Recipe for a Price Squeeze

Posted: 08/1999

Recipe for a Price Squeeze
ILEC Pricing Flexibilty Coming This Fall
By Jonathan E. Canis

At the time of this writing, the Federal Communications Commission (FCC) is leaning toward granting some form of additional pricing flexibility to incumbent local exchange carriers (ILECs). Of course, we won't know what type of flexibility the FCC may grant until its order comes out (likely in late August or September), but the ILECs have asked for flexibility for their special access and dedicated switched access services. The ILECs contend that interoffice transport (typically high capacity transport from one ILEC office to another) and entrance facilities (typically dedicated transport from an ILEC office to an interexchange carrier's [IXC's] point of presence [POP]) are now available from a number of backbone service providers and utility companies. Moreover, the ILECs argue that, in some urban markets, competitive LECs (CLECs) have captured a significant portion of the special access service market, and that this increased competition justifies more flexibility.

If the FCC grants ILECs additional pricing flexibility, it likely will allow ILECs to establish customer-specific contract pricing. This individual case basis (ICB) pricing flexibility probably will be restricted to geographic areas where there are some objective measures showing that competitive carriers have entered the market (e.g., central offices [COs] that have collocated CLECs; evidence that unbundled network elements are being provided in a metropolitan area or LATA).

While action by the FCC this Fall may be premature, additional ILEC pricing flexibility is bound to be granted sooner or later. The FCC must accompany such flexibility with protections for CLECs. Some are fairly straightforward:

- Any ICB contract must be published so the per-service rates are disclosed, to avoid unreasonable discrimination.

- Any ICB to retail customers must be made available at wholesale rates to CLECs for resale as required by Section 251(c)(4) of the Federal Communications Act.

There is one critical issue that is more subtle, however, and it deals with the costing methodologies the FCC uses to determine if ILEC rates are reasonable. Specifically, it appears the FCC may establish Average Variable Cost (AVC) as a floor for ILEC ICB prices. At the same time, the FCC requires ILECs to price unbundled network elements at Total Element Long Run Incremental Cost (TELRIC). We don't need to get into the details, but prices set using AVC can be a lot lower than prices set using TELRIC. What this means is that ILECs may be allowed to set their special access rates at AVC levels, while they set the rates for the unbundled network elements that CLECs must purchase to compete against their special access services at higher TELRIC levels. This leads to an outcome that has long been recognized as a "Price Squeeze" by antitrust courts--if the price of piece-parts that competitors need is higher than the price of an incumbent's retail service, by definition, competitors cannot compete against the incumbent's retail service.

There's only two ways the FCC can avert this patently anti-competitive outcome: prohibit ILECs from setting ICB rates below TELRIC; or set the price for unbundled network elements at AVC. The FCC will spend the rest of the Summer wrestling with this issue, which may lead to a highly contentious decision in the Fall.

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