How to read 'AT&T leaves'

April 1, 2001


Divining the future is no simple task in Washington, DC, where one thing leads to another in endless rounds of bargaining. Michael Armstrong, AT&T's CEO, spoke at the National Press Club in February and gave a hint of what lies ahead: "2001 is...a pivotal year....Either public policy makers will insist that the Bells comply with the law...or they will throw up their hands and allow the Bells to re-monopolize the industry." He praised the FCC's chairman and gave him advice: "We are fortunate to have someone of Michael Powell's intellect and integrity....He and his colleagues [must] move the horse back in front of the telecom first...then deregulating."

The CEO said that unless the current situation changes, his company and others would leave local markets: "[W]e will be forced to stop marketing local service in New York and Texas....Sprint pulled the plug on local service in New York...Texas, Georgia, and California. They couldn't compete with the Bells' stranglehold." His position may not find much support in Congress: At almost the exact time Armstrong was speaking, the chairman of the House Committee on Energy and Commerce, W.J. Tauzin (R-LA), was issuing a press release that said "deregulation will mean more competition" but never mentioned a thing about de-monopolizing local markets.

Demonizing the Bells is probably not an effective way to de-monopolize them, given their support in Congress, where policy-making is based on political linkage, and a player gives in one area to get something in another. This year's give-and-take involves three major issues already deviling the FCC and Congress: open access, the Telecommunications Act's Section 271 applications, and reciprocal compensation.

Open access is a weapon aimed at cable-based Internet providers such as AT&T Broadband and AOL-Time Warner, which are urged to let competitors use the companies' networks. The companies oppose this policy, call it "forced access," and say it would devalue their investment in cable facilities. Last fall, the FCC issued a Notice Inquiry on open access and received several comments in January. Last summer, a few open-access bills were introduced in Congress and gathered significant support, but not enough to become law. The smart money is on the cable operators, but the outcome depends on two other issues.

Section 271 specifies the conditions that must be met for local telephone incumbents to offer long-distance service in their own region. In 1995, these services were a strong incentive for the incumbent to open its market to competitors. Back then, the incumbents did not see the Internet coming, the telecom-pie growing, and Internet service providers getting bigger shares. Last year, the incumbents tried to correct their mistake; their supporters in Congress introduced legislation to amend Section 271, arguing it applied to voice communication and not data services. The legislation died but would have allowed the incumbents to offer data services, even if they were long-distance, without the FCC's approval. In 2001, long-distance is hardly attractive as a standalone offering, and thus may not be incentive enough for the incumbents to open their markets. Peter Tenhula, a right-hand man to FCC chairman Powell, was recently quoted: "I'm sure that many more 271 applications are going to be filed...but whether [the FCC's approval] is a yummy enough carrot anymore, I don't know."

Changing reciprocal compensation could be a more lucrative incentive for the incumbents. Reciprocal compensation is a form of financial settlement in an interconnected telecom system where a phone call originates in one carrier's network but terminates in another carrier's system. Settlement takes many forms, and the most popular one requires the originating carrier to pay the terminating carrier. That's another area where the incumbents were outmaneuvered during the drafting of the Telecom Act-just as they did not envision the Internet as a source of data traffic, they did not see competitive local-exchange carriers (CLECs) serving Internet providers. As the Internet grew, so did the number and length of calls originating in the incumbent's system but terminating in the competitor's; thus the incumbents' liabilities to CLECs grew, as well. The estimated liability in 1999 was about 30 cents per user per hour of Internet connect time.

The incumbents complain, but they cannot unilaterally abandon reciprocal compensation agreements, because the Telecom Act's Section 251, subsection 5, requires local telephone carriers "to establish reciprocal compensation arrangements for the transport and termination of telecommunications." But the incumbents may be rescued; Congressional hearings on reciprocal compensation have already come and gone, and it would be no shock if a bill surfaced to alleviate the incumbents' liabilities to CLECs.

"Liabilities" is the right word because the incumbents may have an opportunity to recoup their reciprocal compensation payments, or in cases where they have withheld payment, it may never be made. In 1997, the National Telecommunications Information Administration held a forum on wireless technology in the local loop. According to the forum transcript, NextLink's vice president of external affairs and industry relations, Gerry Salemme, who had worked for AT&T earlier, said, "Can I just make a point...because it is my only opportunity to do this....We have an incumbent local exchange company...that controls facilities. You have to make interconnection agreements with them....I can tell you, in some of the interconnection agreements that I have signed...I have the right to get reciprocal compensation on [Internet provisioning]...but if that law changes any time, I will pay back [the] money. I will pay rates that are outrageous. There are just different things that you are forced to agree to."

Revenues appearing on CLECs' books will disappear, as will the weaker CLECs, if Congress relieves incumbents of their liabilities for reciprocal compensation. The payback provision is legally enforceable and similar to a legal tactic invoked in property-tax disputes when such taxes are paid under legal protest, so they will revert to the payer if the courts ever find the tax invalid.

Congress has at least three options in 2001: apply an open-access law to the cable operators; relax the restrictions in Section 271; and drop-kick the CLECs by letting the incumbents scoot away from their reciprocal compensation liabilities. The worst policy is "all of the above" and the best is "none of the above," which leaves the incumbents with nothing-an unlikely event.

Imposing open access on the cable operators is not likely, which leaves reciprocal compensation and Section 271. But drop-kicking the CLECs may raise access charges to the Internet and bring quick negative feedback to Congress. Section 271 is the easiest target, because the long-distance market is already riddled with wireless options combining local and long-distance service, and that is where companies like Verizon and Cingular (the joint venture of Bell South and SBC) will make more inroads. Ladies and gentlemen, place your bets.

Stephen N. Brown writes on public policy in telecommunications. He can be contacted by e-mail at [email protected] or telephone: (615) 399-1239.