Having Your Cake - How to Preserve Universal-Service Cross Subsidies While Facilitating Competitive Entry: A Response

Abstract

The Telecommunications Act of 1996 generated substantial controversy regarding the prices that competitive local exchange carriers should pay for using the unbundled network elements ("UNEs") of local exchange carriers. Throughout the debate, two primary pricing methods have been advocated: (1) setting the price of a UNE equal to its direct, forward-looking cost (known as the uniform, total element long-run incremental, cost ("TELRIC") approach), and (2) setting the price equal to the incremental cost of a UNE plus the incumbent's opportunity cost of providing the UNE to a competitor (known as the efficient component pricing rule ("ECPR")). A modification of the ECPR approach (known as "differential access pricing") has been recommended by Professor William Baumol, which allows for the presence of cross subsidies in retail rates.

We explore the subtleties of each pricing method, detailing background on the debate, analyzing the FCC's position, and discussing Professor Baumol's proposal. In doing so, we highlight deficiencies of the TELRIC approach, noting particularly that the method induces entrants to engage in cream-skimming while preventing them from profitably offering service to subsidized retail customers, and prevents incumbent local exchange carriers from recovering forward-looking incremental costs. Further, we discuss how Professor Baumol's differential access pricing method solves most of the problems associated with the TELRIC approach, while noting that Professor Baumol's pricing method is not without its own shortcomings.

Finally, we describe our pricing methodology, called the Market-Determined ECPR (M-ECPR). We demonstrate the advantages of the M-ECPR pricing methodology, concluding that this method eliminates cream-skimming opportunities and facilitates entry into all the local exchange carrier's markets, while allowing regulators to maintain cross-subsidies. We conclude by welcoming Professor Baumol's recent change of position, since he had previously advocated TELRIC pricing.

Keywords: Efficient component pricing rule, TELRIC pricing, marginal cost pricing, monopoly input, essential facilities

JEL Classification: D42, L40, L50, L96