BEFORE THE WASHINGTON UTILITIES AND TRANSPORTATION COMMISSION In the Matter of the Cost Proceeding for) Interconnection, Unbundling Elements, ) Docket UT-960369 Transport and Termination, and Resale ) _______________________________ ) ) Docket UT-960370 And Related Matters ) Docket UT-960371 _______________________________ ) BRIEF OF SPRINT CORPORATION , ON BEHALF OF UNITED TELEPHONE COMPANY OF THE NORTHWEST AND SPRINT COMMUNICATIONS COMPANY L.P. Seth M. Lubin General Counsel United Telephone Company of the Northwest 902 Wasco Street Hood River, OR 97031 Nancy L. Judy Director Regulatory and Governmental Affairs United Telephone Company of the Northwest 902 Wasco Street Hood River, OR 97031 Carol Matchett Sr. Attorney Sprint Communications Company L.P. 1850 Gateway Drive, 7th Floor San Mateo, CA 94404-2467 September 12, 1997 TABLE OF CONTENTS INTRODUCTION LEGAL PARAMETERS AND ISSUES A. Federal Law State Law II. COST METHODOLOGY: PRINCIPLES What should be the goal(s) of the proceeding? How will the cost models be used? What criteria should the Commission follow in examining cost models? TELRIC and its definition Common costs and their definition F. Actual or embedded costs and their utility COST MODELS Description Hatfield Model BCPM USWC Models GTE Models B. Does the model Satisfy the Criteria in II.C? C. Network Architecture Issues Treatment of rural CBGs Loop Lengths and Line Counts Location of Homes and Businesses IV. OTHER MODEL AND INPUT ISSUES: What inputs should the Commission consider when examining or running models? 1. What methodology was used to determine platform/algorithms and inputs? 2. Can the inputs to the models be validated? 3. How should the Commission analyze or set inputs for models? 4. Can the models be run (or modified) by parties other than the model sponsors? 5. Are the model algorithms and data inputs open? Are they correct? B. How should the Commission decide the reasonableness of price, quantity and other inputs? C. Investment 1. Structure sharing 2. Structure mix (i.e. aerial v. buried) 3. Placement Costs, including trenching, boring, poles, manholes and conduit Drops Fill factors 6. Cable sizing, Lengths and Fiber/copper break points 7. Inclusion of special access, “above DS-0” loops Loading coils Integrated/universal digital carrier Host/Remote D. Capital factors, including cost of capital and depreciation E. Expense factors F. Joint, shared and common costs Model validation 1. BCPM 2. GTE Hatfield 4. USWC H. Switch Models 1. Public or proprietary data 2. Power and software 3. Treatment of vertical services V. AVOIDED COSTS A. Definitions and assumptions 1. Services to which discounts will apply 2. Separated or unseparated data 3. TELRIC or Embedded Studies 4. ARMIS or proprietary data 5. Discounted percentage based on revenues or expenses in denominator 6. Exclusion of OS/DA and NRCs from calculation 7. Separate discount for groups of services or one discount rate B. Methodologies and models 1. AT&T GTE 3. MCI 4. Public Counsel 5. Staff 6. USWC C. Direct avoided costs 1. Customer services 2. Uncollectibles 3. Product management 4. Sales 5. Product Advertising 6. Call completion services 7. Number services 8. Carrier access services 9. Public telephone services 10. Directories 11. Testing 12. Operations plan administration 13. Other D. Indirect costs 1. What should be included as indirect costs? . Should avoided direct expenses be divided by direct expenses or total expenses? E. Calculations, conclusion and recommendations VI. N.R.C.s A. Description of studies 1. AT&T 2. MCI 3. US WEST 4. GTE B. What should be included? C. Issues raised by the Commission 1. Do the expense factors in the HM include the one-time costs associated with UNE’s? 2. Can the LEC NRC studies be validated? 3. Should the NRC estimates be based on not-yet-deployed OSS? 4. Reasonableness of time estimates made in late 1980s 5. Travel time estimates included in the LEC studies 6. Are unbundled loops equivalent to special access lines or POTS? 7. Can the retail NRC be used as a proxy? Should avoided costs be deducted? 8. Are the existing NRC compensatory? VII. DEAVERAGING COSTS VIII COLLOCATION IX LOCAL NUMBER PORTABILITY X SIGNALING, INTERCONNECTION/TRANSPORT AND TERMINATION XI OTHER ISSUES [DEPRECIATION LIVES] [TAX LIABILITY] BEFORE THE WASHINGTON UTILITIES AND TRANSPORTATION COMMISSION In the Matter of the Cost Proceeding for) Interconnection, Unbundling Elements, ) Docket UT-960369 Transport and Termination, and Resale ) _______________________________ ) ) Docket UT-960370 And Related Matters ) Docket UT-960371 _______________________________ ) BRIEF OF SPRINT CORPORATION ON BEHALF OF UNITED TELEPHONE COMPANY OF THE NORTHWEST AND SPRINT COMMUNICATIONS COMPANY L.P. Sprint Corporation (Sprint), on behalf of United Telephone Company of the Northwest and Sprint Communications Company L.P., pursuant to WAC 480-09-770, and in accordance with the briefing schedule established by the Administrative Law Judge’s letter of August 4, 1997 to the parties, respectfully submits its Post Hearing Brief in the above-referenced docket. INTRODUCTION The Commission opened this generic proceeding to carry out the requirements of the Telecommunications Act of 1996 (“the Act”) to establish rates for interconnection, unbundled network elements, transport and termination, and resale. The first generic proceeding, UT-960369, was to focus on the development of an appropriate and consistent cost methodology to determine costs of providing certain telecommunications services. Once established, the resulting cost methodology would be used in UT-960370 and UT-960371 to determine the proper level of costs and prices for US WEST 1 Communications (“USWC”) and GTE Northwest Incorporated (“GTE”). The expectation was that these prices would then be used in subsequent arbitrations or tariffs, and would replace prices in existing contracts. In deciding these matters, it is crucial that the Commission adopt costs for unbundled elements based upon true forward-looking economic costs that reflect the costs of Washington Incumbent Local Exchange Carriers (ILECs), and that the Commission set wholesale discounts properly to reflect only those costs that the ILEC actually can eliminate in providing wholesale services. Failing to adopt proper forward-looking economic costs and a discount based directly on realistic avoided costs would have a series of negative effects, and will not serve the public interest. (Ex 152, p. 4, Dunkel) For instance, setting prices too low because underlying unbundled element costs were set too low, or establishing a wholesale discount that is unrealistically high would: Send incorrect economic signals that would discourage development of facilities-based competition; (Ex. 088, p. 19, Judy; Ex. 100, p. 14-15, Meitzen; Ex. 078, p. 12, Williams; Ex. 112, p. 68, Harris; Ex. 102, p. 4, Montgomery); Transfer the ILEC’s costs of providing services to Competitive Local Exchange Carriers (CLECs), to the ILEC’s other customers including residential customers; (Trans. Vol. 13, p. 1021, Williams); and, prevent incumbents from being able to offer high quality services demanded by end users. (Ex. 067, p. 6, Williams; Ex. 112, p. 3, 19, Harris). Conversely, setting prices too high based on embedded costs would thwart competition by creating a barrier to entry, and perpetuate any inefficiency that might currently exist in the incumbent’s network or operation. (Ex. 001, p. 41, Cornell; Ex. 107, p. 7, Blackmon.). It should be noted that Sprint’s recommendations expressed herein reflect the balancing within Sprint Corporation of Sprint ILECs such as United Telephone of the Northwest, with the interests of Sprint’s CLEC and long distance companies. In the future, Sprint will be both a buyer and seller of unbundled elements and wholesale services in Washington. Thus, the Company’s recommendations are based upon a balancing process not unlike that which this Commission must undertake in this docket. (Ex. 088, p. 4-5, Judy). I. LEGAL PARAMETERS AND ISSUES Federal Law Section 252 of the Act sets forth pricing standards for Interconnection and Network Element Charges [252(d)(1)], and charges for transport and termination of traffic [252(d)(2)]. Section 252(d)(1) of the Act requires that: Determinations by a State commission of the just and reasonable rate for the interconnection of facilities and equipment…and the just and reasonable rate for network elements… shall be based on the cost (determined without reference to a rate-of-return or other rate-based proceeding) of providing the interconnection or network element (whichever is applicable), and nondiscriminatory, and may include a reasonable profit. The pricing standards set by the Act for transport and termination are contained in Section 252(d)(2)(A)(ii), which requires that rates for reciprocal compensation be determined “…on the basis of a reasonable approximation of the additional costs of terminating such calls.” Pricing for Unbundled Network Elements Following the Act, the FCC issued its First Report and Order in Docket 96-98, released August 8, 1996. In that order, the FCC adopted rules and definitions for the pricing standards set forth in Section 252(d) of the Act as follows: In practice, this will mean that prices are based on the TSLRIC of the network element, which we will call Total Element Long Run Incremental Cost (TELRIC), and will include a reasonable allocation of forward-looking joint and common costs. (Order No. 96-325, ¶ 672). However the FCC’s preemptive authority over the states’ flexibility in setting prices was contested and ultimately vacated by the 8th Circuit Court when it ruled on July 18, 1997 that: ...the Act specifically calls for the state commissions, not the FCC, to determine the rates for interconnection, unbundled access, resale, and transport and termination of traffic. See 47 U.S.C.A. §252 (c) (2), (d). Consequently, we reject the FCC’s contention that its rulemaking authority is coextensive with the reach of every provision of a formal statute involving telecommunications. (p. 77). Therefore, the FCC’s interpretation of cost-based pricing without reference to rate of return or rate-based proceeding is not binding on this Commission. Nevertheless, it should be noted that the 8th Circuit did not analyze or evaluate the substantive merits of the FCC’s pricing rules. The FCC’s pricing rules reflect analysis and findings based upon an extensive record and merit this Commission’s careful attention as it addresses many of the same issues to be considered in this proceeding. Discounts As to discounts for retail services, §252(d)(3) of the Act states: For purposes of section 251 (c)(4), a State commission shall determine wholesale rates on the basis of retail rates charged to subscribers for the telecommunications service requested, excluding the portion thereof attributable to any marketing, billing, collection, and other expenses that will be avoided by the local exchange carrier. This was further clarified and interpreted in the FCC Order No. 96-325, which ruled that states can either identify and calculate avoided costs based on avoided cost studies, or adopt interim discount rates from within a default range of discount rates adopted by the FCC. In establishing its avoided cost criteria, the FCC “intended to leave state commissions broad latitude in selecting costing methodologies that comport with their own ratemaking practices for retail services.” (Order 96-325, ¶909). Nevertheless, the rules do specify that particular accounts are to be presumed avoidable, unless the ILEC proves that specific expenses will be incurred in the provisioning of wholesale services, or that the particular expense within these accounts are not included in the retail price of the service being resold. (¶909, 934). Washington Law The Commission is obligated to establish rates and charges for telecommunications service, and regulate telecommunications companies in the public interest under Title 80 RCW. II. COST METHODOLOGY: PRINCIPLES Since the costing methodology that the Commission will adopt in this proceeding will establish the prices incumbent providers charge for unbundled network elements, the foundation of the costing methodology must rest on § 252(d)(1) of the Act, as explained in the previous section. Regardless of the cost model used, the underlying principles should remain constant and should apply equally to all ILECs. Specifically: Prices should reflect forward-looking costs for an economically efficient firm (Ex. 90 p. 9, Judy; Ex. 152, p.4, Dunkel). Costing should be performed in sufficient detail so that resulting prices lead to economically rational entry decisions by competitors, as well as efficient utilization of the incumbent’s network. (Ex. 090, p. 9, Judy). Such a policy ensures that prices are set neither too high nor too low, and thus will best serve the public interest. (Ex. 152, p. 3-4, Dunkel). The model should utilize publicly available data. (Ex. 89, pg 6, Judy; Ex. 152, p. 4, Dunkel). The accepted study method should be applicable to all telephone companies in Washington. (Ex. 88 p. 10, Judy; Ex. 152 p. 3,4, Dunkel). In order to serve the public interest, avoided cost discounts, or prices for unbundled network elements, should not be set either significantly higher or lower than indicated by the appropriate information. What should be the goal(s) of the proceeding? The Commission’s goal should be to determine an accepted cost methodology for use in establishing prices and to set prices that will promote competition in a nondiscriminatory manner. The commission’s goal in these proceedings, as articulated in the initiating order, is to derive an accepted cost methodology for use in establishing prices or price ranges for interconnection, unbundled network elements, transport and termination, and wholesale and resale discounts. Related issues concerning interim number portability and collocation costing and pricing were also to be determined in this proceeding. (WUTC Order Instituting Investigation UT-960369, p. 2). Sprint also recommends that a goal of this proceeding should be to set prices that will promote competition in a non-discriminatory manner in keeping with the spirit of the Act. How will the cost models be used? The Costing Methodology must be applied consistently to all ILECs to ensure a non- discriminatory marketplace. The order that instituted and consolidated these proceedings described the first proceeding as a generic investigative proceeding relating to the development of an appropriate and consistent costing methodology to determine costs of providing interconnection, unbundled network elements, transport and termination, and wholesale and resale discounts. The other two investigations concerned the establishment of prices for two incumbent regulated local exchange telecommunications companies, GTE and USWC. Using the appropriate cost methodology, the Commission would determine the costs each company faces and, based on those costs, the proper level of prices for interconnection, unbundled network elements, transport and termination, and resale. The order further stated that: It is expected that those prices or price ranges will be applied in future arbitrations, and that parties will reform their contracts to adopt the Commission-approved prices. It is also anticipated that the determinations made in these proceedings will apply to any relevant tariffs required to be filed pursuant to Commission Orders in the consolidated interconnection proceeding, Docket No. UT-941464, et. Al., and the USWC Rate Case Proceeding Docket No. UT-950200. (Order Instituting Investigation, UT-960369, p. 2-5). In Staff’s view, this phase of the proceeding should determine ‘price floors’ for unbundled network elements. These price floors will establish the rate below which prices cannot be set if anticompetitive cross-subsidies are to be avoided. For resale of finished services, this phase of the proceeding should determine the costs that can be avoided by incumbents if their retail services are purchased by competitors for resale. (Ex. 107, p. 3-4, Blackmon). Whatever costing methodology the Commission selects must be applied consistently to all ILECs. Sprint is concerned about the possibility that different policies, costing/pricing methodologies, etc., will be developed and applied differently to individual industry participants. This does not mean that individual ILECs may not have different costs and/or prices, only that the manner in which the costs/prices are developed and applied be on a consistent basis across all carriers in Washington. This will ensure a non-discriminatory market in which all ILECs and CLECs are afforded an equal opportunity to compete. (Ex. 88, p.10, Judy; Ex. 152 p. 3,4, Dunkel). C. What criteria should the Commission follow in examining cost models? Instead of specifying a single model, Sprint agrees with TCG that the Commission should clearly establish the criteria that constitutes an acceptable costing methodology. (Ex 103, p.16, Montgomery; Ex. 089, p. 6, Judy). The attributes of the cost models are the assumptions that lie behind the model, the inputs, and the calculations. If a LEC can satisfy that it has met the Commission-defined criteria for these attributes then the LEC should be able to use its own models. For this to happen, of course, a model must be available and open to inspection by others, with inputs, assumptions, and calculations thoroughly documented. (Ex. 089, p. 6, Judy; Ex. 29, p. 11, Klick; Ex 46, p. 2, Fitzsimmons). In its Proposed Decision, the Joint Board recommended a set of criteria for evaluating proxy cost models for universal service that Sprint believes are appropriate for evaluating the costing methodology for unbundled network elements (UNEs). They are: Technology assumed in the model should be the least-cost, most efficient and reasonable technology for providing the supported services that is currently available for purchase, with the understanding that the models will use the incumbent LECs’ wire centers as the center of the loop network for the reasonably foreseeable future. (Ex.23, p. 2-6, Joint Board; Ex 88 p. 9, Judy; Ex. 30, p. 6, Klick). Any network function or element, such as loop, switching, transport, or signaling, necessary to product supported services must have an associated cost. (Id). Only forward-looking costs should be included. The costs should not be the embedded cost of the facilities, functions or elements. (Id). The model should measure the long-run costs of providing service by including a forward-looking cost of capital and the recovery of capital through economic depreciation expenses. (Id). The long run period used should be a period long enough that all costs are treated as variable and avoidable. The model should estimate the cost of providing service for all businesses and households within a geographic region. This includes the provision of multi-line business services. Such inclusion allows the models to reflect the economies of scale associated with the provision of these services. (Ex.23, p. 2-6, Joint Board). A reasonable allocation of joint and common costs should be added on to the cost of supported services when establishing prices. (id; Ex 088, p. 9, Judy). This allocation will ensure that the forward-looking costs of providing the supported services do not include an unreasonable share of the joint and common costs incurred in the provision of both supported and non-supported services, e.g., multi-line business and toll services. The model and all underlying data, formulae, computations, and software associated with the model should be available to all interested parties for review and comment. All underlying data should be verifiable, engineering assumptions reasonable, and outputs plausible. (Ex. 89, p. 6, Judy; Ex. 23, p. 2-6, Joint Board). The model should include the capability to examine and modify the critical assumptions and engineering principles. These assumptions and principles include, but are not limited to, the cost of capital, depreciation rates, fill factors, input costs, overhead adjustments, retail costs, structure sharing percentages, fiber-copper cross-over points, and terrain factors. The models should also allow for different costs of capital, depreciation, and expenses for different facilities, functions or elements. (Ex. 23, p. 2-6, Joint Board). D. TELRIC and its definition In interpreting the Act’s pricing standards for interconnection and unbundled network elements, the FCC concluded that the specific language in the Act requires that prices for these services be set at forward-looking economic costs. Specifically, the FCC adopted a version of total service long run incremental costs (“TSLRIC”) as the methodology to be used in determining the costs of interconnection and unbundled network elements. The FCC refers to its methodology as Total Element Long Run Incremental Costs (TELRIC) --a nomenclature designed to indicate that the methodology is applied to the costing of discreet network elements or facilities, not to a service or services provided over that facility. (Ex. 088, p. 9, Judy). The FCC’s specific definition of TELRIC is contained in Part 51.505(b) of its Rules: - Total element long-run incremental cost. The total element long-run incremental cost of an element is the forward-looking cost over the long run of the total quantity of the facilities and functions that are directly attributable to, or reasonably identifiable as incremental to, such element, calculated taking as a given the incumbent LEC’s provision of other elements. Efficient network configuration: The total element long-run incremental cost of an element should be measured based on the use of the most efficient telecommunications technology currently available and the lowest cost network configuration, given the existing location of the incumbent LEC’s wire centers. Forward-looking cost of capital: The forward-looking cost of capital shall be used in calculating the total element long-run incremental cost of an element. Depreciation rates: The depreciation rates used in calculating forward-looking economic cost of an elements shall be economic depreciation rates. According to the FCC’s First Report and Order in Docket 96-98: Per-unit direct costs shall be derived from total costs using reasonably accurate forward-looking ‘fill factors’ (estimates of the proportion of a facility that will be ‘filled’ with network usage); that is, the per unit costs associated with a particular element must be derived by dividing the total cost associated with the element by a reasonable projection of the actual total usage of the element. [¶682]( Ex. 088, p. 9, Judy). Directly attributable forward-looking costs include the incremental costs of shared costs, to the extent they can be attributed to an element. [¶682] (Ex. 088, p. 14, Judy). Costs should be developed assuming that wire centers will be placed at the incumbent LEC’s current wire center locations. A reconstructed local network employing the most efficient technology for reasonably foreseeable capacity requirements is assumed. [¶685 & 690] (Ex 088, p. 9, Judy). Only forward-looking, incremental costs should be included in a TELRIC study. However, it may be appropriate in certain instances to rely on current accounting records to best estimate forward-looking costs. [¶680] (Ex. 088, p. 9, Judy). Retailing costs, such as marketing or customer billing costs associated with retail services, are not attributable to the production of network elements that are offered to interconnecting carriers and must not be included in the forward-looking direct cost of an element. [¶691] (Ex. 088, p.9, Judy). TELRIC studies should utilize risk-adjusted cost of capital and economic depreciation lives. [¶686 & 703] (Ex. 088, p. 9, Judy). Although the specific language of Sections 252(d)(1) and 252(d)(2) of the Act differ somewhat from the FCC’s Order in Docket 96-98, the FCC correctly recognized that the costing methodology used for interconnection and unbundled network elements, as described above, should also be used to determine prices for transport and termination. The FCC correctly recognized the inconsistency that would result if transport, as an unbundled element, were priced differently than transport used in the termination of traffic. [¶1054] Common costs and their definition The Commission should adopt the FCC’s fixed allocation method of recovering common costs through a percent markup applied to the TELRIC of each individual element. Common costs are incurred to benefit all services offered by the company. These are costs that do not change or go away unless the company goes out of business. The classic example is the president’s desk. TELRIC does not include common costs. (Ex. 088, p.14, Judy). As Dr. Blackmon points out, the Commission in this phase of the proceeding should establish price floors rather than prices, so it would not be appropriate to include any common costs. (Ex. 107, p. 5, Blackmon). Although TELRIC should not contain any common costs, some allowance for common cost must be made in rate development in order to set prices that include a reasonable profit. (Ex. 088, p. 3, Judy; Ex. 112, p. 23-24, Harris). The necessity for including common costs in the prices for unbundled network elements was recognized by the FCC in its 96-98 decision [¶ 694]: Given these common costs, setting the price of each discrete network element solely on the forward-looking incremental directly attributable to the production of individual elements will not recover the total forward-looking costs of operating the wholesale network. Dr. Blackmon obviously concurs when he states that “the firm’s common costs can neither be assumed away or left for payment from some hypothetical revenue source. Regulators therefore must set some or all prices a