The Canadian Radio-Television and Telecom Public Notice CRTC 99-16

AT&T Canada Corp. and AT&T Canada Telecom Services Company

November 30, 1999

Review of contribution collection mechanism and related issues.

Introduction

AT&T Canada welcomes this opportunity to provide its perspective on the state of the current regime of subsidy collection within the Canadian telecommunications industry. At the outset, AT&T Canada wishes to note that it is committed to the concept of universal service and applauds the Canadian government’s goal of becoming the most connected nation in the world. AT&T Canada wants to continue to play an active and vital role in achieving that goal – a goal that will provide all Canadians with an opportunity to connect with and explore the world, linking them to a global market and a global community as close as next door.

In that spirit, AT&T Canada believes the Commission has the opportunity in this proceeding to put in place a new subsidy regime that, unlike the existing system, will effectively and efficiently achieve two of Canada’s most fundamental telecommunications policy objectives1:

1) To render reliable and affordable telecommunications services of high quality accessible to Canadians in both urban and rural areas in all regions of Canada; and

2) To foster increased reliance on market forces for the provision of telecommunications services and to ensure that regulation, where required, is efficient and effective.

Given the numerous deep-seated problems with the existing subsidy regime, it is AT&T Canada’s view that this proceeding could not be more timely and, to have the greatest positive impact, must be concluded (i.e., a decision rendered) with the utmost urgency. In the simplest terms, AT&T Canada strongly believes that the current subsidy regime is broken. The current system fails to achieve its stated goals and retards the development of competition. For these reasons, the current regime is not sustainable, even in the immediate future, and in turn jeopardizes the Commission’s ability to simultaneously achieve universal, affordable service and increased reliance on market forces.

Throughout the submission that follows, AT&T Canada will demonstrate that, failing an overhaul to the existing subsidy regime, both universal service and the sustainability of competition, as well as its associated benefits will be impossible to achieve. Instead, in its second submission entitled “A Proposal for Change,” AT&T Canada is advocating a system based on sound principles that ensures the ongoing availability of affordable service in a competitive environment.

AT&T Canada Supports a Principled Approach to Universal Service

AT&T Canada believes that the primary intent of this proceeding is to work through the detailed mechanics associated with the subsidy regime. That being said, AT&T Canada submits that the Commission must not lose sight of the fact that defining an appropriate framework of public interest principles within which this detailed work will be undertaken is critical to the ultimate success of the regime. Defining a framework ensures that whatever regime is finally put in place is consistent with the public interest principles that the Commission considers germane to a sustainable, successful marketplace. To establish an appropriate framework, the Commission must use this proceeding to re-visit and reaffirm the general purpose of subsidies, as well as the design objectives for a subsidy regime within a competitive environment. AT&T Canada submits that this exercise will make it immediately clear that the current regime is no longer effectively serving its intended purpose nor is it meeting its design objectives and must be replaced immediately.

Purpose and Design Objectives

In AT&T Canada’s view, the general purpose of subsidies in the telecommunications industry can be gleaned from the policy objectives spelled out in the Telecommunications Act. Specifically, Section 7(b) of the Act states that it is a Canadian telecommunications policy to:

“render reliable and affordable telecommunications services of high quality accessible to Canadians in both urban and rural areas in all regions of Canada.”

While this industry has been successful in bringing service to many rural areas, AT&T Canada must question to what extent the existing contribution regime necessarily contributed to this and whether in fact this regime is designed to serve the purpose stated in the Act. AT&T Canada understands that the contribution mechanism was intended to keep the provincial phone companies whole, yet implicit in that objective was the expectation that the funds would also be used to achieve the overall objective of universal service advocated by the Act. AT&T Canada suspects that not all of the subsidy funds currently collected are being used for their intended purpose, particularly in light of the fact that even after existing Service Improvement Programs are completed, over 20,000 Canadians businesses and households still will not have access to basic telephone service – many rural Canadians are still waiting to obtain benefits from the contribution regime.

This is particularly disturbing when one considers that the ILECs have collected over seven billion dollars from the contribution mechanism over the last 8 years. Needless to say, that is a great deal of money. One might think it was more than enough to cover the cost of providing service to high cost areas and to achieve universal service. To put the amount in perspective, consider for a moment that AT&T Canada started with a small, private-line network connecting the railroads in Canada, invested a smaller sum of money (slightly over $2 billion) and managed to build a state-of-the-art, long distance network from coast to coast as well as a facilities-based local network in 17 cities. AT&T Canada submits that this startling comparison casts a dark shadow on the efficacy of the existing contribution regime.

In Decision 92-12, the Commission laid out the design objectives of a subsidy regime. In that Decision, the Commission determined that a subsidy regime should: 1) be efficient from an administrative perspective, 2) be sustainable, support the achievement of universal service objectives, and 3) should allow all market participants equal pricing flexibility. While in theory these objectives may have been consistent with the contribution regime as it appeared on paper, based on behaviour readily observable in the market today, AT&T Canada is very concerned that in reality the regime fails to meet the design objectives the Commission set out. AT&T Canada submits that the current practice sacrifices accuracy and accountability in the interests of simplicity. In the end, the result is a regime that allows the ILECs to over-collect an inflated subsidy from their competitors, with an insufficient requirement to validate expenditures.

The Need for Imminent Change – Today’s Realities

AT&T Canada applauds the Commission’s decision to focus on and resolve the significant issues surrounding the contribution collection mechanism before exploring other matters impacting the telecommunications industry in Canada. It is important to understand clearly that this industry today is not poised for future success. In fact, if left unchecked, AT&T Canada is fearful that the eventual outcome will be a re-monopolization of the industry by the incumbent telephone companies.

The provincial phone companies continue to post ever increasing net income and high rates of return on capital, while Call-Net and AT&T Canada post increasing net losses, collectively running at the rate of approximately $1 billion per year. This dramatic dichotomy points to a serious industry structure dilemma, one not witnessed in any other country’s efforts to de-regulate, and the potential for re-monopolization of the Canadian industry.

Return on Capital figures are adjusted to remove impact of extraordinary items

Despite comparable revenue generation and capital development vis-á-vis competitors in other countries, alternative providers in Canada report lower EBITDA as a percentage of industry EBIDTA and larger net losses while the ILECs are profitable, and increasingly so year over year. This is a much different story than in the United States and the United Kingdom where new entrants were profitable after 7 years of competition.

Industry Metrics

Currently, the ILECs are the only companies in the industry providing a return to their shareholders; this situation is not sustainable in the long run. In all sectors, the ILECs still have a dramatic market share advantage, and are now beginning to regain share in some long distance markets.

In addition, it is AT&T Canada’s estimate (included in its business plans) that the ILECs will conservatively have 90% share in local business service, and 95% share in local residential service into the year 2004. Based on the following chart, and mindful of the provincial phone companies’ share in local service, one could easily foresee a return to monopoly.

ILEC Market Share Market Size (in *billions)

Long Distance Voice

Business 67% $4.2
Residence 73% $2.3
Total 69% $6.5

Data Services 71% $2.6

Local Services

Business 97.3% $3.9
Residence 100.0% $3.9
Total 98.6% $7.8

Internet/E-commerce 23% $1.0

Total Market 80% $17.9

In light of all the above, AT&T Canada submits that the Commission must question whether the existing contribution regime could possibly be meeting its objectives. In particular, it is AT&T Canada’s view that it is not possible for a rational, sustainable regime to produce a situation such as the one detailed above. AT&T Canada believes that the dominant market share of the incumbents (80%), combined with the fact that lower per minute prices (and increased demand) lead to significantly more contribution dollars flowing into the pool than needed or expected, causes there to be no incentive for the phone companies to maintain a rational price structure. In fact, the opposite incentive exists, contributing significantly to the demise of competition.

The Proposal for Change – A Principled Approach

If all Canadians are to enjoy the benefits of universal service and if the telecommunications industry in Canada is to be truly competitive and able to attract investment capital that earns a fair return, a number of significant changes must be made. Based on the evidence provided above, as well as results witnessed in the market, it is AT&T Canada’s submission that one of the most urgently required changes is in the contribution formula and the processes surrounding it.

AT&T Canada provides the following principles within which, it is submitted, a subsidy regime must be developed in order to rectify the above stated problems and render a system that meets both the purpose of a subsidy in a competitive environment, as well as the Commission’s more specific design objectives.

Principles for an effective, efficient subsidy regime in a competitive environment:

1. Universal service should be achieved and maintained for all Canadians, including the maintenance of affordable rates for residence customers in high cost areas.

2. The quantum of contribution collected should be limited to the amount of the total subsidy requirement, established on an annual basis. This would avoid the type of overpayment ($162M in 1998 and $78M in 1999) seen in the industry over the last two years. In addition, the quantum should be calculated in substantive and verifiable business cases based on the forward-looking, incremental cost (i.e., Phase II costs) of providing the subsidized services.

Amount should reflect the impact of productivity improvements and technological advances over time – requires a true-up mechanism to ensure that any over-collection would be taken into account in determining the following yearÂ’s requirement. Amount should be based on underlying cost assumptions agreed to by the industry participants. Contribution to this Fund should come only through this established mechanism and not through any additional surcharges/channels.

3. In a world of convergence, the contribution subsidy mechanism must be technologically and competitively neutral and therefore must include all communications players, e.g., wireline, wireless (mobile and fixed) and cable.

4. The subsidy collection mechanism should be structured in a manner that promotes competition and infrastructure investment in facilities-based local service by new entrants through a subsidy credit in order to promote other objectives of the Telecommunications Act, including those objectives dealing with enhancing competitiveness and efficiency of Canadian telecommunications;

5. An Industry Consortium should have oversight of the Universal Service Fund

The Consortium should be a small group (10-12 members) with representatives from all industry segments, plus government and independent representatives In conjunction with the use of a Phase II costing approach to pre-define the need for subsidy, the Commission must implement a tracking mechanism to be used by the fund manager to insure that money withdrawn from the fund is actually being used to satisfy the pre-defined need An independent auditor should conduct regular audits to ensure that the tracking mechanism implemented by the Commission is being applied properly by those receiving subsidy funds There should be no “net payers” – all participants should be required to pay into the fund, even if ultimately they are entitled to receive subsidy payments. All information associated with the disbursement of subsidy funds should be readily available for public review at all times Fund managers (appointed by the Consortium) should attain a minimum earnings threshold on funds held prior to distribution, and all such earnings should reduce future fund requirements.

Conclusion

In retrospect, the Canadian governmentÂ’s vision for telecommunications competition was a good one. As a result of competition, Canadians now enjoy the lowest long distance pricing in the world, innovation and choice have increased dramatically, the number of jobs created across the economy by the communications industry is growing and the entire Canadian economy, for which telecom is an increasingly fundamental enabling technology and engine of growth, is visibly profiting from the impacts of telecommunications competition. Canadians have truly benefited over the course of the last few years.

However, as positive as the story appears on the surface, there is a dark shadow on the horizon that cannot be ignored – the real danger of re-monopolization within the industry. Going forward, both in the re-design of the contribution regime, as well as in other significant proceedings, the Commission must be mindful of market realities. In fact, the once competitive consumer long distance market is now in the process of re-monopolization. The Commission must be wary of the same result in the business sector.

As David Colville said:

“Competition and deregulation are not synonymous. In moving from a monopolistic environment to a market-driven one, you cannot simply take away regulation. You need regulation to take you through a series of rebalancing steps until at least some competitors gain enough market share to sustain themselves in a free environment.”

AT&T Canada submits that current market reality demonstrates that some of the long distance deregulation policies of the past, including the contribution regime, though well intentioned at the time, are not working today as local service is being deregulated and significant investments are being made. Although the Commission has done an excellent job in taking the first steps towards opening up the local exchange market to competition, it is essential at this time that the Commission and the industry as a whole go back and look at the total picture. It is time to re-think and re-engineer policies to ensure that Canada can sustain universal, affordable service, healthy competition, and continued investment and growth.

In closing, AT&T Canada submits that its recommendations in this document and the accompanying submission are made in the same spirit as John Manley’s statement before the Empire Club:

“At the heart of this strategy was our belief in the power of a competitive marketplace. Competition leads to consumer choice. It leads to innovation. It leads to success in the markets of the world, and, therefore, to jobs for Canadians.”

AT&T Canada entirely agrees that healthy competition is critical to realizing CanadaÂ’s vision for the telecommunications industry. The need to achieve and maintain universal service is also critical to this vision. However, to truly be successful, these two objectives must be achieved concomitantly and not exclusively of one another.

This proceeding represents the Commission’s opportunity to implement a new subsidy regime that does just this.

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