Will the US Telecoms Act bring real local competition? Three years gone and still too soon to tell

WILL THE US TELECOMS ACT BRING

REAL LOCAL COMPETITION?THREE YEARS GONE AND STILL

TOO SOON TO TELLTHOMAS J LONG*

Introduction

Having opted for competition as the vehiclefor best serving the needs of telecoms con-sumers,1 policy-makers on both sides of theAtlantic Ocean must grapple with the difficulttask of achieving robust competition for localexchange networks2 and services. In light ofthe enormous fixed costs involved in layingthe wires that run between telecoms switchesand each customer location, called the localloop, the problem is how to foster alternativesto the exchange networks and services offeredby the incumbent operators. The incumbents,of course, control ubiquitous networks withlocal loops serving all of the customers in theirservice areas, while their competitors beginwith no local loops. Legislators and regulatorsmust decide what rules they can fashion sothat competitors will be able to offer localservices that provide a meaningful choice interms of value and quality of service. In theUnited Sates and most of Europe, this isproving to be a far more difficult undertakingthan promoting competition for national andinternational calls.

More is at stake with this issue than justcompetition for local calls. Even in the UnitedStates, where for 15 years consumers havebeen required to choose a long-distancecarrier different from their local operator,many customers are expected to prefer aone-stop shopping approach for all of theirtelecoms services. Since the customer's firststop in obtaining wireline service must be alocal operator, the company that signs upthe customer for local service has a clearadvantage with respect to all other services,including potentially lucrative services suchas voice mail, wireless service, Internet accessand other high bandwidth services.

To date, the United Kingdom and theUnited States have taken somewhat divergent

approaches to promoting local competition.Until recently, the focus in the UnitedKingdom has been on promoting infra-structure competition, i.e. competition thatrelies on alternatives to the incumbent's localloop. In contrast, in the US Telecommunica-tions Act 1996 the United States has optedfor a multi-pronged approach, as will beexplained below.

The best means of promoting local compe-tition is likely to be a key issue in 1999 andbeyond as the European Union considers newtelecoms legislation. In addition, the UKregulator, OFTEL, has recently undertaken areassessment of the success of its policies topromote local competition, in the context offostering access to high bandwidth services.3

In these and other policy debates on this sideof the Atlantic, the success or failure of the USTelecoms Act is likely to be an issue. Now thatthe US Telecoms Act has passed its thirdanniversary (in February), it is a reasonabletime to assess the Act's progress.4

In considering the Act's results thus far, thefocus of this article will be the mass marketfor residential and small business customers.In both the United States and Europe, there islittle doubt that large business customers willbe blessed with ample choice of infrastruc-ture-based providers. The true test of a modelfor implementing local competition is howwell it accomplishes the far more difficult taskof providing meaningful alternatives for thecustomers without huge bills for telecomsservices.

Summary

After a very brief background description ofthe US telecoms industry, this article willexplain the Act's provisions designed to pro-mote competition and examine the extremely

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modest results thus far. It will then assess theprincipal reasons for the slow growth of localcompetition and will conclude with lessonsthat can already be learned from the USexperience. There are three important lessonsfor policy-makers on both sides of the Atlantic.First, a significant waste of resources can beavoided through clarity in defining stateand federal (member state and EU) roles.Secondly, legislators and regulators run therisk of harbouring unduly inflated expecta-tions for competition and deregulation andshould strive to keep their expectations incheck. Thirdly, in the course of their difficultand often frenetic work to promote compe-tition, regulators should not forget thatcompetition is not an end in itself, but rathera means to the end of satisfying customerneeds at the best possible prices.

Background to the US Telecoms Act5

The United States has opened its telecomsmarkets to competition in stages. In 1984, thegiant, privately owned Bell system monopolywas broken up into AT&T, a nationwide,long-distance operator, and the so-called BabyBells, regional monopolies. At the same time,long-distance calling ± both between statesand within states ± was opened to competi-tion.6 In this market, AT&T was the incum-bent. The Baby Bells were excluded in orderto prevent them favouring themselves in theprovision of access to exchange networks forcompleting long-distance calls.

In the long-distance market, AT&T and ahandful of other long-distance operators, suchas MCI (now MCI Worldcom) and Sprint, usetheir own facilities to transmit calls, except forthe local exchange networks owned by theBaby Bells and other local incumbents. For theuse of the local operators' exchange networksto originate and complete calls, the long-distance operators pay `àccess charges'' to thelocal operators. Other long-distance operatorsresell the services of the facilities-based, long-distance operators.7

Over the next dozen or so years, at varioustimes, individual states opened regional long-distance calling to competition.8 In these mar-kets, the Baby Bells are the incumbents, andlong-distance operators, including AT&T, aretrying to erode the Baby Bell's market share.

By the end of 1994, local markets remainedstate-sanctioned monopolies in almost all

states. In the US context, the local marketrefers to the basic subscription for telephoneservice, as well as the calls within one's localcalling area. Most residential customers in theUnited States have the choice of a single-ratelocal service option (called flat-rate service)which includes access to the telephone net-work and unlimited calls at any time of day inthe local calling area.9 However, for a lowermonthly charge, residential customers canelect to pay for local calls on a metered basis(measured-rate service).

By the end of 1995, several states had begunthe process of opening their local markets tocompetition.

Basics of the US Telecoms Act

In February 1996, President Clinton signedthe US Telecoms Act into law. Industry repre-sentatives were thoroughly involved in thedrafting of the Act's local competition pro-visions. Indeed, those provisions can fairly bedescribed as a Congressionally-brokered com-promise between the major camps in the UStelecoms industry at that time ± incumbentlocal carriers, long-distance operators, andwould-be infrastructure competitors, thelatter group being dominated in the legislativedebate by the cable television industry. Tohelp ensure that their respective views wereheard by Congress, all sectors of the industrylavished unusually generous campaign con-tributions on the key legislators.

The Act reflected a consensus amonglegislators and the industry that there shouldbe a national blueprint for opening localmarkets to competition, rather than 50 poten-tially different approaches by the states.However, as discussed below, the Act isunclear about how far the federal regulator,the Federal Communications Commission(FCC), may go in establishing national rulesfor local markets that had traditionally beenregulated by the states.

The linchpin of the Act is its three-prongedapproach to opening local markets. Challen-gers to the incumbents may choose one ofthree paths.

First, through resale, competitors can use theincumbents' faculties entirely, and simplyrebrand the local service as their own. In theUnited Kingdom, this would mean that acompetitor pays British Telecom (BT) a whole-

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Article Util. Law Rev., 10(4) Jul±Aug 1999

sale charge for the customer's line rental andlocal calls and the bills the customer directly forthose services. All of the customer's inter-actions would be with the competitor and thecustomer could therefore be oblivious of thefact that BT was actually providing the service.

Secondly, competitors can use their owninfrastructure (usually called facilities-basedcompetition in the United States). As discussedbelow, this is the approach to local competi-tion most actively promoted in the UnitedKingdom.

Thirdly, competitors can use a hybrid of theprevious two, called unbundled network ele-ment or UNE-based competition,10 which per-mits competitors to lease unbundled elementsof the incumbents' exchange networks and usethose elements in conjunction with facilitiessupplied by the competitor. The unbundlednetwork element (UNE) that Congress expec-ted competitors to make use of the most wasthe incumbent's local loop. A competitor whouses the incumbent's local loop would pay theincumbent a one-off and recurring wholesalecharge for the rental and then connect its ownfaculties to the incumbent's network on thecustomer side of the incumbent's switch. Callswould then be diverted to the competitor'sswitch. As with resale, the customer could beoblivious to the fact that any facilities of theincumbent were being used. The competitorwould be responsible for billing and all otherinteractions with the customer.

Thus, the US Telecoms Act offers altern-atives for competitors who find it infeasible toundertake the massive investment to buildnew local exchange networks, particularly toreach the mass market of residential and smallbusiness customers. For the mass market, thehope is that competitors will establish a marketpresence through either resale or UNE-basedcompetition and use profits to invest graduallyin alternative infrastructure ± a stepping stoneapproach to local competition.

The US Telecoms Act requires the incum-bents to co-operate to facilitate all three typesof competition. In a process that began imme-diately after the Act's enactment, incumbentshave been required to negotiate compre-hensive agreements with each competitor forthat competitor's use of, or interconnectionwith, the incumbent's local network.Unresolved disputes have been resolved byarbitration before state regulators.11 To guidethe negotiations and arbitrations, the FCC has

been charged with implementing rules to putflesh on the Act's skeletal requirements,12 andthe states have also been given authority tomake various determinations, most signifi-cantly, to set the final prices for resale,interconnection, and use of unbundled net-work elements.13 In practice, given theunsurprising reluctance of incumbents toconcede ground willingly to their competi-tors, most key issues have not been addressedthrough negotiation but rather through acombination of FCC and state regulations.

To give the incumbent Baby Bells anincentive to co-operate, the Act holds out theprospect that they could achieve their long-sought goal of entering the long-distancemarket if they satisfy a comprehensive check-list of requirements designed to ensure thatlocal markets are fully open to all three typesof competition.14

The Act's multi-pronged approach is incontrast with the UK's strong, early emphasison infrastructure competition. In 1996, shortlyafter the enactment of the US Telecom Act,OFTEL elected not to require local loopunbundling, on the grounds that it would dis-courage construction of alternative exchangenetworks and would undermine the cableoperators' investments in alternative exchangenetworks.15 Nor has OFTEL devoted mucheffort to making resale of exchange lines andlocal calls feasible. The European Union hasyet to direct member states to adopt aparticular approach for local competition.Similar to the United States prior to 1996,most member states other than the UnitedKingdom have thus far focused on compe-tition for national and international calls.Roughly half of the member states requiresome form of local loop unbundling.16

How well has local competitiondeveloped thus far?

Thus far, competitors have been unable tomake any appreciable inroads in the massmarket for residential and small businesscustomers. Unfortunately, the FCC's marketshare data fail to distinguish between themass market and the market for largebusiness customers. Even so, the data showthat competitors have thus far had verylimited success in the US local market.

With respect to resale, the FCC reports that,as of 30 June 1998, 1.5 per cent of the local



service lines of large incumbents were resold,less than half of those for the purpose ofserving residential customers.17 The percent-age of resold residential lines is likely toremain stagnant or even fall until the incum-bent's ordering interfaces are improved tofacilitate the processing of large numbers oforders from competitors at low cost.18

The FCC's data show that, as of 30 June1998, competitors were leasing unbundledlocal loops on only 0.2 per cent of the linesof large incumbents.19 This very low percent-age can only increase, as evidenced by FCCdata showing that competitors have enteredinto collocation20 arrangements that wouldpermit them to make use of 25 per cent and44 per cent of incumbent's residential andbusiness loops respectively. In the potentiallylucrative markets of the dominant incumbentin California (Pacific Bell), these numbers riseto 47 per cent and 64 per cent for residentialand business lines.21 In addition, in 1998 and1999, some competitors began forays into theemerging high bandwidth markets, by pro-viding DSL services over unbundled loops.22

This suggests that UNE-based competitionmay be important in enhancing the competi-tiveness of markets for high bandwidthservices.

With respect to infrastructure-based com-petition, the FCC estimates (guesses might bemore accurate) in a February 1999 report thatthree per cent of US lines are served bycompetitors using their own facilities.23 In theabsence of adequate data from the FCC,I would estimate that, as of April 1999,very few Americans (substantially less thanone per cent) could choose a facilities-based competitor for their home use. Cabletelevision providers have yet to prove thatthey can economically reach the mass marketfor voice service over their cable networks.Most customers served by facilities-basedcompetitors remain large business andgovernment users.

Further evidence of the limited progress inopening US local markets to competition isthe failure of any Baby Bell (as of April 1999)to gain FCC approval for entry into the long-distance market, despite numerous requestsby various Bells. This reflects a judgmentby the FCC (and most state regulators aswell) that the Baby Bells have failed to takeadequate steps to foster effective localcompetition. A typical assessment is theconclusion of the staff of the California

regulatory commission in an October 1998report that ``Pacific [Bell] has not opened itsmarket to an extent that allows [competitors]a reasonable expectation of serving the massmarket''.24

Why is local competition developingso slowly in the United States?

A variety of factors are contributing to thealmost complete absence of local competitionin the US mass market.

Disappointing performance of thecable industryMost notable in comparison with the UnitedKingdom is the absence of any significantcompetition from cable television operators.This difference owes to the fact that cablenetworks were deployed much earlier in theUnited States, before cable companies enter-tained any serious notions of entering thetelephone market. UK cable operators wereable to design their systems to have a copperwire, for telephony, and a coaxial cable, fortelevision, running into customers' premises.In contrast, US cable systems were designedonly for television service and have only thesingle coaxial cable going into homes. Eventhough it was know when the US TelecomAct was passed that US cable networks wouldnot enjoy the late-starter advantages of theirUK counterparts, Congress still hoped thatthe cable networks could be readily trans-formed into two-way voice networks. How-ever, because of technical problems inachieving the necessary transmission qualityfor conversations over coaxial cable, the UScable networks have proven more costly anddifficulty to upgrade for telephony thanexpected.25 Consequently, telephone serviceofferings by cable companies have beenextremely limited thus far.

With AT&T's acquisition in 1999 of the US'largest cable company, TCI, there may be arenewed push to upgrade the cable networksfor telephony. The cable industry claims tohave solved the technical voice transmissionproblems, and AT&T certainly has consider-able money to invest in upgrading cablenetworks. However, history has shown thatscepticism of the US cable industry's engin-eering boasts is warranted. It has yet to bedemonstrated on a large-scale basis thatexisting US cable networks can be upgradedto provide telephony on a cost-competitive



basis. It is possible that a combination oftechnical and financial factors may lead thecable operators to bypass the voice marketand instead focus on a market for which theyare well-positioned ± high-speed data andvideo services.

Federalism disputesSecondly, federalism issues have delayedconstruction of the detailed regulatory frame-work necessary for local competition. The Actis unclear about the extent to which Congressintended to redraw the boundary betweenfederal and state responsibility for telecoms.Traditionally, regulation of local services hasbeen reserved for the states, as part of theirjurisdiction over intrastate services.26 How-ever, because local networks are necessary forall telecoms services, both intra and interstate,the Act gave the FCC an increased role withrespect to regulating for the purpose ofpromoting local competition.

The uncertainty over the state-federalboundary arises from the fact that the Actconfers on the states responsibility for import-ant tasks, including setting rates for intercon-nection, unbundled network elements, andresale discounts27 and for arbitrating disputesbetween incumbents and competitors.28 At thesame time, the Act creates a national blueprintfor local competition and clearly envisions astrong role for the FCC in prescribing auniform national interpretation of the statute.29

Where the Act is not specific about who is incharge, both sides can make plausible claims tohaving exclusive responsibility.

In January 1999, the US Supreme Courtfinally resolved the overarching jurisdictionaldispute in AT&T Corp v Iowa Utilities Board.30

The court held that, where the Act did notspecifically reserve jurisdiction to the states,the FCC had full authority to establish regula-tions to interpret and implement the Act'slocal competition provisions. The majorityopinion considered the notion of a ``federalprogram administered by 50 independentstate agencies'' to be ``surpassing strange''.31

It is difficult to assess just how much delayhas resulted from the Act's jurisdictionaluncertainty. Regulations promulgated by theFCC were effectively blocked by an appellatecourt for two years, and the FCC wasdeterred from being more assertive by itslack of success at the appellate level. Moststates followed the lead set by the FCC's rules,

even when they were in legal limbo, but onlyafter fully reconsidering the issues. What isclear is that extensive litigation has takenplace at the state level that could have beenavoided if the Act had been clearer about theallocation of responsibility.

Need to construct a complex schemeof regulationTransforming local monopolies into competi-tive markets is a difficult enterprise thatrequires extensive and detailed regulation.Each of the three avenues for local competi-tion mandated by the Act requires regulatorsto establish new rules and rates and tosupervise the development of new technicalsystems.32 In this short space, it is possibleonly to give a flavour of the nature of thenecessary regulatory activities.

Resale, the simplest form of competition,requires state regulators to make the criticaldetermination of the ``resale discount'', themargin between the retail and wholesalerates. To make this decision, which the Actsensibly says must be made on the basisof avoided retail costs,33 regulators havetypically considered a variety of highlycomplex cost studies offered by the variousinterested parties. These studies must bereviewed with care, since the size of themargin will make or break this form ofcompetition, especially with respect to ser-ving the mass market. In addition, regulatorshave been called upon to assess the amount, ifany, of one-off charges that incumbents canassess competitors for processing a resaleorder. Furthermore, disputes have arisenover whether certain services must be resold,such as promotional offerings and otherservices that may not neatly fit the definitionof telecoms services, such as voice mail. Someof these disputes could have been narrowedor avoided altogether at the state level if theFCC's rule-making authority had been madeclearer in the Act.

UNE-based competition is far more com-plex than resale and consequently requiresmore complex regulation. Regulators mustdecide precisely which UNEs must be offeredto competitors and in what configuration.34

They must then determine the ongoing andone-off rates for these UNEs, again based onextremely complex cost studies.35 As withresale, the charges set by regulators willdetermine the extent to which UNE-basedcompetition will penetrate the mass market.



UNE-based competition also requires rules toensure that incumbents do not discriminateagainst or among competitors in makingspace available for collocation of competitors'equipment, as well as an enforcement mech-anism to police the rules.

One of the most significant barriers tolocal competition thus far has been the slowdevelopment by incumbents of suitable`òperations support systems'' (OSS), theordering interface between incumbents andcompetitors who wish to serve a customer viaresale or UNEs. OSS enables a competitor todetermine the state of the facilities at aparticular location, to place an order withthe incumbent, to know when the service willbecome available to the customer, and toensure timely repair and maintenance of thecustomer's service. Incumbents are requiredto provide service to their competitors equalto that which they provide themselves, yethave attempted to do as little configurationof their operating systems as possible andhave attempted to make the project seem ascostly and time-consuming as possible. Thus,regulators have had to devote significantresources to monitoring the incumbents'efforts and pushing them to do more.

Facilities-based competition also raisesa host of regulatory issues, such as inter-connection rates,36 telephone number port-ability, and the sharing of ducts, poles, andconduits. The United Kingdom has a longexperience with these issues, having beenworking at facilities-based competition since1984.

Overall, local competition requires newactivities and systems, such as number porta-bility and OSS, which create new costs and,hence, new cost recovery issues for regulators.Regulators must make the difficult judgmentof what costs have been caused by specialobligations associated with local competition.For example, absent regulatory scrutiny, itwould be easy for an incumbent to inflate thecost of OSS by including expenses for trainingand systems that it intended to implementanyway. Once the new costs have beenidentified, regulators must decide whetherthere needs to be special rules allowingfor the recovery of such costs (e.g. throughmandatory surcharges on customer bills orthrough one-off levies on competitors).Such cost-recovery decisions involve compet-ing considerations, such as fairly compensat-ing incumbents, minimising the costs to

competitors, and avoiding new chargeson customers who may never benefit fromlocal competition.

Foot-dragging by incumbentsCongress wisely conditioned incumbententry into long-distance markets on their co-operation in opening their local markets.However, this has not proven to be asufficient incentive to deter foot-dragging bythe incumbents. Instead, their actual incentivehas been to take only baby steps towardopening their markets and to claim that eachnew step satisfies the requirements for long-distance entry. For example, a report by thestaff of the California regulatory commissionfound that ``Pacific [Bell] designs solutionsonly to meet perceived legal requirements of[the Act]'', not to implement ``solutions whichtruly open the local market to competition''.37

The incumbents have been aided in thisstrategy by the vagueness of the Act, themassive resources they can deploy in pressur-ing regulators,38 and their political power. Asof April 1999, no Baby Bell had beenapproved for long-distance entry. However,their strategy may still prove successful in thatpolitical pressure could force the FCC to openthe door to the long-distance market soonerthan sound public policy would warrant.

Future prospects

The prospects for local competition in theUnited States are best considered by addres-sing the three methods of competition man-dated by the US Telecoms Act. In light ofpersistent questions about the ability of cableoperators to provide voice telephony service ona broad scale, the method by which mass-market customers are most likely to be reachedby competitors is UNE-based competition.

ResaleResale of local service is the weakest form oflocal competition in that it will exert the leastdegree of pressure on incumbents. Because thewholesale price paid by resellers is simply afixed discount off the retail price, resalepermits little if any, price competition. In moststates, the resale discounts that have been setthus far by regulators have not allowed anopportunity to undercut the incumbent'sprices. Similarly, by its very nature, resaleprevents resellers offering any features to thecustomer that differ from those included in the



incumbent's local service. Resellers can dis-tinguish themselves from the incumbent onlythrough innovations in billing, marketing andcustomer care. Consequently, even if a largepercentage of incumbent lines are somedayresold by competitors, this alone can beconsidered an effective constraint on themonopoly power of the incumbents withrespect to local service and networks.

Nevertheless, resale has a potentiallyimportant role to play in promoting morepotent forms of local competition and infostering competition in other telecomsmarkets. Resale is the least costly way for acompetitor to establish a presence in the localmarket, which may be necessary in order tobe competitive with respect to other down-stream services, such as long-distance,voice mail, and Internet service provision.In addition, as noted previously, resale canbe a stepping stone to other methods ofcompetition that involve more infrastructureinvestment.

The prospects for resale competition in theUnited States depend on the deployment ofsatisfactory OSS by incumbents and on theresale discounts and one-off charges set byregulators. In general, the discounts set byregulators have not been sufficient to coverthe potential resellers' costs, let alone, under-cut the incumbents' prices, but this couldchange if incumbents are forced to developeffective electronic ordering interfaces thatminimise the competitors' costs per customer.Because state regulators retain final responsi-bility for setting resale rates, some states mayhave more vibrant resale markets than others.Should the balance between resale rates andcosts in a state permit such competition, resalecompetition could penetrate all segments ofthe mass market.

Facilities-based competitionThis is potentially the most effective form oflocal competition in that, through control of alocal network completely separate from thatof the incumbent, a competitor should be ableto distinguish itself in price, service quality,and diversity of features and service offerings.Of course, it is also the most costly form oflocal competition and takes the longest todevelop.

For the foreseeable future, the hopes forfacilities-based competition in the US massmarket hinge on the cable operators.39 If they

can solve their technical problems, and theeconomics of upgrading their networks allowthem to offer a competitive price, cable com-panies have the potential to be a viable alterna-tive to the incumbents for voice telephony.However, one obstacle US cable operators faceis their reputation in many localities for provi-ding indifferent customer service. In addition,because US cable operators frequently raiserates for their television services, customersmay be concerned that the same pricingpolicies will apply to telecoms services. Con-sequently, cable operators may have to offer adistinctively more attractive package of pricesand services, including price guarantees, inorder to entice many customers to leave theincumbents.

The market for high bandwidth services isa different story. In this market, cableoperators are certain to be the incumbents'principal competitors through services of-fered via cable modems. Cable modemspermit very high-speed Internet access anddata transmission. (Indeed, because for theforeseeable future the cable operators willprobably be the major facilities-based com-petitors to the incumbents for high band-width services, there have been recent callsfor US regulators to require cable networks tobe opened up for use by competitors. Fornow, the FCC has rejected such demands.40)Thus, the choice for cable operators in theUnited States will be whether to competeagainst the incumbents for both voice tele-phony (narrow bandwidth) and fast Internetaccess (high bandwidth), or to focus onthe latter. In addition to the technical andfinancial considerations discussed above,this decision will also be influenced byperceptions of the importance to consumersof one-stop shopping for all telecomsservices.

For the foreseeable future, services offeredby mobile operators cannot be viewed as asubstitute for wireline telecoms services in theUnited States. Although use of mobile phonesis growing rapidly in the United States, as inEurope, mobile telephony remains a premiumservice with premium prices. Narrowbandwireline service provides highly superior datatransmission and Internet access and willcontinue to do so for the next few years.41 Inthe United States, the penetration rate of wire-line service is about 95 per cent, and few, ifany, customers are likely to give up their wire-line phones, which offer cheaper and morereliable service, in favour of a mobile phone.



Unbundled network element-basedcompetitionUNEs permit competitors to offer features andservices that differ from those offered by theincumbents without replicating the entirety ofthe incumbents' local networks. In the UnitedStates, this is a vital form of local competition,which offers the potential to generate price-competitive local service alternatives for manymass-market customers. If the Telecoms Acthad not included UNEs as an option for com-petitors, mass market customers could hopefor, at most, only one price-competitive alter-native ± the unpredictable cable operators ± tothe incumbents for local service.

UNEs will also be important in providing acompetitive alternative for high bandwidthservices. DSL, a family of high bandwidthservices, can be offered over the copper localloops used by the incumbents.42 As notedpreviously, some competitors in the UnitedStates have already begun to offer DSL servicesusing the incumbent's local loops to residentialand small business customers seeking fastInternet access.

The success and ultimate reach of this formof competition will depend on regulatorydecisions that are still being made in theUnited States. The final recurring and one-offprices for the UNEs, including local loops,will be the key determination. These prices, inconjunction with the efficiency of the compe-titors' own faculties and operations, willdetermine the extent to which competitorswill be able to undercut incumbent rates. Inaddition, regulators will need to ensure thatefficient and low-cost OSS interfaces areestablished and that incumbents are not ableto discriminate against their competitors withrespect to other technical issues, such ascollocation of equipment. With the SupremeCourt's recent Iowa Utilities Board decision,the FCC is sure to reassert itself as muchas it can in fashioning pro-competitiverules. Nevertheless, ultimate rate-makingauthority for UNEs still resides with stateregulators.

Even if regulators make pro-competitivedecisions, it should not be presumed that allresidential customers would be reached bymultiple, UNE-based competitors, let aloneany such operators. A competitor that isleasing an incumbent's local loop must stillprovide its own switching and other networkfacilities, which requires considerable invest-ment. Outside densely populated areas, it is

likely that only a small number of competitorswill undertake the investment necessary toreach mass market customers.

In sum, UNE-based competition will becritical in determining the nature and extentof local competition that results from theTelecoms Act. Final decisions that have yet tobe made by federal and state regulatorsregarding UNE prices, OSS requirementsand other technical issues will, in turn,determine the viability of this form ofcompetition.

Lessons

Need for clarity in defining state andfederal rolesIn telecoms, a structure in which regulatoryresponsibility is shared between federal andstate regulators has some important advan-tages, including promoting responsiveness tolocal needs and fostering experimentation.However, in the United States the divisionof responsibility has made regulation lessefficient than it would be in a centralisedstructure. Because of its vagueness, the USTelecoms Act has led to a significant waste ofresources in fashioning the regulatory struc-ture necessary for local competition.

The obvious lesson for both the UnitedStates and the European Union is for telecomslegislation to be as clear as possible in definingthe federal and state roles. The US TelecomsAct lacks a coherent principle for explainingthe division of responsibility it specifies. Forexample, states retain the all-important re-sponsibility for setting the prices which com-petitors will pay incumbents, yet the FCC (asinterpreted by the US Supreme Court) hasbroad responsibility for fashioning rules topromote local competition. There is no cleardividing line between these two spheres ofresponsibility. As a result, further clashes arelikely if the FCC, as can be expected, issuesrules that could be viewed as dictating to thestates the permissible prices they may set.

In the legislation that arises out of the1999 Review, the European Union would bewise to be as clear as possible about thedivision of responsibilities, to provide co-herent principles to explained divisionof duties, and to assign default responsibilityfor the inevitable instances in which thelegislation is unclear.



Fostering local competition requiresincreased regulation, not deregulationIn passing the legislation to President Clintonfor his signature, the US Congress describedthe Telecoms Act as a ``pro-competitive,de-regulatory national policy framework . . .''.43 In addition, the US media has typicallyreferred to the Act as one which ``dereg-ulates'' the US telecoms industry. One shouldnot ascribe too much importance to oftensloppy usage of the word ``deregulation'' inthe United Sates, which is frequently used todescribe the process of introducing compe-tition to an industry previously characterisedby government-sanctioned monopoly. Never-theless, the rhetoric of deregulation has alsocreated expectations on the part of many USlegislators and regulators that the Act willsignificantly reduce the need for regulation.Especially in light of the long time period thatappears necessary to bring about even mini-mal local competition, there is a danger thatunrealistic deregulatory expectations willcause a premature relaxation of regulationsnecessary to constrain the market power ofthe incumbents.

In the short-term at least, there is no questionthat promoting local competition significantlyincreases regulation. Since the US TelecomsAct was enacted in February 1996, federal andstate regulators in the United States have neverbeen busier, as they tackle a seemingly endlesslist of rate-making and rule-making tasks.Over three years laster, the work has notabated. The effort to erect the regulatoryapparatus for competition could easily con-tinue for a few more years in the United States,as the basic framework (e.g. final prices forUNEs and resale, collocation rules, universalservice funding) remains to be completed.Even when the basic framework has beencompleted, competitors can be expected toseek refinements to the rules and rates in orderto improve their capability to offer competitivealternatives. In addition, as high bandwidthservices become increasingly essential for dailylife, there may be a need to consider additionalregulatory measures to enhance competitionfor, and affordable access to, these services.

Even assuming that this current flurry ofrule-making and rate-making ultimately sub-sides, it would be wrong to assume that wewill reach the promised land of deregulation,for two reasons.

First, whatever competition emerges fromall this regulatory effort will not be dictated

solely by market forces, but rather will becontrolled to a significant degree by regula-tors. As noted previously, the success of resaleand UNE-based competition will depend onthe prices set by regulators for the use of theincumbents' networks and services. By settingthe prices for the inputs that competitorsneed, regulators will be able to make or breakcompetition with the stroke of a pen. This isno different from the current situation in theUnited Kingdom in which OFTEL is essen-tially in control of the balance between infra-structure and services competition by settingthe charges that indirect access operators mustpay British Telecom for the use of its network.A market in which regulated rates aredetermining the nature and extent of compe-tition can hardly be considered a deregulatedmarket.

Secondly, the currently foreseeable level ofcompetition for telecoms services for residen-tial and small business customers suggeststhat regulation of the incumbents' retail rateswill remain necessary for most mass marketcustomers for a long time. Thinking optimist-ically about the state of the US market in 2002or 2003, fortunate residential and small busi-ness customers in certain geographic areasmight have two or, at most, three alternativesto the incumbent for narrowband telephoneservice, only one of which would be afacilities-based competitor (i.e. a cable oper-tor).44 Even in such competitively blessedgeographic areas, the market will be charac-terised by a tight oligopoly in which theincumbent will have the dominant marketshare and be able to act as the price leader.Regulation of the incumbent's retail rates willremain essential in order to ensure that ratesfor telecoms services remain reasonable. Inother geographic areas with less competition,the need for retail rate regulation will be evenstronger.

The lesson here is to avoid creating falseexpectations that deregulation will result fromefforts to promote local competition. Creatinglocal competition requires extensive regulat-ory involvement, meaning that regulatorybudgets will have to increase, not decrease.Moreover, the extent of competition that canbe expected in mass markets will not besufficient to allow market forces alone toconstrain the retail rates of the incumbents. Ifpolicy-makers have unrealistic expectationsthat their competition policies will lead toderegulation, incumbents will attempt tocapitalise upon those expectations in order



to gain premature relaxation of necessaryregulations. Such a result would be harmfulto consumers, who would find that theextensive efforts to introduce local compe-tition had only increased their telephone bills.

Competition is a means, not an endIn the whirlwind of activity that is necessaryto promote local competition, it is easy forlegislators and regulators to forget thatcompetition is not the end, but rather ameans to the end. The ultimate goal is to provideall consumers an array of up-to-date, reasonablypriced, high quality telecoms services that meettheir needs in a telecoms-dependent society (Byarray of up-to-date services, I mean all theservices of which modern telecoms networksare capable: the ability to call anywhere in theworld; intelligent network features such ascall waiting, call forwarding, and voice mail;narrow bandwidth Internet access; and, as isnow becoming feasible for the mass market,high bandwidth Internat access. By array, I donot mean a selection of different servicepackages from different suppliers, all offeringessentially the same capabilities and distin-guished solely by different discounting andmarketing schemes.)

Having a choice of supplier is useful, butonly if choice furthers, rather than detractsfrom, the ultimate goal. Indeed, many cust-omers would quite rationally not considerchoice in itself to be a benefit. In hectic leviesthat are full of complex decisions, manyconsumers would rather not have to devotetime and effort to making another complicatedchoice. And if the existence of choice meansthat consumers must be vigilant monitors of aconfusing market place in order to avoidpaying more than the going rate ± which isthe case with long-distance competition in theUnited States ± then customers who lack thetime, inclination or ability to be diligentshoppers will be made relatively worse offby the introduction of choice. I stronglysuspect that most mass market customerswould prefer a single local service supplierwith lower rates than a choice of local servicesupplies, all of which offer higher rates. (I usethe qualifier most because it should beacknowledged that a small minority of massmarket customers would probably be willingto pay a premium simply for the ability tochoose between or among suppliers. Thesecustomers tend to be relatively affluent andsophisticated telecoms users ± often peoplewho are operating businesses from their

homes ± who have unconventional needsthat require special telecoms arrangements.For these customers, the ability to negotiatewith a competitor is valuable.)

The prevailing orthodoxy among policy-makers and regulators on both sides of theAtlantic is that competition is the best meansof securing the ultimate goal. The view is that,once the hard work of putting the necessaryregulatory framework is completed, a com-petitive market will result and the ultimategoal will automatically be achieved. This viewis coloured by the failure to ask what kind ofcompetition will result. Will it look like therobust competition that prevails among res-taurants and greengrocers or more like theweak competition among UK train operators?As discussed above, competition for localtelecoms is likely to be much closer to traincompetition, with alternatives to the incum-bent limited to one or two operators, whenchoices are available at all.

Example of the potential conflict betweenmeans and end: Should the incumbent'sretail rates be increased to promotecompetition?When robust competition cannot be expected,the choices that are made about how topromote competition can affect the extent towhich the ultimate goal is achieved. Thistension specifically arises in the context of theincumbent's regulated retail prices for localservice. In the United States, some incum-bents argue strenuously that the reason localcompetition has been slow in developing isthat their regulated local service rates are toolow and are preventing would-be competitorsfrom entering the market. Similarly, a recentreport prepared for DGXIII of the EuropeanCommission contends that EU member statesshould raise local line rental charges in orderto promote more infrastructure-based compe-tition.45

Such claims should be viewed with a highdegree of scepticism, for a variety of reasons.

First, they are usually based on the incorrectpremise that local services are receiving asubsidy from other services. The conclusionthat local services in the United States aresubsidised is based on the erroneous assump-tion that all of the considerable costs of thelocal loop should be deemed costs of localservice. The reality is that local loop costs areshared and common costs of all telecoms



services that use the loop. After all, servicesranging from national and international callsto call forwarding and voice mail all dependon the local loop. Telecoms suppliers mayprefer to recover all of their loop costs in aguaranteed, up-front charge, but they onlyneed to be recovered from sales of the fullpanoply of products and services madepossible through the loop. In relatively com-petitive markets (ranging from men's razorsto web browser software), it is common forfirms to be forced to keep the charges forinitial access or use low and to recover fixedcosts through other products and services thatcustomers are enticed to buy. If robustcompetition ever materialised for local tele-coms, I suspect that operators would competeto keep their basic subscription charges low inorder to attract customers, and then meet theirrevenue needs through aggressive marketingof the increasingly voluminous array offeatures and services available over the tele-coms network.

Secondly, even if all the fixed cost of thelocal loop are (incorrectly) assigned to localservices, such costs are often exaggerated.For example, the regulatory commission inCalifornia has found that Pacific Bell's actuallocal service costs (including loop costs) arefar lower than Pacific Bell had claimed. As aresult, Pacific Bell's revenues from localservices (including a relatively small portionderived from charges to long-distanceoperators) already cover its costs of localservice provision, plus almost all of the fullcost of its local loop faculties.

Thirdly, before the incumbent's local ser-vice charges are increased to promote compe-tition, thought must be given to the potentialsources of competition that are supposed tomaterialise once the rates are increased. Asdiscussed above, the only full-scale, facilities-based providers on the horizon in the UnitedStates are the cable operators, and UNE-based competition requires a sufficientlyhigh amount of investment so that fewcompanies can be expected to take advantageof this form of competition. It should not bepresumed that an increase in the incumbents'local service rates would bring any additionalcompetitors out of the woodwork. And, if theprice increase caused one of these potentialcompetitors to move off the fence and intocompetition, then an additional competitorwho is barely able to undercut the incum-bent's higher rates is hardly going to makemost customers better off.

Fourthly, regulators who increase incum-bent rates to promote competition may just beopening the door for inefficient competitors.Competitors, who are free of the priceregulations imposed on incumbents, shouldbe able to design their service packages tolimit the risk that their customers will beunprofitable. For example, competitors canoffer bundled service packages of local andnon-local calling and a variety of additionalfeatures for a flat charge designed to covertheir fixed local loop costs as well as theirvariable costs. If competitors cannot profit-ably take advantage of their relative pricingfreedom compared to the incumbent andneed a boost in the incumbent's up-frontcharges in order to survive, then suchcompetitors probably do not belong in themarket. Indeed, regulators can inflict con-siderable harm on customers if they createconditions that permit entry by inefficientcompetitors, who will then demand to beprotected from lower rates made possible byefficient competition.

In summary, in deciding what measures totake to promote local competition, regulatorsmust always ask whether a pro-competitiveoption would also satisfy the ultimate goal ofproviding an array of reasonably priced, highquality services that meet consumers' needs.In the case of raising the incumbent's localrates, the price to consumers is both high andcertain, and the potential incremental benefitslow and speculative.

* Senior Telecommunications Attorney, The UtilityReform Network (TURN), a non-profit consumeradvocacy organisation based in San Francisco,California. The author wrote this article whileresearching UK telecoms regulation as a 1998±99Atlantic Fellow in Public Policy based at theUniversity of Glasgow School of Law.

1. The proposition that competition is always the bestmeans of serving the varied interests of consumersis debatable, as I discuss at the end of this article.

2. In this article I will use the phrases ``local exchangenetwork'' and `èxchange network'' synonymouslyto refer to the networks that connect customerpremises with the first point of switching. Suchnetworks are also sometimes referred to as `àccessnetworks''.

3. OFTEL, Access to bandwidth: Bringing higher band-width services to the consumer (December 1998)(hereinafter OFTEN bandwidth consultation).

4. This review of the US Telecoms Act focuses solelyon its local competition provisions, which can befound in 47 USC } 251±261, and 271±276. The Actembraces several other subjects, including regula-tion of cable television services and broadcastservices.

5. A far more complete background of US telecomsregulation prior to the Act can be found in



Blumenfeld and Kunin, `Ùnited States'', in Long,C, Telecommunications Law and Practice, 2d edn(Sweet & Maxwell, 1995).

6. In US regulatory parlance, these were calls betweenlocal access transport areas (LATAs) or inter-LATAcalls, roughly equivalent to national calls in theUnited Kingdom.

7. In the US long-distance market, there are nowbetween five to 10 faculties-based operators andhundreds of resellers.

8. These are termed intra-LATA calls and can beroughly described as non-local regional calls.

9. In California, a local calling area is defined as alltelephone exchanges within a 12-mile radius of acustomer's ``rate centre''. A rate centre is a desig-nated location within the customer's exchange,often a post office or town hall, used to measurethe distance of a telephone call.

10. In US regulatory-speak, UNE is usually pro-nounced ``yunie''.

11. 47 USC ss 252(a), (b).12. 47 USC ss 251(d) (FCC authority to implement

regulations); 47 USC ss 252(c)(1).13. 47 USC ss 252(c), (d).14. 47 USC ss 271.15. OFTEL's Policy on Indirect Access, Equal Access and

Direct Connection to the Access Network (1996),paras 41±47. As this Statement explains, OFTELhas long required BT to allow other operators tooriginate calls on BT's network through `ìndirectaccess''. However, only in the last few years hasOFTEL reduced the charges that indirect accessoperators pay to BT sufficiently to permit a fewsuch operators to compete with BT for local calls.This competition for local calls is limited and existsonly because of the combination of low callorigination charges and BT's relatively high, localcall charges compared to the United States. Indirectaccess would not be a feasible form of localcompetition in the United States because callorigination and termination charges generallyexceed the low local call charges in the UnitedStates.

16. Lewin and Matthews, Access networks and regulatorymeasures: A final report for DGXIII (Ovum, 1998),sections 2.3 and 5.4 (hereinafter the Ovum Report).

17. Trends in Telephone Service (FCC, 1999), Tables 9.2and 9.3 (hereinafter FCC Report). In contrast, asnoted previously, there is a well-developed marketfor resale of long distance service in the UnitedStates.

18. As discussed below, this has been one of thesignificant impediments to local competition in theUnited States and is termed the Operations SupportSystems (OSS) issue.

19. FCC Report (op.cit., n. 15), Table 9.5.20. Collocation is the placement of a competitor's

equipment in close proximity to the incumbent'sfacilities, usually its switch, for the purpose ofdiverting calls to the competitor's switch.

21. FCC Report (op. cit., n. 15), Table 9.5. The percen-tages in these last two sentences represent only acapacity for UNE-based competition, certainly notan expected market share.

22. See, e.g. Responses to OFTEL's Bandwidth Consul-tation submitted by MCI WorldCom, text accom-panying nn. 10 and 11, and CovadCommunications. These can be found at http://www.oftel.gov.uk/isp/a2bresp.htm

23. FCC Report (op. cit., n. 15), p. 9±1.

24. California Public Utilities Commission Telecommu-nications Division, Final Staff Report, Re: Pacific BellNotice of Intent to File Section 271 Application forInterLATA Authority in California (1998), p. 2(hereinafter CPUC Final Staff Report).

25. A useful discussion of some of the issues involvedin upgrading existing cable networks and buildingnew networks can be found in the Ovum Report(op. cit., n. 16), pp. 50±53.

26. The general rule is that states have jurisdiction overintrastate matters and the Federal CommunicationsCommission (FCC) has jurisdiction over interstatematters. At the retail level, the lines are fairly clearand simple. For example, states regulate rates forflat and measured local service and for intrastatelong distance, while the FCC regulates interstatelong-distance rates. However, at the wholesalelevel, because the local network is used for bothintrastate and interstate services, the jurisdictionalrules are more complex. For example, to complywith the mandate of Smith v Illinois Bell TelephoneCo., 282 US 133 (1930), regulators have designed a``separations process'' which allocates the costs ofthe local loop between the state sphere and thenational sphere. The FCC is then responsible fordesigning a rate structure for interstate accesscharges (the charges paid by long-distanceoperators to local operators to originate andcomplete calls over local networks) which compen-sates the local operators for the interstate share oflocal loop costs. Similarly, state regulators areresponsible for establishing share structure thatcompensates local operators for the intrastate shareof local loop costs.

27. 47 USC ss 252(c), (d).28. 47 USC ss 252(b).29. E.g. 47 USC ss 251(d)(1) (charging the FCC with the

duty to fashion regulations regarding the incum-bents' obligations to open their networks for localcompetition).

30. US, No. 97±826, 25 January 1999. The decision canbe found at hhttp://supct.law.cornell.edu/supct/html/97±826.ZS.htmli

31. Ibid., mimeo. at 11, fn. 6.32. As noted above, the Act mandates negotiations

between incumbents and competitors as a first step,but regulators have been called upon to resolvemost of the key issues. This is the result of themarket dominance of the incumbents and theirunsurprising reluctance to cede any of theiradvantages unless compelled to do so, a pointdiscussed further below.

33. 47 USC ss 252(d)(3). Avoided retail costs includethe costs of marketing, billing and collection.

34. One heavily litigated issue was whether incum-bents could separate already combined networkelements (a such as the local loop and the switch)before leasing them to competitors. In AT&T v IowaUtilities Board, the Supreme Court validated theFCC's rule forbidding such separation.

35. Regulators in California began the process ofcosting and pricing UNEs in 1996 and, as of April1999, had still not set final prices for UNEs.Uncertainty about federal rules has contributed tothe delay, but insufficient regulatory resources toaddress extremely challenging issues has also beena problem.

36. In the United States, the interconnection chargespaid by local operators to complete local calls aredifferentiated from the `àccess charges'' paid by



long distance operators to local operators. Ofteninterconnections charges for completing local callsare structured to some extent on a ``bill and keep''basis. Bill and keep describes the practice ofrefraining from explicit charging when the volumeof calls terminated by two local operators on eachothers's networks is roughly equal.

37. CPUC Final Staff Report (op. cit., n. 24), p. 5.38. As one extreme example, in California in 1998,

Pacific Bell spent large sums of money on atelevision, radio, and print advertising campaigndesigned to pressure state regulators into givingpreliminary approval for their long-distance bid.Such expensive media campaigns are commonplacefor matters to be voted upon by the electorate, butare rarely, if ever, conducted for decisions to bemade by regulators.

39. Of course, it is always possible that a techno-logical breakthrough will permit competition from

another quarter, e.g. electric utilities, sooner thanexpected.

40. Re Applications for Transfer of Control of Licenses fromTele-Communications, Inc to AT&T Corp, FCC 99±24,released 18 February 1999.

41. See Ovum Report, (op. cit., n. 16), pp. 44±46.42. See OFTEL Bandwidth Consultation (op. cit., n. 3),

chapter 3.43. Conference Report, HR Rep No. 104±458, 104th

Cong, 2d Session, p. 1 (emphasis added).44. Resellers are not considered in this statement

because, as explained above, they are unlikely tobe able to offer prices that would constrain theincumbents' pricing behaviour. The ability of theUNE-based competitor(s) to compete based onprice will be determined by the UNE prices set bythe regulators. This analysis assumes UNE pricesthat permit a measure of price competition.

45. Ovum Report (op. cit., n. 16), section 4.2.



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Will the US Telecoms Act bring real local competition? Three years gone and still too soon to tell