Lecture 3
Incentive Regulation in Telecom
7/12/2016
ECO 436 Industry Studies Seminar David G. Loomis 309-438-7979
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Issues with Initial PC plans
Interim plan or better long term solution
 X-Factor Importance
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7/12/2016
ECO 436 Industry Studies Seminar David G. Loomis 309-438-7979
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AT&T Price Cap Plan
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Three baskets
 1.
MTS or the "grandma basket"
 2. 800 service - AT&T retained some control.
 3. Other large business "bye-bye basket".
 Individual price bands +/- 5% X = 3.0
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NPRM, FRPM, 1987 -1989. Approved March
16, 1989.
LECs’ position.
ECO 436 Industry Studies Seminar David G. Loomis 309-438-7979
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LEC PC Plan
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LECs came later - approved September 1990.
LEC productivity 3.3% with ROR bands.
Current ROR was 11.25. IF ROR went >1%,
50/50 sharing until 5% over (i.e. 16.25%). After
that, total giveback.
LECs could choose 4.3% productivity. They
would then retain all profit below 13.25% and
half up to 17.25%.
ECO 436 Industry Studies Seminar David G. Loomis 309-438-7979
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Revised LEC Price Cap Plan May 1995 –
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3 options
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X=4.0%; sharing between 12.25 and 13.25 ROR. Min
10.25; Max 13.25
X=4.7%; sharing between 12.25 and 16.25 ROR. Min
10.25; Max 16.25
X=5.3%; no sharing, min or max.
NYNEX, SNET & U S West chose A; Ameritech,
Bell Atlantic, Bell South, Pacific Telesis & SBC
chose C
ECO 436 Industry Studies Seminar David G. Loomis 309-438-7979
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“Final” PC plan
Effective 7/1/97
 X-factor 6.5 (including CPD)
 No Sharing; No Cap on earnings
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7/12/2016
ECO 436 Industry Studies Seminar David G. Loomis 309-438-7979
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The need for rate rebalancing
Rural versus Urban
 Businesses are higher margin than
residence.
 IntraLATA toll is high margin for both
residence and business.
 Problems of incentive regulation
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7/12/2016
ECO 436 Industry Studies Seminar David G. Loomis 309-438-7979
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Problem
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New entrants will target high margin business
and go after urban areas leaving
unrenumerative customers and for the
incumbent.
ECO 436 Industry Studies Seminar David G. Loomis 309-438-7979
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Problem (cont’d)
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If ROR and price caps were effective
regulation, total revenue from rates to close to
total cost including a normal return.
If the new entrants cream-skim and take the
highest margin customers, the incumbents will
suffer real losses and if they raise rates across
the board to cover losses, more customers will
have incentives to go to a new entrant
ECO 436 Industry Studies Seminar David G. Loomis 309-438-7979
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Solutions
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1. Rate rebalancing before entry. Whose rates
get raised? Rural and residential. Not very
politically feasible.
2. Allow incumbent new revenue sources to
account for losses in local.
ECO 436 Industry Studies Seminar David G. Loomis 309-438-7979
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Long distance and cable as new
sources of revenue
Is this feasible? If customer want one-stopshopping and IXCs already have account
executives for most large businesses, IXCs
might win out.
 Cable does not look very profitable to a new
entrant right now. Also what about
content?
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7/12/2016
ECO 436 Industry Studies Seminar David G. Loomis 309-438-7979
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Competitors than IXCs
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CLECs
Cellular
PCS
Cable
Electric Companies?
Others?
ECO 436 Industry Studies Seminar David G. Loomis 309-438-7979
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Current Cellular Technology
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FCC gave away rights to radio spectrum
25MHz to each of two carriers creating a
duopoly in each market. One license went to
wireline company the other based on “merit”
and hearings, then lottery.
Systems were analog at first. Recently moved
to digital. Two competing technologies TDMA 3x capacity. CDMA 10X capacity.
ECO 436 Industry Studies Seminar David G. Loomis 309-438-7979
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Current Cellular (cont’d)
 Cellular
to date has been a complement rather than
substitute to wireline. Tradeoff of price to mobility.
 Cost of copper wire local loop is about $1800. Cost
of cellular system $700 per subscriber. Cellular use
rates 40-50 cents per minute. (Costs continue to
decrease.)
 Marketing is $600 per sub and general &
administrative $140 per sub. LECs spend less than
$100 on both. Usage costs are higher though. And
you pay to receive calls.
7/12/2016
ECO 436 Industry Studies Seminar David G. Loomis 309-438-7979
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PCS
FCC auctioned off 3 30 MHz blocks and 3
10 MHz blocks in each of 51 MTAs raising
$7.7 billion
 AT&T won 19; Sprint PCS won 29
covering 3/4 of US; PCS Primeco won 11.
 Cheaper to provide than existing cellular
and digital from start
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7/12/2016
ECO 436 Industry Studies Seminar David G. Loomis 309-438-7979
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Cable
Telephony overbuild cost $300-$745 per
sub.
 Still technical diff. Going from one-way to
two-way network.
 Poor customer service and high marketing
cost may prevent high take rates
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7/12/2016
ECO 436 Industry Studies Seminar David G. Loomis 309-438-7979
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VoIP
Voice quality has improved
 Premises equipment is cheap
 No Taxes or fees
 No Access Charges?
 911 Emergency Service
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7/12/2016
ECO 436 Industry Studies Seminar David G. Loomis 309-438-7979
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Can/is the local market
contestable?
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Will rate increase above LRIC cause enough
customers to switch that it makes in
unprofitable for the LEC to do so?
ECO 436 Industry Studies Seminar David G. Loomis 309-438-7979
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