BEFORE THE WASHINGTON UTILITIES AND TRANSPORTATION COMMISSION In the Matter of Access Charge Reform Docket No. UT-970325 Comments of the Department of Defense and All Other Federal Executive Agencies The Department of Defense ("DOD"), on behalf of all Federal Executive Agencies ("FEA") in the State of Washington, submits these comments on the proposal by the Washington Utilities and Transportation Commission ("Commission") to amend its rules at WAC 480-120-000 dealing with the access charges imposed by Local Exchange Carriers ("LECs") for the terminating toll and local switched telephone calls. I. The Interest of DOD/FEA Collectively, the Federal Government's military and civilian agencies are probably the largest single consumer of telecommunications services in the State of Washington. Not only are Federal agencies large consumers of telecommunications, but the telecommunications services they consume cover the entire gamut of technologies, from simple, single-line switched voice grade lines to complex high-speed secure and "hardened" private lines carrying highly sensitive encrypted data. Indeed, Federal agencies probably use virtually all of the services provided by the leading LECs and IXCs in the State of Washington. Among these services, of course, are the intrastate toll services that are affected by the proposed Commission rules. The Competition in Contracting Act of 1984, part of Public Law 98-369, obliges Federal civilian agencies to pursue full and open competition wherever possible in procuring goods and services, 41 USC 5. The Armed Forces Procurement Act 10 USC 2301 et.seq. contains similar provisions for the military services. Pursuant to these obligations, Federal agencies have adopted a systematic policy of acquiring telecommunications services on a competitively bid basis wherever possible. This policy ensures that the Federal government, and by extension all taxpayers, receive the best possible telecommunications services for the lowest possible cost. Since the Federal agencies are committed to competitive procurement of telephone services, they have a vital interest in the creation of a regulatory environment that will ensure that each bidder is able to reflect accurately the underlying economic costs of the services it proposes to render. Otherwise, the bids are distorted, and the prices paid by Federal agencies are higher (or conceivably lower) than those necessary to recover the costs of the services provided. As discussed herein, the present access charge structure results in serious pricing distortions which virtually guarantee that Federal agency purchases of toll service, in particular, do not accurately reflect the underlying costs of the carriers offering them. The Commission's proposed rules represent a major step to resolving those distortions. II. The Commission Should Adopt Its Proposed Rules On May 13, 1998, the Commission proposed rules that would limit the rates charged by LECs for terminating intrastate toll calls received from Interexchange Carriers ("IXCs") to the same level as the rates charged for terminating local calls. Those rates in turn may not exceed the Total Service Long-Run Incremental Cost ("TELRIC") of the terminating access service plus a reasonable contribution to common and overhead costs. This limitation is exclusive of Commission-approved charges to recover the cost of supporting universal service. These rules represent a significant and dramatic step toward an environment where, for the first time ever, toll service rates actually reflect the economic cost of providing toll services.The rules deal only with terminating access, so it is still possible for LECs to charge originating access rates that do not reflect costs. However, since originating access is much more competitive than terminating access, the ability of any carrier to maintain uneconomic originating access rates is constrained by the market. While the rules affect only access charges, and hence the toll rates charged by IXCs, their effect should be to force the LECs' toll rates toward cost. That is because the IXCs will now be able to reduce their rates to the level of their own costs, plus that of the terminating LEC. The LECs that provide competing toll service will be forced to meet these reductions, thereby adjusting the entire toll pricing structure to the approximate level of the underlying costs. Moreover, the Commission's rules will eliminate artificial distinctions between "toll" and "local" services. Heretofore, local service calling areas have been established somewhat arbitrarily, based principally on "communities of interest" within the State, as well as geographic size. Toll calling thresholds did not reflect any logical breakpoints in cost. More often, they reflected the boundaries of carrier service territories, perceived metropolitan area limits, and the interest of the LECs in ensuring that there would be sufficient highly lucrative toll service revenue to offset the inadequate revenues from local service in high-cost exchange areas. When toll access rates reflect the cost of access service, the distinctions between "toll" and "local" calling will fall out of the economics of long-distance telephony service. "Local", that is, flat-rate calling will cover as wide an area as the collective competing carriers -- LECs, CLECs and IXCs -- find it economically feasible to offer service without time-measured charges. Toll rates, that is, time-measured charges, will be imposed only when the use of transport facilities and tandem switches makes total costs so sensitive to usage that it becomes uneconomical to ignore call duration as a cost driver. Possibly the greatest boon from these new rules will be the discovery that neither distance nor usage is a particularly significant driver of costs for most intrastate calling. The capacity of fiber optic cables is so great, and their unit costs so low, that the likely consequence of truly cost-based ratemaking will be an enlargement of flat-rate calling areas and a "postalization" of toll rates beyond them. Postalization means the charging of a single rate per minute or per call regardless of the distance (as for First Class mail). The price-elastic effect of these rate structure changes will be to stimulate calling within the state, thereby knitting Washington into a closer community. III. Failure to Adopt the Proposed Rules Would Perpetuate Present Distortions in Federal Telecommunications Procurement. Possibly the most persuasive argument for adopting the Commission's proposed rules is to examine the effects of the present system of charging for terminating access. That system imposes usage-based access charges for access costs that are largely unaffected by usage, and it imposes those charges in amounts that are multiples of the underlying costs. The effect on most toll service users is simply to inflate toll rates. The effect on consumers such as the Federal agencies that must compete their service procurements is to distort the process of procurement, as discussed below. A. The Present Access Charges Distort Selection Among Carriers. Except for certain types of cost-reimbursement contracts, Federal procurement regulations do not allow agencies to explore the costs underlying their vendors' bids. When the bidding is purely on a price basis, the Federal agency is not expected to delve into the vendor's cost structure, its overheads, or its profits. The presence of competition is expected to ensure that the offerer with the lowest costs will bid the lowest price and win the solicitation. The present access charge structure does not provide that assurance. There are broadly three types of carriers that can compete for intrastate toll service, the incumbent LEC, IXCs that rely on the LEC for call termination, of IXCs that team with -- or are themselves -- a CLEC for call termination. Under the present access charge structure, the third of these three types of carriers will always win the competitive bid. That is because a IXC-CLEC combination is peculiarly situated to avoid both the inflated access charges that are imposed on LEC-dependent IXCs and the inflated LEC toll charges that impute those high access charges. When an IXC hands toll calls off to a cooperating CLEC (or to the CLEC function of the IXC itself), the CLEC then can deliver those calls to their destination with no markup on the termination costs. This scenario assumes, of course, that the CLEC maintains facilities all the way to the call termination point. This assumption is unlikely to be true for most residential calling, where the termination points are dispersed. But Federal agencies tend to concentrate in relatively few points, so it is possible for a CLEC to arrange for, if not actually build, facilities to the principal termination points of many Federal agency calls. When that happens, the CLEC and its IXC partner can always underbid their competitors. Arguably, DOD/FEA should not complain, because the Federal agencies are receiving very low-cost service. The objection, of course, is that the winning IXC-CLEC provider may not, in fact, be the low-cost provider. To the contrary, that bidder is enjoying a price umbrella that encourages it to inflate its bid above true costs, secure in the knowledge that the access price mechanism will insulate it from truly effective competition. This sort of distortion in carrier selection is directly contrary to the intent of the 1996 Telecom Act and the policies of this Commission. The clear objective of the pricing sections of the Telecom Act was that telephone service should be provided to various carriers and, by extension, their customers, on the basis of economic costs. Any subsidies, such as those required for universal services, should be assessed in the form of visible, explicit surcharges. When those subsidies are not isolated but are still imputed in access and toll rates, the result is distorted pricing and, as a consequence, distorted buying. B. The Present Access Charges Distort Selection Among Services. As noted earlier in these Comments, Federal agencies procure virtually all of the services available on the tariffs of the major Washington LECs. Among these services is private line. Private line charges are usually distance sensitive, but they are never usage sensitive. In concept at least, they are dedicated lines between two points that are available for customer use 24 hours a day, 365 days a year. Private lines are justified only when there is a large amount of traffic between a limited number of fixed points. Federal agencies tend to concentrate in a relatively few nodes, principally military bases and Federal buildings, which interchange a large amount of telephone traffic. When that traffic is sufficiently large and continuous, private lines become the most economical means of communications, not just for "hot lines" but for conventional telephone traffic. Private lines can be used to interconnect PBXs, and the end users behind the PBXs cannot tell how his call is handled, whether by switched or private line. The private lines can be banked with PBX trunks to absorb the "base load", while the public switched network handles the overflow. In actual fact, most private lines are not "private" at all, that is, they do not involve dedicated facilities. Rather, they are "virtual private lines," the traffic of which is handled through the public switched network. To the customer they appear as dedicated lines, but to the carrier they appear as conventional access lines which automatically dial the same termination point each time a call is made. The principal distinction between private lines and switched lines is in their pricing. Private lines pay monthly charges that are distance, but not usage related. If provided by an IXC, they bear private line access charges which, for some unknown reason, are termed "special access charges." The same traffic handled over switched lines incurs usage based rates: toll rates if on the LEC's network, IXC charges if on an IXC network. In either case, the traffic bears the access charges that are currently imposed on switched toll services. The markups over costs are not the same for private lines as for switched calls. As noted, switched access charges are currently marked up well above the level of their costs. The LEC toll rates are similarly marked up to match this overpricing. "Special access" charges do not bear the same markups; they are much closer to actual cost. To some extent, this condition reflects the fact that special access -- that is, private line -- is much more competitive than switched access. Any customer that has sufficient calling volume to justify private line service is likely to be a candidate for competitive access service from a CLEC or from an IXC. For this reason, the LECs have been forced to price their special access rates much closer to cost than their switched access rates. For Federal agencies, these disparities in relative markup distort the selection between services. In general, private line service appears more economical relative to switched service than in fact is justified by the underlying economics. This distortion in turn results in a relative underpricing of "on-net" calling among Federal agency locations and an overpricing of "off-net" calling between Federal agency locations and the public switched network. The end result is a set of price signals to the Federal agencies and within those agencies that flatly contradicts the underlying costs of providing the services. The agencies, and the American taxpayers that support them, are not well served by the system. C. The Present Access Charges Distort Geographic Calling Zones. As noted, the geographic zones that determine what is a toll call and what is a local call are largely artificial. They are the result of the LEC's service territories and their determinations (with the concurrence of the Commission) as to what constitute the logical communities of interest within which there should be unlimited flat rate local calling. The present access charge mechanism imposes these arbitrary geographic determinations on the IXCs and the CLECs by requiring them to pay much higher access rates when the call is deemed "toll" than when it is deemed "local." These carriers are thus forced to extend these distinctions to their customers, including Federal agencies. Again, the competitive bidding process may result in severely distorted prices to Federal agencies. The LECs and those CLECs or IXCs that are dependent on the LECs' access service must offer local and toll services based on the existing geographic calling zones. Other carriers that can provide by-pass service will not be so constrained. Their by-pass services can undoubtedly classify calls as "local" that the LECs have designated as "toll." While the prices are lower, the difference is not due to any intrinsic economic characteristic of the service. Rather, it is due to the pricing umbrella created by the present access charge structure. IV. Conclusion The Commission has wisely proposed rules that will rationalize intrastate toll rates so that end-use customers, such as the Federal agencies, will receive price signals from competing LECs, IXCs and CLECs that effectively reflect the underlying costs of the economic resources required to provide the services. DOD/FEA urge the Commission to adopt these rules, so that they can serve as a model for the nation. Respectfully Submitted ROBERT A. GANTON Trial Attorney Regulatory Law Office Office of the Judge Advocate General U.S. Army Litigation Center 901 N. Stuart Street, Suite 713 Arlington, VA 22203-1837 June 12, 1998