DATE: April 13, 1999

TO: Bill Warren through Phil Nyegaard through Lance Ball

FROM: Jim Stanage

SUMMARY RECOMMENDATION:

That the Commission suspend and further investigate U S WEST’s petition.

Introduction

U S WEST Communications Incorporated (U S WEST) filed a petition on March 5, 1999, for an order exempting its Message Telecommunications Service (toll service), Wide Area Telecommunications Services (WATS), and related operator services from regulation. Pursuant to ORS 759.030(7), the Commission has 60 days from the filing date to either determine the appropriateness of the filing or determine that further investigation is necessary. The Commission has until May 4, 1999 to take action on this petition.

U S WEST’s Message Telecommunications Service (MTS) applies to all calls made between two or more rate centers within a Local Access and Transport Area (LATA). MTS provides telecommunications beyond the local calling area and is sometimes called "local long distance" service. MTS charges cover the service furnished between the calling and called stations.

WATS services tariff includes the various WATS service lines, which are access lines dedicated to toll calling only, along with all of U S WEST’s 800 services.

Operator services include operator assisted calling, including Customer-Dialed Calling Card calls, Third-party Billing Number calls, Operator-Assisted Station-to Station calls, and Operator-Assisted Person-to-Person calls.

Staff Procedures for Reviewing Service Exemptions

ORS 759.030(3) requires the Commission to exempt a telecommunications service from regulation if "price and service competition exist." Under ORS 759.030(4), prior to making these findings, "the Commission is required to consider:

The extent to which services are available from alternative providers in the relevant market.

The extent to which the services of alternative providers are functionally equivalent or substitutable at comparable rates, terms, and conditions.

Existing economic or regulatory barriers to entry.

Any other factors deemed relevant by the Commission."

Other Staff Considerations

OAR 860-027-0052 provides a requirement for the allocation of costs between regulated and nonregulated utility operations. The company must be convincing as to the propriety of their proposed treatment of interoperation transactions.

U S West Toll Services and Dialing Parity

U S WEST has provided intraLATA toll services through its tariff since divestiture of the Bell System more than 15 years ago. The company currently provides intraLATA toll service within its own service territory as well as all of the other Oregon telephone exchanges that are not serviced by GTE Northwest, Inc. and Sprint/United Telephone of the Northwest, Inc. Thus, U S WEST is currently the primary interexchange carrier for intraLATA toll services for more than 75% of Oregon telephone customers. Furthermore, within those exchanges 100% of the customers were presubscribed to U S WEST for intraLATA toll service prior to February 8, 1999. On that date, Commission Order No. 98-433 (Docket UT 132) became effective and required dialing parity to be implemented in all Oregon exchanges. Dialing parity is sometimes referred to as "1+ access" or as "equal access."

Long Run Incremental Costs

U S WEST cites cost study results that have been accepted by the Commission relevant to the long run incremental cost (LRIC) of providing toll service. The company’s toll services are currently priced above its LRIC of service.

Price and Service Competition

ORS 759.030 and OAR 860-032-025 require that the Commission consider the extent to which services are available from alternate providers in the relevant market and the extent to which the services of alternate providers are functionally equivalent or substitutable at comparable rates, terms and conditions.

The relevant market is U S WEST’s service territory in Oregon. In its petition, the company presents the names of numerous companies that hold certificates of authority granted by the Commission and who offer toll services in Oregon. The apparent point of such evidence is that the service is subject to at least some level of competition for toll services by the presence of alternative providers.

The company’s only specific attempt to provide direct, qualitative evidence regarding the extent of competition relies on three years’ data on dial-around "by-pass using 10XXX carriers." Although these data vary from month to month and season to season, they fail to demonstrate any clear trend toward a lessening of U S WEST dominance in intraLATA toll. At the end of the three years U S WEST’s market share is about where it was at the beginning: very high.

Moreover, even though the data provide some substantial evidence of competition through dial-around by-pass, U S WEST fails to present any substantial evidence relevant to the dispersion of such competition either geographically or among customer classes. Such evidence is crucial for meeting the implied statutory requirement of ORS 759.030(4)(a) to demonstrate that competition is extensive. The "extent" of competition is especially relevant since "competition" that is concentrated in only the more populous areas of Oregon could leave customers in more rural, high-cost areas with little or no competitive alternatives, and therefore, no protection from a carriers’ monopolistic practices or from complete abandonment of service. The "extent" of competition requirement also is particularly relevant with respect to those in customer classes with less market power, such as residential customers and small businesses.

The petition data regarding dial-around 10XXX by-pass, also does not present any substantial evidence relevant to whether such competition relies merely upon the resale of U S WEST’s own facilities. If dial-around toll by-pass has relied primarily upon the resale of U S WEST facilities, then the continuation of such competition after the deregulation of those facilities could be tenuous at best.

Other than dial-around bypass data, U S WEST’s petition relies upon some anecdotal evidence that is not persuasive evidence of competition. The anecdotal evidence cited makes allusions to toll by-pass through private line service as well as changes in Arizona intraLATA toll presubscription after dialing parity was allowed. The petition acknowledges that some part of the private line service based toll by-pass actually utilizes U S WEST’s own private line service either directly or indirectly through resale. The company states that it is unable to obtain more specific information about by-pass through private line service, "...because U S WEST’s competitors deem these usage figures to be proprietary…" The protective order that U S WEST would be able to obtain through a docketed case could allow it to derive more definitive evidence of such toll competition.

The petition cites Arizona presubscription levels 17 months after dialing parity was allowed there. U S WEST’s citation of those Arizona presubscription levels, so long after dialing parity was allowed, reveals an important aspect of customers’ carrier switching behavior: Presubscription levels do not change overnight. It is well known within the industry, given the AT&T experience, that incumbent toll carriers who enjoy good service reputations with their customers tend to lose their toll market share only slowly over time. Whether dialing parity leads to more extensive competition for intraLATA toll services in Oregon remains to be seen and cannot merely be assumed based on alleged experiences in other states.

Finally, it is important to note that the dialing parity required by Order No. 98-433 did not go into effect until February 8, which was just about three weeks before U S WEST submitted its petition. Therefore, no reliable data measuring the changes in intraLATA presubscription due to the introduction of dialing parity were available at the time the petition was filed. Until dialing parity has more opportunity to run its course, it would be premature to draw any final conclusions about the "extent" of intraLATA toll competition.

Economic Or Regulatory Barriers To Entry

No regulatory or economic barriers to entry into the relevant market have been identified. The only economic hurdles to entry are the normal startup and operating costs, including the cost of the toll service facilities. However, those economic costs are substantial.

Affiliate Transactions

Local exchange companies (LECs), like U S WEST, have certain inherent advantages in the marketing of toll services. These advantages stem from the company’s status as a provider of basic local exchange service. U S WEST routinely has the first contact and maintains continuing communications with most potential toll service customers. It can also utilize current facilities and employees in its marketing and provision of toll service, as well as the company’s current customer record base to identify potential customers. OAR 860-027-0052, OAR 860-035-080, OAR 860-035-090 and OAR 860-035-100 directly or indirectly address various aspects of affiliate transactions. OAR 860-035-0090 and OAR 860-035-0100 address the permitted use of customer proprietary network information (CPNI). Staff review indicates that these OARs adequately minimize the company’s inherent advantages.

Other Factors

There are at least three other factors that are relevant to deregulation of U S WEST’s toll services: (1) the potential for price discrimination by the company, (2) the prospects for the company’s abandonment of some of its toll service routes, and (3) the opportunity for the company to engage in predatory pricing of toll services.

Price discrimination occurs whenever a seller sells a product or service to similarly situated customers at different prices. As a regulated utility it would be illegal for U S WEST to sell a toll service to similarly situated customers at different prices. However, if the Commission grants the company’s petition to exempt its toll services from regulation, then similarly situated customers would lose their Commission protections from such price discrimination. In the absence of regulatory protections, vigorous competition can counterbalance discriminatory pricing practices. Thus, it would be prudent to deregulate U S WEST’s intraLATA toll services only when it becomes clear that vigorous competition is a reality, rather than a vague prospect.

Second, if the Commission grants this petition to exempt U S WEST’s toll services from regulation, then the company would be free to abandon any toll service routes it chooses. This could leave rural exchanges and their customers at risk of losing their rights to reasonably priced toll services. Currently, two Oregon exchanges served by other LECs, but for whom U S WEST is the primary interexchange carrier for intraLATA toll services, do not provide equal access.

Third, deregulation of U S WEST’s intraLATA toll services so soon after the advent of intraLATA dialing parity could create an opportunity for the company to engage in predatory pricing practices. Given the difficulty of proving predation, after the fact, in such a complex and highly technological marketplace, this risk must be considered. However, there is little reason to believe that U S WEST would be able to price its toll services below the LRIC of service, and thereby, engage in predatory pricing or other anti-competitive behavior because it probably could not benefit from such behavior.

Should the PUC Authorize Price Listing of U S WEST’s Toll Services?

While more complete evidence of intraLATA toll competition is required before the company should be allowed to exempt it services from regulation, staff believes that the evidence presented in the petition is sufficient to meet the statutory requirements for price listing. Under ORS 759.030 (8) "If the commission determines that a product or service offered by a telecommunications utility as part of interexchange telecommunications services can be demonstrated by the utility to be subject to competition, the commission, under such conditions as it determines are reasonable, may authorize the utility to file a price list…"

The standard for authorizing price listing is simply that it be "subject to competition." This is a lower standard than that for exempting telecommunications services from regulation, which is that "price and service competition exist." Moreover, it is reasonable that the standard for authorizing price listing be lower than the standard for exempting services from regulation. Under price listing ratepayers could still enjoy protections from, for example, price discrimination, unreasonable rates, and abandonment of service. Ratepayers’ protections can be made even more secure if a "maximum price" condition is added to the price list authorization. Yet, all of the protections provided through the Commission disappear if a service is exempted from regulation.

While dialing parity may not immediately lead to more extensive competition for intraLATA toll services in Oregon, it still changes the toll market status quo. In recognizing that change, it is reasonable to enable U S WEST to respond to current and future competitive conditions for toll services through authorizing price listing. Authorizing price listing would provide the following benefits to ratepayers:

Maintenance of the appropriate balance between the need for price flexibility and the protection of consumers,

Potential reduction of toll rates, and

Little, if any, risk of undue harm to any customer class.

Conclusions

Staff’s analysis outlined above has led to the following conclusions:

U S WEST’s petition does not provide information sufficient to make a finding that "price and service competition exist" for its toll services to the extent that regulation is no longer necessary to protect the public interest.

A further investigation could produce more complete information that could be important in making a decision concerning the petition’s merit.

Toll services are crucial to U S WEST’s toll customers in all of the company’s service territories, and therefore, regulatory protection of their interests should not be abandoned unless competition is extensive enough to clearly offer long term service alternatives at reasonable rates.

The Commission should allow the company to file a price list for its intraLATA toll services and should direct U S WEST to include, as a general condition for the price-listed services, that the rate for any service will not exceed current tariffed rates.

The annual gross revenue effect on toll services due to this filing would be a reduction of approximately $85,000,000, although the overall effect on regulated revenues, after adjusting for access revenue changes and expenses, would result in an amount different from this figure. If this service were deregulated, the appropriate matching rate base expenses and tax reductions would also be made in compliance with Commission rules.

No significant economic or regulatory barriers to entry have been identified.

STAFF RECOMMENDATIONS:

I recommend that the Commission suspend and further investigate U S WEST’s petition to exempt its toll service from regulation. An investigation would provide an opportunity to obtain more complete information upon which to base a decision concerning the petition. By obtaining additional information particularly concerning the dispersion of intraLATA toll competition both geographically and among customer classes, U S WEST’s petition could more completely address the statutory requirement of ORS 759.030(4)(a) to demonstrate that competition is extensive.