Reforming the Most Important Part of the Telecommunications Business You Probably Don't Know About

Submitted on October 14, 2016

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Last week, Federal Communications Commission Chairman Tom Wheeler circulated a proposed update of the FCC’s Business Data Services (BDS) rules. BDS, traditionally referred to as “special access,” are dedicated network connections that support services like ATMs, credit-card readers, and mobile phone service. BDS carry the massive flows of data exchanged by small businesses, industry, and institutions like hospitals, schools and universities, and provide essential infrastructure to support wireless innovation, including the next generation of mobile services called 5G. The new proposal, if adopted, would reform the $45 billion-a-year market and update legacy rules governing incumbent telephone companies (ILECs) designed to address the artificially high prices charged to small businesses, schools, libraries, and, ultimately, consumers.

Why are BDS in need of reform? As Andy Schwartzman noted in his article The Most Important Part of the Telecommunications Business You Probably Don't Know About, “Reform advocates argue that BDS prices are grossly excessive and unjustly enrich the former AT&T local phone companies (i.e., AT&T, Verizon and CenturyLink). They maintain that this has stifled competition and dissuaded new entrants into the market. Since these overcharges are passed through to all consumers, the overcharges have arguably increased the prices that we pay for all manner of services seemingly unrelated to telecommunications. If they are right, the changes under consideration should generate more competition and lower prices."

Based on established markets around certain technologies, Chairman Wheeler’s proposal divides reform into two main categories: 1) price cap adjustment for telecommunication services and 2) a framework to promote competition for ethernet/packet-based services.

1. Price Caps: Adjusting for Efficiency after More Than A Decade
The BDS market is currently governed by “price cap” regulation. As the current proposal states, “Price caps are designed to replicate the effects of a competitive market by setting a maximum price for services, which is continually adjusted downward to account for efficiency gains, offset by inflation. The rate of this downward productivity price adjustment is called the ‘X factor.’ Due to regulatory inaction, the current price caps have not been adjusted since 2004.”

The proposal acts to restore fairness and address the lack of competition through four specific reforms:

Updating price caps to account for over a decade of efficiency gains through a one-time downward adjustment of 11 percent, phased in over 3 years, beginning in July 2017 (specifically, 3 percent in year one, 4 percent in year two, and 4 percent in year three)
Reducing price caps going forward by an annual X factor reduction of 3 percent, offset by inflation, beginning in July 2017, in addition to the one-time adjustment above
Applying “Phase I” pricing rules to all price cap local telephone companies (Local Exchange Carriers, or LECs), which allow contract negotiations for service at rates that may, for example, be below the price cap filed in tariffs at the FCC. As a result, price cap carriers who lacked the ability to decrease their prices below the cap on an individualized basis obtain that flexibility for the first time. And customers of providers who sold legacy services at essentially whatever price they felt fit to charge—meaning that they had “Phase II” flexibility—will have protection from arbitrarily high prices
Mandating fair terms and conditions based on the findings in the FCC’s May 2, 2016 Tariff Investigation Order, including:

Barring new “all-or-nothing” plans that force users to make all of their purchases under one plan rather than split them among more tailored and cost-effective options
Reining in excessive penalties for early termination or failure to purchase a set minimum amount of capacity

2. A Simplified Framework to Promote Competition and Investment in Packet-Based Services
For packet-based services, there is evidence of emerging competition and falling prices, mostly due to cable companies that are primed to challenge local telecommunication companies. Therefore, the proposal applies a light-touch regulatory approach that promotes investment while ensuring just and reasonable prices. Key elements include:

Reaffirming that packet-based BDS is largely a “telecommunications service,” as are TDM-based services
No ex ante pricing regulation
A robust complaint process

BDS reform is part of Chairman Wheeler's ambitious agenda (see Andy Schwartzman's Tom Wheeler In The Home Stretch) he hopes to complete before the end of President Barack Obama's term.

Reactions

The Schools, Health & Libraries Broadband (SHLB) Coalition suggested the FCC had missed the mark. Executive Director John Windhausen said, “The FCC must bring prices for BDS services under control. SHLB believes these efforts should be applied in a technology-neutral way to both TDM and Ethernet services. The FCC has fallen far short on reducing costs, and this proposal threatens to cut off the future of education. Schools, libraries, health providers and other anchor institutions need high-speed broadband connectivity options from a variety of providers, and lowering special access/BDS prices would help spur competition and investment in the broadband marketplace. To move us toward the National Broadband Plan goal of gigabit connectivity for all anchor institutions by the year 2020, more action must be taken."

Communications Workers of America President Chris Shelton said the rate cuts, “will lead to reduced investment in broadband networks and downward pressure on jobs and living standards. The Chairman’s proposal ignores the reality of competition and the market, and will have a devastating effect on the investment necessary for broadband expansion, especially in rural areas. The drastic rate cuts – as much as 20 percent over three years -- will create pressure on companies to cut existing jobs and reduce capital outlays in fiber networks, subverting the very goals the FCC aims to achieve in this proceeding. Because the proposal will lead to less investment in broadband networks, overall job growth in this critical industry will be stagnant. In essence, the Chairman's proposal requires unionized incumbent carriers to subsidize the input costs of low-wage, non-union competitive providers and wireless carriers.”

AT&T senior executive vice president of external & legislative affairs Bob Quinn said, ““This proposal is little more than a wealth transfer to companies that have chosen not to invest in last mile fiber infrastructure. It will result in less fiber investment and contribute to mounting job losses at a time when our country needs just the opposite. Like its privacy and set-top box counterparts (which may or may not also be voted upon in three weeks), the special access proceeding seems designed to pick winners and losers rather than being an even-handed analysis based on facts and sound economics. While the Commission has correctly determined (for the time being) not to re-regulate the Ethernet market, there is no evidence in the record to support the Commission’s proposal to re-regulate all legacy TDM-based service without regard to the number of competitors operating in a markets. To reach such a preposterous conclusion, the Commission had to ignore facts and virtually all of the economic analysis submitted by its own ‘independent’ economist as well as all of the other economists who provided analysis in this proceeding.”

USTelecom President Walter McCormick dubbed it a mixed bag saying, “Chairman Wheeler’s draft order appropriately recognizes that companies are investing and competing in BDS, and that price regulation of packet-based IP technologies is both unwarranted and unwise. We are concerned, however, that the order appears to apply indiscriminate price regulation to legacy TDM services without regard to the state of competition in the local market, or economic factors such as company size, demographics, and geography of the service area. In doing so, that aspect of the order is inconsistent with the commission’s obligation to engage in reasoned decision-making based on the record before it. We would urge the commission to revise its approach here to better align with its statutory mandate to rely wherever possible on competition, rather than regulation, in order to encourage investment, job creation, and economic growth.”

The Internet Innovation Alliance, whose honorary chair is former House Communications Subcommittee Chairman Rick Boucher (D-VA.), was not pleased with the regulations that would be imposed on traditional carriers, saying, “Today, we witness, with great disappointment, the FCC Chairman’s plan to re-regulate all copper-based legacy business data services throughout the nation. We fear that American businesses and consumers will ultimately be ill-served by an expert agency that ignores record evidence of robust competition in the market and instead opts for market intervention to favor certain service providers to the disadvantage of others. We hope that a majority at the agency will recognize the potential harm of this plan and will call for a return to long-held bi-partisan policies aimed at spurring innovation and promoting greater broadband infrastructure investment.”

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