CASE NO. 8715
1__
I.
INTRODUCTION
Q.
PLEASE STATE YOUR NAME AND BUSINESS ADDRESS.
A.
My name is John W. Mayo. My address is Department of
Economics, The University of Tennessee, Knoxville, Tennessee.
Q.
ARE YOU THE SAME JOHN W. MAYO WHO FILED DIRECT TESTIMONY IN
THIS PROCEEDING?
A.
Yes.
Q.
WHAT IS THE PURPOSE OF YOUR TESTIMONY?
A.
I have been asked by AT&T to review and comment on the
testimonies of the other parties in this case.
testimony will focus on
In particular, my
key areas that were either
insufficiently or incorrectly addressed by the other parties to
this case in their direct testimony.
To do so, I will first
offer several general observations that may be gleaned from the
direct testimonies in this case. Second, I will address arguments
made by various parties that either (1) it is unnecessary to
establish efficient carrier access rates in this proceeding, or
(2) the prevailing access rates are in any sense defensible.
Third, I will address the adequacy of the "safeguards" that have
been proposed in the various alternative regulation proposals
that have been proffered.
Finally, I will address some
miscellaneous concerns that stem from the testimony of other
parties.
II.
Q.
GENERAL OBSERVATIONS
IS THERE AGREEMENT THAT ANY ALTERNATIVE REGULATION PLAN FOR
BELL ATLANTIC-MARYLAND (BA-MD) SHOULD BOTH PROMOTE AND
PROTECT COMPETITION?
A.
Yes.
In my direct testimony, I pointed out that a
competition enabling policy -- one that acts both to promote and
protect competition -- is vital to the development of a
successful alternative regulation policy. This view is predicated
upon the belief that policies designed to promote effective
competition and to protect the competitive process are ultimately
the most desirable and most likely to best promote the public
interest in Maryland.
Several other witnesses expressed
support for these underlying tenets of my testimony.
For
example, Staff witness Mr. Waldau states "the goal of price cap
regulation should be to promote economic efficiency, which
includes regulating prices so that they emulate economic
performance of competitive markets as closely as possible until
effective competition exists.1
The goal should also be to
encourage the transition to competition where feasible."2
Similarly, BA-MD witness Professor Kahn notes that the Commission
should "continue its efforts to create the necessary conditions
for competition ubiquitously in telecommunications and to be
prepared to abandon direct regulation wherever those efforts
succeed."3
Dr. Johnson, who testifies on behalf of OPC, also
notes that "effective competition does not always prevail in our
1
See Direct Testimony of Geoffrey Waldau ("Waldau Direct") at
13.
2
3
Id.
See Direct Testimony of Dr. Alfred E. Kahn ("Kahn Direct") at 7.
economy, but it represents an ideal to strive towards, since it
provides a high degree of efficiency and equity."4
Q.
DO THE PARTIES TO THIS CASE AGREE THAT THE MERITS OF AN
ALTERNATIVE REGULATION PLAN DEPEND CRITICALLY UPON THE
STARTING RATES THAT ARE ESTABLISHED FOR BA-MD?
A.
Yes.
The consideration of an alternative regulatory
plan for BA-MD provides a golden opportunity for the Commission
to fully avail itself of the opportunity to promote and protect
competition by establishing an efficient, competitive-like set of
prices at the outset of the price cap plan.
In the case at hand,
there is disagreement about what those beginning prices should
be, but there appears to be a virtual consensus on the importance
of establishing a suitable set of beginning prices for the
alternative regulatory plan.5
Q.
A.
DO THE PARTIES AGREE THAT SAFEGUARDS SHOULD BE AN IMPORTANT
ELEMENT OF ANY ALTERNATIVE REGULATION PLAN THAT IS ADOPTED
IN MARYLAND?
Yes, while there is disagreement about the speed or
conditions under which the Commission may safely move to
eliminate direct regulation of the services of BA-MD, there
appears to be little disagreement with the proposition that an
adequate set of competitive safeguards are necessary for any
successful alternative regulatory plan.
I discussed the need
for, and nature of, such safeguards at some length in my direct
4
See Direct Testimony of Ben Johnson, Ph.D. ("Johnson Direct") at
8.
See, e.g., Affidavit of Alfred E. Kahn, p.11; Johnson Direct at
25-26; Waldau Direct at 22-23.
5
testimony.6
Other parties also acknowledge the need for such
safeguards.
For example, Mr. Waldau notes that "Competitive
safeguards are needed to ensure that new competitors have a fair
opportunity to compete."7
Similarly, Dr. Johnson of OPC notes
the need for safeguards 8.
BA-MD implicitly acknowledges the
importance of competitive safeguards by including the claim that
the safeguards embedded in the
BA-MD proposal will "encourage
the growth of full and fair competition...."9
MCI's economist,
Dr. Cornell, also acknowledges that "[c]ompetitive safeguards are
an absolute necessity if the prices for essential monopoly input
functions are not set at direct economic cost."10
Safeguards are nothing new to this Commission,
since appropriate safeguards have been a part of each flexible
regulation plan since 1988.11
I will discuss the adequacy of the
proposed safeguards later in my testimony.
For the moment
though, it is important to recognize the consensus that any
Commission plan for alternative regulation must embody an
adequate set of competitive safeguards if the new regulatory
6
7
8
9
See Direct testimony of John W. Mayo ("Mayo Direct"), pp. 8-20.
Waldau Direct at 22-23.
Johnson Direct at 85-86.
See Direct Testimony of Daniel J. Whelan ("Whelan Direct"), at
16.
See Supplemental Direct Testimony of Dr. Nina W. Cornell
("Cornell Supplemental Direct") at 89. Perhaps, inadvertantly, the
implication of Dr. Cornell's passage may be taken to mean that, if
prices are set at economic cost, then competitive safeguards are
unnecessary. While this is true of imputation, other competitive
safeguards (e.g., unbundling and resale) remain necessary.
11
See In the Matter of C&P of Maryland Proposal for Regulatory
Reform Trial, Case No. 8106, Order No. 68115, June 30, 1988.
10
regime is to accomplish the goals established in the guiding
legislation.
III.
CARRIER ACCESS PRICING
Q.
HAVE YOU REVIEWED THE PROPOSED ADJUSTMENTS TO CARRIER ACCESS
PRICING THAT ARE EMBEDDED IN THE VARIOUS ALTERNATIVE
REGULATION PLANS?
A.
Yes. Both the Staff and MCI plans make significant
adjustments to the price of carrier access central to their
proposals for alternative regulation.
In contrast, BA-MD
proposes to retain the current access charge rates until 1998 and
allow for price increases after that time by up to the annual
rate of inflation less 1.5 percent.
Finally, the OPC plan
acknowledges a need for carrier access charge reductions, but
balks at the prospect for the changes advocated by Staff and MCI.
Q.
WHAT IS THE RATIONALE FOR THE REDUCTIONS IN CARRIER ACCESS
RATES PROPOSED BY STAFF AND MCI?
A.
The rationale is severalfold.
As Mr. Waldau notes,
reductions in switched access rates to the levels embodied in the
rates for local call termination will promote economic efficiency
and reduce retail rates.12
My only quibble here is that, while it
is true that there will be "long-run" benefits from the
competition sparked by competitive input pricing, consumers will
also clearly benefit in the short run as reductions in carrier
access charges lead directly to reductions in toll rates for
Maryland consumers.
Similarly, Dr. Cornell notes that "Unless
[the rates for the monopoly switched access functions] are set at
direct economic cost, interexchange markets cannot bring rates
for interexchange offerings down to social cost, but will
12
Waldau Direct at 94.
continue to hold rates for these services above that level."13
The approach adopted by these parties is highly congruent with
the economic guideposts that I offered in my direct testimony.
In particular, I pointed out that by reducing the price of
carrier access services to reflect its underlying incremental
costs, several specific benefits inure to consumers, including
the promotion of allocative efficiency, the sending of correct
price signals to consumers, and the generation of efficient
signals to potential investors regarding the costs that are being
incurred by incumbent firms to provide the service.
In sum, the
proposed adjustments to the price of carrier access charges being
proposed by Staff and MCI are entirely warranted on economic
grounds.
Q.
WHAT POSITION HAS OPC TAKEN WITH RESPECT TO THE PRICE OF
CARRIER ACCESS CHARGES?
A.
OPC, too, recommends that access charges be reduced.
The rationale proffered by OPC is, however, somewhat peculiar and
is atavistic in its treatment of carrier access charges.
Specifically, rather than viewing the establishment of efficient
carrier access prices as a necessary prerequisite to the
promotion of economic efficiency, competition, and the
realization of consumer benefits, OPC seems to view the desire
for access charge reductions simply to spring from its belief
that BA-MD is in a position of overearning.
Consequently, and
without specific justification, OPC recommends that the prices of
essentially all BA-MD services, including carrier access, be
13
Cornell Direct at 38.
dropped by the same 23 percent across the board.14
The result of
this exercise is that the price recommendation for carrier access
by OPC fails to fully promote economic efficiency, competition,
universal service, and the consequent realization of consumer
benefits that stem from these goals.
Q.
HOW DO YOU EVALUATE THE NOTION BY OPC THAT, ON THE BASIS OF
COST ALLOCATIONS, THE PRICING OF CARRIER ACCESS AT
PREVAILING OR ONLY MODESTLY REDUCED LEVELS CAN BE DEFENDED?
A.
The notion of establishing prices based upon allocated,
or fully-distributed, cost which is embraced by OPC, has been
thoroughly rejected by the mainstream economics profession.15
Indeed, there are a variety of
reasons for this rejection.
First, such allocations are inherently arbitrary and would only
coincide with economically efficient prices by the most remote
random possibility.16
Second, in the event that regulated markets
are opened to entry, cost allocation-based pricing is quite
likely to lead to distortions in competition.
Specifically, cost
allocation-based-pricing methods force a deviation of prices from
incremental cost that sends inappropriate and inaccurate signals
to both consumers and prospective new entrants regarding the
costs of incrementally providing the service.
Third, because
Johnson Direct at 73, lines 7-10.
See, e.g., Ronald R. Braeutigam "An Analysis of Fully
Distributed Cost Pricing in Regulated Industries," Bell Journal of
Economics, Vol. 11, 1980, pp.182-96; George Sweeney "Welfare
Implications of Fully Distributed Cost Pricing Applied to Partially
Regulated Firms," Bell Journal of Economics, Vol. 13, 1982, pp.525533; and William J. Baumol, et al., "How Arbitrary is 'Arbitrary?' -or, Toward the Deserved Demise of Full Cost Allocation," Public
Utilities Fortnightly, September 3, pp. 16-21.
14
15
16
Ibid.
such allocations are based upon the judgment of the analyst, the
resulting prices are more likely to reflect the philosophical
beliefs of the analyst regarding a "fair" set of end-user prices
than if such allocations were excluded from the analysis.17
As a
result, any Commission that begins down the path of fully
distributed cost must be prepared to engage in endless debates to
determine the "fair" allocation of loop costs to be borne by the
price of subscription.
The alternative view, I believe embraced by most
economists, is that not only is economic efficiency most
clearly tied to marginal (or as it is typically measured in
the telecommunications industry, incremental) cost pricing,
but that it is also arguably "fair" for consumers to pay for
the costs that they cause to be incurred through the act of
becoming and remaining subscribers to the public switched
network.
Thus, the argument that such cost allocations are
necessary or desirable is surely incorrect as a logical
proposition.
Moreover, the cost allocations that have
historically kept carrier access charges high has been shown
Given the judgmental features of such allocations, one can,
independent of sound economic reasoning, question particular
applications as problematical if they do not yield the outcome one
desires. For example, according to OPC, one of the problems with
requiring telecommunications subscribers to pay for the costs caused
by that subscription (which include the cost of the loop) is that such
cost-causative pricing limits the extent of price reductions that are
available for local exchange customers. See Prepared Testimony of
Trevor R. Roycroft ("Roycroft Direct") at 21.
17
empirically to have virtually no beneficial effects on the
achievement of universal service.18
See David L. Kaserman, et al., "Cross-Subsidization in
Telecommunications: Beyond the Universal Service Fairy Tale," Journal
of Regulatory Economics, Vol. 2, September 1990, pp. 231-251.
18
Q.
BUT WHAT ABOUT OPC'S CLAIM THAT THE COSTS OF THE LOCAL LOOP
IS A JOINT COST AND THEREFORE THESE COSTS MUST NECESSARILY
BE RECOUPED THROUGH AN ALLOCATION MECHANISM?
A.
I disagree.
It is well-known in the economic analysis
of the telecommunications industry that there is a well-defined
demand for, and supply of, access to the telecommunications
network.
The costs of providing that access can, and should, be
borne by the consumers that cause these costs to be incurred.
Q.
DOES THE USE OF "SHAPLEY VALUES" RECTIFY THESE PROBLEMS?
(ROYCROFT DIRECT AT 26-28)
A.
No.
I am unpersuaded that employing the concept of
"Shapley Values" circumvents any of the well-known problems with
other fully distributed cost methodologies. For instance, while
the development of "Shapley costs" are alleged to "create an
incremental cost estimate," it is clear that such estimates are
based upon cost allocation methods that have nothing to do with
the key concept of incremental cost analysis -- cost causation.
Instead, costs are allocated to various services based upon the
assigned probabilities of a consumer subscribing to a particular
service.
Given Dr. Roycroft's two-service assumption, each
service is "assigned"
50 percent of the shared loop costs.
This
allocation is, of course, no more defensible from an economic
perspective than the allocation of such costs to a particular
service on the basis of relative revenues, minutes of use,
occurrence of directly attributable costs, income of the
subscriber or any other allocator.
It is because of this
arbitrary nature of such allocation schemes that the economic
profession has been so critical of their use for pricing
particular services.
Q.
HOW DO YOU RESPOND TO THE CHARGE THAT, IF ALL SERVICE PRICES
OF A LOCAL EXCHANGE CARRIER WERE SET EQUAL TO DIRECT
ECONOMIC COSTS, THE FIRM WOULD NOT BE FINANCIALLY VIABLE?
(ROYCROFT DIRECT AT 13)
A.
It is important to put this discussion in perspective.
In my direct testimony, I pointed out that there are a number of
benefits from establishing competitive-like prices.
Where
competition is effective, this task is best left to market
forces.
Thus, any alternative regulatory mechanism adopted by
the Commission should permit BA-MD the opportunity to demonstrate
that a service faces effective competition and, once having made
such a showing, permit it to enjoy price flexibility. Where,
however, services continue to be supplied under conditions of
significant monopoly power, market forces cannot be relied upon
to generate competitive prices.
In such cases, direct regulation
of prices -- with a competitive market guidepost of incremental
cost -- provides a very compelling target upon which to base
prices.
Indeed, it is firmly established that in competitive
markets prices are driven toward, and in long run equilibrium to,
marginal cost.19
I have earlier described a host of economic
benefits from such a pricing philosophy, including, inter alia,
See, for example, Paul A. Samuelson and William Nordaus,
Economics, Twelfth Edition, McGraw-Hill Book Company, New York, 1985,
pp. 480-488.
19
the promotion of economic efficiency, competition, and proper
investment and entry signals.20
The issue raised by OPC, then, must be seen not as a
rebuttal of these benefits, which are, I believe,
essentially incontrovertible, but rather a challenge to
incremental cost-based pricing on practical grounds.
Specifically, it is asserted that if the prices charged for
all the firm's services are set equal to incremental cost,
the financial viability of the regulated firm may come into
question.
To my knowledge, however,
none of the proposals
in this case, including both Staff and MCI's plans, propose
setting all of the firm's products equal to their respective
incremental costs.
It is my understanding that the Staff
and MCI plans call only for the establishment of incremental
cost-based prices for carrier access that remains subject to
supply under conditions of significant monopoly power.
Moreover, under both the Staff and MCI plans, increased
incentive to earn profits and the latitude to retain those
profits is afforded BA-MD, as it is able to operate in a
price cap environment.
Specifically, under any of the
proposed alternative regulatory regimes, BA-MD will be able
to retain earnings and will be able to transition
effectively competitive services into widespread pricing
In this vein, see also, Samuelson and Nordaus, ibid, who state
"Only when price of goods are equal to marginal cost is the economy
squeezing from its scarce resources and limited technical knowledge
the maximum of outputs."
20
flexibility.
Also, as noted by Mr. Wood and Mr. Dionne,
the amount of contribution in excess of the incremental
costs incurred by BA-MD remains high and the financial
viability of BA-MD is not seriously challenged by adopting
efficient pricing of carrier access.21
21
Wood Rebuttal at 10 ; Dionne Rebuttal at 14.
Q.
A.
ARE THERE OTHER TECHNICAL REASONS WHY DR. ROYCROFT IS
TROUBLED BY THE IDEA OF ESTABLISHING THE PRICE OF CARRIER
ACCESS TO REFLECT ITS INCREMENTAL COST?
Yes.
Another, somewhat technical, issue raised by Dr.
Roycroft (p. 13) centers around whether local exchange companies
remain subject to pervasive economies of scale and scope.
If
such economies exist to the point of creating natural monopoly
supply conditions, as appears to be Dr. Roycroft's belief, then
it is true that establishing all of the firm's services at their
incremental costs will result in a revenue shortfall for the
firm. With respect to this potential for natural monopoly, I am,
however, considerably more agnostic than Dr. Roycroft.
In
particular, recent economic evidence has appeared to suggest that
the local exchange companies are not subject to pervasive
economies of scale and scope and that, as a result, they are not
natural monopolies.22
Presumably, policymakers also agree with
this assessment, as they have increasingly embraced the notion of
the desirability of competition in telecommunications markets.
Given the prospect that the market is capable of
sustaining competitive-like prices, it would seem to be
unnecessary for this Commission to maintain contributionladen carrier access prices to protect the financial
viability of a firm under a "natural monopoly theory" of
revenue shortfall.
Indeed, a significant risk of such a
See Richard T. Shin and John S.Ying, RAND Journal of Economics,
"Unnatural Monopolies in Local Telephone," Vol. 23, Summer 1992, pp
171-183.
22
strategy is that by ladening such input prices with such
"make-whole" revenues, the incumbent firm is essentially
protected from having these revenues and any excess costs
that lie behind them competed away.
The result of such an
approach, then, would be that the incumbent would be "made
whole" but at the cost of diminishing, or even removing, the
prospects for competition.
I cannot imagine that such a
policy is what the Maryland Legislature had in mind when it
indicated that an alternative regulation plan adopted by the
Commission should be one that "encourages the development of
competition."23
Q.
A.
IS OPC CORRECT IN ITS CLAIM THAT PRICES FOR LOCAL EXCHANGE
SERVICE THAT FULLY REFLECT THE COST CAUSED BY SUBSCRIPTION
WILL CAUSE PRICES FOR LOCAL SERVICE TO BE INFLEXIBLE?
(ROYCROFT, P. 22)
No.
The establishment of a price cap regime, which is
embodied in the plans of Staff, MCI, BA-MD, and OPC all allow for
price flexibility of local exchange services.
The lower bound on
such price decreases is properly determined by the TSLRIC (or, as
necessary, an imputed price floor).
Q.
DR. JOHNSON ARGUES THAT RATE INCREASES FOR TERMINATING
ACCESS COULD "FUND A REDUCTION IN ORIGINATING RATES." DO YOU
AGREE?
A.
No.
The notion that the Commission can address the
problems caused by the present level of access charges simply by
raising some carrier access prices and reducing others is a
throwback to a time when the rates of a regulated monopoly could
23
Md.Code Ann. art.78, Sec. 69(e) (1995)
be manipulated to accomplish perceived social goals without
distorting competition.
That time is gone.24
The solution today
to the problem of inefficient pricing of carrier access is not to
tweak the rate structure of carrier access charges in hopes of
either (1) preserving revenue flows to the incumbent LEC, or (2)
making it more difficult for competition to work to reduce
interexchange prices.
Rather, the solution is straightforward --
to establish a set of price levels that accurately reflect the
incremental cost imposed by additional purchases of carrier
access service.
Q.
DR. JOHNSON ARGUES THAT INCREASES IN COMPETITION "SHOULD
EVENTUALLY DRIVE DOWN THE OVERALL LEVEL OF SWITCHED ACCESS
RATES."25 CAN YOU COMMENT?
A.
costs.
Yes.
Competition does act to drive prices toward
The problem with Dr. Johnson's apparent advocacy of a
market-based solution to the overpricing of carrier access,
however, is that, as he correctly acknowledges elsewhere "The
evidence suggests that access markets are characterized by
monopoly conditions...."26
Moreover,
Dr. Johnson similarly
acknowledges that "'bypass' never grew as rapidly as predicted"
Indeed, the underlying logic employed by Dr. Johnson here in
advocating a rate design fix to the carrier access problem is
precisely the logic against which he objects when it is employed by
BA-MD to justify "rate rebalancing." Specifically, it is the belief
that it is acceptable to raise prices where competitive pressure is
lax (here, terminating access) to "fund" reductions in other rates
(here, originating access).
24
25
26
Johnson Direct at 47.
Johnson Direct at 47.
despite years of pricing access well in excess of its incremental
cost.27
Thus, to this point, there is essentially no evidence
that market forces can provide the competitive pressure necessary
to achieve efficient prices of switched access charges. To the
extent, then, that the present condition of the access market is
one of significant monopoly power, the assurance that competition
will "eventually" provide improvements in access charge rates is
small consolation to those who prefer to see an alternative
regulatory mechanism encourage competition as embraced by the
Maryland statute.
Q.
BA-MD HAS PROPOSED THAT CARRIER ACCESS RATES FACE A HARD CAP
UNTIL 1998. THEN RATES MAY INCREASE ACCORDING TO THE
INDEXED PRICE FORMULA. DO YOU AGREE WITH BA-MD'S PROPOSAL?
A.
No.
The present rates for carrier access are many
multiples of their corresponding incremental cost.28
Economic
efficiency can be readily and immediately promoted by reducing
these rates, so the idea embedded in the BA-MD plan to freeze
these rates would simply have the effect of locking in a set of
distortionary, economically inefficient rates.
Q.
MR. WHELAN APPEARS TO DEFEND THE PRESENT SET OF ACCESS
CHARGE RATES BY NOTING THAT THEY ARE "PRESUMED REASONABLE
UNDER THE LAW."29 DO YOU FIND THE PRESENT LEGALITY OF SUCH
RATES TO BE A BASIS UPON WHICH TO RETAIN SUCH PRICES?
A.
No. I am not a lawyer and, therefore, cannot offer a
legal opinion.
However, I would note that a variety of
economically indefensible rates and practices have historically
been legitimized under monopoly regulation as "reasonable."
27
28
29
Id. at 56.
Wood Rebuttal at 10-11.
Whelan Direct at 18.
It
seems altogether obvious that such rates and practices that may
have been held to be reasonable under a monopoly regulation
regime become unreasonable under a public policy standard of
promoting competition.
Moreover, I am surprised at Mr. Whelan's defense
of the present rate structure on the grounds that it is
consistent with history.30
In particular, Mr. Whelan argues that,
historically, regulatory bodies have "devised numerous mechanisms
to subsidize basic telephone rates and thus promote universal
service" and that "basic residential rates have also been set
residually.31"
While this characterization of the historical
pattern of pricing telephone services is true, it is precisely
these practices that must now be eliminated if competition is to
develop.
Indeed, Mr. Whelan implicitly acknowledges this fact
when he notes that it is these historical methods of pricing that
have led to a situation where "the rates BA-MD now charges are
out-of-balance in relation to costs."32
Professor Kahn, too, appears to embrace the proposition that
historical regulatory policies preclude efficient pricing on a
forward-going basis. See Affidavit of Alfred E. Kahn at 16. To the
extent that Professor Kahn is correct that historical policies have
kept rates below their economically efficient levels, then the direct
solution would seem to be to take this opportunity to fix those rates
rather than perpetuating the current economically inefficient pricing
of carrier access rates.
30
31
Whelan Direct at 20.
Whelan Direct at 21. To the extent that rates are "out-ofbalance" with costs, and if, as claimed, rates for basic exchange
service in some areas are below their costs, then the public policy
merits of BA-MD's proposed price cap plan become even more
questionable since it fails to fix the problem.
32
IV.
SAFEGUARDS
Q.
MR. WHELAN CLAIMS THAT THE BA-MD PLAN ENCOURAGES THE
DEVELOPMENT OF COMPETITION THROUGH THE IMPOSITION OF
COMPETITIVE SAFEGUARDS. CAN YOU COMMENT?
A.
Yes.
Several aspects of the BA-MD proposal fall short
of the standard of encouraging the development of competition.
Most notably, BA-MD's failure to significantly adjust carrier
access prices misses the present opportunity to as fully as
possible "encourage the development of the competition."
As I
have stressed throughout my direct and reply testimonies, it is
unacceptable to maintain the present, grossly overpriced level of
carrier access charges as a baseline for the initiation of an
alternative regulation plan.
These services, that remain subject
to supply under conditions of significant monopoly power, are
priced at levels that are many multiples of their incremental
costs and, under the BA-MD proposal, there is no assurance that
such prices will ever approach their economically efficient
levels.
AT&T witness Mr. Darrah discusses in detail the
specific safeguards proposed by BA-MD witness Vaden, and the
safeguards that should be a part of any alternative regulatory
plan for BA-MD.
Q.
CAN YOU COMMENT ON MR. WHELAN'S CLAIM33 THAT COMPETITION IS
NOT HARMED BY THE RETENTION OF THE EXTANT CARRIER ACCESS
CHARGE RATES BECAUSE BA-MD IS "SUBJECT TO PAYMENT OR
IMPUTATION OF THE SAME [ACCESS] CHARGES" AS IXCS?
33
Whelan Direct at 19.
A.
claim.
There are at least two problems with Mr. Whelan's
First, the carrier access charges IXCs pay to BA-MD are
very real, explicit payments across companies that constitute
costs to the IXCs whether or not those costs are justified from
an economic perspective.
In contrast, the "payment" of such
charges by BA-MD to itself is not an explicit cost and therefore
is not in any real sense a payment to itself for the provision of
access.
Because such charges are not real costs to BA-MD, but
rather only an accounting fiction, it provides little solace on
the "competitive safeguards" front to say, as does Mr. Whelan,
that BA-MD is subject to the same payments as are the IXCs.
Indeed, the difference between the high price of access and its
much lower incremental cost flows to the benefit of BA-MD and its
shareholders.
Second, the assurance by Mr. Whelan that BA-MD is
subject to imputation is problematic given that the particular
imputation standard BA-MD proposes is inadequate. Specifically,
my understanding of the imputation requirement proposed by BA-MD
requires only that the prices charged will cover "the access
charges it imposes on interexchange carriers...."34
Yet, it is by
this time well established that for services where imputation is
appropriate, the retail rates should recover both the access
charge and the incremental cost of its own retail operations. By
omitting these latter costs from the imputation standard, BA-MD
has erred in the development of adequate competitive safeguards.
Attachment B to Petition of Bell Atlantic - Maryland, Inc. for
Adoption of a Price Cap Form of Alternative Regulation ("Petition") at
4.
34
Q.
A.
IN YOUR DIRECT TESTIMONY, YOU ADDRESSED THE NEED FOR, AND
THE GUIDEPOSTS TO, THE DETERMINATION OF THE LEVEL OF
COMPETITION. HAVE OTHER PARTIES SIMILARLY NOTED THE NEED TO
ESTABLISH A STANDARD FOR THE DETERMINATION OF EFFECTIVE
COMPETITION?
Yes.
There is widespread agreement that where
competition is effective, BA-MD should enjoy, and consumers will
benefit from, essentially all of the marketplace freedoms of
competitors with no significant market power.35
At the same time,
however, there is also widespread agreement that the time has not
yet arrived when BA-MD faces widespread effective competition for
the large majority of its services.
As a result, several other
parties have acknowledged the need to adopt an effective
competition standard for the movement of services into a
"competitive" basket.
Q.
A.
WHAT SPECIFIC STANDARDS FOR THE DETERMINATION OF EFFECTIVE
COMPETITION HAVE BEEN OFFERED BY BA-MD?
BA-MD has proposed a three-part showing to categorize a
new service or reclassify an existing service as "competitive."
("Competitive Service Standard"36)
Specifically, BA-MD proposes
to show that (a) entry into the market
for the service is
unimpeded by technical or legal constraints; (b) there are
economically viable competitors for the provision of the service;
Note though that the presence of significant monopoly power in
the provision of some of its services and effective competition in
others will require that competitive safeguards (e.g., unbundling and
resale) remain in place.
35
36
Attachment B, Petition at 1
and (c) like or substitutable services are available at rates and
terms of service which allow the market to assure that rates for
the service will be just and reasonable.
Q.
A.
CAN YOU COMMENT ON THE ADEQUACY OF THESE PARTICULAR
CRITERIA?
Yes.
The economic merits of classifying a service as
"competitive" turn upon an accurate determination of whether a
service faces effective competition or not.
In this regard, the
proposed criteria are a step in the right direction toward
creating such a filter.
They do not, however, fully reflect the
requirements for effective competition that spring from the
antitrust economic literature.
For example, while correctly
pointing the Commission toward an examination of technical and
legal barriers to entry, the BA-MD proposed criteria are
essentially silent on the matter of economic barriers to entry.
Additional marketplace information, suggested by the economic
literature on market power, point toward a more thorough set of
competitive criteria than are presently embodied in the BA-MD
"Competitive Service Standard."
Because of this looseness in the
BA-MD criteria, I believe that a more complete set of indicators
may be developed and implemented to determine whether a
particular service provided by BA-MD is provided subject to
effective competition.
Q.
WHAT SPECIFIC CRITERIA PROVIDE A RELIABLE BASIS UPON WHICH A
DETERMINATION OF "EFFECTIVE COMPETITION" CAN BE REACHED?
A.
The general guideposts for the determination of
"effective competition" were laid out in my direct testimony.37
A
specific set of criteria that I believe would provide the
Commission with a reliable basis upon which to determine whether
a service offered by BA-MD is effectively competitive include (1)
a determination of the breadth of the relevant market; (2) market
share characteristics of BA-MD in the relevant market;38 (3)
available evidence on the ease of entry and exit; (4) factors
that facilitate or inhibit the ability of entrants and
competitors to expand capacity and capture sales; (5) factors
that facilitate or inhibit the willingness to switch providers;
(6) the price elasticity of demand in the relevant market; and
(7) market data on the percent of customers for whom choices are
available and the percentage who have availed themselves of such
choice.
I should note here that Staff has alluded to a similar
set of competitive filters such as the "supply and demand
elasticities, ease of competitive entry, availability of
comparable competitive services, customer awareness of
competitive choices, the amount of customer switching service
providers and fluctuations in market share, pricing trends, and
LEC pricing below price cap allowed levels."39
Q.
37
HAS THE STAFF OFFERED ADDITIONAL COMPETITIVE STANDARDS?
Mayo Direct at 9-10.
The need to exercise extrordinary caution in the interpretation
of market share statistics is well known. See, e.g., William M.
Landes and Richard A. Posner, Market Power in Antitrust Cases, 94
Harv. L. Rev. 937 (1981).
39
Waldau Direct at 83.
38
A.
The Staff has pointed toward the application of the
Herfindahl-Hirschman Index (HHI) as a mechanism to determine
whether a BA-MD service is competitive under any new price cap
regulation.
Q.
CAN YOU COMMENT ON THE STAFF'S APPLICATION OF THE HHI TO
DETERMINE WHETHER A SERVICE PROVIDED BY BA-MD FACES
EFFECTIVE COMPETITION?
A.
Yes.
Although the HHI has a longstanding history of
use in the antitrust arena, I am reluctant to embrace its
application in the context of a proceeding to determine whether a
firm (in this case BA-MD) enjoys significant monopoly power or,
alternatively, faces effective competition.
In particular, the
use of the HHI by the Department of Justice is primarily in the
context of merger analysis which is driven by Section 7 of the
Clayton Act. That statute is, however, widely perceived by
antitrust scholars to be a prophylactic law that is designed to
halt the development of market power in its incipiency.40 Such an
"incipiency" standard and the corresponding concentration
thresholds embodied in the DOJ/FTC Merger Guidelines are,
therefore, less applicable to an analysis of unilateral market
power held by an incumbent LEC.
V.
MISCELLANEOUS ISSUES
Q.
MR. WALDAU PROPOSES TO CONSIDER THE ADOPTION OF A
COMPREHENSIVE UNIVERSAL SERVICE FUNDING MECHANISM IN A
SEPARATE PROCEEDING. CAN YOU COMMENT?
See Roger D. Blair and David L. Kaserman Antitrust Economics,
Richard D. Irwin, 1985, p. 226.
40
A.
Yes.
The adoption of an alternative regulatory
mechanism provides a golden opportunity to take tangible steps
toward moving to an efficient universal service mechanism and it
is, therefore, vital that progress toward that effort not be
deferred.
In this regard, I am heartened to note that the
proposal by Staff recommends a three-part phase-down of the illconceived historical source of "funding" universal service.
Moreover, the reductions in long distance rates and the
stimulation to competition that will result from the
modifications to the historically distorted access charge rates
will act to stimulate household subscription in Maryland.
Thus,
the proposal by Staff, as well as the proposal of MCI, make
tangible and well-reasoned progress on the universal service
front.
The key in this regard is that the Commission take this
opportunity to end the grossly inefficient and ineffective method
of funding universal service that has historically imposed
distortions on the prices of upstream inputs that must be
purchased by downstream competitors.
In light of this progress,
the Commission could then take up additional universal service
issues, specifically the design of an efficient funding and
targeting mechanism in a separate proceeding.
If, however, the Commission chooses to move
forward with a universal service funding and distribution
mechanism at this time, I strongly recommend that it follow the
criteria for an efficient universal service mechanism that I
proffered in my direct testimony.41
41
Mayo Direct at 25-32.
Mr. Wood has begun to
describe in his testimony the tangible steps that are necessary
to operationalize these criteria.42
Q.
DR. JOHNSON ARGUES THAT IT WILL NOT PRECLUDE COMPETITION IF
THE PRICE OF AN UNBUNDLED LOOP SOLD TO LOCAL EXCHANGE
COMPETITORS IS GREATER THAN THE RETAIL PRICE OF LOCAL
EXCHANGE SERVICE. DO YOU AGREE?
A.
No.
Indeed, I am really quite surprised by Dr.
Johnson's logic here.
Unbundled local loops are potentially a
very important input into the provision of local exchange service
by competitors to BA-MD.
Yet, Dr. Johnson appears to be saying
that the viability of competition is unaffected if the price of
that input exceeds the retail rate for local exchange service. He
argues, in essence, that a set of input prices (i.e., the price
of the local loop) may be greater than retail rates because new
entrants can make up the difference by "other sources of
revenue".
The flaw in this reasoning, however, is at least
two-fold.
First, a vertical price squeeze is defined by a
situation in which a vertically integrated provider establishes a
set of prices for an upstream input such that the firm could not
profitably sell the downstream service (here, basic exchange
service) at prevailing rates if it were made to pay the same
price for the input that it is charging its rivals.
Thus, Dr.
Johnson's belief that unbundled loop prices in excess of retail
basic exchange rates are competitively acceptable is squarely at
odds with the concept of an anticompetitive vertical price
squeeze.
42
Second, the prospect of depending on revenue from other
Wood Rebuttal at 22-24.
"sources of revenue" may have been possible in a monopoly
environment, but is no longer acceptable in an era when public
policy must be driven to "encourage the development of
competition."
Public policy must allow for the emergence of
competition on its merits in individual service offerings through
the pricing of those offerings.
It is a huge stretch in this
situation to argue that competition is not denied because
revenues from other services may be used to make up the shortfall
caused by pricing unbundled loops at prices that exceed retail
rates.
Q.
DOES THIS CONCLUDE YOUR TESTIMONY?
A.
Yes.