Carrier Evolution

The Federal Communications Commission has concluded that its 1999 rules on market-based special access rates “have not worked,” so the FCC is suspending its rules. The FCC says it has to conduct new studies, but most expect the FCC will reimpose pricing regulations.

At stake are special access revenues of incumbent LECs of about $16 billion annually, and also business costs for rival suppliers who lease such circuits to connect their own customers. The move shows the continuing influence regulations have on service provider business models, as any expected re-imposition of price controls will limit seller revenue and at the same time lower operating costs for competitors who buy such circuits.

In the 1999 “Pricing Flexibility Order,” the Commission adopted rules intended to allow price capped service providers to show that certain parts of the country were sufficiently competitive to warrant pricing flexibility for special access services.

But the FCC does not believe its rules have worked as expected, “likely resulting in both over- and under- regulation of special access in parts of the country.” But some will argue that the FCC’s suspension of its rules likely will result in the re-imposition of price controls.

Originally, the FCC expected rather more robust market entry by new competitors, starting in the areas of highest business demand, and then gradually extending elsewhere throughout a metro area.

The FCC says “recent data indicates that competitors have a strong tendency to enter in concentrated areas of high business demand, and have not expanded beyond those areas despite the passage of more than a decade.” In other words, competitive providers have tended to cluster their investments in the areas where potential customer density was highest, and have tended to underplay investments elsewhere.

A reasonable person might say that is about what a rational supplier might do, if the financial return was too low, and the risk too high, in the outlying areas. “Incumbent LECs generally concede that competitors have focused on areas in which demand for special access services is very concentrated,” the FCC says.

“Demand for special access services is highly concentrated in a relatively small number of dense urban wire centers and ex-urban wire centers containing office parks and other campus environments,” the FCC says.

Verizon told the FCC that more than 80 percent of demand is generated in eight percent of its wire centers, allowing new competitors to address a large portion of demand through targeted investments.

SBC, for example, states that a large percentage of its demand for DS1 and DS3 services runs within 1,000 feet, or about three city blocks, of existing alternative fiber. The implication is that competitive local exchange carriers could extend their networks if they wanted. CLECs tend to say that is untrue, in large part because the incumbents make such expansion unduly expensive.

But CLECs also argue that there are other important barriers to entry, including the delays in, or impossibility of, securing municipal franchise agreements, rights-of-way agreements, building access agreements, and building and zoning permits.

In 2006, the U.S. Government Accountability Office (“GAO”) analyzed 16 metropolitan areas in which the Commission had granted pricing flexibility and found that facilities-based competitors served fewer than six percent of buildings with at least a DS1-level of demand.

But a rational executive also would note that it virtually never makes financial sense for a CLEC to build its own facilities to serve even a confirmed customer with that level of demand.

The point, CLECs argue, is that there perhaps “never” will be a business case for extending CLEC facilities much beyond their current state.

TW Telecom relied on data supplied by Verizon in arguing that, between 1996 and 2004, non-incumbent LEC channel termination buildout to commercial buildings increased from 24,000 buildings to approximately 31,467 buildings (a change of 7,467), in contrast to the “millions of buildings served by incumbent LEC fiber.

In 2005, WilTel estimated that competitors had deployed to 25,000 buildings, whereas Sprint asserted in 2007 that only 22,000 buildings had competing connections.

Moreover, TW Telecom has argued that competitors serve only three to five percent of commercial buildings nationwide.

Proponents of special access price regulation rely on three central arguments to support a retreat to strict price regulation. Such proponents argue that markets for special access are unduly concentrated, rates of return are very high and prices are lower in more heavily regulated markets than in markets with the most pricing flexibility.

Economists at the Phoenix Center for Advanced Legal & Economic Public Policy Studies argue that those assertions are not correct, but additionally do not prove the presence of undue market power. The Phoenix Center further argues that much hinges on the definition of “a market.”

At stake is the market cost to a competitive supplier to gain access to high-bandwidth circuits serving customers who cannot be reached by any single supplier’s own network. But the markets have changed, and some would say dramatically, over the intervening years.

What remains uncertain, as the FCC collects new data, is the impact of new supply side changes such as circuits sold by cable companies, for which no mandatory access to competitors is required, or other facilities-based suppliers that might be able to supply DS-1 type circuits, for example. As always, the definition of “the market” and “the suppliers” will be important.

Businesses might well be able to buy high capacity circuits from cable operators, who do not have to allow third parties access to those services. The issue is whether services for business customers, or costs of doing business for competitive local exchange carriers, is the policy objective.

One historic limitation of cable networks was their initial concentration on residential areas. Over the last couple of decades, though, business customers have become more important, and cable operators now are aggressively selling services to business customers, including business grade high speed access services operating up to 100 Mbps.

It is true there are not mandatory access requirements for cable operators. But neither is it true that telco bandwidth now is the only alternative, especially outside the densest areas of business customer concentration.