What Went Awry?

Posted: 01/1998

What Went Awry?

By Charles C. Hunter

Somewhere access charge reform went terribly awry, particularly in the manner it
impacts small- to mid-sized interexchange carriers (IXCs). Expectations were great when
the Federal Communications Commission (FCC) initiated a rulemaking proceeding to address
what the agency characterized as the third leg of its competitive trilogy–the other two
legs being the restructuring of universal service support mechanisms and the
implementation of the local telephony provisions of the Telecommunications Act of 1996. No
one seriously disputed that interstate switched access charges were inflated well above
the economic cost of originating and terminating interstate, interexchange traffic. And
everyone agreed that the archaic access charge system cried out for restructuring, if for
no other reason than to eliminate the myriad subsidies which had been embedded in access
charges over time. But instead of benefiting from a long-overdue rationalization of the
FCC’s access charge structure, accompanied by dramatic reductions in interstate switched
access charges, small- to mid-sized IXCs are facing substantial increases in the cost of
access as a result of misguided access charge reforms.

What went wrong? Well first, the FCC opted to rely on market forces to drive access
charges toward cost, rather than simply prescribing immediate and substantial reductions
in current access charges. While the agency adopted a "prescriptive backstop" in
the event that market forces ultimately proved inadequate to produce cost-based rates,
this mechanism will not be triggered until 2001. The FCC clearly was counting on new
market entrants using unbundled network elements (UNEs) obtained from incumbent providers
to produce competitive exchange access offerings. However, recent actions by the U.S.
Court of Appeals for the 8th Circuit permitting incumbent local exchange carriers (ILECs)
to dismantle existing network platforms before delivering them to new market entrants as
UNEs, coupled with earlier 8th Circuit rulings denying FCC jurisdiction over UNE pricing,
have severely diminished the prospects for extensive use of UNEs by competitive LECs
(CLECs). And, given the dim prospects for full network-based competitive entry into the
local market in the foreseeable future, it is highly unlikely that access charges will be
driven anywhere near the economic cost of traffic origination/termination in the short

This is not to suggest that the FCC did not generate some immediate reductions in
access charges; indeed, ILECs reduced interstate switched access charges this past summer
by an aggregate amount approaching $2 billion. Nor is this to suggest the FCC did not take
any actions to prompt future access charge reductions. After all, the FCC did increase the
annual productivity (or X) factor for price cap LECs to 6.5 percent, thereby ensuring
annual reductions of this magnitude in inflation-adjusted access charges.

Here’s the problem, however. Most network service providers did not pass on to their
resale carrier customers cost savings resulting from the summer’s access charge
reductions. AT&T, for example, applied the bulk of its savings in access costs to
basic residential rates. Moreover, for resale and small- to mid-sized facilities-based
IXCs alike, other regulatory assessments and increases in the cost of access more than
offset any access charge reductions they actually received.

Take, for example, looming universal service assessments. All carriers now are required
to contribute significant percentages of their intrastate, interstate and international
end user revenues to support the provision of telecommunications services to economically
disadvantaged consumers and residents of rural, insular and high-cost areas, as well as
schools, libraries and rural health care providers. Beginning this month and continuing
every calendar quarter thereafter, all carriers will be required to pay 3.32 percent of
their aggregate interstate and international end-user telecommunications revenues and 0.9
percent of their aggregate intrastate, interstate and international end-user
telecommunications revenues. The sole positive elements in this otherwise dismal picture
are that the FCC originally estimated the universal service assessment would be nearly
double the above values and that, because assessments are made on end-user revenues,
resale carriers are less likely to be burdened with the contribution obligations of their
network service providers, as well as their own. While the assessment values will be
adjusted periodically, it is highly unlikely they will be reduced by any substantial
amount. Universal service assessments, however, are just the beginning of the bad news.

The FCC also has directed LECs to impose one of a number of preferred interexchange
carrier charges (PICCs) on IXCs for every access line presubscribed to them. The most
dangerous of the PICCs for small- to mid-sized carriers is the one applied to multiline
business customers. As of Jan. 1, the multiline business PICC is set at $2.75 per month;
thereafter, it will be increased annually by $1.50 as necessary. The imposition of a $2.75
(and ultimately higher) multiline business PICC alone likely will double the effective
cost of access for small IXCs, placing such providers between the proverbial "rock
and a hard place." The low-volume small business customers, which comprise the bulk
of small IXCs’ customer bases, will not be able to tolerate the dramatic rate increases
that a "pass-through" of the multiline business PICC would produce, and small
carriers have neither the traffic volumes over which to spread the new charges without
significantly increasing rates nor the operating margins within which to absorb those
charges. In other words, the multiline business PICC presents small IXCs with the
"Hobson’s Choice" of being devastated financially or devastated competitively.

The FCC, however, was not yet done with small- to mid-sized IXCs. Next, the agency
targeted tandem switching and tandem-switched transport. Because of their lower traffic
volumes, smaller IXCs are the primary users of tandem routing. To "facilitate the
growth of small IXCs to compete with larger carriers," thereby fostering a
"pluralistic supply in the interexchange market," the FCC years before had
mandated the availability of a "unitary" tandem-switched transport rate option.
The "unitary" option allowed smaller IXCs to purchase switched transport between
a serving wire center and an end office at a single, per-minute rate, with mileage
measured between the two offices without reference to the physical routing of the traffic
through the tandem switch. It, thus, provided smaller IXCs an affordable alternative to
the direct trunked transport available to high-volume carriers. In rationalizing its
access charge structure, the FCC inexplicably eliminated the "unitary" option.
As a result, smaller IXCs will pay significantly more for tandem-switched transport, given
that mileage measurements now will be based upon the actual physical routing of traffic.
Worse yet, the physical routing of traffic will be determined by the same ILECs against
whom smaller IXCs will be competing both in the local exchange and interexchange markets.

Complementing its elimination of the affordable "unitary" pricing option, the
FCC also increased the tandem switching charge by roughly 400 percent. In doing so, the
FCC blithely ignored the fact that current tandem switching charges roughly approximate
the interim cost-based rates for tandem switching developed by the agency in implementing
the local telephony provisions of the Telecom Act. As noted above, the primary users of
tandem routing are small- to mid-sized IXCs. Thus, it is the smaller carriers that will
bear the brunt of the massive inflation of tandem switching charges. The competitive
ramifications of burdening small- to mid-sized IXCs with dramatic cost increases, which
are readily avoidable by larger providers, are as devastating as they are obvious.

The picture is bleak, but all is not yet lost. A number of petitions urging
reconsideration of the level of the multiline business PICC, the elimination of the
"unitary" tandem-switched transport rate option, and the gross inflation of the
tandem switching element are currently awaiting action by the FCC. Indeed, the FCC
recently provided a measure of sought-after relief by reducing by nearly 90 percent the
multiline business PICC applicable to users of Centrex service. Petitions also are pending
before the FCC which urge the agency to permit telecommunications carriers to
"pass-through" the universal service assessment as a mandatory end-user
surcharge much like a tax, thus, mitigating potential competitive damage. And, of course,
dozens of appeals of the FCC’s access charge reform and universal service restructuring
have been filed by a broad range of industry and governmental segments in federal
appellate courts throughout the country.

Nonetheless, reality dictates that small- to mid-sized IXCs factor substantial
increases in access costs into their immediate competitive and pricing strategies, as well
as into their long-term business planning. Eventually, interstate switched access charges
may be driven toward the economic cost of traffic origination/termination, but for the
foreseeable future, access costs will rise, often dramatically, for smaller carriers.

The legacy of access charge reform unfortunately will be one of lost opportunities and
regulatory missteps. The damage to the heretofore most vibrant segment of the
interexchange community will not be known until the smoke clears, but it does not take a
soothsayer to anticipate the adverse impacts of regulatory actions that double, triple or
quadruple costs for smaller providers. The old joke of "we’re from the government,
and we’re here to help you" just isn’t very funny in the context of access charge

Charles Hunter is a principal in the Hunter Communications Law Group, Washington,
D.C., and serves as outside general counsel to the Telecommunications Resellers
Association. He can be reached at (202) 293-2500.

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