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recognition to impede competition.

While regulation may be able to prevent some misallocation

of costs and monitor high-risk investment financed through the

ratebase, regulators cannot track all the cost and risk

allocations in an integrated network of transmission lines,

switches, computers, software, plant, personnel, marketing and

advertising used jointly to provide monopoly local phone service and unregulated information services. As the General Accounting Office points out, the "FCC has struggled with (the development

of costing principles)

or over 20 years with what can only be

characterized as limited success."6

With hundreds of billions

of dollars at stake in upgrading the phone network to speed-up

development of an information age infrastructure, 7 the dangers of

cost and risk misallocation involve the potential for substantial

local rate increases.

Since regulation has been unsuccessful in preventing crosssubsidization, proponents of integrating new services within

local networks have proposed new regulatory concepts that are

theoretically superior. Although this " new wave" regulation sounds appealing open network architecture, comparably

efficient interconnection, incentive/price cap regulation

it

relies on contradictory assumptions and has never been tested in

6 GAO, Legislative and Regulatory Actions Needed to Deal with the Changing Domestic Telecommunications Industry, CED-81136 (September 24, 1981), at 86.

7 Robert Pepper, Through the Looking Glass, Office of Plans and Policy, FCC, OPP Working Paper No. 24, Washington, D.C., November 1988 at 6-12.

the marketplace.

The FCC's new method of dealing with a mixture of

competitive and monopoly services provided through the network

(i.e., Computer III and the Joint Cost rules) contradicts the

Commission's rationale for replacing rate of return regulation

with a "price cap" system.

In support of its desire to promote

network integration, the FCC developed a form of regulation that,

rather than separating competitive from monopoly ventures (the

Computer II separate subsidiary requirement), allows integration

of all network services. Separation is no longer necessary,

according to the FCC, because careful accounting practices make it possible to allocate costs without the danger of cross

subsidy. 8 However in its price cap proceeding, the Commission determined that cost allocation under rate of return regulation

is so complicated, difficult and ultimately arbitrary, it is

preferable to cap prices and adjust them based on automatic formulas. 9

Similar regulatory schizophrenia is evident in the

FCC's recent Special Access Order, where the Commission noted

that:

a variety of reasonable allocations could be justified, because of ... the extent to which special access plant is used jointly and commonly to provide these services. Developing detailed cost allocation rules for these services would most likely be a futile attempt to achieve an illusory

8 In the matter of Amendment of Sections 64,702 of the Commission's Rules and Regulations (Third Computer Inquiry), CC Dkt. No. 85-229 (Adopted May 15, 1986).

9 In the matter of Policy and Rules Concerning Rates for Dominant Carriers, CC Dkt. No. 87-313, (Adopted March 16, 1989).

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precision, given the wide range of allocations that would be reasonable for these services.10

In addition, the General Accounting Office points out that "The

level of oversight that (the Commission) is prepared to

provide...will not provide telephone ratepayers or competitors positive assurance that FCC cost allocation rules and procedures are properly controlling cross-subsidy." 11

With this ambivalence toward cost allocation and the fact

that the Computer III and price cap models of regulation have yet

to be tested in the marketplace, it is hard to trust the FCC's

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policies, reinforced by the MFJ, have promoted efficient

infrastructure development, we recognize that Congress would also

like to consider enhancing network investment by promoting

integration of new services within local exchange networks.

We

10 See Investigation of Special Access Tariffs of Local Exchange Carriers, CC Docket No. 85-166, Phase II, Part I, released December 1, 1988 at 35.

11

GAO, Telephone Communications, RCED-88-34 (October, 1987), at 3.

therefore propose a number of factual inquiries designed to

evaluate whether the consumer dangers of network integration can

be outweighed by potential benefits.

Proponents of integrating information services with the

local exchange network argue that cost savings from network

integration (i.e., economies of scope) would make it possible for

the local Bell companies to offer more information services, at a

lower cost, on an accelerated timetable, to more consumers than

anyone else in the information business.

Before accepting this

assertion, CFA believes Congress must investigate and resolve a number of matters essential to protecting consumers' interests:

1.

Congress must gather data to determine whether or not there

are economies associated with integrating information services

within the local exchange network.

Given the dangers of cross

subsidization and overpricing basic local phone services associated with network integration, CFA believes Congress should not promote network integration unless this results in clear cost

savings that will be passed on the consumers.

We know of no

clear empirical evidence that supports the cost-saving assertions

of those who promote network integration.

2.

If Congress determines that network integration would yield

cost savings for any particular services, it should evaluate whether current regulatory tools can accomplish_what none have

adequately mastered in the past

prevention of cross

subsidization and overpricing of basic, monopoly services.

CFA

is skeptica] that the FCC's untested new regulatory theories,

which appear to be fundamentally inconsistent, 12 can adequately

prevent the Bell companies form overpricing monopoly basic phone services to subsidize potentially competitive information

services.

In addition, to protect consumers, Congress must

investigate whether most of the hundreds of billions of dollars

that may be invested in fiber optic local loop transmission

equipment would end up in consumers' local rates through the

FCC's "access charge"

cost-causation theory and the Commission's

limitations on state cost allocation options.

3.

To ensure that a ratepayer bailout, similar to the current

Savings & Loan bailout, cannot arise, Congress must determine

whether or not the extensive risks of speculative investment in

information age services can be fully separated from the local

carriers' regulated ratebase.

CFA is fearful that it may be

virtually impossible to insulate ratepayers from the financial losses associated with information services integrated within local exchange carriers' basic voice network. Given previous

market failures in the information business (e.g., Knight-Ridder,

Times-Mirror videotex failures) and Bell company losses in competitive ventures, 13 it is essential that Congress proceed

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13 Rodney Blythe, Summary Report on the Regional Holding Company Investigations, National Association of Regulatory Utility Commissioners, September 18, 1986, at 8.

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