Collateral Damage

Posted: 4/2003

Collateral Damage
Line Sharing Surprising Casualty of
FCC Dealmaking

By Josh Long

at Covad Communications Co. were stunned by the Federal Communications
Commission decision to eliminate line-sharing requirements, particularly since
two Democrat commissioners apparently phased out the regulations in order to
make a compromise in its Triennial Review order governing telephone and
broadband policies.

"We were absolutely shocked and
baffled by how this played out," says Jason Oxman, assistant general
counsel with Covad.

Under the FCC’s order, line sharing
will be phased out over three years. During each year of the transition, the
price for the high- frequency portion of the loop will increase incrementally.
"New customers may be acquired only during the first year of this
transition," according to an FCC press release.

Three FCC commissioners voted to
eliminate the line-sharing requirements, even though two of those officials
actually wanted them to remain in place, according to a written statement and a
source familiar with the talks. FCC commissioner Kevin J. Martin, who reportedly
led the effort to block FCC Chairman Michael K. Powell’s plan to deregulate the
phone market, was the only official who seemed to back the line-sharing vote.

Even Powell — a big believer in
deregulation to spur investment and innovation — voted against eliminating the
line-sharing regulations, saying the action would result in higher broadband
prices and curtail the Bells’ incentives to invest in new infrastructure. FCC
commissioner Kathleen Q. Abernathy also backed Powell in his line-sharing

Oxman says the two Democrat
commissioners, Michael J. Copps and Jonathan S. Adelstein, sacrificed line
sharing in order to preserve the resale telephone regulations governing the
unbundled network element- platform (UNE-P)

"They didn’t do that as a
matter of substance … but for the need for compromise and that compromise is
nothing less than picking UNE-P and saying it is so important to us to preserve
UNE-P that it is worthwhile selling out broadband competition," Oxman says.

an interview in early March, Oxman was unsure whether Covad would challenge the
line-sharing order before an appeals court. The company was waiting to study the
official order to be published in late March or early April. He added,
"Based on what we have seen so far we believe this order would be [rife]
for judicial review."

Copps said in a written statement he
wanted to keep the line-sharing requirements, but voted to eliminate them as
part of a compromise.

"There are aspects of this
order that are certainly not my preferred approach, but which I have had to
accept in order to reach compromise," Copps said in a press release
accompanying the Triennial Review order. "In particular there is the
decision to eliminate access to only part of the frequencies of the loop as a
network element. I would have preferred to maintain this access, also known as
line sharing. I believe that line sharing has made a contribution to the
competitive landscape."

A person familiar with the talks
says Adelstein felt the same way, which means four out of the five commissioners
wanted to keep line sharing.

"It was not something he would
have done, but there were a lot of … moving parts to this order and there were
some compromises that had to be made and it did come down to the same things it
came down to for commissioner Copps," the person said.

Craig Clausen, senior vice president
of New Paradigm Resources Group, says he interpreted Adelstein’s written remarks
as wanting to preserve line sharing. "Four out of five commissioners would
have kept it which makes it [the decision] kind of perverse. But they voted
against it to keep the compromise in place on the other issues," he says.

Critics of the FCC’s ruling to
eliminate line-sharing requirements say it removes an incentive for the Bells to
upgrade their networks and will result in higher broadband prices for consumers.

One of the biggest critics is
Chairman Powell. "The decision to kill off this element and replace it with
a transition of higher and higher wholesale prices will lead quite quickly to
higher retail prices for broadband consumers," Powell said in his
dissenting remarks the day his agency voted on new broadband and telephone

The decision to eliminate
regulations that allow competitive broadband providers to share the copper loop
with the Bell companies hit Covad the hardest. The Santa Clara, Calif.-based
provider shares a line with the Bells when providing DSL to consumers, a
customer segment responsible for 40 percent of its revenue. Covad also provides
broadband service directly to businesses and partners as a wholesale DSL
supplier with AT&T Corp., Earthlink Inc. and other giants to penetrate the
consumer market.

A central question looms: whether
Covad will be able to negotiate favorable enough rates with the Bell operating
companies to justify remaining in the consumer marketplace. That remains to be

Covad’s Jason Oxman

"Our assumption [is] they have
a very powerful economic incentive to have us around as a revenue source,"
says Oxman. But what incentive would the Bells — the largest providers of DSL
— have to share a network component with a broadband rival? Oxman says the
Bells claim in regulatory proceedings they have spent hundreds of millions of
dollars to support a line-sharing architecture.

Covad would like to remain in the
residential market, but its ultimate decision will hinge on negotiations with
the incumbent phone companies and the parameters of the official order, Oxman

Companies such as Covad share the
incumbent’s loop, specifically the high-frequency portion, when providing
asymmetrical DSL to consumers. Covad pays $4 to $5 a month on average to share
the copper line, vs. the $13 to $15 a month it would have to pay to lease a
dedicated line, says Oxman.

Dave Baker, vice president of public
policy and law at Earthlink, says the FCC decision on line sharing "was
anti-competitive and anti-consumer" and "strikes a blow against the
limited wholesale DSL competition that has existed."

Earthlink, the No. 3 ISP with
780,000 broadband customers as of the end of last year, uses Covad as a DSL
vendor. But the company also taps other wholesale suppliers, including the Bells
and cable titans Comcast Corp. and Time Warner Cable.

In an industry otherwise
characterized by declining prices, consumers have not seen their broadband
prices drop as a result of the "monopoly pricing power of the broadband
owners," Baker says. Earthlink charges consumers $49.95 a month for DSL and
$41.95 for cable modem.

Some analysts say the FCC’s order
could result in higher broadband prices for consumers because companies such as
Covad may have to pass on additional fixed costs. But Yankee Group analyst Matt
Davis says, "I think the near-term impact on broadband will be fairly
negligible. It’s a MSO [cable] vs. ILEC game in the consumer space right

However, Covad is the largest DSL
provider behind the Bells, says a spokesperson. The company last reported a
total of 381,000 consumer and business lines, split equally.

There are other ways to access the
copper loop than through line sharing, phone giants AT&T and MCI resell
local phone service through the unbundled network element — platform and can
split the line into separate voice and data channels in order to provide DSL
service. Line splitting — the process by which two CLECs offer separate phone
and data services over the same line — is something AT&T is pursuing with

In January, AT&T and Covad
announced an agreement by which AT&T will tap its supplier’s network to
market DSL across the country. AT&T, the No. 1 long-distance company, has
about 50 million consumer customers. The arrangement expands upon a prior
agreement, by which Covad was provisioning AT&T-branded DSL in targeted
areas of the country to the phone giant’s dialup AT&T WorldNet Service

"That [new] agreement is
largely based on line splitting, which will enable us to bundle local services
with high-speed access," an AT&T spokesman says. "We haven’t
rolled that out yet."

Covad also is in commercial
discussions with other UNE-P providers to do line splitting, says Oxman.
However, line splitting represents a limited opportunity for the company because
most residential local phone customers still cut their checks to a Bell company.

WorldCom Inc.’s MCI, which has 2.8
million local phone customers, also could use a line-splitting arrangement.
WorldCom CEO Michael D. Capellas has indicated plans to introduce consumers DSL
"before too long," a spokesman says. WorldCom did not reveal its
timeline for the plan.


AT&T Corp.

Covad Communications Co.

Earthlink Inc.

Federal Communications Commission

Time Warner Cable

WorldCom Inc.

Yankee Group

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