BEFORE THE WASHINGTON UTILITIES AND TRANSPORTATION COMMISSION In the Matter of the Pricing ) Proceeding for Interconnection, ) DOCKET NO. UT-960369 Unbundled Elements, Transport and ) Termination, and Resale ) ) ) In the Matter of the Pricing ) Proceeding for Interconnection, ) DOCKET NO. UT-960370 Unbundled Elements, Transport and ) Termination, and Resale for ) US WEST COMMUNICATIONS, INC. ) ) ) ) DOCKET NO. UT-960371 ) In the Matter of the Pricing ) Proceeding for Interconnection, ) Unbundled Elements, Transport and ) Termination, and Resale for ) GTE NORTHWEST INCORPORATED ) ) ) POST-HEARING BRIEF OF AT&T COMMUNICATIONS OF THE PACIFIC NORTHWEST, INC. AND MCI TELECOMMUNICATIONS CORPORATION AND MCIMETRO ACCESS TRANSMISSION SERVICES, INC. TABLE OF CONTENTS Page I. LEGAL PARAMETERS & ISSUES 1 A. Introduction 1 B. Federal Law 4 1. Unbundled Network Elements and Interconnection 4 2. Resale 5 3. A Few Words About the Eighth Circuit and the FCC’s Pricing Rules 6 C. Washington Law 8 II. COST METHODOLOGY: PRINCIPLES 9 A. Goals of this Proceeding 9 B. Choice of Cost Model 10 C. Criteria to Examine Cost Models 11 1. Forward Looking Economic Cost Standard 11 2. Open Model and Inputs 12 D. Total Element Long Run Incremental Cost 14 E. Common Costs, Embedded Costs and Other Proposed Additions to TELRIC 16 1. Embedded Costs and other TELRIC ‘Additions’ 16 2. Common Costs 19 III. COST MODELS 20 A. Model Description and Satisfaction of Cost Model Criteria 20 1. AT&T/MCI - Hatfield Model 21 2. U S WEST - RLCAP 23 3. GTE – Loop Model 27 4. Sprint - BCPM 30 B. Network Architecture Issues 33 1. Rural Census Block Groups (CBG) 34 2. Line Counts 36 3. Locations of Homes & Businesses 38 IV. OTHER MODEL AND INPUT ISSUES 40 A. Characteristics of Valid Model Inputs and Assumptions 40 B. Investments 42 1. Structure Sharing 42 2. Structure Mix 46 3. Placement Costs 47 4. Drops 50 5. Fill Factors 51 6. Cable (sizing/lengths) and Fiber/Copper Break Point 52 7. Load Coils 53 8. Digital Loop Carrier 54 9. Host/Remote Switches 55 C. Capital Factors 55 D. Expense Factors 56 E. Joint, Shared and Common Costs 58 F. Model Validation 58 G. Switch Models 61 V. AVOIDED COSTS 66 A. Definitions and Assumptions 66 1. Services to Apply Discount 66 2. Data Source - Separated vs. Unseparated data 67 3. TELRIC or Embedded Studies 69 4. ARMIS or Proprietary Data 70 5. Discount Percentage – Revenues or Expenses in the Denominator 70 6. Exclusion of OS/DA and NRCs From Calculation of Wholesale Discount Rate 71 7. Separate Discount for Groups of Services or Single Discount Rate 72 B. Avoided Cost Studies 73 C. Direct Avoided Costs 75 D. Indirect Costs 76 VI. NON-RECURRING COSTS 77 A. Description of NRC Studies 80 1. AT&T 80 2. U S WEST 82 3. GTE 83 VII. DEAVERAGING COSTS 83 VIII. COLLOCATION 84 IX. LOCAL NUMBER PORTABILITY 86 X. INTERCONNECTION/TRANSPORT & TERMINATION 87 XI. CONCLUSION 88 I. LEGAL PARAMETERS & ISSUES A. Introduction This proceeding brings the Washington Utilities and Transportation Commission full circle in its ongoing effort to implement the clear mandate of federal and state law to open Washington’s local telephone exchange market to effective competition. In multiple prior dockets opened before passage of the Telecommunications Act of 1996 (“Act”), the Commission sought to implement well-established state public policy to promote competition in the local exchange market. The Act simply, “federalizes that [state] policy”. WUTC v. USWC, UT-950200 (“Rate Case”) , Fifteenth Supplemental Order, p. 8, April 11, 1996. (“Rate Case Order”). The Commission’s words from one of those dockets sets the tone for this proceeding: This is an important proceeding. It comes at a defining time for telecommunications regulation in Washington State . . . [I]t considers policies and pricing that will carry USWC into the competitive environment mandated by the federal government in the Telecommunications Act of 1996. For years, this state’s statutory and regulatory telecommunications policy has directed open markets and consumer choice, . . . This order is a key part of the foundation of a sustainable competitive marketplace. p. 8, Rate Case Order. (emphasis added) Notwithstanding the Commission’s refrain, passage of the Act, adoption of the FCC’s local competition rules In Re: Implementation of the Local Competition Provisions of the Telecommunications Act of 1996, CC Docket No. 96-98, FCC 96-325, First Report and Order (“FCC Order”). and exhaustive negotiation and arbitration between local incumbents and new entrants, Washington has yet to experience anything even remotely resembling a “sustainable competitive marketplace” in local telephone exchange service. The local incumbents’ vice grip on the market remains firmly in place. One Competitive Local Exchange Carrier has recently complained in a federal action it commenced against U S WEST Communications, Inc. (“U S WEST”) that U S WEST has violated federal and state antitrust laws for unlawfully preserving, extending and enhancing its monopoly over local telephone service in various states, including Washington. Electric Lightwave, Inc. v. US West Communications, Inc., Case No. C97-10737, United States District Court for the Western District of Washington at Seattle, filed June 30, 1997. MCI has also justifiably concluded that, “[I]n attempting to preserve their monopolies, [incumbents] delay, disrupt, and discriminate against new entrants, failing to comply with regulatory deadlines, and denying consumers and businesses the benefits of competition.” p. A21, New York Times, August 20, 1997. See also e.g., MCIMetro Access Transmission Services, Inc. v. US West Communications, Inc., UT 971158, filed July 16, 1997. (Complaint alleges US West refusal to permit residential resale and combination of unbundled elements test orders); Reuters 09:07 PM ET 07/15/97: The FCC has created a government task force to probe charges that regional Baby Bell companies are unfairly stifling competition in the $100 billion local phone business. The agency said its "enforcement" task force will identify "trouble spots" and mete out penalties, if necessary, in an effort to open the local market to new competitors after passage of last year's telecommunications law. This proceeding presents the Commission with the opportunity to articulate that: (1) the era of the monopoly market in local exchange service is, once and for all times, at an end; and (2) the Commission will no longer tolerate the business plan of the local incumbents to circumvent the law and stifle competition. With the adoption of sound economic cost models in the first phase of these proceedings, the Commission can take the next critical step towards unlocking the monopoly vice to permit free and robust competition in Washington’s local telephone exchange market. In this first or the “generic” phase of this proceeding, the Commission has the goal of developing a cost methodology through which it will, in subsequent phases, establish rates for interconnection, unbundled network elements (“UNEs”), transport and termination and a wholesale discount rate for the resale of services by U S WEST and GTE. See, Order Instituting Investigations, UT-960369, 960370, 960371, p. 2, November 20, 1996. Another equally significant and interrelated goal of this proceeding is to open cost proceedings to genuine competition in the selection of cost models. AT&T Communications of the Pacific Northwest, Inc. (“AT&T”), MCI Telecommunications Corporation and MCIMetro Access Transmission Services, Inc. MCI joins AT&T in sponsoring the Hatfield model. MCI is not a co-sponsor of AT&T’s avoided cost study. Except with respect to the avoided cost study, any reference to AT&T shall include MCI. (MCI entities referred to collectively as “MCI”) join Commission staff in advocating that the Commission adopt specific cost models as the foundation upon which to later set rates. Tr. 1791- -20 (Spinks Testimony). This is the only practical means for determining the rates to be charged now and in the future to the new entrants who will bring competition to this state. The Commission has heard considerable evidence regarding a wide variety of cost models and studies. As this evidence has established, the models U S WEST and GTE have sponsored here are grossly inadequate to the complex and important task at hand. AT&T has sponsored the only models that consistently adhere to sound economic and modeling principles and that fully comply with the Act and this Commission’s orders. AT&T proposes models designed to fulfill the potential of federal and state law to foster the development of local exchange competition in Washington. Those models will lead to rates that most closely approximate the rates U S WEST and GTE would charge in a competitive environment with competition's attendant pressures to minimize cost and maximize technological innovation and deployment. B. Federal Law Federal policy is clear: with passage of the Act, Congress intended to require telephone companies to open their networks to competition. 47 U.S.C. § 251 et.seq., ¶1, FCC Order. But, effective competition requires more than passage of federal statute. Incumbents possess power to erect substantial artificial barriers to market entry, including setting prices above economic cost or setting prices that discriminate between the incumbents and new entrants. Ex. 1 (Cornell Direct) at 17. To eliminate these barriers and to encourage expeditious entry into the local exchange market, the Act defines specific pricing mechanisms for interconnection, UNEs and wholesale rates. 1. Unbundled Network Elements and Interconnection Under the Act, state commissions are to set rates for unbundled network elements and interconnection as follows: Determinations by a State commission of the . . . just and reasonable rate for the interconnection of facilities and . . . network elements . . . (A) shall be - - (i) based on the cost of providing the . . . interconnection or network element, . . . and (ii) nondiscriminatory, and (B) may include a reasonable profit. 47 U.S.C. § 252(d)(1)(A) The FCC has concluded that “cost” under § 252(d)(1)(A) of the Act must, of necessity, mean the forward-looking economic cost of providing the network elements and interconnection. ¶¶ 620, 632, 672, FCC Order. The effect of the Eighth Circuit’s recent decision vacating the FCC’s pricing rules will be discussed in section I.B.3. below. Pricing network elements or interconnection at their economic cost and nothing more is the only legitimate way to ensure an open and efficient local exchange market. Ex. 1 (Cornell Direct) at 18. The forward-looking economic cost of a network element is its Total Element Long Run Incremental Cost (“TELRIC”) plus a reasonable allocation of shared and common costs. Tr. 266, Ex. 1 (Cornell Direct) at 27. Likewise, ‘non-discriminatory’ pricing in the economic sense is a necessary prerequisite to a competitive local exchange market. Id. at 18. Pricing is non-discriminatory only if the prices offered to two different buyers differ only to the extent that the cost of serving these two buyers in the most efficient manner differs and only if it is efficient to reflect those cost differences in the price. Id. at 27. As Ms. Cornell testified, non-discriminatory pricing is “incredibly important if competition is going to come to local exchange. It is truly vital.” Tr. 257. 2. Resale Resale is a critical strategy necessary for the swift development of competition in Washington’s local exchange market. Resale permits new entrants to develop a sufficiently large customer base to justify facilities-based entry and, moreover, permits new entrants to serve high cost areas where it is not efficient to duplicate incumbent facilities. ¶907, FCC Order. To that end, the Act requires state commissions to determine wholesale rates: [O]n the basis of retail rates charged to subscribers for the telecommunications services requested, excluding the portion thereof attributable to any marketing, billing, collection, and other costs that will be avoided by the local exchange carrier. 47 U.S.C. §252(d)(3). Marketing costs, billing costs and other costs for services that a reseller will have to provide itself should not be charged to the reseller. See, In Re: Application of Ameritech Michigan, CC Docket No. 97-137, FCC 97-298, ¶295, Memorandum Opinion and Order (August 19, 1997) (“FCC Ameritech Order”); see also, 47 C.F.R. §§51.607, 51.609. 3. A Few Words About the Eighth Circuit and the FCC’s Pricing Rules. As the Commission is well aware, on July 18, 1997, the United States Court of Appeals for the Eighth Circuit vacated the FCC’s pricing rules. Iowa Utilities Board v. Federal Communications Commission et.al., 1997 WL 403401 (8th Cir. 1997). This decision notwithstanding, for several reasons, the Commission should follow the FCC’s pricing rules. First, while the Commission currently is not bound to follow the FCC's pricing rules The FCC recently determined that, when a RBOC applies for authority to offer interLATA services under 47 U.S.C. §271, the FCC will review unbundled element pricing for compliance with the pricing principles in the FCC Order. ¶¶289-294, FCC Ameritech Order. If U S WEST intends to seek Section 271 authority to offer interLATA services in Washington, therefore, the prices the Commission establishes in this docket must conform to the FCC’s interpretation of the pricing requirements of the Act. , sound economic principles (as well as federal and state public policy goals to encourage development of effective local exchange competition) support the pricing determinations embodied in the FCC Order. Indeed, in prior proceedings, the Commission has already followed some of the core principles of the FCC’s pricing rules. (e.g., TSLRIC, p. 82, Rate Case Order). Moreover, in support of its decision to adopt TELRIC, the FCC cited specifically to the Rate Case Order, concluding that “A number of states already employ, or have plans to utilized, some form of LRIC or TSLRIC methodology in their approach to setting prices for unbundled network elements, with several states choosing LRIC or TSLRIC as a price floor” ¶631, FCC Order (footnote 1509 citing to p. 82, Rate Case Order) Second, the Court of Appeals expressly elected not to review the merits of the pricing rules, concluding instead as follows: Having concluded that the FCC lacks jurisdiction to issue the pricing rules, we vacate the FCC’s pricing rules on that ground alone and choose not to review these rules on their merits. Id., 1997 WL 403401 *9 (emphasis added). Hence, the decision does not reject the sound economic principles the FCC adopted in the pricing rules. Third, the Court of Appeals’ decision to vacate the pricing rules does not preclude the Commission from following these rules. The Court did not bar state commissions from setting rates based on the pricing rules. On the contrary, the Court endorsed the primacy of state commissions in setting rates for interconnection, services and network elements without any regard to the manner or method by which state commissions should set those rates. The Court articulated no substantive rationale for making pricing decisions different from those embodied in the pricing rules. There are none. Finally, U S WEST and GTE do not significantly dispute the principles underlying the pricing rules. The parties’ disagreement, instead, centers on the manner in which the economic principles articulated in the rules should be implemented. C. Washington Law The national imperative of local competition follows similar long-standing public policy in Washington to promote effective competition in telecommunications. State telecommunications policy is governed by the Regulatory Flexibility Act, which directs the Commission to preserve universal service, promote diversity in services, ensure that competitive services are not subsidized by monopoly rates and permit flexible regulation of competitive telecommunication companies and services. Rate Case Order, p. 9, RCW 80.36.300, Const. Art. 12, §19; see also, In Re: Electric Lightwave, Inc., 123 Wash.2d 530, 538-39, 869 P.2d 1045, 1050-51 (Wash. 1994) (recognizing authority in the Commission to grant monopolies to LECs would frustrate the constitutional [Const. Art. 12, §19] and legislative goal [Regulatory Flexibility Act] of assuring diversity in the supply of telecommunications services). In a critical order presaging passage of the Act, the Commission emphasized the core of its mission for the state’s telecommunications market: In evaluating alternative compensation mechanisms we have sought to maintain the balance between the objective of promoting diversity in the supply of telecommunications services and the responsibility to ensure that companies are fairly compensated for their services. It is not the Commission’s responsibility to protect incumbents from competition; indeed, it is our responsibility to ensure that new entrants have a reasonable opportunity to compete. WUTC v. US West, UT-941464 (“Interconnection Case”), p. 19, 4th Supplemental Order, October 31, 1995. (“Interconnection Order”). (emphasis added). The only way the Commission can succeed in creating competitive opportunity for new entrants is to adopt economic cost models designed for that purpose, not the archaic and “hide the ball” models of incumbents designed to allow recovery of historic costs incurred in an monopoly environment tainted with economic inefficiencies. II. COST METHODOLOGY: PRINCIPLES A. Goals of this Proceeding The Commission’s stated goal in this proceeding is to select cost methodologies to set rates for interconnection, UNEs and the resale of incumbent telecommunication services. But another equally significant and interrelated goal of this proceeding (one incumbents would rather have this Commission ignore) is to bring to the table genuine competition in the selection of cost models. For years, potential new entrants have endured incumbents’ advocacy of cost studies designed to exploit the incumbents’ control of cost information in order to set prices above economic costs. This control is an artificial barrier to market entry. Ex. 1 (Cornell Direct) at 17. Establishing rates for UNEs and interconnection should not be an arbitrary or secretive process. Prices must be based upon open, reliable and economically sound cost models. Accordingly, in evaluating the propriety of a model sponsored in these proceedings, the model should satisfy the following primary criteria: • The model accurately calculates costs for network elements and interconnection in a manner consistent with the forward looking economic cost standard adopted by the Commission and the FCC; • The model and its inputs are open to inspection and analysis. Only the Hatfield meets these criteria. Likewise, AT&T's Avoided Cost Study ("AT&T Study") is an open study that uses publicly available embedded cost data and an economically rational discount factors necessary to calculate wholesale discounts consistent with the requirements of the Act. B. Choice of Cost Model AT&T proposes that the Commission adopt a specific cost model as the basis upon which to set rates for UNEs, interconnection and a wholesale discount rate. AT&T’s Hatfield Model 3.1 updated (“Hatfield”) is the only model sponsored in this proceeding that can accurately estimate the TELRIC of a network element. Moreover, Hatfield captures a reasonable share of any common costs through the addition of a percentage markup over and above TELRIC, resulting in an output equal to the economic cost of the element. In the Rate Case, the Commission agreed. There, the Commission was presented with its first opportunity to consider “on a systematic and consistent” basis the costs U S WEST incurs to provide various services. p. 80, Rate Case Order. In that proceeding, the Commission concluded that the appropriate measure of U S WEST’s costs in providing a service is its Total Service Long Run Incremental Cost (“TSLRIC”). Id. at 82. The Commission adopted a prior version of Hatfield concluding that it is “The most reasonable and accurate measure of incremental cost for these services . . . . Id. at 86. More importantly, the Commission concluded in the Rate Case that this prior version of Hatfield “identifies the Company’s true costs of providing local exchange service more closely than the Company’s study, and is sufficient for purposes of pricing local exchange service.” Id. at 132 (emphasis added). The present Hatfield model has been refined and updated since then for the express purpose of estimating the TELRIC of a network element and interconnection. It is the best cost methodology available to the Commission to set prices for UNEs and interconnection. Further, it is the only model that also be used to determine the costs of universal service, assuring consistency in establishing costs between wholesale and retail services. C. Criteria to Examine Cost Models 1. Forward Looking Economic Cost Standard This Commission has already adopted a forward-looking economic cost standard. In prior dockets, the Commission has held that TSLRIC is an accurate measure of the incremental cost incurred by a carrier to provide an additional service. p. 82, Rate Case Order; p. 89, Interconnection Order, see also, WUTC v. U S WEST Communications, Inc., UT-930957, 931055 & 931058, 4th Supplemental Order (September, 1994). While TLSRIC only measures the incremental cost of a service, the Commission must rely upon the underlying economic principles to establish the standard that complies with the Act’s requirement to set rates for a network ‘element’ rather than a telecommunications service. TELRIC is that standard--as all parties to these proceedings agree in principle--that estimates the forward-looking incremental cost of a network element. Accordingly, any model purporting to establish the economic cost of a network element must, of necessity, be able to accurately calculate the TELRIC of that element. AT&T discusses the TELRIC methodology and rationale for Commission adoption in detail in section II.D. below. 2. Open Model and Inputs Both the FCC and the Commission have recognized that incumbents may control information to their own advantage in estimating the cost of unbundled network elements. For this reason, the FCC and the Commission have fashioned remedies accordingly. When the FCC adopted TELRIC, it concluded that incumbents have greater access to the cost information needed to calculate the in