GAO

United States General Accounting Office

Report to the Subcommittee on Antitrust,

Business Rights and Competition,

Committee on the Judiciary, U.S. Senate

January 2000 TELECOMMUNICATIONS

Development of

Competition in Local

Telephone Markets

GAO/RCED-00-38

Page 1 GAO/RCED-00-38 Competition in Local Telephone Markets

Contents

Letter 3

Appendixes Appendix I: Objectives, Scope, and Methodology 36

Appendix II: Responses to Survey of State Utility Commissions 38

Appendix III: GAO Contacts and Staff Acknowledgments 57

Tables Table 1: Income and Telephone Data for the Five Selected States 36

Figures Figure 1: Market Shares of the Local Telephone Market, by Type of Carrier

14

Figure 2: Growth in the Number of Access Lines Served by Competing

Carriers, 1997-98 15

Abbreviations

AT&T American Telephone and Telegraph

DOJ Department of Justice

FCC Federal Communications Commission

LATA local access and transport area

OSS operations support systems

UNE unbundled network element
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United States General Accounting Office

Washington, D.C. 20548

Resources, Community, and Economic

Development Division

B-283167 Letr

January 25, 2000

The Honorable Mike DeWine

Chairman

The Honorable Herb Kohl

Ranking Minority Member

Subcommittee on Antitrust, Business Rights

and Competition

Committee on the Judiciary

United States Senate

The breakup in 1984 of the American Telephone and Telegraph Company

(now called AT&T) promoted competition in the long-distance and

telephone equipment markets. The breakup was not, however, designed to

promote competition in local telephone service markets1 since it was

assumed that these markets were likely to remain monopolistic. By the

early 1990s, some companies had begun to enter local telephone markets

and compete against incumbent carriers, particularly in large cities,

prompting some states to make regulatory changes to encourage further

entry. Ultimately, many experts came to believe that more competition in

the provision of local telephone service was possible but would not fully

develop without significant revisions to communications law. With the

enactment of the Telecommunications Act of 1996 on February 8, 1996, the

Congress sought to increase competition in local telephone and other

telecommunications markets. The law imposed a variety of obligations on

incumbent local telephone companies that were designed to open their

networks to competitors. Six months later, the Federal Communications

Commission (FCC) issued its first major set of rules implementing the

provisions of the act affecting local telephone markets.

1

Local telephone service includes calls that are made within a designated geographic area or

locality without payment of long-distance charges.
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You asked us to provide information on (1) the development of competition

in local telephone markets and the market strategies employed by new

carriers in five states under the 1996 Telecommunications Act and (2) the

key issues affecting that development and the enforcement activities of

federal and state regulators to address those issues.2 To respond to these

questions, we visited five states: California, Illinois, New York, South

Carolina, and Texas. (App. I discusses the criteria we used to choose these

states.) In these states, we interviewed competing carriers, incumbent

carriers, and state public utility commissions. We also surveyed all 50 state

utility commissions to obtain information on the development of

competition in local telephone markets and on the state commissions’

activities (see app. II). In addition, we reviewed relevant laws and FCC

proceedings.

Results in Brief To date, little competition has emerged in local telephone markets, but new

competing carriers are pursuing several different market strategies.

According to data from FCC and the industry, incumbent local telephone

service providers controlled all but about 3 percent of the traditional

wireline local telephone service market as of December 1998—the most

recent date for which data were available. The number of lines competing

carriers serve has, however, increased rapidly, approximately tripling in

1998 alone. We found, as have FCC and others, that competing carriers

have concentrated on serving relatively profitable urban business

communities. At the same time, some of the competing carriers we

interviewed in the five states we visited were also serving other markets—

residential customers and customers outside the largest cities. The

competing carriers we interviewed were delivering services through all of

the methods envisioned by the 1996 act: reselling—or acting as retailers

of—incumbents’ services, leasing parts of incumbents’ networks, or

constructing their own facilities. Finally, an important competitive strategy

being undertaken by both competing and incumbent carriers is the

2

This report is the second in a series of three reports GAO is issuing for your Subcommittee

on the development of competition in telecommunications markets. The first report

examined competition in the video market. (See GAO/RCED-99-158, July 8, 1999.) The third

report will examine the development of competition in the market for Internet services and

is scheduled for release later in 2000. It will focus on several issues, including the technical

characteristics underlying the provision of Internet access by various types of companies

(telephone, cable, wireless) and the legal and regulatory differences governing the provision

of Internet access by these companies. As part of that assignment, we plan to review

municipal policies on open access issues.
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simultaneous marketing and sale of a package of varied

telecommunications services including, for example, local and longdistance telephone service, Internet access, wireless telephone service, and

video services.

The further development of competition in local telephone markets will

depend, in part, on the resolution of several key issues that may have thus

far affected that development. In particular, the act requires incumbent

carriers to provide competing carriers with access to elements of their

telephone networks, such as equipment and facilities, to enable those

competing carriers to order and provide service to their own customers.

However, our discussions with competing and incumbent carriers in the

five states we visited, as well as with FCC staff, suggest that providing this

access has been difficult because these incumbents’ systems were not

originally designed to be accessible to users external to the incumbent

carrier. In addition, some competing carriers in the five states told us that

negotiating the necessary agreement that details the terms and conditions

governing the business relationship between an incumbent and competing

carriers—referred to as an interconnection agreement—can take a

significant amount of time and thereby delay their market entry. Similarly,

some of the competing carriers we spoke with in the five states said that

negotiating the placement of their equipment in an incumbent’s facilities

can take a significant amount of time. Incumbent carriers noted, however,

that they had invested money and other resources to make elements of

their telephone network accessible to competing carriers, had signed

interconnection agreements, and had allowed competing carriers to place

their equipment inside their own facilities.

Competing carriers in the five states also told us that the act and

accompanying rules needed better enforcement. We found, through our

discussions with FCC officials and our survey of staff at the 50 state

commissions, that state and federal regulators recognize their role is

changing to become less focused on traditional rate-setting regulation and

more focused on mediating disputes among carriers and enforcing laws

and regulations. Consequently, federal and state regulators are in the

process of adjusting their enforcement tools in ways that may lead to a

greater focus on enforcement. For example, FCC recognizes the need to

develop greater staff expertise on enforcement issues and recently created

a new bureau to focus exclusively on enforcement. FCC has also instituted

a formal expedited process for resolving complaints against

telecommunications carriers called the “accelerated docket.” In addition,

regulators at the state and federal level are working with carriers to
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establish systems that will measure incumbent carriers’ performance in

providing service to competing carriers and automatically assess penalties

against incumbent carriers that are not in compliance with the act.

The 1996 act and its implementing regulations imposed significant changes

on local telephone service markets. In the years since the act’s passage,

competing carriers have developed entry strategies, incumbent carriers

have responded to the obligations imposed on them by the act and have

simultaneously undertaken their own new strategies, and regulators and

the courts have played roles in implementing and interpreting the act.

Despite the minimal competition that has emerged thus far in the market,

further competition seems likely to develop in local telephone markets

because competing carriers continue to expand their market share, these

carriers are using all entry modes envisioned by the act, legal and

regulatory issues are increasingly becoming clarified, and the packaging of

varied telecommunications services may enable firms providing other

communications services to effectively compete for local telephone

customers. Moreover, FCC and state regulators are taking steps indicative

of greater enforcement efforts in the future. This report contains no

recommendations.

Background For the first hundred years after the invention of the telephone, federal and

state laws and regulations helped shape the structure of the

telecommunications industry. Over that period, the primary focus of these

laws and regulations shifted from controlling the market dominance of

AT&T to promoting competition in telecommunications markets. During

the 1970s and 1980s, much of the effort to promote competition was geared

toward the long-distance telephone market, but the Telecommunications

Act of 1996 was designed, in part, to open local telephone markets to

greater competition. Technological changes in the telecommunications

industry have also led to changes in the structure of the telephone industry

and in the laws and regulations governing it.

Laws and Regulations Have

Helped Shape the Structure

of the Telephone Industry

After receiving patents for telephone technology in 1876 and 1877,

Alexander Graham Bell and the Bell Telephone Company (later called the

American Telephone and Telegraph Company and then AT&T) controlled

the developing market for telephone service. Once the patents expired,

however, a myriad of independent local telephone service providers

entered the market, and by 1907, the independents provided just over 50

percent of local telephone service in the United States. AT&T responded by
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reducing its prices in markets directly threatened by competitors,

purchasing independent telephone providers, and refusing to allow other

carriers to interconnect with its network. This refusal disadvantaged

AT&T’s rivals because they were unable to route calls from their customers

to customers on AT&T’s much larger network. These actions made it

difficult for independent companies to compete, and many accepted

AT&T’s offer to acquire them.

By the 1930s, communications had become so important to the country

that the Congress passed the Communications Act of 1934, which, among

other things, created FCC and gave it authority over interstate

telecommunications, while leaving the oversight of intrastate telephone

service to state regulators. For many years, AT&T was the primary provider

of local telephone service, long-distance telephone service, and telephone

equipment in the United States. AT&T carried roughly 80 percent of the

nation’s local telephone traffic by the early 1980s, and the remaining 20

percent of local traffic was carried by the independent local companies

unaffiliated with AT&T. Beginning in the 1950s, new companies began

trying to compete against AT&T’s monopoly in the telephone equipment

and long-distance markets. In 1974, the Department of Justice (DOJ)

alleged that AT&T was undertaking anticompetitive actions aimed at

stifling this new competition and filed an antitrust suit against the

company. This case was resolved when a federal court approved a consent

decree entered into by DOJ and AT&T in 1982. Under this decree, known as

the Modification of Final Judgment, AT&T was required to divest its

ownership of the 22 Bell Operating Companies, its local telephone

subsidiaries. However, the company was permitted to continue

manufacturing telephone equipment and offering long-distance service and

to enter some markets from which it was previously excluded—notably the

computer market.

The 22 Bell Operating Companies were reorganized into seven regional

entities, which have since been reduced to four companies through

mergers. While the consent decree permitted the Regional Bells to provide

service within 161 designated local areas that covered much of the country,

it limited the lines of business these companies could enter to ensure that

their monopoly status in the local telephone market did not affect the

development of competition in other telecommunications markets. For

example, the Regional Bells were not permitted to provide long-distance

telephone service or to manufacture telephone equipment without

obtaining a waiver from the federal court.
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By the late 1980s, new companies had begun to compete directly against

incumbent local telephone carriers in some locations by building facilities

that paralleled the incumbent telephone companies’ networks—

particularly in large cities.3 To enhance their likelihood of success,

however, these companies wanted some regulatory changes that would

facilitate the interconnection of their networks with those of incumbent

carriers. Some states enacted legislation or adopted regulations, and FCC

put forth rules designed to facilitate competitors’ entry.4 Meanwhile, the

Regional Bells were becoming increasingly dissatisfied with their exclusion

from the long-distance telephone market and the extensive control by the

federal court over their activities. These and other changes in the market

led many experts, as well as some Members of Congress, to believe that the

Communications Act was becoming outdated and that a major revision of

the law was needed.

The 1996 Act and Its

Implementing Regulations

Establish a Framework for

Greater Competition in

Local Telephone Markets

The passage of the Telecommunications Act of 1996 constituted the first

comprehensive amendments to the federal Communications Act since its

enactment in 1934. One of the key goals of the act was to encourage

competition in local telephone service. To do this, the act imposed a variety

of obligations on incumbent carriers designed to facilitate new companies’

entry via three modes envisioned in the act. The three modes of entry are as

follows:

• Resale. This entry method allows new companies to resell, or act as

retailers of, an incumbent’s telephone services. Resellers purchase local

telephone services from an incumbent at wholesale rates and resell the

services to end users at retail rates.

• Access to Network Elements. This entry method enables new

companies to lease parts of an incumbent’s network—facilities and

equipment that are used to provide local telephone service—at cost3

Incumbent local telephone companies include the Regional Bells as well as many other

independent local telephone carriers that were providing local telephone service before the

1996 act was passed.

4

For example, in 1989, the New York Public Service Commission required New York

Telephone, part of NYNEX, to allow certain types of competitors to interconnect with its

network. Also, in 1995, the Illinois Commerce Commission approved part of Ameritech’s

“Customer First Plan,” under which Ameritech made some pieces of its network available to

competing carriers. In exchange, Ameritech expected to obtain pricing flexibility and

approval to offer long-distance telephone service in its service region.
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based rates. These leased parts of the incumbent’s network are generally

referred to as “unbundled network elements”—also known as UNEs—

because they are specific, or discrete, parts or functions of the

telephone network. Entrants provide local telephone service by leasing

designated pieces of the incumbent’s network or by leasing some pieces

and combining them with their own facilities.

• Construction of New Facilities. Finally, carriers may enter local

telephone markets by building entirely new facilities. Under a full

“facilities-based” method of entry, an entrant builds all the facilities that

it needs to serve customers, including the “last mile,” or the connection

to a user’s premises. This method of entry still requires the incumbent to

allow entrants to interconnect with the incumbent’s network.
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To facilitate competitors’ entry into local telephone markets using these

methods, the act prohibits states from restricting entry into the local

telephone market and requires all telecommunications companies to

interconnect their networks and facilities with those of others. While other

obligations of the act were imposed on all local telephone carriers—for

example, all telephone companies must allow users to keep their existing

telephone numbers when possible and provide access to operator services

and directory assistance without undue delays—additional competitionenhancing obligations were imposed only on incumbent carriers.5 Among

other things, incumbent carriers are required to negotiate, in good faith,

agreements that lay out terms governing the interconnection of their

networks when requested by competitors; allow entrants to resell the same

services that the incumbents provide to their own retail customers; make

UNEs available for purchase at rates that are based on their cost;6 and

allow competing carriers to “collocate,” or place their own equipment in

incumbents’ central offices.7 In addition, the Congress required the

Regional Bells to demonstrate that they have adequately opened their

networks to competitors before they can provide long-distance8 telephone

service in their designated local service areas.9 Specifically, the act lays out

a 14-point checklist (47 U.S.C. 271), which generally requires that a Bell

Company demonstrate to regulators its compliance with the

interconnection and network access requirements detailed in earlier

sections of the act.10

5

The market-opening obligations discussed here are contained in Section 251 of the

Communications Act of 1934, as amended (47 U.S.C. 251).

6

The act was not explicit about how “cost” should be calculated or defined. However, FCC

and state commissions are charged with making this determination.

7

If the incumbent local exchange carrier can demonstrate to the state commission that

physical collocation is not practical for technical reasons or because of space limitations,

the carrier may provide for “virtual” collocation. (47 U.S.C. 251(c)(6)).

8

Long-distance service includes toll calls within “local access and transport areas” (LATA)

and across LATAs. The Regional Bells are allowed to provide intraLATA toll service, but not

interLATA toll service. In the remainder of this report, when we refer to “long-distance”

telephone service, we are referring to interLATA toll service.

9

The Bell Operating Companies were allowed to provide long-distance telephone service

outside their local service areas as of the date of the 1996 act’s enactment.

10Satisfying the 14-point checklist is a determination that FCC must make in approving a

Regional Bell’s entry into the long-distance market (see 47 U.S.C. 271(d)(3)).
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In August 1996, FCC issued an order implementing the local competition

provisions of the act.11 Among the regulations included in that order, FCC

established rules about how interconnection and collocation were to be

provided, put forth a method that state commissions should use to

establish prices for interconnection and UNEs,12 and specified which parts

of an incumbent’s network must be made available to competing carriers

(and are, therefore, UNEs). One of the elements that must, under FCC’s

order, be unbundled and provided to competing carriers as a UNE is an

incumbent’s “operations support systems”—the computer systems and

personnel that entrants use to place orders and provision local telephone

service.13 After FCC released its rules, several telephone service providers

and state regulators challenged the rules before the U.S. Court of Appeals

for the Eighth Circuit. The Eighth Circuit overturned many of FCC’s rules

on the grounds that the commission had exceeded its authority and

misinterpreted the law. Ultimately, in early 1999, the Supreme Court issued

a decision that addressed many of the issues raised in the Eighth Circuit

decision.14 The Supreme Court, noting that the Telecommunications Act of

1996 was vague in some respects, affirmed FCC’s rulemaking authority to

implement the local competition provisions of the act and upheld most of

FCC’s rules. The case was sent back to the lower court for further

proceedings consistent with the Supreme Court’s decision.

Although FCC establishes nationwide guidelines for incumbent telephone

service providers and state regulators, state regulators themselves have

major roles in implementing key provisions of the act, several of which are

directly related to promoting local telephone competition. For example,

state commissions must approve or reject interconnection agreements, and

they have a role in arbitrating and mediating these agreements if asked to

11This order was the first part of FCC’s “competition trilogy,” a set of rulemakings

implementing the 1996 act. 11 FCC Rcd 15499 (released Aug. 8, 1996). The trilogy also

includes orders relating to other key facets of telecommunications policy issues—universal

service and access charges.

12FCC determined that the prices charged by incumbents for UNEs should be based on

forward-looking economic costs and adopted a pricing methodology known as “Total

Element Long Run Incremental Cost.”

13FCC also required incumbent carriers to provide resellers with access to their operations

support systems under section 251(c)(4) of the Communications Act. FCC further noted

that providing nondiscriminatory access to these systems could be viewed as a “term or

condition” of unbundling other network elements under section 251(c)(3).

14AT&T Corp. v. Iowa Utilities Board, 525 U.S. 366 (1999).
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do so by the negotiating carriers. State regulators are also charged with

developing and implementing cost-based prices for interconnection and

UNEs.

Technology of Telephone

Transmission Has Evolved

Over Time

The technology used to transmit telephone calls has evolved since the

invention of the telephone in 1877. In the conventional telephone network,

“dialtone” is transmitted over a pair of copper wires from a telephone

company’s facility, known as a central office, to the caller’s telephone when

the handset is lifted. As the caller dials another party’s number, the number

pattern is received at the central office, and the call is routed through the

telephone network and transmitted to the called party’s telephone. When

the call is answered, the two parties hear each other’s voices because

telephones convert sound into electrical signals that are transmitted

through the telephone lines at both the calling and receiving ends.

In recent years, the conventional telephone network has been modernized.

For example, a new generation of advanced electronic equipment is being

installed in incumbents’ central offices to improve the transmission of

telephone calls. In addition, new delivery systems are being deployed

and/or adapted to provide local telephone service. For example, fiber-optic

cable—a higher-speed, higher-capacity alternative to copper wire—is being

deployed by both incumbent and competitive carriers. Cable companies

are also upgrading their facilities to transport two-way voice services over

their existing coaxial cable transmission facilities. Wireless technologies,

which do not require cables for the transmission of telephone calls, are

providing another alternative to traditional wireline local telephone

service.

While Little

Competition in Local

Telephone Markets Has

Emerged, New Carriers

Are Pursuing Varied

Market Strategies

While competing carriers are still serving only a small portion of the local

telephone market—approximately 3 percent—several carriers have

entered the market using a variety of market strategies. These carriers are

serving primarily urban business customers; however, some competing

carriers are also serving residential customers and those outside the largest

cities. We found that competing carriers were using all of the modes of

entry envisioned by the Telecommunications Act of 1996—reselling

incumbents’ services, leasing UNEs, and building facilities. We also found

that the fundamental manner in which telecommunications services are

produced and marketed is changing as competing and incumbent carriers

are pursuing strategies to offer customers packages of telecommunications
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services, such as local and long-distance telephone service, Internet access,

and video service.

Competing Carriers Provide

Only a Small Percentage of

Local Telephone Service

According to FCC, as of December 1998—the latest point for which data

are available15—there were more than 180 million local telephone lines in

the United States. Although no comprehensive data are available on the

numbers of lines served by different types of carriers, information from

FCC’s voluntary surveys and analysts’ reports suggest that by the end of

1998, approximately 89 percent of these lines were served by six large

incumbent local telephone service providers (the four remaining Regional

Bell Companies, GTE, and the local telephone division of Sprint), about 3

percent were served by competing carriers,16 and the remainder were

served by the many other independent incumbent carriers (see fig. 1).

15At this time, FCC has only preliminary data for June 1999.

16Because competing carriers do not have to report the size of their customer base to

regulators and few participate in FCC’s voluntary surveys, there is no strictly reliable

measure of the size of the market that bypasses incumbents’ networks. FCC reports that

analysts’ estimates of the market also vary somewhat, generally placing competing carriers’

market share between 2 and 3 percent of the market. Using survey data on competing

carriers reported by New Paradigm Research Group, Inc., we estimate that competing

carriers are serving about 3 percent of the local market.
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Figure 1: Market Shares of the Local Telephone Market, by Type of Carrier

Note: Other incumbent carriers include over 1,300 mostly small local telephone carriers.

Source: GAO’s analysis of FCC’s and analysts’ data.

Despite the small presence of competing carriers, our estimates—based on

data from FCC and the industry—show that the number of lines they serve

approximately tripled between December 1997 and December 1998 (see

fig. 2).

3 

 

 Si lar e incumbent carriers

Other incumbent carriers

Competin carriers

 ar et percenta e held by si lar e incumbent carriers

 ar et percenta e held by other incumbent carriers

 ar et percenta e held by competin carriers
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Figure 2: Growth in the Number of Access Lines Served by Competing Carriers,

1997-98

—

Source: GAO’s analysis of data from FCC and The 1999 CLEC ReportTM from New Paradigm

Resources Group, Inc.

While none of the competing carriers were serving large numbers of local

telephone lines, some of these carriers are large telecommunications

companies. For example, in 1998, one large telecommunications service

provider had total revenues of $53.2 billion from its provision of varied

telecommunications services—including long-distance and wireless

services—although only a small fraction of its total revenues are from local

telephone service. At the same time, many of the new companies providing

local telephone service are much smaller. For example, 16 of the competing

carriers we interviewed serve fewer than 100,000 local telephone lines, and

15 have less than $100 million in revenues. The six large incumbent

companies also vary considerably in size—the largest of these carriers as of

1998 earned $26 billion from its provision of domestic telephone services in

that year and served about 41 million telephone lines, while the smallest of

these carriers earned $5 billion from its local telephone operations and

served about 7 million telephone lines.

5.6 M

1.8 M

0

1

2

3

4

5

6

1997 1998

0.00%

0.50%

1.00%

1.50%

2.00%

2.50%

3.00%

3.50%

Percentage of

total access lines served

by competing carriers

Number of access lines

served by competing

carriers (in millions)
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Our analysis of the status of competition in local telephone markets was

limited because systematically collected data were not available on the

local telephone service that competing carriers provide throughout the

country. FCC recently acknowledged its own difficulties in evaluating the

degree of competition in its October 1999 Notice of Proposed Rulemaking

on Local Competition and Broadband Reporting.17 In that notice, FCC

stated that more data on companies’ provision of local telephone and

broadband services (such as high-speed connections to the Internet) are

needed to evaluate the effectiveness of the Commission’s decisions and

otherwise understand the development of competition in these markets.

Obtaining such data would allow parties to better understand and evaluate

the level of competition in this evolving market.

Most Competing Carriers

Focus on Urban Business

Markets, but Some Choose

to Serve Other Markets

In its August 1999 report on competition in local telephone markets, FCC

provided statistical support showing that competition is expanding most

rapidly in urban business districts. In addition, staff at the state utility

commissions we surveyed reported that competition was developing more

rapidly in business markets than in residential markets. For example, staff

at 36 state commissions reported to us that large business markets were

very or somewhat competitive, while staff at 45 state commissions said that

residential markets were not very competitive or had no competition at all.

In addition, staff at many of the state commissions explicitly noted in their

comments that competition was developing most rapidly in urban business

areas within their states. Many of the incumbent carriers we spoke to noted

that the urban business market was one of the markets being targeted by

competing carriers.

Competing carriers are focusing on the urban business market because it is

generally more profitable than other local telephone markets. In particular,

the concentration of customers in urban areas reduces the cost of service

because it shortens the average length of the telephone line that connects a

customer’s premises to a telephone company’s primary facilities.

Additionally, business users can generate more revenue and be less costly

to serve because businesses are more likely than residential customers to

buy a greater volume and variety of telecommunications services. The

greater profitability of serving urban business markets is also related to the

prices—set by regulators—that incumbent carriers charge for telephone

service. Regulators set the rates that incumbent telephone companies

17FCC 99-283, Oct. 1999.
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charge for local business telephone service, special features (such as caller

ID and voice mail), and long-distance telephone service at levels that are

high relative to cost so that they could set the rates for residential and rural

local telephone service at levels that are low relative to the cost of

providing the service, while still enabling the companies to earn a profit.

Thus, new carriers are likely to find it profitable to serve urban business

customers because incumbents’ prices tend to be high relative to the cost

of serving these customers. This pricing structure may change as FCC and

the states work, as required under provisions of the 1996 act, to make the

subsidies that have been implicit within the rate structure more explicit.

In the five states we visited, we interviewed 24 competing carriers that are

using a variety of market strategies and are often serving more than one

market segment.18 Some of these carriers focused mostly on serving large

businesses in large cities, while others focused on serving businesses in

smaller cities, and more than half served at least some residential

customers. In addition, a number of these carriers were providing service

outside the urban business market, including the following:

• Some competing carriers had chosen to serve smaller cities or smaller

businesses in order to focus their entry in areas where larger competing

carriers would be less likely to operate.

• Several competing carriers were targeting small- and medium-sized

businesses by offering them the same kinds of personal service that

larger carriers offer only their largest business users. These companies

told us that by developing highly efficient support systems, they can

profitably offer relatively specialized services to these businesses.

• Some competing carriers that were already providing video or longdistance services to consumers in residential markets—in particular,

cable and long-distance companies—are focusing their entry in these

areas.

18One of the carriers we interviewed does not provide voice services.
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• In New York City, Chicago, and southern California, competing carriers

were choosing to serve residential customers in multiple dwelling units,

which include apartment buildings and condominiums. A carrier in

southern California told us that this market is attractive because a third

to a half of the residential customers in California live in multiple

dwelling units. In addition, because residential users are highly

concentrated in these buildings, they can be less expensive to serve.19

• Some carriers had found a profitable niche serving residential

consumers who could no longer obtain telephone service from

incumbent providers because they had not paid their bills. These

competing carriers charge a prepaid amount as high as $49 a month for

service strictly limited to the local calling area.

Competing Carriers Are

Using All Modes of Entry

Envisioned by the Act

The 1996 act outlined three means by which competing carriers could

provide local telephone service: reselling incumbents’ services, leasing

incumbents’ network elements, and constructing their own facilities.

National data and our interviews with competing companies indicated that

entering companies are pursuing all of these means, to varying degrees.

Resale FCC reported that in December 1998, about 1.9 percent of the access lines

in the United States were being served by resellers.20 In responding to our

survey of the 50 state utility commissions, staff at 25 of the commissions

said that resale constituted a major portion of competing carriers’ service

to residential customers in their states, while staff at 18 commissions said

that resale constituted a major portion of competing carriers’ services to

business customers. In addition, in about 23 states, commission staff

reported that they expect the use of resale to increase in both business and

residential markets.

Although resale is the most common entry mode employed by competing

companies, the resellers we interviewed almost universally told us that

resale is not a profitable means of providing local telephone service. They

noted that resale can be a good way to enter the market quickly and build a

customer base before investing in facilities. However, these carriers told us

19Despite their focus on serving multiple dwelling units, competing carriers undertaking this

strategy told us they are having problems accessing essential telephone facilities in these

properties.

20FCC’s preliminary data for June 1999 suggest that resale has continued to grow modestly

as a percentage of access lines.
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that they cannot earn a profit from reselling incumbents’ local telephone

service because there is not a great enough difference between the

wholesale rates resellers pay incumbent carriers for service—rates set by

state commissions in accordance with specifications in the 1996 act—and

the retail prices resellers can charge their own customers. Nevertheless,

one competing carrier told us that carriers may pursue this strategy

because of the profits they earn by providing customers with packages of

telecommunications services.

Access to Network Elements FCC reported that in December 1998, only two-tenths of 1 percent of the

telephone lines in the United States were being served by competing

carriers that were leasing UNEs from incumbent carriers.21 Nevertheless,

FCC’s data show that competing carriers have collocated their equipment

in the incumbents’ central offices that provide almost 50 percent of the

nation’s local telephone lines, indicating that competing carriers may have

the potential to serve many more customers through the leasing of UNEs.

Staff at utility commissions in only four states said that competing carriers

were using UNEs to deliver a major portion of their service to businesses,

and staff in only two states reported that competing carriers were using

UNEs to deliver a major portion of their service in residential markets;

however, staff at 26 of the state commissions expected the use of UNEs to

increase in both residential and business markets in the future.

Additionally, 15 of the companies we interviewed were providing local

telephone service to some of their customers by combining incumbents’

UNEs with elements of their own networks.

21FCC’s preliminary data for June 1999 suggest that the use of UNEs has grown markedly as

a percentage of access lines, although the use of UNEs still accounts for less than 1 percent

of the market.
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Competing carriers’ decisions to provide service using UNEs depended, in

part, on the prices of these elements. Like the wholesale rates that resellers

pay incumbent carriers, the rates that entrants pay for UNEs are set by

state commissions in accordance with provisions of the act and direction

from FCC. FCC directed that the states use a forward-looking economic

cost methodology to set these rates.22 Under this approach, rates would be

based on the forward-looking cost to incumbent carriers of providing the

UNE using the most efficient technologies currently available—a method

that may lead, in many cases, to rates that are lower than would be realized

under other cost methods.23 In the five states we visited, the commissions

were in various stages of setting prices for UNEs.

Some competing carriers are attempting to provide local telephone service

by leasing an incumbent’s entire set of UNEs—a method that has come to

be called the UNE-Platform. Although the act did not specifically mention

the UNE-Platform as an entry method, it did allow competing carriers to

purchase combinations of network elements. Some competing carriers told

us that because UNEs must be sold at rates based on cost, this entry

method can be more cost-effective than resale but still has the advantage of

requiring minimal investment. According to FCC, very little service is

currently being offered using the UNE-Platform. In responding to our

survey, staff at only one state commission reported that the UNE-Platform

was the major method being used by competing carriers to provide service

to both business and residential users in their state. In one of the five states

we visited, the Bell Company was being explicitly required to offer the

platform, and a competing carrier reported that, as a result, the company

had acquired upwards of 60,000 new local residential customers in that

state during the first 5 months of 1999.24

Construction of Facilities The degree to which local telephone service is provided by competing

carriers that rely entirely on their own facilities is not well known because

these providers do not have to report information about their businesses to

22The appropriateness of the forward-looking cost method is currently under review by the

U.S. Court of Appeals for the Eighth Circuit.

23FCC has also directed states to “deaverage” UNE rates across urban and rural regions so

that UNE prices more accurately reflect the differential cost to incumbents of providing

UNEs in these different settings.

24In another of the states we visited, the incumbent carriers were being required to offer the

UNE-Platform as part of the standard interconnection agreement.
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regulatory authorities and do not purchase services on an individual

telephone line basis from incumbents. These full-facilities-based competing

carriers are employing a variety of strategies. For example, we spoke to

some carriers that were targeting business customers by deploying fiberoptic cable within and around cities. Additionally, some carriers we spoke

to are reconfiguring existing cable systems or building new systems to

provide local telephone service mostly to residential customers. While

estimates show that full-facilities-based carriers were providing local

telephone service to only about 1 percent of the national market at the end

of 1998, FCC estimates that the amount of fiber-optic cable owned by

competing carriers increased fivefold between 1995 and 1998. Some fullfacilities-based carriers are also using wireless technologies. For example,

the wireless carrier we interviewed was using a fixed wireless technology

to serve customers primarily in multiple dwelling units in large cities.

Competing and Incumbent

Carriers Are Providing

Packages of

Telecommunications

Services and Entering New

Markets

Both competing and incumbent carriers are providing packages of

telecommunications services—including local telephone service, longdistance service, data services, Internet access, video service, wireless

telephone service, and directory assistance—to consumers.25 This focus is

generally attributed to consumers’ desire for a “one stop shop” for their

varied telecommunications needs. Additionally, some savings in the cost of

providing these services can occur when several services are offered over

the same infrastructure or when the marketing and administrative

functions for several services can be combined. The tendency of carriers to

provide an array of telecommunications services is fundamentally changing

how carriers operate in the market and how telecommunications services

are bought and sold.

To provide an array of services, many communications companies are

redesigning their infrastructures to expand their capabilities. For example,

cable television companies are modifying their networks—which were

initially designed for one-way video transmission over coaxial cable wire—

to accommodate high-quality, two-way voice and data transmissions as

well. Similarly, incumbent telephone companies are developing highercapacity transmission technologies to remain competitive in the market for

25Another new line of business for incumbent carriers—though not a part of the package of

services they supply to retail customers—is the wholesale services (i.e., resale and UNEs)

they provide to competing carriers. Officials of several of the incumbent carriers said they

recognize that these wholesale operations are becoming increasingly important.
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high-speed interactive data transmission (for example, Internet access). In

addition, some mobile and fixed wireless companies are providing

telephone service, data services, and, in some cases, video services.

Both competing and incumbent carriers are also entering new markets,

sometimes through corporate mergers. For example, some of the

incumbent carriers told us they were starting to enter other incumbents’

traditional territories to compete—that is, they are becoming competing

carriers in other incumbents’ regions. In addition, both competing and

incumbent carriers are entering new markets by merging with other

companies whose telecommunications infrastructures or service offerings

complement their own. For example, some of the competing carriers have

been acquired by long-distance companies. Also, Bell Atlantic expanded its

service area by acquiring NYNEX, and SBC expanded its area by acquiring

PacTel, Southern New England Telephone Company, and Ameritech. US

WEST is awaiting FCC’s approval of its proposed merger with Qwest, a

provider of data and long-distance telephone services.

A unique challenge for the Regional Bell Companies in attempting to offer a

competitive package of telecommunications services is the prohibition on

their providing long-distance service within their service region until they

have received approval from FCC through the process outlined in the 1996

act. In December 1999, Bell Atlantic received approval from FCC to enter

the long-distance market in its New York region.26 On January 10, 2000, SBC

Communications filed an application with the FCC to provide long-distance

service within the state of Texas. The two remaining Regional Bell

Companies are pursuing FCC’s approval but have made varying degrees of

progress toward attaining it.

Several Issues Affect

the Development of

Competition in Local

Telephone Markets

Several issues may have slowed the development of competition in local

telephone markets. Competing carriers, incumbent carriers, and regulators

cited difficulties in making incumbent carriers’ operations support

systems—needed to perform critical business functions—accessible to

competing carriers. Competing carriers and regulators also cited

difficulties in negotiating interconnection agreements and obtaining

adequate collocation space as problems that may have inhibited or delayed

market entry. Additionally, some competing carriers stated that greater

26After FCC’s approval of the Bell Atlantic 271 application, AT&T and Covad

Communications challenged this approval in federal court.
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enforcement of the act would help to foster a more competitive

environment in local telephone markets.

While Critical to the

Development of

Competition, Equivalent

Access to Incumbent

Carriers’ Operations

Support Systems Has Been

Difficult to Achieve

In its order on local competition implementing the 1996 act, FCC required

incumbent local telephone carriers to give competitors access to the

incumbents’ computer systems and personnel that competing carriers need

to perform critical business functions—systems known collectively as

operations support systems (OSS).27 FCC specified that competitors must

have access to incumbents’ OSS so that they can perform business

functions such as ordering, provisioning, and maintaining telephone

service for their customers.28 According to FCC, competing carriers must

be able to use these systems to perform these business functions as easily

as incumbents perform these functions for themselves in terms of quality,

accuracy, and timeliness. If incumbent carriers access these business

functions electronically, then they are required to provide competitors with

equivalent electronic access to these functions; likewise, if incumbents

perform these functions manually—by telephone or fax—then the same

access is required for competitors.29 In responding to our survey, staff at

nearly all of the state regulatory commissions said that competitors’ access

to incumbents’ OSS functions is very important to the development of local

telephone competition.

Obtaining equivalent access to OSS functions is important for competing

carriers to attract and retain customers. The competing carriers we

interviewed often cited deficiencies in access to OSS functions as a serious

impediment to the development of competition. Some competing carriers

noted that incumbents’ systems were frequently unable to complete

electronically placed orders without manual intervention, especially for

27In its local competition order, FCC identified OSS as an “unbundled network element” and

determined that incumbents must provide access to OSS functions under their duty to

provide UNEs and their duty to offer resale services. Incumbents must provide access to

computer systems that contain information related to telephone service, such as available

service plans and installation options, customer profiles, and the availability of telephone

numbers.

28FCC specified five critical business functions: (1) pre-ordering (developing the customer

profiles—e.g., name, address, and existing telephone services—necessary to place accurate

orders for potential customers); (2) ordering; (3) provisioning (executing customers’

requests for local telephone service); (4) maintenance and repair; and (5) billing.

29For OSS functions for which there is no retail analog, incumbents must provide access

sufficient to give efficient competitors a “meaningful opportunity to compete.”
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complex orders. In addition, competing carriers noted that ordering

services from more than one incumbent carrier can be cumbersome

because incumbents use different ordering systems. Competing carriers

also told us that incumbents were not confirming orders and assigning

installation dates in a timely manner. Additionally, competing carriers told

us that incumbents occasionally left customers without telephone service

by failing to transfer them to the competitor’s system at the designated

time. Some carriers also claimed that they are not notified in advance if the

facilities at a customer’s site require special preparation before installation

and are then charged excessive fees for the special preparation. Finally,

competing carriers noted that incumbents’ wholesale operations staff often

failed to handle service requests in a timely and effective manner, a

problem that carriers attributed partially to a lack of training and

experience on the part of incumbents’ wholesale personnel.

Incumbent carriers acknowledged that there have been problems with

adapting their OSS to the needs of entering companies. Incumbents said

that providing comparable access to their support system functions is

difficult, however, because these computer systems were designed at an

earlier time for internal use by the incumbent, not for external use or use

by other companies. Incumbents also noted that giving competitors access

to these complex systems requires significant technical modifications,

resources, and time. They said they are expending significant effort to

improve the ability of competitors to access these system functions. For

example, one incumbent carrier said that it now offers competing carriers

the choice of five electronic systems and provides an electronic handbook

on the Internet to facilitate competitors’ access. That incumbent also

showed us materials that it is using to train competing carriers’ personnel

to better use the available systems, while another incumbent said that it is

training its own personnel to provide better service to its wholesale

customers. However, incumbent carriers said that problems still occur

when competing carriers’ personnel make errors or are unwilling to use the

appropriate electronic systems.

An FCC official agreed with incumbents that an important reason access to

OSS is difficult to provide is that such systems were designed for internal

use. FCC officials further noted that there were no national standards for

OSS and, as a result, these systems varied considerably across carriers. A

DOJ official and state officials also told us that problems in accessing OSS

functions pose the primary impediment to the development of local

telephone competition. Additionally, staff at 27 state commissions reported

that the Regional Bell Company in their state was working to address OSS
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Page 25 GAO/RCED-00-38 Competition in Local Telephone Markets

issues and had made at least “some” progress. In the states where the

Regional Bell Companies are seeking authority to provide long-distance

service, the state commissions have been helping to address OSS issues by

testing incumbents’ OSS. In one region, several state commissions are

cooperating with each other and with the incumbent carrier to test its OSS

functions.

Some Competing Carriers

Cited Difficulties

Negotiating Interconnection

Agreements

The 1996 act requires incumbent carriers to negotiate agreements that

stipulate how and under what conditions competing carriers will connect

their facilities and equipment with those of incumbents.30 The act and

FCC’s implementing rules provide competing carriers with several options

for developing interconnection agreements: negotiating their own

agreement, adopting an agreement that another carrier has negotiated with

the incumbent in that state, or choosing provisions from other signed

agreements within the state to form a new agreement or to combine with

other newly negotiated provisions.31 The act authorizes state utility

commissions to mediate or arbitrate interconnection disputes between the

carriers if requested by the carriers and requires the state commissions to

approve or reject all agreements.

Some competing carriers were concerned that difficulties they are having

negotiating interconnection agreements may delay their market entry.

These carriers told us that incumbent carriers did not always negotiate

contracts in a timely manner and that disputes involving the agreements

were sometimes slow to be resolved. For example, one carrier told us that

it can take almost a year to negotiate an agreement with an incumbent. In

an arbitration proceeding involving another carrier, the arbitrator stated

that the incumbent carrier had not been negotiating in good faith as

required by the act. Some competing carriers told us that they opt into

existing contracts even when the contracts are not relevant to their needs

because doing so eliminates costly and time-consuming negotiations.

30The terms and conditions of interconnection agreements are to be just, reasonable, and

nondiscriminatory.

31The last of these options, known as “pick and choose,” has been the subject of court

challenges; however, in Jan. 1999, the Supreme Court affirmed FCC’s interpretation of the

statutory language that requires an incumbent carrier to allow competing carriers to choose

options from prior contracts signed by that incumbent.
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Incumbent carriers, on the other hand, said they are working to facilitate

negotiations on interconnection agreements and point to a large number of

signed interconnection agreements as evidence that there are no major

problems for competitors in this area. According to a telecommunications

trade association, incumbent and competitive carriers had signed over

5,400 interconnection agreements nationwide as of February 1999, 3 years

after the 1996 act became law. One incumbent carrier we interviewed said

it had concluded over 400 agreements that had been approved by the state

and was currently negotiating another 750.32

The five utility commissions in the states we visited had approved and

arbitrated interconnection agreements. For example, in 1998, the Illinois

utility commission approved 37 agreements. In Texas, the public utility

commission has responded to complaints from some competing carriers by

developing a preapproved interconnection agreement that competing

carriers may adopt. While one competing carrier expressed concern that

the terms of the proposed interconnection agreement would not meet its

needs, the staff of the Texas commission noted that the agreement provides

consistency and addresses certain issues that earlier interconnection

agreements did not discuss.

Some Competing Carriers

Reported Difficulties

Obtaining Adequate

Collocation Space

Under the 1996 act, an incumbent carrier must allow competing carriers to

collocate, or place their equipment in the incumbent’s central offices, on

nondiscriminatory, just and reasonable rates, terms, and conditions.

Several of the competing carriers we interviewed reported difficulties in

obtaining adequate collocation space. These difficulties included

insufficient collocation space, long delays in providing space, high rates for

providing the cages (metal frames) within which competing carriers store

their facilities, and inconvenient access to collocation equipment. For

example, after an incumbent carrier reported having no space in its central

offices, the state commission found that the incumbent could convert

space that was being used for less important functions. Even when

collocation space is available, staff at a state utility commission said it

takes as long as 18 months for competing carriers to obtain collocation

space. Additionally, some competing carriers alleged that incumbents

charge high rates for collocation. Finally, competing carriers reported that

incumbents adopted policies that made it inconvenient for the competing

32This incumbent reported that only 60 of the 440 companies with which it has reached an

interconnection agreement are actually providing local telephone service.
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companies to service their collocation equipment. For example, some

competing carriers told us that their access within central offices is so

limited that, in some cases, they cannot use restrooms, elevators, or other

facilities in the offices.

Competing carriers were collocating equipment in many incumbents’

central offices in the five states we visited. According to FCC’s August 1999

report on local telephone competition, as of the end of 1998, approximately

50 percent of the incumbents’ customer telephone lines were served by

central offices where competing carriers had collocation arrangements.

Incumbent carriers told us that collocation space is expensive to prepare

and maintain. Additionally, while incumbent carriers told us that

collocation space is limited, one such carrier also described its efforts to

provide space when requested. For example, this carrier showed us space

that had been converted from a break room for employees to collocation

space. Another incumbent carrier also told us that it had made restrooms

and frame rooms available to designated employees of competing

companies.

Staff at several state commissions mentioned collocation as one of the 1996

act’s most difficult requirements to satisfy. Until recently, FCC allowed

incumbent carriers to require competing carriers to place their equipment

in a cage that is at least 100 square feet—specifications that competing

carriers believed increased the difficulty and cost of obtaining adequate

collocation space. Recognizing that collocation was a continuing problem

for new entrants, FCC issued new rules on March 31, 1999, that allow

collocators to share a collocation cage with other competing carriers or to

install their equipment in uncaged space. Some of the competitors with

whom we spoke believed that the new rules would improve their ability to

collocate their equipment in incumbents’ central offices.

Competing Carriers

Consider Enforcement

Necessary to Open Local

Telephone Markets to

Competition

FCC and state utility commissions have the primary responsibilities for

enforcing the 1996 act. However, according to the competing carriers we

spoke with, the act is not being adequately enforced. Incumbent carriers

also expressed concerns about the regulators’ implementation and

enforcement of telecommunications laws. As a result of the act, federal and

state regulators are having to adapt to changing roles, and many are taking

actions that may improve enforcement, such as resolving complaints more

quickly and adopting performance measures.
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Competing Carriers Say

Enforcement Is Critical to Their

Success

Although many competing carriers told us that the Telecommunications

Act of 1996 does not need to be revised, several said that swifter

enforcement of the law is needed. In particular, carriers emphasized that

their market strategies are often contingent on their ability to enter the

market rapidly and develop a customer base. Therefore, quickly resolving

the problems that they described to us, such as difficulties in accessing an

incumbent’s OSS, negotiating interconnection agreements, or obtaining

collocation space, is crucial for the successful implementation of their

business plans. Moreover, several competing carriers told us that

regulators do not impose penalties, do not assess penalties in a timely

manner, or levy penalties that are too small to influence an incumbent’s

behavior or fully compensate a competing carrier for the loss of its

customers.

Despite their desire for greater enforcement, many competing carriers

expressed concern about making direct complaints to enforcement

authorities because they were reluctant to jeopardize their relationships

with their only wholesale suppliers. These and other carriers were worried

about losing their retail customers if those customers were alerted to

problems the carriers were having with their primary wholesalers. Finally,

some companies did not have the time or resources to be involved in

protracted regulatory processes.

Some competing carriers noted that the process that Regional Bells must

go through to gain approval to enter the long-distance market—known as

the section 271 process—serves as an incentive for the Regional Bell

Companies to open their markets to competition. These competing carriers

said that Bell Companies seeking approval to offer long-distance service

were more responsive to the concerns of competing carriers than were

other incumbents that are already permitted to offer long-distance service

in their service regions. These competing carriers are concerned about the

loss of this incentive when the Bell Companies gain approval to enter the

long-distance market.

Incumbent Carriers Also Express

Concerns About Regulators’

Implementation and

Enforcement of

Telecommunications Laws

The incumbent carriers we spoke with expressed some concerns about

how regulators are implementing and enforcing the Telecommunications

Act of 1996. The incumbents were concerned primarily about what they

saw as a lack of clear guidance from FCC on what the Regional Bell

Companies must do to pass the 14-point checklist required for entry into

the long-distance telephone market. One incumbent carrier told us that it

thought it was in compliance with the items on the checklist only to find

that FCC considered its progress insufficient. However, FCC did not, in the
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opinion of officials at this Regional Bell Company, provide adequate

guidance on what actions the company would need to take to be in

compliance with the checklist. One incumbent carrier suggested that FCC

had raised the “hurdle” over time, increasing the requirements for

satisfying the checklist. Representatives of some of these companies told

us that even today, they do not have a clear sense of what will enable their

companies to pass the checklist and gain approval to enter the longdistance market. However, one incumbent did say that FCC’s replies to

applications from Bell Companies to enter the long-distance market had

provided somewhat more detailed guidance over time.

Regulators Adapt Enforcement

Tools and Role to Changing

Market

At the federal level, the Congress charged FCC with implementing the local

competition provisions of the 1996 act. FCC has a variety of enforcement

tools that can be used to implement these provisions, including, for

example, the authority to issue penalties and resolve complaints. As

previously noted, FCC also has the authority, after consultation with DOJ

and the relevant state commission, to approve an application by a Regional

Bell Company to enter the long-distance market in its local telephone

service area.33 In addition, states and state utility commissions have

enforcement authority under the 1996 act and their own laws. In

responding to our survey, staff at some state utility commissions indicated

that their commissions had certain tools for enforcing their laws. For

example, the authority to issue civil penalties or revoke carriers’ operating

licenses. Many of the states have an expedited process for handling

complaints similar to FCC’s, and some other states are considering the

adoption of an expedited process. Staff at many of the state commissions

believe, however, that their authority to assess fines is not adequate to

enforce the laws and regulations that govern local telephone companies.

Staff at some state commissions said that they have no fining authority and

must rely on a court or other state agency to issue monetary penalties

against a carrier or have fining authority that is restricted to specific retail

abuses.

According to FCC officials, the 1996 act has shifted the balance between

FCC’s roles as an industry regulator and a market facilitator in such a way

33FCC is required to give substantial weight to DOJ’s evaluation. If FCC determines that a

Bell Operating Company has fallen out of compliance with the competitive checklist after

authority to provide in-region long-distance service has been granted, FCC may issue an

order directing the company to correct the deficiency, impose a penalty on the company, or

suspend or revoke such authority.
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that FCC now focuses more on mediating and refereeing differences among

telecommunications providers. In particular, FCC officials told us that as

telecommunications markets become more competitive, there will be less

need for FCC to regulate carriers and more demand for the agency to

ensure the efficient functioning of the market by mediating disputes and

enforcing compliance with the law. Recognizing these changes, the relevant

congressional committees recently approved FCC’s plan for an

enforcement bureau to strengthen the agency’s efforts to enforce the law.

This plan was implemented in November 1999. FCC officials also told us

that the Commission recognizes the need for staff training in the

enforcement area. FCC has likewise recognized the importance of swifter

enforcement and has instituted an “accelerated docket,” a formal expedited

process to resolve all forms of complaints against telecommunications

carriers.34 In addition, FCC has used its authority to impose conditions on

recent merger approvals as a way to encourage incumbents to further

remove impediments to competition. For example, in approving the Bell

Atlantic-NYNEX merger, FCC required the merged company to improve

competing carriers’ access to OSS by offering them a uniform computer

interface in the states where Bell Atlantic now operates.

According to FCC officials, under FCC’s authority to approve applications

by Regional Bell Companies to enter the long-distance market in their local

telephone service areas, the Commission has spent considerable resources

clarifying the entry requirements for these companies. These officials said

that they provided early guidance on satisfying the entry requirements set

forth in the 14-point checklist in their August 1996 order implementing the

local competition provisions of the 1996 act and in their response to the

first application for entry into the long-distance market by a Bell Company.

More recently, the officials said, they addressed the requirements for all 14

points in an October 1998 order denying Bell South’s second application to

enter the long-distance market in Louisiana. And, in a December 1999

document approving Bell Atlantic’s application to enter the long-distance

market in New York, they again provided guidance for satisfying all 14

points.

When we asked staff at the state utility commissions whether the role of

the commissions had changed since the act’s passage, staff at 48

commissions said that the role had changed, and staff at 36 of these

34In addition to formal proceedings, regulators are also using informal procedures to resolve

many complaints.
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Page 31 GAO/RCED-00-38 Competition in Local Telephone Markets

commissions said that the role had changed greatly. Staff at some

commissions said they were doing less traditional regulation, such as rate

setting, while staff at many commissions said they were more involved in

resolving disputes among carriers. These state commission staff

characterized their roles since the act’s passage as mediators, arbitrators,

and referees. In addition, staff at 31 of the 50 state commissions reported at

least some increase in the resources devoted to the regulation of telephone

service during the act’s first 3 years. However, staff at 40 commissions

noted that at least some increase in resources was needed to address the

increased workload that has occurred since the act’s passage; staff at 31 of

these commissions said they needed a moderate or large increase in

resources.

Regulators and Carriers Believe

Performance Measures Are

Necessary to Ensure Compliance

One of the actions that regulators are taking to better enforce laws and

regulations is to develop better information about the services incumbents

are providing to competing carriers. In general, telephone companies use

“performance measures” to measure the quality of the services they

provide. For example, one performance measure might indicate how long it

takes, on average, to install a customer’s telephone service. Another

measure might track the time required to repair a customer’s telephone

service. Competing carriers and regulators have urged the development of

performance measures to ensure that incumbent carriers comply with the

1996 act’s requirement to provide the same quality of service to competing

carriers as they provide to their own retail customers. In addition, one

senior DOJ official stated that performance measures are important for the

development of competition in local telephone markets. Similarly, staff

from 40 of the state commissions claimed that performance measures were

very important for opening local markets to competition.

Performance measures are being designed to enable regulators, competing

carriers, and incumbent carriers themselves to monitor incumbents’

performance. In several of the performance measurement plans being

considered by the state commissions, monetary penalties paid to a

competing carrier are automatically imposed on an incumbent when one or

more of the performance measures indicate that the incumbent has not

provided adequate service to the competing carrier. Furthermore, some

plans give state regulators the authority to impose additional financial

penalties on an incumbent carrier that continues to provide inadequate

service to its competitors. In its December 1999 approval of Bell Atlantic’s

application to enter the long-distance market in New York, FCC said that it

will use the performance measures developed in New York to monitor Bell

Atlantic’s performance for at least 1 year after that company enters the
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long-distance market. FCC says that if those measures fall sufficiently

below the ones submitted by Bell Atlantic when it applied to enter the longdistance market in New York, FCC will take enforcement action, including

the possible suspension or revocation of the company’s authority to offer

long-distance service in New York.

Incumbent and competing carriers hold different views on how

performance measures should be evaluated, how many are needed, and

how great the penalties should be.

• Incumbents and larger competing carriers differ over which statistical

measures provide the most reliable and cost-effective information on

incumbents’ performance. Smaller competing carriers are generally

more interested in whether measures of an incumbent’s overall

performance will appropriately reflect the quality of the service being

provided to individual companies.

• The number of required performance measures varies among the states

that have developed performance plans. Some incumbent carriers told

us that often there were more performance measures than needed to

comply with the act’s requirements, while competing carriers favored

additional measures to ensure that they have adequate data to

determine whether incumbents are providing all of the required

services.

• Incumbent and competing carriers also had different views on

provisions in some of the performance plans that impose monetary

penalties on incumbent carriers if they do not provide required services

to competitors. Incumbents noted that the penalties in plans proposed

by some states, including annual maximums, are sufficiently high.

Competing carriers told us that the penalties in several of these plans

are not high enough to encourage compliance with the performance

standards and deter misconduct.

Observations The Telecommunications Act of 1996 fundamentally changed the laws and

regulations governing the telecommunications industry. However, some of

the companies and regulators we spoke with noted, as did the Supreme

Court, that the act was not entirely clear about how some provisions were

to be implemented. In the 4 years since the act was passed, regulatory

actions and court decisions have clarified some of these issues, while

others are awaiting resolution or clarification. During the same 4 years, an

array of companies—both incumbents and new competing carriers—have

spent considerable resources responding to the incentives and obligations
B-283167

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created by the act. They have pursued new business plans, developed new

technologies, invested in new facilities, adapted existing facilities,

restructured their businesses through mergers, and otherwise refocused

their companies toward the future. Thus, the time since the act’s passage

has constituted a necessary period of adjustment, for regulators and

companies alike.

Given the many changes that have taken place and are ongoing, it is

difficult to determine whether the degree of competition that has emerged

in local telephone markets thus far should be viewed as disappointing or as

about what should have been expected. Moreover, the market for local

telephone service is continuing to evolve. For example, some forms of

communication, such as mobile wireless telephone service and electronic

mail, are already being substituted at times for traditional voice telephone

service, and the Internet may soon provide further alternatives. Most

important, the carriers we spoke with noted that customers are

increasingly influenced in their selection of local telephone service

providers by whether carriers can also provide other telecommunications

services, such as long-distance service and Internet access. That is,

consumers now focus less on purchasing individual telecommunications

services and give more attention to simultaneously purchasing a package of

these services. This packaging is thus blurring the traditional distinctions

among telecommunications services and among providers, as firms that

once provided only certain services broaden their market offerings.

Understanding this trend is important for analyzing the further

development of competition throughout this industry. As the marketplace

continues to change, one of the many remaining challenges for regulators

and the Congress will be to obtain the information needed to measure and

track the development of competition.

Agency Comments We provided a draft of this report to the Federal Communications

Commission (FCC) and to the Department of Justice (DOJ) for review and

comment. DOJ officials did not have any comments on this report. FCC

officials, including the Associate Chief, Common Carrier Bureau, provided

oral comments to us. They stated that that they had no significant

disagreement with the overall findings and conclusions of the report. In

addition, they provided a variety of technical clarifications and comments

that we incorporated as appropriate.
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We conducted our review from April 1999 through December 1999 in

accordance with generally accepted government auditing standards. For

more information on our scope and methodology, see appendix I.

As agreed with your offices, unless you publicly release its contents earlier,

we plan no further distribution of this report until 14 days after the date of

this letter. At that time, we will send copies of this report to interested

congressional committees; the Honorable William E. Kennard, Chairman,

Federal Communications Commission; the Honorable Joel Klein, Assistant

Attorney General, Antitrust, Department of Justice; and other interested

parties. We will also make copies available to others on request.

If you or your staff have any questions about this report, please contact me

at (202) 512-7631. Key contributors to this report are listed in appendix III.

Stanley J. Czerwinski

Associate Director, Housing, Community

Development, and Telecommunications Issues
Page 35 GAO/RCED-00-38 Competition in Local Telephone Markets
Page 36 GAO/RCED-00-38 Competition in Local Telephone Markets

Appendix I

Objectives, Scope, and Methodology ApApenednxidexiIs

To obtain information about competition in local telephone markets, the

Chairman and the Ranking Minority Member of the Subcommittee on

Antitrust, Business Rights, and Competition, Senate Committee on the

Judiciary, asked us to conduct a study on emerging competition in local

telephone markets. In response to this request, we analyzed (1) the

development of competition in local telephone markets and the market

strategies employed by new carriers in five states under the 1996

Telecommunications Act, and (2) the key issues affecting that development

and the enforcement activities of federal and state regulators to address

those issues. To obtain information about how competition is developing in

local telephone markets, we visited five states—California, Illinois, New

York, South Carolina, and Texas—that had varying demographic and

telephone usage characteristics (see table 1). We chose these states

because they varied by the date when competing carriers first entered the

marketplace, contained urban and rural areas, varied in the status of the

Bell Company’s application for entry into the long-distance market, and had

public service commissions with different focuses. In addition, these were

among the states recommended by trade association officials and other

experts whom we asked for recommendations.

Table 1: Income and Telephone Data for the Five Selected States

Sources: These data were the most recent available. The median household income numbers are from

the U.S. Bureau of the Census, State and Metropolitan Area Data Book 1997-98; the remaining

information is based on data in FCC’s Trends in Telephone Service (Sept. 1999).

Criterion California Illinois New York South Carolina Texas

Median household income in 1998 $40,934 $43,178 $37,394 $33,267 $35,783

Percentage of households with telephone

service in July 1999 96.5% 91.7% 95.4% 91.1% 93.5%

Total number of telephone lines as of

December 1998 (in thousands) 22,222 8,209 12,844 2,248 12,617

Percentage of total state lines provided to

competing carriers for resale as of

December 1998 1.4% 2.4% 1.9% 2.6% 3.0%

Percentage of resold lines provided by

large incumbent carriers serving

residences as of December 1998 51.5% 42.6% 23.8% 59.3% 59.4%

Percentage of total U.S. telephone

revenue in 1997 11.8% 4.4% 7.4% 1.3% 6.9%
Appendix I

Objectives, Scope, and Methodology

Page 37 GAO/RCED-00-38 Competition in Local Telephone Markets

In these five states, we interviewed and collected information from officials

of the Regional Bell Companies and other incumbent carriers, state public

utility commissions, and 24 competing carriers. We chose the competing

carriers by talking to experts and officials at state utility commissions. In

each state, we attempted to identify competing carriers that served

different markets and used different technologies to deliver local telephone

service. To gain information about how competition is evolving more

broadly and how well state officials feel they are able to implement the

1996 act, we mailed surveys to staff at the public utility commissions of all

50 states and received responses from all of them. The survey was sent to

staff members who were charged with ensuring that knowledgeable

staffers completed it. To ensure that all commissions participated in the

survey and that we fully understood the answers to our questions, we

telephoned all 50 state public utility commissions to pose follow-up

questions and record all survey responses. In addition, some state

commissions provided written responses by mail. The survey administered

to the Alaska and Hawaii commissions differed from the one administered

to the other 48 commissions because Alaska and Hawaii do not have

Regional Bell Companies and, therefore, some of the questions were not

applicable. Because we did not speak to commissioners, the survey

responses represent the views of commission staff. See appendix II for the

survey responses.

To identify the key issues affecting the development of competition and the

enforcement activities of federal and state regulators to address those

issues, we interviewed and collected information from officials at the

Regional Bell Companies and other incumbent carriers, the state public

utility commissions, and competing carriers in the selected states. We also

used, as appropriate, information from our surveys of the state public

utility commissions. In addition, we interviewed officials at and gathered

information about FCC, DOJ, trade associations, and other experts.

Moreover, we conducted literature searches and legal and regulatory

research related to relevant federal and state legislation and legal

documents.
Page 38 GAO/RCED-00-38 Competition in Local Telephone Markets

Appendix II

Responses to Survey of State Utility

Commissions ApendxiI

Note: Numbers show the

number of

commissions selecting

each response.

Some questions were not

answered by all

respondents and therefore

totals do not necesarily

add to 50 states.
Appendix II

Responses to Survey of State Utility

Commissions

Page 39 GAO/RCED-00-38 Competition in Local Telephone Markets
Appendix II

Responses to Survey of State Utility

Commissions

Page 40 GAO/RCED-00-38 Competition in Local Telephone Markets
Appendix II

Responses to Survey of State Utility

Commissions

Page 41 GAO/RCED-00-38 Competition in Local Telephone Markets
Appendix II

Responses to Survey of State Utility

Commissions

Page 42 GAO/RCED-00-38 Competition in Local Telephone Markets
Appendix II

Responses to Survey of State Utility

Commissions

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Appendix II

Responses to Survey of State Utility

Commissions

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Appendix II

Responses to Survey of State Utility

Commissions

Page 45 GAO/RCED-00-38 Competition in Local Telephone Markets
Appendix II

Responses to Survey of State Utility

Commissions

Page 46 GAO/RCED-00-38 Competition in Local Telephone Markets
Appendix II

Responses to Survey of State Utility

Commissions

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Appendix II

Responses to Survey of State Utility

Commissions

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Appendix II

Responses to Survey of State Utility

Commissions

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Appendix II

Responses to Survey of State Utility

Commissions

Page 50 GAO/RCED-00-38 Competition in Local Telephone Markets
Appendix II

Responses to Survey of State Utility

Commissions

Page 51 GAO/RCED-00-38 Competition in Local Telephone Markets
Appendix II

Responses to Survey of State Utility

Commissions

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Appendix II

Responses to Survey of State Utility

Commissions

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Appendix II

Responses to Survey of State Utility

Commissions

Page 54 GAO/RCED-00-38 Competition in Local Telephone Markets
Appendix II

Responses to Survey of State Utility

Commissions

Page 55 GAO/RCED-00-38 Competition in Local Telephone Markets
Appendix II

Responses to Survey of State Utility

Commissions

Page 56 GAO/RCED-00-38 Competition in Local Telephone Markets
Page 57 GAO/RCED-00-38 Competition in Local Telephone Markets

Appendix III

GAO Contacts and Staff Acknowledgments ApendxiI

GAO Contacts Stanley J. Czerwinski (202) 512-7631

Amy Abramowitz (202) 512-4936

Acknowledgments In addition to those named above, Dennis Amari, Nancy Barry, Elizabeth

Eisenstadt, Thomas Farrell, Fran Featherston, Jennifer McCarthy, Myrna

Pérez, and Mindi Weisenbloom made key contributions to this report.

(385793) Letr
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Appendix III

GAO Contacts and Staff Acknowledgments

Page 59 GAO/RCED-00-38 Competition in Local Telephone Markets
Appendix III

GAO Contacts and Staff Acknowledgments

Page 60 GAO/RCED-00-38 Competition in Local Telephone Markets

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