customers, and because different customers have different patterns of originating and terminating traffic. Other factors that will generate a traffic imbalance include (a) the different mix of businesses and residences in the communities served by the central offices of the two different carriers; (b) monthly fluctuations in AEC traffic mix that will occur with customer growth; and, (c) the fact that different AECs are unlikely to have the same level of success marketing their service to every customer class. According to USWC, these factors will cause the traffic flow between carriers to vary on a monthly basis.

USWC also argues that, even if the volume of traffic exchanged between carriers is roughly equal, LECs will nevertheless experience higher costs to terminate traffic. Arguing in support of the I-USC, Dr. Harris states that AECs are selectively deploying facilities to serve low cost business customers, and leaving the LECs with the obligation of serving high cost customers He argues that interconnection compensation should reflect these underlying cost differentials as well as the value that AECs derive from network redundancy and back up capacity provided by the ubiquitous networks of the LECs.

USWC adds that bill and keep should not be used because USWC will incur substantially greater transport costs than the AECs due to differences in the respective networks of the providers. According to Mr. Owens, AECs are likely to interconnect at USWC's tandem switches and use USWC's transport network to reach USWC end offices throughout its dispersed service territory. In contrast, traffic terminated by USWC on AEC networks will be confined to a relatively compact serving area. Greater use of USWC's transport network by AECs will cause USWC to incur substantially greater transport costs that cannot be recovered under a bill and keep arrangement.

GTE argues bill and keep is essentially a "forced barter" arrangement that fails to reflect the fact that the value of the interconnection services being exchanged are not the same. Because of "inevitable imbalances in traffic" and "differing cost structures of the various firms," it is not possible for a bill and keep compensation arrangement to provide payments that are equal in value.

Opponents of bill and keep also claim that in kind compensation is incompatible with a multiprovider telecommunications environment. Identification, measurement and pricing of services exchanged is the common business practice observed by competitive firms. USWC witness Dr. Robert Harris emphasizes that no other industry operates on the premise that traffic interchange will be balanced; rather, firms negotiate exchange rates and price the services they provide for each other. He observes:

The central tenet of economics is that prices play a critically important role in the allocation and distribution of goods and services in a market economy. I agree with Staff's opposition to "bill and keep" because it violates that principle. Furthermore, the use of bill and keep is without empirical foundation in a market economy. There are countless instances in which two businesses provide services to each other. In most cases, businesses price those services and collect payment based on the actual volume of services provided, just as they would any other customer. In a few cases - when bartering is involved-firms trade services in kind, without exchanging money payment; even then, the firms keep an account of what has been provided by each party to the exchange, so that each party knows what is "owed" the other party. In other words, mutual compensation . . . is not observed as a business practice in competitive industries.

Although bill and keep is currently used for EAS traffic exchanged between LECs, opponents argue that in kind arrangements are inappropriate in a competitive environment. Staff witness Turner emphasizes that EAS compensation arrangements were designed to accommodate utilities with similar regulatory obligations and are reasonable because they avoid the costs and complexities of joint compensation, minimize EAS costs, and promote universal service and customer fairness. AECs, on the other hand, are not subject to the same regulatory constraints as the LECs. Dr. Harris further emphasizes that existing EAS compensation was never predicated on the assumption that traffic would be balanced, but rather that each LEC would be made whole for its costs through the revenue requirement, ratemaking, and separations process.

Staff also argues that, because bill and keep allows "free access" to the networks of incumbent LECs, it will create incentives for IXCs to obtain the "lowest priced access by routing traffic via the AEC's free interconnection arrangement." In other words, Staff contends that toll traffic handed off from an IXC to an AEC and then terminated on an LEC network, may be improperly designated as local traffic to avoid payment of switched access charges.

Finally, USWC argues that bill and keep will create incentives for LECs to look outside their traditional exchange boundaries for new customers and to terminate traffic from these customers under existing bill and keep arrangements. USWC states that such LEC "cream skimming" would not be in the public interest.

Commission Findings and Decision: Issue IV(f)

Based on the evidence and arguments presented, the Commission finds that compensation for the exchange of local traffic between the applicants and the LECs in the competitive zones should be based on bill and keep arrangements for an interim period of not more than 24 months. We are persuaded that bill and keep has fewer shortcomings than other compensation proposals made in this case and will function as a reasonable compensation mechanism during the initial stages of competitive entry into the local exchange market. At the same time, we recognize that bill and keep is only a temporary means of accommodating local exchange competition and that a more permanent intercompany compensation mechanism must be developed as competition progresses. Accordingly, we find that an industry work group should be created to address interconnection compensation issues.

The task of the work group shall be to formulate proposals for implementing a reciprocal interconnection rate structure applicable to all switched telecommunications traffic by the end of the 24 month period. We agree with Dr. Beauvais and others who maintain that telecommunications customers will not realize the full benefits of competition until existing classifications such as "toll," "local," and "EAS" are eliminated in favor of a single integrated pricing structure. The advantages of an integrated pricing structure are that it is nondiscriminatory, technologically neutral, and does not entail enforcement problems inherent in current rate structures. It also conveys the correct economic signals, thereby creating incentives for each carrier to make the most efficient use of its network and resources. It is not clear, however, that the transition to an integrated price structure can be accomplished in one step. The work group shall be responsible for evaluating the extent to which a phased approach is necessary, and shall develop appropriate recommendations regarding the timing and implementation of rate structure changes.

The interconnection compensation work group shall consist of representatives from USWC, GTE, Staff, MFS, ELI, MCImetro, and other interested parties, including consumer groups, ILECs, IXCs, and other competitive providers. Staff shall submit a report to the Commission every six months detailing the progress of the work group. In addition, the applicants, USWC and GTE shall conduct and submit periodic traffic studies of local and EAS traffic exchanged with other carriers. The first study shall be submitted within six months from the date of this order. Additional traffic studies shall be submitted every six months thereafter. This information can be used by the work group to develop its recommendations regarding reciprocal compensation arrangements for terminating traffic.

Our decision to adopt bill and keep on an interim basis will allow the applicants to enter the local exchange market while the Commission concludes a number of important dockets that will have a major impact on interconnection rates paid by telecommunications providers. Before substantial progress can be made toward a new interconnection pricing structure, the Commission must complete the pending universal service and unbundling/repricing dockets. As noted above, we recently issued Order

No. 95-1103 in docket UM 731, establishing a method of funding universal service in Oregon. Phase II proceedings are now underway in that docket to resolve implementation issues. In addition, hearings have recently concluded in UM 351. An order specifying the level and extent of unbundling of LEC services will be issued shortly. A likely outcome of that docket will be additional proceedings to determine the extent to which LEC rates must be rebalanced to correspond with the unbundling and pricing policies adopted in UM 351. In our opinion, there must be substantial resolution of these matters before a more permanent compensation structure for interconnecting all carriers can be implemented.

There are several other advantages to implementing bill and keep as an interim compensation mechanism. Because bill and keep is the dominant practice for terminating EAS traffic between adjacent LEC exchanges in Oregon and throughout the nation, it is the least difficult compensation arrangement to implement from an administrative standpoint. The inherent simplicity of bill and keep makes it a sensible choice as a transitional compensation mechanism until a more comprehensive interconnection rate structure can be implemented.

In this context, we note that the reciprocal compensation proposals made by USWC and GTE contemplate that AECs will file access tariffs and cost support data. Presumably, this information would have to be audited before the applicants could begin providing service, to ensure that the proposed interconnection rates exceed TSLRIC, but are not unreasonably high. Evaluating AEC cost data would be extremely time consuming and could delay competitive entry for several months. The interim bill and keep arrangements authorized in this order avoid that process and hasten the provision of competitive local exchange service without any adverse consequences. At the same time, the Commission retains authority pursuant to ORS 759.050(3) to require the AECs to make all filings necessary to justify continued certification as competitive local exchange providers.

Interim bill and keep arrangements will also avoid transactions costs associated with cash based compensation methods because interconnecting carriers will not incur the expense of measuring, collecting, and auditing traffic. This is advantageous during the initial stages of competition, because measurement costs impose a greater relative burden on new entrants, who must spread the capital cost of such systems over much smaller volumes of traffic. The record discloses that interexchange carriers incur significant costs to collect and audit switched access minutes calculated by LECs.

USWC argues that the system it is developing to measure local traffic is inexpensive, but the record suggests otherwise. Cost studies filed by USWC in Washington State show that the cost of local end office switching is more than doubled by the addition of measurement and billing costs. Moreover, in Washington, USWC estimated that the proposed new system would be over three times more costly per minute than the cost to measure switched access minutes of use. Even if we were inclined to adopt a minute of use compensation structure at this time, USWC has not demonstrated that its proposed method of measuring local traffic is reasonable. Until such a system is in place, the LECs could rely on AEC measurements of originating traffic. That process, however, would presumably entail the same type of costs now incurred by IXCs to audit switched access minutes.

The Commission also notes that a number of other jurisdictions have concluded that bill and keep is a reasonable method of compensating carriers for the exchange of local traffic on an interim basis. On October 31, 1995, the Washington Utilities and Transportation Commission adopted bill and keep as an interim compensation measure for local exchange carriers in that state. WUTC vs. U S WEST Communications, Inc., et al., Docket Nos. UT-941464, UT-941465, UT-950146, & UT-950265, at 29-36. On July 24, 1995, the California Public Utilities Commission adopted interim rules requiring LECs and competing local carriers to use bill and keep for interconnection compensation for a one year period. Orders Instituting Rulemaking and Investigation on the Commission's Own Motion for Local Exchange Service, Docket Nos. R. 95-04-043 and I. 95-04-044, 163 PUR 4th 155 (Cal. P.U.C. 1995). On February 23, 1995, the Michigan Public Service Commission adopted a modified approach, authorizing bill and keep unless there is a traffic imbalance greater than five percent. In the Matter of the Application of City Signal, Inc., Case No. U-10647, 159 PUR 4th 532, 543-48, 577 (Mich. P.S.C. 1995).

In reaching the decision to use bill and keep as a transitional compensation mechanism, the Commission has considered the opposing arguments raised by USWC, GTE and Staff. For the reasons discussed below, we find those arguments unpersuasive.

(a) The claim that bill and keep allows "free use" of LEC facilities is predicated on the assumption that AECs will terminate more traffic on LEC networks than vice versa. There are no traffic studies in the record to substantiate that claim. On the contrary, the record indicates that traffic exchanged between AECs and LECs is likely to be within a few percentage points of equilibrium. In fact, traffic studies performed by MFS in New York disclose that where there has been an imbalance, more traffic has been terminated on AEC facilities than on the facilities of the incumbent utility.

We agree with the applicants that bill and keep compensation is appropriate for the early stages of competition because it will not affect traffic flows or influence a carrier's choice of customers. The usage based rates proposed in this docket, on the other hand, would foster traffic imbalances by distorting an entrant's incentives to serve certain types of customers. Notwithstanding LEC arguments to the contrary, we believe that, if the AECs are able to attract and serve customers in the Portland metro area with calling patterns that are similar to adjacent USWC or GTE customers residing in the same area, traffic flows in a competitive co-carrier environment are likely to be in balance.

Even if traffic flows are out of balance, we agree with Dr. Teske that the degree of imbalance must justify the cost of measuring, billing and auditing the traffic. As noted above, there is not enough information in the record to enable the Commission to ascertain the costs associated with those activities.

(b) GTE and USWC argue that, because bill and keep compensation allows AECs to use LEC facilities at a "zero" price, it discourages AECs from using new technology and results in the over consumption of access services. We disagree. To begin with, the argument assumes that entrants will consume more access services than the LECs; in other words, that traffic flows will not be in balance. As noted above, the record does not support that claim.

Second, we are not convinced that bill and keep will foster inefficiency in the near term. Bill and keep simply requires each carrier to absorb the cost of traffic terminating on its system. Since those costs are ultimately passed along to customers, it would seem that each company has an incentive to reduce interconnection costs to remain competitive. Conversely, the minute of use arrangements proposed by USWC, GTE and Staff may not create a similar incentive, since termination costs are borne by other carriers.

Third, new entrants have a significant incentive to build out their own facilities regardless of the method of interconnection compensation. The applicants have already invested in substantial facilities and are presumably interested in maximizing profits by serving as many customers and exchanging as much traffic as possible. They are unlikely to implement business plans based on "over consumption" of LEC resources because of the obvious uncertainties associated with such a strategy. Moreover, the applicants are unlikely to survive as local exchange providers unless they are capable of providing consistently high quality telecommunications service. By building their own facilities, the applicants will have greater control over service quality provided to their customers and will be less reliant on the networks of the incumbents.

(c) We are not persuaded by the claim that bill and keep is a "forced barter" arrangement because it places the same value on the terminating facilities of each carrier. GTE and USWC fail to recognize that usage sensitive compensation yields the same result. Because usage sensitive pricing imposes interconnection costs on competing carriers, there may be little economic incentive to lower those costs. In fact, depending on how the pricing structure is designed, interconnection rates could gravitate to the level of the least efficient carrier in the marketplace. On examination, both Dr. Cornell and USWC witness Purkey agreed that usage sensitive pricing could yield equal interconnection rates over time.

For similar reasons, we are not persuaded by USWC's argument that bill and keep forces it to absorb higher interconnection costs because of greater use of its transport facilities. USWC's argument presumes the existence of a specific network configuration that may or may not exist once the applicants begin operations. Furthermore, even if USWC is correct, it does not force the conclusion that bill and keep is an unreasonable interim interconnection arrangement. From a regulatory standpoint, USWC is entitled to earn a reasonable rate of return on the assets it has dedicated to utility service. That does not mean that a separate charge must be levied for every functionality or asset placed in service.

We also disagree with Staff's claim that bill and keep compensation will cause carriers to misreport toll traffic in order to avoid payment of switched access charges. While it is conceivable that a carrier would risk decertification by deliberately misreporting traffic, that possibility already exists, and will exist as long as the cost of terminating toll traffic exceeds the cost of terminating local calls. To eliminate the possibility for misreporting traffic altogether, the Commission will, however, have to equalize termination rates, either by raising local termination rates or lowering toll access rates. The record discloses that raising local termination rates to switched access rate levels would create a price squeeze and preclude AECs from entering the local exchange market. Lowering toll access rates, on the other hand, may require a substantial realignment of LEC rates to reduce the level of contribution now incorporated in switched access charges. As emphasized above, the ultimate solution is to develop a single interconnection rate structure applicable to all carriers. That process, however, will take time to accomplish.

Aside from the problems noted above, the Commission has a number of additional concerns with the usage sensitive and flat rate compensation methods proposed in this case:

(a) The record indicates that the minute of use compensation proposals offered in this proceeding do not accurately reflect the manner in which interconnection costs are incurred. Telecommunications networks are engineered primarily to meet system capacity requirements and are largely comprised of nontraffic sensitive costs. Minutes of use consumed during off peak periods thus have a marginal cost of nearly zero. Consequently, a compensation structure that charges the same amount for each minute of use does not convey the accurate price signals and may lead to uneconomic consumption.

By declining to adopt the usage sensitive rate structures presented in this case, we do not intend to foreclose future consideration of measured compensation arrangements that require reciprocal cash payments. The work group established to examine interconnection compensation should carefully evaluate the need for reciprocal payments in a competitive environment that includes not only facilities based carriers such as the applicants, but also other types of telecommunications providers.

(b) The usage sensitive rates proposed by USWC and GTE would make it extremely difficult, if not impossible, for the applicants to compete for medium to high volume customers. Usage rate comparisons presented by Drs. Cornell and Teske disclose that, beyond a moderate usage level, the rates in USWC and GTE retail tariffs are lower than the proposed interconnection rates, effectively placing AECs in a price squeeze. Since customers with higher usage are most likely to consider using an alternative telecommunications provider, the proposed interconnection rates create a significant barrier to competition.

Minute of use interconnection pricing is also problematic because of the predominately flat rate pricing environment for local service in Oregon. As long as flat rate local service is required by law, usage sensitive rates need to be carefully structured to avoid creating a price squeeze. Usage sensitive switched access rates have worked well in the toll market because the retail price structure for toll has traditionally been based on measured usage. Because that is not the case for local service in this state, precautions must be taken to ensure that future usage sensitive rate proposals do not produce anticompetitive effects.

The interconnection rates recommended by Staff and the LECs are also likely to distort normal traffic patterns by encouraging applicants to serve customers with a high volume of incoming calls in order to avoid interconnection charges. Normally, AECs would be expected to also target customers with a significant percentage of outgoing calls in order to maximize the revenue potential from services such as toll. By disrupting traffic flows within the local exchange market, the usage sensitive rates recommended by the LECs and Staff will result in inefficiency and customer confusion.

(c) We are not persuaded by the imputation analyses offered by USWC to show that its interconnection proposal will not result in a price squeeze. First, it is not clear that USWC used the correct cost methodology to perform its studies. Mr. Purkey acknowledged that the ADSRC methodology differs from the cost methodology approved by the Commission in Phase I of docket UM 351, but asserted that the ASIC methodology used in his analysis mirrored the UM 351 approach. Our understanding is that ASIC and the UM 351 methodology differ in several respects. Second, Mr. Purkey's analysis assumes that certain inputs to the imputation analysis are nonessential rather than essential functions. In Order No. 95-313, we held that all service elements should be treated as essential until such time as an LEC is able to demonstrate that viable alternatives exist in the relevant market. Third, it is not clear that the imputation analyses include all of the necessary functions or the correct usage and price data.

Because of these concerns, we do not place any significant weight to the imputation studies presented in this case. Many of the questions raised in these proceedings regarding imputation will be addressed in docket UM 351. In the meantime, our decision to use bill and keep as an interim compensation mechanism will avoid expensive and time consuming disputes regarding imputation that would otherwise result from choosing a cash compensation approach.

(d) The Commission disagrees with USWC's proposal to include an I-USC in the interconnection charge. The I-USC is not required to ensure that AECs contribute to universal service. Although USWC raises a number of valid concerns, the Commission has already established a method in docket UM 731 to fund universal service in Oregon. On October 17, 1995, we issued Order No. 95-1103, approving an assessment on the intrastate gross revenues of all authorized telecommunications providers. Phase II of that docket is now underway to resolve issues relating to the specific design and implementation of the universal service charge. Furthermore, the applicants have stated that they will comply with Commission imposed universal service requirements. Pursuant to ORS 759.050(2)(c), compliance with such requirements shall be a condition of the applicants' authority to provide local service.

USWC's proposed I-USC has a number of other flaws that make it unacceptable as a component of interconnection compensation. To begin with, the I-USC is not based on the actual cost of interconnection, but is intended to compensate USWC for lost contribution that results when customers choose an AEC for business service. USWC's calculation of the I-USC also assumes that USWC will lose a business customer for every line obtained by an AEC. As emphasized earlier in this order, the Commission does not agree with the assumption that the local exchange market is static. Rather, we expect that competition will cause local service markets to expand, creating additional customer demand. We also believe that LEC fears of substantial near term net revenue loss are overstated. As MFS points out, it will likely take several months for AECs to begin operations. Once they do, the AECs will compete with incumbent carriers that now supply 100 percent of the local exchange market. This level of LEC market dominance, together with the unavailability of database number portability, should limit AEC market penetration for some time to come.

A second problem with USWC's proposal is that it can collect an I-USC for minutes terminated by customers who were never USWC customers, but were former customers of another LEC. This is clearly inappropriate, since it effectively creates a new revenue source unrelated to USWC's objective of maintaining universal service support. It is also inefficient, because USWC would have no incentive to compete if it could receive contribution from a customer even when it did not incur any cost to provide service.

USWC has also not quantified the level of support necessary to fund universal service or indicated how the monies collected by the I-USC would be used. In contrast to the universal service support mechanism established in docket UM 731, there is no assurance the I-USC would be administered in a manner that is competitively neutral.

Finally, the criteria proposed by USWC for waiving the I-USC are arbitrary and extremely difficult to enforce. They would engender endless disputes over whether an AEC has sustained a "comparable ratio of business to residential customers" or whether it serves a "similar demographic and geographic penetration." Such conditions have the effect of discouraging competitive entry and are unnecessary given our decision in the universal service docket.

(e) In addition to our concerns with the I-USC, we also disagree with USWC's proposed interconnection charge. The interconnection charge is a residually priced element designed to recover revenues associated with USWC's proposed Local Transport Restructure (LTR) filing. The Commission has not made a decision on that filing.

(f) The Commission also finds that the one way compensation approach recommended by Staff is not in the public interest. Staff's attempt to achieve "regulatory symmetry" by denying AECs compensation for interconnection would effectively foreclose meaningful competition for local exchange service. Although USWC and GTE have shouldered responsibility for universal service to date, those obligations will be shared by all telecommunications providers, pursuant to our decision in UM 731. The LECs continue to have responsibility for providing ubiquitous service within their respective service territories, but we are not convinced that COLR status is a liability for the incumbents. As Mr. Montgomery points out, the ubiquitous provider also possesses the opportunity to generate substantial revenues by marketing vertical services to customers. Based on the evidence presented, there is substantial reason to believe that ubiquity may be an asset in a competitive environment.

While Staff asserts that AECs do not have the same regulatory obligations as the LECs, it does not acknowledge the most significant benefit associated with public utility status. As regulated utilities, USWC and GTE are entitled to earn a reasonable rate of return on all assets used to provide utility service. If GTE believes its earnings are unreasonable, it may request a rate increase from the Commission. It may also qualify for interim rate relief under certain circumstances. USWC may also seek regulatory relief if its return falls below below the minimum level specified in its AFOR plan. Competitive providers do not have these options and must rely entirely on their performance in the marketplace.

We also disagree with Staff's attempt to compare AEC operations with those of other providers. We are persuaded that the facilities based services proposed by the applicants are differently situated than the RCCs, STS, and other providers mentioned by Staff. Likewise, we cannot find that the existing RCC compensation structure supports Staff's claim that nonreciprocal compensation will allow AECs to compete effectively in the local exchange market. Instead, we are inclined to agree with Dr. Cornell that nonreciprocal compensation is one reason why cellular service is not perceived by the market as a substitute for local dial tone service.

(g) We decline to adopt the flat rate proposal recommended by TCG. There is insufficient evidence in the record to allow us to determine whether the input assumptions used in calculating the tandem port charge are reasonable. For example, we cannot tell whether the estimated DS1 trunk usage of 216,000 minutes per month is a reasonable approximation of actual usage. Second, we are reluctant to adopt flat rate charges without a more complete understanding of how such an approach corresponds with the cost methodology adopted in Phase I of docket UM 351.

Also, because TCG's proposal is designed to encourage end office terminations, it may skew AEC network architecture decisions. There may be circumstances where it is more efficient for an AEC to use tandem switching. We agree with MCImetro that the Commission should not presume that one type of network architecture is superior to another. Instead, the market should determine how networks are constructed to meet customer needs.

Although we do not adopt TCG's proposal, we believe that flat rate charges warrant further investigation. Based on our understanding of how interconnection costs are incurred, some type of flat rate structure may provide a reasonable basis for compensating carriers. We also agree with Dr. Teske that flat rate carrier compensation arrangements may be more compatible with the flat rate retail pricing environment in Oregon than the usage sensitive proposals offered in this case. In addition, flat rate charges may be simpler and less costly to administer than usage based methods.

Issue IV(f)(1): What arrangements are necessary to accommodate existing extended area service (EAS) routes?

Positions of the Parties

ELI, MFS, MCImetro and TCG recommend that new entrants should be allowed to establish EAS routes with incumbent LECs on the same terms and conditions as exist over those routes between incumbent LECs. These parties contend that there is no justification for treating AECs differently from LECs and ILECs. EAS routes were established to reflect communities of interest, which do not change when a customer elects to receive service from another carrier. MFS maintains that it would be discriminatory to require AECs to pay higher rates than LECs for the exchange of EAS traffic. MCImetro contends that requiring AECs to pay switched access charges for EAS traffic would only increase the overall price floor for local exchange services, contrary to the public interest.

AT&T, OCTA, ELI, MFS, and TCG filed joint recommendations stating that applicants will adopt existing local exchange and EAS boundaries for purposes of intercompany compensation.

Staff opposes bill and keep arrangements for EAS traffic handled by AECs. It contends that current EAS arrangements were designed for entities with similar regulatory obligations. Also, the Commission's primary goal in establishing EAS policy was to extend "local" dialing arrangements between adjacent communities where a strong community of interest exists, not to promote economic efficiency in a competitive environment. Staff argues that its one way compensation proposal should apply to traffic between AECs and LECs within and outside the EAS regions.

Staff supports the comprehensive redesign of intercompany network access charges proposed by USWC and GTE, because competition will make access distinctions untenable in the long run. As part of that redesign, Staff agrees that current bill and keep arrangements for EAS traffic exchanged by incumbent LECs should be eliminated. Such changes should not be made in these dockets, however. The record is inadequate to assess the effect of changes in access policy for IXCs, RCCs, and EAS-connecting LECs. Staff recommends a separate EAS proceeding to investigate revenue impacts and consider pricing issues.

GTE argues that this is not the proper forum to integrate AECs into existing EAS arrangements. Since EAS is an interexchange service and the only issue in this case is the applicants' status as local exchange service providers, there is no basis to establish the rates applicants should pay to terminate their EAS-like traffic.

GTE further argues that existing EAS arrangements apply only to specific LECs and were designed to function only in a regulated monopoly environment. Further, current bill and keep arrangements for EAS traffic are merely an administrative detail. The purpose of EAS is to change end user toll billing, not to provide access charge discounts to interexchange service providers.

GTE also contends that LECs have given the Commission control over their end user charges, and in return receive free terminating access service for EAS traffic. Neither AECs nor IXCs have made such a trade, and AECs should be excluded from the existing EAS arrangements, just as IXCs are. GTE maintains that applicants should pay the same access charges to terminate interexchange traffic as IXCs now pay to terminate toll traffic. Ultimately, the Commission must decide whether flat rate EAS is viable in a competitive market.

Finally, GTE maintains that if the Commission approves an interconnection compensation arrangement for EAS-like traffic that is different than for toll traffic, then EAS-like traffic must be defined in the same manner for LECs and AECs. This poses no problem, because the AECs propose to operate in competitive zones that are coextensive with existing LEC exchange areas. But there may be a problem with defining toll calls for rating purposes. Specifically, while some of the applicants intend to define local and EAS-like traffic in a manner consistent with current industry practice, it is not clear that they intend to establish toll rating points consistent with current practices. If they do not, customer toll bills will be affected.

USWC also argues that the exchange of EAS traffic on a bill and keep basis is premised on a monopoly environment, which no longer exists. The policy reasons that led the Commission to approve EAS must be reevaluated in a competitive environment. Since all providers are potential competitors, the current approach to EAS is not sustainable and must be converted to interexchange access charges.

USWC acknowledges that it may not be possible to evaluate the impact of competition on EAS in these dockets. Until the Commission can consider an integrated approach to interconnection and compensation, USWC proposes that USWC and the ILECs in the Portland EAS region continue to exchange traffic between their respective customers through the use of the existing bill and keep EAS arrangements.

For traffic between AECs and ILECs within the Portland EAS region, USWC proposes the following interim interconnection arrangement: For traffic delivered by an AEC directly to USWC for termination on ILEC facilities, USWC would charge the AEC tandem switching, tandem switched transport, local switching, and the I-USC. For traffic delivered by an ILEC to USWC for termination on AEC facilities, USWC would pay the AEC its local switching charge. During the interim, incumbent LECs would not be charged for the portion of the traffic that transits each company's respective EAS facilities. Existing compensation relationships between USWC and the ILECs will remain unchanged.

OITA argues that the Commission should establish a fully competitive local exchange market if the applications are granted. The best way to do this is to adopt the model of the competitive interexchange market, including explicit intercarrier compensation. Bill and keep arrangements are only valid in an EAS market with restricted competition.

OITA also argues that EAS is not the subject of these dockets and should not be changed here. AECs should not be permitted to participate in established EAS routes, because EAS is an interexchange service and these applications relate to the establishment of competitive zones, not interexchange authority. Further, OITA states that the Portland EAS region is served by seven LECs, only two of which are parties to these dockets. The other LECs should also be parties to any docket that deals with EAS issues.

OITA asserts that the AECs are free to structure flat rate offerings to their customers within the EAS zones. They are not required to adopt EAS rates imposed on the LECs and are not restricted by existing EAS boundaries. Therefore, AECs do not need EAS to compete.

OITA opposes USWC's recommendation that other LECs in the Portland EAS region pay transport charges for traffic originated by an ILEC and transferred by USWC to a point of interconnection with an AEC. USWC's proposal would alter the current compensation arrangements for EAS traffic between USWC and the other LECs in the Portland EAS region to resemble the compensation arrangements that USWC proposes for AECs. OITA claims that it is inappropriate to modify EAS arrangements among LECs in these dockets.

Commission Findings and Decision-Issue IV(f)(1)

The Commission disagrees with OITA's claim that EAS issues should not be addressed in this proceeding because (a) these applications involve local exchange competition and EAS is an interexchange service; and (b) not all affected LECs are represented in this docket. In the policy order establishing EAS regions, Order

No. 89-815, UM 189, at 7, the Commission stated:

Flat rate EAS is a hybrid with elements of both local and toll service. EAS is currently provided by local exchange carriers as part of local exchange service, with seven-digit dialing, and local service billing. Because EAS goes beyond local exchange boundaries, however, it is not "local exchange tele- communications service" under Oregon law.

It is appropriate to deal with EAS, as a hybrid service with elements of local service, in the current dockets, for the purpose of distinguishing between local and toll calling for purposes of intercompany compensation.

OITA's second point, that some affected LECs are not represented in this proceeding, is without merit. OITA is an organization that represents those ILECs. Moreover, all LECs had notice of this docket, with the list of issues including the EAS issue. If any LECs did not participate in these dockets, their decision was an informed one.

The Commission disagrees that current EAS arrangements are specific to incumbent LECs and that the AECs should pay switched access charges and subsidies similar to those that IXCs now pay to originate and terminate long distance traffic. Under the proposals made by OITA, USWC, GTE and Staff, calls between exchanges that would otherwise qualify as EAS traffic would instead be toll calls if they originate from a new entrant's customer. We see no justification for treating incumbent LECs and AECs differently for EAS purposes. Since we have decided to adopt bill and keep as an interim compensation method for intraexchange traffic, it would be illogical to impose a different form of compensation for EAS traffic. Moreover, current EAS routes are established based on criteria that consider community of interest calling areas. In the case of AECs, calls between exchanges reflect customer calling areas of interest between two neighboring exchanges just as if calls were handled by the incumbent LECs. The identity of the companies involved is irrelevant. The proposal to treat LECs and AECs differently within the EAS region could severely disadvantage the new entrants and hamper competition.

Furthermore, if the entrants are required to pay switched access charges for traffic that would otherwise be EAS traffic, it creates a windfall for the incumbents. The cost of turning the affected routes into local as opposed to toll routes is financed by the EAS surcharge. If such traffic is originated by an incumbent, no access revenues are currently received. No revenues should be generated just because an entrant originates the call.

Until otherwise ordered by the Commission, existing local exchange boundaries and EAS routes shall apply to AECs as well as incumbents for the purpose of distinguishing between local and toll calling and for intercompany compensation. Thus, traffic originated by any authorized local carrier that crosses exchange boundaries within the Portland EAS region shall be treated as a local call. In other words, if an LEC or AEC originates a call that is terminated by another carrier within the EAS region, compensation shall be on a bill and keep basis. Finally, if USWC's or GTE's networks are used to transit calls between an AEC's network and an ILEC's network within the Portland EAS region, USWC or GTE must hand off the call on the same terms and conditions as a call originating on their own networks.

With respect to GTE's concern about toll rating, AECs shall limit each of their NXX codes to a given exchange and establish rate centers in those exchanges that are proximate to the existing LEC rate centers.

In reaching this decision, we recognize that EAS regions were created in a regulated monopoly environment. That environment is changing rapidly. As a number of parties have emphasized, it will be necessary to reexamine EAS as competition expands. The continued viability of existing EAS arrangements should be examined by the work group established to investigate interconnection compensation. As part of that process, the work group shall consider the impact on rates and policy that may result from the transition from existing bill and keep arrangements to an interconnection compensation mechanism based on reciprocal payments.

Issue IV(g): Is the applicants' proposed service compatible with the existing network configuration and other requirements associated with providing enhanced 911 (E-911) service?

Positions of the Parties

Staff believes that the AECs will use equipment that is commonly used in the telecommunications industry. Assuming that the AECs use acceptable engineering and design methods, Staff expects no technical problems regarding the routing of the AECs' E-911 traffic to the USWC selective routing tandem switch and ultimately to the appropriate public safety answering point (PSAP).

ELI states that its proposed service is compatible with the existing network configuration and other requirements associated with providing E-911 service. ELI needs the incumbent LECs to route E-911 calls from subscribers to direct inward dialed numbers as well as the ELI NXX (972). To expedite E-911 capability, ELI will purchase E-911 trunks and database services from existing 911 interconnection tariffs. When formal agreements are drafted between USWC and ELI for other ancillary services, ELI will negotiate E-911 agreements with the relevant governmental authority and the incumbent LEC just as ILECs do.

MFS also states that its services will be compatible with the existing network configuration in Oregon and will meet the requirements associated with providing E-911 service. It will have the capability to complete calls to 911 emergency services and will coordinate with the agency operating the PSAP in each locality that MFS serves, to assure that 911 calls are routed and delivered in the manner desired by the PSAP. Where E-911 service has been implemented, MFS will also make arrangements for the proper delivery of Automatic Number Identification and Automatic Location Identification (ALI) information to the PSAP. As one of its co-carrier arrangements, MFS requests that USWC and GTE be required to provide trunk connections to their 911 tandems and to cooperate in loading ALI and other routing information into databases.

MCImetro agrees to work with the LECs and the emergency service agencies to make the necessary arrangements for compatibility.

Commission Findings and Decision: Issue IV(g)

There is a reasonable basis to conclude that the service proposed by the applicants will be compatible with the existing network configuration and other requirements associated with providing E-911 service. The applicants have primary responsibility to work with the E-911 agencies to make certain that all users of their services have access to the emergency system.

Issue IV(h): What interconnection arrangements between the applicants and LEC should be provided?

(1)What should be the conditions of such arrangements?

(2)What technical issues must be resolved?

Positions of the Parties: Physical Interconnection Issues

ELI, MFS, AT&T, TCG and OCTA filed joint recommendations requesting that LECs and AECs interconnect their facilities at mutually agreed upon meet points. If parties do not agree upon a meet point within 45 days, either may seek appropriate and immediate relief from the Commission.

The signatories to the joint recommendations and MCImetro contend that AECs should be allowed to interconnect with LECs for the mutual exchange of local and EAS traffic under the same interconnection arrangements used by incumbent LECs. LEC networks are interconnected using two way dedicated trunks at mutually agreed meet points. Each carrier is responsible for building and maintaining its own facilities up to the meet point and for maintaining common technical specifications at the meet point. In addition, each carrier is responsible for traffic originating on its network up to the meet point and for terminating the traffic handed off from another carrier at the meet point.

ELI opposes USWC's recommendation that interconnection occur just outside the central office of the carrier originating the call. Under that proposal, all interconnection would fall under USWC's Virtual Expanded Interconnection Tariff. ELI contends that USWC's proposal is inefficient and discriminatory, particularly since USWC does not propose modifying existing meet point interconnection arrangements with ILECs. ELI states that there are no unresolved technical issues regarding the interconnection of LEC and AEC networks.

MFS states that there must be a common set of standards to permit physical interconnection of carrier networks. Since USWC and GTE already interconnect with a variety of other carriers, the Commission need not specify the actual terms of interconnection. Instead, AECs should be permitted to designate interconnection meet points so that network economies can be achieved. By limiting interconnection to LEC end offices, existing network inefficiencies will be imposed on AECs. If implementation issues arise, AECs should be allowed to seek relief from the Commission.

TCG contends that the most efficient and economical interconnection between LECs and AECs is to use two way DS1 trunks with full Feature Group D characteristics and SS7 capabilities. Using one way or multiple traffic specific trunks requires additional facilities, which necessarily increases the cost of interconnection. Likewise, it depletes switch capacity by requiring additional ports and imposes costs to prematurely upgrade and expand switch capacity.

TCG also recommends that the location of interconnection facilities should be determined by good faith negotiations between interconnecting parties. The aim of such negotiations should be to equalize the costs and benefits to both parties in selecting and constructing interconnection points. In order to equalize the bargaining power of the parties and create an incentive for the most efficient interconnection, the Commission should require equal sharing of all costs associated with the construction of facilities. TCG stresses that it is inappropriate to allow LECs to unilaterally designate interconnection meet points, since the LECs have an incentive to select locations that will disadvantage the AECs.

Staff states that interconnection between the AECs and LECs should use the same technical methods now used by LECs to interconnect their networks. If all carriers use the same procedures, protocols, and equipment designed for the existing telephone network, no technical problems should arise. The only condition of interconnection should be that applicants not take any action that impairs the ability of the incumbent LECs to meet the service standards specified by the Commission. With interconnected networks, all carriers must cooperate to maintain uninterrupted operation of the combined network.

USWC states that competitive entry by facilities based telecommunications providers will not create technical interconnection issues. In a competitive environment, interconnecting carriers must be able to extend their facilities to the end offices of other providers if they choose, and not be forced to use the facilities of any other provider. Tandem interconnection should also be available. Virtual collocation and expanded interconnection should be offered by all carriers so that interconnection is efficient. Providers should work out mutual arrangements and based on what makes sense in any given circumstance. LECs have negotiated interconnection arrangements for many years and there is no reason to assume the same process will not work with the AECs.

Regarding the location of interconnection facilities, USWC proposes that the carrier originating a call should have the right to establish the interconnection point between the networks. USWC is willing to offer AECs the option of using USWC's transport network to interconnect the AEC switch with other local exchange carriers within the same LATA. USWC currently provides the same functionality for traffic exchanged between IXCs and independent telephone companies. USWC opposes using meet point arrangements, because establishing meet points in the middle of the transport line between the parties' respective switches would result in an unacceptable level of meet points scattered randomly throughout the Portland metropolitan area.

GTE does not believe that the technical aspects of interconnection will be problematic and assumes that the parties will negotiate in good faith to establish mutually agreeable arrangements. Once connections are established, GTE and applicants must negotiate a billing process that will enable the carrier terminating a call to bill applicable charges for local, EAS, and toll calls. Second, if compensation differs between types of traffic, then separate trunk groups will need to be established for each type of traffic in accordance with current industry practice.

Commission Findings and Decision: Issue IV(h) Physical Interconnection

Consistent with our decision that AECs should be treated as co-carriers, the Commission finds that the applicants should be permitted to interconnect with incumbent providers on the same terms and conditions that LECs have used to interconnect their telecommunications networks. This process contemplates that the interconnecting parties will negotiate mutually acceptable locations where network facilities can be joined. In some cases, carriers will decide that the most efficient connection will be at the end office of one of the carriers. In others, it may be more convenient and less costly to establish meet points to connect network facilities. Because these decisions will vary on a case by case basis, the parties are in the best position to determine the manner in which interconnection should take place. We also agree with TCG that the parties will bargain on more equal terms and have a greater incentive to agree upon the most efficient interconnection if all costs associated with the construction of facilities are shared equally.

The Commission declines to adopt recommendations that would give either the LECs or the AECs the power to unilaterally designate interconnection meet points. In a competitive environment, carriers should not have an opportunity to select interconnection locations that may disadvantage competing providers.

The parties appear to agree that there are no significant technical obstacles to interconnection, provided the AECs follow existing protocols and procedures and install equipment that complies with network standards. Since the applicants have indicated that they intend to abide by such requirements, we have no reason to believe that technical problems will occur. We concur with Staff that the applicants shall not take any action that impairs the ability of the incumbent LECs to meet the service standards specified by the Commission.

GTE's concern regarding trunking arrangements for AEC traffic should be handled in the same manner that such issues are now handled among incumbent providers. Since we have determined that carriers should be compensated for local and EAS traffic using the bill and keep arrangements currently in place for incumbent providers, we presume that similar trunking arrangements are also appropriate.

The Commission anticipates that USWC, GTE and the applicants will negotiate in good faith and will establish mutually acceptable interconnection arrangements in the vast majority of cases. Where parties are unable to agree, they should notify the Commission within three days. We will then take the steps necessary to resolve the dispute on an expedited basis.

Unbundling and Resale Issues

Most of the parties agreed with or did not oppose the provision in the Partial Stipulation that NAC unbundling would be addressed in docket UM 351 rather than in the present docket. Although we adopted this provision of the Partial Stipulation, a number of parties request interim unbundling in these dockets.

Positions of the Parties

ELI, MFS, AT&T, TCG, and OCTA submitted joint recommendations requesting that USWC and GTE be required to file interim tariffs offering (a) local loops unbundled from switching, channel termination, and channel performance at the prices currently in effect for two wire private line NACs; and (b) NAC connection at the TSLRIC specified in the UM 351 Phase I cost report.

ELI claims that AECs need immediate access to unbundled loops to bring the benefits of local exchange competition to customers throughout Oregon. Without unbundling, competition will proceed to rural areas and residential customers much more slowly, if at all. ELI faces substantial economic barriers to expanding its network to serve certain geographical locations and to extend its advanced services to other customer groups. Requiring unbundled loops on an interim basis is consistent with Order No. 94-1851, which recognized that there might be a need for interim relief pending the outcome of docket UM 351.

MFS concurs that failure to unbundle the local loop will substantially circumscribe the development of local exchange competition. It observes that the incumbent LECs have virtually ubiquitous loops that provide access to every interexchange carrier and virtually all residential and business premises in their territory. Incumbent LECs have had the protection of their monopoly status in building their networks, plus the advantage of favorable franchises, access to rights of way, unique tax treatment, access to buildings on an unpaid basis, and protection against competition. AECs do not share in these advantages, and it would be cost prohibitive and economically inefficient in most cases for them to construct duplicate loop facilities. Moreover, competitors cannot obtain public and private rights of way, franchises, or building access on the same terms that incumbent LECs enjoyed. Without unbundled loops, AECs will not be able to offer competitive service to most of the population in a given area. Various regulatory commissions have concluded that unbundling the loop is essential to local exchange competition

MFS also contends that the price of unbundled loops must bear a reasonable relationship to the retail price charged by the incumbent LEC for a business line. Unbundled loop rates should be based on TSLRIC costs developed in docket UM 351. MFS requests the Commission to specify that the combined cost of the unbundled elements cannot exceed the bundled retail rate. Moreover, until TSLRIC cost studies are complete, USWC and GTE should be required to impute whatever rates they charge for unbundled loops into their own retail rates. Also, the combination of unbundled loop costs and other elements should not exceed total bundled loop costs.

MCImetro requests the Commission to require that USWC and GTE unbundle and make available for resale the 34 unbundled functionalities, or building blocks, listed on MCImetro Exhibits 3 and 5. If these building blocks are available on an unbundled basis, the new entrants will be able to provide a variety of services they cannot otherwise economically afford to offer. Unbundled loops, for example, are necessary to permit entrants to offer local residential or business dial tone to customers not located on the entrant's fiber optic ring. Removing restrictions on resale is equally important to the provision of meaningful local exchange service. Prices for unbundled functions should be based on TSLRIC at a level which allows an LEC's comparable bundled tariff rates to pass an imputation test, so that entrants are not placed in a price squeeze. Resellers should be permitted to bundle these services with auxiliary services of their own choosing to bring the benefits of competition to Oregon consumers.

MCImetro states that USWC's offer to sell retail private line service to entrants in lieu of providing unbundled loops effectively places the entrants in a price squeeze. MCImetro also contends that USWC's definition of "essential facilities" is contrary to the approach recently adopted by the Commission in Order Nos. 94-1851 and 95-313.

AT&T contends that the LECs are refusing to unbundle the local network in order to impede competition. This refusal will force the new entrants to use inappropriate, overpriced substitutes. It will also prevent new entrants from developing their networks in the most efficient manner, by preventing interconnection at all feasible points. Third, it will prohibit innovation by preventing the new entrants from developing creative, useful services using unbundled monopoly elements. Finally, by refusing to permit commercially viable resale of their services, the LECs will preclude consumers, especially residential and rural customers, from enjoying the benefits of competition as soon as possible.

AT&T acknowledges that unbundling will be addressed comprehensively in docket UM 351. As indicated in Order No. 94-1851, however, the Commission should unbundle the local network in a limited fashion in these proceedings by ordering USWC and GTE to provide unbundled loops and ports immediately. The availability of unbundled loops will allow new entrants to expand their service areas more rapidly. Also, as Dr. Cornell notes, by selling loops to new entrants the LECs will continue to receive revenues, offsetting the loss of a customer. Finally, consumers will benefit from having more choice.

TCG states that the Commission should order USWC and GTE to unbundle and make available for resale subscriber loops and line side interconnection as described in the joint recommendations. The availability of these facilities at imputable rates, terms, and conditions will enhance the AECs' ability to expand their networks more rapidly, facilitating more end office interconnection and provision of service to residential and small business customers. AECs cannot construct overnight the same network that LECs' have taken decades to build.

USWC opposes the unbundling proposals submitted in this proceeding. It maintains that the Commission lacks jurisdiction to require a utility to make "bits and pieces" of its facilities available to competitors under any circumstances. USWC argues that none of its services are truly essential to competitors as long as network interconnection is offered on reasonable terms and conditions. It maintains that no facts have been introduced to support the claim that loops and loop components such as drops and feeder and distribution are essential facilities.

USWC proposes to unbundle its switched access service by implementing its LTR and expanded interconnection channel termination proposals. This will allow interconnecting carriers to use only the switching and transport services of USWC that they desire. USWC expects the Commission will resolve unbundling issues in the context of UM 351.

USWC states that resale would not be an issue if its rates were set to cover cost and make a reasonable contribution, and there were no artificial distinctions between classes of service. But this is not the case. All services permitted to be resold should be priced above ADSRC. Residential service should not be resold as business service if it is priced differently in the interests of universal service. Other carriers should not be able to resell USWC exchange services bundled with their interLATA long distance services until USWC is permitted to do the same. Finally, other carriers should not be allowed to avoid the payment of access charges by delivering traffic to USWC through the resale of its exchange services.

Commission Findings and Decision: Issue IV(h) Unbundling and Resale

In Order No. 93-852, we adopted Open Network Architecture rules in order to obtain efficient delivery of enhanced telecommunications services to the public and achieve greater competitive equity between providers of telecommunications service. The rules require unbundling of telecommunications services "to encourage the development of enhanced services and provide for a more competitive enhanced services market." OAR 860-35-030(1). Without unbundling and the eventual removal of resale restrictions, competition will proceed to rural and residential customers slowly, if at all. New local exchange providers face substantial economic barriers to expanding their networks to serve certain geographical locations and providing advanced services to residential customers. Constructing new facilities is a capital intensive, time consuming process. In the near future, the new entrants cannot be expected to duplicate the extensive networks maintained by the LECs. Unbundling and resale of telecommunications services will hasten the arrival of effective competition in Oregon.

As noted elsewhere in this order, the Commission is in the final stages of docket UM 351, a comprehensive investigation of unbundling and pricing issues. Evidentiary hearings have concluded in that proceeding and an order is expected shortly. In that proceeding, the Commission will specify the level and extent of unbundling that must occur to accommodate competition in telecommunications markets. In addition, we will address issues relating to existing use and user restrictions and the resale of telecommunications services. In view of these facts, we have elected not to unbundle any telecommunications services or remove any resale restrictions in these dockets.

Issue IV(i): What arrangements are necessary for the assignment of telephone numbers to the applicants?

The assignment of telephone numbers is administered by the North American Numbering Plan Administrator, who assigns Numbering Plan Area (NPA) codes and Service Area Codes (SAC). The NPAs are assigned to Area Code Administrators, who assign the prefixes (NXX codes) to carriers. The combination of the NPA and the NXX identifies a specific carrier's central office, which serves a specific geographical area. The last four digits identify a specific line appearance on a switch to which the end user is connected (e.g., 503-223-9999). SACs are assigned to carriers to provide services such as 800, 700, etc. These numbers are aliases for geographic numbers and must be translated into geographic numbers before a call can be completed.

Geographic numbers are assigned only to carriers who provide wireline or cellular telephone service in the Public Switched Telephone Network. They are assigned according to the Central Office Code Assignment Guidelines (ICCF 93-00729-010) developed by the Industry Numbering Committee. Before a carrier can obtain prefixes, it must prove that it is authorized to provide service.

Positions of the Parties

USWC, as numbering plan administrator for Oregon, is responsible for assigning central office codes to AECs. USWC assigns codes in accordance with the industry's Central Office Code Assignment Guidelines, which assures that AECs will have equitable access to central office code assignments. ELI has already been assigned the central office code 972 for Portland.

GTE agrees that procedures are already in place for assigning telephone numbers, and that, once authorized, the applicants need only request numbering resources from USWC, the plan administrator.

Staff, MCImetro, MFS, Sprint, and TCG recommend that USWC assign numbering resources to the applicants according to normal guidelines in a nondiscriminatory manner.

AT&T expresses concern that the LECs may give themselves preference in providing and administering numbers because the incumbents currently control number assignment and administration. It recommends that the Commission order USWC to administer numbers on a competitively neutral basis. Eventually, the only way to ensure evenhanded allocation of numbering resources among competing vendors is to vest control of numbering resources and administration in an impartial third party.

Commission Findings and Decision: Issue IV(i)

AECs cannot compete in the local exchange market unless they have nondiscriminatory access to numbering resources. As co-carriers, AECs are entitled to receive central office code assignments according to the same rates, terms, and conditions as any RBOC or LEC. Guidelines for the assignment of numbers are in place, and ELI has already received the 972 prefix for the Portland area. USWC shall apply existing guidelines for assigning numbers to the AECs in a nondiscriminatory manner.

Issue IV(j): What arrangements are necessary to ensure adequate number portability?

Under the North American Numbering Plan, LECs receive blocks of telephone numbers, which are assigned to a given switch or serving wire center served by a switch. Traditionally, customers moving outside the area served by a switch must relinquish their telephone numbers and receive new numbers from the new serving switch. This is the case regardless of whether the new switch is operated by the incumbent LEC or an AEC.

Number portability allows customers to retain their telephone numbers even when served by a different switch or local service provider. There are two general types of number portability. Service provider number portability permits customers to keep their telephone numbers if they change local service providers. Geographic number portability, on the other hand, allows customers to move from one location to another without changing telephone numbers. As the geographic area associated with number portability expands, implementation issues become significantly more complex.

Positions of the Parties

Applicants and several intervenors argue that number portability is essential to local exchange competition. Market studies conducted by MFS indicate that most customers are reluctant to change telephone carriers if they are also required to change telephone numbers at the same time. Customers consider changing telephone numbers both an inconvenience and an expense. Telephone numbers are given out to a wide variety of individuals, and are stored in computer databases, fax machines, modems and personal files. Businesses are generally required to print new stationery and business cards and send mailings to customers and vendors notifying them of the new number. Smaller businesses often invest substantial amounts of money in advertising their telephone number. Some rely on incoming calls as the primary source of sales.

TCG points out that number portability is necessary to achieve traffic balance between LECs and AECs. Without number portability, customers with predominantly inbound usage are likely to remain with the LEC rather than change telephone numbers. Customers with predominantly outbound usage, on the other hand, are not similarly handicapped by the lack of portability. AECs will thus be relegated to serving customers with primarily outbound usage and will terminate the vast majority of that traffic on LEC networks.

USWC takes the position that number portability is not essential for AECs to compete for local exchange traffic. According to USWC witness Purkey, the new prefixes assigned to AECs will allow them to offer hundreds of "good numbers" to their customers. So while it may be desirable for a customer to retain an existing telephone number, it is not essential to local exchange competition.

Database Number Portability. A long term solution to service provider and geographic number portability will require use of a centralized database and Advanced Intelligent Network (AIN) capabilities incorporated in modern switching technology. Although such a solution is not yet ready for implementation, efforts are underway to resolve outstanding technical, operational and administrative issues. Several of the parties to this proceeding are participating in the Number Portability Workshop convened by the Industry Numbering Committee. Technical trials of three proposed database solutions are also underway in other states.

GTE argues that database portability will be costly to implement and may not generate sufficient customer demand to warrant the expense. In the alternative, GTE suggests that customers and AECs be assigned nongeographic "virtual" numbers that operate similar to an "800" number and can direct calls to a customer's current geographic number no matter which local service provider originally assigned the number. GTE witness Beauvais maintains that this approach is technologically feasible, relatively cheap compared to other portability schemes, and will function as an interim or permanent solution depending on customer demand.

The parties also disagree over the timetable for implementing database number portability. ELI and MCImetro state that a solution is possible within 12-18 months, but assert that incumbent LECs have no incentive to proceed with the development of a database solution. They recommend that the Commission order an investigation of different number portability approaches, and require the LECs to submit a report within six months. USWC and GTE, on the other hand, contend that a database solution will not be available in the near term. USWC points out that the FCC has initiated a new rulemaking docket to investigate number portability, and suggests that it is premature to mandate deployment of a specific database solution until other methods can be fully evaluated.

Staff recommends against adopting a permanent number portability solution in this docket. Staff witness Harris asserts that requiring special number portability procedures would effectively impose an obligation on LECs to assist competitors. Staff states that the number portability solution ultimately adopted by the Commission should (a) include both service provider and geographic portability,

(b) be reciprocal among telecommunications providers; and (c) not degrade access to emergency services. Staff further recommends that the cost to develop, deploy and use number portability should be born by those who use it.

As noted above, Item 4 of the Partial Stipulation submitted by MFS, ELI, AT&T, Sprint, OCTA, TCG, OECA, and GTE requested that the Commission open a docket by January 31, 1996, to consider and resolve issues relating to database number portability. The stipulation also requests that a work group be created to monitor the progress and results of number portability trials in other states.

Interim Portability. The parties generally agree that, until a database solution is developed, interim arrangements using existing technology can be employed to provide service provider number portability.

USWC proposes to offer service provider portability using Remote Call Forwarding (RCF) and Directory Number Route Indexing (DNRI) at a price of approximately $4.00 per month. A nonrecurring charge would apply to an AEC's initial establishment of DNRI or RCF in each central office. A second nonrecurring charge would apply to activation of each portable number.

GTE acknowledges that neither database portability or its proposed virtual nongeographic method are currently available. It is willing to consider alternative methods, such as remote call forwarding, to provide interim portability. GTE argues that the cost of portability arrangements should be borne by those customers that demand the service.

Staff recommends that the Commission require USWC and GTE to file tariffs offering RCF or DNRI to AECs as an interim solution to number portability. Staff notes that existing tariff rates may need to be changed in order to allow those services to be resold by the applicants. USWC's version of remote call forwarding, known as Market Expansion Line, is currently offered at $16.00 per month. GTE offers a RCF service for $15.00 per month. Staff proposes that USWC and GTE file cost support for interim number portability tariffs within 60 days after an order is issued in these proceedings.

ELI, MFS and TCG recommend that interim number portability be implemented using remote call forwarding methods. These methods - also referred to as co-carrier call forwarding (CCF) - can be deployed quickly and have fewer technical limitations than other interim approaches. According to MFS witness Schulz, CCF eliminates inefficient trunking arrangements by allowing forwarded calls to be routed through the tandem switch over common trunk groups. It also permits use of SS7 signaling capabilities. Technical concerns associated with CCF and other interim number portability solutions include: (a) the fact that all calls must be routed to the LEC switch before being forwarded to AEC facilities, resulting in additional transmission and switching expense, and call setup time; and (b) most CLASS services cannot be provided. ELI recommends that CCF interim number portability be included in LEC local interconnection tariffs and offered to AECs at rates no greater than TSLRIC. Pricing at this level reflects the technical limitations inherent in interim portability arrangements and mitigates the economic penalty imposed on AECs by the absence of database number portability.

AT&T and MCImetro argue that all of the proposed interim portability arrangements are seriously flawed and no meaningful effort should be spent on improving them if industry resources would otherwise be diverted from work on a database solution. Aside from the problems mentioned above, technical limitations associated with interim portability include difficulty determining the source of service problems and the proper attribution of access charges from interexchange carriers. AT&T also states that interim arrangements should enable AECs to interconnect at an access tandem rather than at every LEC end office in which the AEC has customers. Interim arrangements should also allow AECs to receive signaling information (e.g., calling party number) so that the AEC may offer its "ported" customers the same complement of service features that would otherwise be available from its switch.

MCImetro argues that number portability is fundamentally a method of routing traffic and should be treated as an interconnection service rather than an end user service. As a result, interim portability should be priced below retail rates. MCImetro proposes that the Commission follow the pricing approach taken in New York or Michigan. The New York Public Service Commission decision pools the cost of interim portability arrangements and requires both LECs and AECs to pay a surcharge on each telephone number. The underlying rationale is that all consumers benefit from number portability because consumers benefit from competition generally. In Michigan, the Public Service Commission concluded that interim portability is an essential service and should be offered to AECs at a price no greater than economic cost.

ELI, MFS, AT&T, TCG and OCTA filed joint recommendations requesting that the Commission require USWC and GTE to file tariffs providing interim portability, including RCF and DNRI, at a price equal to TSLRIC. Interim portability arrangements should be offered on a bill and keep basis until USWC and GTE file tariffs with appropriate cost support.

Commission Findings and Decision: Issue IV(j)

Based on the evidence presented, the Commission is persuaded that number portability is an interconnection service that is essential to the development of effective local exchange competition. We agree with applicants that business and residential customers have a substantial interest in retaining their existing telephone numbers and are unlikely to change service providers if forced to change those numbers.

Because number portability is necessary for competitive local exchange markets to develop, it is important for the telecommunications industry to produce a database solution as soon as possible. At the same time, the Commission does not want to take steps that duplicate or are inconsistent with efforts now underway to arrive at a national solution to portability issues. We therefore agree with the recommendation to establish a work group to monitor developments in this area, including the results of number portability trials in other states. The number portability work group shall include the applicants, USWC, GTE, Staff, and other interested parties, including consumer groups, ILECs, and competitive providers. The work group shall submit periodic reports evaluating the progress of database portability trials and including recommendations regarding the timing and implementation of a database number portability solution. The first report shall be filed with the Commission no later than July 1, 1996.

For the present, interim number portability should be offered by allowing AECs to use RCF or DNRI technology. The evidence indicates that these methods have a number of technical limitations, but there appears to be general agreement that they will function reasonably well as an interim solution.

From a pricing standpoint, we find that USWC and GTE should file interim number portability tariffs offering both the RCF and DNRI functions at a price equal to TSLRIC. Tariffs for RCF and DNRI should be filed with the Commission no later than 30 days from the date of this order. The tariffs filed by GTE and USWC may include a nonrecurring service provisioning charge, which should also be set at cost. The interim number portability rates prescribed in this order should remain in effect until such time as the Commission concludes its most recent cost investigation in docket UM 773. Based on the results of that investigation, we may modify the rate adopted in these proceedings. The rate for interim number portability may also be adjusted as a result of the unbundling and pricing investigation in docket UM 351 and/or subsequent rate proceedings for USWC and GTE.

USWC and GTE will not be adversely affected if interim number portability is offered to the applicants at TSLRIC. As noted above, we expect that it will take several months for AECs to begin operations, and an even longer period of time before they are able to penetrate local exchange markets to any significant extent. Demand for interim number portability should therefore not be substantial in the near term. Also, because DNRI and RCF are technically inferior methods of providing number portability, it is reasonable to establish the initial price at economic cost. The current tariff rates for remote call forwarding services, on the other hand, would impose very high costs on the AECs and effectively foreclose competitive entry. USWC did not file any cost justification for its proposed $4.00 interim portability rate.

Issue IV(k): If the applications are granted, should there be any limits on the LEC pricing flexibility in ORS 759.050(5)(a)?

Subsection (5)(a) of ORS 759.050 provides:

unless the commission determines that it is not in the public interest at the time a competitive zone is created, upon designation of a competitive zone, price changes, service variations, and modifications of competitive zone services offered by a telecommunications utility in the zone shall not be subject to [the notice, hearing and tariff suspension procedures in] ORS 759.180 to ORS 759.190, and at the telecommunications utility's discretion, such changes may be made effective upon filing with the commission.

Subsection (5)(b) of ORS 759.050 further provides:

[t]he price and terms of service offered by a telecommunications utility for a competitive zone service within a competitive zone may differ from that outside of the zone. However, the price for a competitive zone service within the zone may not be lower than the total service long run incremental cost, for nonessential functions, of providing the service within the zone and the charges for essential functions used in providing the service but the commission may establish rates for residential local exchange telecommunications service at any level necessary to achieve the commission's universal service objectives. Within the zone, the price of a competitive zone service or any essential function used in providing the competitive zone service may not be higher than those prices in effect when the competitive zone was established unless authorized by the commission.

Subsection (5)(a) allows telecommunications utilities to respond to competition within a competitive zone by authorizing rate adjustments and implementation of new services without regulatory intervention. Subsection (5)(b) discourages anticompetitive pricing by imposing an imputation price floor on all competitive zone services. It also prevents price gouging by prescribing existing rates as the price cap for all essential functions and competitive zone services.

Positions of the Parties

ELI argues that LEC pricing flexibility should be limited until: (a) a certificate is issued to an AEC; (b) the AEC begins providing telecommunications service within its authorized geographic area; and (c) the incumbent LEC has provided the AEC with all necessary forms of interconnection, including interconnection to unbundled loops. ELI maintains that customers within the competitive zone will not have a reasonable alternative for local exchange service until such time as interconnection arrangements are in place and there is a mutual exchange of traffic. ELI asserts that granting LECs premature pricing flexibility within the competitive zone will allow them to lock in customers with special discounts and contractual arrangements before the AECs have entered the market, thereby retarding competition in a manner contrary to the public interest.

ELI also argues that AECs must have access to unbundled loops in order to compete for customers located within the competitive zone but outside the scope of existing AEC facilities. Because these loops are essential functions, LECs cannot satisfy statutory imputation requirements if LECs have pricing flexibility prior to the availability of unbundled loops. According to ELI witness Robert McMillin, incumbent LECs will not be materially disadvantaged by lack of pricing flexibility, because AECs are foreclosed from effective market entry until full interconnection and unbundled loops are available. Further, LECs will still be able to enter into special contract arrangements with those customers who do have a competitive alternative.

MCImetro argues that the preconditions proposed by ELI are necessary but not sufficient. It maintains that pricing flexibility should be granted to LECs only when there is effective competition in competitive zones or when pricing flexibility in the competitive zones is not paid for by price increases outside of the competitive zones. Dr. Cornell emphasizes that incumbent LECs should not have the ability to lower prices within the competitive zone and implement offsetting increases to customers located outside the competitive zone.

MFS recommends that consideration of LEC pricing flexibility should begin with the acknowledgment that the incumbent provider commands virtually 100 percent market share, has the potential to cross subsidize because of its captive customer base, and, as a result, wields enormous market power within its service territory. This situation is not changed by the appearance of AECs, nor does it signal the presence of effective competition. It also recommends that LECs not receive pricing flexibility within the competitive zone until effective competition exists.

TCG emphasizes that the substantial market power of incumbent LECs requires that they be regulated with greater scrutiny than AECs. LECs should be required to file cost justified tariffs for all competitive services and adhere to the imputation requirements in ORS 759.050(5)(b) for all competitive service offerings.

GTE, Staff, AT&T, and Sprint do not advocate placing limits on LEC pricing flexibility beyond those imposed by statute. Sprint emphasizes that regulation of incumbent LECs should be a function of market power and the extent to which the LECs are able to leverage control of essential facilities. As long as incumbent LECs possess substantially more market power than new entrants, greater regulatory oversight is appropriate. Sprint further argues that traditional rate base regulation should eventually be replaced with price and service regulation designed to provide appropriate incentives as local telephone competition emerges.

USWC points out that it already possesses both upward and downward pricing flexibility for nonessential services under its AFOR plan. It urges that the upward pricing flexibility permitted by the AFOR should not be restricted and disputes the suggestion that it might use such flexibility to shift costs to noncompetitive services. USWC witness Carl Inouye emphasizes that if USWC decides to lower essential service prices within the competitive zone, the only way to recover those revenues under the AFOR is by raising rates for nonessential services. To date, USWC has made little use of its limited upward pricing flexibility and is more likely absorb a revenue shortfall than increase prices. Moreover, to the extent that shifts in revenue requirement responsibility occur in a competitive market, it is incorrect to assume that such changes will result in a cross subsidy or other inappropriate policy result.

USWC maintains that LECs should also receive the downward pricing flexibility contemplated by ORS 759.050(5). Since essential service rates are effectively frozen under the AFOR, downward flexibility within the competitive zone will benefit USWC's essential service customers. USWC emphasizes that the imputation requirement in the statute effectively precludes any possibility that LECs will cross subsidize services. In addition, USWC challenges the argument that LEC pricing flexibility should be withheld until effective competition exists. Mr. Inouye notes that such a requirement is not imposed by ORS 759.050 and is illogical in any event, since there is no possibility of effective competition if LECs cannot respond to AEC market initiatives. USWC points out that the Commission rejected the notion that effective competition must be present when it approved the existing AFOR plan.

With respect to the incentives created by traditional regulatory processes, USWC intends to propose price regulation as an alternative regulatory framework when the AFOR expires in 1996. USWC contemplates that rate rebalancing, including rate deaveraging and the elimination of internal subsidies, will be an issue in the rate trueup process in that docket.

Commission Findings and Decision: Issue IV(k)

The Commission finds that USWC and GTE should receive pricing flexibility under ORS 759.050(5) once: (a) applicants have received certificates of authority to provide local exchange service consistent with the terms of this order; (b) the Commission approves the tariffs filed by USWC and GTE in compliance with this order; and (c) Staff notifies the Commission that interconnection arrangements are in place and a mutual exchange of traffic exists between GTE and USWC and an authorized AEC. These conditions will ensure that there is a competitive alternative in the local market at the time USWC and GTE receive the pricing flexibility contemplated by ORS 759.050.

We also find that the pricing flexibility authorized in USWC's AFOR should not be restricted. No evidence has been presented to show that USWC has engaged in anticompetitive pricing or otherwise abused its authority to price list nonessential services during the four years the AFOR has been in effect. ORS 759.195(7) and

ORS 756.500 provide adequate procedural remedies for any customer who alleges that USWC's pricing decisions are unreasonable.

We do not agree with MCImetro and MFS that LEC pricing flexibility should be withheld until effective competition exists. ORS 759.050(2)(b) provides that "price and service competition . . .shall not be deemed to exist by virtue of the establishment of a competitive zone." While the Commission could impose such a requirement as a condition to creating competitive zones, we do not believe that it is necessary to protect customers or foster competition in local exchange markets. In our opinion, the imputation price floor prescribed in the competitive zone statute effectively precludes the potential for cross subsidy and other forms of anticompetitive pricing. Moreover, USWC already exercises pricing flexibility under its AFOR plan without any discernible adverse effects. As an additional safeguard, ORS 759.050(7) provides that any telecommunications provider or customer aggrieved by the prices, terms of service or practices of another provider may file a complaint with the Commission under ORS 756.500.

The Commission is also not persuaded by ELI's argument that LEC loops must be unbundled prior to granting LECs the pricing flexibility contemplated by the competitive zone statute. As we have emphasized, access to unbundled LEC loops is being examined as part of the comprehensive unbundling and repricing investigation in docket UM 351, Phase II. The order issued in that docket will specify the level and extent of unbundling of LEC services necessary to permit effective competition in Oregon telecommunications markets.

ORS 759.050(5)(d) provides that the Commission may order a telecommunications utility to disaggregate and offer essential functions of the utility's local exchange network. Our decision to authorize pricing flexibility for USWC and GTE in the competitive zones is predicated on the assumption that those LECs will comply with the unbundling decisions that we make in docket UM 351. Failure to comply with our unbundling determinations will require us to reconsider the decision that pricing flexibility is in the public interest.

CONCLUSION (BACK)

The Commission has reviewed the record in these dockets in light of the factors required by ORS 759.050(2)(a). On consideration of those factors, the Commission concludes that it is in the public interest to grant the applications of Electric Lightwave, Inc., MFS Intelenet of Oregon, Inc., and MCI Metro Access Transmission Services, Inc., for authority to provide local telecommunications services in Oregon. The following USWC exchanges should be designated as competitive zones under the statute: Burlington, Lake Oswego, Milwaukie, North Plains, Oak Grove, Oregon City, and Portland. In addition, the following GTE exchanges shall be designated as competitive zones: Beaverton, Forest Grove, Gresham, Hillsboro, Scholls, Sherwood, Stafford, and Tigard.

ORDER (BACK)

IT IS ORDERED that:

1. The applications of Electric Lightwave, Inc., MFS Intelenet of Oregon, Inc., and MCI Metro Access Transmission Services, Inc., to provide local exchange telecommunications services in the service areas of USWC and GTE are in the public interest and are granted.

2. The following USWC exchanges are designated as competitive zones: Burlington, Lake Oswego, Milwaukie, North Plains, Oak Grove, Oregon City, and Portland.

3. The following GTE exchanges are designated as competitive zones: Beaverton, Forest Grove, Gresham, Hillsboro, Scholls, Sherwood, Stafford, and Tigard.

4. GTE and USWC shall offer ancillary services to the applicants as agreed in the Stipulation and set forth in this order. The applicants shall fulfill the conditions for 911 service stated in the Stipulation.

5. The applicants shall offer Enhanced 911 service as described in this

order.

6. Compensation for the exchange of local and EAS traffic between the applicants and the LECs in the competitive zones shall be based on bill and keep arrangements for a period of not more than 24 months.

7. An industry work group shall be created to address interconnection compensation issues as described in this order.

a. The task of the work group shall be to formulate proposals for implementing a reciprocal interconnection rate structure applicable to all switched telecommunications traffic.

b. The interconnection compensation work group shall evaluate the need for reciprocal payments in a competitive environment that includes facilities based carriers as well as other types of telecommunication service providers.

c. The interconnection compensation work group shall examine the continued viability of existing EAS arrangements. The work group should consider the impact on rates and policy from the transition from bill and keep to interconnection compensation based on reciprocal payments.

d. Staff shall submit reports to the Commission every six months detailing the progress of the interconnection compensation work group.

e. The applicants, USWC and GTE shall conduct and submit periodic traffic studies of local and EAS traffic exchanged with other carriers. The first study shall be submitted within six months of the date of this order. Additional studies shall be submitted every six months thereafter.

8. Existing local exchange boundaries and EAS routes established by the Commission shall apply to AECs as well as incumbents for the purpose of distinguishing between local and toll calling and for intercompany compensation, until otherwise ordered. AECs shall limit each of their NXX codes to a given exchange and establish rate centers in those exchanges that are proximate to existing LEC rate centers.

9. The applicants shall be permitted to interconnect with incumbent providers on the same terms and conditions that LECs have used to interconnect their telecommunications networks. Applicants shall not take any action that impairs the ability of the incumbent LECs to meet the service standards specified by the Commission.

10. USWC shall apply existing guidelines for assigning numbers to the AECs in a nondiscriminatory manner.

11. A work group shall be established to monitor database number portability issues, including the results of number portability trials in other states.

a. The work group shall include the applicants, USWC, GTE,

Staff, and other interested parties, including consumer groups, ILECs and competitive providers.

b. The work group shall submit periodic reports evaluating the progress of database portability trials and including recommendations regarding the timing and implementation of a database number portability solution. The first report shall be filed with the Commission no later than July 1, 1996.

12. Interim number portability shall be offered by allowing AECs to use RCF or DNRI technology. USWC and GTE shall file tariffs within 30 days from the date of this order offering both the RCF and DNRI functions at a price equal to TSLRIC. The tariffs may include a nonrecurring service provisioning charge, which should also be set at cost.

13. USWC and GTE shall receive pricing flexibility under

ORS 759.050(5) once (a) applicants have received certificates of authority to provide local exchange service consistent with the terms of this order; (b) the Commission approves the tariffs filed by USWC and GTE in compliance with this order; and (c) Staff notifies the Commission that interconnection arrangements are in place and a mutual exchange of traffic exists between GTE and USWC and an authorized AEC.

14. Pursuant to ORS 759.050(2)(c), the applicants shall comply with Commission imposed universal service requirements as a condition of authority to provide local exchange service.

Made, entered, and effective ________________________.

A party may request rehearing or reconsideration of this order pursuant to ORS 756.561. A request for rehearing or reconsideration must be filed with the Commission within 60 days of the date of service of this order. The request must comply with the requirements in OAR 860-14-095. A copy of any such request must also be served on each party to the proceeding as provided by OAR 860-13-070(2). A party may appeal this order to a court pursuant to ORS 756.580.

i:\cporder\order.doc

APPENDIX A (BACK)

THE APPLICATIONS

CP 1: ELECTRIC LIGHTWAVE, INC..

On November 14, 1994, Electric Lightwave, Inc. (ELI) filed an application with the Commission for certification to provide telecommunications service in Oregon as a competitive provider. ELI's application seeks authority to provide intraexchange switched services. Initially, ELI intends to offer services targeted to the business customer market within the ELI service territory as defined below. These services will include, but not be limited to, Centrex-type services, circuit-switched data services, standard business line services, private branch exchange (PBX) trunks, digital switched services, and ISDN services. Other intraexchange switched services, including residential service offerings, may be provided in the future. ELI also seeks authority to provide all intrastate intraexchange services incidental, supplementary, or related to any of the foregoing.

ELI seeks authority to provide intraexchange switched service in areas coextensive with the following local exchange areas: Lake Oswego, Milwaukie-Oak Grove, Oregon City, and Portland (USWC exchanges); and Beaverton, Gresham, Hillsboro, Sherwood, Stafford, and Tigard (GTE exchanges).

Functionally equivalent or substitute intraexchange switched services are readily available in the ELI service territory from incumbent carriers including USWC and GTE. In addition, substitute or alternative services are also available from Centrex Resellers such as Enhanced Telemanagement Inc. (ET) and shared tenant service providers.

ELI currently owns, controls, and operates a digital fiber optic Metropolitan Area Network (MAN) in the Portland, Oregon metropolitan area. The network is comprised of 134 miles of 96-strand, single mode fiber optic cable in place or under construction, with an additional 200 miles in various stages of engineering. ELI also has a primary network hub located in downtown Portland. That hub contains a Northern Telecom DMS 100-200 switch with a DMS Supernode SE 60 processor. ELI seeks to establish meet points and interconnect with incumbent LECs' networks at various points, including end office switches, EAS tandems, intraLATA toll tandems, interexchange carrier access tandems, and operator services tandems. It will also request transport facilities from LECs to transport ELI services to remote locations. Transport facilities will include both analog and digital transmission media. The traffic will be handed to LECs at respective meet points and will be terminated at either the customer premise, other carrier locations, or other ELI/LEC meet points. ELI also will request ancillary services from LECs, including 911 routing, directory assistance, number portability, CLASS services, and operator services.

ELI is prepared to meet LECs in a timely fashion with a circuit interface that accommodates the LECs' ability to complete the meet point interconnections as soon as possible, with either electrical or fiber transmission media. Moreover, ELI has the ability to support all types of signaling commonly used between LECs. This includes traditional inbound signaling (analog or digital) and digital out-of-band signaling with SS7 signaling protocol.

To ensure network reliability and system compatibility with LEC embedded facilities and equipment, ELI has provisioned its network with equipment documented by the RBOCs as acceptable for purchase and installation within RBOC central offices and/or facilities.

ELI continues to adhere to and review standards and interconnection issues. In addition, ELI has established the same physical, electrical, and protocol levels with USWC and other independent LECs that will be required for intraexchange switched telecommunications products and services the company proposes to provide in Oregon. ELI's existing and proposed plant of system in Oregon will not conflict with or adversely affect the operations of any existing certified utility in the state that supplies the same products or services to the public.

ELI seeks to provide universal access to its network, whether by other service providers, subscribers, or competitors. In order to accomplish this goal, ELI's fiber optic transmission network and switching systems are designed to provide an open network platform, allowing for maximum present flexibility and the ability to grow as technology changes. ELI currently makes physical collocation and interconnection available at its network hubs to carriers, customers, and competitors.

ELI agrees to participate in all existing Commission approved programs and can satisfy statutory requirements relating to the provision of 911/E-911 services and the Telecommunications Devices Access Program.

ELI will not provide operator services under contract with a call aggregator as defined in ORS 759.690. ELI will not directly provide operator services in Oregon but will contractually arrange to have such services provided by an incumbent LEC or by another company that is in compliance with all Commission rules.

CP 14: MFS INTELENET OF OREGON, INC.

On December 14, 1995, MFS Intelenet of Oregon, Inc. (MFS), filed an application with the Commission for certification to provide telecommunications service in Oregon as a competitive provider. MFS's application seeks authority to provide intraexchange switched services. MFS has been authorized to provide interexchange telecommunications services on a resale and a facilities basis. Docket UM 668, Order No. 94-1322.

MFS intends initially to offer services targeted to the business customer market, especially small and mid-sized businesses within its service territory. MFS will offer intraexchange access services (basic business lines, key system lines, analog private branch exchange [PBX] trunks, analog direct inward dial [DID] trunks, digital PBX and DID trunks, Centrex-type system lines); intraexchange usage services (direct dial calling, toll-free calling [i.e., local 800, 950, or comparable services), operator assisted calling, directory assistance service, emergency 911 service at no charge to the caller, and switched carrier access services, including terminating access (to enable other common carriers to terminate traffic via end user access services provided by MFS) and originating access (to enable customers of MFS' intraexchange access service to employ those services to access the intrastate, interstate, and international calling service of other interexchange carriers on an equal access (1+ or 10XXX) basis.

MFS may provide other intraexchange services in the future. MFS also seeks authority to provide all intrastate intraexchange services incidental, supplementary, or related to any of the foregoing services.

MFS has applied for authority to provide telecommunications service areas coextensive with the following local exchange areas: Burlington, Lake Oswego, North Plains, Oak Grove-Milwaukie, Oregon City, and Portland (USWC exchanges); and Beaverton, Forest Grove, Gresham, Hillsboro, Scholls, Sherwood, Stafford, and Tigard (GTE exchanges).

MFS intends to provide its services through an Ericcson AXE-10 switch. MFS's sister company, Metropolitan Fiber Systems of Oregon, Inc. (MFS), is currently constructing a digital fiber optic ring network in the Portland metropolitan area, pursuant to authority granted in Order No. 94-1322. MFS will provide its intraexchange services primarily using its own switch and facilities leased from its sister company.

MFS Intelenet, Inc., the parent company of MFS, establishes operating subsidiaries on a state-by-state basis. The switching and network systems of the MFS Intelenet, Inc. corporate family feature advanced common channel signaling (called CCS or SS7) and database capabilities. It has established a matched pair of service transfer point/service control point (STP/SCP) facilities to enable CCS signaling between MFS affiliates and other carriers for advanced call setup and CLASS features interoperability.

MFS Intelenet has also set up a Network Operations Control Center (NOCC) in New Jersey, which is staffed 24 hours a day, 365 days per year. The NOCC monitors the operations of the switch, all peripherals, and all network facilities on a continuous basis. The NOCC is designed to allow MFS Intelenet technicians, working in cooperation with MFS technicians, to detect troubles as they occur and to implement corrective measure before customers experience outages or service degradation.

MFS seeks to establish meet points and interconnect with ILEC networks at various points, including ILEC end office switches, EAS tandems, intraLATA toll tandems, IXC access tandems, and operator services tandems. It will also request transport facilities from ILECs to transport MFS services to remote locations. Transport facilities will include both analog and digital transmission media. The traffic will be handed to ILECs at respective meet points and will be terminated at either the customer premises, other carrier locations, or other MFS-ILEC meet points. MFS will also request certain ancillary services from ILECs, including 911 routing, directory assistance, number portability, CLASS services, and operator services.

MFS will need to make co-carrier arrangements with the ILECs covering number assignments; meet-point billing; reciprocal traffic exchange and compensation; shared platforms for 911, telecom relay, directory assistance, etc.; unbundled local loops; and co-carrier number forwarding.

Functionally equivalent or substitute intraexchange switched services are readily available in the MFS service territory from incumbent carriers including USWC and GTE. In addition, substitute or alternative services are also available from Centrex resellers such as Enhanced Telemanagement, Inc., and shared tenant service providers. Finally, if ELI's application is granted, ELI will also provide functionally equivalent or substitute intraexchange switched services.

CP 15: MCI METRO ACCESS TRANSMISSION SERVICES, INC.

On December 20, 1994, MCI Metro Access Transmission Services, Inc. (MCImetro) applied for authority to provide telecommunications service in Oregon as a competitive provider. MCImetro is a wholly owned subsidiary of MCI Telecommunications Corporation (MCIT). MCIT is certified in Oregon as a competitive telecommunications provider. It provides interLATA and intraLATA toll services, 800 services, and WAT services.

MCImetro intends to provide local exchange service and carrier access services to business customers. These services will include, but are not limited to, two-way local lines or trunks, direct inward or outward dialing options, local calling operator assistance services, directory assistance, dual party relay service, and 911 emergency services via the established 911 network.

MCImetro seeks to provide services in the Portland metropolitan area, including portions of Multnomah, Clackamas, and Washington counties. Service will be provided in areas coextensive with the following local exchange areas: Lake Oswego, Milwaukie, Oak Grove, Oregon City, Portland (USWC exchanges); Beaverton, Forest Grove, Gresham, Hillsboro, Scholls, Sherwood, and Stafford (GTE exchanges).

MCImetro intends to own and deploy its own digital switches with stored program control software. MCImetro has not yet selected the switches it will deploy in Oregon.

If MCImetro can purchase transmission service from the incumbent LECs in a cost effective manner, MCImetro will try to do so. MCImetro anticipates that transmission service elements such as loops and network access facilities will be available from the LECs on an unbundled basis and at cost based rates in the near future, as a result of UM 351.

If MCImetro cannot purchase cost-effective transmission service from the incumbent LECs, MCImetro will construct its own transmission facilities. In other jurisdictions where MCImetro has constructed a redundant network, MCImetro has used high reliability fiber rings with SONET technology for most of its facilities. Attachment D to MCImetro's application describes its network plan for Washington state, which has been approved by the Washington Utility & Transportation Commission. If MCImetro receives authority to operate in Oregon, it anticipates that its network plan for Oregon would be similar.

APPENDIX B (BACK)

APPEARANCES AT HEARING

The following parties entered appearances at the hearing in these cases:

Party Representative

Electric Lightwave, Inc. (ELI) Ellen Deutsch

MFS Intelenet of Oregon, Inc. (MFS) Robert Berger and Leslie Bottomly

MCI Metro Access Transmission

Services, Inc. (MCImetro) Beth Kaye and Susan Weiske

GTE Northwest, Inc. (GTE) Richard Potter

US West Communications, Inc. (USWC) Molly Hastings and Douglas Owens

AT&T Communications of the

Pacific Northwest, Inc. (AT&T) Susan Proctor

Oregon Cable Telecommunications

Association (OCTA) Sara Siegler Miller

Oregon Exchange Carriers

Association (OECA) Robert Hollis

Oregon Independent Telephone

Association (OITA) Michael Morgan and Gary Bauer

Sprint Communications

Company L.P. (Sprint) Lesla Lehtonen

Teleport Communications

Group Inc. (TCG) Teresa Marrero and Mark Trinchero

Commission Staff (Staff) W. Benny Won

ORDER NO.

Glossary (BACK)

ADSRC Average Direct and Shared Residual Cost

AEC Alternative Exchange Carrier

ALI Automatic Location Identification

ASIC Average Service Incremental Cost (ADSRC minus Shared Residual Cost)

BOC Bell Operating Company, e.g., USWC

CCF Co-carrier Call Forwarding

CCL Carrier Common Line

CLASS Custom Local Area Signaling Services

cpm cents per minute

COLR Carrier of Last Resort

DNRI Directory Number Route Indexing

DS1 A type of high-speed private line service, transmitting at 1.544 megabytes per second, the equivalent capacity required to provide 24 voice grade equivalent channels

DS3 Another high-speed private line service, transmitting at 44.736 megabytes per second, the equivalent capacity required to provide 672 voice paths or 28 DS1s

DSS Digital Switched Services

EAS Extended Area Service

ESN Emergency Service Number

ILEC Independent Local Exchange Carrier

ISDN Integrated Services Digital Network

I-USC Interim Universal Service Charge

IXC Interexchange Carrier

LEC Local Exchange Company

LTR Local Transport Restructure

NAC Network Access Channel

NPA (Telephone) Numbering Plan Area codes

NXX Geographic number prefixes assigned to carriers

OCAF Oregon Customer Access Fund

OCAP Oregon Customer Access Plan

OUSF Oregon Universal Service Fund

PBX Private Branch Exchange

PIU Percentage of Interstate Usage

PLU Percentage of Local Usage

PSAP Public Safety Answering Point

RCC Radio Common Carrier

RCF Remote Call Forwarding

SS7 Signalling System Seven

STS Shared Telecommunications Service

TSLRIC Total Service Long Run Incremental Cost (sum of service specific volume sensitive costs plus the service specific volume insensitive costs)