By Harvey Berkman

12 ¦ May 1996 Illinois Issues

The Telecommunications Act of 1996, signed in February, constitutes the first overhaul of federal communications laws in three generations.

When President Bill Clinton and House Speaker Newt Gingrich hailed the bright and brave new world of telecommunications competition heralded by the rewrite of the nation's communications laws, Illinoisans could have been excused for sniffing, "Been there, dialed that."

Along with regulators in New York and a handful of other states, the Illinois Commerce Commission acted early to move utilities from monopolies to markets. When the Baby Bells — the seven major regional providers of local phone service born in the 1984 breakup of AT&T — were barely old enough for kindergarten, the ICC was exploring ways to exchange the reins of regulation for the less forgiving, if more efficient controls of competition.

The commission first cracked open narrow elements of the state's local phone market to competitors in 1989. And in 1994 it implemented a new regulatory regime for the state's major local provider, Ameritech Illinois, a system intended to improve and expand services by mimicking the carrot and stick of the market.

But the days of simply mimicking the market are over.

The Telecommunications Act of 1996, signed in February, constitutes the first overhaul of the federal communications laws in nearly three generations.

It severs many significant government controls over the communications industry and weakens most of the rest. And it is already spawning major mergers within and across industries, as well as an explosive start-up of new businesses.

Individual companies can now own television stations whose combined audience reaches up to 35 percent of U.S. households, up from 25 percent, and cable companies and their rates will be deregulated by 1999; most smaller cable companies should be deregulated by the end of this year.

Long-distance telephone companies can sell local phone service — service now delivered by regulated monopolies — and local phone companies, cable companies and even electric utilities can sell long-distance. In fact, they can sell any and all of one another's services, as well as anything else they can think of that involves the transmission of information at the beginning of the Information Age.

The rewrite envisions the ultimate existence of myriad companies — from lean, mean boutiques to behemoths proffering one-stop shopping — all competing to provide local and long-distance phone service and their multiplying accoutrements, as well as cellular service, beepers, home and business alarm systems, Internet access, personal and commercial Web sites and programming for your television.

"In the end it will be marketing for soup-to-nuts services for anything you could put over a wire or through the airwaves," says Martin Cohen, the executive director of the Citizens Utility Board.

But before they retreat, regulators face one last, frantic spate of rule-making: The introduction of competition must be guided. The Federal Communications Commission is in the midst of an intense, six-month process of writing regulations for all the telecommunications industries — often covering topics that Illinois regulators have long been addressing. "The problem with the implementation of the act is that some states are more advanced than the FCC," says Andrew Barrett, a nearly 10-year ICC commissioner who was an FCC commissioner from 1989 until March 31, when he became managing director of the Global Telemedia Group of the public relations company Edelman Worldwide.

"[FCC Chairman] Reed Hundt has to worry about states that are not going to enter into a competitive environment willingly," says ICC Chairman Dan Miller, an ardent deregulator who was perhaps the only state utility commissioner to pull a ballot for the pro-privatization Libertarian Party in the recent primaries. "In worrying about [those states], if he sets the standards so low that we have to dumb down our telecommunications market, we'd do a gross injustice to business and residential consumers," many of whom have either long had or are about to have choices concerning providers for parts or all of their local service.

His concern that Illinois would have to step backwards to let federal authorities catch up helped prompt Miller to engage in acts of bureaucratic generosity, one regulator to another, loaning commission staff to the feds.

Illinois Issues May 1996 ¦ 13

'Don't pre-empt us. Learn from us. The FCC can lead the way standing on our shoulders.'

Agustin "Augie" Ros — previously Miller's top aide and now the chief assistant to the ICC's executive director — has been in Washington since April 1, working with the FCC's rule-writing policy division. Before him, Charlotte TerKeurst, who heads the ICC's new unified telecommunications division (the commission merged three telecom departments in early April), was dispatched to the FCC for two weeks, just after the federal rewrite passed. And in March, Jake Jennings, an ICC telecommunications economist, gave FCC Chairman Hundt a presentation on his proposed method for determining the appropriate wholesale prices for various elements of the local phone system.

Both ICC Chairman Miller and CUB Executive Director Cohen call the wholesale-pricing issue crucial, perhaps the single most important problem presently facing government regulators.

"Jake's presentation [on wholesale prices] dazzled Reed Hundt, and it's not easy to leave him speechless," Miller says. "The message to Reed was: Don't pre-empt us. Learn from us. The FCC can lead the way standing on our shoulders."

The reason that wholesale prices are so important is that each of the Bells, and the nation's other dozen monopoly providers of local phone service, is the only carrier in its region with the mechanical facilities to cover its whole local market. So the only realistic way for long-distance companies or anyone else to sell local service, at least for now, is to buy it first from the Bells. To create genuine competition, the federal law requires the Bells to sell their local service to their competitors at a wholesale markdown — essentially their cost of production. This is to prevent the Bells from selling local service to competitors at a price higher than the service costs to produce. That would give the Bells profits they could use to subsidize their own entry into long-distance markets, offering prices that undercut those of other providers who don't have the cushion even a diminished monopoly provides.

So the federal rewrite gives the Bells an incentive to make their local grid available to all comers equitably and promptly: It lets such long-distance phone companies as AT&T, MCI and Sprint enter local markets right now, but it doesn't let local phone companies sell long-distance to their own customers until they face true competition for local service on their previously sacrosanct turf.

One reason Jennings' presentation to Hundt was so impressive is that the issue of fixing wholesale prices is extremely difficult. In part this is because the system has so many elements — the wire into your house, a local switching system, a transport mechanism from the switch to where you're calling, each of which can be sold separately — and in part because so many services are now priced not by the cost of providing them (often a nearly insignificant amount) but by the value placed on them by customers.

Former ICC and FCC Commissioner Barrett, for example, says he places "tremendous value" on the call answering service he purchases but does not have cable TV and never has. "I'd pay $30 to $40 a month [for call answering] because it has a value to me," Barrett says. "Cable has no value to me. So, as a result, I don't have cable. I look at that $30, $40, $50 a month and I say I'm never going to be home and I'm not going to watch it."

When AT&T filed its petition with the ICC last September (under Illinois' pro-competition telecommunications statute) to compete for local service with Ameritech Illinois, it suggested that Ameritech should be required to make available to AT&T its local service at a 35 percent wholesale discount. Ameritech suggested a discount in the range of 5 percent to 6 percent. Jennings' proposed methodology results in a discount of roughly 20 percent. The ICC is expected to vote on it by June 26. AT&T hopes that by fall it can sell Illinoisans long-distance and local phone service both, just like in the old days, under the late Ma Bell.

Under the federal rewrite, the task of deciding when local phone providers face true local competition falls to the FCC; the law provides advisory roles for state regulators and the U.S. Department of Justice.

The state commissions make recommendations to the federal board, evaluating the existence of competition against a 14-point federal checklist; a variety of other questions will be resolved by some not-yet-clearly defined joint action among state and federal authorities. "Federalism is alive and well in the 1996 Telecommunications Act," says Richard Wiley, a former FCC general counsel and chairman whose law firm, Wiley, Rein and Fielding, is widely considered to have the pre-eminent telecommunications practice in Washington.

"Although the FCC can pre-empt state regulation, the whole focus is not pre-emption, but state action." ICC's Miller has his doubts about federal deference for state activity; already municipalities have reacted angrily to a federal rule concerning cellular telephone towers that they say pre-empts local zoning ordinances.

State commissions will certainly have responsibility for resolving the various complaints that the move from monopoly to markets is likely to engender. For example, deregulating

14 ¦ May 1996 Illinois Issues

long-distance markets has produced not only cheaper prices but also slamming — changing people's long-distance carriers without their informed consent. Calling it an anti-slamming offer, Ameritech sent customers a notice with their December bills allowing them to "freeze" their accounts. If you returned a form, Ameritech pledged never to send you to another carrier — even if you had authorized the other carrier to make that request — unless you first phoned Ameritech or sent the company a note.

Almost a million customers accepted Ameritech's offer.

Coincidentally or not, this would make it moderately harder for new Ameritech competitors to woo those million customers — something that is no longer hypothetical. On April 7, Illinois, well ahead of the feds, opened the first significant swath of Ameritech's service to competitors: intra-lata calls, or local calls traveling more than 15 miles. It's a market that Ameritech now owns, but that all the long-distance carriers are eager to service. The move means Ameritech's 100 percent market share can only diminish.

On April 3, by a contentious 3-2 vote, the ICC ruled that Ameritech's anti-slamming missive was misleading and anti-competitive. It ordered Ameritech to send its customers a new, clarifying insert, and it lifted the freeze on customers who wanted to change intra-lata carriers until October 7, when such changes will go from free to $5 per line. The ICC staff suggested that the new insert Ameritech had proposed was "confusing and potentially misleading," and did not comply with the commission's initial order. Ameritech subsequently agreed.

This market-monitoring function will not be the only thing government regulators will have to do once competition ensues. The federal rewrite also charges them with finding a way to provide universal service — ensuring that all Americans have some fundamental access to the nation's telecommunications grid — and with determining just what that access consists of, and what it should cost.

"If each customer is to bear their true cost, some customers will find their rates going through the roof," says CUB'S Cohen. "If you're a farmer connected by a mile of wire that connects nobody else but you, you're a very expensive customer to serve. The closer the market gets to being fully competitive, the more you're going to need explicit subsidies."

The ICC and the state's utilities have been studying universal service since last year and a report is expected this spring.

"Universal service is a very important aspect of this law, and states feel — I think justifiably

Illinois' telecommunications markets The Illinois Commerce Commission splits the state's telecommunications industry into three groups: the local market, the long-distance (interexchange) market and the market comprised of alternative carriers. In Illinois, an unusually large number of telecommunications providers service those sectors — divisions the federal Telecommunications Act of 1996 is partly intended to render obsolete — with single companies providing local phone service, long-distance service, cellular service, cable TV and even electricity. Local exchange market: Five companies, divided into geographic monopolies, dominate Illinois' local phone market; one, Ameritech Illinois, dominates the other four. Its 5.1 million phone lines — 3.8 million residential and 1.3 million business — represent more than four out of every five local lines in the state. No. 2 local server, GTE North, provides just over 700,000 phone lines, or 11.4 percent of the Illinois total. Together, those two companies represent 94 percent of the local market in the state. But four dozen more companies provide some sort of local service, some as co-ops serving rural areas and some as niche servers offering such specialties as high-speed data transmission. Local service consists of a dial tone — each customer's fundamental connection to the nation's telecommunications grid — and such amenities as call waiting, call forwarding, three-way calling, return-call service and Caller ID. Interexchange market: In 1988, four years after the breakup of AT&T, 36 companies competed to provide long-distance service in Illinois; as of last October, there were 291, with AT&T, MCI and Sprint the state's and nation's leaders. Alternative carriers: Thirty-one companies (many of which are sister subsidiaries of larger conglomerates) provide cellular service in Illinois, and a handful more are poised to provide the new, similarly wireless systems called personal communications systems. -Harvey Berkman

Illinois Issues May 1996 ¦ 15

— that they have a better feel for that topic than the feds, and I think the FCC agrees," says former FCC Chairman Wiley, who was born in Peoria, grew up in the Chicago suburbs and practiced law in Chicago for most of the 1960s.

Finally, participants on all sides of the debate agree that true and lasting local-phone competition won't arrive as long as all local service providers have to purchase that service from the current local carriers, the only providers who now have all the necessary facilities.

"Right now there's only one wire that can carry telephone service into your home, and it's owned in most cases by Ameritech," says CUB'S Cohen. "Competition limited to repackaging services provided by the incumbent monopoly is a very limited form of competition that doesn't provide full benefits to consumers."

"If we're just reselling somebody else's service from an existing grid, then you're buying the embedded costs and inefficiencies and design that's already out there," echoes ICC Chairman Miller.

Cohen says cable companies might be a source of facility-based telephone competition, although right now difficulties remain in carrying voice and video over one wire simultaneously. A second problem: The acrimony that on occasion seems to exist between cable companies and their customers.

Miller says other possible facility-based competitors include gas companies — "there's an awful lot of space for wires inside that conduit carrying natural gas" — and electric utilities. And he notes that the General Assembly is expected to rewrite the state's Public Utilities Act next year, "doing for electricity in one bill what it took 12 years to do for telecommunications."

Harvey Berkman, a reporter in the Washington Bureau of The National Law Journal, covered utilities issues as a reporter in the Illinois Statehouse.

16 ¦ May 1996 Illinois Issues