How Telephone Companies Make Money

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How Telephone Companies Make Money
Regulated Earnings
in Telecommunications
Doug Kitch Vince Wiemer
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Discussion

• Rate-of-Return Regulation
• Revenue Requirement
• Jurisdictional Separations
• Cost Recovery
• Local Rates
• Access
• The NECA Pools
• Universal Service Funds

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Rate-of-Return

• A method of utility regulation that provides a
  company with an exclusive service area but limits
  their earnings
• The utility earns a pre-determined rate-of-return
  on their utility investment plus recovers allowed
  operating expenses and income taxes

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Rate-of-Return (contd)

• RoR regulation was put in place to encourage the
  large investments required for utilities
• Common for gas, electric, and telephone utilities
• The amount of money that a RoR utility is
  entitled to earn is called their REVENUE
  REQUIREMENT

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Revenue Requirement

• The authorized level of earnings allowed

Telephone Property, Plant Equipment -
Accumulated Depreciation Rate Base x
Rate-of-Return Return on Rate Base
Operating Expenses Income Taxes REVENUE
REQUIREMENT
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Revenue Requirement (contd)

• Rate-of-Return regulation means that more plant
  investment and more operating expenses result in
  more income (revenue requirement)

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Revenue Requirement Example

• RoR also means that over time, earnings will
  decrease as plant depreciates

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Jurisdictional Separations

• Telephone carriers are regulated by both state
  federal government
• State jurisdiction ? local state toll
• Federal jurisdiction ? interstate toll
• So rate base and revenue requirement must be
  divided into their respective jurisdictions
• Separations or cost studies are performed to
  accomplish this task

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Separations
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Part 36 Separations Rules

• Primary purpose of Part 36 is to assign property
  costs, revenues, expenses, taxes and reserves
  between state and interstate jurisdictions
• Costs are categorized based on function and use
  of the related plant

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Basic Studies

• Four basic studies are performed to determine the
  use of facilities
• Traffic Study
• Commercial Office Study
• Central Office Equipment Study
• Cable Wire Facility Study
• Then costs (plant balances expenses) are
  allocated to jurisdictions based on these usage
  factors

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Cost Recovery

• Once the jurisdictional revenue requirements are
  determined, there is the issue of recovering the
  costs
• Telephone companies have three revenue streams
• Local service rates from end-users
• Access rates from long distance carriers
• Interstate and State access rates
• Universal Service Funds from the Federal state
  governments

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Revenue Sources
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Universal Service Rates

• All rates are influenced by universal service
• Universal Service is a policy that states that
  all Americans have the right to quality
  telecommunications services at affordable rates
• Because of universal service, local telephone
  service in urban areas subsidizes rural service

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Cost Recovery (contd)

• Local Rates are set by State PUC
• Access rates are determined by the cost of
  providing toll services (access costs)
• Determined by cost study
• Universal service funds make up most of the
  difference between the cost of providing local
  service and the local rate

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Access Rates

• Access costs vary for each telco
• Access cost
• Toll minutes
• Access rate
• For ease of administration, the National Exchange
  Carrier Association (NECA) produces one tariff
  for a large number of telcos

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Access NECA Pools

• The telco charges the long distance company the
  tariff rate (the average access rate developed by
  NECA)
• NECA pools the money and distributes it to the
  telco based on the telcos individual costs
• Determined from the cost study

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Universal Service Funds

• Universal service funds are government subsidies
  for local service in high cost area
• The telcos average cost per loop is calculated
• rate base operating expenses
• number of lines
• and compared to the National Avg Cost per Loop
  (NACPL)
• A percentage of the difference is received as a
  subsidy

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