Don’t Believe ‘Special Access’ Hype

by on June 24, 2009 · 27 comments

A new coalition, NoChokePoints, has been formed to lobby Congress and the Federal Communications Commission to further regulate the prices that incumbent telephone companies (Regional Bell Operating Companies or Incumbent Local Exchange Carriers) can charge for special access services purchased by businesses and institutions.  Special access circuits are dedicated, private lines.  For example, Sprint purchases special access circuits to connect its cell towers to its backbone.

According to a coalition spokeswoman,

Huge companies like Verizon and AT&T control the broadband lines of almost every business in the United States. The virtually unchallenged, exclusive control of these lines costs businesses and consumers more than $10 billion annually and generates a profit margin of more than 100 percent for the controlling phone companies, according to their own data provided to the FCC. This hidden broadband tax results in enormous losses for consumers and the economy, and this country cannot afford it; especially now.

An analysis prepared by Peter Bluhm with Dr. Robert Loube under contract with the National Association of Regulatory Commissioners (NARUC) disputes this conclusion.
NARUC represents both state utility commissioners who are pro-business as well as state utility commissioners who are hostile toward regulated utilities.  NARUC is not supporting the incumbent network providers on the issue of special access regulation.  According to Bluhm and Loube,

Buyers have criticized the FCC’s current regulatory regime because it has apparently allowed excessive earnings. For their part, the RBOCs contend that the ARMIS figures are virtually meaningless. We agree with the RBOCs ….

Before 2000, special access investment was categorized by what is called “direct assignment.” The purpose was to assign 100% of investment for interstate special access to the interstate jurisdiction and 100% of investment for intrastate special access to the state jurisdiction. In practice, direct assignment required carriers to perform studies on how their networks were used ….

In 2001, the FCC “froze” separations categories and factors for large companies. At that point, large carriers stopped performing direct assignment studies ….

During [the ensuing] period, carriers greatly increased their sales of interstate special access, and all of that revenue was assigned to interstate. As a result, interstate special access revenues increase every year, but not interstate special access costs.  This imbalance has inflated ARMIS special access earnings reports and made them unreliable. (emphasis added.)

Likewise, a paper by Harold Ware, Christian Dippon and William Taylor at NERA Economic Consulting concludes,

accounting profits generated from [ARMIS] data bear no relationship with economic profits and cannot serve any useful purpose in determining whether pricing flexibility has generated excessive rates of return.

In an effort to get to the bottom of this, Bluhm and Loube estimated the current actual cost and found that the carriers are probably earning substantially less than ARMIS indicates.  Instead of earning a 138% return on special access investment, AT&T is more likely earning 30%.  Qwest is probably earning 38%, not 175%.  And Verizon, 15% instead of 62%.

The revised percentages are still more than a regulated utility would be allowed to earn.  However, there are at least two points to consider.

First, absent cost studies there is no way to know how much the network providers are earning.  According to Ware, Dippon and Taylor,

allocations and adjustments can produce wildly different results depending on what factors are used. This is why economists and regulators have long rejected use of cost allocations such as those in the ARMIS data. It is also why [Bluhm and Loube’s] conclusions regarding profits for special access should be summarily rejected.

Incidentally, Ware, Dippon and Taylor predict that the potential benefits of additional special access regulation are not worth the “potentially large costs.”

They point out that if different adjustments are chosen, the return on investment could be even lower.

For another, competitors are entering the market and they are capturing market share.  Bluhm and Loube concede that

Cable television and fixed wireless have low entry and exit costs where their networks are currently established, and each can provide substitutable dedicated services to many customers. Overall, these competitors are still acting on the fringes of special access markets, but they have larger roles in some locations and their market shares appear to be growing. Fixed wireless may hold a large market share in five years, particularly if WiMAX proves reliable and if these carriers can attract sufficient capital to expand. These newer technologies may be poised to become major competitors and are increasingly constraining ILEC behavior, but they have not yet grown beyond fringe competitors in most markets.

Maybe these competitors are still “acting on the fringes” because profit margins afforded by the market aren’t fat enough.

If AT&T, Qwest and Verizon are earning excess profits, cable and fixed wireless competitors will be able to undercut their prices and capture market share. The higher the profits, the faster the entry.

What would happen if Congress or the FCC decided to intervene?  If regulation pushed special access prices lower, that would reduce the revenue investors could expect to earn from new competitive facilities.  If investment won’t be profitable, it won’t be made.

NoChokePoints includes telecommunications providers Sprint, BT (British Telecom) and tw telecom among its members.

These competitors would not be pushing to cap the special access prices charged by incumbent network providers if they wanted to profitably invest in competing facilities.  They would want incumbent providers to charge high prices so they could charge lower prices and still make a profit.

The logical conclusion is that competitors don’t want to invest in new facilities.  They simply want to cut costs.  (Sprint, which has partnered with Clearwire and is exploring a combination with Level 3, is hedging its bets.)

A desire to cut costs rather than assume investment risks is not surprising.

But the coalition claims that additional special access regulation will create jobs.

Policymakers need to consider whether they want to help companies who don’t want to invest save jobs at the expense of their suppliers, or whether it would be better to maintain incentives for investment.  Investment will create sustainable jobs.

Cost cutting will simply lead to more layoffs, here or there.

The message for Congress is: (1) the “controlling phone companies” are not earning margins in excess of 100%, according to any credible observer; (2) determining what the exact margin really is would require cost studies which are expensive, time consuming and would probably lead to litigation and (3) if prices do exceed reasonable costs it will be profitable for competitors to invest in new facilities which will create needed jobs.

For more information, a recent column I wrote about proposals to expand special access regulation can be found here.

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