SPEECH OF REED HUNDT CHAIRMAN, FEDERAL COMMUNICATIONS COMMISSION JOINT MEETING OF THE GREAT LAKES CONFERENCE OF PUBLIC UTILITIES COMMISSIONERS AND MID-ATLANTIC CONFERENCE OF REGULATORY UTILITY COMMISSIONERS CLEVELAND, OHIO JULY 8, 1996 [As prepared for delivery] FCC TO STATES: HOWDY PARDNERS! Thank you, Commissioner Salmon, for you kind introduction and for inviting me to join all of you today. I also want to acknowledge my good friend and former colleague Andy Barrett. In the same category of recently departed and much missed Commissioners I count my friend Lisa Rosenblum. A big hello to her. I want you all to know how much I have valued my increasing acquaintance with our colleagues among state utilities commissioners. Lynn Butler, Craig Glazer, Dan Miller, David Rolka, Russell Frisby, Ed Salmon and Cheryl Parrino are just some of the commissioners from states in the Great Lakes and the Mid-Atlantic region who have become trusted advisers, leaders, and friends of mine. I am acutely aware that there are no states more sophisticated and advanced than the Great Lakes and Mid-Atlantic states in addressing the opportunities for competition in the biggest monopolized market left in the U.S. -- the local exchange market. In particular I want to single out Cheryl Parrino for her leadership of NARUC. Thanks in large part to Cheryl, the NARUC-FCC relationship has never been closer, better, or more important. Since the passage of the monumental Telecommunications Reform Act of 1996, no business or organization has provided us better guidance or expertise than NARUC. We have shared personnel, thoughts, meetings with industry, weekend worries and weekday plans. Cheryl's leadership has also inspired a productive partnership with the Universal Service Joint Board, where Commissioners Ken McClure, Sharon Nelson, Julia Johnson, and Laska Schoenfelder, and State Consumer Advocate Martha Hogerty are full partners with the three FCC commissioners. In time, I believe Cheryl will come to be described in the regulatory or -- better -- deregulatory history books as the greatest NARUC chief in the most important time in that organization's long existence. But it's way too early to think about the role of any of us in the history books. Right now the present is enough for us to deal with. We are all knee deep right now in what my father used to call the reward for good work: more work. I'm here today to talk to you about the specific ways the FCC needs your help over the next six months. These are the most important six months of the FCC's 62 year history of involvement with the hugely successful American telephone industry. We have here a case of it ain't broke, but let's fix it anyhow. Congress rarely takes steps to undo something that works. But the goal of deregulating and introducing competition in America's largest monopolized markets has so many potential benefits for consumers, business users, and communications companies that Congress was able to muster the bipartisan consensus necessary to pass the new law. ` Now the states and the FCC together have to write the procompetitive rules that will make the new law's promise come true. At the FCC, Congress has given us, in effect, a contract to write a trilogy. The first volume is a 400 pager with the catchy title of "Interconnection under section 251: Competition means never having to say you're sorry." This will be published the first week in August. The FCC is the author; the states are helping with the plot and the characterization. The draft is being completed this week and will be circulated to all FCC commissioners next week. The second volume, due in November, is called "Universal Service under Section 254: Something Old (affordable rates), Something New (classroom connections), Something Borrowed (ideas from the states), and No One Blue (I hope)." The Joint State-Federal Board is the author. This volume will tell us how to raise and distribute what I guess will be somewhere between $6 to $12 billion per year from all telecommunications providers. Plot lines include a commitment to competitive neutrality among recipients, better targeting of subsidies, equitable collection of subsidy funds, and the funding of a large enough subsidy pool to guarantee the continuation of affordable service to all Americans, and especially to network each and every classroom in every school in the country, every library, and every rural health care facility. The final volume in the trilogy is called "Access Reform: Paying for access to the local exchange network when the network is shared, broken up, interconnected, overbuilt, packetized, bypassed, and Internetted." This is due in January. The book jacket will read, "By the FCC" but I'd like to add, "with the help of the states." The trilogy will not be easy page turners, but our goal is to have the total of these three volumes be shorter than the FERC's retail wheeling order. These three volumes will tell the story of competition. Each volume relates to the others. You will find many chapters familiar -- they will be borrowed from many states' groundbreaking decisions. But Wall Street and business and consumers will just have to wait until the whole trilogy is written in order to figure out if the FCC and the States deserve the Nobel Prize for Telecom Reform. I do think the trilogy won't get the Nobel prize for literature, but we have a chance to get the economics award and I'm sure that everyone in this room knows the importance of the work. In the trilogy, and in all the other work done by the states and the FCC, we will be discussing three things. First, the ways that new entrants will be let in to the telco monopolies, while promoting universal service; second, the commitments and contingencies that should condition the Bell's being let in to the long distance market; and, third, FPFT. This last is an acronym. I have found that you can't pretend to know what you're talking about in telephone rulewriting unless you use acronyms. And I definitely want to seem to know what I'm talking about. So I've invented my own acronym. FPFT stands for Fair Play in Follow Through. This relates to the future competition beyond our trilogy, and beyond the letting in of AT&T, MCI, Sprint and the others to the local exchange market, and even beyond the letting out of the Bells into the interexchange market. FPFT refers to the role of state and federal utility commissioners as competition enforcement agencies and consumer advocates in the complex, unpredictable communications sector of the future. Our roles will change radically but the need for umpires enforcing fair rules of competition will be greater than ever as business follows through on the promise of the new law. I. Let In. "Letting in" is about the implementation of one of the most unusual laws ever written. This isn't the first time government has decided to take on monopolies, even monopolies as well as entrenched as the local telephony companies who today capture 99% of all local telephone revenues. But the method set forth in the new telecom law is unprecedented. In breaking up the Standard Oil trust, government dissolved Rockefeller's creation from one firm into a handful of many different oil companies we still buy from today. To end the AT&T monopoly, we forced lines to be drawn down the middle of buildings and more across the company, and created from one company eight different firms. But in the new telecom law, no company has to be subdivided. Instead, the telephone companies' networks must be shared, borrowed, rented, partnered up with other networks, sold in part, and converted from retail to wholesale businesses -- all at the demand of none other than the new competitors of the telephone companies. Imagine if Congress in the 1960s had thought that GM needed new competitors, and then had ordered that the GM manufacturing facilities could be leased part-time by, say, Toyota. And imagine further if a Federal Car Commission and its state counterparts set the price for the facility on a long run incremental cost basis, as opposed to letting GM pick the number. That would be like the new Telecom Law's requirement that the switch must be sold as an unbundled element at a cost-based price. Imagine further if Congress told GM to sell its Chevrolets and Cadillacs to Toyota at a discounted wholesale price so that Toyota could resell them in competition with GM dealers. That's what the new law says about all retail phone services. And suppose Congress said that GM dealers had to make themselves available for receiving and delivering to customers Toyota vehicles, because Toyota might not have a dealership network in place. That's the transport and termination requirement of the new telecom law. And suppose that the car companies in Detroit had agreed to provide cars for reduced prices to people in remote areas and to people of reduced means, so that everyone in America could buy a car. And suppose these lower prices were sustainable by high prices charged for special products like radios and Corinthian leather upholstery, and the higher prices charged for cars in Cleveland and Detroit, where unit costs are lower because of volume. But then Congress said, we want cars priced everywhere at affordable levels, and in addition we want cars given to every schoolteacher in every classroom, but we want the FCC and the states to invent a whole new way to make the subsidies flow fairly and fully where they are needed, while letting the prices of radios and leather interiors and cars in Cleveland move to the levels that competition would set. What a job! Don't you get the feeling that under these circumstances the car companies in Detroit would have some resistance to this sort of Congressional intrusion in their business? How can we expect that the local telephone companies as competitive business organizations will naturally, readily accept the stringent necessities of this new law? In these difficult times of change, we have to give enormous credit to telephone company executives like Dick Notebaert, Ivan Seidenberg and Ray Smith, of the Great Lakes' and Mid-Atlantic's Bell companies, among others. These executives are transforming their companies into double digit growth companies, into competitive forces on a regional, national and international level, into change oriented, business battle-ready teams. Yet the new law imposes on them duties that no other business in our history has ever faced. I know they will meet those duties. But we in government have to understand how unusual, unprecedented, and difficult meeting those duties is for the telephone companies as organizations and as cultures. It is our responsibility, I think, to be as clear and decisive as we can be, so as to set forth the new duties of the telephone companies clearly and to empower the leaders of these great companies to exercise their own will to change. I see our rules at the federal and state level as helping a new generation of telco leaders to serve their shareholders, employees, consumers and country by forcing the profound changes that will inevitably transform the culture of our telephone companies. I see these fine companies evolving at a prodigious pace from high quality, reliable, profit-guaranteed but upside limited monopolies into high quality, reliably innovative, upside unlimited, profit-not-guaranteed competitors against all rivals and in all markets. This bright, if unpredictable, future depends in significant part on the ability of the FCC and the states to chart a clear deregulatory path. The Commission's June 27 number portability item is a harbinger of the approach we should use for resale, unbundled elements, the pricing of those elements, and termination and transport. On number portability, state representatives were in on the final decision making. The FCC set national uniform principles for how to price interim number portability and who should pay, but we rely on states to make individual decisions about the calculation of costs, the exact manner of cost recovery and other crucial matters. This approach should work for the major issues in the Interconnection Order in August. In the August Order, we probably also need to provide "fail-safe" or "default" options for those states that do not have the resources to go through pricing proceedings by the end of November. That is approximately the deadline for concluding the Big Three arbitrations in each state. I am referring of course to the arbitrations between MCI, AT&T, and Sprint on one side and on the other side, the incumbent telephone company -- most often a Bell. These arbitrations will follow from the negotiations now going on. We have all heard a great deal of chest thumping and seen much finger pointing about the negotiations. From where I sit, none of the theatrics means much of anything. The duties imposed by section 251 on the incumbent telcos are, as I said earlier, unnatural and difficult. It is easy to suppose that the incumbent telcos would have some resistance to volunteering to give their competitors all the advantages that the law in fact provides AT&T, MCI, Sprint and the other new entrants. Nor do MCI, AT&T or Sprint bring anything to these negotiations that any Bell wants. In a sense these negotiations do not resemble commercial negotiations, but rather are more like negotiated rulemakings. On the other hand, the IXCs and the other new entrants are seeking in the interconnection negotiations all the necessities of competing in a business that they have for the most part not been in. We should not wonder if it is difficult for them to focus their negotiating demands when they do not yet have a meaningful presence in the local exchange market. And furthermore AT&T, MCI and Sprint -- the Big Three I will call them -- know that the terms and conditions of their own interconnection agreements with the Bells are highly relevant to any state or DOJ or FCC consideration of the question of Bell entry into their long distance markets. We should not be surprised if that consideration tends to discourage the Big Three from seeking quick and easy privately negotiated interconnection arrangements. Plainly at the state and federal level we would welcome the prospect of interconnection arrangements being struck between any of the Big Three and any Bell (or other large incumbent LEC) without government mediation, arbitration or indirect guidance via our section 251 rules. Surely in the hundreds of paragraphs of these arrangements there are many terms and conditions that cover ground that none of the parties could reasonably expect the state arbitrators or the FCC to write better than the private parties themselves can do. But realistically there is no one to fault if the Big Three and the Bells (or other large incumbent telcos) wait for the FCC's Interconnection Order to come out before pushing a conclusion of their negotiations. Voluntary agreements involving the Big Three now, of course, could help influence in a mighty way the contents of our decision. But I do expect that, in most if not all of the 49 jurisdictions where Bell long distance entry is at issue, negotiations will lead to arbitrations for the Big Three. And there may be no voluntary arrangements involving the Big Three any earlier than the very end of the arbitration period. Moreover, in many states I anticipate that, by the end of November, the arbitrators will in effect have written the rules of interconnection by making crucial decisions on their own about material terms of the arrangements and by translating the section 251 interconnection order of August into the explicit terms and conditions of the Big Three arrangements. Those arbitrated arrangements or agreements will be the key blueprints for competition in the local exchange market. Those arbitrated arrangements will be in effect the most important words on the topic of competition written by government. These arbitrations may be the most important work the FCC and its state counterparts have ever had to perform. This is for at least three reasons: first, the arrangements between the Big Three and the Bell and other incumbents in each state will have the greatest immediate effect on consumers. Certainly in 1997, MCI, AT&T and Sprint are clearly the most aggressive, well-financed, brand-name-oriented, mass-marketing-skilled, new entrants that the residential local exchange market is likely to see. Second, it is primarily MCI, AT&T and Sprint whose customers today are the prime targets of the Bells tomorrow. MCI, AT&T and Sprint should have objectively fair interconnection arrangements in order to market against any Bell that seeks to enter the long distance market. This is reciprocity in competition. It intuitively seems fair that these companies should have reciprocal opportunities to compete against each other. And third, the individual terms and conditions of each of the Big Three arrangements will be available by law for copying into the interconnection arrangements of each other or any new entrant. So the Big Three's arrangements will in effect define the so-called level playing field for all competitors. This "most-favored-nation" treatment is dictated by the new law, and it is good policy. Just think of how unfair it would be otherwise. Without the ability to select through "most- favored nation" treatment provisions from either of the Big Three arrangements -- which likely will be obtained through a hard, fair arbitration -- a new entrant that lacked the resources to fight though an arbitration would get the worst interconnection arrangement. This sort of "weak get weaker" policy would be bad for competition. One important additional topic relates to the concerns of small, independent telephone companies. I believe in the short time we have ahead of us, we would most profitably spend our time addressing interconnection rules for the 95% of subscribers and revenues served by the larger telephone companies. These are the rules we have to get right immediately to have competition begin to develop. These are the rules that are critical to get in place prior to Bell entry into long distance. We can and should indulge ourselves with a little more time as to the 5% of subscribers served by small telephone companies. I am looking to the states to give us clear guidance on how to make sure that our trilogy can reflect this view. II. Universal Service Before moving on to "letting out", I want to talk a little bit about universal service. One of the Act's great challenges is to reconcile our commitment to competition with our commitment to universal service. Some have suggested that competition and universal service are fundamentally at odds. Those commentators couldn't be more wrong. We can simultaneously promote competition and continue to ensure universal service. We just need to be innovative and develop new tools. It is important to recognize, though, that we need a new toolkit. Competition blunts many of our tried and true methods of promoting universal service -- and, ironically, many of our tried and true methods also blunt competition. In the past, we have all relied on the ability to raise prices to one set of customers, in order to lower prices to another. With competition, however, competitors will surely attack the portion of the market that has been priced up, undermining the funding for universal service. Similarly in the past we have all averaged downtown with out-of-town. Yet competition is likely to hit downtown first, again undermining the subsidy. This suggests that in our new toolbox, we will need to have a system of explicit payments that targets the subsidy to the customers that are the intended beneficiaries. The money to fund these subsidies must be raised, in a competitively neutral way, from all carriers. In this way, we will not create incentives to switch carriers just to avoid funding the subsidy. One caveat I need to add. In the near term, again I believe it would be profitable to separate universal service reform for large carriers from changes in the system for small carriers. If we can truly reform the system for 95% of the Americans served by large carriers, we will have accomplished what we need to initially to get our competition and universal service policies working together. We can and should address universal service reform for small companies, but it need not happen in the same time frame given that competition is likely to be slower in coming to the largely rural small company service areas. So how big is the new universal service toolbox. It's hard to make any estimates at this time with precision. But in very rough terms, my personal guess is someplace between $6 and $12 billion dollars. The largest piece of that would be for high cost residential rate assistance. I also believe that with respect to this high cost assistance, we ought to design a system that drives the subsidy levels down over time -- ideally through market-driven mechanisms. If we do this, I believe we can create a universal service system that will assure that the telephone bills of ordinary residential customers remain stable. And I believe we can also accomplish another important task that the Telecommunications Reform Act assigns to all of us, and that is to provide our schools with turn-of-the Twenty First Century connections to the Information Highway. Too many of our nations schoolchildren still learn in environments that reflect the informational and educational tools of 1899, rather than 1999. The Snowe-Rockefeller-Exon-Kerrey provision of the Telecommunications Act direct us to do our part to remedy this. There is much to be studied about how this best can be accomplished, and much of the specifics should probably be left to schools themselves. But we there are a few key ideas we ought to be able to discuss and agree on in the early going. Most critically, we ought to agree that a network that ends on the schoolhouse steps does little to advance education. If we fund networks to the doorstep of the school, we will have done little. It's not enough to get to the principal's office -- when I went to school, the only learning that occurred in the principal's office was disciplinary. To help our children master the 3 R's, our networks must get to the place where the learning happens -- into the classroom. III. Letting Out On to "letting out." The Act, in return for imposing on the BOCs the obligation to "Let In", gives them the opportunity to get "let out." I mean, of course, letting the Bells out of the last vestiges of the Modification of Final Judgment, and into the interLATA long distance marketplace. This is a reciprocal idea. Bells get into the long distance markets currently occupied by the Big Three and others, and reciprocally, the long distance companies (and anyone else) get into local exchange. The fundamental economic, business, and antitrust problem with this reciprocal deal is that Bells have close to 100% market share for residential customers, and no long distance company does. And the long distance companies need the Bells to complete a call, whereas no Bell needs a long distance company to complete a local call. Nor will any Bell need a long distance company as an ally to go into the long distance market. To demonstrate how the Bells don't really need anything from AT&T, MCI or Sprint, we see that AT&T had to offer bulk long distance minutes to BellSouth the other day for 1.5 cents a minute. The average long distance call goes for about 13 cents a minute. Backing out access that still leaves about 7 cents a minute margin for the retail price. Selling the long distance minute for 1.5 cents a minute wholesale means for AT&T giving up 5.5 cents of margin. That's a pretty good deal BellSouth struck. It could get this deal because there is a great deal of competition in the long distance market. Consumers would like to see still more: when it comes to competition, there is never enough. But still, the fact is that BellSouth doesn't need AT&T; it has other long distance providers to go to. But as of now AT&T needs BellSouth to get access to the residential consumer in the BellSouth region. Moreover, as long as the IXCs need to use Bell networks to complete a call, then the Bells inevitably will be tempted to discriminate against any long distance competitor using the local network to enter the Bell's market. For example, in the event of outage, would a Bell be tempted to repair the network for the benefit of its own customers before taking care of the rival's customers who also suffered from the outage? I'm not saying any Bell will succumb to temptation, I'm just explaining where the economic incentives lie. So there is an inherent inequality in economic position between the IXCs and the Bells to address in order to achieve the reciprocal entry policy laid out by the new law. That is one reason why the DOJ seeks a broad amount of factual input on how the "public interest" test for Bell entry into long distance should be interpreted and applied. No one should object to analyzing the public interest by reference to facts. Good policy is rarely made based on pure hypotheticals, and there's no reason to use guesswork when the facts can be got. We will give substantial weight to DOJ's analysis on the entry issue, as the law requires. The private parties will hang on DOJ's every word. It would be a lot easier for the private sector, the states, and the FCC to use DOJ's very valuable expertise if DOJ's analysis is grounded in facts. So everyone should welcome DOJ's statement to the states in Washington last week that they are looking to the states to help provide them with detailed facts about the local exchange market. Similarly the states in analyzing compliance with the checklist will be exploring whether the all-important arbitrations with the Big Three create enough actual and potential competition in the local exchange market to justify Bell entry in the long distance market. At the FCC we are looking for the states to give us a full understanding of what's happening in the relevant markets in each state. We are hoping for a record from the states on all the entry-related issues that is replete with assertions by all parties, rebuttals if any, well supported findings of fact, and any and all conclusions the state wishes to provide. This is what we must have in our record at the FCC to withstand judicial review of our entry decision. There is no reason to believe we can make this record better on our own in the limited 90-day period set by the law than any state can do as part of its verification of the checklist. In short, we need the states to be a sort of court of first impression for exploring the issues of Bell entry, including especially the prospects for entry into the Bell markets as a fair reciprocal move by long distance companies seeing their own customers at risk. You might call this the multilayered cake approach to the issue of long distance entry. States are the first layer of the cake, next comes the Department of Justice, then the FCC, then the Court of Appeals and the Supreme Court. The hallmarks of this approach are a coordinated deliberative process with an open record, with a full written decision at the state level, addressing all relevant issues. The state's decision is reviewed first by the Department of Justice, and then both Justice's and the state's decisions are reviewed by the FCC. Ultimately, we all get examined by the courts. I'm not saying this process is a piece of cake. But it does not need to last the rest of the century or to consume the wealth of all companies spent on attorneys fees. The key to speed and fairness is a sound record at the most important, fundamental layer of the cake: the state verification proceeding. V. Fair Play, Follow Through Finally, long after letting in and letting out are over, effective enforcement will be the key to maintaining a level playing field. This is the FPFT part of our job. We must together consider and confront the challenges of enforcement -- as we have with joint audits -- recognizing that joint efforts are often the most effective at obtaining compliance. I will be inviting all states to participate in an enforcement meeting at the FCC this fall. We need to work together to craft fair, effective, and expeditious enforcement techniques that place at serious risk any would-be failure to comply with section 251 or with arbitrations or otherwise to discriminate against a rival. For those who suggest that the new law means the demise of the FCC and its state counterparts, I think a dose of reality is in order. Our jobs will change radically, but umpires in the competitive game are going to be necessary as far in the future as I can imagine. Indeed, I believe the short term demands on the FCC and the states are going to be immensely greater than any of us now realize. I hope and trust that appropriators at the federal and state level understand that penny wise is pound foolish. A failure to appropriate the comparatively few pennies necessary to create efficient enforcement forums at the state and federal level, will yield not pounds but tons of unfairness and frustrated competitive efforts and consumer unhappiness and lack of economic and job growth. Last, but not least, at the federal and state level, even as we focus on the incredibly important and difficult next six months, after that we must remember our own three R's. I don't mean reading, writing and arithmetic. I refer to review, revise and reconcile. It is not conceivable that the FCC will write all the rules ever needed for competition in the next four weeks, or that the states will do everything competition will ever require in the arbitrations that will shortly commence. We will all try to get it all right, but we can't know in 1996 everything we will come to know in 1997 and beyond. Technologies, markets, and conditions for competition will continue to evolve. To adjust to this dynamic process, we must review the level of competition at the state and national level, revise our rules at the state and national levels as necessary, and reconcile interconnection arrangements to the results of that revision. As we see how competition works out in the local exchange market and as we discover the what more needs doing, what needs fixing, what needs revising, we need to make sure that the hundreds of interconnection arrangements across the country can accommodate our own changes. * * * We certainly have a lot facing us all in the coming year. Clearly, we will be working together a great deal. In that vein, I want to close by thanking all of you for making yourselves, your colleagues or your staffs available to attend our forum last week on Bell Long Distance entry issues. On short notice, you came from across the country -- from 44 out of the 49 jurisdictions with Bell Companies. I greatly appreciate the spirit that you showed in doing that. You have my commitment that we will continue to hang together over the coming year. After all, as Benjamin Franklin said, if we don't hang together, assuredly we will hang separately. -FCC-