COMMISSION In the Matter of the Pricing ) Proceeding for Interconnection, ) NO. UT-960369 Unbundled Elements, Transport and ) Termination, and Resale ) ----------------------------------) ) In the Matter of the Pricing ) Proceeding for Interconnection, ) NO. UT-960370 Unbundled Elements, Transport and ) Termination, and Resale for ) U S WEST COMMUNICATIONS, INC. ) ----------------------------------) ) In the Matter of the Pricing ) Proceeding for Interconnection, ) NO. UT-960371 Unbundled Elements, Transport and ) Termination, and Resale for ) VOLUME 15 GTE NORTHWEST INCORPORATED ) Pages 1419-1734 ----------------------------------) A hearing in the above matter was held at 8:10 a.m. on July 15, 1997, at 1300 South Evergreen Park Drive Southwest, Olympia, Washington before Commissioners SHARON NELSON, RICHARD HEMSTAD, and WILLIAM R. GILLIS and Administrative Law Judge TERRENCE STAPLETON. Also present was the Commission's economic advisor DAVID GABEL. The parties were present as follows: GTE NORTHWEST INCORPORATED, by MARK AUSTRIAN, Attorney at Law, 3050 K Street NW, Suite 400, Washington D.C. Lisa K. Nishikawa, CSR, RPR Court Reporter APPEARANCES (Cont'd.) U S WEST COMMUNICATIONS, INC., by EDWARD SHAW and LISA ANDERL, Attorneys at Law, 1600 Bell Plaza, Room 3206, Seattle, Washington 98191. AT&T COMMUNICATIONS, by DANIEL WAGGONER, Attorney at Law, 2600 Century Square, 1501 Fourth Avenue, Seattle, Washington 98101 and SUSAN D. PROCTOR, Attorney at Law, 1875 Lawrence Street, Suite 1575, Denver, Colorado, 80202. MCI COMMUNICATIONS and MCImetro, by ROBERT W. NICHOLS, Attorney at Law, 2600 Broadway, Suite 200, Boulder, Colorado 80302. FRONTIER TELEMANAGEMENT and SHARED COMMUNICATION SERVICE, INC., by SARA SIEGLER MILLER, Attorney at Law, 2000 NE 42nd, Suite 154, Portland, Oregon 97213. UNITED TELEPHONE COMPANY OF THE NORTHWEST and SPRINT CORPORATION, by SETH LUBIN, General Counsel/Secretary, 902 Wasco Street, Hood River, Oregon 97031. WITA, by RICHARD A. FINNIGAN, Attorney at Law, 2405 Evergreen Park Drive SW, Suite B-1, Olympia, Washington 98501. TRACER, by ARTHUR A. BUTLER, Attorney at Law, 601 Union Street, Suite 5450, Seattle, Washington 98101-2327. TCG SEATTLE and NEXTLINK WASHINGTON, LLC, by GREGORY J. KOPTA, Attorney at Law, 2600 Century Square, 1501 Fourth Avenue, Seattle, WA 98101-1688. THE WASHINGTON UTILITIES AND TRANSPORTATION COMMISSION STAFF, by SHANNON E. SMITH, Assistant Attorney General, 1400 South Evergreen Park Drive Southwest, Olympia, Washington 98504-0128. THE PUBLIC, by ROBERT MANIFOLD, Assistant Attorney General, 900 Fourth Avenue, #2000, Seattle, WA 98164. I N D E X D C RD RC EXAM MEITZEN 1426 1428 1468 1472 1456 MONTGOMERY 1474 1476 1522 1525 1507 1529 1527 BLACKMON 1531 1532 1589 1580 SPINKS 1599 1600 1721 1698 EXHIBIT MARKED ADMITTED 100 1422 1427 101 1422 1427 102 1424 1475 103 1424 1475 104 1425 1734 C-105 1425 1734 106 1425 1734 107 1425 1598 108 1425 1598 109 1426 1734 110 1426 1734 111 1537 1598 P R O C E E D I N G S JUDGE STAPLETON: Let's be on the record. This is a continuing series of hearings in the matter of the pricing proceeding for interconnection, unbundled elements, transport and termination, and resale in docket numbers UT-960369, 960370, and 960371. Today's date is Tuesday, July 15, 1997. We're convened in Olympia, Washington before Commissioners Sharon L. Nelson, Richard Hemstad, William R. Gillis, and Administrative Law Judge Terrence Stapleton. We'll mark the testimony and exhibits to be used in this next phase of the cross-examination. For identification purposes, I will mark the direct testimony of Mark Meitzen dated March 28, 1997 and including two exhibits MEM-2 and MEM-3 as Exhibit Number 100. And I will mark the rebuttal testimony of Mark Meitzen dated April 25, 1997 as Exhibit 101. Do any parties have any exhibits to be entered during the cross of Mr. Meitzen? All right. (Marked Exhibits Nos. 100 and 101.) MR. FINNIGAN: Your Honor, I did distribute an errata sheet. JUDGE STAPLETON: Yes. Thank you very much. I have it sitting under my nose. I will note that. Which pieces of testimony, Mr. Finnigan, does this attach to? MR. FINNIGAN: The first three items are for the direct testimony. The last item which is identified as rebuttal testimony is for that testimony. And my thirteens look like threes, or my threes look like thirteens, I should say. I have to do an errata to the errata sheet. Item number 2 should be page 3 rather than 13. JUDGE STAPLETON: That's all right. We'll just correct this on the errata sheet. You don't have to redistribute it. The second item is page 2, line -- MR. FINNIGAN: Item 2 should read page "3" rather than "13." JUDGE STAPLETON: Is there anything confidential in the exhibits of Mr. Montgomery, Mr. Kopta? Do we need to mark any of the exhibits of Mr. Montgomery confidential? MR. KOPTA: No. JUDGE STAPLETON: The direct testimony of William Montgomery dated March 28, 1997 will be marked for identification as Exhibit 102. Are there attachments or exhibits attached to that testimony, Mr. Kopta? (Marked Exhibit No. 102.) MR. KOPTA: No, there are not. JUDGE STAPLETON: Okay. Thank you. And the reply testimony of William Montgomery dated April 25, 1997 will be marked as Exhibit Number 103. Does anyone have exhibits they wish to introduce during the cross of Mr. Montgomery? Ms. Shannon, do you have a preference for order? (Marked Exhibit No. 103.) MS. SMITH: No. JUDGE STAPLETON: Okay. The testimony of Thomas Spinks dated March 27, 1997, including attachments TLS-1 and confidential Exhibit TLS-2. I'm sorry. I guess I'll mark the confidential exhibit as a separate exhibit. So the testimony dated March 27 with TLS-1 will be marked as Exhibit Number 104. And we will mark the confidential Exhibit TLS-2 as C-105. All right. Exhibit 104, in addition to the testimony of March 27 and TLS-1, also includes TLS-3 and revisions to the testimony itself which is an April 17 filing with the Commision. Ms. Shannon, please note you will be reprimanded by the bench later. (Marked Exhibits Nos. 104 and C-105.) MS. SMITH: For what? JUDGE STAPLETON: The rebuttal testimony of Thomas Spinks dated April 24, 1997 will be marked as Exhibit 105. It does not appear there are any attachments or additions. MS. SMITH: 106. JUDGE STAPLETON: Thank you. Yes. Thank you. It is 106. (Marked Exhibit No. 106.) JUDGE STAPLETON: The testimony of Glenn Blackmon dated March 28, 1997 will be marked as Exhibit 107, and the rebuttal testimony dated April 24 will be marked as Exhibit 108. (Marked Exhibits Nos. 107 and 108.) JUDGE STAPLETON: Let's be off the record for a moment. (Discussion off the record.) JUDGE STAPLETON: Let's be back on the record. While we were off the record, exhibits to be used during the cross-examination of Mr. Spinks were distributed. I have marked for identification as Exhibit 109 the deposition upon oral examination of Thomas Spinks dated June 4, 1997, and as Exhibit Number 110, response data request number 5 and response. All right. And let's be off the record again. (Marked Exhibits Nos. 109 and 110.) (Discussion off the record.) JUDGE STAPLETON: We'll be back on the record, please. Mr. Meitzen, will you please rise and raise your right hand. Whereupon, MARK E. MEITZEN, having been first duly sworn, was called as a witness herein and was examined and testified as follows: JUDGE STAPLETON: Thank you. Mr. Finnigan, will you please qualify your witness. MR. FINNIGAN: Thank you. DIRECT EXAMINATION BY MR. FINNIGAN: Q. Dr. Meitzen, would you please state your name and give your business address for the record. A. My name is Mark E. Meitzen. My business address is 4610 University Avenue, Madison, Wisconsin. Q. Do you have with you Exhibit 100, which is your direct testimony of March 28 with two attached exhibits, and Exhibit 101, which is your rebuttal testimony of April 25? A. Yes, I do. Q. Were those exhibits prepared by you or under your direction? A. Yes, they were. MR. FINNIGAN: I'll offer Exhibits 100 and 101 at this time. JUDGE STAPLETON: Thank you. Those exhibits will be admitted into the record. (Admitted Exhibits Nos. 100 and 101.) MR. FINNIGAN: Dr. Meitzen is available for cross-examination. JUDGE STAPLETON: Thank you. Commission staff, do you have questions for this witness? MS. SMITH: No. JUDGE STAPLETON: Mr. Manifold? MR. MANIFOLD: No. JUDGE STAPLETON: Mr. Kopta? MR. KOPTA: No. JUDGE STAPLETON: Mr. Waggoner? MR. WAGGONER: I wasn't expecting it to get to me so quickly. I'm sorry. CROSS-EXAMINATION BY MR. WAGGONER: Q. Good morning, Dr. Meitzen. My name is Dan Waggoner. I represent AT&T. I have a few questions for you about your testimony. And just to do something novel, we'll just kind of walk through your testimony in order here, so if you've got that easily available, that will facilitate the process. First looking at your direct testimony, which was I believe marked as Exhibit 100 -- and if you could turn to page 3 of 17 of that in the discussion from lines 10 to 20. Am I correct just generally in understanding that you have at least two major concerns, one is with the evolution of TELRIC into a fully distributed cost methodology and another with the blank slate interpretation of forward-looking costs? A. Yes. That would be correct. Q. Now, could you just give me your definition of fully distributed cost? A. Fully distributed cost would be a method of determining a services price that primarily relies on cost information. And that cost information not only includes the direct or incremental cost of the service in question, but in the case where there are substantial nonincremental costs and whether you define them as shared, common, or joint, there needs to be a way of covering those costs in addition to incremental costs. And the fully distributed cost method would rely primarily on the cost information and not really consider the other factors that would go into efficient pricing. And, namely, we're talking about market conditions, whether it be demand elasticity, consumers' willingness to pay for the service, et cetera. So much of that information would be not used in an FDC-type method. Q. In your mind, is there any distinction between forward-looking or embedded costs that is inherent in the concept of fully distributed costs as you use it? A. There doesn't have to be. I mean, I think a forward-looking cost study could also then be used to develop FDC-type prices based on the forward-looking costs estimated from the model. Q. So your answer, a fully distributed cost methodology could either be forward-looking in nature or embedded in nature? A. Yes. Q. Now turning to your second concern, the blank slate interpretation of forward-looking network. And you also, I believe, characterized that as the instantaneous build-out or the instantaneous construction, is that correct? A. Yes. Q. Did you have a particular paragraph of the FCC order in mind when you criticized them for adopting an instantaneous build-out approach? A. Not that I recall. I think it's more a matter of interpretations that have been put on the methodology. Q. So you're not criticizing the FCC specifically for adopting an instantaneous build-out approach? A. Again, I -- at this time I cannot point to a particular paragraph that I would say is evident of that. Q. Well, are you going to be here this morning the whole morning? Do you plan to stay for a little while? Would you do me a favor at the break, and if you could just check to determine whether you do have any particular FCC paragraph or paragraphs that you are referring to? A. Sure. Q. Thank you. And perhaps if your counsel could just supplement the record, that way we won't have to put you back on the stand. A. Okay. Fine. JUDGE STAPLETON: Is that agreeable with you, Mr. Finnigan? MR. FINNIGAN: That's fine. JUDGE STAPLETON: Thank you. Q. Now, turning to the next page, page 4, in the area of lines 13 through 15 you talk about shared costs or common costs, correct? A. Yes. Q. And I believe in your answer to one of my earlier questions you also used the term "joint costs." Did I hear you correctly? A. Yes, I did use that term. Q. Do you consider joint costs, shared costs, and common costs to be synonymous with each other? A. You know, that's an interesting I think technical economic art. There have been various definitions of joint, shared, and common in the economic literature. I believe that one of the ways that cost terminology has evolved over time is to basically use shared and common as various types of nonincremental cost, and it's really the level at which these costs occur. And in the sense that I'm using these terms, shared would be those costs that pertain to some subset of the firm services, and it may be two, three, or however many services. And common costs, as the usage of the word has evolved, typically refers to company-wide costs that are basically not attributable to any subset or particular service of the firm. So that's the sense in which I'm using these terms here. Q. So is the answer that no, they are not synonymous or yes, they are synonymous in your mind? A. I would say the common usage of the terms has led them to be synonymous, although, I mean, you could get into a technical economic quibble as to whether they really are. And I didn't intend to really get into that kind of a quibble. Q. Well, at least as you're using the term "shared cost," then, do you intend it to be the same as common costs? A. Well, in my exposition, as I said, I'm referring to them as shared cost just for the simplicity of the testimony so we don't have to go through and naming these. And I didn't feel like it was an -- important enough to keep making the distinction. So as I state in my testimony, I will just refer to these in this testimony as shared. Q. So the answer is yes, whenever you use the term "shared costs" you mean either common costs or also including common costs? A. Yes, unless I make a specific exception to that. Q. Thank you. Turning ahead to page 6, lines 1 through 3, this is one of the places where you refer to the need to look at demand side conditions, correct? A. Yes. Q. And when looking at demand side conditions, do you define that as the customers' willingness to pay or elasticity of demand? A. Those are typically the primary demand side conditions, yes. Q. And do you consider opportunity costs as part of measuring demand side conditions? A. Opportunity cost of whom? Q. The supplying firm. A. That's a supply side of that condition, as far as I'm concerned. Q. Would you consider opportunity costs in your analysis that you're setting forth in this testimony? A. Well, I think economic costs generally do include opportunity costs, and so if we're measuring some form of economic cost, opportunity costs need to be considered. Q. Dr. Meitzen, we've sort of evolved this direction in this hearing that people try to start with either a yes or no and get an explanation. If you could do that, that would certainly expedite. A. Sure. I would like you to fully understand. Q. Yes. If you could start with a yes or no. MR. FINNIGAN: Just so the witness understands, you do have the opportunity to explain your answer. And if the question is not capable of being responded to in a yes-or-no fashion, you can indicate that. THE WITNESS: Sure, that's fine. Q. So the answer was yes, you do believe the Commission should consider opportunity costs when looking at supply side conditions? A. Yes. Q. Could you define opportunity costs? A. Quite simply, it's the opportunity foregone by pursuing one action versus the next best alternative. Q. So if we have in mind a hypothetical of an incumbent local exchange carrier selling unbundled network elements to a competitive local exchange carrier, do you have that in mind? A. Yes. Q. What would be the opportunity cost that the incumbent local exchange carrier would experience in selling that unbundled network element to a competitive local exchange carrier? A. The opportunity cost would be its loss of business if that unbundled network element could have been used by the carrier itself to provide service. Q. So for instance, if an unbundled network element were sold for a $10 price as a result of direction from this Commission, and the retail price for that service by the incumbent local exchange carrier would have been $20, am I correct in understanding that that $10 difference, at least in part, is an opportunity cost? A. Yes. Q. Now, returning to this notion of demand side conditions and the consumers' willingness to pay, who is the consumer of unbundled network element? A. It would be the purchaser of the unbundled network element, presumably the CLECs, for example. Q. When you're discussing consumers here, with regard to unbundled network elements those would be other carriers as opposed to end user retail customers, is that correct? A. If we're in the context of unbundled network elements, yes. Q. At the bottom of page 8 and the top of page 9 you reference a number of examples regarding markups over incremental costs in competitive markets. Do you see that? A. Yes. Q. Do you think it's important in making that kind of examination of markups over incremental costs to look at the phenomenon over a more extended period of time or is it appropriate simply to look at a snapshot? A. I would say over an extended period of time would be more appropriate. Q. Let's turn to page 15 of 17 of your Exhibit 100, lines 3 through 5. In there you reference Professor Kahn, correct? A. Yes. Q. Now, with regard to TELRIC costs, is it your opinion that new entrants will experience TELRIC costs at the time they enter the market? A. I guess I don't quite understand the question. Could you try to rephrase that for me, please. Q. All right. Well, you're discussing yours and apparently Professor Kahn's belief that if TELRIC costs are set unrealistically low, then that will deter facilities-based competition, correct? A. Mm-hmm. Q. Is that a yes? A. Sorry. Yes. Q. And I'm trying to understand whether you believe that a new entrant providing what you call facilities-based competition will experience TELRIC costs at the time it enters the market. A. Yes, it will for the given amount of demand it serves. However, its TELRIC, if it only serves a subset of the market, not the full extent of the ubiquitous service as an incumbent would, TELRIC for a subset might obviously be different than TELRIC for an incumbent. Q. Do you believe that incumbent local exchange carriers experience economies of scope and scale in serving their exchange territories? A. Yes. Q. And do you believe a new entrant would necessarily experience those same economies of scope and scale at the time it enters the market? A. That depends on the extent to which the entrant is in other lines of business, besides just the provision of that local exchange. So it's, I believe, an empirical matter. Q. So if the new entrant did not have other lines of business, do you believe that it would experience those economies of scope and scale at the time it entered the market? A. No, not to the extent of the incumbent. Q. So, for instance, if a new entrant only went in to serve one customer with one drop and one loop, they would not experience the same economies that an incumbent carrier would experience in serving multiple customers with multiple drops and multiple loops, correct? A. No, they would not. Q. On page 16 in your question and answer that begins at around line 8, you discuss a transition period for rural companies. Is that comparable to kind of a soft-landing approach as it is sometimes used in the common parlance? A. I guess I'm not quite sure what you mean by soft landing. I would say that, as I state in my answer, because small companies do not have the resources or necessarily the experience in these types of matters as the larger local exchange companies do, it seems that there would be a transition period that would be needed so that they could also, you know, be performing these studies or at least have access to suitable studies. And as I say in my answer, I have no doubt that one way or another competition will one way or another have an influence on these companies. So I'm not asking for a lifetime exemption, but I do think some types of mechanisms are needed to make sure that these companies are properly brought into this new era of competition and deregulation and that it's done without undue -- you know, unneeded damage. Q. And did you have in mind a transition period that was more or less than two years? A. I had no time period in mind. I think it depends on what seems to be appropriate for the companies in the state of Washington. Q. And you haven't looked at all, have you, on whether the embedded costs of the independent companies in the state of Washington are higher or lower than their forward-looking costs, have you? A. No, I have not. Q. You don't know whether their technology is more efficient and up to date than, for instance, U S WEST's and GTE's, do you? A. No, I do not. Q. If we could turn to your attachment which is entitled Appropriate Standards for Cost Models and Methodologies, Christensen Associates, February 13, 1997. How many people are in Christensen Associates? A. The firm itself is over 80 people. Q. And how many of those are professional economists versus other kinds of people? A. I don't know if the answer is good or bad. I believe 50 to 60 are professional economists, and we also have engineers, support people, computer experts, et cetera. Q. Does the firm primarily serve telecommunications clients or does it serve a broader range of clients? A. It serves a very broad range of clients outside of telecommunications. Q. And you individually, is your focus primarily on telecommunications or do you focus on other areas? A. My primary focus is telecommunications. Q. At the bottom of page 1, there's a bullet under the term "forward-looking economic costs" that says, quote, The appropriate interpretation of what constitutes forward-looking economic costs is the expected costs of an actual market participant, period, closed quote. When you use the term or your firm used the term "actual market participant" there, did you have in mind whether that was an incumbent local exchange carrier or a new entrant? A. I think it could be either. Q. And in the application of TELRIC methodology by this Commission, is it your recommendation that this Commission look at the costs of the incumbent or the new entrant? A. Well, I think to establish the proper incentives for facilities-based entrants, and as we discussed, they may or may not have the same forward-looking costs as an incumbent. The incumbents should be the target out there for everybody else to shoot for. So I mean, if the policy is to establish the proper cost standards to determine whether facilities-based entry is efficient or not, I think under those conditions you would probably want to take a look at what the forward-looking costs of the incumbent would be, because that would be the proper yardstick by which all others would measure whether or not it was worthwhile for them to enter the market on a facilities basis. Q. While we're talking about how you would recommend this Commission apply TELRIC methodologies, we earlier discussed the opportunity cost term. Do you recall that? A. Yes. Q. Would you recommend that the Commission take into account opportunity costs in setting TELRIC? A. I believe they should, yes. Q. And how should they do that? A. I haven't made any particular recommendations on that, so I don't really have a definite proposal at this time. I would say that, you know, obviously opportunity costs are a part of economic cost and need to be included in whatever definition of economic cost that is used. Q. Do you believe they should be included as part of TELRIC or as a separate analysis? A. Well, strictly speaking, if we are literally interpreting TELRIC as economic costs, they should be part of TELRIC. That's how an economist would define cost, and as economic costs includes opportunity costs. Q. Let's turn to page 14 of that same report of February 13, 1997. And the lines are not numbered, but if you look at the sentence that is the last line of the second full paragraph, it reads, quote, However, ARMIS, A R M I S, or similar sources, comma, are not likely to provide a good prediction of forward-looking investment costs, period, closed quote. Do you see that? A. Yes, I do. Q. So you believe or at least your firm believes that ARMIS is not a -- well, let me just ask you what you were trying to say there when you said that ARMIS was not likely to provide a good prediction. A. Well, as I think we go on to say in the next paragraph -- and this ties into the ARMIS reference -- booked capital values, in other words, telephone, plant, and service, are not likely to provide a good prediction of forward-looking investment costs because book values are based on historic costs, not current or forward-looking costs. Q. And what similar sources did you have in mind, if you know, that reference to ARMIS or similar sources? A. I think similar sources would be, you know, companies are required to file similar types of reports at the state level, for example. Q. So you weren't saying ARMIS should be ignored; you were simply saying you can't just adopt it without analysis and some modification? A. Correct. MR. WAGGONER: I think that's all I have. Thank you very much. JUDGE STAPLETON: Mr. Butler, did you have questions? MR. BUTLER: No. JUDGE STAPLETON: Mr. Shaw? MR. SHAW: Yes. CROSS-EXAMINATION BY MR. SHAW: Q. Good morning. You are here on behalf of WITA, the Washington Independent Telephone Association? A. Yes, that's correct. Q. And I just want to explore which company specifically you're talking about. I take it you're not here on behalf of General Tel? A. No, I am not. Q. Are you here on behalf of all other so-called independent telephone companies other than General Tel? A. I would ask my counsel to help out. Q. That would be fine. MR. FINNIGAN: Dr. Meitzen is appearing on behalf of those members of WITA who are not appearing here in their own capacity, which would be GTE of the Northwest and Sprint, Sprint United. Q. With that understanding, is it your opinion, Dr. Meitzen, that all companies, that is, PTI and the rest of the independent telephone companies doing business in the state of Washington, are rural companies by definition? A. My understanding, yes. Q. That is the assumption of your testimony, that pursuant to the federal act of '96 that they are rural companies and should be classified as such? A. In constructing my testimony, I made a statement about the rural companies and the need to get -- have a transition period for them. I did not have particular companies in mind or particular definitions. It was more of a general statement. So, you know, the particulars of any one company are really not something that I directly spoke to in my testimony. Q. So you would agree that whether or not any independent telephone company you represent in this proceeding requires a transition is a case-by-case analysis by this Commission? A. I would say that I am certainly not in a position now -- if you gave me names of companies which would be eligible or not, I cannot make that judgment at this point. Q. Would you agree that one of the purposes of the federal act is to bring competitive choices to all consumers, not just consumers of RBOCs or larger LECs? A. Yes, I wo