Lecture 3 Incentive Regulation in Telecom

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Lecture 3Incentive Regulation in Telecom
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Issues with Initial PC plans

• Interim plan or better long term solution
• X-Factor Importance

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ATT Price Cap Plan

• Three baskets
• 1. MTS or the "grandma basket"
• 2. 800 service - ATT retained some control.
• 3. Other large business "bye-bye basket".
• Individual price bands /- 5 X 3.0
• NPRM, FRPM, 1987 -1989. Approved March 16, 1989.
• LECs position.

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LEC PC Plan

• LECs came later - approved September 1990.
• LEC productivity 3.3 with ROR bands. Current ROR
  was 11.25. IF ROR went gt1, 50/50 sharing until
  5 over (i.e. 16.25). After that, total
  giveback.
• LECs could choose 4.3 productivity. They would
  then retain all profit below 13.25 and half up
  to 17.25.

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Revised LEC Price Cap Plan - May 1995

• 3 options
• X4.0 sharing between 12.25 and 13.25 ROR.
  Min 10.25 Max 13.25
• X4.7 sharing between 12.25 and 16.25 ROR. Min
  10.25 Max 16.25
• X5.3 no sharing, min or max.
• NYNEX, SNET U S West chose A Ameritech, Bell
  Atlantic, Bell South, Pacific Telesis SBC chose
  C

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Final PC plan

• Effective 7/1/97
• X-factor 6.5 (including CPD)
• No Sharing No Cap on earnings

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The need for rate rebalancing

• Rural versus Urban
• Businesses are higher margin than residence.
• IntraLATA toll is high margin for both residence
  and business.
• Problems of incentive regulation

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Problem

• New entrants will target high margin business
  and go after urban areas leaving unrenumerative
  customers and for the incumbent.

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Problem (contd)

• If ROR and price caps were effective regulation,
  total revenue from rates to close to total cost
  including a normal return.
• If the new entrants cream-skim and take the
  highest margin customers, the incumbents will
  suffer real losses and if they raise rates across
  the board to cover losses, more customers will
  have incentives to go to a new entrant

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Solutions

• 1. Rate rebalancing before entry. Whose rates
  get raised? Rural and residential. Not very
  politically feasible.
• 2. Allow incumbent new revenue sources to account
  for losses in local.

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Long distance and cable as new sources of revenue

• Is this feasible? If customer want
  one-stop-shopping and IXCs already have account
  executives for most large businesses, IXCs might
  win out.
• Cable does not look very profitable to a new
  entrant right now. Also what about content?

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Competitors than IXCs

• CLECs
• Cellular
• PCS
• Cable
• Electric Companies?
• Others?

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Current Cellular Technology

• FCC gave away rights to radio spectrum 25MHz to
  each of two carriers creating a duopoly in each
  market. One license went to wireline company the
  other based on merit and hearings, then
  lottery.
• Systems were analog at first. Recently moved to
  digital. Two competing technologies - TDMA 3x
  capacity. CDMA 10X capacity.

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Current Cellular (contd)

• Cellular to date has been a complement rather
  than substitute to wireline. Tradeoff of price
  to mobility.
• Cost of copper wire local loop is about 1800.
  Cost of cellular system 700 per subscriber.
  Cellular use rates 40-50 cents per minute. (Costs
  continue to decrease.)
• Marketing is 600 per sub and general
  administrative 140 per sub. LECs spend less
  than 100 on both. Usage costs are higher though.
  And you pay to receive calls.

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PCS

• FCC auctioned off 3 30 MHz blocks and 3 10 MHz
  blocks in each of 51 MTAs raising 7.7 billion
• ATT won 19 Sprint PCS won 29 covering 3/4 of
  US PCS Primeco won 11.
• Cheaper to provide than existing cellular and
  digital from start

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Cable

• Telephony overbuild cost 300-745 per sub.
• Still technical diff. Going from one-way to
  two-way network.
• Poor customer service and high marketing cost may
  prevent high take rates

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VoIP

• Voice quality has improved
• Premises equipment is cheap
• No Taxes or fees
• No Access Charges?
• 911 Emergency Service

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Can/is the local market contestable?

• Will rate increase above LRIC cause enough
  customers to switch that it makes in unprofitable
  for the LEC to do so?