Opinion ID: 786960
Heading Depth: 2
Heading Rank: 1

Heading: Common Cost Markup

Text: 37 We turn first to the CPUC's decision to adopt Pacific's methodology in determining the common-cost markup to be applied to the cost of UNEs, a decision we review de novo. We interpret the 1996 Act and the FCC regulations in light of Congress's pro-competitive goals. See Local Competition Order ¶ 618. 38 The Local Competition Order grants state commissions considerable latitude in determining how to allocate common costs. Id. ¶ 696 ([F]orward-looking common costs shall be allocated among elements and services in a reasonable manner....). The CPUC decided to use a fixed allocator of common costs, a method suggested by the FCC's Order. Given the consistency of the FCC's Order with the terms and goals of the Act, we cannot say that the CPUC's decision to use that methodology violates the Act. Since the common costs are, by definition, costs that are common to all or part of an ILEC's operation, allowing a standard markup over all UNEs for common costs properly attributable to UNEs should allow an ILEC to recover the full costs of providing UNEs, as contemplated by the Act itself, while still allowing CLECs to compete with the incumbents on an level playing field. That is, the price paid by the CLEC should approximate the cost to the ILEC of providing the UNEs. 39 MCI's and AT & T's central challenge is not to this basic methodology, but rather to the CPUC's implementation of it. They claim that the denominator should include retail-related and Category III direct costs, not just the direct costs of providing the UNEs. As noted by the CPUC, however, this would mix apples and oranges. See OANAD Decision at 64. The CPUC allocated the common costs of providing UNEs by dividing these common costs by what the CPUC determined were the direct costs of the UNEs. If, as the CPUC claims, the common costs are only those involved in wholesale operations, adding the direct costs of providing retail-related and Category III services to the denominator would reduce the percentage markup and would, to that extent, underestimate the amount of common costs required to produce a given UNE. 40 Of course, the CPUC could have included all retail-related and Category III common costs in the numerator, and included the direct costs of providing those services in the denominator. This would have produced a markup that could be applied to all services, both those that the ILEC would provide to CLECs (such as UNEs) and retail services that the ILEC provides to its own retail customers. However, that calculation of the markup would be less accurate, because the markup for providing network services might be different from that for retail services. For instance, if the markup for retail services were 30%, and that for network services were 20%, with each comprising 50% of an ILEC's business, the markup including both retail and wholesale would be 25%. When applied to UNEs, the 25% markup would therefore overestimate the cost or providing UNEs. This inaccuracy, however, might be outweighed by the ease of application and the difficulty of determining which common costs have a retail component, and which do not. 41 The point here is not to discuss the merits of such an approach, which we decline to do, but simply to point out that, like the CPUC's approach, such a method would be consistent, comparing apples to apples. To include only wholesale common costs in the numerator and to include all firm-wide direct costs in the denominator, by contrast, would be inconsistent, and would underestimate the common costs that Pacific has a right to recoup when it charges CLECs for access to its networks. This would essentially force Pacific to subsidize MCI and AT & T's retail operations, which the Act does not require. The CPUC was therefore correct in rejecting MCI's and AT & T's methodology. 42 This does not, however, end our inquiry. The foregoing analysis assumes that the CPUC properly removed all retail-related costs from both the common costs and the direct costs of providing the UNEs, such that the numerator and denominator included only wholesale costs. That is, while we conclude that the CPUC was correct in concluding that it should consider wholesale costs and not retail costs, it is not necessarily the case that they actually did so. Rather, it appears that the CPUC included some retail-related common costs in the numerator, thereby artificially inflating the markup. 43 The key to understanding the CPUC's mistake is in the district court's description of the hypothetical world contemplated by the CPUC. According to the district court, in calculating the common cost markup the CPUC considered which common costs would remain in a hypothetical forward-looking environment in which Pacific is solely a wholesaler and in which Pacific engaged in no retail activity. AT & T, 228 F.Supp.2d at 1093. The CPUC apparently believed this hypothetical exercise to be required by the FCC's Local Competition Order, ¶ 694. Paragraph 694 requires no such thing, however. While the Order does appear to forbid state commissions from considering retail common costs, it does not require it to imagine such a hypothetical state. Rather, imagining a hypothetical wholesale-only world inflates the common costs, since in such a world common costs that in actuality support both retail and wholesale activities are assigned solely to the ILEC's wholesale activities. 44 An example from Pacific's own brief illustrates how this is so. Pacific notes, correctly, that the salary of an executive, such as the company's president, should be considered a common cost. See id. (Common costs also include costs incurred by the firm's operations as a whole, that are common to all services and elements ( e.g., salaries of executives involved in overseeing all activities of the business) ...). Pacific further argues that most of the cost of the company's president should be considered as a common cost attributable to wholesale operations, since in a wholesale-only environment, the ILEC would still require a president. While the current cost or salary of the ILEC's president might be slightly reduced to account for the fact that the president of a smaller company ( i.e., a wholesale-only telephone company) might be paid less, according to Pacific the majority of the president's salary should be counted as a wholesale common cost. 45 Pacific's example may be used to illustrate the problem with the methodology. We agree with Pacific that in the hypothetical world in which Pacific is a wholesale-only company, the president's salary might be reduced slightly from its present amount, but that it would likely remain close to the original amount. But what if, in the real world, Pacific actually performs half wholesale and half retail operations? In that event, in the real world, the common cost of the president's salary should be allocated half and half between the wholesale and retail operations. To put it another way, the president's salary might remain at 80% of its present level if all retail operations were terminated or if all wholesale operations were terminated. By considering only the first alternative, the CPUC hypothetical would exclude only 20% of the president's pay as being attributable to retail operations. To the extent that the hypothetical salary of Pacific's president in the hypothetical wholesale-only world exceeds one-half of his or her present real-world salary, that hypothetical salary overstates the common costs properly attributable to Pacific's wholesale operations. 46 Nothing in the Act or the implementing regulations requires the TELRIC methodology to be implemented in the manner adopted by the CPUC. Indeed, this implementation leads to an anti-competitive result. As noted above, ¶ 694 nowhere mentions the hypothetical world contemplated by the CPUC. Although the direct costs of the UNE must be measured based on the use of the most efficient telecommunications technology currently available and the lowest cost network configuration, given the existing location of the incumbent's wire centers, this hypothetical-world approach does not extend to the calculation of common costs. See 45 C.F.R. § 51.5015(c)(1). More important, the CPUC's hypothetical world produces a situation in which a CLEC has to pay its own direct retail costs and some of the common retail costs of the incumbent. 47 Stated another way, under the methodology adopted by the CPUC, Pacific will not have to pay all of its retail-related common costs, thereby allowing it to charge lower prices for its own retail services than it otherwise would. Conversely, the CLECs must pay some of Pacific's retail-related costs, thereby increasing the CLECs' costs of providing telephone service and exerting upward pressure on the prices they charge their customers. Thus, under the CPUC's approach, the CLECs are essentially subsidizing Pacific's provision of retail services and, to that extent, increasing their own costs. As previously noted, the very reason why the CPUC adopted TELRIC was to prevent the barrier to entry faced by a CLEC if it has to incur its own retailing costs as well as ... the incumbent's retailing costs. First Cost Decision at 21-22. As the Act, the Local Competition Order, and the CPUC's decisions themselves make clear, this is an anti-competitive and unreasonable interpretation of the Act. 48 Our conclusion is different with respect to Category III costs, however. As noted above, the CPUC found that there was a separate accounting mechanism for Category III costs, such that those services are billed for any overhead they use from Pacific, as required by the FCC. OANAD Decision at 65-66. To support this conclusion, the CPUC relied on the testimony of Richard Scholl, a witness for Pacific. The district court also accepted this conclusion. See AT & T, 228 F.Supp.2d at 1102 n. 16. We hold that this finding is supported by substantial evidence. Unlike retail common costs, which we have concluded have been improperly included in the CPUC's calculations of common costs, the separate billing structure of Pacific's Category III services prevents the common costs used to support them from being included in Pacific's calculation of its common costs. The CPUC was correct in not including Category III costs in the denominator. 49 We therefore reverse the decision of the district court affirming the CPUC's determination establishing the common cost markup added to the direct cost of UNEs. On remand, the district court should direct the CPUC to calculate the markup using a common cost figure that properly accounts for the portion of Pacific's activities that are retail-related.