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 Federal  Communications  Commission  FCC  03-  224 
 Before  the  Federal  Communications  Commission 
 Washington,  D.  C.  20554 


 In  the  Matter  of 
 Review  of  the  Commissions  Rules  Regarding  the  Pricing  of  Unbundled  Network  Elements 
 and  the  Resale  of  Service  by  Incumbent  Local  Exchange  Carriers 


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 WC  Docket  No.  03-  173 


 NOTICE  OF  PROPOSED  RULEMAKING 
 Adopted:  September  10,  2003  Released:  September  15,  2003 
 Comment  Date:  60  days  after  Federal  Register  publication  of  this  Notice  Reply  Comment  Date:  105  days  after  Federal  Register  publication  of  this  Notice 


 By  the  Commission:  Chairman  Powell,  Commissioners  Abernathy,  Martin,  and  Adelstein  issuing  separate  statements;  Commissioner  Copps  approving  in  part,  dissenting  in  part,  and  issuing  a 
 separate  statement. 


 TABLE  OF  CONTENTS 
 I.  INTRODUCTION  ..................................................................................................................  1 
 II.  BACKGROUND  ..................................................................................................................  10 
 A.  GENERAL  RATEMAKING  PRINCIPLES  .................................................................................  10  B.  RATEMAKING  UNDER  THE  1996  ACT.................................................................................  15 


 1.  UNE  Prices....................................................................................................................  15  2.  Resale............................................................................................................................  23 
 C.  REVIEW  OF  UNE  PRICES  UNDER  SECTION  271  ..................................................................  26 
 III.  FORWARD-  LOOKING  METHODOLOGY...................................................................  29 


 IV.  UNE  PRICING  .................................................................................................................  38 
 A.  OVERARCHING  ISSUES  .......................................................................................................  38  1.  Goals  of  UNE  Pricing  ...................................................................................................  38 


 2.  Impact  of  Triennial  Review  ..........................................................................................  42  3.  Relationship  to  Universal  Service.................................................................................  45 
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 B.  NETWORK  ASSUMPTIONS...................................................................................................  49  1.  General  Theory  .............................................................................................................  49 
 2.  Specific  Network  Inputs  ...............................................................................................  62  C.  COST  OF  CAPITAL  ..............................................................................................................  82 
 D.  DEPRECIATION  EXPENSE....................................................................................................  92  1.  Asset  Lives....................................................................................................................  94 
 2.  Depreciation  Rate........................................................................................................  102  E.  EXPENSE  FACTORS...........................................................................................................  109 
 F.  NON-  RECURRING  CHARGES.............................................................................................  114  1.  Identification  of  Costs.................................................................................................  116 
 2.  Recovery  of  Costs  .......................................................................................................  120  3.  Disconnection  Costs....................................................................................................  126 
 4.  Loop  Conditioning......................................................................................................  129  G.  RATE  STRUCTURE............................................................................................................  131 
 H.  RATE  DEAVERAGING  .......................................................................................................  133  I.  RATE  CHANGES  OVER  TIME  ............................................................................................  138 


 V.  RESALE  PRICING  ............................................................................................................  141 
 VI.  INTERCONNECTION  PRICING  AND  RECIPROCAL  COMPENSATION..............  147 
 VII.  IMPLEMENTATION  ISSUES  ......................................................................................  149 
 VIII.  PROCEDURAL  MATTERS  ..........................................................................................  152 
 A.  INITIAL  PAPERWORK  REDUCTION  ACT  ANALYSIS  ............................................................  152  B.  INITIAL  REGULATORY  FLEXIBILITY  ACT  ANALYSIS  ........................................................  153 


 1.  Need  for,  and  Objectives  of,  the  Proposed  Rules  .......................................................  154  2.  Legal  Basis..................................................................................................................  158 
 3.  Description  and  Estimate  of  the  Number  of  Small  Entities  to  which  the  Proposed  Rules  Will  Apply  ........................................................................................................  159 
 4.  Description  of  Projected  Reporting,  Recordkeeping,  and  Other  Compliance  Requirements  ..............................................................................................................  191 
 5.  Steps  Taken  to  Minimize  Significant  Economic  Impact  on  Small  Entities,  and  Significant  Alternatives  Considered  ...........................................................................  192 
 6.  Federal  Rules  that  May  Duplicate,  Overlap,  or  Conflict  with  the  Proposed  Rules  ....  195  C..  EX  PARTE  PRESENTATIONS..............................................................................................  196 
 D.  COMMENT  FILING  PROCEDURES  ......................................................................................  197 
 IX.  ORDERING  CLAUSES.................................................................................................  203 


 I.  INTRODUCTION 
 1.  In  this  Notice  of  Proposed  Rulemaking  (NPRM),  the  Commission  begins  its  first  comprehensive  review  of  the  rules  applicable  to  the  pricing  of  unbundled  network  elements 


 (UNEs)  pursuant  to  section  252(  d)(  1)  of  the  Communications  Act  of  1934  (the  Act),  as  amended  by  the  Telecommunications  Act  of  1996  (the  1996  Act).  The  Commission  adopted 
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 its  current  UNE  pricing  rules,  which  base  UNE  prices  on  the  Total  Element  Long  Run  Incremental  Cost  (TELRIC)  of  a  UNE,  in  1996  in  the  Local  Competition  Order.  1  The 
 Commission  stated  at  that  time  that  it  would  continue  to  review  its  pricing  rules  based  on  the  results  of  state  arbitration  proceedings  and  provide  additional  guidance  as  necessary.  2  We  have 
 not  undertaken  a  comprehensive  review  of  the  TELRIC  methodology  in  the  seven  years  since  it  was  adopted,  and  it  is  appropriate  to  conduct  such  a  review  at  this  time. 


 2.  Our  concerns  in  evaluating  the  TELRIC  pricing  rules  are  somewhat  different  than  those  present  at  the  time  the  Commission  adopted  its  Local  Competition  Order.  At  that  time, 
 local  competition  was  largely  a  theoretical  exercise  and  we  placed  a  premium  on  the  need  to  stimulate  entry  into  the  local  exchange  market.  To  ensure  that  UNE  prices  provided  appropriate 
 economic  signals  for  competitive  and  investment  purposes,  we  adopted  a  forward-  looking  cost  methodology  that  calculates  the  cost  today  of  building  and  operating  an  efficient  facility,  as 
 opposed  to  the  cost  of  an  existing  facility  at  the  time  it  was  built.  3  In  stating  that  forward-  looking  costs  were  intended  to  send  appropriate  economic  signals,  we  mean  that  UNE  prices  in  excess  of 
 forward-  looking  costs  would  encourage  competitors  to  build  facilities  when  the  more  efficient  course  might  be  to  lease  facilities  from  the  incumbent  LEC,  while  prices  below  forward-  looking 
 costs  might  encourage  them  to  rely  on  the  incumbents  facilities  when  the  more  efficient  course  might  be  to  construct  their  own  facilities.  At  the  same  time,  we  anticipated  that  UNE  prices 
 based  on  forward-  looking  costs  also  would  not  discourage  investment  by  incumbent  LECs  because  such  prices  would  allow  them  to  recover  their  costs. 


 3.  Today,  now  that  competition  has  taken  root  in  many  areas  of  the  country,  we  initiate  this  proceeding  to  consider  whether  our  pricing  methodology  is  working  as  intended  and, 
 in  particular,  whether  it  is  conducive  to  efficient  facilities  investment.  To  the  extent  that  the  application  of  our  TELRIC  pricing  rules  distorts  our  intended  pricing  signals  by  understating 
 forward-  looking  costs,  it  can  thwart  one  of  the  central  purposes  of  the  Act:  the  promotion  of  facilities-  based  competition.  While  our  UNE  pricing  rules  must  produce  rates  that  are  just, 
 reasonable  and  nondiscriminatory,  consistent  with  the  Acts  goal  of  promoting  sustainable  competition,  they  should  not  create  incentives  for  carriers  to  avoid  investment  in  facilities.  4 


 1  Implementation  of  the  Local  Competition  Provisions  in  the  Telecommunications  Act  of  1996,  CC  Docket  No. 
 96-  98,  First  Report  and  Order,  11  FCC  Rcd  15499  (1996)  (Local  Competition  Order),  affd  in  part  and  vacated  in  part  sub  nom.  Comp.  Tel.  Assoc.  v.  FCC,  117  F.  3d  1068  (8  th  Cir.  1997)  and  Iowa  Utils.  Bd.  v.  FCC,  120  F.  3d  753 


 (8  th  Cir.  1997),  affd  in  part  and  remanded,  AT&  T  v.  Iowa  Utils.  Bd.,  525  U.  S.  366  (1999);  on  remand  Iowa  Utils.  Bd.  v.  FCC,  219  F.  3d  744  (8  th  Cir.  2000)  (Iowa  Utilities  II),  reversed  in  part  sub  nom.  Verizon  Communications,  Inc. 
 v.  FCC,  535  U.  S.  467  (2002)  (Verizon  v.  FCC). 
 2  Local  Competition  Order,  11  FCC  Rcd  at  15813,  para.  620. 


 3  Id.  at  15844,  para.  672  (  We  believe  the  prices  that  potential  entrants  pay  for  these  elements  should  reflect 
 forward-  looking  costs  in  order  to  encourage  efficient  levels  of  investment  and  entry.). 
 4  See,  e.  g.,  Review  of  the  Section  251  Unbundling  Obligations  of  Incumbent  Local  Exchange  Carriers,  Report  and 
 Order  and  Order  on  Remand  and  Further  Notice  of  Proposed  Rulemaking,  CC  Docket  No.  01-  338,  FCC  03-  36,  para.  682  (released  Aug.  21,  2003)  (Triennial  Review  Order)  (  Establishing  UNE  prices  based  on  an  unreasonably 


 low  cost  of  capital  would  discourage  competitive  LECs  from  investing  in  their  own  facilities  and  thus  slow  the  development  of  facilities-  based  competition.).  The  Supreme  Court  found  that  competitive  LECs  had  invested  $55 
 billion  from  1996-  2000  and  that  a  regulatory  scheme  that  can  boast  such  substantial  competitive  capital  spending 
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 4.  This  NPRM  solicits  comment  on  tentative  conclusions  and  modifications  to  our  current  UNE  pricing  regime  that  seek  to  preserve  its  forward-  looking  emphasis  and  its  pro-competitive 
 purposes,  while  at  the  same  time  making  it  more  transparent  and  theoretically  sound.  Specifically,  we  propose  to  simplify  TELRIC  pricing,  while  simultaneously  improving  the 
 accuracy  of  its  pricing  signals,  by  resolving  one  of  the  key  internal  tensions  that  marks  its  current  application:  the  assumption  that  for  some  purposes  rates  should  reflect  a  market  with  widespread 
 facilities-  based  competition  but,  for  other  purposes,  rates  should  reflect  a  market  with  a  single  dominant  carrier.  We  seek  comment  on  an  approach  that  bases  UNE  prices  on  a  cost  inquiry  that 
 is  more  firmly  rooted  in  the  real-  world  attributes  of  the  existing  network,  rather  than  the  speculative  attributes  of  a  purely  hypothetical  network. 


 5.  The  Supreme  Court  in  Verizon  v.  FCC  affirmed  our  choice  of  TELRIC  as  a  permissible  methodology  for  states  to  use  in  ratemaking  proceedings.  5  The  court  held  that  the 
 Commissions  decision  to  adopt  a  forward-  looking  cost  methodology  was  a  reasonable  interpretation  of  the  statute  and  that  the  Commission  did  not  err  in  rejecting  alternative 
 methodologies  advocated  by  the  incumbent  LECs.  6  The  court  also  rejected  arguments  that  various  aspects  of  the  TELRIC  methodology  were  unlawful.  7  Nevertheless,  the  TELRIC  rules 
 have  proven  to  take  a  great  deal  of  time  and  effort  to  implement,  and  have  been  the  subject  of  extensive  criticism.  In  particular,  critics  argue  that  the  TELRIC  methodology  is  flawed  due  to  an 
 alleged  emphasis  on  unrealistic  efficiency  assumptions.  They  contend  that  these  unrealistic  assumptions  result  in  rates  that  are  so  far  below  an  incumbent  LECs  actual  costs  that  neither 
 incumbent  LECs  nor  competitive  LECs  have  an  incentive  to  invest  in  new  facilities.  8 
 6.  Since  1996,  virtually  all  states  have  conducted  at  least  one  round  of  cost  proceedings  under  these  rules.  State  pricing  proceedings  under  the  TELRIC  regime  have  been 


 extremely  complicated  and  often  last  for  two  or  three  years  at  a  time.  9  State  commissions 


 over  a  4-  year  period  is  not  easily  described  as  an  unreasonable  way  to  promote  competitive  investment.  Verizon  v.  FCC,  535  U.  S.  at  517.  As  of  2002,  that  figure  had  increased  to  $71  billion.  See  Appropriate  Framework  for 
 Broadband  Access  to  the  Internet  over  Wireline  Facilities,  CC  Docket  Nos.  02-  33,  01-  318,  01-  321,  Letter  from  Jonathan  Askin,  General  Counsel,  Association  for  Local  Telecommunications  Services,  to  Marlene  H.  Dortch, 
 Secretary,  FCC,  Attach.  at  11  (filed  July  17,  2003).  As  one  court  of  appeals  has  noted,  however,  the  existence  of  investment  of  a  specified  level  tells  us  little  or  nothing  about  incentive  effects.  The  question  is  how  such  investment 
 compares  with  what  would  have  occurred  under  a  different  regulatory  regime.  United  States  Telecom.  Assn  v.  FCC,  290  F.  3d  415,  425  (D.  C.  Cir.  2002). 


 5  Verizon.  v.  FCC,  535  U.  S.  at  497-  529. 
 6  Id.  at  507-  08  (  Having  considered  the  proffered  alternatives  and  the  reasons  the  FCC  gave  for  rejecting  them, 
 we  cannot  say  that  the  FCC  acted  unreasonably  in  picking  TELRIC  to  promote  the  mandated  competition.). 
 7  Id.  at  523. 


 8  See  infra  notes  98  and  100. 
 9  See,  e.  g.,  Application  by  Verizon  New  England  Inc.,  Bell  Atlantic  Communications,  Inc.  (d/  b/  a  Verizon  Long 
 Distance),  NYNEX  Long  Distance  Company  (d/  b/  a  Verizon  Enterprise  Solutions),  Verizon  Global  Networks,  Inc.,  and  Verizon  Select  Services,  Inc.,  for  Authorization  to  Provide  In-  Region,  InterLATA  Services  in  Rhode  Island,  CC 


 Docket  No.  01-  324,  Memorandum  Opinion  and  Order,  17  FCC  Rcd  3300,  3312-  15,  paras.  21-  26  (2002)  (Verizon  Rhode  Island  271  Order)  (Rhode  Island  Public  Utilities  Commission  conducted  a  four-  year  series  of  proceedings  to 
 establish  UNE  rates);  Application  by  BellSouth  Corporation,  BellSouth  Telecommunications,  Inc.,  and  BellSouth 
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 typically  are  presented  with  at  least  two  conflicting  cost  models,  and  hundreds  of  inputs  to  those  models,  all  supported  by  the  testimony  of  expert  witnesses.  These  cases  are  extremely  complex, 
 as  state  commissions  must  make  dozens  of  detailed  decisions  regarding  the  calculation  of  the  forward-  looking  cost  of  building  a  local  telecommunications  network.  The  drain  on  resources 
 for  the  state  commissions  and  interested  parties  can  be  tremendous.  We  also  note  that,  for  any  given  carrier,  there  may  be  significant  differences  in  rates  from  state  to  state,  and  even  from 
 proceeding  to  proceeding  within  a  state.  We  are  concerned  that  such  variable  results  may  not  reflect  genuine  cost  differences  but  instead  may  be  the  product  of  the  complexity  of  the  issues, 
 the  very  general  nature  of  our  rules,  and  uncertainty  about  how  to  apply  those  rules.  The  resulting  rates  might  not,  therefore,  achieve  fully  the  Commissions  goal  of  sending  appropriate 
 economic  signals. 
 7.  Part  of  the  difficulty  that  states  and  interested  parties  have  encountered  springs  from  the  excessively  hypothetical  nature  of  the  TELRIC  inquiry.  Because  of  the  general  nature 


 of  our  rules,  state  commissions  have  wide  latitude  in  applying  the  most  efficient  technology  standard  under  the  current  rules.  This  creates  the  potential  for  a  TELRIC  proceeding  to  become 
 a  black  box  from  which  a  variety  of  possible  rates  may  emerge.  In  the  absence  of  more  specific  guidance,  this  can  make  network  modeling  opaque  and  make  it  difficult  to  understand 
 how  actual  UNE  rates  are  derived.  The  lack  of  predictability  in  UNE  rates  is  difficult  to  reconcile  with  our  desire  that  UNE  prices  send  correct  economic  signals.  Moreover,  these 
 complicated  and  time-  consuming  proceedings  may  work  to  divert  scarce  resources  from  carriers  that  otherwise  would  use  those  resources  to  compete  in  local  markets. 


 8.  We  also  request  comment  in  this  proceeding  on  our  resale  pricing  rules.  Section  251(  c)(  4)  requires  incumbent  LECs  to  offer  for  resale  at  wholesale  rates  any 
 telecommunications  service  that  the  carrier  provides  at  retail  to  subscribers  who  are  not  telecommunications  carriers.  10  Section  252(  d)(  3)  of  the  Act  requires  that  state  commissions 
 establish  wholesale  rates  for  resold  services  based  on  the  incumbent  LECs  retail  rates,  excluding  the  portion  thereof  attributable  to  any  marketing,  billing,  collection,  and  other  costs 
 that  will  be  avoided  by  the  local  exchange  carrier.  11  This  section  of  the  Act  is  independent  of  section  252(  d)(  1),  which  sets  forth  the  pricing  standard  for  UNEs  and  interconnection.  12  The 
 Commissions  resale  pricing  rules  were  vacated  by  the  U.  S.  Court  of  Appeals  for  the  Eighth 


 Long  Distance,  Inc.,  for  Authorization  to  Provide  In-  Region,  InterLATA  Services  in  Florida  and  Tennessee,  WC  Docket  No.  02-  307,  Memorandum  Opinion  and  Order,  17  FCC  Rcd  25828,  24840-  44,  paras.  24-  31  (2002) 
 (BellSouth  Florida/  Tennessee  271  Order)  (Florida  Public  Service  Commission  conducted  a  two-  year  proceeding  to  set  UNE  rates  (for  the  second  time);  Tennessee  Regulatory  Authority  established  UNE  rates  over  four  years  in  a 
 two-  phased  proceeding);  Application  by  Qwest  Communications  International,  Inc.  for  Authorization  to  Provide  In-Region,  InterLATA  Services  in  the  States  of  Colorado,  Idaho,  Iowa,  Montana,  Nebraska,  North  Dakota,  Utah, 
 Washington  and  Wyoming,  WC  Docket  No.  02-  314,  Memorandum  Opinion  and  Order,  17  FCC  Rcd  26303,  26412-  14,  paras.  186-  190  (2002)  (Qwest  9-  State  271  Order)  (Colorado  Public  Utilities  Commission  established  UNE  rates 
 (for  the  second  time)  in  a  25-  month  proceeding). 
 10  47  U.  S.  C.    251(  c)(  4). 


 11  47  U.  S.  C.    252(  d)(  3). 
 12  Compare  47  U.  S.  C.    251(  c)(  4)(  A),  252(  d)(  3)  (resale  standard)  with  47  U.  S.  C.    251(  c)(  3),  252(  d)(  1)  (UNE 
 standard). 
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 Circuit  in  2000.  13 
 9.  Our  objective  in  this  proceeding  is  to  modify  or  clarify  the  Commissions  rules  in  order  to  help  state  commissions  more  easily  develop  UNE  prices  and  resale  discounts  that  meet 


 the  statutory  standards  established  by  Congress  in  section  252(  d)  and  to  provide  more  certainty  and  consistency  in  the  results  of  these  state  proceedings.  Based  on  the  wealth  of  experience  that 
 has  been  developed  over  the  last  seven  years,  we  hope  to  compile  a  substantial  record  on  a  broad  range  of  issues  related  to  UNE  pricing  and  resale  discounts.  We  are  particularly  interested  in  the 
 perspective  of  the  state  commissions  on  the  successes  and  failures  of  our  current  rules,  and  the  possible  modifications  that  would  most  help  them  in  fulfilling  their  important  statutory  role  in 
 setting  UNE  prices  and  resale  discounts. 
 II.  BACKGROUND 
 A.  General  Ratemaking  Principles 
 10.  Cost  of  service  ratemaking  methodologies,  14  whether  based  on  forward-  looking  cost,  historical  cost,  or  some  other  methodology,  follow  a  common  approach  to  estimating 


 recurring  monthly  charges.  15  Specifically,  a  recurring  rate  set  in  a  regulatory  ratemaking  proceeding  generally  will  be  based  on  the  sum  of  three  separate  cost  components    operating 
 costs,  depreciation  expense,  and  return  on  capital.  16  In  addition  to  recurring  rates,  regulators  generally  establish  non-  recurring  charges  (NRCs)  that  allow  a  carrier  to  recover  the  cost  of 
 certain  labor  activities  at  the  time  the  activity  is  performed.  We  discuss  each  of  these  components  briefly  below. 


 11.  Operating  Costs.  Operating  costs  are  the  non-  capital  costs  associated  with 
 13  Iowa  Utilities  II,  219  F.  3d  at  754-  756,  765  (vacating  rules  47  C.  F.  R.    51.  609,  51.  611),  revd  on  other  grounds 
 sub  nom.  Verizon  v.  FCC,  535  U.  S.  1646. 
 14  Cost  of  service  ratemaking  is  different  from  price  caps  and  other  forms  of  price  regulation  that  adjust  prices 
 from  one  period  to  the  next  based  on  factors  other  than  a  carriers  cost  of  providing  service,  such  as  anticipated  productivity  and  inflation. 


 15  See  Verizon  v.  FCC,  535  U.  S.  at  487-  88  (  The  enduring  feature  of  ratesetting  from  Smyth  v.  Ames  to  the 
 institution  of  price  caps  was  the  idea  that  calculating  a  rate  base  and  then  allowing  a  fair  rate  of  return  on  it  was  a  sensible  way  to  identify  a  range  of  rates  that  would  be  just  and  reasonable  to  investors  and  ratepayers.).  The 


 Supreme  Court  recognized  that  TELRIC  essentially  follows  this  same  approach,  but  with  a  rate  base  valued  in  terms  of  .  .  .  equipment  an  incumbent  may  not  own.  Id.  at  501. 


 16  ALFRED  KAHN,  THE  ECONOMICS  OF  REGULATION,  PRINCIPLES  AND  INSTITUTIONS,  Vol.  1  at  26-  27  (1970) 
 (KAHN)  (Regulators  need  to  make  determinations  about  which  costs  they  were  prepared  to  authorize  for  inclusion  in  the  computed  company  cost-  of-  service;  and  of  these,  which  could  be  charged  directly  as  operating  expenses  and 


 thus  included  in  annual  revenue  requirements  dollar  for  dollar,  and  which  capitalized,  thus  entering  the  cost  of  service  in  the  form  of  annual  allowances  for  depreciation  and  return  on  the  undepreciated  portion  of  the 
 investment.);  JAMES  C.  BONBRIGHT,  ET  AL.,  PRINCIPLES  OF  PUBLIC  UTILITY  RATES  at  200  (2d  ed.  1988)  (BONBRIGHT)  (  Under  the  usual  forms  of  regulation,  a  fair  return  is  the  excess  in  operating  revenues  over  operating 
 expenses  for  which  a  commission  will  make  provision  in  a  rate  case  as  a  component  of  the  companys  annual  revenue  requirements.  The  operating  expenses  include  allowances  for  depreciation  and  for  nearly  all  taxes,  not  even 
 excepting  corporate  income  taxes.). 
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 operating  a  network,  including  maintenance  expense,  administrative  expense,  and  an  allocation  of  other  common  and  overhead  costs.  Under  an  historical  cost  methodology,  rates  are  designed 
 to  recover  all  operating  costs  unless  disallowed  by  the  regulator.  17  Under  a  forward-  looking  methodology,  operating  costs  may  be  estimated  in  a  variety  of  ways.  For  instance,  they  may  be 
 estimated  by  multiplying  the  projected  investment  by  an  expense  factor,  sometimes  referred  to  as  an  annual  charge  factor  (ACF),  which  is  typically  the  ratio  of  current  expenses  to  current 
 investment.  18  Alternatively,  expenses  may  be  estimated  by  applying  productivity  and  inflation  factors  to  a  carriers  current  expenses.  19 


 12.  Depreciation  Expense.  Depreciation  expense  represents  an  effort  to  recover  the  decline  in  the  economic  value  of  capital  assets  over  time.  20  There  are  various  ways  to  estimate 
 depreciation  expense.  For  example,  under  straight-  line  depreciation,  the  initial  capital  investment  in  an  asset  is  divided  by  its  useful  life  to  derive  an  annual  depreciation  expense.  21 
 Economic  depreciation,  in  contrast,  is  intended  to  reflect  the  actual  decline  in  the  economic  value  of  a  capital  asset  between  one  period  and  the  next.  The  difference  between  the  two  is  largely  one 
 of  timing,  as  both  approaches  recover  the  same  total  investment  over  the  life  of  the  asset.  Depreciation  expense  is  difficult  to  estimate  because  it  requires  the  regulator  to  predict  the 
 service  life  of  the  asset  and  how  its  value  declines  over  time.  The  economic  value  of  a  capital  asset  is  likely  to  decline  more  quickly  if  new,  more  efficient  (i.  e.,  more  productive  or  less 
 expensive)  capital  assets  are  introduced  that  would  increase  the  net  present  value  of  expected  cash  flows  associated  with  the  new  assets.  Consequently,  to  estimate  economic  depreciation  it  is 
 necessary  to  estimate  the  likely  decline  in  the  value  of  an  existing  asset  that  will  result  from  improvements  in  technology. 


 13.  Return  on  Capital.  The  return  on  capital  is  estimated  by  multiplying  a  firms  cost  of  capital  by  its  investment  base.  The  cost  of  capital  is  the  cost  a  firm  will  incur  in  raising  funds 
 in  a  competitive  capital  market.  22  The  cost  of  capital  is  generally  estimated  as  a  weighted  average  of  the  cost  of  equity  and  the  cost  of  debt.  The  rate  financial  markets  will  demand  before 
 they  are  willing  to  purchase  a  particular  companys  debt  or  equity  will  depend  on  the  markets 
 17  CHARLES  F.  PHILLIPS,  JR.,  THE  REGULATION  OF  PUBLIC  UTILITIES  at  255  (3d  ed.  1993)  (PHILLIPS)  (citing 
 Mississippi  River  Fuel  Corp.  v.  Federal  Power  Comm.,  163  F.  2d  433,  437  (D.  C.  Cir.  1947)  (  Expenses  .  .  .  are  facts.  They  are  to  be  ascertained,  not  created,  by  the  regulatory  authorities.  If  properly  incurred,  they  must  be 


 allowed  as  part  of  the  composition  of  rates.  Otherwise,  the  so-  called  allowance  of  a  return  upon  investment,  being  an  amount  over  and  above  expenses,  would  be  a  farce.)). 


 18  Federal-  State  Joint  Board  on  Universal  Service,  CC  Docket  Nos.  96-  45,  97-  160,  Tenth  Report  and  Order,  14 
 FCC  Rcd  20156,  20301-  02,  20304,  paras.  341,  346  (1999)  (USF  Inputs  Order),  affd  sub  nom.  Qwest  Corp.  v.  FCC,  258  F.  3d  1191  (10  th  Cir.  2001). 


 19  Qwest  9-  State  Order,  17  FCC  Rcd  at  26419-  20,  paras.  202-  04  (rejecting  argument  that  a  4  percent  reduction  in 
 expenses  to  reflect  productivity,  net  of  inflation,  was  inconsistent  with  TELRIC  requirements). 
 20  KAHN  at  32  (Depreciation  is  an  imputed  cost,  introduced  to  take  account  of  the  fact  that  the  economic  life  of 
 capital  assets  is  limited;  to  distribute  the  decline  in  their  value    which  is  a  genuine  cost  of  production    over  their  economic  life,  in  order  to  assure  its  recoupment  from  customers.). 


 21  Id.  at  117;  BONBRIGHT  at  276-  77. 
 22  KAHN  at  45. 
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 assessment  of  that  firms  overall  risk.  23  As  with  depreciation,  the  calculation  of  the  cost  of  capital  is  complicated  and  subject  to  dispute.  One  reason  that  a  cost  of  capital  is  difficult  to 
 calculate  is  that  the  calculation  depends  on  an  assessment  of  a  particular  firms  risk  going  forward.  Regulators,  however,  generally  only  have  data  on  the  cost  of  debt  and  equity  that 
 particular  firms  or  groups  of  firms  have  experienced  in  the  past.  24 
 14.  Non-  recurring  costs.  Estimating  non-  recurring  costs  and  determining  how  to  recover  them  raise  issues  different  from  recurring  costs.  In  the  regulatory  context,  non-  recurring 


 costs  are  one-  time  costs  that  a  firm  incurs  in  supplying  a  facility  or  service  to  a  customer  or  other  carrier.  Examples  of  non-  recurring  costs  include  the  cost  of  having  a  technician  turn  up  (or 
 install)  a  second  line  to  a  customer,  the  cost  of  a  technician  cutting  over  a  loop  to  a  carriers  collocation  cage,  and  the  cost  of  removing  load  coils  so  that  digital  subscriber  line  (DSL)  service 
 can  be  provided  over  copper  loops.  One  important  characteristic  of  non-  recurring  charges  is  that  they  generally  represent  a  sunk  investment  to  the  customer  or  carrier  that  must  pay  them,  and 
 they  therefore  can  constitute  a  barrier  to  entry.  25 
 B.  Ratemaking  Under  the  1996  Act 
 1.  UNE  Prices 
 15.  Under  the  ratemaking  process  for  UNEs  established  in  the  1996  Act,  incumbent  LECs  and  requesting  carriers  in  a  given  state  may  negotiate  an  agreement  with  respect  to  UNE 


 prices.  The  state  commission  must  approve  such  an  agreement  unless  it  is  discriminatory  or  otherwise  contrary  to  the  public  interest.  26  If  parties  are  unable  to  agree  and  an  arbitration  is 
 necessary,  section  252(  d)(  1)  of  the  Act  provides  that  rates  for  interconnection  and  UNEs  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  and  may  include  a  reasonable  profit.  27  The  prohibition  on  reference  to  a  rate-  base/  rate-  of-  return  proceeding  renders  section 
 252(  d)(  1)  radically  unlike  all  previous  statutes  in  that  it  appears  to  be  an  explicit  disavowal  of  the  familiar  public  utility  model  of  rate  regulation.  28 


 16.  In  the  Local  Competition  Order,  the  Commission  adopted  guidelines  to  be  applied  when  parties  cannot  agree  and  state  commissions  are  called  on  to  arbitrate  disputes  regarding  the 
 prices  for  interconnection  and  UNEs  pursuant  to  section  252(  d)(  1).  29  Specifically,  the 
 23  ROGER  A.  MORIN,  REGULATORY  FINANCE,  UTILITIES  COST  OF  CAPITAL  at  20  (1994). 


 24  KAHN  at  45-  46. 
 25  Local  Competition  Order,  11  FCC  Rcd  at  15875-  76,  para.  749. 
 26  47  U.  S.  C.    252(  e)(  2). 
 27  47  U.  S.  C.    252(  d)(  1). 
 28  Verizon  v.  FCC,  535  U.  S.  at  1661. 
 29  Local  Competition  Order,  11  FCC  Rcd  at  15844-  56,  paras.  672-  703.  The  Commission  also  concluded  that  rates 
 for  reciprocal  compensation  under  section  252(  d)(  2)  should  be  based  on  the  same  principles.  Id.  at  16023,  para.  1054. 
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 Commission  adopted  a  forward-  looking  economic  cost  (FLEC)  methodology,  which  it  called  Total  Element  Long  Run  Incremental  Cost  or  TELRIC.  TELRIC  is  based  on  the  assumption 
 that  competition  would  constrain  the  value  of  an  incumbent  LEC  network  and  the  price  that  could  be  charged  for  use  of  that  network.  In  other  words,  the  cost  of  the  element  for  purposes 
 of  section  252(  d)(  1)  equals  the  price  that  an  incumbent  LEC  would  be  able  to  charge  for  an  element  in  a  competitive  market.  30 


 17.  The  Commissions  TELRIC  pricing  rules  equate  the  incumbent  LECs  cost  of  providing  network  elements  with  the  cost  today  of  building  a  local  network  that  can  provide  all 
 the  services  its  current  network  provides,  using  the  least-  cost,  most-  efficient  technology  currently  available.  31  The  Commission  added  one  additional  constraint  on  the  design  of  this 
 reconstructed  network:  the  new  network  must  take  as  given  the  existing  wire  center  locations.  32  Because  of  this  constraint,  the  TELRIC  methodology  adopted  by  the  Commission  often  is 
 characterized  as  a  scorched  node  approach  to  costing.  In  describing  this  methodology,  the  Commission  stated  that  regulators  should  use  economic  depreciation  in  calculating  depreciation 
 expense,  and  that  they  should  adjust  the  cost  of  capital  to  reflect  the  risks  faced  by  the  incumbent  as  competition  is  introduced  into  its  local  market.  33 


 18.  The  TELRIC  methodology  assumes  that  the  relevant  increment  of  output  is  all  current  and  reasonably  projected  future  demand,  i.  e.,  it  is  designed  to  calculate  the  total  cost  of 
 building  a  new,  efficient  network.  34  UNE  prices  are  then  calculated  by  dividing  the  total  cost  for  a  particular  element  by  the  number  of  units  of  that  element.  For  example,  if  the  TELRIC  of  all 
 outside  loop  plant  were  $10  million  and  the  network  had  one  million  loops,  then  the  TELRIC  of  a  loop  would  be  $10.  In  other  words,  TELRIC  calculates  the  long-  run  average  incremental  cost 
 of  a  network  element. 
 19.  In  the  Local  Competition  Order,  the  Commission  concluded  that,  as  a  general  rule,  rates  for  unbundled  network  elements  should  recover  costs  in  the  manner  in  which  they  are 


 incurred.  35  The  Commission  stated  that  recurring  costs  should  be  recovered  through  recurring  charges.  36  The  Commission  further  stated  that  non-  recurring  costs  could  be  recovered  either 
 through  non-  recurring  charges  or  recurring  charges  (provided  that  the  regulated  firm  did  not 


 30  Id.  at  15846,  para.  679  (  Adopting  a  pricing  methodology  based  on  forward-  looking  economic  costs  best 
 replicates,  to  the  extent  possible,  the  conditions  of  a  competitive  market.). 
 31  Id.  at  15848-  49,  para.  685;  47  C.  F.  R.    51.  501    51.  511. 


 32  Local  Competition  Order,  11  FCC  Rcd  at  15848-  49,  para.  685  (the  assumption  of  existing  wire  centers 
 mitigates  incumbent  LECs  concerns  that  a  forward-  looking  pricing  methodology  ignores  existing  network  design,  while  basing  prices  on  efficient  new  technology  that  is  compatible  with  existing  infrastructure);  47  C.  F.  R. 


   51.  505(  b)(  1). 
 33  Local  Competition  Order,  11  FCC  Rcd  at  15856,  para.  703. 


 34  Id.  at  15850,  para.  690. 
 35  Id.  at  15874,  para.  743. 
 36  Id.  at  15874-  75,  para.  745-  48. 
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 recover  more  than  the  total  forward-  looking  cost).  37  The  Commissions  primary  focus  in  the  Local  Competition  Order  was  the  calculation  of  recurring  costs.  It  said  little  about  how  a  state 
 regulator  should  provide  for  recovery  of  non-  recurring  costs,  although  it  did  require  the  use  of  forward-  looking  costs. 


 20.  The  TELRIC  rules  were  the  subject  of  lengthy  litigation  over  both  the  Commissions  jurisdiction  to  establish  them  and  whether  the  Commission  reasonably  interpreted 
 the  statute  in  establishing  them.  The  Supreme  Court  upheld  the  Commissions  jurisdiction  to  establish  a  pricing  methodology  for  UNEs  and  interconnection  in  AT&  T  v.  Iowa  Utilities 
 Board.  38  The  court  found  that  section  201(  b)  of  the  Act  gives  the  Commission  authority  to  prescribe  rules  and  regulations  necessary  to  carry  out  the  Act,  including  the  local  competition 
 provisions  in  sections  251  and  252.  39  The  court  stated  that  this  authority  is  not  diminished  by  the  Acts  delegation  of  ratesetting  authority  to  the  states  under  section  252(  c)(  2).  40 


 21.  Subsequently,  in  Verizon  v.  FCC,  the  Supreme  Court  affirmed  the  substance  of  the  Commissions  TELRIC  rules.  41  As  noted  above,  the  court  rejected  arguments  by  incumbent 
 LECs  that  the  statute  requires  a  pricing  standard  that  considers  historical  costs.  42  The  court  found  that  the  Commissions  decision  to  adopt  a  forward-  looking  cost  methodology  was  a  reasonable 
 interpretation  of  the  statute.  43  In  particular,  the  court  found  that  the  Commissions  rules  may  provide  incentives  and  opportunities  for  competitors  to  build  their  own  network  elements  and 
 that  competitors  had  in  fact  done  so  in  the  four  years  following  passage  of  the  1996  Act.  44  The  court  also  rejected  arguments  that  various  aspects  of  the  TELRIC  methodology  were  unlawful, 
 and  it  found  that  the  constitutional  claims  advanced  by  the  incumbent  LECs  were  premature  in  the  absence  of  a  challenge  to  a  specific  TELRIC-  based  rate.  45 


 22.  In  the  Triennial  Review  proceeding,  several  parties  requested  that  the  Commission  clarify  or  modify  the  TELRIC  methodology.  46  In  response,  we  clarified  the  existing  rules  with 
 37  Id.  at  15875-  76,  paras.  749-  50 
 38  AT&  T  v.  Iowa  Utils.  Bd.,  525  U.  S.  at  378-  85. 
 39  Id.  at  378. 
 40  Id.  at  384  (  The  FCCs  prescription,  through  rulemaking,  of  a  requisite  pricing  methodology  no  more  prevents 
 the  States  from  establishing  rates  than  do  the  statutory  Pricing  standards  set  forth  in  section  252(  d).). 
 41  Verizon  v.  FCC,  535  U.  S.  at  523. 


 42  Id.  at  501. 
 43  Id.  at  507-  08. 
 44  Id.  at  507  (  Inefficiencies  built  into  the  scheme  may  provide  incentives  and  opportunities  for  competitors  to 
 build  their  own  network  elements.);  id.  at  516  (  The  entrants  have  presented  figures  showing  that  they  have  invested  in  new  facilities  to  the  tune  of  $55  billion  since  the  passage  of  the  Act.). 


 45  Id.  at  523. 
 46  Letter  from  Cronan  OConnell,  Vice  President    Federal  Regulatory,  Qwest,  to  Marlene  H.  Dortch,  Secretary, 
 Federal  Communications  Commission  at  12  (Oct.  28,  2002)  (Qwest  TELRIC  Letter);  Letter  from  Chris  Frentrup,  Senior  Economist,  WorldCom,  to  Ms.  Marlene  Dortch,  Secretary,  Federal  Communications  Commission  at  8  (Oct. 
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 respect  to  two  key  components  of  TELRIC    cost  of  capital  and  depreciation.  47  The  Commission  made  clear  that,  in  establishing  a  TELRIC-  based  cost  of  capital,  state  commissions  must  reflect 
 the  risk  of  participating  in  a  market  with  facilities-  based  competition.  48  With  respect  to  depreciation,  the  Commission  declined  to  mandate  a  particular  set  of  asset  lives.  We  did, 
 however,  clarify  that  it  was  appropriate  for  state  commissions  to  employ  accelerated  depreciation  in  order  to  reflect  accurately  the  anticipated  decline  in  the  value  of  assets  in  a  competitive 
 market.  49 
 2.  Resale 
 23.  Section  252(  d)(  3)  of  the  Act  requires  that  state  commissions  establish  wholesale  rates  for  resold  services  based  on  the  incumbent  LECs  retail  rates,  excluding  the  portion 


 thereof  attributable  to  any  marketing,  billing,  collection,  and  other  costs  that  will  be  avoided  by  the  local  exchange  carrier.  50  As  noted  above,  this  section  of  the  Act  is  independent  of  section 
 252(  d)(  1),  which  sets  forth  the  cost-  based  pricing  standard  for  UNEs  and  interconnection.  51 
 24.  In  the  Local  Competition  Order,  the  Commission  adopted  a  reasonably  avoidable  standard  governing  the  costs  that  must  be  considered  avoided  when  calculating  the 


 wholesale  discount.  52  That  is,  the  Commission  found  that  any  costs  that  reasonably  can  be  avoided  by  the  incumbent  LEC  when  it  provides  a  service  at  resale  must  be  considered  avoided 
 in  determining  the  wholesale  discount.  53 
 25.  The  Commissions  original  resale  pricing  rules  were  vacated  by  the  Eighth  Circuit  in  Iowa  Utilities  II  because  the  court  found  that  the  rules  were  inconsistent  with  the  plain 


 meaning  of  the  statute.  54  In  Iowa  Utilities  II,  the  Eighth  Circuit  found  that  the  appropriate  standard  for  determining  avoided  costs  is  not  those  costs  that  can  be  avoided,  but  rather  those 
 costs  that  the  [incumbent  LEC]  will  actually  avoid  incurring  in  the  future.  55  Further,  the  court 


 23,  2002);  Letter  from  William  M.  Daley,  President,  SBC  Communications,  Inc.,  to  Hon.  Michael  K.  Powell,  Chairman,  FCC  (Sept.  4,  2002);  Letter  from  James  W.  Cicconi,  General  Counsel  and  Executive  Vice  President, 
 AT&  T,  to  Honorable  Michael  Powell,  Chairman,  Federal  Communications  Commission,  Attach.  at  3  (July  26,  2002);  Letter  from  William  P.  Barr,  Executive  Vice  President  and  General  Counsel,  Verizon,  to  Honorable  Michael 
 Powell,  Chairman,  Federal  Communications  Commission  (July  16,  2002). 
 47  Triennial  Review  Order  at  paras.  675-  91. 


 48  Id.  at  para.  680. 
 49  Id.  at  para.  690. 
 50  47  U.  S.  C.    252(  d)(  3). 
 51  See  supra  para.  8. 
 52  Local  Competition  Order,  11  FCC  Rcd  at  15956-  15957,  para.  912. 
 53  47  C.  F.  R.    51.  609(  b). 
 54  Iowa  Utilities  II,  219  F.  3d  at  754-  756,  765. 
 55  Id.  at  755. 
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 explained  that,  when  determining  avoided  costs,  the  state  commission  may  not  assume  that  the  incumbent  is  acting  as  a  wholesaler  only,  but  rather  must  assume  that  the  incumbent  provider  is 
 acting  as  both  a  wholesale  and  a  retail  provider.  56  The  Commission  has  not  conducted  any  further  rulemaking  to  provide  additional  guidance  on  establishing  wholesale  discounts. 


 C.  Review  of  UNE  Prices  Under  Section  271 
 26.  Pursuant  to  section  271(  d)  of  the  Act,  the  Commission  is  responsible  for  reviewing  applications  by  Bell  Operating  Companies  (BOCs)  for  authority  to  provide  in-  region 


 interLATA  services.  57  As  part  of  that  review,  the  Commission  considers  whether  a  BOC  offers  access  to  UNEs  at  prices  that  comply  with  section  252(  d)(  1).  58  In  reviewing  state  pricing 
 decisions  in  the  section  271  context,  the  Commission  does  not  conduct  a  de  novo  review.  Rather,  given  that  the  purpose  of  our  section  271  review  is  to  determine  whether  a  BOC  has 
 opened  its  local  market  to  competitors,  the  Commission  determines  whether  the  state  has  established  rates  that  are  within  the  range  that  a  reasonable  application  of  TELRIC  principles 
 would  produce.  59 
 27.  In  a  number  of  cases,  the  Commission  found  that  various  aspects  of  state  pricing  decisions  appeared  to  be  inconsistent  with  the  forward-  looking  cost  principles  on  which  our  rules 


 are  based.  60  Because  an  error  in  one  component  of  a  pricing  decision  does  not  necessarily  mean  that  UNE  prices  do  not  comply  with  TELRIC,  the  Commission  developed  an  alternative  method, 
 known  as  benchmarking,  by  which  BOCs  can  demonstrate  that  their  UNE  rates  are  in  the  range  that  TELRIC  principles  would  produce.  61  Under  the  benchmarking  alternative,  a  BOC  can 
 demonstrate  that  its  rates  in  a  particular  state,  adjusted  for  known  cost  differences,  are  at  or  below  the  level  of  rates  in  another  state  in  its  region  that  the  Commission  already  has  found  to  be 


 56  Id. 
 57  47  U.  S.  C.    271(  d). 
 58  47  U.  S.  C.    271(  c)(  2)(  B)(  ii). 
 59  See,  e.  g.,  Joint  Application  by  SBC  Communications  Inc.,  Southwestern  Bell  Telephone  Company,  and 
 Southwestern  Bell  Communications  Services,  Inc.  d/  b/  a  Southwestern  Bell  Long  Distance  for  Provision  of  In-Region,  InterLATA  Services  in  Kansas  and  Oklahoma,  CC  Docket  No.  00-  217,  Memorandum  Opinion  and  Order, 


 16  FCC  Rcd  6237,  6266,  para.  59  (2001)  (SBC  Kansas/  Oklahoma  271  Order),  remanded  in  part  sub  nom.  Sprint  Communications  Co.  v.  FCC,  271  F.  3d  549  (D.  C.  Cir.  2001). 


 60  SBC  Kansas/  Oklahoma  271  Order,  16  FCC  Rcd  at  6275-  76,  para.  80;  Application  of  Verizon  New  England  Inc., 
 Bell  Atlantic  Communications,  Inc.  (d/  b/  a  Verizon  Long  Distance),  NYNEX  Long  Distance  Company  (d/  b/  a  Verizon  Enterprise  Solutions)  and  Verizon  Global  Networks  Inc.,  For  Authorization  to  Provide  In-  Region,  InterLATA 


 Services  in  Massachusetts,  CC  Docket  No.  01-  9,  Memorandum  Opinion  and  Order,  16  FCC  Rcd  8988,  9006-  07,  paras.  38-  39  (2001)  (Verizon  Massachusetts  271  Order);  Verizon  Rhode  Island  271  Order,  17  FCC  Rcd  at  3318-  19, 
 paras.  34-  45. 
 61  See,  e.  g.,  Verizon  Massachusetts  271  Order,  16  FCC  Rcd  at  9006-  08,  paras.  37,  40;  Verizon  Rhode  Island  271 
 Order,  17  FCC  Rcd  at  3320-  21,  paras.  38-  40;  Qwest  9-  State  271  Order,  17  RCC  Rcd  at  25429-  30,  26458-  60,  paras.  228,  280-  82. 
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 TELRIC-  compliant.  62 
 28.  Because  it  is  difficult  to  demonstrate  that  state  pricing  decisions  fully  comply  with  TELRIC  principles  during  the  statutory  90-  day  review  period  for  section  271  applications,  the 


 BOCs  have  made  frequent  use  of  the  benchmarking  alternative.  Indeed,  in  a  number  of  cases,  BOCs  reduced  rates  below  the  rate  established  by  the  state  commission  in  order  to  satisfy  our 
 benchmarking  test.  63  Thus,  to  the  extent  that  errors  in  applying  TELRIC  rules  may  have  resulted  in  inappropriately  high  UNE  rates  in  some  states,  the  benchmarking  process  has  acted  to 
 constrain  these  rates.  The  Commission  has  no  comparable  process,  however,  for  identifying  or  correcting  rates  when  an  error  in  applying  the  TELRIC  rules  results  in  rates  that  are 
 inappropriately  low.  64  Although  we  have  addressed  some  specific  cost  input  disputes  as  they  have  arisen  in  section  271  proceedings,  our  disposition  of  those  disputes  has  provided  no 
 systematic  guidance  on  pricing  issues.  We  embark  on  this  proceeding  to  provide  states  and  interested  parties  comprehensive  guidance  lacking  in  our  consideration  of  section  271 
 applications. 
 III.  FORWARD-  LOOKING  METHODOLOGY 
 29.  Before  addressing  the  detailed  issues  related  to  UNE  pricing,  we  first  must  determine  whether  to  alter  the  Commissions  fundamental  decision  to  use  a  methodology  that 


 sets  prices  on  the  basis  of  the  forward-  looking  cost  of  providing  UNEs.  Although  some  incumbent  LECs  continue  to  press  for  UNE  rates  based  on  an  historical  cost  methodology,  in  this 
 proceeding  we  reaffirm  our  commitment  to  forward-  looking  costing  principles.  As  the  Supreme  Court  has  made  clear,  an  approach  based  on  forward-  looking  cost  is  an  entirely  reasonable 
 approach  to  follow  under  section  252(  d)(  1).  65  Below  we  briefly  examine  a  number  of  alternative  pricing  theories,  as  well  as  the  relative  merits  of  a  forward-  looking  cost  methodology. 


 30.  Forward-  Looking  Cost.  A  forward-  looking  costing  methodology  considers  what  it  would  cost  today  to  build  and  operate  an  efficient  network  (or  to  expand  an  existing  network) 
 that  can  provide  the  same  services  as  the  incumbents  existing  network.  The  benefit  of  a  forward-  looking  approach  is  that  it  gives  potential  competitors  efficient  price  signals  in  deciding 
 whether  to  invest  in  their  own  facilities  or  to  lease  the  incumbents  facilities.  That  is,  if  construction  of  new  facilities  by  a  competitive  LEC  would  cost  less  than  leasing  facilities  at 
 prices  based  on  FLEC,  the  efficient  result  is  for  the  new  entrant  to  build  its  own  facilities.  66 
 62  Relative  cost  differences  among  states  are  determined  by  reference  to  the  results  of  the  Synthesis  Model  that  the 
 Commission  uses  for  universal  service  purposes.  See,  e.  g.,  SBC  Kansas/  Oklahoma  271  Order,  16  FCC  Rcd  at  6276-77,  paras.  81-  84;  Verizon  Massachusetts  271  Order,  16  FCC  Rcd  at  9007-  08,  para.  40. 


 63  See,  e.  g.,  Qwest  9-  State  271  Order,  17  FCC  Rcd  at  26431,  26433-  34,  26436-  37,  26439-  40,  26442,  26444-  45, 
 16448,  25451,  26460,  paras.  230,  235,  241,  246,  249,  255,  261,  268,  283. 
 64  As  discussed  in  paragraph  40  infra,  the  Commission  did  state  in  the  Local  Competition  Order  that  it  would 
 consider  incumbent  LEC  claims  that  particular  rates  were  confiscatory. 
 65  Verizon  v.  FCC,  535  U.  S.  at  507-  08. 


 66  As  we  discuss  in  section  IV.  H  infra,  the  effectiveness  of  FLEC-  based  UNE  prices  in  signaling  whether  it  is 
 efficient  for  a  carrier  to  enter  a  particular  market  may  depend  in  large  part  on  whether  retail  rates  are  cost-  based. 
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 Assuming  that  the  modeling  method  is  accurate,  a  forward-  looking  cost  approach  more  closely  approximates  the  costs  that  would  exist  in  a  competitive  market  than  does  an  historical  cost 
 approach  by  revealing  potential  efficiencies  that  might  not  otherwise  be  apparent. 
 31.  As  noted  above,  the  Commissions  rules  have  been  criticized  for  some  of  the  assumptions  incorporated  into  the  forward-  looking  approach  adopted  in  1996.  For  example, 


 critics  argue  that  the  assumption  that  new  technology  will  be  deployed  instantaneously  and  ubiquitously  is  unrealistic  even  in  the  most  competitive  markets.  67  We  note  that  these  criticisms 
 are  directed  at  the  version  of  forward-  looking  cost  adopted  by  the  Commission,  and  are  not  criticisms  of  forward-  looking  cost  per  se.  68 


 32.  Historical  cost.  Traditional  rate-  base/  rate-  of-  return  ratemaking  has  generally  been  based  on  the  use  of  historical  costs,  i.  e.,  the  costs  the  regulated  firm  incurred  in  building  its 
 network  and  providing  service  and  that  it  recorded  in  its  books  of  account.  As  an  initial  matter,  an  historical  cost  approach  is  highly  dependent  on  the  accuracy  of  an  incumbent  LECs 
 accounting  records,  which  potentially  creates  a  significant  information  asymmetry  that  benefits  the  incumbent  LECs.  In  addition  to  the  problems  associated  with  reliance  on  incumbent  LEC 
 accounting  records,  the  use  of  historical  costs  does  not  necessarily  provide  efficient  investment  signals  to  potential  entrants.  As  many  economists  have  noted,  it  is  forward-  looking  costs,  not 
 historical  costs,  that  are  relevant  in  setting  prices  in  competitive  markets.  69  If  historical  costs  are  higher  than  the  forward-  looking  costs  an  entrant  would  face,  setting  rates  on  the  basis  of 
 historical  cost  could  result  in  UNE  prices  that  deter  entry  generally,  or  cause  entrants  to  build  their  own  facilities  even  when  it  is  inefficient  to  do  so.  Conversely,  if  historical  costs  are  lower 
 than  forward-  looking  costs,  UNE  rates  based  on  historical  costs  might  cause  entrants  to  lease  facilities  when  it  was  more  efficient  either  to  build  their  own  or  not  to  enter  a  particular  market. 


 33.  The  Supreme  Court  found  that  the  statutory  language  places  a  heavy  presumption  against  any  method  resembling  the  traditional  embedded-  cost-  of-  service  model  of 
 ratesetting.  70  The  court  noted  that  any  use  of  embedded  costs  would  allow  LECs  to  pass  on  to  competitors  the  results  of  past  inefficiencies,  which  is  at  odds  with  the  objective  of  forcing  all 


 67  Alfred  E.  Kahn,  Timothy  J.  Tardiff  and  Dennis  L.  Weisman,  The  Telecommunications  Act  at  three  years:  An 
 economic  evaluation  of  its  implementation  by  the  Federal  Communications  Commission,  11  Info.  and  Econ.  Policy  319,  326-  27  (1999). 


 68  Id.  at  324-  25. 
 69  Id.  (  Among  economists,  there  is  widespread  agreement  in  principle  that  (1)  the  costs  that  would  be  the  basis 
 for  efficient  prices  would  be  forward-  looking,  rather  than  historical  and  (2)  the  prices  set  on  that  basis  should  emulate  the  ones  that  would  emerge  from  local  exchange  competition,  if  it  were  feasible.);  ARMEN  A.  ALCHIAN 


 AND  WILLIAM  R.  ALLEN,  EXCHANGE  AND  PRODUCTION  at  222  (3d  ed.  1983)  (  Once  [an  item]  is  acquired,  [its  cost 
 is]  irrelevant  to  the  setting  of  price  in  competitive  markets.);  N.  GREGORY  MANKIW,  PRINCIPLES  OF  ECONOMICS  at  291  (1997)  (  The  irrelevance  of  sunk  costs  explains  how  real  businesses  make  decisions.);  PAUL  A.  SAMUELSON 


 AND  WILLIAM  D.  NORDHAUS,  ECONOMICS  at  167  (16  th  ed.  1998)  (  One  of  the  most  important  lessons  of  economics 
 is  that  you  should  look  at  the  marginal  costs  and  marginal  benefits  of  decision  and  ignore  past  or  sunk  costs.). 


 70  Verizon  v.  FCC,  535  U.  S.  at  512. 
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 carriers  to  make  efficient  choices.  71 
 34.  Efficient  Component  Pricing  Rule  (ECPR).  The  ECPR  posits  that  interconnection  and  UNE  rates  should  be  based  on  the  incumbents  incremental  cost  of  providing  the  service, 


 where  that  incremental  cost  includes  the  incumbents  opportunity  cost,  measured  in  terms  of  foregone  profits.  Advocates  of  the  ECPR  claim  that  this  rule  most  closely  parallels  the  method  a 
 firm  in  a  competitive  market  would  employ  when  faced  with  the  opportunity  of  selling  inputs  to  firms  that  intend  to  compete  with  it  in  the  final  product  market.  72  Advocates  further  claim  that 
 the  ECPR  not  only  will  ensure  that  the  incumbent  will  be  indifferent  between  selling  inputs  to  a  competitor  versus  selling  final  products  to  end-  user  customers,  but  that  it  will  also  ensure 
 efficient  entry.  73 
 35.  In  the  Local  Competition  Order,  the  Commission  rejected  the  ECPR  approach.  It  found  that  ECPR  would  discourage  competition  because  it  relies  on  prevailing  retail  prices 


 (which  are  not  cost-  based  and  may  reflect  monopoly  rents)  in  setting  the  rates  new  entrants  pay  incumbents  for  inputs.  74  The  Supreme  Court  agreed  that  ECPR  had  flaws  similar  to  a  historical 
 cost  methodology  because  the  opportunity  cost  of  providing  the  UNE  is  based  on  the  amount  of  lost  revenue,  which  in  turn  is  a  function  of  embedded  costs,  or  is  not  related  to  cost  at  all.  75 


 36.  Ramsey  Pricing.  The  Commission  in  1996  also  considered  and  rejected  Ramsey  pricing,  which  is  a  method  for  allocating  common  costs  among  retail  services.  76  Under  this 
 approach,  common  costs  are  allocated  among  services  in  inverse  proportion  to  the  elasticity  of  demand  for  a  particular  service.  The  Commission  found  that  Ramsey  pricing  would  raise  prices 
 for  the  most  critical  bottleneck  elements  and  therefore  would  undermine  the  pro-  competitive  objectives  of  the  1996  Act.  77  The  Supreme  Court  agreed  with  the  Commission  that  Ramsey 
 pricing  is  inconsistent  with  the  Act  because  rates  would  be  highest  for  those  elements  that  are  most  difficult  to  replicate,  thus  deterring  the  competitive  entry  that  is  one  of  the  principal  goals 
 of  the  Act.  78 
 37.  We  conclude  that  our  decision  remains  sound  to  base  UNE  prices  on  the  forward-looking  cost  of  providing  UNEs.  This  approach  is  supported  both  by  the  Supreme  Courts 


 endorsement  of  our  forward-  looking  cost  methodology  and  its  concerns  regarding  alternative 


 71  Id. 
 72  J.  Gregory  Sidak  and  Daniel  F.  Spulber,  The  Tragedy  of  the  Telecommons:  Government  Pricing  of  Unbundled 
 Network  Elements  Under  the  Telecommunications  Act  of  1996,  97  Columbia  L.  Rev.  1081,  1093-  94  (1997). 
 73  Id.  at  1098-  99. 


 74  Local  Competition  Order,  11  FCC  Rcd  at  15859-  60,  paras.  709-  11. 
 75  Verizon  v.  FCC,  535  U.  S.  at  514. 
 76  Local  Competition  Order,  11  FCC  Rcd  at  15853,  para.  696. 
 77  Id. 
 78  Verizon  v.  FCC,  535  U.  S.  at  515-  16. 
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 pricing  methodologies  that  rely  in  whole  or  in  part  on  embedded  costs.  We  also  note  the  general  absence  of  criticism  showing  that  a  forward-  looking  costing  methodology  per  se  is  flawed  or 
 unreasonable.  Accordingly,  we  decline  to  open  an  inquiry  into  alternative  pricing  theories.  Instead,  this  NPRM  will  focus  on,  and  solicit  comments  regarding,  clarifications  or 
 modifications  of  the  current  FLEC-  based  rules  that  will  more  fully  satisfy  the  Commissions  policy  goals  and  the  statutory  requirements  of  section  252(  d)(  1). 


 IV.  UNE  PRICING 
 A.  Overarching  Issues 
 1.  Goals  of  UNE  Pricing 
 38.  In  the  Local  Competition  Order,  the  Commission  found  that  a  UNE  pricing  regime  should  achieve  two  objectives.  First,  UNE  prices  should  be  set  in  a  manner  that  sends 


 efficient  entry  and  investment  signals  to  all  competitors.  79  Second,  UNE  prices  should  provide  incumbent  LECs  an  opportunity  to  recover  the  forward-  looking  costs  of  providing  UNEs.  80  We 
 ask  parties  to  comment  on  whether  these  should  remain  the  primary  goals  of  the  Commissions  UNE  pricing  rules.  If  not,  parties  should  identify  alternative  pricing  goals  and  explain  what 
 circumstances  have  changed  since  1996  that  would  justify  changing  the  Commissions  objectives. 


 39.  Because  the  Commission  designed  UNE  prices  to  serve  two  distinct  objectives    providing  appropriate  economic  signals  with  respect  to  efficient  competitive  entry  and 
 investment  while  providing  incumbent  LECs  with  the  opportunity  to  recover  the  forward-  looking  costs  of  providing  UNEs    determining  whether  UNE  prices  for  a  given  carrier  in  a  given  state 
 have  been  set  at  the  correct  level  is  an  extremely  complicated  task.  With  respect  to  the  first  objective,  we  seek  comment  on  how  the  Commission  could  measure  empirically  whether  those 
 prices  are  sending  appropriate  signals  with  respect  to  competitive  entry  and  investment?  What  should  we  expect  to  see  in  the  market  if  UNE  prices  are  sending  correct  economic  signals?  At 
 what  speed  and  over  what  period  of  time  would  we  expect  entry  and  investment  to  occur? 
 40.  With  respect  to  cost  recovery,  we  note  that  the  Commission  offered  incumbent  LECs  the  opportunity  to  seek  relief  from  the  TELRIC  pricing  rules  if  they  could  demonstrate  the 


 rules  had  been  applied  to  produce  confiscatory  rates,  and  the  Commission  did  not  foreclose  the  possibility  of  establishing  a  separate  mechanism  to  recover  embedded  costs  not  recovered 
 through  UNE  rates.  81  Does  the  availability  of  this  relief  diminish  the  need  for  us  to  be  concerned 
 79  Local  Competition  Order,  11  FCC  Rcd  at  15844,  para.  672  (  We  believe  that  the  prices  that  potential  entrants 
 pay  for  these  elements  should  reflect  forward-  looking  economic  costs  in  order  to  encourage  efficient  levels  of  investment  and  entry.). 


 80  47  U.  S.  C.    252(  d)(  1).  UNE  prices  need  not,  however,  provide  for  full  recovery  of  historical  costs.  Local 
 Competition  Order,  11  FCC  Rcd  at  15857-  58,  para.  705  (  Neither  a  methodology  that  establishes  prices  for  interconnection  and  access  to  network  elements  directly  on  the  costs  reflected  in  the  regulated  books  of  account,  nor 


 a  price  based  on  forward-  looking  costs  plus  an  additional  amount  reflecting  embedded  costs,  would  be  consistent  with  the  approach  we  are  adopting.). 


 81  Local  Competition  Order,  11  FCC  Rcd  at  15872,  para.  739. 
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 with  whether  UNE  rates  provide  for  full  cost  recovery?  In  measuring  the  reasonableness  of  UNE  prices,  is  a  comparison  to  an  incumbent  LECs  historical  costs  relevant?  We  note  in  this  respect 
 that  the  Supreme  Court  called  into  question  whether  historical  costs  were  even  accurate.  82  Does  this  criticism  undermine  our  ability  to  make  any  kind  of  reliable  comparison?  Are  there  other 
 comparisons  that  would  provide  a  more  useful  measure  of  whether  UNE  rates  are  providing  an  appropriate  level  of  cost  recovery? 


 41.  Are  there  other  goals  the  Commission  should  consider  in  establishing  a  UNE  pricing  methodology?  For  example,  two  goals  identified  in  the  universal  service  context   
 transparency  and  verifiability    also  may  be  relevant  to  a  state  commissions  ability  to  determine  UNE  costs  in  a  reasonable  time  frame.  83  By  transparency  we  mean  that  the  logic  and  algorithms 
 of  a  cost  study  or  cost  model  should  be  revealed  to  and  understandable  by  the  parties  and  regulators.  For  example,  if  a  cost  model  were  presented  in  an  electronic  spreadsheet,  but  all  the 
 formulae  were  concealed  so  that  parties  could  not  ascertain  the  underlying  assumptions,  the  model  would  not  be  transparent.  By  verifiability  we  mean  that  data  or  inputs  that  are  used  to 
 estimate  costs  should  be  derived  from  public  sources,  or  they  should  be  able  to  be  verified  or  audited  without  undue  cost  and  delay.  We  ask  parties  to  comment  on  the  importance  of 
 transparency  and  verifiability.  Are  these  goals  as  important  as  the  investment  and  cost  recovery  goals  discussed  above?  Is  there  any  way  for  the  Commission  to  measure  whether  these  goals  are 
 being  achieved? 
 2.  Impact  of  Triennial  Review 
 42.  In  the  Triennial  Review  Order,  the  Commission  made  a  number  of  significant  changes  to  the  regime  for  determining  what  elements  must  be  unbundled  by  an  incumbent  LEC. 


 In  particular,  the  Commission  adopted  a  new  interpretation  of  section  251(  d)(  2)  for  determining  whether  requesting  telecommunications  carriers  are  entitled  to  access  to  an  unbundled  network 
 element.  84  We  seek  comment  on  the  relationship,  if  any,  between  this  new  interpretation  and  the  Commissions  UNE  pricing  rules. 


 43.  The  unbundling  obligations  set  forth  in  the  Triennial  Review  Order  with  respect  to  hybrid  fiber/  copper  loops  are  limited.  85  What  implications  does  this  limitation  have  for  a 
 pricing  methodology  based  on  forward-  looking  costs?  The  Commissions  TELRIC  methodology  attempts  to  measure  the  cost  of  discrete  network  elements,  rather  than  that  of  particular  network 


 82  Verizon  v.  FCC,  535  U.  S.  at  512  ([  T]  he  temptation  would  remain  to  overstate  book  costs  to  ratemaking 
 commissions  and  so  perpetuate  the  intractable  problems  that  led  to  the  price-  cap  innovation.);  id  at  1676  (  the  book  value  or  embedded  costs  of  capital  presented  to  traditional  ratemaking  bodies  often  bore  little  resemblance  to 


 the  economic  value  of  capital);  id.  at  518  ([  B]  ook  costs  may  be  overstated  by  approximately  $5  billion.  (quoting  FCC  Releases  Audit  Report  on  RBOCs  Property  Records,  Report  No.  CC  99-  3  (rel.  February  25,  1999)). 


 83  Federal-  State  Joint  Board  on  Universal  Service,  CC  Docket  No.  96-  45,  First  Report  and  Order,  12  FCC  Rcd 
 8776,  8915,  para.  250  (1997)  (USF  First  Report  and  Order)  (subsequent  history  omitted). 
 84  Triennial  Review  Order  at  paras.  55-  172. 


 85  Specifically,  incumbent  LECs  are  not  required  to  provide  unbundled  access  to  hybrid  loops  for  the  provision  of 
 packetized  broadband  services.  Incumbent  LECs  must  continue  to  provide  unbundled  access  to  TDM  features,  functions  and  capabilities  of  their  hybrid  loops.  Id.  at  paras.  285-  97. 
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 technologies,  in  order  to  minimize  the  difficulties  inherent  in  allocating  joint  and  common  costs.  86  Previously,  UNEs  were,  with  limited  exceptions,  not  defined  with  regard  to  technology. 
 What  adjustments,  if  any,  should  states  make  to  recognize  this  more  limited  availability  of  UNE  loops?  Should  the  price  of  an  entire  copper  loop  be  the  same  as  the  price  of  the  portion  of  a 
 hybrid  fiber/  copper  loop  that  must  be  unbundled?  In  either  case,  how  should  prices  for  these  loop  elements  be  developed?  How  should  the  costs  of  fiber  be  allocated  given  the  limited 
 availability  of  hybrid  fiber/  copper  loops?  In  addition,  the  Commissions  new  UNE  loop  rules  limit  the  availability  of  fiber  loops.  87  If  a  competitive  LEC  leases  a  copper  loop  that  has  been 
 otherwise  replaced  by  a  fiber  loop  (and  therefore  depreciated  fully),  is  a  price  based  on  forward-looking  cost  still  appropriate?  What  adjustments  should  be  made  so  that  requesting  carriers  are 
 not  charged  for  operating  costs,  such  as  maintenance,  associated  with  deployment  of  fiber  networks  to  which  they  have  limited  access? 


 44.  In  addition  to  limiting  unbundling  requirements  with  respect  to  the  local  loop,  the  Triennial  Review  Order  also  limited  unbundling  obligations  with  respect  to  high-  capacity  loops, 
 switching,  and  transport.  88  Specifically,  under  the  new  rules,  high-  capacity  loops  and  transport  elements  might  not  be  available  in  all  geographic  areas.  Similarly,  the  switching  element  may 
 not  be  available  in  all  geographic  areas  or  for  all  customer  classes.  How  should  states  develop  costs  for  UNEs  that  no  longer  are  required  to  be  provided  throughout  a  carriers  service  area  (i.  e., 
 if  the  total  element  no  longer  is  unbundled)?  For  example,  does  our  finding  that  competitive  LECs  are  not  impaired  without  access  to  unbundled  local  circuit  switching  when  serving  the 
 enterprise  market  change  the  manner  in  which  unbundled  switching  costs  should  be  developed?  We  encourage  parties  to  identify  other  ways  in  which  decisions  in  the  Triennial  Review  Order 
 should  affect  the  Commissions  UNE  pricing  rules. 
 3.  Relationship  to  Universal  Service 
 45.  In  the  Universal  Service  proceeding,  the  Commission  decided  that  funding  should  be  based  on  the  forward-  looking  cost  of  providing  universal  service.  89  The  Commission 


 identified  criteria  to  guide  the  selection  of  a  forward-  looking  universal  service  cost  model.  90  It  then  applied  these  criteria  in  developing  a  computer  cost  model  (the  Synthesis  Model)  and 
 selecting  the  inputs  necessary  to  develop  forward-  looking  costs.  91  Currently,  the  Commission 
 86  Local  Competition  Order,  11  FCC  Rcd  at  15852,  para.  695  (  Because  the  unbundled  network  elements 
 correspond,  to  a  great  extent,  to  discrete  network  facilities,  and  have  different  operating  characteristics,  we  expect  that  common  costs  should  be  smaller  than  the  common  costs  associated  with  the  long-  run  incremental  cost  of  a 


 service.). 
 87  Triennial  Review  Order  at  paras.  273-  84. 


 88  Id.  at  paras.  201-  02  (summarizing  high  capacity  loop  requirements),  419-  28  (summarizing  switching 
 requirements),  359-  60,  534  (summarizing  transport  requirements). 
 89  USF  First  Report  and  Order,  12  FCC  Rcd  at  8776,  8888,  8889-  90,  8903-  17,  paras.  199,  223-  226,  232-  251. 


 90  Id.,  12  FCC  Rcd  at  8912-  16,  para.  250. 
 91  Federal-  State  Joint  Board  on  Universal  Service,  CC  Docket  Nos.  96-  45,  97-  160,  Fifth  Report  and  Order,  13 
 FCC  Rcd  21323,  21335-  62,  paras.  26-  92  (1998)  (USF  Platform  Order);  USF  Inputs  Order,  14  FCC  Rcd  at  20171-  350,  paras.  29-  439. 
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 uses  the  model  to  determine  high-  cost  support  for  non-  rural  carriers  based  on  a  comparison  of  forward-  looking  costs  among  states.  92 
 46.  In  developing  the  model  and  inputs  necessary  to  calculate  universal  service  funding,  the  Commission  did  not  intend  to  provide  any  systematic  guidance  to  states  in  the  area 
 of  TELRIC  rate-  setting.  Indeed,  the  Commission  emphasized  at  the  time  that  its  decisions  on  particular  inputs  were  made  solely  for  the  purpose  of  calculating  universal  service  support  and 
 may  not  be  appropriate  for  the  calculation  of  UNE  prices.  93  For  these  reasons,  we  continue  to  discourage  states  from  using  the  nationwide  inputs  for  the  purpose  of  developing  UNE  prices. 


 47.  In  the  absence  of  more  specific  guidance  from  the  Commission,  however,  some  state  regulators  have  utilized  our  USF  Inputs  Order  to  reach  conclusions  regarding  the  TELRIC-based 
 cost  of  building  a  network.  Although  we  understand  why  state  regulators  might  refer  to  the  USF  Inputs  Order  in  developing  forward-  looking  costs,  in  at  least  some  cases  there  might  be 
 unintended  and  undesirable  consequences  that  result  from  extrapolating  from  statements  made  in  the  context  of  universal  service  funding.  For  example,  the  Commission  stated  in  the  USF  Inputs 
 Order  that  it  is  necessary  to  assume  that  the  telephone  industry  will  have  at  least  the  same  opportunity  to  share  the  cost  of  building  plant  that  existed  when  the  plant  was  first  built.  94  This 
 statement  was  intended  to  address  only  the  issue  of  structure  sharing  in  the  universal  service  model,  but  it  has  been  interpreted  by  some  states  as  endorsing  a  backward-  looking  approach  for 
 other  inputs  in  a  TELRIC  model,  such  as  the  relative  frequency  of  various  construction  types  (e.  g.,  boring  through  concrete,  trenching  through  dirt).  95  Applying  this  particular  statement  from 
 the  USF  Inputs  Order  out  of  context  erroneously  assumes  away  not  just  the  features  of  an  incumbent  LECs  existing  network  but  also  attributes  of  the  real  world  in  which  incumbents  and 
 competitors  operate. 
 48.  Our  approach  is  not  to  single  out  these  applications  for  special  critique,  but  to  suggest  more  broadly  that  imposing  some  real-  world  boundaries  on  the  UNE  cost  inquiry  is 


 needed  to  ensure  that  appropriate  pricing  signals  are  sent  to  the  market.  The  questions  we  ask  in  this  proceeding  are  directed  solely  at  our  UNE  pricing  rules.  In  a  number  of  places,  however,  we 
 seek  comment  on  the  relevance  of  Commission  statements  in  the  universal  service  context  for  specific  UNE  pricing  rules.  We  also  invite  parties  to  comment  on  the  relationship  between  the 


 92  See  Qwest  Corp.  v.  FCC,  258  F.  3d  1191  (10  th  Cir.  2001)  (affirming  USF  Inputs  Order  but  remanding  non-  rural 
 high-  cost  support  methodology  for  further  explanation).  The  Commission  currently  has  in  place  for  rural  carriers  an  interim,  five-  year  plan  under  which  they  receive  support  based  on  embedded  costs.  See  Federal-  State  Joint  Board 


 on  Universal  Service,  CC  Docket  No.  96-  45,  Fourteenth  Report  and  Order,  16  FCC  Rcd  11244  (2000). 
 93  USF  Inputs  Order,  14  FCC  Rcd  at  20172,  para.  32  (  The  federal  cost  model  was  developed  for  the  purpose  of 
 determining  federal  universal  service  support  and  it  may  not  be  appropriate  to  use  nationwide  values  for  other  purposes,  such  as  determining  prices  for  unbundled  network  elements.  We  caution  parties  from  making  any  claims 


 in  other  proceedings  based  upon  the  input  values  we  adopt  in  this  Order.). 
 94  Id.  at  20261,  para.  244  n.  504. 


 95  Qwest  TELRIC  Letter  at  9. 
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 two  sets  of  rules.  96 
 B.  Network  Assumptions 
 1.  General  Theory 
 49.  Perhaps  the  most  controversial  aspect  of  the  TELRIC  rules  is  the  assumption  that  the  cost  of  a  UNE  should  be  calculated  based  on  the  cost  of  ubiquitous  deployment  of  the  most 


 efficient  technology  currently  available.  97  In  implementing  this  requirement,  current  TELRIC  models  typically  are  designed  to  answer  the  following  question:  If  a  single  carrier  were  to  build 
 an  efficient  network  today  to  serve  all  customer  locations  within  a  particular  geographic  area,  taking  as  given  only  the  locations  of  existing  wire  centers,  how  much  would  it  cost  to  construct 
 and  maintain  the  network? 
 50.  One  of  the  central  internal  tensions  in  the  application  of  the  TELRIC  methodology  is  that  it  purports  to  replicate  the  conditions  of  a  competitive  market  by  assuming 


 that  the  latest  technology  is  deployed  throughout  the  hypothetical  network,  while  at  the  same  time  assuming  that  this  hypothetical  network  benefits  from  the  economies  of  scale  associated 
 with  serving  all  of  the  lines  in  a  study  area.  In  the  real  world,  however,  even  in  extremely  competitive  markets,  firms  do  not  instantaneously  replace  all  of  their  facilities  with  every 
 improvement  in  technology.  98  Thus,  even  the  most  efficient  carriers  network  will  reflect  a  mix  of  new  and  older  technology  at  any  given  time. 


 51.  Simultaneously  assuming  a  market  inhabited  by  multiple  competitors  and  one  with  a  ubiquitous  carrier  with  a  very  large  market  share  may  work  to  reduce  estimates  of 
 forward-  looking  costs  below  the  costs  that  would  actually  be  found  even  in  an  extremely  competitive  market.  99  It  therefore  may  undermine  the  incentive  for  either  competitive  LECs  or 


 96  However,  we  will  not  consider  any  changes  to  the  model  or  inputs  used  in  calculating  universal  service  support 
 in  this  proceeding. 
 97  Local  Competition  Order,  11  FCC  Rcd  at  15848-  49,  para.  685;  47  C.  F.  R.    51.  505(  b)(  1). 


 98  See,  e.  g.,  Dennis  L.  Weisman,  The  (in)  efficiency  of  the  efficient  firm  cost  standard,  Antitrust  Bulletin  (Spring 
 2000)  (  If  regulators  had  sufficient  information  to  implement  the  efficient-  firm  cost  standard,  competition  would  be  wholly  unnecessary.  In  this  respect,  the  efficient-  firm  cost  standard  is  fatally  flawed  because  it  confuses  mandating 


 the  competitive  outcome  with  fostering  the  competitive  process.);  Kahn,  Tardiff  and  Weisman,  11  Info.  and  Econ.  Policy  at  326  (  In  a  world  of  continuous  technological  progress,  it  would  be  irrational  for  firms  constantly  to  update 
 their  facilities  in  order  completely  to  incorporate  todays  lowest  -cost  technology.)  (emphasis  in  original);  id  at  322  ([  C]  ompetitive  prices  will  not  tend,  in  a  technologically  dynamic  industry,  to  be  equated  to  the  lowest  cost  of 
 duplicating  a  service  with  the  most  recent  technology.);  but  see  David  Gabel  and  David  I.  Rosenbaum,  Whos  Taking  Whom:  Some  Comments  and  Evidence  on  the  Constitutionality  of  TELRIC,  52  Fed.  Comm.  L.  J.  239,  254 
 (2000)  (  As  regards  the  so-  called  hypothetical  nature  of  the  regulatory  judgments  required  for  the  implementation  of  the  TELRIC  methodology,  it  is  uncertain  as  to  whether  the  factual  inquiry  required  for  the  conduct  of  a  proper 
 TELRIC  study  is  any  more  hypothetical  in  nature  than  the  judgments  called  for  in  determining  whether  or  not  capital  costs,  some  of  which  were  incurred  decades  ago,  were  prudently  made  or  used  and  useful.  ). 


 99  The  clarifications  we  made  to  our  TELRIC  rules  in  the  Triennial  Review  Order  begin  to  address  this  concern. 
 Specifically,  by  clarifying  that  a  consistent  set  of  assumptions  is  to  be  used  for  all  the  components  of  TELRIC  (operating  expenses,  cost  of  capital,  and  depreciation)  and  that  accelerated  depreciation  may  be  used  to  reflect  the 
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 incumbent  LECs  to  build  new  facilities,  even  when  it  is  efficient  for  them  to  do  so.  100  We  seek  comment  on  this  concern. 
 52.  We  tentatively  conclude  that  our  TELRIC  rules  should  more  closely  account  for  the  real-  world  attributes  of  the  routing  and  topography  of  an  incumbents  network  in  the 
 development  of  forward-  looking  costs.  We  seek  comment  on  whether  such  an  approach  would  address  claims  that  our  TELRIC  rules  currently  distort  a  competitors  decision  whether  to  invest 
 in  new  facilities  or  to  lease  an  incumbents  existing  facilities.  Yet  we  also  wish  to  ensure  that  a  reformed  TELRIC  methodology  does  not  swing  in  the  other  direction  and  give  incumbents 
 undue  advantages.  We  seek  comment  on  this  tentative  conclusion  and,  in  particular,  on  how  such  an  approach  may  differ  from  the  practices  of  state  commissions  in  UNE  pricing 
 proceedings. 
 53.  We  seek  comment  on  proposals  that  would  achieve  these  objectives.  We  seek  comment  on  whether  it  is  appropriate  to  assume  that  the  cost  of  an  existing  element  is  the  cost  of 


 that  element  if  it  were  being  replaced  today.  Under  this  approach,  the  cost  to  the  incumbent  LEC  of  using  its  existing  facilities  is  the  cost  that  would  actually  be  incurred  (including  actual 
 placement  costs)  to  place  new  facilities  in  the  same  location.  As  discussed  above,  the  UNE  pricing  methodology,  while  forward-  looking,  must  be  representative  of  the  real  world  and  should 
 not  be  based  on  the  totally  hypothetical  cost  of  a  most-  efficient  provider  building  a  network  from  scratch.  To  that  end,  the  UNE  cost  study  should  be  based  upon  the  incumbent  LECs  actual 
 network  topography  and  currently  available,  forward-  looking  technologies. 
 54.  Alternatively,  we  seek  comment  on  whether  we  should  define  the  relevant  network  as  one  that  that  incorporates  upgrades  planned  by  the  incumbent  LEC  over  some 


 objective  time  horizon  (e.  g.,  three  or  five  years),  as  documented,  for  example,  in  an  incumbent  LECs  actual  engineering  plans.  Although  this  approach  would  take  as  given  whatever  existing 
 facilities  will  remain  in  the  network  at  the  end  of  the  designated  period,  it  also  should  capture  technological  evolution  within  that  period.  Such  an  approach  may  provide  an  appropriate  middle 
 ground  between  the  hypothetical  assumptions  required  under  our  current  rules  and  the  replacement  cost  approach  described  in  the  previous  paragraph.  Finally,  we  seek  comment  on 
 any  other  alternatives  that  would  ground  our  TELRIC  rules  in  the  attributes  of  an  incumbents  existing  network.  We  ask  parties  to  comment  on  whether  any  or  all  of  these  approaches  would 
 produce  results  that  are  more  consistent  across  states  and  send  better  entry  and  investment  signals  to  incumbents  and  competitors. 


 55.  In  the  Local  Competition  Order,  the  Commission  defined  the  term  long  run  to 
 anticipated  decline  in  value  of  assets  over  their  useful  life,  we  have  provided  state  commissions  additional  guidance  that  should  help  to  avoid  unreasonable  rates  that  might  be  caused  by  inconsistent  assumptions. 
 100  See,  e.  g.,  Thomas  M.  Jorde,  J.  Gregory  Sidak  and  David  J.  Teece,  Innovation,  Investment  and  Unbundling,  17 
 Yale  J.  Reg.  1  (Winter  2000)  ([  M]  andatory  unbundling  confers  a  second-  mover  advantage  and  substantially  decreases  a  CLECs  incentives  to  make  a  sunk  investment.);  Sidak  and  Spulber,  97  Columbia  L.  Rev.  1081  (  If  the 


 incumbent  LEC,  the  putative  owner  of  the  local  network,  no  longer  can  recover  the  costs  of  investments  that  it  would  make  on  a  forward-  looking  basis    let  alone  keep  any  economic  rents  accruing  to  such  investments    then 
 entrants  become  free  riders  and  the  incumbent  LECs  incentive  to  make  further  investment  in  the  local  exchange  network  evaporates.);  but  see  Gabel  and  Rosenbaum,  52  Fed.  Comm.  L.  J.  at  264-  65. 
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 mean  a  period  long  enough  for  all  of  a  firms  costs  to  become  variable  or  avoidable.  101  Does  our  tentative  conclusion  compel  us  to  shift  from  a  long-  run  average  cost  methodology  to  a  short-  run 
 average  cost  methodology?  If  so,  what  are  the  consequences  of  such  a  shift?  To  the  extent  the  cost  of  a  UNE  under  such  an  approach  would  in  part  be  based  on  the  existing  incumbent  LEC 
 network,  is  such  an  approach  consistent  with  the  heavy  presumption  against  the  use  of  embedded  costs?  102  Would  it  be  more  effective  to  retain  a  long-  run  pricing  methodology,  but 
 provide  specific  guidance  to  the  states  on  the  appropriate  long-  run  assumptions  upon  which  to  base  network  inputs? 


 56.  We  ask  parties  to  suggest  other  ways  of  defining  the  network  that  is  to  be  modeled  in  a  UNE  pricing  proceeding.  To  what  extent  should  network  assumptions  reflect 
 evidence  of  the  network  decisions  made  by  competitive  LECs?  Parties  should  explain  in  detail  the  network  assumptions  they  advocate  and  the  competitive  assumptions  implicit  in  their 
 proposals.  Parties  also  should  explain  whether  they  are  proposing  a  theory  based  on  short-  run  costs  or  long-  run  costs,  and  how  their  proposed  definition  of  the  network  will  produce  more 
 accurate  economic  signals  and  more  consistent  results  than  our  current  regime. 
 57.  The  dispute  as  to  the  relevant  network  for  pricing  purposes  is  in  large  part  a  dispute  over  what  constitutes  efficiency.  Is  our  current  approach  of  looking  at  efficiency  at  a 


 single  point  in  time  consistent  with  the  longer  time  horizon,  and  corresponding  uncertainties,  that  carriers  actually  consider  when  deciding  to  invest  in  long-  lived  assets  that  are  expensive,  if  not 
 impossible,  to  redeploy?  What  is  the  efficiency  standard  that  the  Commission  should  use  in  order  to  achieve  UNE  prices  that  send  the  correct  economic  signals  regarding  investment,  while 
 still  achieving  the  necessary  level  of  cost  recovery?  To  what  extent  is  the  efficiency  standard  related  to  assumptions  about  the  state  of  competition?  For  example,  the  requirement  in  the 
 current  rules  to  assume  the  most  efficient  technology  currently  available  is  based  on  the  assumption  that  competitors  would  deploy  the  most  efficient  technology  on  a  widespread  basis, 
 thereby  constraining  the  value  of  the  incumbent  LEC  network.  We  ask  parties  to  be  very  specific  in  defining  the  standard  of  efficiency  and  explaining  how  to  determine  whether  a 
 network  is  optimized  for  economic  efficiency. 
 58.  A  central  principle  of  the  current  UNE  pricing  rules  is  that  competitive  LECs  should  not  pay  UNE  rates  that  compensate  incumbent  LECs  for  past  inefficiencies.  103  We  ask 


 parties  to  comment  on  whether  there  is  any  reason  to  depart  from  this  principle.  One  of  the  reasons  that  the  Commission  moved  from  rate-  of-  return  regulation  to  price  cap  regulation  of 
 some  carriers  was  to  create  a  strong  incentive  for  carriers  to  operate  as  efficiently  as  possible.  Given  that  most  large  incumbent  LECs  have  been  subject  to  forms  of  price  cap  regulation  at  the 
 state  level  for  some  time  and  at  the  federal  level  since  1991,  is  there  reason  for  the  Commission 


 101  Local  Competition  Order,  11  FCC  Rcd  at  15845,  para.  677;  see  also  USF  First  Report  and  Order,  12  FCC  Rcd 
 at  8913,  para.  250(  3). 
 102  Verizon  v.  FCC,  535  U.  S.  at  512. 


 103  Id.  at  511-  12. 
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 to  find  that  an  incumbent  LECs  practices  presumptively  are  efficient?  104  Why  or  why  not?  We  ask  incumbent  LECs  to  comment  on  what  portion  of  their  networks  were  installed  since  the  onset 
 of  price  cap  regulation.  What  would  be  the  effect  of  a  presumption  of  efficiency  on  a  state  commissions  pricing  proceeding?  What  type  of  evidence  would  be  sufficient  to  rebut  this 
 presumption?  How  difficult  would  it  be  for  competitive  LECs  to  develop  such  evidence?  What  effect  should  any  asymmetry  in  access  to  information  about  incumbent  LECs  practices  and  their 
 costs  have  on  any  presumptions  we  may  create?  If  we  modify  our  network  assumptions  to  track  more  closely  the  incumbent  LECs  existing  network,  how  will  CLECs  that  purchase  UNEs 
 receive  the  benefit  of  efficiency  gains  that  should  be  occurring  in  the  network?  Is  the  adoption  of  some  sort  of  productivity  factor  a  necessary  part  of  any  transition  to  network  assumptions  that 
 rely  on  the  existing  network? 
 59.  Parties  that  propose  changing  our  network  assumptions  should  explain  whether  assuming  a  different  network  than  under  the  current  rules  would  lead  to  higher  UNE  prices.  Will 


 that  create  more  situations  in  which  a  competitive  LEC  will  choose  to  build  its  own  facilities,  rather  than  lease  from  the  incumbent  LEC?  What  is  the  consequence  of  such  an  approach  in 
 situations  where  it  is  not  economically  feasible  for  a  competitive  LEC  to  build  its  own  facilities?  In  assessing  the  potential  impact  on  UNE  rates  of  a  change  in  network  assumptions,  we  note  that 
 any  move  away  from  the  Commissions  current  assumptions  about  competition  and  technology  affects  other  aspects  of  the  rate  calculation.  For  example,  the  cost  of  capital  might  be  lower 
 under  a  regime  that  looked  at  an  incumbent  LECs  existing  network,  rather  than  the  most  efficient  network  available  today,  because  keeping  existing  facilities  might  be  less  risky  than 
 investing  in  new  facilities.  105  We  ask  parties  that  favor  a  change  in  network  assumptions  to  identify  how  such  a  change  would  affect  each  component  of  the  pricing  rules  (e.  g.,  operating 
 expenses,  cost  of  capital,  depreciation). 
 60.  We  ask  parties  to  discuss  whether  a  regime  focused  more  closely  on  the  existing  network  of  an  incumbent  LEC  would  be  easier  for  state  commissions  to  implement  than  the 


 current  TELRIC  regime.  The  results  produced  under  the  current  TELRIC  rules  depend  in  large  part  on  the  assumptions  made  by  the  regulator  with  respect  to  the  level  of  competition  and  the 
 spread  of  new  technology.  Even  if  the  current  approach  is  correct  as  a  matter  of  economic  theory,  the  resulting  decisions  are  predictive,  and  reliance  on  these  assumptions  may  increase  the 
 likelihood  of  error.  Would  an  approach  based  on  real-  world  attributes  of  an  incumbent  LECs  network  eliminate  much  of  the  speculation  that  now  takes  place  within  the  context  of  a  UNE 
 pricing  proceeding?  Are  there  benefits  to  a  scorched  node  approach  that  outweigh  the  potential  for  error?  For  example,  we  note  that  any  move  toward  a  version  of  forward-  looking 
 cost  that  places  greater  reliance  on  the  attributes  of  an  incumbent  LECs  existing  network  raises  issues  of  transparency  and  verifiability.  Unlike  most  ratesetting  regimes  that  rely  on  contested 
 proceedings,  the  Commissions  TELRIC  rules  put  the  parties  to  a  pricing  dispute  on  relatively 
 104  As  noted  by  the  Supreme  Court,  the  price-  cap  scheme  starts  with  rates  generated  by  the  conventional  cost-  of-service 
 formula.  Id.  at  487.  The  court  also  stated  that  price  caps  do  not  eliminate  gamesmanship,  but  they  do  give  companies  an  incentive  to  improve  productivity  to  the  maximum  extent  possible.    Id.  (quoting  Policy  and 


 Rules  Concerning  Rates  for  Dominant  Carriers,  CC  Docket  No.  87-  313,  Second  Report  and  Order,  5  FCC  Rcd  6786,  6787-  88,  paras.  7-  9  (1990)). 


 105  Triennial  Review  Order  at  paras.  680-  82. 
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 equal  footing  because  information  on  the  current  cost  of  current  technology  is  not  solely  under  the  control  of  the  incumbent  LEC.  106  In  contrast,  an  approach  that  relies  more  heavily  on 
 information  regarding  the  incumbents  existing  network  or  planned  upgrades  could  give  the  incumbent  a  significant  advantage  in  a  rate  proceeding.  We  seek  comment  on  whether  focusing 
 the  cost  inquiry  on  an  incumbents  existing  network  might  place  competitive  LECs  at  an  informational  disadvantage  in  litigating  any  factual  issues  about  which  the  incumbent  LEC,  as 
 owner  of  that  network,  may  have  better  information. 
 61.  We  welcome  proposals  for  concrete  procedural  safeguards  designed  to  minimize  risks  of  an  informational  imbalance  resulting  from  the  methodological  reforms  discussed  in  this 


 NPRM.  For  example,  states  might  require  that  the  parties  engage  in  a  limited  discovery  period  before  submitting  their  cost  proposals,  to  ensure  that  both  the  incumbents  and  competitors  are 
 working  from  the  same  data.  At  the  same  time,  we  seek  comment  on  ways  in  which  UNE  pricing  proceedings,  which  often  last  for  years  under  our  current  rules,  can  be  streamlined 
 without  placing  any  party  at  a  material  informational  disadvantage.  For  example,  can  and  should  we  provide  guidance  to  the  states  as  to  the  appropriate  topics  of  discovery  for  particular 
 categories  of  cost  disputes?  Can  and  should  we  obviate  the  need  for  excessive  discovery  by  identifying,  whenever  possible,  objective  sources  of  inputs  to  be  used  in  calculating  TELRIC 
 rates?  If  so,  what  should  those  sources  be?  Are  there  other  procedural  requirements  that  we  could  establish  that  might  facilitate  resolution  of  UNE  pricing  proceedings? 


 2.  Specific  Network  Inputs 
 62.  In  addition  to  our  tentative  conclusion  that  a  forward-  looking  pricing  methodology  should  more  closely  account  for  the  real-  world  attributes  of  the  routing  and 


 topography  of  an  incumbent  LECs  network,  we  believe  there  are  a  number  of  aspects  of  the  current  efficient  network  assumption  that  might  benefit  from  clarification  or  modification.  We 
 discuss  some  of  these  issues  below,  and  we  encourage  parties  to  identify  additional  steps  we  might  take  to  produce  prices  that  satisfy  the  objectives  that  we  have  identified. 


 a.  Network  Routing  and  Construction 
 63.  To  establish  prices  based  on  forward-  looking  costs,  states  must  make  assumptions  about  how  a  network  will  be  routed  and  what  construction  techniques  will  be  used  in  building  it. 


 We  seek  comment  on  the  network  routing  assumptions  that  would  be  consistent  with  our  tentative  conclusion  that  prices  should  account  for  the  real-  world  attributes  of  the  routing  and 
 topography  of  an  incumbent  LECs  network.  Specifically,  how  critical  are  the  locations  of  existing  rights-  of-  way,  existing  poles,  and  existing  conduit  (all  of  which  are  located  on  existing 
 roads  and  routed  around  existing  natural  obstacles)  for  all  wireline  carriers  (incumbents  and  new  entrants)  when  new  facilities  are  built?  Is  there  any  theoretical  basis  for  an  approach  that  does 
 not  assume  the  existence  of  existing  roads,  buildings,  and  natural  obstacles? 
 64.  Regardless  of  whether  we  adopt  our  tentative  conclusion,  should  we  modify  the  scorched  node  theory  and  adopt  routing  assumptions  more  closely  tied  to  an  incumbent  LECs 


 106  See  Verizon  v.  FCC,  535  U.  S.  at  522. 
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 existing  network?  One  approach,  for  example,  might  be  to  extend  the  assumption  of  existing  switch  locations  to  other  parts  of  the  network  (e.  g.,  existing  feeder  routes,  existing  remote 
 terminal  locations).  Another  approach  might  be  to  require  that  states  assume  that  the  network  is  built  along  existing  rights-  of-  way,  and  that  those  rights-  of-  way  are  in  their  current  condition 
 (e.  g.,  paved  or  unpaved).  Parties  supporting  this  approach  should  explain  how  states  can  best  determine  current  right-  of-  way  routes,  whether  a  standard  based  on  existing  rights-  of-  way 
 provides  parties  other  than  the  incumbent  LEC  an  opportunity  to  participate  effectively,  and  how  such  routes  can  be  compared  to  the  routes  of  incumbent  LECs  and  the  routes  generated  by 
 computer  cost  models. 
 65.  We  seek  comment  on  other  principles  we  could  apply  in  deciding  on  the  appropriate  network  routing  and  construction  techniques  for  costing  purposes.  Parties  should 


 explain  how  their  proposed  network  principles  reflect  the  variables  that  incumbent  and  competitive  LECs  consider  in  making  routing  and  construction  decisions.  To  the  extent  parties 
 propose  principles  based  on  the  real-  world  attributes  of  an  incumbent  LECs  existing  network,  they  should  explain  in  detail  how  a  state  commission  would  establish  the  forward-  looking  cost  of 
 an  existing  network,  and  how  such  a  costing  approach  differs  from  rate-  of-  return  or  other  rate-based  methodologies  that  are  prohibited  under  section  252(  d)(  1).  We  note  that,  in  the  USF 
 Platform  Order,  the  Commission  declined  to  verify  the  Synthesis  Models  outside  plant  design  parameters  by  comparing  them  to  incumbent  LEC  outside  plant  on  the  ground  that  incumbent 
 LEC  networks  may  not  represent  the  least-  cost,  most-  efficient  design  in  some  cases.  107  We  invite  parties  to  discuss  the  applicability  of  this  conclusion,  if  any,  in  the  context  of  UNE  pricing. 


 66.  Under  our  current  TELRIC  rules,  the  rates  established  in  a  state  pricing  proceeding  depend  significantly  on  the  computer  cost  model  adopted  by  the  state  commission. 
 We  ask  parties  to  comment  on  whether,  and  how,  our  tentative  conclusion  to  account  more  closely  for  the  real-  world  routing  and  topography  of  an  incumbents  network  would  affect  the 
 ability  of  carriers  to  use  computer  cost  models.  Is  it  more  difficult  to  model  an  existing  network  than  a  hypothetical  one?  We  invite  state  commissions  to  comment  on  whether  they  have  adopted 
 cost  models  that  are  capable  of  reflecting  existing  network  routing. 
 b.  Technology 
 67.  Our  current  rules  require  states  to  assume  that  the  most  efficient  telecommunications  technology  currently  available  is  used  throughout  the  network.  108  The 


 Commission  concluded  in  the  Local  Competition  Order  that  the  forward-  looking  pricing  methodology  for  interconnection  and  UNEs  should  be  based  on  a  reconstructed  local  network 
 [that]  will  employ  the  most  efficient  technology  for  reasonably  foreseeable  capacity  requirements.  109  At  the  same  time,  the  Commission  recognized  a  need  for  basing  prices  on 


 107  USF  Platform  Order,  13  FCC  Rcd  at  21349-  50,  para.  66. 
 108  47  C.  F.  R.    51.  505(  b)(  1). 
 109  Local  Competition  Order,  11  FCC  Rcd  at  15848-  49,  para.  685. 
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 efficient,  new  technology  that  is  compatible  with  the  existing  infrastructure.  110 
 68.  As  noted  above,  it  is  unlikely  that  any  carrier,  no  matter  how  competitive  the  marketplace,  would  deploy  new  technology  instantaneously  and  ubiquitously  throughout  its 


 network.  Even  if  the  objective  is  to  replicate  the  results  of  a  competitive  market,  an  approach  that  reconstructs  the  network  over  time  seems  to  be  more  appropriate  than  one  that  assumes  the 
 instantaneous  deployment  of  100  percent  new  technology. 
 69.  We  seek  comment  on  how  our  tentative  conclusion  above  affects  the  technology  assumptions  used  to  develop  UNE  prices.  Of  what  relevance  is  the  Commissions  statement  in 


 the  universal  service  context  that  [  e]  xisting  incumbent  LEC  plant  is  not  likely  to  reflect  forward-  looking  technology  or  design  choices?  111  How  should  a  state  commission  determine 
 the  price  for  equipment  in  the  incumbent  LEC  network  that  no  longer  is  widely  used  in  the  industry,  such  as  analog  switches  or  older  versions  of  digital  loops  carrier  systems?  How  does 
 an  approach  that  replicates  an  incumbent  LECs  existing  technology  compare  to  a  reproduction  cost  methodology?  112 


 70.  We  encourage  parties  to  identify  the  specific  factors  that  influence  their  decisions  with  respect  to  how  quickly  to  deploy  new  technology.  How,  if  at  all,  should  we  factor  in  the 
 uncertainty  associated  with  the  timing  and  efficiency  of  new  technology?  Of  what  relevance,  if  any,  is  the  pace  at  which  incumbent  LECs  have  deployed  new  technologies  in  the  past  (e.  g., 
 digital  switches)?  If  our  goal  is  to  replicate  the  results  of  a  competitive  market,  is  there  evidence  as  to  the  diffusion  rates  of  new  technology  in  competitive  markets  as  opposed  to  monopoly 
 markets  that  might  inform  our  analysis?  113 
 c.  Structure  Sharing 
 71.  Structure  sharing  refers  to  how  much  of  the  cost  of  installing  poles,  digging  trenches,  and  placing  conduit  would  be  shared  on  a  forward-  looking  basis  by  the  incumbent  LEC 


 with  other  entities,  such  as  power  companies,  cable  operators,  or  other  telecommunications  carriers.  The  more  sharing  that  is  assumed,  the  lower  the  cost  to  the  incumbent  LEC  of 


 110  Id. 
 111  USF  Platform  Order,  13  FCC  Rcd  at  21336,  para.  30. 
 112  Under  a  reproduction  cost  methodology,  the  regulator  takes  the  incumbents  existing  network  as  given  and  then 
 estimates  what  it  would  cost  to  replace  the  existing  network  with  new  facilities  that  are  identical  to  the  existing  facilities.  See,  e.  g.,  KAHN  at  109-  116.  Thus,  if  the  existing  network  contained  an  analog  switch,  under  the 


 reproduction  cost  approach,  the  regulator  would  try  to  determine  what  it  would  cost  today  to  purchase  a  brand  new  analog  switch.  This  approach  generally  has  been  discredited.  As  Justice  Brandeis  recognized  nearly  eighty  years 
 ago,  [  i]  f  the  aim  were  to  ascertain  the  value  (in  its  ordinary  sense)  of  the  utility  property,  the  enquiry  would  be,  not  what  it  would  cost  to  reproduce  identical  property,  but  what  it  would  cost  to  establish  a  plant  which  could  render  the 
 service,  or  in  other  words,  at  what  cost  could  an  equally  efficient  substitute  be  then  produced.  Missouri  ex  rel.  S.  W.  Bell  Tel.  Co.  v.  Public  Serv.  Commn,  262  U.  S.  276,  312  (1923)  (Brandeis,  J.  dissenting). 


 113  See,  e.  g.,  Shelanski,  Competition  and  Deployment  of  New  Technology  in  U.  S.  Telecommunications,  2000  U. 
 Chi.  Legal  F.  85,  115  (  When  deployment  times  and  market  structures  are  matched,  faster  deployment  times  correlate  with  more  competitive  markets.  .  .  .  [A]  verage  deployment  times  speed  up  as  markets  become  more 


 competitive.). 
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 providing  the  element.  The  Local  Competition  Order  provides  no  guidance  on  this  practical  issue.  114  Structure  sharing  has  been  a  consistently  difficult  issue  for  state  commissions  to  resolve, 
 particularly  with  respect  to  buried  and  underground  plant.  115  The  difficulty  arises  from  confusion  over  the  appropriate  assumptions  to  make  about  construction  by  entities  other  than  the  incumbent 
 LEC  under  TELRICs  scorched  node  construct. 
 72.  We  ask  parties  to  offer  suggestions  on  how  the  Commission  might  provide  guidance  to  state  commissions  on  the  method  for  establishing  structure  sharing  percentages, 


 particularly  in  light  of  our  tentative  conclusion  that  the  pricing  methodology  should  account  for  real-  world  attributes  of  the  routing  and  topography  of  an  incumbent  LECs  network.  Is  it 
 appropriate  to  consider  sharing  opportunities  that  were  available  at  the  time  the  plant  was  built,  as  the  Commission  suggested  in  the  USF  Inputs  Order?  116  How  relevant  are  an  incumbent  LECs 
 actual  sharing  percentages?  Are  they  dispositive?  If  the  incumbent  LECs  actual  data  are  not  dispositive,  what  other  sources  of  data  should  be  used  in  developing  structure  sharing  inputs? 
 Are  there  factors  that  either  encourage  or  discourage  parties  from  sharing  construction  costs  today  (e.  g.,  municipal  ordinances  requiring  joint  construction)?  If  so,  how  should  these  factors 
 be  reflected  in  the  sharing  percentages  used  to  calculate  UNE  prices?  Parties  should  provide  empirical  data  with  respect  to  their  experiences  sharing  construction  costs  with  other  entities. 


 d.  Fill  Factors 
 73.  A  fill  factor  represents  the  percentage  of  the  capacity  of  a  particular  facility  or  piece  of  equipment  that  is  used  on  average  over  its  life.  Increasing  fill  factors  has  the  effect  of 


 lowering  costs  by  reducing  the  amount  of  spare  capacity  that  must  be  allocated  to  working  units.  For  example,  if  the  investment  in  loop  plant  is  $1  million  and  there  are  1000  total  loops,  the 
 investment  per  working  loop  would  be  $2000  if  the  fill  factor  were  50  percent,  but  only  $1429  per  loop  with  a  70  percent  fill  factor.  The  Local  Competition  Order  provides  no  guidance  to 
 state  commissions  on  this  specific  issue  beyond  the  general  requirement  that  the  network  should  be  sized  to  meet  reasonably  foreseeable  demand.  117  In  the  USF  Inputs  Order,  the  Commission 


 114  The  Commission  addressed  the  issue  of  structure  sharing  percentages  in  the  universal  service  proceeding.  It 
 adopted  percentages  that  varied  by  type  of  structure  (aerial,  buried,  or  underground)  and  line  density.  Parties  generally  agreed  that  sharing  occurs  more  frequently  with  aerial  structure  and  in  higher  density  zones,  although  they 


 disagreed  on  the  extent  of  sharing.  The  Commission  explained  that  its  determination  of  structure  sharing  percentages  requires  a  degree  of  predictive  judgment.  It  stated  that  a  forward-  looking  mechanism  must  estimate 
 the  structure  sharing  opportunities  available  to  a  carrier  operating  in  the  most-  efficient  manner,  and  that  the  forward-  looking  practice  of  a  carrier  does  not  necessarily  equate  to  the  historical  practice  of  the  carrier.  USF 
 Inputs  Order,  14  FCC  Rcd  at  20262,  para.  247.  Parties  in  that  proceeding  did  not  submit  accurate  and  verifiable  data  with  respect  to  existing  sharing  percentages,  but  even  if  they  had  the  Commission  said  that  it  would  have 
 needed  to  decide  whether  or  not  those  existing  percentages  were  appropriate  starting  points  for  determining  input  values.  Id.  at  20262,  para.  245.  Given  the  divergence  of  opinion  on  the  extent  of  structure  sharing  opportunities  in 
 the  future,  the  Commission  expressly  anticipated  revisiting  this  issue  at  a  later  date.  Id. 
 115  Sharing  of  pole  space  among  utilities  is  a  well-  established  practice  that  has  been  subject  to  regulation  under 
 section  224  since  before  the  1996  Act. 
 116  USF  Inputs  Order,  14  FCC  Rcd  at  20261,  para.  244  n.  504. 


 117  Local  Competition  Order,  11  FCC  Rcd  at  15847,  para.  682.  We  note  that  competitive  LECs  raised  issues 
 related  to  fill  factors  in  limited  instances  during  section  271  proceedings  before  the  Commission.  In  one  case,  the 
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 established  forward-  looking  fill  factors  based  on  current  demand,  which  it  defined  to  include  excess  capacity  for  short-  term  growth,  rather  than  on  ultimate  demand,  which  it  found  to  be  too 
 speculative.  118 
 74.  We  seek  comment  on  appropriate  guidelines  for  states  to  follow  in  establishing  fill  factors.  What  factors  do  states  currently  consider  in  developing  fill  factors?  How  relevant 


 are  an  incumbent  LECs  existing  fill  factors  in  establishing  forward-  looking  costs?  Should  they  be  dispositive  given  our  tentative  conclusion  to  more  closely  account  for  the  real-  world  attributes 
 of  the  routing  and  topography  of  an  incumbent  LECs  network?  If  an  incumbent  LECs  existing  fill  factors  are  not  dispositive,  what  other  evidence  should  a  state  commission  consider?  Would 
 it  be  relevant  if  competitors  routinely  operated  facilities  at  a  higher  or  lower  fill?  Should  state  commissions  consider  carrier  of  last  resort  obligations  in  deciding  on  the  appropriate  fill 
 factor?  Would  the  fill  factors  of  other  incumbent  LECs  be  relevant  to  demonstrate  achievable  efficiencies? 


 75.  Would  we  expect  carriers  to  operate  at  higher  or  lower  fill  factors  as  the  level  of  facilities-  based  competition  increases  in  a  market?  Is  there  empirical  evidence  that  distinguishes 
 between  the  fill  factors  that  carriers  experience  in  competitive  markets  and  monopoly  markets?  Would  carriers  in  competitive  markets  be  expected  to  reduce  prices  in  order  to  increase  fill? 
 How  are  fill  factors  likely  to  vary  as  the  rate  of  demand  growth  varies?  Finally,  we  seek  comment  on  methods  for  quantifying  dynamically  efficient  fill  factors  on  a  forward-  looking 
 basis. 
 e.  Switch  Discounts 
 76.  An  issue  that  has  arisen  in  numerous  section  271  proceedings  is  whether  to  base  unbundled  switching  prices  on  payments  that  the  incumbent  LEC  makes  to  the  vendor  for:  (1) 


 an  entirely  new  (or  replacement)  switch;  (2)  growth  equipment,  such  as  line  or  trunk  termination  equipment,  added  to  the  existing  switch  to  increase  capacity  and  satisfy  growing  demand; 
 (3)  technology  upgrades  to  existing  equipment,  such  as  the  processor,  to  increase  speed  and  capacity  that  make  new  features  and  services  possible;  or  (4)  some  combination  of  these.  This 
 issue  arises  because  switch  manufacturers  typically  offer  a  relatively  large  price  discount  for  an  entirely  new  switch  and  a  smaller  discount  on  growth  or  upgrade  equipment  added  to  an  existing 
 switch. 
 77.  The  Commission  has  found  that  state  commissions  in  setting  UNE  rates  may  take  into  account  that  there  will  be  growth  in  a  network  in  the  future  and  that  it  may  not  be  cost-effective 


 to  acquire  all  of  the  projected  switching  capacity  needed  over  the  life  of  the  switch  at 


 Commission  concluded  that  a  fill  factor  of  30  percent  for  distribution  cable  in  Oklahoma  was  too  low  and  violated  TELRIC  principles  because  it  assumed  that  too  much  of  the  capacity  would  be  idle  for  an  indefinite  time,  contrary  to 
 TELRICs  presumption  of  an  efficient  network.  SWBT  Kansas/  Oklahoma  271  Order,  16  FCC  Rcd  at  6275-  76,  para.  80. 


 118  USF  Inputs  Order,  14  FCC  Rcd  at  20243-  44,  para.  199  ([  T]  he  fact  that  the  industry  may  build  distribution 
 plant  sufficient  to  meet  demand  for  ten  or  twenty  years  does  not  necessarily  suggest  that  these  costs  should  be  supported  by  the  federal  universal  service  support  mechanism.). 
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 the  outset.  119  The  Commission,  therefore,  has  rejected  an  assumption  that  the  appropriate  switching  discount  for  TELRIC  pricing  purposes  must  be  based  on  a  purchase  of  100  percent 
 new  switches.  120  The  Commission  recognized  that  certain  vendors  provide  a  greater  discount  for  new  switches  and  a  smaller  discount  for  growth  additions,  and  that  the  large  initial  discount  is 
 available  only  when  an  overall  purchase  of  both  new  and  growth  equipment  is  planned.  Cost  models  may  in  a  forward-  looking  manner  take  into  account  specific  new  and  growth  discounts 
 that  carriers  receive  in  contracts  with  vendors  and,  accordingly,  may  reflect  a  reasonable  combination  of  new  and  growth  switch  deployment.  121 


 78.  Because  switching  equipment  has  a  high  degree  of  modularity,  carriers  over  time  grow  their  switches  and  upgrade  them  with  new  technology  as  it  evolves  on  the  premise  that  this 
 is  a  better  way  to  minimize  costs  than  purchasing  a  switch  large  enough  to  satisfy  anticipated  demand  over  the  entire  life  of  the  switch.  We  seek  comment  on  whether  unbundled  switching 
 costs  should  be  based  on  the  prices  that  an  efficient  incumbent  LEC  or  other  entrant  would  pay  for  switching  equipment  over  the  life  of  the  switch  and  not  at  a  particular  point  in  the  switchs 
 life  cycle,  e.  g.,  not  at  the  beginning  of  the  life  cycle  when  the  carrier  is  paying  vendors  for  a  new  switch,  nor  at  the  end  of  the  switchs  life  when  a  carrier  is  paying  vendors  primarily  for  growth 
 additions  or  technology  upgrades  to  the  switch.  In  addressing  this  question,  parties  also  should  explain  what  assumptions  they  make  with  respect  to  line  demand  and  technology  improvements. 
 Is  it  reasonable  to  assume  that  switched  access  line  demand  will  grow?  Is  it  reasonable  to  assume  continued  improvement  in  switching  technology?  What  assumptions  have  state 
 commissions  made  with  respect  to  vendor  discounts?  Parties  also  should  explain  their  assumptions  regarding  vendor  pricing  strategies,  and  the  basis  for  those  assumptions. 


 79.  The  basic  formula  for  developing  a  price  for  an  element  is  to  divide  total  cost  by  total  demand.  In  the  case  of  switching,  does  the  total  cost  consist  of  a  new  switch  reflecting  a 
 relatively  large  vendor  discount  plus  growth  and  upgrade  equipment  reflecting  relatively  small  discounts?  Should  this  cost  then  be  spread  over  total  demand  consisting  of  all  the  lines  served  by 
 the  new,  growth,  and  upgraded  equipment  over  the  switchs  life?  We  ask  for  comment  on  the  use  of  this  principle  in  developing  a  price  that  is  based  on  costs  of  equipment  installed  in 
 increments  over  the  life  of  the  switch.  Parties  also  should  explain  whether,  and  how,  these  calculations  should  account  for  the  time  value  of  money.  Should  the  future  costs  associated  with 
 growth  and  upgrade  equipment  be  discounted  to  their  present  value?  Should  the  same  treatment  apply  to  additional  future  demand  associated  with  that  equipment?  Is  the  appropriate  discount 


 119  Application  by  Verizon  New  Jersey  Inc.,  Bell  Atlantic  Communications,  Inc.  (d/  b/  a  Verizon  Long  Distance) 
 NYNEX  Long  Distance  Company  (d/  b/  a  Verizon  Enterprise  Solutions),  Verizon  Global  Networks  Inc.,  and  Verizon  Select  Services  Inc.,  for  Authorization  to  Provide  In-  Region,  InterLATA  Services  in  New  Jersey,  WC  Docket  No.  02- 


 67,  Memorandum  Opinion  and  Order,  17  FCC  Rcd  12275,  12293,  para.  43  (2002)  (Verizon  New  Jersey  271  Order). 
 120  Verizon  New  Jersey  271  Order,  17  FCC  Rcd  at  12293,  para.  43. 


 121  Joint  Application  by  BellSouth  Corporation,  BellSouth  Telecommunications,  Inc.,  and  BellSouth  Long  Distance, 
 Inc  for  Provision  of  In-  Region,  InterLATA  Services  in  Georgia  and  Louisiana,  CC  Docket  No.  02-  35,  Memorandum  Opinion  and  Order,  17  FCC  Rcd  9018,  9059-  60,  para.  82  (2002).  Similarly,  although  we  recognize  that  an  efficient 


 competitor  might  anticipate  some  growth  additions  over  the  long  run,  the  Commission  has  found  that  rates  based  on  an  assumption  of  100  percent  growth  additions  and  no  new  switches  do  not  comply  with  TELRIC  principles. 
 Verizon  Rhode  Island  271  Order,  17  FCC  Rcd  at  3318,  para.  34. 
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 rate  the  cost  of  capital  used  in  calculating  UNE  prices  generally? 
 80.  Assuming  that  unbundled  switching  prices  should  reflect  vendor  prices  for  switch  equipment  that  is  installed  in  increments  over  the  life  of  the  switch  (not  the  price  that  the  carrier 


 pays  for  equipment  at  any  one  point  in  the  life  cycle  of  the  switch),  we  seek  comment  on  whether  the  starting  point  for  calculating  costs  should  be  a  new  switch  that  is  installed  today.  We  also 
 seek  comment  on  whether  unbundled  switching  prices  should  reflect,  in  addition  to  costs  for  the  initial  switch  equipment,  costs  of  growth  additions  and  technology  upgrades,  growth  additions 
 alone,  or  upgrades  alone  for  the  years  following  the  initial  installation.  Commenters  that  believe  current  prices  should  recover  costs  of  future  upgrades  should  explain  why  current  competitive 
 LECs  should  pay  for  benefits  that  they  do  not  yet  receive.  In  light  of  our  conclusion  that  UNE  pricing  should  continue  to  be  based  on  a  forward-  looking  methodology,  we  ask  commenters  to 
 describe  in  detail  any  rationale  for  supporting  or  rejecting  UNE  prices  based  on  vendor  prices  that  incumbent  LECs  currently  pay  for  equipment  they  are  installing  today  in  existing  switches, 
 i.  e.,  vendor  prices  for  growth  additions  and  technology  upgrades  made  at  a  particular  point  in  the  life  cycle  of  an  existing  switch. 


 81.  We  ask  parties  to  explain  in  detail  the  methodology  that  should  be  used  to  develop  total  cost  and  total  demand  under  this  approach.  We  also  invite  parties  to  submit  studies 
 showing  how  to  develop  an  unbundled  switching  price.  These  studies  should  assume  that  service  is  provided  using  modern  digital  switches  that  are  installed  today.  We  ask  that  commenters 
 develop  this  price  for  either  an  incumbent  LECs  study  area  or  a  UNE  zone  within  a  study  area.  One  study  should  develop  the  costs  of  initial  new  equipment  and  all  future  growth  equipment 
 that  is  expected  to  be  installed  periodically  over  the  life  of  the  switch.  A  second  study  should  develop  costs  for  these  two  components  plus  costs  of  all  future  technology  upgrade  equipment 
 that  is  expected  to  be  installed  periodically  over  the  life  of  the  switch.  Parties  should  explain  and  fully  document  the  methodology,  assumptions,  and  data  they  use  to  estimate  these  costs  and  the 
 demand  over  which  these  costs  are  spread.  122  If  a  commenter  believes  UNE  prices  should  be  based  on  a  switch  technology  other  than  digital  technology,  that  party  may  submit  other  studies 
 in  addition  to,  rather  than  in  place  of,  the  studies  requested  above. 
 C.  Cost  of  Capital 
 82.  In  the  Local  Competition  Order,  the  Commission  stated  that  the  currently  authorized  rate  of  return  at  the  federal  or  state  level  is  a  reasonable  starting  point  in  determining 


 the  cost  of  capital  and  that  incumbent  LECs  bear  the  burden  of  demonstrating  with  specificity  that  the  business  risks  that  they  face  providing  unbundled  network  elements  and  interconnection 


 122  At  a  minimum,  commenters  should  document  the  following  assumptions:  (1)  switched  access  line  annual  rate 
 of  growth,  (2)  switched  access  minutes  of  use  annual  rate  of  growth,  (3)  annual  rate  of  growth  of  busy  hour  minutes  of  use  per  switched  access  line,  (4)  how  frequently  growth  equipment  is  added  to  the  switch  to  satisfy  growing 


 demand,  e.  g.,  yearly,  every  two  years,  etc.,  (5)  how  frequently  technology  upgrade  equipment  is  added,  (6)  expected  useful  life  of  a  switch  installed  today,  (7)  cost  of  capital  used  to  calculate  the  present  value  of  all  current  and  future 
 costs  and  all  current  and  future  demand,  and  (8)  how  frequently  the  central  processor,  switch  memory  and  other  getting  started  equipment  are  entirely  replaced  with  new  equipment,  or  augmented  by  adding  equipment,  to 
 increase  capacity  for  satisfying  growing  demand  or  providing  advanced  features  and  services.  The  getting  started  cost  of  the  switch,  also  known  as  the  first  cost,  is  for  the  central  processor,  memory,  maintenance,  administrative, 
 test,  spare  and  other  common  equipment. 
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 services  would  justify  a  different  risk-  adjusted  cost  of  capital  or  depreciation  rate.  123  The  Commission  noted  that  11.25  percent  was  the  currently  authorized  rate  of  return  at  the  federal 
 level,  but  it  held  that  states  may  adjust  the  cost  of  capital  if  a  party  demonstrates  to  a  state  commission  that  either  a  higher  or  lower  level  of  cost  of  capital  is  warranted.  124 


 83.  In  the  Triennial  Review  Order,  the  Commission  clarified  that  a  TELRIC-  based  cost  of  capital  should  reflect  the  risks  of  a  competitive  market.  125  Because  the  objective  of 
 TELRIC  is  to  establish  a  price  that  replicates  the  price  that  would  exist  in  a  market  in  which  there  is  facilities-  based  competition,  the  Commission  held  that  TELRIC  prices  should  reflect  the 
 risk  of  losing  customers  to  other  facilities-  based  carriers.  126  The  Commission  found  that  calculating  rates  based  on  an  assumption  of  a  forward-  looking  network  that  uses  the  most 
 efficient  technology  (i.  e.,  the  network  that  would  be  deployed  in  a  competitive  market),  without  also  compensating  for  the  risks  associated  with  investment  in  such  a  network,  would  reduce 
 artificially  the  value  of  the  incumbent  LEC  network  and  send  improper  pricing  signals  to  competitors.  127  The  Commission  stated  that  establishing  UNE  prices  based  on  an  unreasonably 
 low  cost  of  capital  would  discourage  competitive  LECs  from  investing  in  their  own  facilities  and  thus  slow  the  development  of  facilities-  based  competition. 


 84.  As  noted  above,  the  importance  of  this  clarification  was  to  confirm  that  state  commissions  must  use  a  consistent  set  of  assumptions  when  they  calculate  the  three  components 
 of  rates  (operating  expenses,  cost  of  capital,  and  depreciation  expense).  128  That  is,  if  the  network  assumptions  are  based  on  projections  about  what  a  network  would  look  like  in  the  long-  run 
 assuming  facilities-  based  competition,  the  same  approach  should  be  followed  in  developing  the  cost  of  capital.  We  invite  parties  to  comment  on  whether  this  principle  should  apply  even  if  the 
 Commission  adopts  a  UNE  pricing  methodology  that  is  tied  more  closely  to  the  existing  network  of  an  incumbent  LEC.  If  we  ultimately  were  to  find  that  state  commissions  should  consider  an 
 incumbent  LECs  existing  network  in  calculating  the  investment  in  the  network,  should  they  also  calculate  cost  of  capital  based  on  the  existing  competitive  risk  associated  with  that  network? 


 85.  We  ask  parties  to  identify  the  specific  variables  that  determine  the  cost  of  capital  under  the  network  assumptions  that  they  advocate,  and  to  offer  suggestions  as  to  how  to  quantify 
 the  various  components  of  risk  that  should  be  reflected  in  a  companys  cost  of  capital.  What  are  the  theoretical  arguments  that  support  the  use  of  these  variables?  Is  there  empirical  evidence 
 regarding  the  effect  each  variable  has  on  a  carriers  cost  of  capital?  How  should  the  cost  of  debt  and  cost  of  equity  be  weighted?  How  should  states  determine  the  appropriate  capital  structure? 
 Is  incremental  investment  typically  funded  through  debt  or  equity?  Should  the  cost  of  capital 


 123  Local  Competition  Order,  11  FCC  Rcd  at  15856,  para.  702. 
 124  Id. 
 125  Triennial  Review  Order  at  paras.  680-  84. 
 126  Id.  at  para.  680. 
 127  Id.  at  paras.  680-  82. 
 128  Id.  at  paras.  682,  689. 
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 reflect  this? 
 86.  In  the  Triennial  Review  Order,  we  recognized  that  one  important  risk  factor  to  consider  is  the  risk  of  losing  customers  to  facilities-  based  competitors.  How  should  this  risk  be 


 measured?  What  is  the  relationship  between  this  risk  and  the  network  assumptions  that  we  adopt?  Is  it  always  the  case  that  supplying  a  given  product  or  service  in  a  fully  competitive 
 market  is  more  risky  than  supplying  the  same  product  or  service  in  a  market  in  transition  from  monopoly  to  competition?  We  also  ask  parties  to  address  the  role  of  fixed  and  sunk  costs, 
 assumptions  about  the  level  and  kind  of  competition,  and  entry  strategies  of  competitors  in  affecting  risk  and  cost  of  capital  of  incumbent  carriers. 


 87.  We  ask  parties  to  comment  on  the  relationship,  if  any,  between  our  unbundling  rules  and  the  risk  of  stranded  investment.  The  Local  Competition  Order  suggested  that  the 
 availability  of  long-  term  contracts  presented  one  mechanism  by  which  incumbent  LECs  might  reduce  the  risk  of  stranded  investment.  129  We  ask  parties  to  discuss  whether  long-  term  contracts 
 have  been  used  in  the  provision  of  UNEs.  If  they  have  not,  why  not?  Does  the  process  of  setting  prices  at  forward-  looking  costs  in  an  industry  in  which  costs  generally  are  decreasing,  and 
 revising  these  prices  periodically,  discourage  entry  into  long-  term  contracts?  How,  if  at  all,  should  any  increased  risk  of  stranded  investment  due  to  the  use  of  month-  to-  month  contracts  be 
 considered  in  calculating  the  cost  of  capital?  How  can  this  risk  be  quantified?  Does  the  use  of  economic  depreciation  eliminate  the  need  to  compensate  separately  an  incumbent  LEC  for  any 
 additional  risk  of  stranded  investment? 
 88.  We  also  ask  parties  to  comment  on  ways  in  which  the  Commission  might  simplify  the  task  of  setting  the  cost  of  capital.  For  example,  if  we  retain  our  current  rules,  and  the  cost  of 


 capital  is  intended  to  reflect  the  risk  of  participating  in  a  market  with  facilities-  based  competition,  is  there  any  reason  that  the  cost  of  capital  would  vary  among  different  states,  or 
 among  different  companies?  If  not,  would  it  be  appropriate  for  the  Commission  to  establish  a  particular  cost  of  capital  for  states  to  employ?  If  we  move  to  a  pricing  regime  that  looks  more 
 closely  at  the  incumbent  LECs  actual  network,  are  there  any  presumptions  we  could  establish  to  facilitate  selection  of  a  cost  of  capital?  We  ask  parties  to  provide  studies  in  support  of  their 
 proposals.  Regardless  of  our  network  assumptions,  are  there  particular  models  for  projecting  cost  of  capital  that  clearly  should  or  should  not  be  used?  Are  there  particular  data  sources  that 
 should  or  should  not  be  given  deference?  We  ask  parties  to  identify  proxy  companies  or  industries  for  use  in  estimating  the  UNE  cost  of  capital  and  to  explain  in  detail  why  they  believe 
 the  identified  proxies  are  appropriate.  130 
 89.  In  the  Triennial  Review  Order,  the  Commission  also  clarified  that  a  TELRIC-based  cost  of  capital  should  reflect  any  unique  risks  (above  and  beyond  the  competitive  risks 


 discussed  above)  associated  with  new  services  that  might  be  provided  over  certain  types  of 


 129  Local  Competition  Order,  11  FCC  Rcd  at  15849,  para.  687. 
 130  Because  no  actual  company  is  in  the  business  solely  of  providing  UNEs,  it  is  necessary  to  determine  the  risk 
 associated  with  the  UNE  business  by  using  as  a  proxy  existing  companies  or  industries  that  are  believed  to  have  a  comparable  level  of  risk. 
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 facilities.  131  The  Commission  reiterated  its  finding  from  the  Local  Competition  Order  that  different  UNEs  may  have  different  costs  of  capital  132  and  clarified  that  the  use  of  UNE-  specific 
 costs  of  capital  is  an  acceptable  method  of  reflecting  in  UNE  prices  any  risk  associated  with  new  facilities  that  employ  new  technology  and  offer  new  services.  We  ask  parties  to  comment  on 
 when  it  would  be  appropriate  for  a  state  commission  to  establish  different  costs  of  capital  for  different  UNEs.  What  types  of  risks  would  distinguish  one  element  from  another  with  respect  to 
 cost  of  capital?  Would  such  an  approach  accurately  reflect  how  incumbent  LECs  actually  raise  capital  (i.  e.,  on  an  entity-  wide  as  opposed  to  a  per-  facility  basis)  and,  if  not,  is  this  relevant? 


 90.  Although  states  have  had  the  option  of  establishing  UNE-  specific  costs  of  capital  since  1996,  we  are  not  aware  of  any  states  that  have  followed  this  approach.  We  ask  parties  to 
 comment  on  the  reasons  why  such  an  approach  has  not  been  implemented.  We  are  particularly  interested  in  comments  from  state  commissions  that  have  considered  and  rejected  this  approach. 
 Are  there  steps  the  Commission  could  take  to  facilitate  the  ability  of  states  to  establish  UNE-specific  costs  of  capital?  Do  the  benefits  of  using  a  cost  of  capital  that  more  accurately  reflects 
 the  risk  associated  with  providing  a  particular  UNE  outweigh  the  administrative  burden  of  such  an  approach? 


 91.  We  ask  parties  to  explain  whether  different  proxy  groups  should  be  used  to  estimate  the  cost  of  capital  for  different  UNEs.  If  parties  believe  that  different  proxy  groups 
 should  be  used,  they  should  identify  these  proxy  groups  and  explain  in  detail  why  these  are  appropriate.  An  alternative  approach  would  be  to  estimate  the  cost  of  capital  based  on  a  single 
 proxy  group  and  then  adjust  that  cost  of  capital  according  to  the  relative  risk  of  the  particular  UNE.  Parties  that  favor  such  an  approach  should  explain  in  detail  how  to  make  the  relative  risk 
 adjustments.  Please  also  identify  the  proxy  group  of  companies  used  as  the  starting  point  to  estimate  the  cost  of  capital  and  explain  in  detail  why  this  proxy  group  is  appropriate. 


 D.  Depreciation  Expense 
 92.  Economic  depreciation  is  a  method  of  reflecting  anticipated  declines  in  the  net  present  value  of  an  asset  over  the  course  of  its  useful  life.  If  equipment  prices  are  expected  to 


 decline  over  time,  the  value  of  equipment  currently  in  use  in  the  network  (and  therefore  the  price  under  a  forward-  looking  methodology)  should  decline  over  time  at  the  same  rate.  Calculating 
 the  appropriate  rate  of  price  decline  is  quite  complicated  because  it  is  based  largely  on  projections  about  future  events.  In  UNE  pricing  cases,  however,  the  task  is  made  even  more 
 difficult  by  the  manner  in  which  most  computer  cost  models  calculate  prices.  Specifically,  most  models  include  a  levelization  function  that  imposes  a  constant  price  schedule  over  the  life  of  the 
 asset.  As  we  discuss  in  more  detail  below,  there  is  an  inherent  tension  between  levelizing  prices,  on  the  one  hand,  and  establishing  UNE  prices  that  reflect  anticipated  equipment  price  changes, 
 on  the  other  hand. 
 93.  There  are  two  components  of  depreciation    the  useful  life  of  the  asset,  and  the 
 131  Triennial  Review  Order  at  para.  683. 
 132  Local  Competition  Order,  11  FCC  Rcd  at  15856,  para.  702  (  We  note  that  the  risk-  adjusted  cost  of  capital  need 
 not  be  uniform  for  all  elements.). 
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 rate  at  which  the  asset  is  depreciated  over  that  useful  life.  In  the  Local  Competition  Order,  the  Commission  stated  that  properly  designed  depreciation  schedules  should  take  into  account 
 expected  declines  in  the  value  of  goods.  133  Similarly,  the  Commissions  rules  require  the  use  of  "economic  depreciation"  but  provide  no  additional  detail.  134  In  the  Triennial  Review  Order,  we 
 declined  to  mandate  any  particular  set  of  economic  lives  because  there  was  no  record  to  support  such  a  finding.  135  With  respect  to  the  rate  of  depreciation,  however,  we  clarified  that  a  carrier 
 may  accelerate  recovery  of  the  initial  capital  outlay  for  an  asset  over  its  life  to  reflect  any  anticipated  decline  in  its  value.  136  Recovering  more  of  the  initial  capital  outlay  for  the  asset  in 
 the  early  years  would  enable  a  carrier  to  recover  less  in  later  years,  thereby  allowing  it  to  compete  with  carriers  that  have  purchased  new,  lower-  priced  equipment  in  those  later  years.  137 


 1.  Asset  Lives 
 94.  The  useful  life  of  an  asset  normally  is  determined  by  comparing  the  operating  cost  of  the  existing  asset  with  the  operating  cost  plus  the  investment  cost  of  a  new  asset  that  performs 


 the  same  functions  (assuming  the  new  equipment  will  generate  the  same  revenue  as  the  existing  equipment).  Estimating  asset  lives  is  difficult  because  the  estimate  depends  on  the  physical  life 
 of  the  existing  asset,  the  expected  operating  cost  of  the  existing  asset,  and  the  expected  investment  and  operating  cost  of  new  assets,  some  of  which  may  not  yet  have  been  invented. 


 95.  In  1994  and  1995,  the  Commission  simplified  its  depreciation  process  by  establishing  a  safe  harbor  range  of  asset  lives  for  use  by  incumbent  LECs.  138  The  Commission 
 modified  the  range  for  digital  switching  equipment  in  1999.  139  Asset  lives  prescribed  by  the  Commission  were  intended  to  be  forward-  looking  when  they  were  established,  140  and  the 
 Supreme  Court  specifically  found  that  FCC-  prescribed  asset  lives  were  a  reasonable  starting  point  for  developing  the  depreciation  expense  to  be  used  in  setting  UNE  prices.  141 


 96.  In  the  Biennial  Review  Depreciation  Order,  the  Commission  noted  that  more  than 
 133  Id.  at  15849,  para.  686. 


 134  47  C.  F.  R.    51.  505(  b)(  3). 
 135  Triennial  Review  Order  at  para.  688. 
 136  Id.  at  paras.  689-  91. 
 137  Id.  at  para.  690. 
 138  Simplification  of  the  Depreciation  Prescription  Process,  CC  Docket  No.  92-  296,  Second  Report  and  Order,  9 
 FCC  Rcd  3206  (1994);  Third  Report  and  Order,  10  FCC  Rcd  8442  (1995). 
 139  1998  Biennial  Review    Review  of  Depreciation  Requirements  for  Incumbent  Local  Exchange  Carriers,  CC 
 Docket  No.  98-  137,  Report  and  Order,  15  FCC  Rcd  242,  247-  48,  para.  13  (1999)  (Biennial  Review  Depreciation  Order). 


 140  See  USF  Inputs  Order,  14  FCC  Rcd  at  20344-  45,  para.  426  (  We  believe  this  process  of  combining  statistical 
 analysis  of  historical  information  with  forecasts  of  equipment  replacement  generates  forward-  looking  projected  lives  that  are  reasonable  estimates  of  economic  lives  and,  therefore,  are  appropriate  measures  of  depreciation.). 


 141  Verizon  v.  FCC,  535  U.  S.  at  519-  20. 
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 20  states  have  used  FCC  regulatory  lives  in  calculating  TELRIC-  based  UNE  prices.  In  the  same  order,  the  Commission  rejected  the  use  of  asset  lives  reflected  in  financial  reporting.  142  It  did, 
 however,  permit  incumbent  LECs  to  seek  waivers  that  would  allow  them  to  use  financial  book  lives,  143  although  no  LEC  has  yet  sought  a  waiver  under  these  rules.  This  decision  did  not, 
 however,  specifically  consider  whether  FCC  lives  or  financial  book  lives  are  more  appropriate  for  use  in  a  TELRIC  calculation.  In  the  universal  service  proceeding,  the  Commission  used 
 FCC-  prescribed  regulatory  lives  in  running  the  Synthesis  Model.  144  In  its  section  271  decisions,  the  Commission  has  found  both  FCC  regulatory  lives  and  financial  book  lives  to  be  consistent 
 with  TELRIC  principles.  145  Similarly,  in  the  Triennial  Review  Order,  the  Commission  declined  to  mandate  one  set  of  asset  lives  or  the  other.  146 


 97.  The  issue  of  asset  lives  is  one  where  we  believe  more  guidance  from  the  Commission  would  be  helpful  to  state  commissions.  Although  the  record  in  the  Triennial 
 Review  proceeding  did  not  offer  a  basis  for  providing  such  guidance,  this  NPRM  provides  an  opportunity  for  parties  to  present  evidence  to  support  such  guidance. 


 98.  In  past  decisions,  the  Commission  has  been  reluctant  to  rely  solely  on  financial  reporting  lives  out  of  concern  that  Generally  Accepted  Accounting  Principles  (GAAP)  might 
 permit  companies  to  adopt  depreciation  methods  that  result  in  excessive  depreciation  expense.  147  Is  this  reluctance  warranted  in  the  context  of  UNE  ratesetting?  Do  the  financial  lives  used  to 
 develop  earnings  reported  to  shareholders  match  those  that  companies  use  to  plan  their  future  capital  expenditures?  If  not,  are  the  financial  lives  used  to  develop  reported  earnings  shorter  or 
 longer  than  those  that  companies  use  to  plan  their  capital  expenditures?  Please  explain  why  these  lives  differ,  assuming  that  they  do.  We  request  that  competitive  LECs  and  incumbent 
 LECs  submit  the  lives  that  they  use  to  plan  their  capital  expenditures. 
 99.  We  seek  comment  on  how  financial  reporting  lives  are  developed  and  whether  they  accurately  represent  the  anticipated  economic  life  of  assets.  For  example,  how  do  financial 


 reporting  lives  reflect  the  potential  impact  of  future  technologies?  With  respect  to  the  major  categories  of  plant  and  equipment  (switching,  loops,  interoffice  transport),  is  there  objective 
 evidence  that  anticipated  changes  in  technology  will  cause  equipment  installed  today  to  have  shorter  lives  than  the  same  equipment  that  was  installed  in  the  past?  Is  there  objective  evidence 
 that  potential  advances  in  technology  may  actually  lengthen  the  useful  life  of  some  types  of 
 142  Biennial  Review  Depreciation  Order,  15  FCC  Rcd  at  262-  63,  para.  48  (  We  believe  that  giving  incumbent 
 LECs  the  right  to  select,  for  regulatory  purposes,  any  depreciation  rate  allowed  by  GAAP  [Generally  Accepted  Accounting  Principles]  is  inappropriate  as  long  as  incumbent  LECs  reserve  the  right  to  make  claims  for  regulatory 


 relief  based  on  the  increased  depreciation  that  would  result  from  granting  them  that  flexibility.). 
 143  Id.  at  252-  53,  para.  25  (establishing  waiver  requirements). 


 144  USF  Inputs  Order,  14  FCC  Rcd  at  20344,  para.  426. 
 145  See,  e.  g.,  Verizon  Rhode  Island  271  Order,  17  FCC  Rcd  at  3316-  17,  para.  30  (FCC  lives);  SBC 
 Kansas/  Oklahoma  271  Order,  16  FCC  Rcd  at  6274,  para.  76  (financial  lives). 
 146  Triennial  Review  Order  at  para.  688. 


 147  Biennial  Review  Depreciation  Order,  15  FCC  Rcd  at  263,  para.  48. 
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 assets?  What  asset  lives  are  appropriate  for  equipment  in  the  existing  incumbent  LEC  network  that  is,  or  soon  will  be,  obsolete?  How  relevant,  if  at  all,  is  the  actual  retirement  experience  of  an 
 incumbent  LEC,  its  depreciation  reserves,  or  its  projected  investment  plans  for  the  near  future?  Is  there  other  objective  evidence  the  Commission  should  consider  in  this  regard?  We  encourage 
 parties  to  provide  studies  forecasting  the  economic  lives  of  the  major  local  exchange  carrier  assets  in  support  of  their  proposals. 


 100.  We  also  seek  comment  on  whether  compliance  with  GAAP  results  in  any  systematic  bias.  For  example,  does  the  conservatism  principle  underlying  GAAP  lead  to  a 
 downward  bias  in  asset  lives?  148  How  much  discretion  does  GAAP  give  incumbent  LECs  in  setting  asset  lives?  Will  pressure  from  the  financial  markets  ensure  that  asset  lives  are  estimated 
 accurately?  Does  the  use  of  different  asset  lives  for  different  regulatory  purposes  create  incentives  for  regulatory  arbitrage? 


 101.  We  also  ask  parties  to  comment  on  whether  FCC  regulatory  lives  reflect  the  competition  and  technology  assumptions  required  under  a  forward-  looking  costing  methodology. 
 We  note  that  it  has  been  almost  a  decade  since  the  Commission  first  established  forward-  looking  asset  lives,  and  the  Commission  last  adjusted  its  safe  harbor  asset  lives  in  1999.  149  Are  these 
 lives  still  accurate?  We  ask  parties  to  explain  whether  the  validity  of  FCC  asset  lives  depends  in  part  on  whether  the  Commission  retains  a  scorched  node  approach  to  network  design  or  instead 
 adopts  its  tentative  conclusion  that  forward-  looking  costs  should  more  closely  account  for  the  real-  world  attributes  of  the  routing  and  topography  of  an  incumbent  LECs  network. 


 2.  Depreciation  Rate 
 102.  As  noted  above,  economic  depreciation  is  a  method  of  reflecting  anticipated  declines  in  the  net  present  value  of  an  asset  over  the  course  of  its  useful  life.  Where  equipment 


 prices  are  expected  to  decline  over  time,  the  value  of  existing  network  assets  (and  therefore  prices  under  a  forward-  looking  methodology)  should  decline  at  the  same  rate.  In  the  Triennial 
 Review  Order,  we  stated  that  front-  loading  depreciation  may  be  appropriate  in  such  situations,  although  we  noted  that  there  were  a  number  of  unanswered  questions  regarding  precisely  how 
 carriers  could  reflect  anticipated  equipment  price  changes  in  their  UNE  prices.  150  This  proceeding  presents  an  opportunity  to  explore  these  questions. 


 103.  As  noted  above,  the  rate  of  equipment  price  changes,  if  normalized  to  reflect  advances  in  technology,  should  be  a  significant  factor  in  calculating  TELRIC  prices.  We  ask 


 148  GAAP  is  guided  by  the  conservatism  principle  which  holds,  for  example,  that  when  alternative  expense 
 amounts  are  acceptable,  the  alternative  having  the  least  favorable  effect  on  net  income  should  be  used.  Biennial  Review  Depreciation  Order,  15  FCC  Rcd  at  263,  para.  48  (quoting  Simplification  of  the  Depreciation  Prescription 


 Process,  CC  Docket  No.  92-  296,  Report  and  Order,  8  FCC  Rcd  8025,  8044  (1993)). 
 149  Simplification  of  the  Depreciation  Prescription  Process,  CC  Docket  No.  92-  296,  Second  Report  and  Order,  9 
 FCC  Rcd  3206  (1994);  Third  Report  and  Order,  10  FCC  Rcd  8442  (1995);  Biennial  Review  Depreciation  Order,  15  FCC  Rcd  at  247-  48,  para.  13. 


 150  Triennial  Review  Order  at  paras.  690-  91.  Conversely,  back-  loading  depreciation  may  be  appropriate  when 
 equipment  prices  are  rising. 
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 parties  to  comment  on  the  relationship  between  the  rate  of  change  in  equipment  prices  and  the  rate  of  change  in  final  product  prices.  To  what  extent  do  companies  in  competitive  markets 
 consider  changes  in  the  economic  efficiency  of  assets  (e.  g.,  price  changes,  technological  advances)  in  deciding  how  quickly  to  recover  investments?  How  can  we  measure  anticipated 
 changes  in  the  efficiency  of  equipment?  To  be  useful,  must  any  measurement  of  equipment  price  changes  also  reflect  advances  in  the  capabilities  of  the  equipment?  Are  there  publicly  available 
 price  indices  that  adjust  for  changes  in  economic  efficiency  that  could  be  used  in  establishing  depreciation  schedules?  Are  there  other  sources  of  information  that  would  be  more  appropriate 
 for  use  in  establishing  rates  based  on  a  forward-  looking  costing  methodology?  Parties  should  explain  how  different  sources  of  data  address  changing  capabilities  of  equipment  over  time. 
 Parties  also  should  explain  whether  recent  declines  in  equipment  costs,  if  any,  are  useful  in  establishing  a  general  approach  going  forward,  or  are  they  instead  extraordinary  events  caused 
 by  the  recent  sudden  decline  in  markets  for  telecommunications  equipment  generally  and  therefore  not  reliable  indicators  of  general  trends  in  equipment  pricing? 


 104.  If  the  investment  cost  of  equipment  declines  from  year  to  year,  UNE  prices  also  should  decline  from  year  to  year,  all  else  being  equal.  Similarly,  if  investment  costs  are  expected 
 to  increase  from  year  to  year,  then  UNE  prices  also  should  increase  from  year  to  year.  A  regime  with  wholesale  prices  that  change  over  time  may  be  a  rational  response  to  a  market  where 
 investment  costs  are  changing  and  facilities-  based  competition  exists  or  is  expected  to  exist.  We  ask  parties  to  comment  on  the  costs  and  benefits  of  such  a  regime.  We  also  ask  parties  to  address 
 whether  adjustments  to  depreciation  expense  represent  the  best  mechanism  for  reflecting  anticipated  equipment  price  changes  in  UNE  prices.  If  UNE  prices  can  be  adjusted  directly  to 
 reflect  anticipated  equipment  price  changes,  there  may  be  no  need  to  develop  complicated  mechanisms  for  reflecting  such  changes  in  depreciation  expense. 


 105.  One  of  the  difficulties  in  reflecting  changing  equipment  costs  in  UNE  prices  is  that  most  cost  models  used  in  setting  TELRIC  prices  do  not  reflect  the  actual  investment  patterns 
 of  carriers.  Carriers  continually  invest  in  new  assets  and  depreciate  (and  eventually  retire)  old  assets.  In  contrast,  the  cost  models  typically  assume  that  the  entire  investment  in  the  network  is 
 made  at  a  single  point  in  time,  and  that  no  additional  investment  is  made  in  subsequent  periods.  This  same  process  is  then  repeated  each  time  a  state  commission  sets  new  rates.  Because  the 
 return  on  investment  will  decline  in  each  period  as  the  base  of  undepreciated  investment  declines,  even  straight-  line  depreciation  will  result  in  rapidly  declining  prices  over  time  unless 
 recovery  is  levelized  across  time  periods.  Consequently,  a  levelization  function  is  included  in  most  cost  models  to  replicate  real-  world  investment  and  recovery  patterns. 


 106.  The  levelization  of  rates  that  occurs  in  most  cost  models  appears  to  be  inconsistent  with  the  concept  of  adjusting  UNE  prices  to  reflect  anticipated  changes  in 
 equipment  prices.  We  ask  parties  to  comment  on  this  statement  and  to  discuss  the  consequence  of  running  current  cost  models  without  the  levelization  function.  Does  the  use  of  levelization 
 send  incorrect  signals  to  the  extent  that  it  produces  UNE  prices  that  do  not  vary  over  time  even  when  input  prices  are  rising  or  falling?  Would  there  be  dramatic  variation  in  rates  from  year  to 
 year  if  rates  were  not  levelized?  Would  this  type  of  variation  distort  the  economic  signals  regarding  the  efficient  use  of  incumbent  LEC  facilities  by  competitors? 


 107.  An  alternative  method  of  reflecting  economic  depreciation  might  be  to  recover 
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 through  depreciation  expense  the  difference  between  the  current  value  of  the  asset  and  the  anticipated  value  of  the  asset  at  the  next  rate  proceeding.  As  a  practical  matter,  how  would  such 
 an  approach  work?  How  would  the  anticipated  future  value  of  assets  be  determined?  One  issue  that  arises  under  this  alternative  approach  is  whether  and  how  prices  should  be  adjusted  if  a  state 
 commissions  expectations  regarding  equipment  prices  prove  to  be  incorrect.  We  ask  parties  to  comment  on  this  approach  to  economic  depreciation  and  to  identify  other  approaches  that  might 
 be  used. 
 108.  Given  the  potential  difficulties  associated  with  some  of  the  mechanisms  described  above,  we  ask  parties  to  comment  on  whether  a  reduction  in  asset  lives  might  be  used  as  a  proxy 


 for  changing  investment  costs.  Under  what  circumstances  would  a  carrier  retire  an  asset  before  the  end  of  its  useful  life?  Once  an  asset  is  in  service,  is  it  reasonable  to  assume  that  it  would  be 
 retired  early  only  if  the  net  present  value  of  the  expected  future  cash  flows  associated  with  buying  and  operating  new  technology  is  higher  than  the  expected  cash  flows  associated  with 
 operating  the  old  asset?  If  the  use  of  shorter  asset  lives  increases  the  amount  of  cost  recovery,  is  this  an  appropriate  method  of  reflecting  anticipated  technological  improvements  that  would 
 lower  costs?  Is  there  a  risk  of  over-  recovery  if  asset  lives  are  shortened?  Is  there  evidence  that  this  is  how  unregulated  companies  account  for  the  uncertainties  associated  with  equipment  price 
 changes  and  other  consequences  of  advancing  technology? 
 E.  Expense  Factors 
 109.  One  area  of  controversy  in  state  pricing  proceedings  has  been  the  calculation  of  monthly  operating  expenses.  In  theory,  the  monthly  operating  cost  should  be  calculated  by 


 estimating  the  total  forward-  looking  operating  expense  associated  with  a  particular  network  element  (e.  g.,  by  conducting  time  and  motion  studies  of  likely  maintenance  activities)  and  then 
 dividing  the  total  operating  expense  by  the  appropriate  number  of  units,  such  as  lines,  to  obtain  the  expected  average  operating  expense.  Such  an  approach  is  difficult  to  implement  in  practice, 
 however,  so  regulators  often  estimate  projected  operating  expenses  by  multiplying  the  projected  investment  in  the  network  by  an  annual  cost  factor  (ACF).  151  An  ACF  typically  is  a  ratio  of 
 current  expenses  to  current  investment  for  a  particular  account.  The  ratio  is  multiplied  by  the  projected  investment  to  obtain  the  projected  expenses.  An  alternative  method  of  calculating 
 monthly  operating  costs  is  to  look  at  current  operating  expenses  and  make  any  adjustments  to  reflect  anticipated  experience  in  the  period  for  which  the  projection  is  made,  such  as  adjustments 
 for  productivity  and  inflation. 
 110.  We  seek  comment  on  these  approaches  to  estimating  expenses.  Is  one  approach  clearly  superior  to  the  others?  Under  the  network  assumptions  required  by  our  TELRIC  rules,  is 


 it  correct  to  assume  that  expenses  will  be  reduced  in  proportion  to  reductions  in  investment?  Would  such  an  assumption  be  more  acceptable  if  we  changed  the  network  assumptions  to  more 
 closely  track  an  incumbent  LECs  existing  network?  Would  it  be  reasonable  to  assume  that  an  incumbent  LECs  current  expenses  represent  the  forward-  looking  costs  of  operating  a  network? 
 Why  or  why  not?  Are  there  approaches  to  projecting  expenses  that  do  not  rely  on  an  incumbent  LECs  past  experience,  such  as  benchmarking  to  other  companies?  Are  there  other  approaches 


 151  See,  e.  g.,  USF  Inputs  Order,  15  FCC  Rcd  at  20301-  02,  20304,  paras.  341,  346. 
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 that  might  be  used  to  estimate  expenses  more  accurately? 
 111.  We  invite  parties  to  provide  empirical  evidence  that  demonstrates  the  factors  that  most  influence  the  level  of  expenses.  For  example,  are  outside  plant  expenses  more  likely  to  be 


 correlated  to  changes  in  labor  rates,  the  level  of  outside  plant  investment,  or  some  other  factor  or  combination  of  factors?  Do  the  same  factors  control  the  expenses  associated  with  switching  and 
 transport,  or  are  there  other  factors  upon  which  those  expenses  should  be  based?  Do  the  factors  that  influence  expenses  vary  by  state  or  by  carrier?  Is  the  level  of  expenses  affected  by  the 
 assumed  life  of  an  asset  for  depreciation  purposes?  For  example,  if  we  shorten  asset  lives  as  a  proxy  for  accelerated  depreciation,  as  discussed  above,  would  it  also  be  appropriate  to  reduce 
 operating  expenses  under  the  assumption  that  the  carrier  would  avoid  the  higher  expense  of  operating  an  asset  at  the  end  of  its  useful  life? 


 112.  If  we  find  that  the  best  method  of  projecting  expenses  is  to  make  forward-  looking  adjustments  to  actual  expenses,  what  type  of  adjustments  would  be  appropriate?  If  adjustments 
 are  made  for  inflation  and  productivity,  how  should  those  factors  be  measured?  Are  an  incumbent  LECs  past  productivity  gains  a  relevant  consideration,  or  should  we  look  at  measures 
 of  productivity  across  carriers,  or  across  the  industry  generally?  From  what  sources  should  this  information  be  developed? 


 113.  We  ask  parties  to  address  any  specific  issues  that  arise  in  connection  with  estimating  non-  plant  expenses,  such  as  customer  care  or  common  overhead.  How  should  these 
 costs  be  allocated  among  different  elements?  Is  it  appropriate  to  allocate  these  costs  to  non-recurring  charges,  or  should  they  be  recovered  only  through  recurring  charges? 


 F.  Non-  Recurring  Charges 
 114.  As  discussed  above,  non-  recurring  costs  may  be  thought  of  as  the  installation  or  set-  up  costs  an  incumbent  LEC  incurs  processing  and  provisioning  a  competitive  LEC  order 


 for  a  UNE.  Non-  recurring  charges  (NRCs)  constitute  an  upfront  cost  to  the  competitive  LEC  that  is  generally  not  recoverable  if  it  subsequently  loses  the  end-  user  customer  served  with  the 
 UNE.  Consequently,  as  the  Commission  recognized  in  the  Local  Competition  Order,  NRCs  can  be  a  serious  barrier  to  entry,  especially  if  they  are  unduly  high.  152 


 115.  In  the  Local  Competition  Order,  the  Commission  concluded  that,  as  a  general  rule,  rates  for  unbundled  network  elements  should  recover  costs  in  the  manner  in  which  they  are 
 incurred.  153  The  Commission  required  that  recurring  costs  be  recovered  through  recurring  charges,  rather  than  through  a  non-  recurring  charge.  154  It  gave  discretion  to  state  commissions, 
 however,  to  require  incumbent  LECs  to  recover  non-  recurring  costs  through  recurring  charges  over  a  reasonable  period  of  time.  The  Commission  found  that  recovery  of  non-  recurring  costs 
 through  recurring  charges  was  a  common  practice  that  fully  compensated  the  incumbent 


 152  Local  Competition  Order,  11  FCC  Rcd  at  15875,  para.  747. 
 153  Id.  at  para.  743. 
 154  Id.  at  15874-  75,  para.  745. 
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 LECs  for  their  non-  recurring  costs.  155  It  also  required  that  states  take  steps  to  ensure  an  equitable  distribution  of  non-  recurring  costs  among  carriers  that  benefit  from  a  non-  recurring  activity  (e.  g., 
 by  providing  the  initial  competitive  LEC  a  pro  rata  refund  of  charges  paid  when  a  subsequent  competitive  LEC  uses  the  same  facility).  156 


 1.  Identification  of  Costs 
 116.  The  subject  of  NRCs  presents  two  sets  of  issues  that  have  been  a  constant  source  of  dispute  in  state  proceedings  and  in  section  271  applications  since  1996.  The  first  set  of  issues 


 relates  to  what  costs  an  incumbent  LEC  should  be  permitted  to  recover  for  the  activities  needed  to  initiate  service  to  a  competitive  LEC.  In  TELRIC  proceedings,  a  significant  issue  has  been 
 whether  the  state  commission  should  assume  a  state-  of-  the-  art  network  in  calculating  non-recurring  costs  just  as  it  does  with  recurring  costs,  as  our  rules  suggest,  157  or  whether  it  should 
 use  a  different  network  assumption  that  more  closely  reflects  the  costs  associated  with  providing  services  on  the  incumbent  LECs  existing  network. 


 117.  We  believe  that  consistency  among  the  various  components  of  rates  is  important.  Using  one  set  of  network  assumptions  for  recurring  charges  and  a  different  set  of  network 
 assumptions  for  NRCs  potentially  results  in  some  over-  recovery  or  under-  recovery.  Nevertheless,  we  are  sensitive  to  the  practical  concern  that  network  assumptions  that  depart 
 significantly  from  an  incumbent  LECs  existing  network  might  preclude  recovery  of  the  cost  of  non-  recurring  activities  that  would  be  required  in  establishing  a  competitive  market.  We  ask 
 parties  to  address  whether  our  tentative  conclusion  in  paragraph  52  should  apply  with  respect  to  NRCs  and,  if  it  does,  whether  this  ensures  that  incumbent  LECs  will  be  able  to  recover  all  of 
 their  forward-  looking  costs  of  non-  recurring  activities. 
 118.  A  related  issue  that  often  arises  in  state  proceedings  is  the  relationship  between  NRCs  for  manual  activities  and  an  incumbent  LECs  operational  support  systems  (OSS).  In  light 


 of  our  tentative  conclusion  to  more  closely  account  for  the  real-  world  attributes  of  the  routing  and  topography  of  the  incumbent  LECs  existing  network  in  developing  forward-  looking  costs, 
 what  assumptions  should  be  made  with  respect  to  the  capability  of  the  incumbent  LECs  OSS?  Should  the  costs  associated  with  OSS  be  recovered  through  expense  factors  or  should  separate 
 charges  be  permitted?  If  charges  to  recover  OSS  costs  are  permitted,  how  should  they  be  calculated?  Should  incumbent  LECs  be  permitted  to  recover  through  separate  OSS  charges  the 
 costs  associated  with  systems  that  are  used  for  both  wholesale  and  retail  services?  Given  that  many  OSS  upgrades  affect  both  wholesale  and  retail  functions,  how  should  regulators  allocate 
 OSS  costs  between  these  functions?  Should  all  costs  of  opening  an  incumbent  LECs  OSS  to  competitors  be  borne  by  the  competitors,  or  are  there  costs  that  are  more  appropriately  spread 
 among  the  incumbent  LECs  retail  customers  as  well? 


 155  Id.  at  15875-  76,  para.  749. 
 156  Id.  at  15876,  paras.  750-  51. 
 157  47  C.  F.  R.    51.  507(  e)  (  Non-  recurring  charges  .  .  .  shall  not  permit  an  incumbent  LEC  to  recover  more  than  the 
 total  forward-  looking  cost  of  providing  the  applicable  element.). 
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 119.  Even  with  highly  automated  systems,  some  manual  activities  always  will  be  needed.  We  ask  parties  to  comment  on  the  particular  activities  that  are  not  susceptible  to 
 automation.  How  should  state  commissions  determine  the  cost  of  performing  these  activities?  We  note  that  testimony  on  these  issues  in  state  TELRIC  proceedings  typically  relies  primarily,  if 
 not  exclusively,  upon  the  subjective  opinions  of  panels  of  subject  matter  experts.  158  We  seek  comment  on  how  state  commissions  might  develop  more  objective  evidence  on  non-  recurring 
 costs.  Would  a  shift  to  network  assumptions  that  more  closely  track  the  incumbent  LECs  existing  network  eliminate  some  of  the  speculation  that  often  characterizes  state  proceedings?  Is 
 it  appropriate  to  establish  a  presumption  that  an  incumbent  LECs  current  practices  with  respect  to  non-  recurring  activities  are  efficient,  or  are  an  incumbent  LECs  incentives  to  be  efficient 
 diminished  when  competitive  LECs  are  the  primary  users  of  a  particular  activity? 
 2.  Recovery  of  Costs 
 120.  The  second  set  of  issues  relates  to  whether  non-  recurring  costs  should  be  recovered  through  NRCs  or  through  recurring  charges.  The  costs  at  issue  generally  are  labor 


 costs,  i.  e.,  the  cost  of  sending  a  technician  to  a  customer  location,  a  remote  terminal,  or  a  central  office  to  perform  some  activity  that  is  necessary  for  the  competitive  LEC  to  be  able  to  serve  an 
 end  user.  Beyond  a  general  preference  for  recovery  through  recurring  charges,  159  the  Local  Competition  Order  provided  no  guidance  to  the  states  as  to  how  they  should  distinguish  between 
 costs  recoverable  through  NRCs  and  costs  to  be  treated  as  operating  expenses  that  are  recovered  through  recurring  charges. 


 121.  One  possible  guideline  for  making  this  difficult  decision  would  be  to  limit  recovery  through  NRCs  to  those  costs  that  exclusively  benefit  the  competitive  LEC  ordering  the 
 UNE.  This  approach  provides  a  mechanism  by  which  an  incumbent  LEC  can  recover  the  cost  of  activities  related  to  the  initiation  of  service  by  competitive  LECs,  while  at  the  same  time 
 reducing  the  barriers  to  entry  for  competitive  LECs.  The  cost  of  activities  for  which  NRCs  are  not  permitted  generally  would  be  recovered  in  recurring  charges  through  expense  factors,  just  as 
 LECs  recover  costs  associated  with  repair  and  maintenance  of  their  networks.  160 
 122.  Would  allowing  NRCs  only  for  activities  that  solely  benefit  a  specific  competitive  LEC  reduce  the  number  of  activities  for  which  NRCs  would  be  permitted?  For  example,  should 


 installation  of  a  cross-  connect  at  a  feeder/  distribution  interface  (FDI)  be  subject  to  a  NRC  if  such  a  facility  typically  remains  in  place  after  a  customer  terminates  service?  Conversely,  should 
 placement  of  a  cross-  connect  from  the  main  distribution  frame  (MDF)  in  a  central  office  to  a  competitive  LECs  collocation  space  remain  subject  to  a  NRC  because  only  the  competitive  LEC 
 that  orders  the  cross-  connect  would  benefit  from  the  work? 
 123.  We  also  ask  parties  to  comment  on  how  an  approach  that  limits  NRCs  to  activities 
 158  See  Qwest  9-  State  271  Order,  17  FCC  Rcd  at  26425,  paras.  214,  216. 


 159  Local  Competition  Order,  11  FCC  Rcd  at  15875-  76,  para.  749. 
 160  A  possible  exception  to  this  approach  would  be  in  cases  where  the  incumbent  LEC  can  demonstrate  that  the  cost 
 was  not  considered  in  calculating  the  expense  factor,  e.  g.,  where  it  did  not  need  to  perform  the  activity  for  its  own  operations  and  competitive  LECs  were  not  yet  requesting  the  activity. 
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 benefiting  a  particular  CLEC  would  be  implemented  by  the  states.  Although  such  an  approach  would  reduce  the  likelihood  that  NRCs  would  impose  a  barrier  to  competitive  entry,  would  it 
 also  provide  incumbent  LECs  with  full  recovery  of  their  forward-  looking  costs?  Would  such  an  approach  simplify  the  calculation  of  NRCs  by  state  commissions?  Is  it  necessary  under  such  an 
 approach  to  back  out  certain  costs  from  the  calculation  of  expenses  to  avoid  double  recovery?  Is  there  a  simple  way  to  make  such  an  adjustment?  How  should  carriers  that  have  paid  a  NRC  for  a 
 particular  activity  be  credited  if  an  incumbent  LEC  subsequently  eliminates  the  NRC  and  recovers  those  same  costs  through  recurring  charges? 


 124.  We  solicit  comment  on  whether  a  contrary  approach,  allowing  NRCs  for  every  activity  related  to  a  competitive  LEC  order,  would  provide  sufficient  incentive  for  incumbent 
 LECs  to  use  mechanized  processes  when  it  is  efficient  to  do  so.  Would  allowing  NRCs  for  all  such  activities  increase  the  potential  for  over-  recovery  of  these  costs?  Would  regulators  need  to 
 develop  mechanisms  to  back  out  these  costs  in  developing  expense  factors?  Would  it  be  necessary  to  develop  some  type  of  refund  mechanism  if  other  carriers  also  benefit  from  the 
 work?  Parties  that  oppose  limiting  the  activities  for  which  NRCs  are  permitted  should  suggest  practical  methods  for  making  such  adjustments  in  order  to  avoid  double  recovery  of  costs. 


 125.  We  invite  parties  to  offer  other  suggestions  on  principles  that  states  could  apply  to  identify  when  it  is  appropriate  to  recover  costs  through  NRCs,  and  the  consequence  of  those 
 principles  on  competitive  entry  and  cost  recovery.  For  example,  of  what  relevance  are  the  NRCs  imposed  by  incumbent  LECs  on  retail  customers?  Could  those  NRCs  serve  as  a  basis  for 
 assessing  the  reasonableness  of  NRCs  imposed  on  competitive  LECs?  Could  we  resolve  concerns  about  the  level  of  NRCs  by  eliminating  or  reducing  the  allocation  of  common  costs  and 
 overhead  to  activities  for  which  NRCs  are  imposed? 
 3.  Disconnection  Costs 
 126.  Beyond  these  general  issues  related  to  when  NRCs  should  be  imposed  and  what  costs  they  should  recover,  we  note  that  there  are  a  number  of  specific  issues  that  are  a  continuing 


 source  of  controversy  in  state  pricing  proceedings.  One  issue  that  arises  in  many  proceedings  is  the  question  of  disconnect  costs.  Incumbent  LECs  typically  favor  recovering  the  cost  of 
 disconnecting  UNEs  at  the  time  of  installation,  while  competitive  LECs  generally  argue  that  such  costs,  if  they  exist  at  all,  should  be  recovered  at  the  time  service  actually  is  disconnected.  161 


 127.  We  note  that  calculating  the  appropriate  charge  for  disconnection  may  be  more  complex  if  it  is  imposed  at  the  time  of  installation.  As  an  initial  matter,  it  is  difficult  to  predict 
 how  often  disconnect  costs  actually  will  be  incurred.  Many  NRCs  that  incumbent  LECs  charge  their  retail  customers  cover  both  installation  and  disconnection  of  service,  and  therefore  the  cost 
 of  disconnecting  a  UNE  may  already  have  been  recovered  by  the  incumbent  LEC.  162  In  other  cases,  the  customer  may  switch  to  another  carrier  and  the  cost  of  rearranging  the  facilities  would 
 be  recovered  through  the  installation  charge  on  the  new  carrier.  We  ask  parties  to  provide  empirical  evidence  with  respect  to  the  frequency  with  which  facilities  actually  are  disconnected 


 161  Qwest  9-  State  271  Order,  17  FCC  Rcd  at  26326-  27,  paras.  218-  20. 
 162  Id.  at  26426,  para.  219. 
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 and  the  costs  are  not  recovered  through  other  charges. 
 128.  Another  possible  complication  if  disconnect  costs  are  recovered  at  the  time  of  installation  is  that  the  charge  should  be  discounted  to  reflect  the  time  value  of  money  over  the 


 average  period  for  which  the  competitive  LEC  is  expected  to  use  the  UNE.  In  the  absence  of  objective  evidence  on  which  to  base  this  calculation,  accelerating  the  recovery  of  disconnect 
 costs  is  likely  to  lead  to  an  under-  recovery  or  over-  recovery  of  costs.  We  ask  parties  that  favor  such  an  approach  to  explain  whether  there  are  other  factors  that  outweigh  the  consequences  of 
 having  an  intentional  mismatch  between  costs  and  revenues. 
 4.  Loop  Conditioning 
 129.  A  second  specific  issue  that  has  created  significant  disputes  at  the  state  level  is  loop  conditioning.  In  the  UNE  Remand  Order,  the  Commission  stated  that  incumbent  LECs 


 could  charge  for  conditioning  loops,  notwithstanding  the  fact  that  such  activity  may  not  be  necessary  in  a  forward-  looking  network.  163  The  Commission  required  the  states  to  ensure  that 
 any  line  conditioning  charges  comply  with  FCC  pricing  rules  for  non-  recurring  costs.  164  In  the  Triennial  Review  Order,  the  Commission  stated  that  state  commissions  have  discretion  to 
 determine  whether  loop  conditioning  costs  are  forward-  looking  costs,  and  whether  those  costs  should  be  recovered  through  recurring  charges  or  non-  recurring  charges.  165 


 130.  We  ask  parties  to  comment  on  when  and  how  the  costs  associated  with  loop  conditioning  should  be  recovered.  The  Commission  noted  in  the  UNE  Remand  Order  that, 
 pursuant  to  industry  engineering  standards,  loops  under  18,000  feet  in  length  generally  should  be  free  of  impairments  such  as  load  coils  and  excessive  bridged  taps.  166  Under  a  forward-  looking 
 costing  methodology,  should  competitive  LECs  be  required  to  pay  the  costs  of  conditioning  such  loops?  Does  the  answer  to  this  question  depend  on  whether  we  retain  the  network  assumptions 
 of  the  current  TELRIC  rules?  We  noted  in  the  Triennial  Review  Order  that  one  option  available  to  state  commissions  would  be  to  permit  NRCs  for  loop  conditioning  only  in  extraordinary 
 circumstances,  such  as  copper  loops  that  are  longer  than  18,000  feet.  167  Is  this  a  useful  distinction?  How,  if  at  all,  should  such  NRCs  be  distributed  among  the  competitive  LEC 
 requesting  the  conditioning  and  future  carriers  that  provide  DSL  service  over  the  conditioned  loop? 


 G.  Rate  Structure 
 163  Implementation  of  the  Local  Competition  Provisions  of  the  Telecommunications  Act  of  1996,  CC  Docket  No. 
 96-  98,  Third  Report  and  Order  and  Fourth  Further  Notice  of  Proposed  Rulemaking,  15  FCC  Rcd  3696,  3784,  para.  193  (1999)  (  UNE  Remand  Order)  (subsequent  history  omitted). 


 164  UNE  Remand  Order,  15  FCC  Rcd  at  3784,  para.  194. 
 165  Triennial  Review  Order  at  para.  641. 
 166  UNE  Remand  Order,  15  FCC  Rcd  at  3784,  para.  193. 
 167  Triennial  Review  Order  at  para.  641.  We  note  that  load  coils  are  not  necessary  for  voice  service  on  loops  less 
 than  18,  000  feet  in  length  and  generally  can  be  removed  in  a  batch  process;  on  loops  in  excess  of  18,  000  feet,  however,  load  coils  are  needed  for  voice  service  and  typically  must  be  removed  one  loop  at  a  time. 
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 131.  The  rules  adopted  in  the  Local  Competition  Order  contain  a  variety  of  requirements  regarding  how  UNE  rates  should  be  structured.  Charges  for  dedicated  facilities, 
 including  unbundled  loops  and  dedicated  transport,  must  be  flat-  rated.  168  The  costs  of  shared  facilities,  on  the  other  hand,  may  be  recovered  through  flat-  rated  or  usage-  based  charges,  as  long 
 as  the  rate  structure  efficiently  apportions  costs  among  users.  169  The  Commission  also  allowed,  but  did  not  require,  the  use  of  peak-  period  pricing  for  local  switching  and  other  shared 
 facilities.  170 
 132.  We  seek  comment  on  whether,  and  under  what  circumstances,  changes  are  needed  to  our  rate  structure  requirements.  Would  it  be  appropriate  to  require  that  switching  costs  be 


 recovered  solely  through  flat-  rated  charges?  What  are  the  benefits  and  drawbacks  of  such  an  approach?  Would  flat-  rated  recovery  of  switching  costs  comply  with  the  statutory  pricing 
 standard  under  section  252(  d)(  1)?  Would  flat-  rated  prices  also  be  appropriate  for  shared  transport?  For  example,  should  the  costs  of  shared  transport  be  allocated  among  carriers  using  a 
 facility  based  on  the  proportion  of  lines  each  carrier  connects  to  the  transport  facility? 
 H.  Rate  Deaveraging 
 133.  In  the  Local  Competition  Order,  the  Commission  found  that  geographically  deaveraged  rates  more  closely  reflect  the  cost  of  providing  UNEs.  171  The  Commission  required 


 states  to  establish  at  least  three  cost-  based  rate  zones.  172  During  the  course  of  section  271  proceedings,  both  incumbent  LECs  and  competitive  LECs  raised  concerns  about  the 
 consequences  of  UNE  rate  deaveraging.  In  addressing  these  concerns,  the  Commission  has  noted  that  the  combination  of  retail  rates  that  include  implicit  support  flows  (and  therefore  are 
 not  entirely  cost-  based)  and  the  availability  of  cost-  based,  deaveraged  UNE  rates  could  affect  entry  incentives  with  respect  to  different  geographic  areas  within  a  state.  173 


 134.  The  Local  Competition  Order  also  addressed  the  subject  of  class-  of-  service  deaveraging.  The  Commission  found  that  there  was  no  evidence  that  the  cost  of  providing 
 particular  UNEs  varies  with  the  type  of  retail  service  or  retail  customer.  174  As  with  geographic  deaveraging,  the  requirement  to  average  UNE  rates  across  different  classes  of  customers  affects 
 how  attractive  customers  might  be  to  competitive  LECs  in  states  where  similar  averaging  is  not 
 168  47  C.  F.  R.    51.  509(  a),  (c). 


 169  Id.    51.  509(  b),  (d),  (e);  Local  Competition  Order,  11  FCC  Rcd  at  15878,  para.  755. 
 170  Local  Competition  Order,  11  FCC  Rcd  at  15878,  para.  756-  57. 
 171  Id.  at  15882-  83,  para.  764. 
 172  Id.  at  15882-  83,  para.  765. 
 173  See,  e.  g.,  Application  by  Verizon  New  England  Inc.,  Bell  Atlantic  Communications,  Inc.  (d/  b/  a  Verizon  Long 
 Distance),  NYNEX  Long  Distance  Company  (d/  b/  a  Verizon  Enterprise  Solutions),  Verizon  Global  Networks  Inc.,  and  Verizon  Select  Services  Inc.,  for  Authorization  To  Provide  In-  Region,  InterLATA  Services  in  Vermont,  CC 


 Docket  No.  02-  7,  Memorandum  Opinion  and  Order,  17  FCC  Rcd  7625,  7661-  64,  paras.  65-  69  (2002)  (discussing  the  relationship  between  possible  retail  rate  subsidies  and  UNE  price  squeeze  allegations). 


 174  Local  Competition  Order,  11  FCC  Rcd  at  15883,  para.  766. 
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 required  for  retail  services.  For  example,  if  retail  business  rates  are  higher  than  retail  residential  rates  for  a  comparable  service,  but  prices  are  the  same  for  the  UNEs  necessary  to  provide  that 
 service,  we  would  expect  competitive  LECs  to  target  high-  margin  business  customers  and  to  avoid  low-  margin  residential  customers. 


 135.  Although  our  Triennial  Review  Order  explains  how  the  Commissions  impairment  standard  takes  into  account  implicit  support  flows  among  retail  services,  that  order 
 does  not  directly  address  issues  related  to  differences  in  the  averaging  of  incumbent  LEC  retail  rates  and  UNE  rates.  175  Given  the  Commissions  limited  ability  to  influence  or  control  retail 
 local  exchange  rates,  how  can  the  Commission  achieve  its  goal  of  sending  appropriate  economic  signals  with  respect  to  competitive  entry  and  investment?  Would  changes  to  our  deaveraging 
 policies  with  respect  to  UNEs  address  these  concerns  or  are  there  alternative  steps  that  the  Commission  might  take? 


 136.  We  seek  comment  on  whether,  and  under  what  circumstances,  we  should  retain  the  requirement  of  geographic  deaveraging.  What  are  the  consequences  of  deaveraging  UNE 
 prices  in  states  where  retail  rates  are  not  similarly  deaveraged?  Would  it  be  appropriate  to  require  deaveraging  only  in  states  where  retail  rates  are  deaveraged?  Is  it  possible  to  reconcile 
 such  an  approach  with  the  cost-  based  pricing  standard  contained  in  section  252(  d)? 
 137.  We  seek  comment  on  whether,  and  under  what  circumstances,  to  retain  the  requirement  to  average  rates  across  different  classes  of  service.  Parties  that  favor  elimination  or 


 modification  of  this  requirement  should  present  evidence  demonstrating  that  the  costs  of  serving  different  classes  of  customers  are  sufficiently  different  to  warrant  deaveraging  of  those  rates. 
 For  example,  is  there  objective  evidence  that  the  cost  of  serving  business  customers  is  either  higher  or  lower  than  the  cost  of  serving  residential  customers?  If  so,  what  is  the  cause  of  these 
 cost  differences?  Is  deaveraging  UNE  rates  across  classes  of  customers  appropriate  if  retail  rates  do  not  reflect  these  same  cost  differences? 


 I.  Rate  Changes  Over  Time 
 138.  One  issue  on  which  all  parties  likely  agree  is  that  UNE  pricing  proceedings  under  the  Commissions  current  rules  require  a  substantial  commitment  of  resources  from  everyone 


 involved.  A  typical  UNE  pricing  proceeding  may  take  two  to  three  years  to  complete,  which  results  in  rates  that  may  be  outdated  at  the  time  they  are  adopted.  Moreover,  even  as 
 circumstances  change,  states  may  be  reluctant  to  adopt  new  prices  to  reflect  those  changes  because  they  are  not  willing  to  commit  the  resources  needed  for  these  proceedings. 


 139.  We  ask  parties  to  comment  on  whether  there  might  be  mechanisms  that  could  be  used  to  adjust  UNE  prices  over  time,  thereby  reducing  the  need  for  state  commissions  to  conduct 
 a  full  UNE  pricing  proceeding  every  few  years.  Such  an  approach  might,  for  example,  be  similar  to  many  price  cap  regimes,  which  periodically  adjust  rates  based  on  productivity  and  inflation 
 factors.  How  might  such  an  approach  work  for  UNE  prices?  In  particular,  we  ask  parties  how  productivity  factors  might  be  calculated.  Could  a  single  productivity  factor  be  used,  or  would  it 


 175  Triennial  Review  Order  at  paras.  154-  69. 
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 be  necessary  to  develop  different  factors  for  different  UNEs?  Could  a  national  factor  be  used  or  would  it  be  necessary  to  develop  state-  specific  productivity  factors?  What  sources  of  data  could 
 we  use  to  derive  these  factors?  We  invite  parties  to  provide  empirical  evidence  regarding  productivity,  such  as  productivity  studies,  that  we  could  use  to  establish  productivity  factors  if 
 we  pursue  this  approach. 
 140.  If  the  use  of  productivity  factors  to  adjust  rates  periodically  is  feasible,  should  it  be  mandatory?  Or  should  states  retain  the  ability  to  conduct  a  full  UNE  pricing  proceeding  at 


 their  discretion?  Would  a  periodic  adjustment  to  rates  in  lieu  of  a  full  UNE  pricing  proceeding  be  sufficient  to  satisfy  a  states  legal  obligations  under  section  252?  Are  there  methods  other 
 than  the  use  of  productivity  factors  that  could  be  used  to  make  periodic  rate  adjustments? 
 V.  RESALE  PRICING 
 141.  Section  252(  d)(  3)  of  the  Act  requires  that  state  commissions  establish  wholesale  rates  for  resold  services  based  on  the  incumbent  LECs  retail  rates,  excluding  the  portion 


 thereof  attributable  to  any  marketing,  billing,  collection,  and  other  costs  that  will  be  avoided  by  the  local  exchange  carrier.  176  In  the  Local  Competition  Order,  the  Commission  adopted  a 
 reasonably  avoidable  standard  governing  the  costs  that  must  be  considered  avoided  when  calculating  the  wholesale  discount.  177  That  is,  the  Commission  found  that  any  costs  that 
 reasonably  can  be  avoided  by  the  incumbent  LEC  when  it  provides  a  service  at  resale  must  be  considered  avoided  in  determining  the  wholesale  discount.  178 


 142.  The  Commissions  original  resale  pricing  rules  were  vacated  by  the  Eighth  Circuit  in  Iowa  Utilities  II  because  the  court  found  that  the  rules  were  inconsistent  with  the  plain 
 meaning  of  the  statute.  179  The  Eighth  Circuit  found  that  the  appropriate  standard  for  determining  avoided  costs  is  not  those  costs  that  can  be  avoided,  but  rather  those  costs  that  the  [incumbent 
 LEC]  will  actually  avoid  incurring  in  the  future.  180  Further,  the  court  explained  that,  when  determining  avoided  costs,  the  state  commission  may  not  assume  that  the  incumbent  is  acting  as 
 a  wholesaler  only,  but  rather  must  assume  that  the  incumbent  provider  is  acting  as  both  a  wholesale  and  a  retail  provider.  181  The  Commission  has  not  conducted  any  further  rulemaking  to 
 provide  additional  guidance  on  establishing  wholesale  discounts. 
 143.  In  light  of  Iowa  Utilities  II,  we  ask  parties  to  comment  on  the  need  for  the  Commission  to  adopt  new  rules  implementing  section  252(  d)(  3).  Is  the  statutory  language,  as 


 interpreted  by  the  Eighth  Circuit,  sufficiently  clear  that  further  guidance  from  the  Commission  is  unnecessary?  Parties  that  favor  the  establishment  of  national  rules  should  explain  what  those 


 176  47  U.  S.  C.    252(  d)(  3). 
 177  Local  Competition  Order,  11  FCC  Rcd  at  15956-  15957,  para.  912. 
 178  47  C.  F.  R.    51.  609(  b). 
 179  Iowa  Utilities  II,  219  F.  3d  at  754-  756,  765. 
 180  Id.  at  755. 
 181  Id. 
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 rules  would  require.  For  example,  does  the  courts  decision  that  the  discount  should  be  calculated  as  if  the  carrier  were  both  a  wholesale  and  retail  provider  require  the  Commission  or 
 the  state  commission  to  make  some  type  of  assumption  as  to  how  much  competition  there  is  in  the  marketplace,  or  did  the  court  simply  intend  for  the  state  to  consider  the  current  level  of 
 competition  and  the  current  split  between  an  incumbent  LECs  retail  and  wholesale  services? 
 144.  Is  it  necessary,  or  helpful,  for  the  Commission  to  identify  categories  of  costs  that  either  are  presumptively  avoided  or  presumptively  not  avoided?  For  example,  is  it  still 


 appropriate  for  the  Commission  to  conclude,  as  it  did  in  the  Local  Competition  Order,  that  all  marketing,  billing,  and  collection  costs  are  avoided?  182  Parties  that  favor  the  Commission 
 establishing  this  type  of  presumption  should  provide  objective  evidence  demonstrating  the  type  of  costs  that  incumbent  LECs  actually  avoid  when  they  provide  services  to  competitors  for 
 resale.  Under  the  interpretation  of  the  section  252(  d)(  3)  adopted  by  the  Eighth  Circuit,  how  should  common  costs  be  treated?  If  an  incumbent  LEC  is  assumed  to  be  both  a  retail  and  a 
 wholesale  provider,  what  types  of  common  costs,  if  any,  actually  will  be  avoided  when  the  incumbent  LEC  resells  services? 


 145.  We  ask  parties  to  discuss  whether  it  is  necessary,  or  helpful,  for  the  Commission  to  establish  any  evidentiary  guidelines  with  respect  to  the  resale  discount.  Should  incumbent 
 LECs  be  obligated  to  file  cost  studies  in  support  of  their  proposed  discounts,  or  are  there  alternative  showings  that  might  be  sufficient?  If  studies  are  required,  what  level  of  detail  should 
 they  contain?  Must  direct  and  indirect  avoided  costs  be  specifically  identified? 
 146.  In  the  Local  Competition  Order,  the  Commission  concluded  that  the  Subscriber  Line  Charge  (SLC)  imposed  on  retail  customers  should  be  paid  by  resellers,  but  that  it  was  not 


 subject  to  the  resale  discount.  183  Although  the  SLC  relates  to  interstate  access  services,  which  are  not  subject  to  the  resale  discount,  it  is  charged  to  end  users  and  paid  by  end  users  to  recover  costs 
 for  which  they  are  the  cost  causer.  The  SLC  could,  therefore,  be  considered  a  retail  service  for  purposes  of  section  251(  c)(  4).  We  ask  parties  to  address  whether  it  would  be  appropriate  for  the 
 Commission  to  revisit  its  prior  analysis  of  whether  the  SLC  should  be  subject  to  the  resale  discount. 


 VI.  INTERCONNECTION  PRICING  AND  RECIPROCAL  COMPENSATION 
 147.  Under  section  252(  d)(  1),  interconnection  is  subject  to  the  same  cost-  based  pricing  standard  as  UNEs.  184  We  ask  parties  to  comment  on  whether  there  is  any  reason  that  changes  to 


 the  current  pricing  rules  for  UNEs  should  not  also  apply  to  interconnection  provided  pursuant  to  section  251(  c)(  2).  We  note  that  the  Commission  is  considering  issues  related  to  the  costs 
 associated  with  interconnecting  networks  in  the  pending  Intercarrier  Compensation  proceeding.  185  Parties  are  invited  to  comment  on  the  relationship  between  the  section  252(  d)(  1) 


 182  Local  Competition  Order,  11  FCC  Rcd  at  15958,  para.  917. 
 183  Id.  at  15984,  para.  984. 
 184  47  U.  S.  C.    252(  d)(  1). 
 185  Developing  a  Unified  Intercarrier  Compensation  Regime,  CC  Docket  No.  01-  92,  Notice  of  Proposed 
 Rulemaking,  16  FCC  Rcd  9610  (2001)  (Intercarrier  Compensation  NPRM). 
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 pricing  standard  and  proposals  for  recovery  of  interconnection  costs  that  are  now  under  consideration  in  the  Intercarrier  Compensation  proceeding.  We  also  invite  parties  to  comment 
 on  issues  related  to  the  pricing  of  collocation,  which  also  is  subject  to  the  section  252(  d)(  1)  pricing  standard.  For  example,  we  solicit  comment  on  whether  charges  for  direct  current  (DC) 
 power  should  be  based  on  the  number  of  amps  consumed  or  the  number  of  amps  fused. 
 148.  In  the  Local  Competition  Order,  the  Commission  also  decided  that  TELRIC  pricing  was  appropriate  for  reciprocal  compensation  under  section  251(  b)(  5).  186  In  the 


 Intercarrier  Compensation  proceeding,  the  Commission  sought  comment  on  whether  a  different  interpretation  of  the  additional  cost  standard  in  section  252(  d)(  2)  was  warranted.  187  We  ask 
 parties  to  address  whether  the  Commission  should  continue  to  apply  the  same  pricing  rules  to  UNEs  and  to  reciprocal  compensation.  What  would  be  the  consequences  of  having  different 
 pricing  regimes  for  these  two  different  functions? 
 VII.  IMPLEMENTATION  ISSUES 
 149.  We  ask  parties  to  comment  on  how  any  changes  to  the  Commissions  UNE  pricing  rules  should  be  implemented  by  the  states.  The  pricing  standard  imposed  under  section 


 252(  d)(  1)  applies  when  states  are  called  on  to  arbitrate  disputes  regarding  the  pricing  of  interconnection  and  unbundled  network  elements.  188  In  most  states,  however,  it  appears  that  rates 
 are  established  in  generic  proceedings  that  are  not  specific  to  the  arbitration  between  any  particular  pair  of  carriers.  We  ask  parties  to  explain  how  state  commissions  have  proceeded  in 
 establishing  prices  under  section  252(  d)(  1). 
 150.  We  seek  comment  on  whether  we  should  establish  a  national  timetable  pursuant  to  which  states  will  conduct  new  UNE  cost  proceedings  to  reset  all  rates  in  accordance  with  any 


 new  rules.  If  we  establish  a  timetable  for  initiating  new  UNE  rate  proceedings,  should  we  require  that  such  proceedings  be  resolved  within  a  certain  time  period,  consistent  with  our 
 direction  to  the  states  to  perform  the  granular  inquiries  set  forth  in  the  Triennial  Review  proceeding?  If  so,  is  a  nine-  month  time  period  sufficient  to  establish  new  UNE  prices?  What 
 recourse  should  carriers  have  if  a  state  fails  to  act  in  the  allotted  time?  Rules  that  address  such  considerations  could  quickly  bring  consistency  and  certainty  to  the  UNE  market,  and  we  seek 
 comment  on  our  authority  to  adopt  them. 
 151.  We  also  seek  comment  on  whether  it  may  be  appropriate  to  establish  a  true-  up  mechanism  for  the  difference  between  what  a  competitor  pays  for  network  elements  under  rates 


 established  pursuant  to  the  current  TELRIC  rules  and  what  that  competitor  would  pay  for  the  same  facilities  or  services  under  rates  established  pursuant  to  any  new  rules  we  may  adopt  in  this 
 proceeding.  If  a  true-  up  mechanism  is  appropriate,  to  what  period  should  any  true-  up  be  applicable?  Should  the  beginning  of  the  true-  up  period  be  the  effective  date  of  the  final 
 Commission  order  in  this  proceeding?  Or  is  some  other  true  up  period  more  appropriate?  We 


 186  Local  Competition  Order,  11  FCC  Rcd  at  16023,  para.  1054. 
 187  Intercarrier  Compensation  NPRM,  16  FCC  Rcd  at  9646,  para.  101. 
 188  47  U.  S.  C.    252(  d)(  1). 
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 have  recognized  in  several  contexts  that  the  use  of  interim  rates  subject  to  true-  up  is  an  appropriate  means  of  protecting  all  parties'  interest  when  permanent  rates  under  the  governing 
 cost  methodology  have  not  yet  been  set. 
 VIII.  PROCEDURAL  MATTERS 
 A.  Initial  Paperwork  Reduction  Act  Analysis 
 152.  This  Notice  of  Proposed  Rulemaking  (NPRM)  contains  either  a  proposed  or  modified  information  collection.  As  part  of  the  continuing  effort  to  reduce  paperwork  burdens, 


 we  invite  the  general  public  and  the  Office  of  Management  and  Budget  (OMB)  to  comment  on  the  information  collections  contained  in  this  NPRM,  as  required  by  the  Paperwork  Reduction  Act 
 of  1995,  44  U.  S.  C.    3501  et  seq.  Public  and  agency  comments  are  due  at  the  same  time  as  other  comments  on  this  NPRM;  OMB  comments  are  due  60  days  from  the  date  of  publication  of  this 
 NPRM  in  the  Federal  Register.  Comments  should  address:  1)  whether  the  proposed  collection  of  information  is  necessary  for  the  proper  performance  of  the  functions  of  the  Commission, 
 including  whether  the  information  shall  have  practical  utility;  2)  the  accuracy  of  the  Commissions  burden  estimates;  3)  ways  to  enhance  the  quality,  utility,  and  clarity  of  the 
 information  collected;  and  4)  ways  to  minimize  the  burden  of  the  collection  of  information  on  the  respondents,  including  the  use  of  automated  collection  techniques  or  other  forms  of 
 information  technology. 
 B.  Initial  Regulatory  Flexibility  Act  Analysis 
 153.  As  required  by  the  Regulatory  Flexibility  Act  of  1980,  as  amended  (RFA),  189  the  Commission  has  prepared  the  present  Initial  Regulatory  Flexibility  Analysis  (IRFA)  of  the 


 possible  significant  economic  impact  on  a  substantial  number  of  small  entities  by  the  policies  and  rules  proposed  in  this  NPRM.  Written  public  comments  are  requested  on  this  IRFA. 
 Comments  must  be  identified  as  responses  to  the  IRFA  and  must  be  filed  by  the  deadlines  for  comments  on  the  NPRM  provided  below  in  Section  C.  The  Commission  will  send  a  copy  of  the 
 NPRM,  including  this  IRFA,  to  the  Chief  Counsel  for  Advocacy  of  the  Small  Business  Administration.  190  In  addition,  the  NPRM  and  IRFA  (or  summaries  thereof)  will  be  published  in 
 the  Federal  Register.  191 
 1.  Need  for,  and  Objectives  of,  the  Proposed  Rules 
 154.  In  this  NPRM,  the  Commission  initiates  the  first  comprehensive  review  of  TELRIC  pricing  rules  since  they  were  adopted.  Section  252(  d)(  1)  of  the  Act  sets  forth  the 


 pricing  standard  for  UNEs.  Section  252(  d)(  3)  of  the  Act  requires  that  state  commissions  establish  wholesale  rates  for  resold  services  based  on  the  incumbent  LECs  retail  rates.  Seven 
 years  ago,  the  Commission  adopted  its  current  rules  that  base  UNE  prices  on  the  Total  Element 
 189  See  5  U.  S.  C.    603.  The  IRFA,  see  5  U.  S.  C.    601-  612,  has  been  amended  by  the  Small  Business  Regulatory 
 Enforcement  Fairness  Act  of  1996  (SBREFA)  Pub.  L.  No.  104-  121,  Title  II,  110  Stat  857  (1996). 
 190  See  5  U.  S.  C.    603(  a). 


 191  See  id. 
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 Long  Run  Incremental  Cost  (TELRIC)  of  a  UNE.  192  The  Commission  stated  at  that  time  that  it  would  continue  to  review  its  pricing  rules  based  on  the  results  of  state  arbitration  proceedings 
 and  provide  additional  guidance  as  necessary. 
 155.  Based  on  the  wealth  of  experience  that  has  been  developed  over  the  last  seven  years,  the  Commission  initiates  this  proceeding  to  consider  whether  the  TELRIC  methodology 


 for  pricing  UNEs  under  the  Act  is  working  as  intended  and  whether  it  is  conducive  to  efficient  facilities  investment.  The  Commission  also  requests  comment  in  this  proceeding  on  its  resale 
 pricing  rules.  Incumbent  LECs  are  required  to  resell  retail  services  pursuant  to  section  251(  c)(  4)  of  the  Act.  This  NPRM  seeks  to  preserve  the  forward-  looking  emphasis  and  pro-  competitive 
 purposes  of  TELRIC,  while  simplifying  this  methodology.  The  Commissions  objective  is  to  help  state  commissions  more  easily  develop  UNE  prices  and  resale  discounts  that  meet  the 
 statutory  standards  established  by  Congress  in  section  252(  d)  and  to  provide  more  certainty  and  consistency  in  the  results  of  these  state  proceedings. 


 156.  Although  the  Commission  has  addressed  some  specific  TELRIC  cost  input  disputes  as  they  have  arisen  in  section  271  proceedings,  the  Commissions  disposition  has 
 provided  no  systematic  guidance  on  pricing  issues.  This  proceeding  will  provide  states  and  interested  parties  comprehensive  guidance  lacking  in  our  consideration  of  section  271 
 applications.  In  the  Triennial  Review  Order,  the  Commission  clarified  the  existing  rules  regarding  two  key  components  of  TELRIC    cost  of  capital  and  depreciation.  193 


 157.  Because  of  the  general  nature  of  the  Commissions  rules  and  the  hypothetical  and  complex  nature  of  the  TELRIC  inquiry,  it  is  often  difficult  to  understand  how  actual  UNE  rates 
 are  derived.  Uncertainty  or  inconsistency  in  how  to  apply  TELRIC  rules  may  also  result  in  rates  that  significantly  vary  from  state  to  state  without  regard  to  genuine  cost  differences.  This  lack  of 
 predictability  in  UNE  rates  is  difficult  to  reconcile  with  the  Commissions  desire  that  UNE  prices  send  correct  economic  signals  for  competitive  and  investment  purposes.  This  NPRM  seeks  to 
 simplify  TELRIC  pricing,  provide  more  specific  guidance  to  make  the  TELRIC  rate-  setting  process  less  speculative  and  improve  the  accuracy  of  its  pricing  signals. 


 2.  Legal  Basis 
 158.  This  Notice  is  adopted  pursuant  to  sections  1,  4(  i),  (4j),  201-  205,  251,  252,  and  303  of  the  Communications  Act  of  1934,  as  amended,  47  U.  S.  C.    151,  154(  i),  (j),  201-  205, 


 251,  252,  and  303. 
 3.  Description  and  Estimate  of  the  Number  of  Small  Entities  to  which  the  Proposed  Rules  Will  Apply 


 159.  The  RFA  directs  agencies  to  provide  a  description  of  and,  where  feasible,  an 
 192  Implementation  of  the  Local  Competition  Provisions  in  the  Telecommunications  Act  of  1996,  CC  Docket  No. 
 96-  98,  First  Report  and  Order,  11  FCC  Rcd  15499  (1996). 
 193  Review  of  the  Section  251  Unbundling  Obligations  of  Incumbent  Local  Exchange  Carriers,  Report  and  Order 
 and  Order  on  Remand  and  Further  Notice  of  Proposed  Rulemaking,  CC  Docket  No.  01-  338,  FCC  03-  36  (released  August  21,  2003). 
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 estimate  of  the  number  of  small  entities  that  will  be  affected  by  the  proposed  rules.  194  The  RFA  generally  defines  the  term  small  entity  as  having  the  same  meaning  as  the  terms  small 
 business,  small  organization,  and  small  governmental  jurisdiction.  195  In  addition,  the  term  small  business  has  the  same  meaning  as  the  term  small  business  concern  under  the  Small 
 Business  Act.  196  A  small  business  concern  is  one  which:  (1)  is  independently  owned  and  operated;  (2)  is  not  dominant  in  its  field  of  operation;  and  (3)  satisfies  any  additional  criteria 
 established  by  the  Small  Business  Administration  (SBA).  197  The  term  small  governmental  jurisdiction  is  defined  as  governments  of  cities,  towns,  townships,  villages,  school  districts,  or 
 special  districts,  with  a  population  of  less  than  fifty  thousand.  198  As  of  1997,  there  were  about  87,453  governmental  jurisdictions  in  the  United  States.  199  This  number  includes  39,044  county 
 governments,  municipalities,  and  townships,  of  which  37,546  (approximately  96.2%)  have  populations  of  fewer  than  50,000,  and  of  which  1,498  have  populations  of  50,000  or  more.  Thus, 
 we  estimate  the  number  of  small  governmental  jurisdictions  overall  to  be  84,098  or  fewer.  We  also  note  that  the  term  small  governmental  jurisdiction  includes  state  regulatory  bodies 
 commonly  known  as  state  public  utilities  commissions  or  public  service  commissions  which  may  be  directly  affected  by  this  NPRM. 


 160.  In  this  section,  we  further  describe  and  estimate  the  number  of  small  entity  licensees  and  regulatees  that  may  also  be  indirectly  affected  by  rules  adopted  pursuant  to  this 
 NPRM.  The  most  reliable  source  of  information  regarding  the  total  numbers  of  certain  common  carrier  and  related  providers  nationwide,  as  well  as  the  number  of  commercial  wireless  entities, 
 appears  to  be  the  data  that  the  Commission  publishes  in  its  Trends  in  Telephone  Service  report.  200  The  SBA  has  developed  small  business  size  standards  for  wireline  and  wireless  small  businesses 
 within  the  three  commercial  census  categories  of  Wired  Telecommunications  Carriers,  201  Paging,  202  and  Cellular  and  Other  Wireless  Telecommunications.  203  Under  these  categories,  a 


 194  5  U.  S.  C.    603(  b)(  3),  604(  a)(  3). 
 195  Id.    601(  6). 
 196  Id.    601(  3)  (incorporating  by  reference  the  definition  of  small  business  concern  in  the  Small  Business  Act, 
 15  U.  S.  C.    632).  Pursuant  to  5  U.  S.  C.    601(  3),  the  statutory  definition  of  a  small  business  applies  unless  an  agency,  after  consultation  with  the  Office  of  Advocacy  of  the  Small  Business  Administration  and  after  opportunity 


 for  public  comment,  establishes  one  or  more  definitions  of  such  terms  which  are  appropriate  to  the  activities  of  the  agency  and  publishes  such  definitions(  s)  in  the  Federal  Register. 


 197  15  U.  S.  C.    632. 
 198  5  U.  S.  C.    601(  5). 
 199  U.  S.  Census  Bureau,  Statistical  Abstract  of  the  United  States:  2000,  Section  9,  pages  299-  300,  Tables  490  and 
 492. 
 200  FCC,  Wireline  Competition  Bureau,  Industry  Analysis  and  Technology  Division,  Trends  in  Telephone  Service, 
 Table  5.3  (May  2002)  (Trends  in  Telephone  Service). 
 201  13  C.  F.  R.    121.201,  North  American  Industry  Classification  System  (NAICS)  code  513310  (changed  to 
 517110  in  October  2002). 
 202  Id.    121.  201,  NAICS  code  513321  (changed  to  517211  in  October  2002). 


 203  Id.    121.  201,  NAICS  code  513322  (changed  to  517212  in  October  2002). 
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 business  is  small  if  it  has  1,500  or  fewer  employees.  Below,  using  the  above  size  standards  and  others,  we  discuss  the  total  estimated  numbers  of  small  businesses  that  might  be  affected  by  our 
 actions. 
 161.  We  have  included  small  incumbent  LECs  in  this  present  RFA  analysis.  As  noted  above,  a  small  business  under  the  RFA  is  one  that,  inter  alia,  meets  the  pertinent  small 


 business  size  standard  (e.  g.,  a  wired  telecommunications  carrier  having  1,500  or  fewer  employees),  and  is  not  dominant  in  its  field  of  operation.  204  The  SBAs  Office  of  Advocacy 
 contends  that,  for  RFA  purposes,  small  incumbent  LECs  are  not  dominant  in  their  field  of  operation  because  any  such  dominance  is  not  national  in  scope.  205  We  have  therefore  included 
 small  incumbent  LECs  in  this  RFA  analysis,  although  we  emphasize  that  this  RFA  action  has  no  effect  on  Commission  analyses  and  determinations  in  other,  non-  RFA  contexts. 


 162.  Wired  Telecommunications  Carriers.  The  SBA  has  developed  a  small  business  size  standard  for  Wired  Telecommunications  Carriers,  which  consists  of  all  such  companies 
 having  1,500  or  fewer  employees.  206  According  to  Census  Bureau  data  for  1997,  there  were  2,225  firms  in  this  category,  total,  that  operated  for  the  entire  year.  207  Of  this  total,  2,201  firms 
 had  employment  of  999  or  fewer  employees,  and  an  additional  24  firms  had  employment  of  1,000  employees  or  more.  208  Thus,  under  this  size  standard,  the  great  majority  of  firms  can  be 
 considered  small. 
 163.  Incumbent  Local  Exchange  Carriers  (LECs).  Neither  the  Commission  nor  the  SBA  has  developed  a  size  standard  for  small  businesses  specifically  applicable  to  incumbent 


 local  exchange  services.  The  closest  applicable  size  standard  under  SBA  rules  is  for  Wired  Telecommunications  Carriers.  Under  that  size  standard,  such  a  business  is  small  if  it  has  1,500 
 or  fewer  employees.  209  According  to  Commission  data,  210  1,329  carriers  reported  that  they  were  engaged  in  the  provision  of  local  exchange  services.  Of  these  1,329  carriers,  an  estimated  1,024 
 have  1,500  or  fewer  employees  and  305  have  more  than  1,500  employees.  Consequently,  the  Commission  estimates  that  most  providers  of  incumbent  local  exchange  service  are  small 
 businesses  that  may  be  affected  by  the  rules  and  policies  adopted  herein. 


 204  5  U.  S.  C.    601(  3). 
 205  Letter  from  Jere  W.  Glover,  Chief  Counsel  for  Advocacy,  SBA,  to  William  E.  Kennard,  Chairman,  FCC 
 (May  27,  1999).  The  Small  Business  Act  contains  a  definition  of  small  business  concern,  which  the  RFA  incorporates  into  its  own  definition  of  small  business.  See  15  U.  S.  C.    632(  a);  5  U.  S.  C.    601(  3).  SBA 


 regulations  interpret  small  business  concern  to  include  the  concept  of  dominance  on  a  national  basis.  13  C.  F.  R.    121.102(  b). 


 206  13  C.  F.  R.    121.  201,  NAICS  code  513310  (changed  to  517110  in  October  2002). 
 207  U.  S.  Census  Bureau,  1997  Economic  Census,  Subject  Series:  Information,  Establishment  and  Firm  Size 
 (Including  Legal  Form  of  Organization),  Table  5,  NAICS  code  513310  (issued  October  2000). 
 208  Id.  The  census  data  do  not  provide  a  more  precise  estimate  of  the  number  of  firms  that  have  employment  of 
 1,500  or  fewer  employees;  the  largest  category  provided  is  Firms  with  1,000  employees  or  more. 
 209  13  C.  F.  R.    121.  201,  NAICS  code  513310  (changed  to  517110  in  October  2002). 


 210  Trends  in  Telephone  Service  at  Table  5.3. 
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 164.  Competitive  Local  Exchange  Carriers  (CLECs).  Neither  the  Commission  nor  the  SBA  has  developed  a  size  standard  for  small  businesses  specifically  applicable  to  providers  of 
 competitive  exchange  services  or  to  competitive  access  providers  or  to  Other  Local  Exchange  Carriers,  all  of  which  are  discrete  categories  under  which  TRS  data  are  collected.  The  closest 
 applicable  size  standard  under  SBA  rules  is  for  Wired  Telecommunications  Carriers.  Under  that  size  standard,  such  a  business  is  small  if  it  has  1,500  or  fewer  employees.  211  According  to 
 Commission  data,  212  532  companies  reported  that  they  were  engaged  in  the  provision  of  either  competitive  access  provider  services  or  competitive  local  exchange  carrier  services.  Of  these 
 532  companies,  an  estimated  411  have  1,500  or  fewer  employees  and  121  have  more  than  1,500  employees.  213  In  addition,  55  carriers  reported  that  they  were  Other  Local  Exchange  Carriers. 
 Of  the  55  Other  Local  Exchange  Carriers,  an  estimated  53  have  1,500  or  fewer  employees  and  two  have  more  than  1.500  employees.  214  Consequently,  the  Commission  estimates  that  most 
 providers  of  competitive  local  exchange  service,  competitive  access  providers,  and  Other  Local  Exchange  Carriers  are  small  entities  that  may  be  affected  by  the  rules  and  policies  adopted 
 herein. 
 165.  Interexchange  Carriers  (IXCs).  Neither  the  Commission  nor  the  SBA  has  developed  a  size  standard  for  small  businesses  specifically  applicable  to  interexchange  services. 


 The  closest  applicable  size  standard  under  SBA  rules  is  for  Wired  Telecommunications  Carriers.  Under  that  size  standard,  such  a  business  is  small  if  it  has  1,500  or  fewer  employees.  215 
 According  to  Commission  data,  216  229  companies  reported  that  their  primary  telecommunications  service  activity  was  the  provision  of  interexchange  services.  Of  these  229  companies,  an 
 estimated  181  have  1,500  or  fewer  employees  and  48  have  more  than  1,500  employees.  217  Consequently,  the  Commission  estimates  that  the  majority  of  interexchange  service  providers  are 
 small  entities  that  may  be  affected  by  the  rules  and  policies  adopted  herein. 
 166.  Operator  Service  Providers  (OSPs).  Neither  the  Commission  nor  the  SBA  has  developed  a  size  standard  for  small  businesses  specifically  applicable  to  operator  service 


 providers.  The  closest  applicable  size  standard  under  SBA  rules  is  for  Wired  Telecommunications  Carriers.  Under  that  size  standard,  such  a  business  is  small  if  it  has  1,500 
 or  fewer  employees.  218  According  to  Commission  data,  219  22  companies  reported  that  they  were 


 211  13  C.  F.  R.    121.  201,  NAICS  code  513310  (changed  to  517110  in  October  2002). 
 212  Trends  in  Telephone  Service  at  Table  5.3. 
 213  Id. 
 214  Id. 
 215  13  C.  F.  R.    121.  201,  NAICS  code  513310  (changed  to  517110  in  October  2002). 
 216  Trends  in  Telephone  Service  at  Table  5.3. 
 217  Id. 
 218  13  C.  F.  R.    121.  201,  NAICS  code  513310  (changed  to  517110  in  October  2002). 
 219  Trends  in  Telephone  Service  at  Table  5.3. 
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 engaged  in  the  provision  of  operator  services.  Of  these  22  companies,  an  estimated  20  have  1,500  or  fewer  employees  and  two  have  more  than  1,500  employees.  220  Consequently,  the 
 Commission  estimates  that  the  great  majority  of  operator  service  providers  are  small  entities  that  may  be  affected  by  the  rules  and  policies  adopted  herein. 


 167.  Payphone  Service  Providers  (PSPs).  Neither  the  Commission  nor  the  SBA  has  developed  a  size  standard  for  small  businesses  specifically  applicable  to  payphone  services 
 providers.  The  closest  applicable  size  standard  under  SBA  rules  is  for  Wired  Telecommunications  Carriers.  Under  that  size  standard,  such  a  business  is  small  if  it  has  1,500 
 or  fewer  employees.  221  According  to  Commission  data,  222  936  companies  reported  that  they  were  engaged  in  the  provision  of  payphone  services.  Of  these  936  companies,  an  estimated  933  have 
 1,500  or  fewer  employees  and  three  have  more  than  1,500  employees.  223  Consequently,  the  Commission  estimates  that  the  great  majority  of  payphone  service  providers  are  small  entities 
 that  may  be  affected  by  the  rules  and  policies  adopted  herein. 
 168.  Prepaid  Calling  Card  Providers.  The  SBA  has  developed  a  size  standard  for  a  small  business  within  the  category  of  Telecommunications  Resellers.  Under  that  SBA  size 


 standard,  such  a  business  is  small  if  it  has  1,500  or  fewer  employees.  224  According  to  Commission  data,  225  32  companies  reported  that  they  were  engaged  in  the  provision  of  prepaid 
 calling  cards.  Of  these  32  companies,  an  estimated  31  have  1,500  or  fewer  employees  and  one  has  more  than  1,500  employees.  226  Consequently,  the  Commission  estimates  that  the  great 
 majority  of  prepaid  calling  card  providers  are  small  entities  that  may  be  affected  by  the  rules  and  policies  adopted  herein. 


 169.  Other  Toll  Carriers.  Neither  the  Commission  nor  the  SBA  has  developed  a  size  standard  for  small  businesses  specifically  applicable  to  Other  Toll  Carriers.  This  category 
 includes  toll  carriers  that  do  not  fall  within  the  categories  of  interexchange  carriers,  operator  service  providers,  prepaid  calling  card  providers,  satellite  service  carriers,  or  toll  resellers.  The 
 closest  applicable  size  standard  under  SBA  rules  is  for  Wired  Telecommunications  Carriers.  Under  that  size  standard,  such  a  business  is  small  if  it  has  1,500  or  fewer  employees.  227 
 According  to  Commissions  data,  228  42  companies  reported  that  their  primary  telecommunications  service  activity  was  the  provision  of  payphone  services.  Of  these  42 


 220  Id. 
 221  13  C.  F.  R.    121.  201,  NAICS  code  513310  (changed  to  517110  in  October  2002). 
 222  Trends  in  Telephone  Service  at  Table  5.3. 
 223  Id. 
 224  13  C.  F.  R.    121.  201,  NAICS  code  513330  (changed  to  517310  in  October  2002). 
 225  Trends  in  Telephone  Service  at  Table  5.3. 
 226  Id. 
 227  13  C.  F.  R.    121.  201,  NAICS  code  513310  (changed  to  517110  in  October  2002). 
 228  Trends  in  Telephone  Service  at  Table  5.3. 
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 companies,  an  estimated  37  have  1,500  or  fewer  employees  and  five  have  more  than  1,500  employees.  229  Consequently,  the  Commission  estimates  that  most  Other  Toll  Carriers  are  small 
 entities  that  may  be  affected  by  the  rules  and  policies  adopted  herein. 
 170.  Wireless  Service  Providers.  The  SBA  has  developed  a  small  business  size  standard  for  wireless  firms  within  the  two  broad  economic  census  categories  of  Paging  230  and 


 Cellular  and  Other  Wireless  Telecommunications.  231  Under  both  SBA  categories,  a  wireless  business  is  small  if  it  has  1,500  or  fewer  employees.  For  the  census  category  of  Paging,  Census 
 Bureau  data  for  1997  show  that  there  were  1320  firms  in  this  category,  total,  that  operated  for  the  entire  year.  232  Of  this  total,  1303  firms  had  employment  of  999  or  fewer  employees,  and  an 
 additional  17  firms  had  employment  of  1,000  employees  or  more.  233  Thus,  under  this  category  and  associated  small  business  size  standard,  the  great  majority  of  firms  can  be  considered  small. 
 For  the  census  category  Cellular  and  Other  Wireless  Telecommunications  firms,  Census  Bureau  data  for  1997  show  that  there  were  977  firms  in  this  category,  total,  that  operated  for  the  entire 
 year.  234  Of  this  total,  965  firms  had  employment  of  999  or  fewer  employees,  and  an  additional  12  firms  had  employment  of  1,000  employees  or  more.  235  Thus,  under  this  second  category  and  size 
 standard,  the  great  majority  of  firms  can,  again,  be  considered  small. 
 171.  Broadband  Personal  Communications  Service.  The  broadband  Personal  Communications  Service  (PCS)  spectrum  is  divided  into  six  frequency  blocks  designated  A 


 through  F,  and  the  Commission  has  held  auctions  for  each  block.  The  Commission  defined  small  entity  for  Blocks  C  and  F  as  an  entity  that  has  average  gross  revenues  of  $40  million  or 
 less  in  the  three  previous  calendar  years.  236  For  Block  F,  an  additional  classification  for  very  small  business  was  added  and  is  defined  as  an  entity  that,  together  with  its  affiliates,  has 
 average  gross  revenues  of  not  more  than  $15  million  for  the  preceding  three  calendar  years.  237  These  standards  defining  small  entity  in  the  context  of  broadband  PCS  auctions  have  been 


 229  Id. 
 230  13  C.  F.  R    121.201,  NAICS  code  513321  (changed  to  517211  in  October  2002). 
 231  Id.    121.  201,  NAICS  code  513322  (changed  to  517212  in  October  2002). 
 232  U.  S.  Census  Bureau,  1997  Economic  Census,  Subject  Series:  Information,  Employment  Size  of  Firms  Subject 
 to  Federal  Income  Tax:  1997,  Table  5,  NAICS  code  513321  (issued  Oct.  2000). 
 233  Id.  The  census  data  do  not  provide  a  more  precise  estimate  of  the  number  of  firms  that  have  employment  of 
 1,500  or  fewer  employees;  the  largest  category  provided  is  Firms  with  1,000  employees  or  more. 
 234  U.  S.  Census  Bureau,  1997  Economic  Census,  Subject  Series:  Information,  Employment  Size  of  Firms  Subject 
 to  Federal  Income  Tax:  1997,  Table  5,  NAICS  code  513322  (issued  Oct.  2000). 
 235  Id.  The  census  data  do  not  provide  a  more  precise  estimate  of  the  number  of  firms  that  have  employment  of 
 1,500  or  fewer  employees;  the  largest  category  provided  is  Firms  with  1,000  employees  or  more. 
 236  See  Amendment  of  Parts  20  and  24  of  the  Commissions  Rules    Broadband  PCS  Competitive  Bidding  and  the 
 Commercial  Mobile  Radio  Service  Spectrum  Cap,  WT  Docket  No.  96-  59,  Report  and  Order,  61  FR  33859  (July  1,  1996);  see  also  47  C.  F.  R.    24.720(  b). 


 237  See  id. 
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 approved  by  the  SBA.  238  No  small  businesses,  within  the  SBA-  approved  small  business  size  standards  bid  successfully  for  licenses  in  Blocks  A  and  B.  There  were  90  winning  bidders  that 
 qualified  as  small  entities  in  the  Block  C  auctions.  A  total  of  93  small  and  very  small  business  bidders  won  approximately  40  percent  of  the  1,479  licenses  for  Blocks  D,  E,  and  F.  239  On  March 
 23,  1999,  the  Commission  re-  auctioned  347  C,  D,  E,  and  F  Block  licenses.  There  were  48  small  business  winning  bidders.  On  January  26,  2001,  the  Commission  completed  the  auction  of  422 
 C  and  F  Broadband  PCS  licenses  in  Auction  No.  35.  Of  the  35  winning  bidders  in  this  auction,  29  qualified  as  small  or  very  small  businesses.  Based  on  this  information,  the  Commission 
 concludes  that  the  number  of  small  broadband  PCS  licenses  will  include  the  90  winning  C  Block  bidders,  the  93  qualifying  bidders  in  the  D,  E,  and  F  Block  auctions,  the  48  winning  bidders  in 
 the  1999  re-  auction,  and  the  29  winning  bidders  in  the  2001  re-  auction,  for  a  total  of  260  small  entity  broadband  PCS  providers,  as  defined  by  the  SBA  small  business  size  standards  and  the 
 Commissions  auction  rules.  Consequently,  the  Commission  estimates  that  260  broadband  PCS  providers  are  small  entities  that  may  be  affected  by  the  rules  and  policies  adopted  herein. 


 172.  Narrowband  Personal  Communications  Services.  To  date,  two  auctions  of  narrowband  personal  communications  services  (PCS)  licenses  have  been  conducted.  For 
 purposes  of  the  two  auctions  that  have  already  been  held,  small  businesses  were  entities  with  average  gross  revenues  for  the  prior  three  calendar  years  of  $40  million  or  less.  Through  these 
 auctions,  the  Commission  has  awarded  a  total  of  41  licenses,  out  of  which  11  were  obtained  by  small  businesses.  To  ensure  meaningful  participation  of  small  business  entities  in  future 
 auctions,  the  Commission  has  adopted  a  two-  tiered  small  business  size  standard  in  the  Narrowband  PCS  Second  Report  and  Order.  240  A  small  business  is  an  entity  that,  together 
 with  affiliates  and  controlling  interests,  has  average  gross  revenues  for  the  three  preceding  years  of  not  more  than  $40  million.  A  very  small  business  is  an  entity  that,  together  with  affiliates 
 and  controlling  interests,  has  average  gross  revenues  for  the  three  preceding  years  of  not  more  than  $15  million.  The  SBA  has  approved  these  small  business  size  standards.  241  In  the  future, 
 the  Commission  will  auction  459  licenses  to  serve  Metropolitan  Trading  Areas  (MTAs)  and  408  response  channel  licenses.  There  is  also  one  megahertz  of  narrowband  PCS  spectrum  that  has 
 been  held  in  reserve  and  that  the  Commission  has  not  yet  decided  to  release  for  licensing.  The  Commission  cannot  predict  accurately  the  number  of  licenses  that  will  be  awarded  to  small 
 entities  in  future  actions.  However,  four  of  the  16  winning  bidders  in  the  two  previous  narrowband  PCS  auctions  were  small  businesses,  as  that  term  was  defined  under  the 


 238  See.  e.  g.,  Implementation  of  Section  309(  j)  of  the  Communications  Act    Competitive  Bidding,  PP  Docket  No. 
 93-  253,  Fifth  Report  and  Order,  59  FR  37566  (July  22,  1994). 
 239  FCC  News,  Broadband  PCS,  D,  E  and  F  Block  Auction  Closes,  No.  71744  (released  January  14,  1997).  See 
 also  Amendment  of  the  Commissions  Rules  Regarding  Installment  Payment  Financing  for  Personal  Communications  Services  (PCS)  Licenses,  WT  Docket  No.  97-  82,  Second  Report  and  Order,  62  FR  55348  (Oct. 


 24,  1997). 
 240  Amendment  of  the  Commissions  Rules  to  Establish  New  Personal  Communications  Services,  Narrowband  PCS, 
 Docket  No.  ET  92-  100,  Docket  No.  PP  93-  253,  Second  Report  and  Order  and  Second  Further  Notice  of  Proposed  Rulemaking,  65  FR  35875  (June  6,  2000). 


 241  See  Letter  to  Amy  Zoslov,  Chief,  Auctions  and  Industry  Analysis  Division,  Wireless  Telecommunications 
 Bureau,  FCC,  from  Aida  Alvarez,  Administrator,  SBA  (Dec.  2,  1998). 
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 Commissions  Rules.  The  Commission  assumes,  for  purposes  of  this  analysis,  that  a  large  portion  of  the  remaining  narrowband  PCS  licenses  will  be  awarded  to  small  entities.  The 
 Commission  also  assumes  that  at  least  some  small  businesses  will  acquire  narrowband  PCS  licenses  by  means  of  the  Commissions  partitioning  and  disaggregation  rules. 


 173.  220  MHz  Radio  Service    Phase  I  Licensees.  The  220  MHz  service  has  both  Phase  I  and  Phase  II  licenses.  Phase  I  licensing  was  conducted  by  lotteries  in  1992  and  1993. 
 There  are  approximately  1,515  such  non-  nationwide  licensees  and  four  nationwide  licensees  currently  authorized  to  operate  in  the  220  MHz  band.  The  Commission  has  not  developed  a 
 small  business  size  standard  for  small  entities  specifically  applicable  to  such  incumbent  220  MHz  Phase  I  licensees.  To  estimate  the  number  of  such  licensees  that  are  small  businesses,  we 
 apply  the  small  business  size  standard  under  the  SBA  rules  applicable  to  Cellular  and  Other  Wireless  Telecommunications  companies.  This  standard  provides  that  such  a  company  is  small 
 if  it  employs  no  more  than  1,500  persons.  242  According  to  Census  Bureau  data  for  1997,  there  were  977  firms  in  this  category,  total,  that  operated  for  the  entire  year.  243  Of  this  total,  965  firms 
 had  employment  of  999  or  fewer  employees,  and  an  additional  12  firms  had  employment  of  1,000  employees  or  more.  244  If  this  general  ratio  continues  in  the  context  of  Phase  I  220  MHz 
 licensees,  the  Commission  estimates  that  nearly  all  such  licensees  are  small  businesses  under  the  SBAs  small  business  size  standard. 


 174.  220  MHz  Radio  Service    Phase  II  Licensees.  The  220  MHz  service  has  both  Phase  I  and  Phase  II  licenses.  The  Phase  II  220  MHz  service  is  a  new  service,  and  is  subject  to 
 spectrum  auctions.  In  the  220  MHz  Third  Report  and  Order,  we  adopted  a  small  business  size  standard  for  small  and  very  small  businesses  for  purposes  of  determining  their  eligibility  for 
 special  provisions  such  as  bidding  credits  and  installment  payments.  245  This  small  business  size  standard  indicates  that  a  small  business  is  an  entity  that,  together  with  its  affiliates  and 
 controlling  principals,  has  average  gross  revenues  not  exceeding  $15  million  for  the  preceding  three  years.  246  A  very  small  business  is  an  entity  that,  together  with  its  affiliates  and 
 controlling  principals,  has  average  gross  revenues  that  do  not  exceed  $3  million  for  the  preceding  three  years.  The  SBA  has  approved  these  small  business  size  standards.  247  Auctions  of  Phase  II 


 242  13  C.  F.  R.    121.  201,  NAICS  code  513322  (changed  to  517212  in  October  2002). 
 243  U.  S.  Census  Bureau,  1997  Economic  Census,  Subject  Series:  Information,  Employment  Size  of  Firms  Subject 
 to  Federal  Income  Tax:  1997,  Table  5,  NAICS  code  513322  (issued  Oct.  2000). 
 244  Id.  The  census  data  do  not  provide  a  more  precise  estimate  of  the  number  of  firms  that  have  employment  of 
 1,500  or  fewer  employees;  the  largest  category  provided  is  Firms  with  1,000  employees  or  more. 
 245  Amendment  of  Part  90  of  the  Commissions  Rules  to  Provide  for  the  Use  of  the  220-  222  MHz  Band  by  the 
 Private  Land  Mobile  Radio  Service,  PR  Docket  No.  89-  552,  GN  Docket  No.  93-  252,  PP  Docket  No.  93-  253,  Third  Report  and  Order  and  Fifth  Notice  of  Proposed  Rulemaking,  12  FCC  Rcd  10943,  11068-  70,  at  paras.  291-  95  (1997) 


 (220  MHz  Third  Report  and  Order). 
 246  Id.  at  11068-  70,  para.  291. 


 247  See  letter  to  D.  Phythyon,  Chief,  Wireless  Telecommunications  Bureau,  FCC,  from  Aida  Alvarez, 
 Administrator,  SBA  (Jan.  6,  1998). 
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 licenses  commenced  on  September  15,  1998,  and  closed  on  October  22,  1998.  248  In  the  first  auction,  908  licenses  were  auctioned  in  three  different-  sized  geographic  areas:  three  nationwide 
 licenses,  30  Regional  Economic  Area  Group  (EAG)  Licenses,  and  875  Economic  Area  (EA)  Licenses.  Of  the  908  licenses  auctioned,  693  were  sold.  Thirty-  nine  small  businesses  won 
 licenses  in  the  first  220  MHz  auction.  The  second  auction  included  225  licenses:  216  EA  licenses  and  9  EAG  licenses.  Fourteen  companies  claiming  small  business  status  won  158 
 licenses.  249 
 175.  800  MHz  and  900  MHz  Specialized  Mobile  Radio  Licenses.  The  Commission  awards  small  entity  and  very  small  entity  bidding  credits  in  auctions  for  Specialized  Mobile 


 Radio  (SMR)  geographic  area  licenses  in  the  900  MHz  bands  to  firms  that  had  revenues  of  no  more  than  $15  million  in  each  of  the  three  previous  calendar  years,  or  that  had  revenues  of  no 
 more  than  $3  million  in  each  of  the  previous  calendar  years.  250  The  SBA  has  approved  these  size  standards.  251  The  Commission  awards  small  entity  and  very  small  entity  bidding  credits  in 
 auctions  for  Specialized  Mobile  Radio  (SMR)  geographic  area  licenses  in  the  800  MHz  bands  to  firms  that  had  revenues  of  no  more  than  $40  million  in  each  of  the  three  previous  calendar  years, 
 or  that  had  revenues  of  no  more  than  $15  million  in  each  of  the  previous  calendar  years.  252  These  bidding  credits  apply  to  SMR  providers  in  the  800  MHz  and  900  MHz  bands  that  either  hold 
 geographic  area  licenses  or  have  obtained  extended  implementation  authorizations.  The  Commission  does  not  know  how  many  firms  provide  800  MHz  or  900  MHz  geographic  area 
 SMR  service  pursuant  to  extended  implementation  authorizations,  nor  how  many  of  these  providers  have  annual  revenues  of  no  more  than  $15  million.  One  firm  has  over  $15  million  in 
 revenues.  The  Commission  assumes,  for  purposes  here,  that  all  of  the  remaining  existing  extended  implementation  authorizations  are  held  by  small  entities,  as  that  term  is  defined  by  the 
 SBA.  The  Commission  has  held  auctions  for  geographic  area  licenses  in  the  800  MHz  and  900  MHz  SMR  bands.  There  were  60  winning  bidders  that  qualified  as  small  or  very  small  entities  in 
 the  900  MHz  SMR  auctions.  Of  the  1,020  licenses  won  in  the  900  MHz  auction,  bidders  qualifying  as  small  or  very  small  entities  won  263  licenses.  In  the  800  MHz  auction,  38  of  the 
 524  licenses  won  were  won  by  small  and  very  small  entities.  Consequently,  the  Commission  estimates  that  there  are  301  or  fewer  small  entity  SMR  licensees  in  the  800  MHz  and  900  MHz 
 bands  that  may  be  affected  by  the  rules  and  policies  adopted  herein. 
 176.  Paging.  In  the  Paging  Third  Report  and  Order,  we  developed  a  small  business  size  standard  for  small  businesses  and  very  small  businesses  for  purposes  of  determining 


 248  See  generally  Public  Notice,  220  MHz  Service  Auction  Closes,  14  FCC  Rcd  605  (1998). 
 249  Public  Notice,  Phase  II  220  MHz  Service  Spectrum  Auction  Closes,  14  FCC  Rcd  11218  (1999). 
 250  47  C.  F.  R.    90.  814(  b)(  1). 
 251  See  Letter  from  Aida  Alvarez,  Administration,  Small  Business  Administration  to  Daniel  B.  Phythyon,  Chief, 
 Wireless  Telecommunications  Bureau,  Federal  Communications  Commission  (Oct.  27,  1997).  See  Letter  from  Aida  Alvarez,  Administrator,  Small  Business  Administration  to  Thomas  Sugrue,  Chief,  Auctions  and  Industry  Analysis 


 Division,  Wireless  Telecommunications  Bureau,  Federal  Communications  Commission  (Aug.  10,  1999). 
 252  47  C.  F.  R.    90.  814(  b)(  1)  A  request  for  approval  of  800  MHz  standards  was  sent  to  the  SBA  on  May  13,  1999. 
 The  matter  remains  pending. 
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 their  eligibility  for  special  provisions  such  as  bidding  credits  and  installment  payments.  253  A  small  business  is  an  entity  that,  together  with  its  affiliates  and  controlling  principals,  has 
 average  gross  revenues  not  exceeding  $15  million  for  the  preceding  three  years.  Additionally,  a  very  small  business  is  an  entity  that,  together  with  its  affiliates  and  controlling  principals,  has 
 average  gross  revenues  that  are  not  more  than  $3  million  for  the  preceding  three  years.  The  SBA  has  approved  these  size  standards.  254  An  auction  of  Metropolitan  Economic  Area  licenses 
 commenced  on  February  24,  2000,  and  closed  on  March  2,  2000.  255  Of  the  985  licenses  auctioned,  440  were  sold.  Fifty-  seven  companies  claiming  small  business  status  won.  At 
 present,  there  are  approximately  24,000  Private-  Paging  site-  specific  licenses  and  74,000  Common  Carrier  Paging  licenses.  According  to  the  most  recent  Trends  in  Telephone  Service, 
 471  carriers  reported  that  they  were  engaged  in  the  provision  of  either  paging  and  messaging  services  or  other  mobile  services.  256  Of  those,  the  Commission  estimates  that  450  are  small, 
 under  the  SBA  business  size  standard  specifying  that  firms  are  small  if  they  have  1,500  or  fewer  employees.  257 


 177.  700  MHz  Guard  Band  Licensees.  In  the  700  MHz  Guard  Band  Order,  we  adopted  a  small  business  size  standard  for  small  businesses  and  very  small  businesses  for  purposes  of 
 determining  their  eligibility  for  special  provisions  such  as  bidding  credits  and  installment  payments.  258  A  small  business  as  an  entity  that,  together  with  its  affiliates  and  controlling 
 principals,  has  average  gross  revenues  not  exceeding  $15  million  for  the  preceding  three  years.  Additionally,  a  very  small  business  is  an  entity  that,  together  with  its  affiliates  and  controlling 
 principals,  has  average  gross  revenues  that  are  not  more  than  $3  million  for  the  preceding  three  years.  An  auction  of  52  Major  Economic  Area  (MEA)  licenses  commenced  on  September  6, 
 2000,  and  closed  on  September  21,  2000.  259  Of  the  104  licenses  auctioned,  96  licenses  were  sold  to  nine  bidders.  Five  of  these  bidders  were  small  businesses  that  won  a  total  of  26  licenses.  A 
 second  auction  of  700  MHz  Guard  Band  licenses  commenced  on  February  13,  2001  and  closed  on  February  21,  2001.  All  eight  of  the  licenses  auctioned  were  sold  to  three  bidders.  One  of 


 253  220  MHz  Third  Report  and  Order,  12  FCC  Rcd  at  11068-  70,  paras.  291-  295,  62  FR  16004  at  paras.  291-  295 
 (1997). 
 254  See  Letter  from  Aida  Alvarez,  Administrator,  Small  Business  Administration  to  Thomas  Sugrue,  Chief, 
 Auctions  and  Industry  Analysis  Division,  Wireless  Telecommunications  Bureau,  Federal  Communications  Commission  (June  4,  1999). 


 255  Revision  of  Part  22  and  Part  90  of  the  Commissions  Rules  to  Facilitate  Future  Development  of  Paging 
 Systems,  WT  Docket  No.  96-  18,  PR  Docket  No.  93-  253,  Memorandum  Opinion  and  Order  on  Reconsideration  and  Third  Report  and  Order,  14  FCC  Rcd  10030,  10085,  at  para.  98  (1999). 


 256  Trends  in  Telephone  Service  at  Table  5.3. 
 257  Id.  The  SBA  size  standard  is  that  of  Paging,  13  C.  F.  R.    121.201,  NAICS  code  517211. 
 258  See  Service  Rules  for  the  746-  764  MHz  Bands,  and  Revisions  to  part  27  of  the  Commissions  Rules,  WT  Docket 
 No.  99-  168,  Second  Report  and  Order,  15  FCC  Rcd  5299,  5344,  at  para.  108  (2000). 
 259  See  generally  Public  Notice,  220  MHz  Service  Auction  Closes,  Report  No.  WT  98-  36  (Wireless 
 Telecommunications  Bureau,  Oct.  23,  1998). 
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 these  bidders  was  a  small  business  that  won  a  total  of  two  licenses.  260 
 178.  Rural  Radiotelephone  Service.  The  Commission  has  not  adopted  a  size  standard  for  small  businesses  specific  to  the  Rural  Radiotelephone  Service.  261  A  significant  subset  of  the 


 Rural  Radiotelephone  Service  is  the  Basic  Exchange  Telephone  Radio  System  (BETRS).  262  The  Commission  uses  the  SBAs  small  business  size  standard  applicable  to  Cellular  and  Other 
 Wireless  Telecommunications,  i.  e.,  an  entity  employing  no  more  than  1,500  persons.  263  There  are  approximately  1,000  licensees  in  the  Rural  Radiotelephone  Service,  and  the  Commission 
 estimates  that  there  are  1,000  or  fewer  small  entity  licensees  in  the  Rural  Radiotelephone  Service  that  may  be  affected  by  the  rules  and  policies  adopted  herein. 


 179.  Air-  Ground  Radiotelephone  Service.  The  Commission  has  not  adopted  a  small  business  size  standard  specific  to  the  Air-  Ground  Radiotelephone  Service.  264  We  will  use  SBAs 
 small  business  size  standard  applicable  to  Cellular  and  Other  Wireless  Telecommunications,  i.  e.,  an  entity  employing  no  more  than  1,500  persons.  265  There  are  approximately  100  licensees 
 in  the  Air-  Ground  Radiotelephone  Service,  and  we  estimate  that  almost  all  of  them  qualify  as  small  under  the  SBA  small  business  size  standard. 


 180.  Aviation  and  Marine  Radio  Services.  Small  businesses  in  the  aviation  and  marine  radio  services  use  a  very  high  frequency  (VHF)  marine  or  aircraft  radio  and,  as  appropriate,  an 
 emergency  position-  indicating  radio  beacon  (and/  or  radar)  or  an  emergency  locator  transmitter.  The  Commission  has  not  developed  a  small  business  size  standard  specifically  applicable  to 
 these  small  businesses.  For  purposes  of  this  analysis,  the  Commission  uses  the  SBA  small  business  size  standard  for  the  category  Cellular  and  Other  Telecommunications,  which  is  1,500 
 or  fewer  employees.  266  Most  applicants  for  recreational  licenses  are  individuals.  Approximately  581,000  ship  station  licensees  and  131,000  aircraft  station  licensees  operate  domestically  and  are 
 not  subject  to  the  radio  carriage  requirements  of  any  statute  or  treaty.  For  purposes  of  our  evaluations  in  this  analysis,  we  estimate  that  there  are  up  to  approximately  712,000  licensees  that 
 are  small  businesses  (or  individuals)  under  the  SBA  standard.  In  addition,  between  December  3,  1998  and  December  14,  1998,  the  Commission  held  an  auction  of  42  VHF  Public  Coast  licenses 
 in  the  157.1875-  157.4500  MHz  (ship  transmit)  and  161.775-  162.0125  MHz  (coast  transmit)  bands.  For  purposes  of  the  auction,  the  Commission  defined  a  "small"  business  as  an  entity  that, 
 together  with  controlling  interests  and  affiliates,  has  average  gross  revenues  for  the  preceding  three  years  not  to  exceed  $15  million  dollars.  In  addition,  a  "very  small"  business  is  one  that, 
 together  with  controlling  interests  and  affiliates,  has  average  gross  revenues  for  the  preceding 
 260  Public  Notice,  700  MHz  Guard  Band  Auction  Closes,  DA  01-  478  (released  Feb.  22,  2001). 
 261  The  service  is  defined  in    22.  99  of  the  Commissions  Rules,  47  C.  F.  R.    22.  99. 
 262  BETRS  is  defined  in    22.  757  and  22.  759  of  the  Commissions  Rules,  47  C.  F.  R.    22.  757  and  22.  759. 
 263  13  C.  F.  R.    121.  201,  NAICS  code  513322  (changed  to  517212  in  October  2002). 
 264  The  service  is  defined  in    22.  99  of  the  Commissions  Rules,  47  C.  F.  R.    22.  99. 
 265  13  C.  F.  R    121.201,  NAICS  codes  513322  (changed  to  517212  in  October  2002). 
 266  Id.    121.  201,  NAICS  code  513322  (changed  to  517212  in  October  2002). 
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 three  years  not  to  exceed  $3  million  dollars.  267  There  are  approximately  10,672  licensees  in  the  Marine  Coast  Service,  and  the  Commission  estimates  that  almost  all  of  them  qualify  as  "small" 
 businesses  under  the  above  special  small  business  size  standards. 
 181.  Fixed  Microwave  Services.  Fixed  microwave  services  include  common  carrier,  268  private  operational-  fixed,  269  and  broadcast  auxiliary  radio  services.  270  At  present,  there  are 


 approximately  22,015  common  carrier  fixed  licensees  and  61,670  private  operational-  fixed  licensees  and  broadcast  auxiliary  radio  licensees  in  the  microwave  services.  The  Commission 
 has  not  created  a  size  standard  for  a  small  business  specifically  with  respect  to  fixed  microwave  services.  For  purposes  of  this  analysis,  the  Commission  uses  the  SBA  small  business  size 
 standard  for  the  category  Cellular  and  Other  Telecommunications,  which  is  1,500  or  fewer  employees.  271  The  Commission  does  not  have  data  specifying  the  number  of  these  licensees  that 
 have  more  than  1,500  employees,  and  thus  are  unable  at  this  time  to  estimate  with  greater  precision  the  number  of  fixed  microwave  service  licensees  that  would  qualify  as  small  business 
 concerns  under  the  SBAs  small  business  size  standard.  Consequently,  the  Commission  estimates  that  there  are  up  to  22,015  common  carrier  fixed  licensees  and  up  to  61,670  private 
 operational-  fixed  licensees  and  broadcast  auxiliary  radio  licensees  in  the  microwave  services  that  may  be  small  and  may  be  affected  by  the  rules  and  policies  adopted  herein.  We  noted,  however, 
 that  the  common  carrier  microwave  fixed  licensee  category  includes  some  large  entities. 
 182.  Offshore  Radiotelephone  Service.  This  service  operates  on  several  UHF  television  broadcast  channels  that  are  not  used  for  television  broadcasting  in  the  coastal  areas  of 


 states  bordering  the  Gulf  of  Mexico.  272  There  are  presently  approximately  55  licensees  in  this  service.  We  are  unable  to  estimate  at  this  time  the  number  of  licensees  that  would  qualify  as 
 small  under  the  SBAs  small  business  size  standard  for  Cellular  and  Other  Wireless  Telecommunications  services.  273  Under  that  SBA  small  business  size  standard,  a  business  is 


 267  Amendment  of  the  Commission's  Rules  Concerning  Maritime  Communications,  PR  Docket  No.  92-  257,  Third 
 Report  and  Order  and  Memorandum  Opinion  and  Order,  13  FCC  Rcd  19853  (1998). 
 268  See  47  C.  F.  R.    101  et  seq.  (formerly,  Part  21  of  the  Commissions  Rules)  for  common  carrier  fixed 
 microwave  services  (except  Multipoint  Distribution  Service). 
 269  Persons  eligible  under  parts  80  and  90  of  the  Commissions  Rules  can  use  Private  Operational-  Fixed 
 Microwave  services.  See  47  C.  F.  R.  Parts  80  and  90.  Stations  in  this  service  are  called  operational-  fixed  to  distinguish  them  from  common  carrier  and  public  fixed  stations.  Only  the  licensee  may  use  the  operational-  fixed 


 station,  and  only  for  communications  related  to  the  licensees  commercial,  industrial,  or  safety  operations. 
 270  Auxiliary  Microwave  Service  is  governed  by  Part  74  of  Title  47  of  the  Commissions  Rules.  See  47  C.  F.  R.  Part 
 74.  This  service  is  available  to  licensees  of  broadcast  stations  and  to  broadcast  and  cable  network  entities.  Broadcast  auxiliary  microwave  stations  are  used  for  relaying  broadcast  television  signals  from  the  studio  to  the 


 transmitter,  or  between  two  points  such  as  a  main  studio  and  an  auxiliary  studio.  The  service  also  includes  mobile  television  pickups,  which  relay  signals  from  a  remote  location  back  to  the  studio. 


 271  13  C.  F.  R.    121.  201,  NAICS  code  513322  (changed  to  517212  in  October  2002). 
 272  This  service  is  governed  by  Subpart  I  of  Part  22  of  the  Commissions  Rules.  See  47  C.  F.  R.    22.  1001-22. 
 1037. 
 273  13  C.  F.  R.    121.  201,  NAICS  code  513322  (changed  to  517212  in  October  2002). 
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 small  if  it  has  1,500  or  fewer  employees.  274 
 183.  Wireless  Communications  Services.  This  service  can  be  used  for  fixed,  mobile,  radiolocation,  and  digital  audio  broadcasting  satellite  uses.  The  Commission  established  small 


 business  size  standards  for  the  wireless  communications  services  (WCS)  auction.  A  small  business  is  an  entity  with  average  gross  revenues  of  $40  million  for  each  of  the  three  preceding 
 years,  and  a  very  small  business  is  an  entity  with  average  gross  revenues  of  $15  million  for  each  of  the  three  preceding  years.  The  SBA  has  approved  these  small  business  size  standards.  275 
 The  Commission  auctioned  geographic  area  licenses  in  the  WCS  service.  In  the  auction,  there  were  seven  winning  bidders  that  qualified  as  very  small  business  entities,  and  one  that 
 qualified  as  a  small  business  entity.  We  conclude  that  the  number  of  geographic  area  WCS  licensees  affected  by  this  analysis  includes  these  eight  entities. 


 184.  39  GHz  Service.  The  Commission  created  a  special  small  business  size  standard  for  39  GHz  licenses    an  entity  that  has  average  gross  revenues  of  $40  million  or  less  in  the  three 
 previous  calendar  years.  276  An  additional  size  standard  for  very  small  business  is:  an  entity  that,  together  with  affiliates,  has  average  gross  revenues  of  not  more  than  $15  million  for  the 
 preceding  three  calendar  years.  277  The  SBA  has  approved  these  small  business  size  standards.  278  The  auction  of  the  2,173  39  GHz  licenses  began  on  April  12,  2000  and  closed  on  May  8,  2000. 
 The  18  bidders  who  claimed  small  business  status  won  849  licenses.  Consequently,  the  Commission  estimates  that  18  or  fewer  39  GHz  licensees  are  small  entities  that  may  be  affected 
 by  the  rules  and  polices  adopted  herein. 
 185.  Multipoint  Distribution  Service,  Multichannel  Multipoint  Distribution  Service,  and  ITFS.  Multichannel  Multipoint  Distribution  Service  (MMDS)  systems,  often  referred  to  as 


 wireless  cable,  transmit  video  programming  to  subscribers  using  the  microwave  frequencies  of  the  Multipoint  Distribution  Service  (MDS)  and  Instructional  Television  Fixed  Service  (ITFS).  279 
 In  connection  with  the  1996  MDS  auction,  the  Commission  established  a  small  business  size  standard  as  an  entity  that  had  annual  average  gross  revenues  of  less  than  $40  million  in  the 
 previous  three  calendar  years.  280  The  MDS  auctions  resulted  in  67  successful  bidders  obtaining 
 274  Id. 
 275  See  Letter  to  Amy  Zoslov,  Chief,  Auctions  and  Industry  Analysis  Division,  Wireless  Telecommunications 
 Bureau,  FCC,  from  Aida  Alvarez,  Administrator,  SBA  (Dec.  2,  1998). 
 276  See  Amendment  of  the  Commissions  Rules  Regarding  the  37.  0-  38.6  GHz  and  38.  6-  40.0  GHz  Bands,  ET 
 Docket  No.  95-  183,  Report  and  Order,  63  FR  6079  (Feb.  6,  1998). 
 277  Id. 


 278  See  Letter  to  Kathleen  OBrien  Ham,  Chief,  Auctions  and  Industry  Analysis  Division,  Wireless 
 Telecommunications  Bureau,  FCC,  from  Aida  Alvarez,  Administrator,  SBA  (Feb.  4,  1998). 
 279  Amendment  of  Parts  21  and  74  of  the  Commissions  Rules  with  Regard  to  Filing  Procedures  in  the  Multipoint 
 Distribution  Service  and  in  the  Instructional  Television  Fixed  Service  and  Implementation  of  Section  309(  j)  of  the  Communications  Act    Competitive  Bidding,  MM  Docket  No.  94-  131  and  PP  Docket  No.  93-  253,  Report  and  Order, 


 10  FCC  Rcd  9589,  9593  at  para.  7  (1995). 
 280  47  C.  F.  R.    21.  961(  b)(  1). 
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 licensing  opportunities  for  493  Basic  Trading  Areas  (BTAs).  Of  the  67  auction  winners,  61  met  the  definition  of  a  small  business.  MDS  also  includes  licensees  of  stations  authorized  prior  to  the 
 auction.  In  addition,  the  SBA  has  developed  a  small  business  size  standard  for  Cable  and  Other  Program  Distribution,  which  includes  all  such  companies  generating  $12.5  million  or  less  in 
 annual  receipts.  281  According  to  Census  Bureau  data  for  1997,  there  were  a  total  of  1,311  firms  in  this  category,  total,  that  had  operated  for  the  entire  year.  282  Of  this  total,  1,180  firms  had 
 annual  receipts  of  under  $10  million  and  an  additional  52  firms  had  receipts  of  $10  million  or  more  but  less  than  $25  million.  Consequently,  we  estimate  that  the  majority  of  providers  in  this 
 service  category  are  small  businesses  that  may  be  affected  by  the  rules  and  policies  adopted  herein.  This  SBA  small  business  size  standard  also  appears  applicable  to  ITFS.  There  are 
 presently  2,032  ITFS  licensees.  All  but  100  of  these  licenses  are  held  by  educational  institutions.  Educational  institutions  are  included  in  this  analysis  as  small  entities.  283  Thus,  we  tentatively 
 conclude  that  at  least  1,932  licensees  are  small  businesses. 
 186.  Local  Multipoint  Distribution  Service.  Local  Multipoint  Distribution  Service  (LMDS)  is  a  fixed  broadband  point-  to-  multipoint  microwave  service  that  provides  for  two-  way 


 video  telecommunications.  284  The  auction  of  the  1,030  Local  Multipoint  Distribution  Service  (LMDS)  licenses  began  on  February  18,  1998  and  closed  on  March  25,  1998.  The  Commission 
 established  a  small  business  size  standard  for  LMDS  licenses  as  an  entity  that  has  average  gross  revenues  of  less  than  $40  million  in  the  three  previous  calendar  years.  285  An  additional  small 
 business  size  standard  for  very  small  business  was  added  as  an  entity  that,  together  with  its  affiliates,  has  average  gross  revenues  of  not  more  than  $15  million  for  the  preceding  three 
 calendar  years.  286  The  SBA  has  approved  these  small  business  size  standards  in  the  context  of  LMDS  auctions.  287  There  were  93  winning  bidders  that  qualified  as  small  entities  in  the  LMDS 
 auctions.  A  total  of  93  small  and  very  small  business  bidders  won  approximately  277  A  Block  licenses  and  387  B  Block  licenses.  On  March  27,  1999,  the  Commission  re-  auctioned  161 
 licenses;  there  were  40  winning  bidders.  Based  on  this  information,  we  conclude  that  the  number  of  small  LMDS  licenses  consists  of  the  93  winning  bidders  in  the  first  auction  and  the  40 
 winning  bidders  in  the  re-  auction,  for  a  total  of  133  small  entity  LMDS  providers. 
 281  13  C.  F.  R.    121.  201,  NAICS  code  513220  (changed  to  517510  in  October  2002). 
 282  U.  S.  Census  Bureau,  1997  Economic  Census,  Subject  Series:  Information,  Establishment  and  Firm  Size 
 (Including  Legal  Form  of  Organization),  Table  4,  NAICS  code  513220  (issued  October  2000). 
 283  In  addition,  the  term  small  entity  within  SBREFA  applies  to  small  organizations  (nonprofits)  and  to  small 
 governmental  jurisdictions  (cities,  counties,  towns,  townships,  villages,  school  districts,  and  special  districts  with  populations  of  less  than  50,  000).  5  U.  S.  C.    601(  4)-(  6).  We  do  not  collect  annual  revenue  data  on  ITFS  licensees. 


 284  See  Rulemaking  to  Amend  Parts  1,  2,  21,  and  25  of  the  Commissions  Rules  to  Redesignate  the  27.  5-  29.  5  GHz 
 Frequency  Band,  to  Reallocate  the  29.  5-  30.  0  GHz  Frequency  Band,  and  to  Establish  Rules  and  Policies  for  Local  Multipoint  Distribution  Service  and  for  Fixed  Satellite  Services,  CC  Docket  No.  92-  297,  Second  Report  and  Order, 


 12  FCC  Rcd  12545  (1997). 
 285  Id. 


 286  See  id. 
 287  See  Letter  to  Dan  Phythyon,  Chief,  Wireless  Telecommunications  Bureau,  FCC,  from  Aida  Alvarez, 
 Administrator,  SBA  (Jan.  6,  1998). 
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 187.  218-  219  MHz  Service.  The  first  auction  of  218-  219  MHz  spectrum  resulted  in  170  entities  winning  licenses  for  594  Metropolitan  Statistical  Area  (MSA)  licenses.  Of  the  594 
 licenses,  557  were  won  by  entities  qualifying  as  a  small  business.  For  that  auction,  the  small  business  size  standard  was  an  entity  that,  together  with  its  affiliates,  has  no  more  than  a  $6 
 million  net  worth  and,  after  federal  income  taxes  (excluding  any  carry  over  losses),  has  no  more  than  $2  million  in  annual  profits  each  year  for  the  previous  two  years.  288  In  the  218-  219  MHz 
 Report  and  Order  and  Memorandum  Opinion  and  Order,  we  established  a  small  business  size  standard  for  a  small  business  as  an  entity  that,  together  with  its  affiliates  and  persons  or  entities 
 that  hold  interests  in  such  an  entity  and  their  affiliates,  has  average  annual  gross  revenues  not  to  exceed  $15  million  for  the  preceding  three  years.  289  A  very  small  business  is  defined  as  an 
 entity  that,  together  with  its  affiliates  and  persons  or  entities  that  hold  interests  in  such  an  entity  and  its  affiliates,  has  average  annual  gross  revenues  not  to  exceed  $3  million  for  the  preceding 
 three  years.  290  The  SBA  has  approved  these  size  standards.  291  We  cannot  estimate,  however,  the  number  of  licenses  that  will  be  won  by  entities  qualifying  as  small  or  very  small  businesses 
 under  our  rules  in  future  auctions  of  218-  219  MHz  spectrum. 
 188.  24  GHz    Incumbent  Licensees.  This  analysis  may  affect  incumbent  licensees  who  were  relocated  to  the  24  GHz  band  from  the  18  GHz  band,  and  applicants  who  wish  to 


 provide  services  in  the  24  GHz  band.  The  applicable  SBA  small  business  size  standard  is  that  of  Cellular  and  Other  Wireless  Telecommunications  companies.  This  category  provides  that  such 
 a  company  is  small  if  it  employs  no  more  than  1,500  persons.  292  According  to  Census  Bureau  data  for  1997,  there  were  977  firms  in  this  category,  total,  that  operated  for  the  entire  year.  293  Of 
 this  total,  965  firms  had  employment  of  999  or  fewer  employees,  and  an  additional  12  firms  had  employment  of  1,000  employees  or  more.  294  Thus,  under  this  size  standard,  the  great  majority  of 
 firms  can  be  considered  small.  These  broader  census  data  notwithstanding,  we  believe  that  there  are  only  two  licensees  in  the  24  GHz  band  that  were  relocated  from  the  18  GHz  band,  Teligent  295 
 and  TRW,  Inc.  It  is  our  understanding  that  Teligent  and  its  related  companies  have  less  than 
 288  Implementation  of  Section  309(  j)  of  the  Communications  Act    Competitive  Bidding,  PP  Docket  No.  93-  253, 
 Fourth  Report  and  Order,  59  FR  24947  (May  13,  1994). 
 289  Amendment  of  Part  95  of  the  Commissions  Rules  to  Provide  Regulatory  Flexibility  in  the  218-  219  MHz 
 Service,  WT  Docket  No.  98-  169,  Report  and  Order  and  Memorandum  Opinion  and  Order,  64  FR  59656  (Nov.  3,  1999). 


 290  Id. 
 291  See  Letter  to  Daniel  B.  Phythyon,  Chief,  Wireless  Telecommunications  Bureau,  Federal  Communications 
 Commission,  from  Aida  Alvarez,  Administrator,  Small  Business  Administration  (Jan.  6,  1998). 
 292  13  C.  F.  R.    121.  201,  NAICS  code  513322  (changed  to  517212  in  October  2002). 


 293  U.  S.  Census  Bureau,  1997  Economic  Census,  Subject  Series:  Information,  Employment  Size  of  Firms  Subject 
 to  Federal  Income  Tax:  1997,  Table  5,  NAICS  code  513322  (issued  Oct.  2000). 
 294  Id.  The  census  data  do  not  provide  a  more  precise  estimate  of  the  number  of  firms  that  have  employment  of 
 1,500  or  fewer  employees;  the  largest  category  provided  is  Firms  with  1,000  employees  or  more. 
 295  Teligent  acquired  the  DEMS  licenses  of  FirstMark,  the  only  licensee  other  than  TRW  in  the  24  GHz  band 
 whose  license  has  been  modified  to  require  relocation  to  the  24  GHz  band. 
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 1,500  employees,  though  this  may  change  in  the  future.  TRW  is  not  a  small  entity.  Thus,  only  one  incumbent  licensee  in  the  24  GHz  band  is  a  small  business  entity. 
 189.  24  GHz    Future  Licensees.  With  respect  to  new  applicants  in  the  24  GHz  band,  the  small  business  size  standard  for  small  business  is  an  entity  that,  together  with  controlling 
 interests  and  affiliates,  has  average  annual  gross  revenues  for  the  three  preceding  years  not  in  excess  of  $15  million.  296  Very  small  business  in  the  24  GHz  band  is  an  entity  that,  together 
 with  controlling  interests  and  affiliates,  has  average  gross  revenues  not  exceeding  $3  million  for  the  preceding  three  years.  297  The  SBA  has  approved  these  small  business  size  standards.  298 
 These  size  standards  will  apply  to  the  future  auction,  if  held. 
 190.  Internet  Service  Providers.  While  internet  service  providers  (ISPs)  are  only  indirectly  affected  by  our  present  actions,  and  ISPs  are  therefore  not  formally  included  within 


 this  present  IRFA,  we  have  addressed  them  informally  to  create  a  fuller  record  and  to  recognize  their  participation  in  this  proceeding.  The  SBA  has  developed  a  small  business  size  standard  for 
 Online  Information  Services,  which  consists  of  all  such  companies  having  $21  million  or  less  in  annual  receipts.  299  According  to  Census  Bureau  data  for  1997,  there  were  2,751  firms  in  this 
 category,  total,  that  operated  for  the  entire  year.  300  Of  this  total,  2,659  firms  had  annual  receipts  of  $9,999,999  or  less,  and  an  additional  67  had  receipts  of  $10  million  to  $24,999,999.  301  Thus, 
 under  this  size  standard,  the  great  majority  of  firms  can  be  considered  small. 
 4.  Description  of  Projected  Reporting,  Recordkeeping,  and  Other  Compliance  Requirements 


 191.  We  do  not  intend  that  any  proposal  we  may  adopt  pursuant  to  this  Notice  will  increase  existing  reporting,  recordkeeping  or  other  compliance  requirements.  Rather,  we  seek  to 
 simplify  TELRIC  pricing  and  modify  or  clarify  the  Commissions  rules  to  help  state  commissions  more  easily  develop  UNE  prices  and  resale  discounts  that  meet  the  statutory 
 standards  established  by  Congress  in  section  252(  d)  and  to  provide  more  certainty  and  consistency  in  state  proceeding  outcomes. 


 5.  Steps  Taken  to  Minimize  Significant  Economic  Impact  on  Small  Entities,  and  Significant  Alternatives  Considered 


 296  Amendments  to  Parts  1,  2,  87  and  101  of  the  Commissions  Rules  to  License  Fixed  Services  at  24  GHz,  WT 
 Docket  No.  99-  327,  Report  and  Order,  15  FCC  Rcd  16934,  16967  (2000);  see  also  47  C.  F.  R.    101.538(  a)(  2). 
 297  Amendments  to  Parts  1,  2,  87  and  101  of  the  Commissions  Rules  to  License  Fixed  Services  at  24  GHz,  WT 
 Docket  No.  99-  327,  Report  and  Order,  15  FCC  Rcd  at  16967;  see  also  47  C.  F.  R.    101.  538(  a)(  1). 
 298  See  Letter  to  Margaret  W.  Wiener,  Deputy  Chief,  Auctions  and  Industry  Analysis  Division,  Wireless 
 Telecommunications  Bureau,  FCC,  from  Gary  M.  Jackson,  Assistant  Administrator,  SBA  (July  28,  2000). 
 299  13  C.  F.  R.    121.  201,  NAICS  code  514191  (changed  to  518111  in  October  2002). 


 300  U.  S.  Census  Bureau,  1997  Economic  Census,  Subject  Series:  Information,  Receipts  Size  of  Firms  Subject  to 
 Federal  Income  Tax:  1997,  Table  4,  NAICS  code  514191  (issued  October  2000). 
 301  Id. 
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 Federal  Communications  Commission  FCC  03-  224 
 66 
 192.  The  RFA  requires  an  agency  to  describe  any  significant,  specifically  small  business,  alternatives  that  it  has  considered  in  reaching  its  proposed  approach,  which  may 
 include  the  following  four  alternatives  (among  others):  (1)  the  establishment  of  differing  compliance  or  reporting  requirements  or  timetables  that  take  into  account  the  resources  available 
 to  small  entities;  (2)  the  clarification,  consolidation,  or  simplification  of  compliance  or  reporting  requirements  under  the  rule  for  small  entities;  (3)  the  use  of  performance,  rather  than  design, 
 standards;  and  (4)  an  exemption  from  coverage  of  the  rule,  or  any  part  thereof,  for  small  entities.  302 


 193.  We  will  consider  any  proposals  made  to  minimize  significant  economic  impact  on  small  entities.  The  overall  objective  of  this  proceeding  is  to  simplify  TELRIC  pricing  while 
 simultaneously  improving  the  accuracy  of  its  pricing  signals.  The  Notice  seeks  comment  on  an  approach  that  bases  UNE  prices  on  a  cost  inquiry  that  is  more  firmly  rooted  in  the  real-  world 
 attributes  of  the  existing  telecommunications  network,  rather  than  the  speculative  attributes  of  a  purely  hypothetical  network.  This  may  change  the  standards  applicable  to  cost  studies  on  which 
 UNE  prices  are  based  and  indirectly  result  in  changes  to  rates  for  UNEs  that  competitive  LECs,  including  small  carriers,  order  from  incumbent  LECs. 


 194.  State  commissions  stand  to  benefit  directly  to  the  extent  that  we  clarify  our  TELRIC  rules  and  provide  more  specific  guidance  so  that  state  proceedings  to  determine  UNE 
 pricing  and  the  resale  discount  become  a  less  complex  and  speculative  process.  Providing  greater  certainty  and  consistency  in  how  to  apply  our  rules  could  help  make  the  regulatory 
 process  throughout  states  more  efficient  and  streamlined,  indirectly  benefiting  small  entities  which  participate  in  these  proceedings.  Complicated  and  time-  consuming  proceedings  may  work 
 to  divert  scarce  resources  from  small  carriers  that  otherwise  would  use  those  resources  to  compete  in  local  markets.  Moreover,  to  the  extent  that  we  may  be  able  to  enhance  the  TELRIC 
 ratemaking  process,  we  may  better  be  able  to  achieve  the  Commissions  goal  of  sending  appropriate  economic  signals  to  the  marketplace  for  efficient  competition  and  entry  among 
 providers  that  include  small  entities. 
 6.  Federal  Rules  that  May  Duplicate,  Overlap,  or  Conflict  with  the  Proposed  Rules 


 195.  None. 
 C.  Ex  Parte  Presentations 
 196.  This  matter  shall  be  treated  as  a  permit-  but-  disclose  proceeding  in  accordance  with  the  Commissions  ex  parte  rules.  303  Persons  making  oral  ex  parte  presentations  are 


 reminded  that  memoranda  summarizing  the  presentations  must  contain  summaries  of  the  substance  of  the  presentations  and  not  merely  a  listing  of  the  subjects  discussed.  More  than  a 
 one-  or  two-  sentence  description  of  the  views  and  arguments  presented  generally  is  required.  304 
 302  5  U.  S.  C.    603(  c). 


 303  47  C.  F.  R.    1.1200  et  seq. 
 304  Id.    1.1206(  b)(  2). 
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 Federal  Communications  Commission  FCC  03-  224 
 SEPARATE  STATEMENT  OF  CHAIRMAN  MICHAEL  K.  POWELL 


 Re:  Review  of  the  Commission  Rules  Regarding  the  Pricing  of  Unbundled  Network  Elements  and  the  Resale  of  Services  by  Incumbent  Local  Exchange  Carriers  (WC 
 Docket  No.  03-  173  (Adopted  September  10,  2003) 
 Seven  years  is  a  long  time  in  the  telecommunications  industry.  At  the  time  the  Commission  initially  adopted  its  pricing  rules  in  1996,  it  promised  to  review  them  after 
 states  had  implemented  the  first  round  of  pricing  decisions.  I  am  pleased  that  today    seven  years  after  the  first  pricing  rules  were  adopted    the  Commission  has  moved  to 
 keep  the  promise  we  made  in  1996.  Todays  Notice  represents  the  first-  ever  comprehensive  and  directed  approach  to  reviewing  our  TELRIC  pricing  methodology. 


 Now  that  competition  has  taken  root  in  many  areas  of  the  country,  we  initiate  this  proceeding  to  consider  whether  our  pricing  rules  are  working  as  intended,  in  particular, 
 whether  it  is  conducive  to  facilities  investment.  The  stakes  are  high:  without  the  correct  pricing  signals  in  the  market,  our  rules  can  thwart  a  central  purpose  of  the  Act,  the 
 development  of  facilities-  based  competition. 
 The  hypothetical  nature  of  the  TELRIC  inquiry  has  been  difficult  for  states  to  implement  and  has  resulted  in  a  lack  of  consistency  that  disadvantages  incumbents  and 
 competitors  alike.  It  is  my  hope  that  at  the  end  of  this  proceeding  the  market  will  benefit  from  a  methodology  that  is  less  theoretically  freewheeling.  The  tentative  conclusion 
 stated  in  the  item  supports  this  policy  direction.  While  I  have  heard  some  concern  surrounding  the  tentative  conclusion,  our  commitment  to  retaining  a  forward-  looking 
 approach  is  unwavering    what  we  are  debating  is  the  extent  to  which  realistic  assumptions  about  the  incumbents  network  should  be  included  in  our  pricing  rules.  I 
 believe  that  an  approach  grounded  in  the  real-  world  attributes  of  the  incumbents  network  would  address  claims  that  our  TELRIC  rules  currently  distort  a  competitors  decision 
 whether  to  invest  in  new  facilities  or  to  lease  an  incumbents  existing  facilities. 
 I  look  forward  to  reviewing  the  submissions  in  the  proceeding  and  working  with  state  regulators  to  capture  the  experience  they  have  gained  implementing  our  pricing 
 methodology.  Finally,  I  appreciate  the  support  of  my  colleagues  in  initiating  a  fair  and  balanced  review  of  our  pricing  rules. 
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 Federal  Communications  Commission  FCC  03-  224 
 STATEMENT  OF  COMMISSIONER  MICHAEL  J.  COPPS, 
 APPROVING  IN  PART  AND  DISSENTING  IN  PART 
 Re:  Review  of  the  Commissions  Rules  Regarding  the  Pricing  of  Unbundled  Network  Elements  and  the  Resale  of  Service  by  Incumbent  Local  Exchange  Carriers 
 (WC  Docket  No.  03-  173) 
 Seven  years  ago,  the  Commission  adopted  a  forward-  looking  economic  cost  policy  for  pricing  unbundled  network  elements.  We  did  the  right  thing.  The  Supreme 
 Court  blessed  our  action  pretty  heady  stuff  for  a  Commission  not  always  accustomed  to  such  approbations  from  above.  So  were  building  on  solid  ground  here,  with  no  judicial 
 charge  to  start  all  over  or  to  perform  drastic  reconstruction.  Its  clear  to  me  that  from  time  to  time  we  should  review  and  recalibrate  our  policy,  known  as  Total  Element  Long 
 Run  Incremental  Cost,  or  TELRIC.  We  have  a  duty  to  adjust  it  over  time  to  ensure  that,  as  Congress  intended,  incumbents  are  justly  compensated  for  their  network  costs  plus  a 
 reasonable  profit.  At  the  same  time,  we  need  to  ensure  that  competitors  pay  prices  that  induce  efficient  market  entry.  There  is  also  the  need  to  adjust  our  policy  to  reflect  the 
 new  realities  of  the  recent  Triennial  Review. 
 To  a  significant  extent  we  initiate  a  proceeding  today  that  lays  the  groundwork  for  accomplishing  these  objectives.  There  is  much  in  this  item  that  I  am  pleased  to  support. 
 I  regret,  however,  that  I  cannot  support  todays  Notice  of  Proposed  Rulemaking  en  toto.  I  just  dont  believe  the  record  at  hand  justifies  the  making  of  important,  even  if  tentative, 
 conclusions.  Such  tentative  conclusions  often  have  a  curious  way  of  becoming  final.  On  the  basis  of  little  or  no  prior  record,  the  majority  today  adopts  a  tentative  conclusion 
 concerning  so-  called  real-  world  network  attributes  that  I  believe  is  confusing  and  inconsistent  with  basic  premises  of  TELRIC  that  were  upheld  as  a  reasonable 
 interpretation  of  Section  252(  d)(  1)  by  the  Supreme  Court.  For  a  Commission  striving  to  provide  clarity  to  an  industry,  this  is  a  strange  way  to  do  it. 


 Moreover,  some  of  the  questions  that  flow  from  this  tentative  conclusion  come  close  to  saying  that  the  assumptions  that  undergird  our  TELRIC  policy  are  misdirected 
 and  flawed.  Again,  these  are  the  same  assumptions  that  passed  muster  with  the  highest  court  in  the  land.  I  have  no  objection  to  asking  probing  questions;  I  just  think  that  a 
 tentative  conclusion  here  is  unnecessary  and  probably  unwise. 
 Despite  this  reservation,  I  appreciate  my  colleagues  willingness  to  engage  in  a  dialogue  and  their  efforts  to  accommodate  some  of  my  concerns.  I  think  this  is  a  stronger 
 item  as  a  result.  I  look  forward  to  our  continuing  work  together  on  this. 
 Finally,  I  hope  I  really  hope  that  we  can  encourage  all  the  parties  interested  in  TELRIC  to  sit  together  and  discuss  the  issues  attending  it  in  something  approaching 
 candor  and  maybe  even  a  little  cooperation.  I  think  all  the  company  CEOs  and  others  directly  impacted  have  heard  my  plea  on  this  over  the  past  two  years  since  I  came  here. 
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 Federal  Communications  Commission  FCC  03-  224 
 2 
 Frankly,  it  was  easier  to  get  the  Russians  and  the  Chinese  to  sit  down  with  us  during  the  latter  days  of  the  Cold  War  than  it  is  to  convene  a  TELRIC  dialogue.  Its  not  that  I 
 expect  everyone  to  come  to  a  joyous  outcome  on  this,  but  rather  just  a  hope  that  there  might  be  one  or  two  or  maybe  even  three  facts  we  could  agree  on  and  then  see  if  from  a 
 small  patch  of  common  ground  we  cant  do  some  building  out.  Id  like  to  see  everyone  a  part  of  this  incumbents  and  competitors,  our  Commission  and  the  State  Commissions, 
 traditional  and  non-  traditional  stakeholders.  Crafting  appropriate  rules  for  our  unbundled  network  element  pricing  policy  will  be  a  daunting  task.  We  cannot  get  it  done  without 
 less  rhetoric  and  more  dialogue  among  all  the  players.  Toward  that  end,  Mr.  Chairman  and  my  colleagues,  I  would  very  much  like  to  see  us  hold  some  hearings  or  a  forum  to 
 bring  the  players  together,  or  perhaps  even  commence  a  Joint  Conference  to  jumpstart  discussion  and  engage  our  counterparts  in  the  States  on  this  important  topic.  I  think  this 
 would  be  an  excellent  way  to  follow  through  on  the  work  this  proceeding  today  commences. 
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 Federal  Communications  Commission  FCC  03-  224 
 STATEMENT  OF 
 COMMISSIONER  KEVIN  J  .  MARTIN 


 Re:  Review  of  the  Commissions  Rules  Regarding  the  Pricing  of  Unbundled  Network  Elements  and  the  Resale  of  Service  by  Incumbent  Local  Exchange  Carriers.  WC  Docket  No.  03-  173 


 I  am  pleased  that  we  are  taking  action  to  alter  our  existing  TELRIC  pricing  regime.  Today,  we  tentatively  conclude  that  our  unbundled  network  element  pricing  methodology,  while 
 forward-  looking,  should  be  based  upon  the  incumbent  local  exchange  carriers  actual  network  rather  than  the  totally  hypothetical  assumptions  contained  in  a  cost  proxy  model.  I  believe  that 
 the  prices  for  unbundled  network  elements  should  be  based  on  the  forward-  looking  replacement  cost  of  the  ILECs  network. 


 As  I  have  long  stated,  I  believe  that  that  the  TELRIC  rules  should  be  reviewed  and  revised.  I  have  also  stated  before  that  the  existing  TELRIC  formula  may  provide  incumbent 
 service  providers  with  an  insufficient  return  on  investment  capital  for  new  infrastructure.  Todays  item,  in  conjunction  with  our  decision  in  the  recent  Triennial  Review  Order,  begins  the 
 process  to  provide  the  necessary  adjustments  to  the  TELRIC  formula  that  will  more  accurately  reflect  incumbent  costs  and  help  spur  deployment  in  new  facilities  and  services. 


 While  I  am  pleased  that  we  are  initiating  this  proceeding,  I  am  cognizant  that  the  Wireline  Competition  Bureaus  interpretation  of  the  TELRIC  pricing  rules  in  the  recent  Virginia 
 Arbitration  Order  may  not  reflect  the  direction  and  spirit  of  todays  decision 
73
 Federal  Communications  Commission  FCC  03-  224 
 STATEMENT  OF  COMMISSIONER  JONATHAN  ADELSTEIN 
 Re:  Review  of  the  Commissions  Rules  Regarding  the  Pricing  of  Unbundled  Network  Elements  and  the  Resale  of  Service  by  Incumbent  Local  Exchange  Carriers,  WC  Docket  No.  03-  173 
 I  lend  my  support  to  todays  Notice  because  I  believe  that  it  is  reasonable  and  appropriate  to  look  once  again  at  our  pricing  rules  for  unbundled  network  elements,  interconnection,  and 
 resale  of  service  under  Sections  251  and  252  of  the  Act.  These  pricing  rules,  while  certainly  esoteric,  have  an  enormous  impact  on  the  telecommunications  industry  and  on  consumers.  If 
 prices  for  unbundled  network  elements  are  too  high,  competitors  may  face  much  greater  hurdles  than  Congress  intended  --  particularly  given  our  recent  decision  in  the  Triennial  Review  Order, 
 that  limits  unbundling  to  those  facilities  for  which  competitors  are  truly  impaired  --  and  may  be  limited  in  the  services  which  they  can  offer.  On  the  other  hand,  if  the  prices  for  unbundled 
 elements  are  too  low,  this  could  have  serious  consequences  for  our  nations  incumbent  carriers.  For  the  American  consumers  who  obtain  more  than  18  million  lines  from  competitors  by  resale 
 or  unbundled  elements,  our  decision  can  mean  the  difference  between  having  a  choice  of  providers  or  returning  to  a  world  of  one  option.  So,  the  stakes  are  high. 


 While  I  am  sympathetic  to  concerns  that  this  Notice  may  open  another  source  of  regulatory  instability,  it  has  been  seven  years  since  the  FCC  adopted  these  rules  and  this  is  the 
 first  comprehensive  review.  Through  the  Triennial  Review  process,  our  section  271  review,  and  discussions  with  carriers,  numerous  concerns  have  been  raised.  We  must  look  carefully  at  these 
 concerns  and  it  is  fair  to  open  this  dialogue. 
 That  said,  I  enter  this  proceeding  with  a  very  open  mind.  Our  TELRIC  pricing  rules  have  been  challenged  in  almost  every  forum  and  on  just  about  every  basis  since  their  adoption  in 
 August  of  1996.  Despite  those  challenges,  our  rules  have  been  upheld  by  the  highest  court  of  the  land.  The  Supreme  Courts  affirmation  of  our  rules  sent  a  strong  signal  that  the  Commission  had 
 struck  the  right  balance.  Indeed,  by  making  parts  of  the  incumbents  network  available  to  competitors  at  economic  cost,  our  rules  enable  consumers  to  reap  the  benefits  of  the  incumbents 
 economies  of  scope  and  scale,  as  well  as  the  benefits  of  competition.  Moreover,  the  investment  that  these  rules  have  encouraged  has  been  remarkable;  as  noted  by  the  Supreme  Court, 
 competitors  have  invested  approximately  51  billion  dollars  between  1996  and  2000,  which  is  now  up  to  71  billion  dollars  according  to  recent  estimates.  I  recognize,  however,  that  there  may 
 be  ways  to  improve  these  rules. 
 Given  the  Supreme  Courts  endorsement  of  our  existing  rules,  the  importance  of  this  proceeding,  and  the  fact  that  we  have  no  direct  record  on  these  issues,  I  would  strongly  prefer  to 
 issue  this  Notice  without  any  tentative  conclusions,  simply  seeking  comment  on  how  we  might  improve  our  rules.  The  Notice  seeks  comment  on  several  alternatives  for  modifying  our  rules, 
 but  I  am  pleased  that  the  item  does  not  specifically  endorse  any  single  alternative  methodology.  I  nonetheless  join  in  a  limited  tentative  conclusion  that  our  TELRIC  rules  should  more  closely 
 account  for  certain  real-  world  factors    namely,  the  routing  and  topography  of  the  incumbent  LECs  network.  Because  this  issue  has  become  a  flash-  point  for  criticism  of  our  TELRIC  rules,  I 
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 Federal  Communications  Commission  FCC  03-  224 
 2 
 believe  that  it  is  worthwhile  to  signal  to  the  outside  community  that  the  FCC  has  concerns  about  how  our  rules  account  for  these  factors.  I  should  make  clear,  however,  that  I  remain  open  to  all 
 possibilities  in  this  proceeding  and  will  look  carefully  at  the  evidence  filed  on  this  and  other  issues. 


 It  is  critical  that  we  develop  a  full  and  comprehensive  record  in  this  proceeding  and  that  we  not  rush  to  judgment  before  analyzing  this  record.  To  this  end,  I  encourage  and  fully  expect 
 that  we  will  see  active  participation  by  our  colleagues  from  the  state  public  utility  commissions.  They  have  front  line  experience  implementing  our  rules  and  are  perhaps  best  positioned  to 
 explain  how  the  current  rules  have  been  implemented,  where  they  are  ambiguous,  where  they  are  problematic,  and  where  they  have  functioned  well. 


 I  would  like  to  thank  my  colleagues,  particularly  the  Chairman,  for  seeking  our  input  on  this  item  and  working  to  accommodate  many  of  our  concerns.  I  would  also  like  to  thank  Bill  and 
 his  team  for  their  hard  work  on  this  item  and  to  wish  them  well  as  we  kick  off  what  will  be,  Im  sure,  a  challenging  proceeding. 
75