Structural Separation and Universal Service Conference on The Enduring Lessons of the Breakup of AT

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Structural Separation and Universal
ServiceConference on The Enduring Lessons of
the Breakup of ATT  A Twenty-Five Year
RetrospectiveUniversity of Pennsylvania Law
School, April 18-19, 2008

• Michael Riordan
• Columbia University

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High cost fund

• Over 4 billion and growing
• Duplicative payments to ETCs (ILECS and CETCs)

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Reverse auction NPRM

• Goals
• Market determination of universal service
  subsidies in high-cost areas
• Efficient mix of technologies for provision of
  supported services
• Adaptation to evolving technology

• Design issues
• Single winner?
• COLR obligation?
• Per line subsidy?
• Geographic area?
• Frequency?
• Maximum subsidy

• Neglected issues
• Access regime
• Stranded costs
• Structural separation
• Legal issues
• New FCC rules?
• Modification of 251(f)?

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Access issues

• To be a viable or efficient competitor, a CETC
  might in some geographic areas require access to
  ILEC network
• Backhaul
• Interconnection
• Resale / UNEs
• Evolving technology implies shifting access
  requirements
• Denial of efficient access puts CETC at
  competitive disadvantage
• Discourages participation
• Distorts auction outcome
• Dampens innovation

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Structural separation

• Mandatory unbundling of network elements (UNEs)
• Netco sells network services
• Non-discriminatory access
• Regulated terms and conditions
• Loops, switching and transport and combinations
  (UNE-P)
• Servco sells retail services
• Competes in auction
• Advanced services
• Purchases network services from Netco as required

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Stranded costs

• Network assets owned by Netco
• Fair rate of return on historical rate base
• Embedded cost recovery
• Profits from network services
• Profits from wholesale advanced services
• Distributions from universal service fund

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Simple model

• ILEC and CLEC compete in reverse auction
• The winner has a COLR obligation is to provide
  basic telecommunications service to a community
  at affordable price
• Regulated retail price P
• ILEC initially requires subsidy to be viable
• ILEC has cost is CI gt P
• Initial minimum required subsidy So CI P

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Simple model, contd

• CLEC requires access to the incumbents network
  in order to provide service at the lowest
  possible cost
• ILEC cost of access is CA
• Price of access is PA
• CLEC complementary facilities cost is CE
• Total CLEC cost is CE PA
• CLEC requires subsidy to be viable
• Minimum subsidy SE CE PA P

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Simple model, contd

• Open descending auction
• CLEC bids down to SE CE PA P
• ILEC bids down to SI CI P PA CA ? So
• Efficient outcome
• CLEC wins if CE CA lt CI and receives SI
• ILEC wins if CI ? CE CA and receives SE
• Equilibrium subsidy exceeds initial subsidy
• Subsidy increases with PA
• Dual jurisdiction problem PUC sets PA and
  federal USF pays subsidy

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Bypass

• CLEC might bypass the ILEC network with own
  facilities
• Cost of bypass CB gt CA CE
• Bypass occurs if PA gt CB CE
• Bypass makes ILEC more aggressive
• CLEC required subsidy SE CB P
• ILEC required subsidy SI CI P So
• Distorts outcome
• CLEC wins if CB lt CI
• ILEC wins if CI ? CB

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Stranded cost

• ILEC embedded cost exceeds the cost of access
• ILEC historical cost is CH gt CA
• Initial subsidy is So CH P
• Above-cost access pricing mitigates stranded cost
• If ILEC wins, then stranded cost CH CE PA
• If CLEC wins, then stranded cost CH CI CA PA
• Stranded cost recovery might blunt competitive
  bidding
• Promises to leaves ILEC whole
• Structural separation remedies this problem
• Promises to leave NETCO whole
• Commits regulator not to take SERVCO profits
• May fail to reduce subsidies in the short run

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Advanced services

• Winning ILEC and CLEC have opportunity to earn
  additional revenue from advanced services
• Revenue from unregulated service R
• Incremental cost K
• Extension to asymmetric revenues and costs
• Profits from advanced services reduce subsidy
  requirements
• Subsidy less by R K
• No outcome distortion unless inefficient bypass
  occurs
• Expand USO to include advanced services
• What is an affordable price? Comparable price
• But dont exclude CLECs!

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Conclusions

• Structural separation enables competition by
  enforcing non-discriminatory access to network
  elements
• Efficient mix of dynamically evolving
  technologies
• Low-cost service provider
• Above-cost access pricing (or access foreclosure)
  distorts competitive provision of universal
  service in high-cost areas
• Inefficient bypass
• Non-participation
• Reverse auctions may or may not reduce subsidies
• Cross subsidy from advances services
• Avoids duplicative subsidies
• Above-cost access pricing
• Stranded cost problem