ott revenueA report issued by the Federal Communications Commission last week recommends a substantial reduction in the rate of return that the nation’s smallest telephone companies earn through the inter-carrier compensation (ICC) system.

Since 1990 that rate has been 11.25% but if the recommendations made by the FCC Wireline Competition Bureau are adopted that rate could fall to as low as 8.06% or even 7.39%. Either of those rates is likely to be unpopular with small telcos, some of whom have already seen revenues reduced through caps that have been put on the amount of funding carriers can collect through the Universal Service program.

When the FCC adopted reforms to the Universal Service program and ICC system in 2010, the commission also suggested other areas for reform – including a recommendation to re-evaluate the rate of return for small telcos. At that time several organizations representing small rural carriers indicated they might accept a 10% rate of return, although some small carriers argued that the 10% level was too low. Also at that time, state members of the Universal Service federal-state joint board proposed that the rate should be 8.5%.

In the new report, the FCC explores several different approaches to calculating the small telco return rate, including using publicly traded rate-of-return companies as proxies to determine the weighted average cost of capital, calculating the cost of equity using both the capital asset pricing model and the discounted cash flow model and determining a “zone of reasonableness” within which the rate of return can be selected.

Using various calculations, the report estimates the weighted average cost of capital at between 7.39% and 8.72%. But considering “the current historically-low interest rates and the infrequency of represcription,” the report concludes that the commission should consider setting the authorized rate of return in the upper half of this range – between 8.06% and 8.72%.

The recommendation about changing the return rate is just one of several actions the FCC took on the small carrier front last week. The commission also issued a notice of proposed rulemaking seeking input on how the Universal Service program for small rate of return carriers should be transitioned from focusing on voice service to a Connect America Fund focusing on broadband service. The FCC has made considerably more progress on making the same transition for the nation’s largest price cap carriers.