[ Text Version ]


Philadelphia, PA
October 3, 1997

(As Prepared for Delivery)

It is my pleasure to be here - in my final days as Chairman of the FCC - to bring together federal and state regulators to discuss the implications of the Bell Atlantic/Nynex merger and find ways in which we can work together to foster local competition. It was in Philadelphia of course that our Federalism was invented. So, this is a good place to be in order to talk about how to emphasize the virtues of our complicated jurisdictional arrangements and how to minimize its vices.

The biggest vice is that Federalism gives attorneys many opportunities to invent procedural debates for the ulterior purpose of serving substantive goals of their clients. There is no such thing as a pure procedural issue. Procedural arguments are rarely asserted without some substantive purpose. All procedural rulings have substantive impact.

That is why the world generally and all of us here specifically are anxious about the repeated coincidence of state jurisdictional arguments against the FCC and substantive anti-FCC arguments by incumbent telephone companies. Does this coincidence create the appearance of tacit understandings between state regulators and the industry they regulate?

The states and NARUC are sincerely anxious about the impact of the 1996 Telecommunications Act on state jurisdiction. But none of us lose sight, I am sure, for a moment that state-FCC procedural arguments have tremendous substantive impact. No one can doubt that the slow pace of competition in most states is attributable in significant part to investor uncertainty about the rules of competition; and that uncertainty is directly traced to the judicial rulings clouding or delaying definitive holdings about what government authority, state or federal, is responsible for the rules of competition.

In short, the Eighth Circuit interconnection ruling was not about substance but has had a substantive, and in my view a negative impact. And if the Eighth Circuit entertains the recent state filing about the Michigan 271 decision, again there will be a major substantive, and in my view a negative impact.

So, what is to be done to reduce these substantive impacts? Clearly even I acknowledge that the states are never going to refrain from making a procedural jurisdictional argument. Indeed if even one state wants to make such an argument the reality appears to be that NARUC will back that argument in all courts with formidable legal firepower. Typically the telephone companies will join in.

But if there's no changing the state approach to jurisdictional issues, is it possible that the states and the FCC can nevertheless together work out some other working relationship that minimizes any negative substantive impact from jurisdictional litigation? Can we take steps to divorce substantive issues from procedural fights? Can we find a way to guarantee that whether a state or the FCC sets the competition rules, the result will be precisely the same, or so close as to make no practical difference to investors, incumbents, and new entrants?

This I think is the great challenge for all the governments gathering here in Philadelphia. This is a challenge for the next FCC Chairman, the brilliant and experienced and compassionate General Counsel, Bill Kennard. And this is a challenge that we can only meet by specific, concrete commitments to joint and several action.

I propose that the next FCC and the states of the huge new Bell Atlantic region promise to lead the way to a new set of understandings about the rules of competition, thereby minimizing or reducing to insignificance the procedural fights that have historically divided us and impaired our separate efforts to achieve the right goals of competition and deregulation.

To this end, the FCC imposed in the Bell Atlantic-Nynex merger a set of commitments and conditions that are drawn from the best practices of all the states in the region, that are not incompatible as I see it with the bulk of the actual decisions by these states, and that can be enforced either at the FCC or in the states.

I want to discuss today the details of these commitments, the issues they raise, and the means for enforcing them.

Merger Theory and Conditions of the Bell Atlantic/Nynex Merger

The FCC laid out its comprehensive merger theory in the Bell Atlantic/Nynex and BT/MCI decisions. These decisions permit a detailed understanding of our theory; and it is this theory that will be applied, e.g., to such proposed deals as the recent WorldCom proposal to buy MCI.

When reviewing a merger the FCC must determine if the transaction is in the public interest. This is an affirmative finding the FCC must make.

The purpose of FCC merger policy is to create the conditions of competition that will enable the eventual deregulation of telecommunications markets. We all know that competitive markets operate much more efficiently and responsively to consumer demands than any regulated monopolist. The sooner the FCC can facilitate an overall market structure which is conducive to competitive market forces, then the sooner the FCC can deliver the other goal of the 1996 Telecommunications Act -- deregulation. For this reason, in evaluating the competitive affects of the merger as part of the public interest test, the Commission will determine whether the merger enhances competition.

It is critically important that the states join us in promoting competition policies in connection with mergers. I hope and trust that the states of the Bell Atlantic region will develop such policies together, and will apply them to reviewing future merger proposals.

I hope the states will consider the technique we used in Bell Atlantic-NYNEX: the use of pro-competitive commitments that offset possible adverse effects on competition stemming from the merger. In brief, the conditions include: 1) Performance monitoring reports, negotiated performance standards, and enforcement mechanisms; 2) Carrier-to-carrier testing of uniform OSS - operational support systems -- that enable resale and unbundled network elements; 3) Prices (other than for resold services) based on forward looking economic costs; 4) Shared transport facilities priced on a minutes of use basis; and 5) Easy payment plans for non-recurring charges.

One of the purposes of today's meeting is to discuss in detail these conditions and the means for enforcing them at the FCC and in the states.


One of the most important conditions is pricing.

As one telecommunications analyst said last year: "The differences between states and the FCC are over jurisdiction far more than substance. They appear to agree on goals. Both jurisdictions are moving aggressively to open markets...both sides also appear to agree on the economic principles."

From a legal viewpoint, the word "cost" in Section 252 must have the same meaning in all 50 states of the country. There can be no serious debate about this. As a Federal statute, the language of the statute is presumed to have the same meaning nationwide.

However, the actual cost of interconnection or unbundled loops will not be identical from state to state or even within regions across a state. Nor is it necessary and logical that the actual number that is the "cost" will be determined at the FCC; I think we should all agree that the number -- the loop price that is based on the term "cost" or the interconnection price based on the term "cost"-- should be calculated by the state at issue, and not by the FCC. The states have the experience, data base, and personnel to do this job.

But it is not reasonable to entertain the possibility that in New Jersey cost includes historic or legacy cost; in Pennsylvania it includes forward looking cost plus a contribution of x percent to universal service; in West Virginia it includes TELRIC but with a cost of capital assumption of 30%, whenever all other states in the region are at 15% and so forth. These are not true situations, but hypothetical ones I am describing. I am simply saying if such a range of hypotheticals were to come into reality, it would be contrary to common sense, bad policy, and very negative for investors and new entrants.

How can these results be avoided? The simplest best answer is that everyone in this room can agree on the details of the methodology to be used for pricing interconnection and elements, and can agree further on how the methodologies will be applied by each state, and can agree lastly on when this process will be completed. So why don't we all do just exactly that?

It should be clear that a sound competition policy requires a level playing field that stretches across state lines, and indeed is national in scope. And as long as competition requires efficient prices for connecting to and sharing the existing network, then competition requires a coherent and detailed and predictable definition of cost that is the same everywhere. I think the notion that this ought to be a forward looking definition is conceded everywhere. TELRIC is one of the possible names for forward looking methodology; a rose is a rose by any other name and I think that whether you call the methodology TELRIC or something else, the key points are contained in the characteristics. TELRIC or any other name for an appropriate forward looking cost methodology does not include elements of subsidy that have traditionally gone into access charges. For example, it does not include any universal service subsidy. Nor does it include the historic sunken costs of an incumbent's network. These historic costs would not be recovered in a competitive market, where prices are based on forward looking costs.

I think further that there is sufficient flexibility to the TELRIC idea -- or whatever other name you want to give it -- that it easily embraces all parameters worthy of discussion here: I include cost of capital, line count, and other variables. The job of this group I think is to come into agreement on these parameters, aim to announce a general approach to the pricing issue,and then, after substance is agreed to, debate who shall have the enforcement jurisdiction.

Why does TELRIC advance local competition? 1) A pricing methodology based on forward looking costs best replicates the conditions of a competitive marketplace for network elements, because competitive markets will push prices toward forward looking economic costs; 2) A forward looking cost methodology constrains the ability of an incumbent to inhibit competition by setting a price higher than the cost of providing the service 3) The availability to competitors of the ILECs' UNEs at their economic cost means that consumers will benefit from retail prices that reflect the ILEC's economies of scale and scope; and 4) A forward looking pricing methodology provides incentives to new entrants to invest in facilities where and when it is economically efficient.

I would like therefore to propose that over the next 60 days federal and state regulators throughout the Bell Atlantic region come together to discuss this vital issue. We should examine in detail the prices that the states are setting for interconnection to see if these prices are in accord with the fundamental pro-competitive principles that I mentioned above. As I discussed above, the TELRIC methodology has significant flexibility. That is why the details must be discussed. What will be key is to have actual wholesale prices or inter-carrier prices be pro-competitive. Where prices are procompetitive, Bell Atlantic will have complied with its merger commitments and pricing will not be an obstacle to its attempt to enter the long distance market.

Now let's talk about long distance entry. During the debate on the telcom act the Bells wanted a date certain; they didn't get that provision; that was regarded as a defeat. Therefore, the general view was that they shouldn't and couldn't get into long distance as soon as the date certain suggested, unless and until they truly opened their local markets. The date certain they lobbied for would have been February 1999. Certainly until then and even after that date no reasonable person could expect a Bell company to get into long distance unless it truly opens its local market.

The Michigan decision by the Commission makes extremely clear what any Bell needs to do to get into long distance. I hope everyone here recognizes that our decision in fact represents a summing up of the thoughts, views, and opinions of most of the Ameritech region states and the Department of Justice. There is scarcely an aspect of our Michigan decision that isn't drawn from those states and/or DOJ. Indeed, even the pricing dimension of the Michigan decision -- blasted by NARUC in one of the most unfortunate court filings that organization has ever made -- in effect only endorses the Michigan commission's well-established view.

It's odd and regrettable that NARUC chose to sue us in a court which doesn't have Michigan in its jurisdiction when we in effect endorsed Michigan's own views about the appropriate pricing of interconnection and elements. This lawsuit was also regrettable because the Ameritech state commissions virtually all tacitly endorsed our Michigan decision in advance. In fact, our decision strengthened those state commissions in their treatment of the Bell filings.

You will remember that the FCC reached out to the states in unprecedented meetings last year in order to invent a common and consensus-building process for analyzing Bell entry applications. We should be doing that now; that's what this meeting is also about.

In any event, just as the courts do, so the Commission follows a policy of "stare decisis." Unless ordered by a court or presented with new evidence that a situation has changed or our understanding of a factual predicate was mistaken, the Commission does not overturn its policies. We follow precedent. Consequently I believe and trust the next Commission will be guided by the Michigan decision in examining the recent South Carolina application by Bell South. I hope also that the South Carolina commission will be guided by the Michigan commission's comments on Bell South's application.

Universal Service Reform

A key to local competition in local markets is universal service reform. We need to finance and subsidize universal service obligations in a competitively neutral way. There is a real need for fresh thinking on how best to do this.

The FCC and the states are developing models and conducting studies based on forward looking cost methodology to estimate the cost of universal service for high cost rural areas. Roughly, the universal service subsidy would be equal to the difference between the forward-looking cost of providing service and a revenue benchmark appropriate for universal service goals.

These cost models are sophisticated undertakings, but estimates are estimates. In some cases the estimates may be too high and in some cases too low relative to reality. What to do about this is one place where creative thinking is needed.

A promising idea is to use market-based mechanisms to "correct" the estimates. Auctioning the rights to serve a high cost area is a possible method to bid down subsidies that are two high. A firm should be willing to provide service as the subsidy plus expected revenues exceed the cost of supplying services. Competition should bid the subsidy down to the minimum necessary, and also provide powerful incentives for firms to reduce their costs.

An estimated subsidy that is too low creates a possible stranded cost problem if all other expected revenues combined with the subsidy do not offer a reasonable opportunity to recover cost incurred. In this case, the subsidy plus expected revenues would be insufficient to cover the embedded cost of the network. The appropriate definition of stranded cost is the difference between the market value and the embedded cost of the assets. The question is how to calculate market value.

An answer is to permit or encourage the sale of the relevant rural assets. A small rural telco can be created by divesting wirecenter assets and putting them up for bid. There is analogy here with what the electricity industry is doing very successfully in some states to deal with the stranded cost problem for electric power plants.

In any event, stranded cost recovery to which the parent telco is entitled based on the market value of the wirecenter assets could be financed by a competively neutral charge on telecommunications services, or by temporarily higher access prices. This charge on the access surcharge could and probably should be disproportionately allocated to business, high volume residential, and second line users. The economic inefficiencies attendant to this approach are probably outweighed by the wisdom of avoiding rate shock for single line, low volume residential customers. If the charges are competitively neutral they will not enhance the cream skimming risk faced by incumbents.

These methods of financing stranded cost recovery are competitively neutral and are vastly preferable to seeking to recover stranded costs by raising the price of UNE's. UNE prices, based on forward looking costs, enable entrants to compete with incumbents on a level playing field. Setting higher UKE prices would create a barrier to entry and discourage local competition.

It has been a privilege and pleasure to work with all of you in the last four years. Your public service is immensely important to the country. I wish you success and joy in your work in the future, and I thank you for letting me share in your efforts during the last four years.