USW318M.docx

1 BOISE, IDAHO, TUESDAY, MARCH 18, 1996, 9:30 A. M.
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4 COMMISSIONER SMITH: Good morning, ladies
5 and gentlemen. We'll take up again with our U S WEST
6 hearing. I understand, Mr. Harwood, we're going to take
7 your witness first.
8 MR. HARWOOD: Yes, Madam Chairman. AT&T
9 calls Howard Bell.
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11 HOWARD BELL,
12 produced as a witness at the instance of AT&T
13 Communications, having been first duly sworn, was
14 examined and testified as follows:
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16 DIRECT EXAMINATION
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18 BY MR. HARWOOD:
19 Q Good morning, Mr. Bell.
20 A Good morning.
21 Q Would you state your name and business
22 address for the record, please?
23 A Yes. My name is Howard Bell. My business
24 address is 901 Marquette Avenue, Fourth Floor,
25 Minneapolis, Minnesota, 55402.
1975
CSB REPORTING BELL (Di)
Wilder, Idaho 83676 AT&T
1 Q Thank you. And by whom are you employed
2 and in what capacity?
3 A I am employed by AT&T as a policy witness.
4 Q Are you the same Howard Bell that caused
5 direct testimony dated November 26th, 1996, to be filed
6 in this case?
7 A Yes.
8 Q And do you have any corrections to make to
9 that testimony at this time?
10 A Yes. On page 5 of the direct testimony on
11 line 11, a phrase got dropped out somehow or other in the
12 processing between "presume" and "U S WEST" and what
13 should be inserted is "that he is referring to the
14 possible inclusion of imputed directory revenues that,"
15 and with that insertion, the sentence on page 11 would
16 read in the beginning portion, "I presume that he is
17 referring to the possible inclusion of imputed directory
18 that U S WEST receives when," and it would continue as
19 written.
20 Q Thank you. Are you the same Howard Bell
21 that caused rebuttal testimony to be filed in this case
22 on February 21st, 1997?
23 A Yes.
24 Q Do you have any corrections to make to that
25 testimony at this time?
1976
CSB REPORTING BELL (Di)
Wilder, Idaho 83676 AT&T
1 A Not at this time.
2 Q Mr. Bell, if I were to ask you the same
3 questions that appear in your direct and rebuttal
4 testimony, would your answers be the same today?
5 A Yes, they would.
6 MR. HARWOOD: Madam Chair, I would then
7 move for the admission of Mr. Bell's direct and rebuttal
8 testimony and ask that it be spread upon the record as if
9 read.
10 COMMISSIONER SMITH: If there is no
11 objection, it is so ordered.
12 (The following prefiled direct and
13 rebuttal testimony of Mr. Howard Bell is spread upon the
14 record.)
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1977
CSB REPORTING BELL (Di)
Wilder, Idaho 83676 AT&T
1 Q PLEASE STATE YOUR NAME AND BUSINESS
2 ADDRESS.
3 A My name is Howard Bell. My business
4 address is 901 Marquette Ave. S., Fourth Floor,
5 Minneapolis, MN 55402.
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7 Q BY WHOM ARE YOU EMPLOYED AND IN WHAT
8 CAPACITY?
9 A I am employed by AT&T. My job title is
10 Senior Policy Witness. My job responsibilities relate to
11 presenting AT&T's position in connection with various
12 intrastate regulatory proceedings.
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14 Q PLEASE DESCRIBE YOUR EDUCATIONAL BACKGROUND
15 AND PROFESSIONAL EXPERIENCE.
16 A I have a Bachelor of science, a Master of
17 Science, and a Doctor of Philosophy degree in engineering
18 from the University of California at Berkeley. I have
19 also completed two separate short courses at Iowa State
20 University entitled "Management of Capital Investments"
21 -- Parts 1 and 2. In addition, I have attended numerous
22 industry conferences and in-house courses dealing with a
23 variety of topics related to telecommunications.
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25 From 1965 to 1971, I was a member of the faculty
1978
Bell, Di 2
AT&T
1 of the College of Engineering at Iowa State University
2 ("ISU") in Ames, Iowa. My position at ISU entailed both
3 research and teaching responsibilities. From 1969
4 through 1970, I was
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1979
Bell, Di 2A
AT&T
1 appointed by Governor Robert D. Ray to serve as a member
2 of the Municipal Laws Review Committee which submitted a
3 rewrite of all of Iowa's state laws relating to city
4 governments to the Iowa Legislature in order to comply
5 with the Home Rule Amendment. During 1970 and 1971, I
6 also served as a member of the Ames City Council.
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8 From 1971 through 1975, I served as a Commissioner
9 with the Iowa State Commerce Commission (predecessor to
10 the current Iowa Utilities Board). From 1975 through
11 1978, I was the Director of the Iowa Department of
12 Transportation's Office of Transportation Research. From
13 1978 through 1983, I held the position of Staff Manager -
14 Pricing Research with Northwestern Bell. I have worked
15 on regulatory matters for AT&T since divestiture.
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17 Q HAVE YOU PREVIOUSLY FILED TESTIMONY WITH
18 REGULATORY AGENCIES?
19 A Yes. I have provided testimony to
20 regulatory agencies in Minnesota, Nebraska, North Dakota,
21 Wisconsin, South Dakota, Iowa, Ohio, Indiana, Utah,
22 Washington, New Mexico and Illinois.
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1980
Bell, Di 3
AT&T
1 Q HAVE YOU HAD ANY OTHER FORMAL INVOLVEMENT
2 WITH REGULATORY PROCEEDINGS?
3 A Yes. I have served as a member of
4 intraLATA equal access presubscription study committees
5 in Michigan, Minnesota, North Dakota, Washington,
6 Wisconsin, and Illinois. I have also participated in
7 Commission sponsored workshops dealing with the
8 implementation of local exchange competition in Iowa,
9 Indiana, and Utah. In addition, I have participated in
10 extended area service and area code number exhaustion
11 workshops in Minnesota, plus I chaired an Open Network
12 Architecture study group in North Dakota. I am currently
13 participating in a local exchange competition rulemaking
14 workshop in Minnesota and an Universal Service Fund
15 workshop in Nebraska.
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17 Q WHAT IS THE PURPOSE OF YOUR TESTIMONY IN
18 THIS PROCEEDING?
19 A My testimony will address a number of
20 issues that were set forth in the direct testimony of
21 various U S WEST Communications, Inc. ("U S WEST")
22 witnesses in this proceeding. My testimony, as well as
23 that of other AT&T witnesses, is not intended to develop
24 alternative rate levels to those proposed by U S WEST for
25 various service offerings, but rather to point out the
1981
Bell, Di 4
AT&T
1 approach that should have been employed in order to
2 ensure intercustomer equity and to be consistent with the
3 results that would have occurred in a competitive
4 marketplace. My testimony will also address certain
5 approaches that should be followed in order to create an
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1982
Bell, Di 4A
AT&T
1 environment which would foster the development of
2 competition in accordance with the procompetitive
3 national public policy that has been set forth in the
4 Federal Telecommunications Act of 1996.
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6 Q ON PAGE 19 OF HIS TESTIMONY, U S WEST
7 WITNESS WOZNIAK STATES THAT "...THE RELIANCE ON IMPLICIT
8 SUBSIDIES...SHOULD BE ELIMINATED...". DO YOU CONCUR WITH
9 THIS POSITION?
10 A As a general matter, yes, I believe that
11 the use of subsidies should be discontinued since they
12 are not compatible with a competitive environment and can
13 lead to intercustomer inequities. Mr. Wozniak also
14 refers to the imputation of advertising revenues from a
15 non telephone service. I presume that he is referring to
16 the possible inclusion of imputed directory revenues that
17 U S WEST receives when determining whether or not the
18 price of basic residential service needs to be increased,
19 and if so, by how much. In this instance, since
20 directory advertising revenues were left with U S WEST,
21 and other RBOCs, at divestiture in order to keep
22 residential rates low it would not be unreasonable, at
23 this time, to include these revenues in any comparison of
24 the revenue stream associated with residential service
25 (e.g., basic rates, subscriber line charge, access
1983
Bell, Di 5
AT&T
1 charges - particularly the Carrier Common Line Charge
2 ("CCLC") which has no cost associated with it and is
3 intended to offset the cost associated with the local
4 loop) with the forward-looking economic cost of service
5 provision.
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1984
Bell, Di 5A
AT&T
1 Q WHAT IS THE BASIS FOR YOUR BELIEF THAT ONE
2 OF THE PRIMARY REASONS FOR U S WEST RETAINING THE
3 PROVISION OF DIRECTORIES AT THE TIME OF DIVESTITURE WAS
4 TO KEEP RESIDENTIAL RATES AT A LOW LEVEL?
5 A During the course of divestiture,
6 directories were initially assigned to remain with AT&T
7 but Judge Harold Greene decided to transfer directories
8 to the Bell operating companies, such as U S WEST. A
9 primary reason for this transfer was to allow RBOCs to
10 retain directory profits so that they could be used to
11 support low residential rates, as indicated by the
12 following excerpt:
13 "For example, the State of California claims that
a two dollar increase in the rates for monthly
14 telephone service would be necessary to offset the
loss of revenues from directory advertising.
15 Other states assert that increases of a similar
magnitude would be required. Evidence submitted
16 during the AT&T trial indicates that large rate
increases of this type will reduce the number of
17 households with telephones and increase the
disparity, in terms of the availability of
18 telephone service, between low income and well-off
citizens. This result is clearly contrary to the
19 goal of providing affordable telephone service for
all Americans." (United States V. AT&T Co., 552 F.
20 Supp. 131, 194, [D.D.C. 1982])
21 As this quote from the divestiture order clearly
22 indicates, one of the reasons that directory provision
23 was transferred to the RBOCs was to keep residential
24 rates at a low level. Consideration of directing
25 advertising revenues in connection with basic residential
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Bell, Di 6
AT&T
1 service is reasonable at this juncture but would need to
2 be revisited in the event that the RBOC directory was no
3 longer the pre-eminent directory in its service territory
4 (i.e., "the book that's used") or when widespread
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1986
Bell, Di 6A
AT&T
1 competitive entry by facilities-based local exchange
2 competitors become imminent. In the latter case, the
3 Commission could consider having U S WEST assign some
4 portion of the directory profits into an Idaho Universal
5 Service Fund so that targeted residential rates could be
6 kept low regardless of the carrier selected by the end
7 user.
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9 Q WHAT IS THE BASIS FOR YOUR GENERAL
10 OPPOSITION TO THE USE OF SUBSIDIES IN SETTING THE PRICE
11 OF TELECOMMUNICATIONS SERVICES?
12 A There are a number of criteria that should
13 be met in connection with setting the price of local
14 exchange services in today's emerging competitive
15 environment. Among the primary needs are: fairness to
16 customers; promoting economic efficiency; and,
17 consistency with the development of competition. A
18 system of subsidies from one group of telecommunications
19 services to the users of another group of
20 telecommunications services would violate each of these
21 criteria. Among other things, this argues against the
22 future flow of revenues from Title 62 services to Title
23 61 services in Idaho.
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1987
Bell, Di 7
AT&T
1 Q PLEASE EXPLAIN HOW THE FLOW OF REVENUES
2 FROM ONE GROUP OF SERVICES TO SUBSIDIZE ANOTHER GROUP OF
3 SERVICES IS UNFAIR?
4 A It is a matter of basic intercustomer
5 fairness that customers should, as a general rule, pay
6 the full cost of providing the goods and services that
7 they consume and benefit from. Failure to have their
8 rates cover cost would likely create a financial burden
9 on the consumers of other goods and services provided by
10 the firm. The sole exception for the inequity of
11 cross-subsidization is when the cross-subsidization is
12 targeted to underwrite the needs of a specific group of
13 consumers who need the service but are not apt to be able
14 to afford it in the absence of financial assistance.
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16 Q WHY DO YOU BELIEVE THAT CROSS-SUBSIDIZATION
17 IS CONTRARY TO ECONOMIC EFFICIENCY?
18 A Economic efficiency is obtained when the
19 price for a service is based upon the economic cost of
20 providing it. In this manner, consumers are provided
21 with the proper pricing signals for the efficient
22 utilization of society's scarce resources. As a general
23 rule, when prices move toward efficient levels, the
24 overall financial well-being of society is enhanced.
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1988
Bell, Di 8
AT&T
1 Q WHY DO YOU BELIEVE THAT CROSS-SUBSIDIES
2 FLOWING FROM ONE GROUP OF SERVICES TO ANOTHER GROUP OF
3 SERVICES CAN IMPEDE THE DEVELOPMENT OF COMPETITION IN THE
4 MARKET FOR THE RECIPIENT GROUP OF SERVICES?
5 A When a particular group of services is
6 being subsidized by other services the price of the
7 subsidized service(s) can be expected to be below the
8 cost of provision. Under these conditions, equally
9 efficient -- or even more efficient competitors will be
10 unable to compete utilizing their own and/or leased
11 facilities. Since the long term development of local
12 exchange service competition depends upon the presence of
13 competitors using facilities to provide competitive
14 services, as well as resellers, this will impede, if not
15 thwart, the development of competition. A flow of
16 cross-subsidies from Title 62 to Title 61 services could
17 have that result in Idaho.
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19 Q ON PAGE 3 OF HER TESTIMONY, U S WEST
20 WITNESS MARGARET WRIGHT INDICATED THAT U S WEST's REQUEST
21 FOR A $38 MILLION REVENUE INCREASE WAS BASED UPON A
22 TARGET OF A 10.55% RATE OF RETURN AND A 13.00% RETURN ON
23 EQUITY. SUPPORT FOR THIS VALUE WAS SET FORTH IN THE
24 TESTIMONY OF U S WEST WITNESS PETER CUMMINGS. DO YOU
25 HAVE ANY CONCERNS REGARDING THESE RETURN LEVELS?
1989
Bell, Di 9
AT&T
1 A Yes. Under current cost of capital
2 conditions, U S WEST's return targets appear to be too
3 high. For example, U S WEST's own depiction of the
4 forward-looking cost of capital in other jurisdictions
5 have fallen below the 10.55% target set for Idaho in this
6 proceeding. In Iowa Docket No. RPU-95-10, U S WEST's
7 cost witness Brian Farrow testified that U S WEST's
8 forward-looking cost of capital at that time at the time
9 of filing in I994 was 11.3% but in reply testimony filed
10 in 1995 indicated at that time that it was 10.4%. During
11 the interim the cost of capital has continued to
12 generally trend downward and in a subsequent Oregon
13 proceeding U S WEST agreed to utilize a forward-looking
14 cost of capital of 9.98% for use in its cost studies in
15 that state (based upon a 11.75% cost of equity, a 7.1%
16 cost of debt, and a debt-equity ratio of 38:62). In the
17 same vein, during the course of Minnesota Docket No.
18 P-442,421/M-96-855 et al., the Minnesota Department of
19 Public Service utilized a discounted cash flow analysis
20 to arrive at a U S WEST cost of equity of 11.5% from
21 which they arrived at a overall cost of capital (i.e.,
22 needed rate of return) of 9.8%. This data strongly
23 suggests that U S WEST has overstated its earnings needs
24 in this proceeding and hence exaggerates the need for
25 additional revenue.
1990
Bell, Di 10
AT&T
1 Q DURING HIS TESTIMONY REGARDING U S WEST's
2 PURPORTED NEED TO RAISE RESIDENTIAL RATES, U S WEST
3 WITNESS DALLAS ELDER
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1991
Bell, Di 10A
AT&T
1 RELIES UPON EMBEDDED COSTS FOR PRICING PURPOSES. IS THAT
2 APPROPRIATE?
3 A It is a mistake to utilize embedded costs
4 for ratemaking purposes. The appropriate cost criteria
5 for setting prices and determining if existing prices are
6 compensatory in terms of their forward-looking economic
7 costs (e.g., total service long run incremental costs).
8 The use of embedded costs is inappropriate for a number
9 of reasons. Embedded costs are based upon accounting
10 costs which are historical in nature and do not
11 necessarily reflect the future conditions for which rates
12 are being set. In addition, embedded costs used for
13 pricing purposes are generally the byproduct of arbitrary
14 allocations of costs for which no universally accepted
15 standards exist. Economic costs on the other hand are
16 forward looking in nature and are more apt to reflect the
17 future conditions during the period for which rates are
18 being set. In addition, economic costs relate
19 specifically to costs that are caused by the provision of
20 the service or element for which prices are to be set.
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22 Q WHAT IS THE PROBLEM WITH HAVING COSTS FOR
23 PRICING THAT DEPEND UPON THE ALLOCATION OF COSTS?
24 A As a general rule, economists are very
25 critical of any attempt to allocate costs in the
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Bell, Di 11
AT&T
1 determination of costs for setting prices. For example,
2 Dr. John Wenders has noted that, "The topic of costing is
3 filled with sloppy thinking and rhetoric. Costs can be
4 discovered; costs can be identified; costs can be
5 estimated; but costs
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1993
Bell, Di 11A
AT&T
1 cannot be allocated. They are not a pie to be divided up
2 among customers. Never use the word allocated in the
3 same sentence with costs...So much regulatory discussion
4 of costs is crippled by the idea of `allocating costs'
5 that it is important to begin by purging one's
6 vocabulary. Costs can be caused, and costs can be
7 avoided, but they cannot be allocated." (John T. Wenders,
8 The Economics of telecommunications: Theory and Evidence
9 (Cambridge, MA: The MIT Press) 1994, p. 56) A matter of
10 particular concern with cost allocations is that they can
11 cause substantial deviations from economically efficient
12 prices that reflect the costs caused by the production of
13 the item in question. Total service long run incremental
14 costs ("TSLRIC") are in reality the additional costs
15 incurred by a firm when it produces an item when the
16 output of all other items remains constant. Conversely,
17 they represent the decrease in the total cost of
18 operation if the firm ceased to produce a particulary
19 item but continued to produce all other goods and
20 services at their current output levels. When prices are
21 based upon TSLRIC they are not only economically
22 efficient and provide consumers with appropriate price
23 signals to enable them to optimize resource utilization,
24 but they also promote intercustomer equity since the cost
25 causer bears the cost of the items that they consume
(i.e., cross subsidies between customers is eliminated).
1994
Bell, Di 12
AT&T
1 Q ON PAGE 11 OF HIS TESTIMONY, U S WEST
2 WITNESS ELDER DESCRIBES THE MANNER IN WHICH THE LOCAL
3 LOOP IS ALLOCATED. WOULD YOU PLEASE COMMENT ON THIS
4 PRACTICE?
5 A Yes. There is no sound basis for
6 allocating the cost of the local loop (i.e., the
7 transmission facility connecting a customer's premises to
8 the central office serving that location) between various
9 telecommunications services that are available to the
10 customer. While this approach may have a certain appeal,
11 it is not an appropriate method to use when developing
12 costs for pricing purposes. The most appropriate
13 approach is to consider the local loop as a separately
14 identifiable service with its own unique costs and
15 benefits to consumers. As such, the loop has
16 non-traffic-sensitive costs that should be recovered by
17 means of flat-rate charges to end-users. When treated in
18 this manner, the end result is a pricing format that is:
19 (a) economically efficient with attendant customer
20 benefits; (b) consistent with intercustomer equity
21 considerations; and compatible with both the development
22 of competition and the preservation of universal service.
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24 Q WOULD YOU PLEASE DESCRIBE THE LOCAL LOOP
25 AND ASSOCIATED SERVICE COMPONENTS?
1995
Bell, Di 13
AT&T
1 A There are three general categories of
2 service available to end user customers, each with its
3 own identifiable costs and each providing its own
4 benefits. They are (a) the local loop (i.e.,
5 connectivity to the telecommunications network); (b)
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1996
Bell, Di 13A
AT&T
1 usage, and (c) toll usage. The general nature of these
2 three basic service groups can be described as follows:
3 (a) Local loop The local loop is comprised of the
4 physical plant that connects a customers premises to the
5 local end office. It provides the end user with the
6 benefits of connectivity (or access to the
7 telecommunications network) and the ability to place or
8 receive calls. The costs incurred by the serving LEC are
9 caused by the decision of end users to have telephone
10 service and connect to the telephone network. These
11 costs are non-traffic-sensitive in nature since they
12 relate to the loop itself and are unaffected by
13 variations in traffic or usage volumes -- or the lack
14 thereof.
15 (b) Local usage This service provides the end
16 user with the exchange of messages or data within a local
17 calling area. The costs to the LEC for providing this
18 service include billing and collection, switching, and
19 possibly transport between switches in the local calling
20 area. Whether the end user places any local calls during
21 a billing period, however, (and some end users do not)
22 has no effect on the cost of the local loop.
23 (c) Toll usage This service provides the end user
24 with the exchange of messages or data by means of
25 interexchange calls either within Idaho or to points to
1997
Bell, Di 14
AT&T
1 or from outside the state. The LEC incurs costs in
2 performing such functions as transport and switching.
3 Whether or not toll calls are made, and if so, in what
4 volumes, has no impact on the LEC's local loop costs,
5 however.
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1998
Bell, Di 14A
AT&T
1 Q HOW SHOULD THE LOCAL LOOP AND ITS ATTENDANT
2 COSTS BE TREATED?
3 A Part of the confusion associated with the
4 issue of how to recover loop costs probably stems from
5 the manner in which loop costs have typically been
6 recovered in local rates. Customers appear to have a
7 distinct preference for flat-rated local service. It is
8 common, therefore, for LECs to combine the recovery of
9 loop costs and the average customers local usage costs
10 into flat-rated local service charges. It is certainly
11 feasible, however, to bill for connectivity (i.e., the
12 local loop) and local usage separately, and, in fact,
13 such billing is done in connection with a number of
14 local-measured-service plans throughout the United
15 States.
16 It should also be borne in mind that treating the
17 local loop separately in terms of recovering its cost is
18 consistent with the expectation that loops will be
19 unbundled and made separately available in many
20 localities once local exchange service competition is
21 established. In short, the direct recovery of local loop
22 cost is fully consistent with, and is in fact necessary
23 for, the efficient recovery of cost in conformance with
24 the economic principles of cost recovery.
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1999
Bell, Di 15
AT&T
1 Q IN HER TESTIMONY, U S WEST WITNESS MARY
2 OWEN UTILIZED THE TERM "TRUE COMPETITION" IN CONNECTION
3 WITH FACILITIES-
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2000
Bell, Di 15A
AT&T
1 BASED COMPETITION. IN ADDITION, U S WEST WITNESS BARBARA
2 WILSON INDICATED THAT RESALE COMPETITION WOULD NOT BE
3 EFFECTIVE IN DRIVING DOWN THE PRICE OF LOCAL SERVICE.
4 WOULD YOU PLEASE COMMENT ON THEIR POSITION?
5 A Yes. While facility-based competition is
6 important for the long-term viability of local exchange
7 competition, resale competition also has a vital role to
8 play and will yield substantial consumer benefits. This
9 has been the case with the development of effective
10 competition and should also occur in the local exchange
11 marketplace.
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13 Congress clearly recognized the important role
14 that resale can play in providing consumers with the
15 benefits of competition and the Federal
16 Telecommunications Act of 1996 ("the Federal Act") sets
17 forth provisions for both facilities-based and resale
18 competition. In fact, the presence of resale competitors
19 can facilitate the development of facilities-based
20 competition. This point was recognized by the FCC which
21 stated in its August 8, 1996 Order in CC Docket No. 96-98
22 that:
23 "Resale will be an important entry strategy for
many new entrants, especially in the short term
24 when they are building their own facilities.
Further, in some areas and for some new entrants,
25 we expect that the resale option will remain an
2001
Bell, Di 16
AT&T
1 important entry strategy over the longer term.
Resale will also be an important entry strategy
2 for small businesses that may lack capital to
compete in the local exchange market by purchasing
3 unbundled elements or by building their own
networks. In light of the strategic importance of
4 resale to the development of competition, we
conclude that it is especially important to
5 promulgate national rules for use by state
commissions in setting wholesale rates."
6 (Paragraph 907)
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2002
Bell, Di 16A
AT&T
1 Resale is, therefore, very important to the
2 development of a competitive telecommunications market,
3 and can in and of itself yield substantial consumer
4 benefits.
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6 Q WOULD YOU PLEASE DESCRIBE SOME OF THE
7 CONSUMER BENEFITS THAT COULD RESULT FROM RESALE OF LOCAL
8 SERVICE?
9 A Yes. While certain forms of resale simply
10 rebrand LEC service offerings, resale can also occur in a
11 manner in which resellers add value to the resold
12 service. Value added service can occur when resellers
13 provide additional billing detail, pay particular
14 attention to service quality, and/or provide improved
15 customer service. Another possible scenario would
16 involve a reseller aggregating features and functions to
17 form a new end user capability. Other resellers may
18 combine a variety of services, such as local exchange
19 service, customer calling services, and toll to form
20 another option for end users. Some providers may combine
21 local exchange service with wireless service or cable TV,
22 while other resellers may utilize some of their own
23 facilities to provide customized service offerings.
24 Access to AIN triggers would provide additional
25 customization capabilities for resellers. Resale can,
2003
Bell, Di 17
AT&T
1 therefore, lead to a fuller use of telecommunications
2 facilities, and provide consumers with a wider variety of
3 services and service quality. To this end, the Minnesota
4 Public Utilities Commission in a January 19,
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2004
Bell, Di 17A
AT&T
1 1993 Order, involving resold Centron service in Docket
2 No. P-999/CI-90-235, noted that:
3 "ETI offers voice mail service, resells
long-distance service through a variety of long
4 distance providers and offers several auxiliary
services to its customers in conjunction with
5 resold CENTRON service: consultation and system
design services, installation and training
6 services, telecommunications troubleshooting and
repair services, and single bill services. As
7 such, ETI offers a one stop shopping source for
small and medium-sized business customers and can
8 serve, in effect, as the telecommunications
manager for small firms that may not be able to
9 employ a telecommunications specialist." (p. 9)
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11 Q IS U S WEST WITNESS WILSON CORRECT IN HER
12 ASSERTION THAT THERE IS NO REASON WHY RESALE PRICES
13 SHOULD DRIVE DOWN THE PRICE OF BASIC LOCAL SERVICE?
14 A No. Experience with both the resale of
15 telecommunications service in the long distance and
16 wireless markets indicate that a wholesale/retail price
17 differential of 35% or more is common. In addition,
18 pursuant to Sec. 252(d)(3) of the Federal Act, AT&T has
19 conducted studies of U S WEST accounting records in other
20 jurisdictions and has often arrived at anticipated
21 avoidable costs when providing services on a wholesale
22 basis to resellers that are on the order of 30% and more.
23 With price differentials of this order of magnitude and
24 the value-added aspects of the service offerings of many
25 resellers, resellers that can match or exceed the
2005
Bell, Di 18
AT&T
1 efficiency of U S WEST's retail operations can create
2 downward pressure on U S WEST rates. This would result
3 from U S WEST having to provide a
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2006
Bell, Di 18A
AT&T
1 competitive price/value mix compared to that offered by
2 resellers. This could be accomplished by matching the
3 value added features provided by resellers, lower prices,
4 or provide consumers with some combination thereof.
5
6 Q ON PAGES 3 AND 4 OF U S WEST WITNESS OWEN's
7 TESTIMONY THERE IS A PROPOSAL TO BOTH SIMPLIFY THE USAGE
8 RATE STRUCTURE OF MEASURED SERVICE AND TO INCREASE THE
9 RATE TO $0.03 PER MINUTE. A 3 HOUR FREE CALL ALLOWANCE
10 IS ALSO PROPOSED, ALONG WITH MONTHLY RATES THAT WOULD
11 INCREASE IN THREE STAGES. DO YOU HAVE ANY CONCERNS WITH
12 THE U S WEST PROPOSAL?
13 A Yes. U S WEST should be required to submit
14 forward-looking economic cost studies to demonstrate that
15 the proposed rates are cost-based and compensatory. As
16 Ms. Owen point out the revenue from residential customer
17 usage is expected to decrease due to the introduction of
18 a 3 hour call allowance. If U S WEST's proposed flat
19 rate residential rates are truly required to cover their
20 cost of service, then there would appear to be a distinct
21 possibility that the proposed residential measured
22 service rates would not cover cost of service. Failure
23 to have the measured service rates cover cost of service
24 could impede the establishment of the very
25 facilities-based competition which Ms. Owen considers to
be a desirable "true" competition.
2007
Bell, Di 19
AT&T
1 Q DO YOU HAVE ANY CONCERNS REGARDING U S
2 WEST's ITAP PROPOSAL AS SET FORTH ON P. 17 OF WITNESS
3 OWEN's TESTIMONY?
4 A The reduced price that U S WEST is
5 proposing to make available to customers qualifying under
6 the Idaho Telephone Assistance Plan ("ITAP") appear
7 unlikely to cover cost of service. As a result, in and
8 of themselves they are anticompetitive. At a minimum,
9 U S WEST should be required to make these offerings
10 available to resellers at the midpoint of the default
11 discount range set forth in the FCC's August 8, 1996
12 Order in Docket No. 96-98 (i.e., 21%) until an Idaho
13 wholesale discount rate is established for U S WEST
14 offerings. Furthermore, it is imperative as local
15 exchange competition evolves that a competitively neutral
16 Idaho Universal Service Fund be established to provide
17 any financial aid, above that provided by the Federal
18 Universal Service Fund, that is deemed necessary for
19 households that need assistance due to low income or
20 their residing in a high cost of service area.
21
22 Q WOULD YOU BRIEFLY DESCRIBE HOW A
23 COMPETITIVELY NEUTRAL IDAHO UNIVERSAL SERVICE FUND
24 ("USF") WOULD OPERATE?
25 A An Idaho USF should be set up that would
2008
Bell, Di 20
AT&T
1 provide aid to households that meet either a financial
2 need criteria or that reside in a high cost of service
3 area. The USF should raise funds from all
4 telecommunications providers in Idaho based
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2009
Bell, Di 20A
AT&T
1 upon a percentage of their revenues and collected as a
2 surcharge on their end user bills, the fund should be
3 administered by a third party that is not associated with
4 any contributor to or recipient from the fund, and the
5 aid should be provided to qualified service providers
6 based upon the number of qualified households that they
7 provide a Commission approved universal service bundle
8 to, with the aid being portable when the customer
9 switches from one qualified service provider to another.
10 The aid level should be based upon differences between
11 TSLRIC based rates and Commission set affordability
12 benchmarks for the two recipient groups. The
13 effectiveness of the USF should be monitored by keeping
14 track of subscribership levels reported by the FCC and
15 the federal census.
16
17 Q U S WEST WITNESS OWEN PROPOSES THAT THE
18 COMMISSION ELIMINATE THE CURRENT REQUIREMENT THAT AID
19 RECIPIENTS BE OVER 60 AND RELY ON A LOW-INCOME STANDARD.
20 DO YOU CONCUR?
21 A Yes. The need of household for financial
22 aid to afford cost-based telephone service is not a
23 matter of chronology but of financial condition. One set
24 of eligibility criteria that the Commission should
25 consider applying to determine if a household is in
2010
Bell, Di 21
AT&T
1 financial need is to apply the eligibility criteria
2 utilized in connection with the Link-Up program (i.e.,
3 recipient of AFDC, Food Stamps, Aid to the Aged, Blind &
4 Disabled, or Medical Assistance).
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2011
Bell, Di 21A
AT&T
1 Q ON PAGE 22 OF HER TESTIMONY, U S WEST
2 WITNESS OWEN STATED THAT IT IS APPROPRIATE TO RECOGNIZE
3 THE VALUE OF THE EAS REGIONS IN RATE DESIGN. DO YOU
4 CONCUR WITH THIS POSITION?
5 A No. I believe that rates should be
6 primarily based upon their economic cost of service.
7 Value is a very subjective criteria and should not be
8 relied upon in instances such as this when rates are
9 being set for services that are still being provided in a
10 basically monopoly environment. Value to end users in
11 the case of EAS is particularly problematic. In general
12 with EAS a relatively small percentage of the customers
13 places the majority of calls over an EAS route - less
14 than one-third of the customers placing over two-thirds
15 of the calls is commonplace. Furthermore, in the instant
16 case the value to the majority of the consumers involved
17 with the EAS routes is unknown since there was no
18 balloting of end users and the positions set forth at
19 public forums may not have been typical of the average
20 end user since persons motivated financially are usually
21 the ones motivated to attend a public hearing regarding
22 EAS and participate therein.
23
24 Q DO YOU HAVE ANY OBSERVATIONS TO MAKE
25 REGARDING U S WEST's PROPOSED CHANGES TO NONRECURRING
2012
Bell, Di 22
AT&T
1 CHARGES THAT MS. OWEN INDICATES WERE MADE IN ORDER TO
2 MAKE ITS PRICE STRUCTURES SIMPLE AND EASY TO UNDERSTAND?
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2013
Bell, Di 22A
AT&T
1 A Yes. While it is certainly desirable to
2 make rate structure understandable for end users, as we
3 pursue the national policy of making competition in local
4 exchange markets available to all Americans it is
5 imperative that incumbent LEC rates be cost-based.
6 U S WEST has proposed changes to their nonrecurring
7 charges which will have a negative revenue impact of
8 $140 thousand annually. These reductions may be quite
9 appropriate but U S WEST should be required to file
10 forward-looking economic cost studies to demonstrate that
11 the rates are compensatory and not anticompetitive.
12
13 Q U S WEST WITNESS OWEN ALSO TESTIFIED TO THE
14 FACT THAT U S WEST IS PLANNING CHANGES TO ITS VACATION
15 RATE SCHEDULES THAT WILL RESULT IN NEGATIVE FINANCIAL
16 IMPACTS FOR BOTH RESIDENTIAL AND BUSINESS CUSTOMERS. DO
17 YOU HAVE ANY CONCERNS REGARDING THOSE PROPOSALS?
18 A My only concern regarding those proposed
19 changes is that U S WEST has not filed forward-looking
20 economic cost studies to indicate that the proposed rates
21 are compensatory and not anticompetitive. U S WEST
22 should be required to make such a filing before the
23 Commission approves the rates.
24 Q DOES THIS CONCLUDE YOUR TESTIMONY?
25 A Yes.
2014
Bell, Di 23
AT&T
1 Q PLEASE STATE YOUR NAME AND ADDRESS.
2 A My name is Howard Bell. My business
3 address is 901 Marquette Ave., Fourth Floor, Minneapolis,
4 Minnesota 55402.
5 Q HAVE YOU PREVIOUSLY SUBMITTED TESTIMONY IN
6 THIS PROCEEDING?
7 A Yes. I submitted Direct Testimony on
8 November 26, 1996.
9 Q WHAT IS THE PURPOSE OF YOUR SURREBUTTAL
10 TESTIMONY?
11 A My surrebuttal testimony will respond to
12 several of the points raised by U S WEST Communications,
13 Inc. ("USWC") witnesses Mary Owen and James Wozniak,
14 American Association of Retired Persons ("AARP") witness
15 Dr. Don Reading, and Commission Staff ("staff") witness
16 Bill Eastlake in their direct testimony. I will also
17 explain why U S WEST should impute Yellow Page Directory
18 revenues to its revenue requirement calculation, contrary
19 to what witness Ms. Ann M. Koehler-Christensen is
20 advocating for U S WEST.
21
22 U S WEST POSITIONS
23
24 Q ON PAGE 5 OF HER REBUTTAL TESTIMONY USWC
25 WITNESS MARY OWEN STATES THAT THE INTRALATA LONG DISTANCE
2015
Bell, Reb 1
AT&T
1 MARKET IN IDAHO IS COMPETITIVE. DO YOU AGREE WITH HER
2 ASSESSMENT?
3 A No, I believe that she overestimates the
4 competitive forces at work in the intralata toll market.
5 Although there is some degree of competition in the Idaho
6 intralata toll market today, the development of effective
7 competition throughout the market is severely hampered by
8 the absence of dialing parity for 1+ and 0+ intralata
9 toll traffic. The competition that is present is most
10 developed in the case of larger business customers that
11 can avail themselves of PBXs that automatically dial
12 access codes, or which can utilize services that entail
13 direct connections to competing IXCs (e.g., MEGACOM
14 WATS).
15 For example, if small business or residential
16 customers want to use a carrier other than
17 U S WEST in USWC's service territory to handle their
18 intralata toll calls today, they must first dial a
19 five-digit access code (that is being converted to a
20 seven-digit 101XXXX access code) to utilize that
21 carrier's toll service. This is both inconvenient to
22 many people and time-consuming. In addition, if the
23 customer forgets to dial the carrier's access code, or
24 doesn't realize that a particular call is an intralata
25 call, the intralata toll call will automatically be
2016
Bell, Reb 2
AT&T
1 routed to and carried over USWC's network. The necessity
2 for customers to dial either the five or seven digit
3 access codes when placing an intralata toll call in order
4 to use the IXC of their choice serves to discourage many
5 customers from making use of alternative toll carriers.
6 Evidence of this can be found in numerous LEC toll ads
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2017
Bell, Reb 2A
AT&T
1 which tout the convenience of non-access code dialing and
2 urge customers to simply dial 1+ or 0+ for their
3 intralata toll needs.
4 Q WHAT IS THE SIGNIFICANCE OF THE LACK OF
5 INTRALATA PRESUBSCRIPTION?
6 A Intralata presubscription is essential for
7 the development of effective competition throughout the
8 intralata toll market. As noted previously, this is
9 particularly true in that portion of the market involving
10 residential and small to medium business customers. From
11 a customer perspective, intralata presubscription
12 transfers control of the 1+/0+ dialing resource from the
13 local exchange company and gives that control to end
14 users. When this was done through the implementation of
15 equal access presubscription in the interLATA toll
16 marketplace it was a keystone in the development of
17 effective competition in that market and gave rise to
18 extensive consumer benefits.
19 Q HAVE ANY REGULATORY AGENCIES CONCURRED WITH
20 YOUR BELIEF THAT INTRALATA PRESUBSCRIPTION IS A
21 PREREQUISITE FOR EFFECTIVE INTRALATA TOLL COMPETITION FOR
22 ALL CUSTOMERS?
23 A Yes. The Minnesota Public Utilities
24 Commission, in its Order in Docket No. P-999/CI-85-582,
25 has noted that "...intralata equal access presubscription
2018
Bell, Reb 3
AT&T
1 is required for effective competition. As the sole 1+/0+
2 intralata toll carrier,
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2019
Bell, Reb 3A
AT&T
1 Northwestern Bell has a distinct advantage." The
2 Michigan Public Service Commission made a similar finding
3 regarding Ameritech and GTE in Case No. U-10138. In the
4 same vein, the pro-competitive Federal Telecommunications
5 Act of 1996 requires that incumbent LECs provide dialing
6 parity for toll calls in Sec. 251(b)(3).
7 Q WHAT ROLE DO ACCESS CHARGES PLAY IN
8 IMPEDING THE DEVELOPMENT OF FULL COMPETITION IN THE
9 INTRALATA TOLL MARKET?
10 A Access charges which exceed their forward
11 looking economic cost of service can impede the
12 development of full competition in the toll market. For
13 example, this scenario can occur: A competitor has to set
14 its toll rates high enough to recover the price it pays
15 the LEC for access service plus its other operating
16 costs. A LEC could charge competitors excessive access
17 rates and then price its own toll service lower than its
18 price for access to competitors plus other LEC operating
19 costs. Then the competitor is caught in a price squeeze
20 with high access rates that it must pay to the LEC and
21 LEC toll prices to compete against which are below the
22 cost the competitor incurs to provision toll service
23 (i.e., the LEC's access charges plus the economic cost of
24 other input factors) but are more than the economic cost
25 of service that the LEC itself incurs (i.e., the economic
cost of access plus other input factors).
2020
Bell, Reb 4
AT&T
1 Even in the absence of a price squeeze (i.e., when
2 the LEC charges less for its toll service offerings than
3 the economic cost of toll service other than access and
4 the price of access service it charges to dependent
5 competitors) the incumbent LEC will be advantaged by
6 realizing a higher profitability for providing toll
7 service at any rate since the access charge that is a
8 pure cost to competing IXCs is a source of economic
9 profit to the LEC in its toll service rates.
10 Q ARE THERE ANY OTHER BENEFITS THAT REDUCED
11 ACCESS CHARGES COULD PROVIDE IDAHO RATEPAYERS?
12 A Yes. The presence of economic profit in
13 access charges could be used as a source of funds which
14 the incumbent LEC could use to thwart competitive entry
15 in the local exchange service market. This could cause
16 Idaho to miss out on the benefits of competition that
17 will result once the local service market transitions
18 from a monopolistic to a competitive environment. In
19 light of their purported support for the development of
20 local exchange competition it is unfortunate that USWC
21 has not take the opportunity afforded by this case to
22 fully address its inflated access charges. As noted in
23 the quote attributed to USWC President and CEO Sol
24 Trujillo, on pages 12 and 13 of the direct testimony of
25 staff witness Bill Eastlake, USWC receives on the order
2021
Bell, Reb 5
AT&T
1 of $800 million per year in contributions (i.e., normally
2 defined as revenues in excess of economic cost) with
3 which to ward off competitive entry in the local service
4 marketplace.
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2022
Bell, Reb 5A
AT&T
1 In addition, the presence of economic profit in
2 access charges causes the price of other carrier's toll
3 service to be inflated. This in turn can hinder economic
4 development in rural areas, create economic inefficiency,
5 and adversely impact the affordability of telephone
6 service for consumers with high toll calling needs. In
7 addition, economic profit in access charges creates a
8 departure from having prices that reflect the cost of
9 service and will cause intercustomer inequities since
10 prices will depart from the principle of cost causation.
11 Q WHAT ARE THE LIKELY CONSUMER BENEFITS THAT
12 WOULD RESULT FROM EFFECTIVE COMPETITION IN THE INTRALATA
13 TOLL MARKET?
14 A One can expect that the benefits to
15 consumes from the development on effective competition in
16 the intralata toll market would be similar in nature to
17 those that have resulted from the development of
18 effective competition in the interLATA toll market. This
19 would include: greater choice for consumers both in terms
20 of service providers and service offerings; service
21 providers that are more efficient and more concerned with
22 meeting customer needs and desires; prices which move
23 towards the cost of service; and, the deployment of
24 technological developments is accelerated.
25 Q ON PAGE 24 OF HER REBUTTAL TESTIMONY
2023
Bell, Reb 6
AT&T
1 WITNESS OWEN REFERS TO THE USE OF "SHAM" UNBUNDLING IN
2 SOME
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2024
Bell, Reb 6A
AT&T
1 JURISDICTIONS AS A MEANS FOR COMPETITIVE LOCAL EXCHANGE
2 CARRIERS ("CLECS") TO ENTER THE LOCAL MARKET. WOULD YOU
3 PLEASE COMMENT ON HER CHARACTERIZATION OF THIS ENTRY
4 APPROACH?
5 A It is inappropriate to characterize a new
6 entrant that combines the unbundled network elements of
7 an incumbent LEC to provide its own competing local
8 service offering as constituting "sham" unbundling.
9 There is nothing deceitful about this practice. In fact,
10 it is fully sanctioned by 47 U.S.C. Sec. 252(c)(3) which
11 states "...An incumbent local exchange carrier shall
12 provide such unbundled network elements in a manner that
13 allows requesting carriers to combine such elements in
14 order to provide such telecommunications service."
15 It is also of interest to note that this form of
16 service provision has been approved by the Federal
17 Communications Commission. In its August 8, 1996 Order
18 in CC Docket 96-98, the FCC stated that: "Under section
19 251(c)(3), incumbent LECs must provide access to
20 unbundled network elements in a manner that allows
21 requesting carriers to combine such elements in order to
22 provide" a telecommunications service. We agree with the
23 Illinois Commission, the Texas Public Utility Council,
24 and others that this language bars incumbent LECs from
25 imposing limitations, restrictions, or requirements on
2025
Bell, Reb 7
AT&T
1 requests for, or the sale or use of, unbundled elements
2 that would impair the ability of requesting carriers to
3 offer telecommunications services in the manner they
4 intend....We believe this interpretation provides new
5 entrants with the requisite ability to use unbundled
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2026
Bell, Reb 7A
AT&T
1 elements flexibly to respond to market forces, and thus
2 is consistent with the procompetitive goals of the 1996
3 Act." (para 292). The FCC also observed that "We believe
4 this phrase means that incumbents must provide unbundled
5 elements in a way that enables requesting carriers to
6 combine them to provide a service." (para 294).
7 Q HOW WOULD CONSUMERS BENEFIT FROM THIS
8 APPROACH TO PROVIDING COMPETITIVE LOCAL EXCHANGE SERVICE
9 OFFERINGS?
10 A The development of full facilities-based
11 local exchange competition is apt to be some time off for
12 most customers, particularly residential and small
13 business customers. The early stages of competition in
14 most instances will occur by means of either the resale
15 of incumbent LEC retail offerings or as a result of firms
16 obtaining some or all of an incumbent LEC's network
17 elements on a lease basis. When a CLEC simply resells
18 the incumbent LEC's existing retail service offerings
19 consumers will only be able to obtain the existing
20 capabilities of those offerings and CLECs will have to
21 compete solely on the base of price, customer service or
22 other such factors. When the CLEC combines LEC unbundled
23 network elements, on the other hand, it will have the
24 ability to either combine existing capabilities in new or
25 different ways or to supply its own facilities or
2027
Bell, Reb 8
AT&T
1 functionalities to enhance communications offerings.
2 From a consumer perspective this holds forth the promise
3 of additional service offering capabilities
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2028
Bell, Reb 8A
AT&T
1 to choose from -- and additional customer choice is one
2 of the cornerstone characteristics of competition.
3 Q WOULD RE-BUNDLING INDIVIDUALLY PURCHASED
4 NETWORK ELEMENTS TO PROVIDE LOCAL SERVICE OFFERINGS BE
5 APT TO DETER THE DEVELOPMENT OF FACILITIES-BASED LOCAL
6 COMPETITION?
7 A No. Other things being equal, a CLEC would
8 prefer to utilize its own facilities rather than being
9 dependent upon facilities that are supplied by a
10 competitor. The ability to re-bundle individual network
11 elements to initiate operations as service provider and
12 to establish a customer base should hasten the day when
13 it is practical to begin to provision service with some
14 or all of its own network elements. With this entry
15 option available to CLECs, they will be in a position to
16 establish themselves in the market and to then introduce
17 the use of their own network elements to provide local
18 service in an orderly and economic basis.
19 Q ON PAGE 10 OF HIS REBUTTAL TESTIMONY, USWC
20 WITNESS JAMES WOZNIAK STATED THAT IT WAS APPROPRIATE TO
21 USE EMBEDDED COSTS FOR MAKING PRICING DECISIONS. WOULD
22 YOU PLEASE COMMENT UPON HIS ASSERTION?
23 A Mr. Wozniak is in error in his position and
24 is at odds with the position advocated by USWC witnesses
25 in other proceedings. The appropriate cost basis for
pricing
2029
Bell, Reb 9
AT&T
1 consists of using forward looking economic costs of
2 service provision. Price setting is a forward looking
3 undertaking and should be based upon costs which will be
4 experienced in the future. Embedded costs, on the other
5 hand, are historical costs which may bear little
6 relationship to future costs of service provision.
7 Forward looking economic costs, however, are designed to
8 reflect future operating conditions and costs. Setting
9 prices on these costs will, therefore, serve to achieve
10 economic efficiency and better serve the interests of
11 intercustomer fairness by enabling prices to reflect cost
12 causation.
13
14 AARP TESTIMONY
15
16 Q ON PAGES 21-4 OF HIS DIRECT TESTIMONY,
17 AMERICAN ASSOCIATION OF RETIRED PERSONS WITNESS DR. DON
18 READING ADVOCATES ALLOCATING THE COST OF THE LOCAL LOOP
19 RATHER THAN TREATING IT AS A SEPARATE PRODUCT. WOULD YOU
20 PLEASE COMMENT ON THIS POSITION?
21 A Yes. As I discussed at some length in my
22 direct testimony, the local loop should be considered to
23 be a separate offering for end users since it provides
24 its own benefits to consumers and has its own readily
25 identifiable costs. Treating it in this manner and
2030
Bell, Reb 10
AT&T
1 collecting the cost of the loop directly from the
2 cost-causing end user either by having a flat monthly
3 connection charge and then charging separately for local
4 and long distance usage, or by incorporating it into flat
5 rate local service
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2031
Bell, Reb 10A
AT&T
1 which charges the consumer for the loop plus the cost of
2 the average consumer's local usage is the fairest and
3 most practical way to recover loop costs as we enter an
4 era of competitive local service provision. The
5 practicality of this approach can be appreciated in light
6 of the fact that under the Federal Telecommunications Act
7 CLECs will be able to lease the use of the local loop as
8 an unbundled network element and pay for it on the basis
9 of its forward looking economic cost. It would be both
10 practical and fair for the incumbent LEC to recover cost
11 of the local loop in like manner. The fairness results
12 from the fact that in this manner the cost causer pays
13 the cost of the service that they utilize and benefit
14 from. The practicality results from the fact that only
15 in this manner can one be sure that the loop cost is
16 recovered in the same manner on the supply side of local
17 exchange competition (i.e., when the incumbent LEC leases
18 the unbundled local loop to a CLEC) and on the demand
19 side when the incumbent LEC sells connectivity to the
20 network to end users (in which case the loop cost may be
21 either recovered directly as in the case of certain
22 private line offerings and some residential measured
23 service offerings that do not have an usage allowance or
24 else incorporated in the rate for flat rate local
25 service). Failure to account for the local loop cost in
2032
Bell, Reb 11
AT&T
1 a manner that does not allow for the direct recovery of
2 the loop would give rise to Rube Goldberg-like
3 allocations of cost to various service offerings which
4 pass through the local loop -- which of necessity would
5 be arbitrary in nature. Since arbitrariness is not the
6 basis for sound public policy any approach which seeks to
7 artificially allocate the cost of the local loop should
8 be rejected.
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2033
Bell, Reb 11A
AT&T
1 COMMISSION STAFF TESTIMONY
2
3 Q ON PAGE 14 OF HIS TESTIMONY, STAFF WITNESS
4 BILL EASTLAKE INDICATED A PREFERENCE FOR ECONOMIC COST
5 BASED PRICES BUT STATED THAT THIS CASE IS NOT THE
6 APPROPRIATE VENUE TO SWITCH FROM AN EMBEDDED COST
7 STANDARD. DO YOU CONCUR WITH HIS POSITION?
8 A I agree that economic cost based prices are
9 appropriate. I do not agree with his belief that this
10 proceeding is not the venue for establishing economic
11 cost based prices. The Federal Telecommunications Act
12 has made it national policy to foster the development of
13 local exchange competition. As the Federal
14 Communications Commission ("FCC") noted in its August 8,
15 1996 Order in FCC Docket No. 96-98, prices of
16 interconnection and unbundled elements should reflect
17 forward-looking economic costs, rather than embedded
18 costs, in order to encourage efficient levels of
19 investment and entry (paragraph 672). In a similar vein
20 the Joint Board, that issued its Recommended Decision to
21 the FCC on November 8, 1996 in CC Docket No. 96-45,
22 proposed to the FCC that universal service fund
23 assistance to high cost of service areas be tied to
24 economic cost. In paragraph 270 the Joint Board noted:
25 "We find that forward-looking economic costs should be
2034
Bell, Reb 12
AT&T
1 used to determine the cost of providing universal
2 service. Those costs best approximate the costs that
3 would be incurred by an efficient competitor entering
4 that market." Since local exchange competition can be
5 expected to
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2035
Bell, Reb 12A
AT&T
1 occur in the not too distant future in Idaho, the time is
2 ripe to implement pricing practices which reflect the
3 only appropriate cost basis for pricing in a competitive
4 environment -- forward looking economic costs (e.g.,
5 TSLRIC/TELRIC).
6 Q ON PAGES 23 THROUGH 25 OF HIS TESTIMONY,
7 STAFF WITNESS EASTLAKE SUPPORTS MAINTENANCE OF A BUSINESS
8 TO RESIDENTIAL FLAT RATE SERVICE RATE RATIO IN EXCESS OF
9 TWO. IN SUPPORTING THIS RELATIONSHIP HE INDICATED THAT
10 "VALUE OF SERVICE CONSIDERATIONS DESERVE SOME MENTION."
11 DO YOU HAVE ANY CONCERNS ABOUT THIS APPROACH?
12 A Yes. While value of service may have some
13 applications in pricing, it is a unreliable guide to use
14 when setting rates for basic services -- particularly
15 since value tends to vary with the eye of the beholder.
16 FAX transmissions were cited as an example of increased
17 business usage and value but many homes utilize FAXs as
18 well, as evidenced by the fact that mail order houses,
19 such as Land's End, William-Sonoma, Victoria's Secret,
20 Cabela's, and J. C. Whitney Automotive, commonly provide
21 FAX numbers for their residential consumers to use when
22 placing orders. Telephone service provides many
23 businesses with a vital link to consumers that has value,
24 but telephone service also provides residences with a
25 vital link to emergency services which can be of
2036
Bell, Reb 13
AT&T
1 particular value to the elderly and young. In addition,
2 high business rates do not necessarily benefit
3 residential
4
5 /
6
7 /
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9 /
10
11
12
13
14
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2037
Bell, Reb 13A
AT&T
1 customers either, since the cost of telephone service is
2 just another operating expense to a business which must
3 be covered by prices for the goods and services that it
4 sells to the public. In addition, with the pending
5 appearance of local exchange competition, unless the cost
6 of providing business service compared to residential
7 service is also in excess of two to one, the current
8 price ratio is apt to be unsustainable once competition
9 develops.
10 Q PLEASE EXPLAIN AT&T'S POSITION WITH RESPECT
11 TO THE TREATMENT OF YELLOW PAGE DIRECTORY IMPUTATION.
12 A AT&T believes that U S WEST should continue
13 to impute Yellow Pages Directory revenues to its
14 regulated Part 61 services. As explained on page 4 of
15 AT&T witness Howard Bell's testimony, "Judge Harold
16 Greene decided to transfer directories to the Bell
17 Operating Companies, such as U S WEST to allow RBOCs to
18 retain directory profits so they could be used to support
19 low residential rates". This was also reiterated in
20 Dr. Selwyn's and Ms. Carlock's testimonies. In the
21 absence of a federal ruling to the contrary, this
22 Commission should continue to uphold the status quo on
23 this issue.
24 Q MS. KOEHLER-CHRISTENSEN STATED IN HER
25 TESTIMONY THAT THE MFJ AND JUDGE GREENE'S DECISIONS HAVE
2038
Bell, Reb 14
AT&T
1 BEEN SUPERCEDED BY THE FEDERAL TELECOMMUNICATIONS ACT OF
2 1996. THEREFORE, THERE IS NO LONGER A VALID REASON TO
3
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8 /
9
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13
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2039
Bell, Reb 14A
AT&T
1 IMPUTE DIRECTORY ADVERTISING REVENUES. DO YOU AGREE WITH
2 HER CONTENTION?
3 A It is, indeed, true that Judge Greene
4 issued his imputation order at the time when he was
5 expecting that basic local exchanges were to be provided
6 by the RBOCs in monopoly operating environment. Since
7 U S WEST continues to exercise a monopoly in the Title 61
8 local service arena, then it should continue imputing
9 Yellow Page Advertising revenues to its revenue
10 requirement. The Telecommunication Act of 1996 should
11 pave the way to eliminating the subsidy only when
12 U S WEST can prove that an effective competition exists
13 in Title 61 services in Idaho. To eliminate the
14 imputation at this time would be premature.
15 Q PLEASE COMMENT ON MS. KOEHLER-CHRISTENSEN'S
16 STATEMENT THAT "...DISCOUNTS COMPUTED USING RATES THAT
17 CONTAIN A SUBSIDY AS A RESULT OF A YELLOW PAGE IMPUTATION
18 PROVIDE A WINDFALL TO THE RESELLER WHO GETS THE BENEFIT
19 OF THE LOWER RETAIL RATE....".
20 A I do not know exactly what
21 Ms. Koehler-Christensen meant by "windfall to reseller".
22 In a resale environment, the resellers get a discount
23 based on whatever price U S WEST charges its retail
24 customers regardless of any embedded subsidy. Hence, a
25 competing reseller such as AT&T cannot charge more than
2040
Bell, Reb 15
AT&T
1 U S WEST charges its customers. The only way resellers
2 can make any profit on resold services is if they are
3 able to more efficiently manage those components of costs
4
5 /
6
7 /
8
9 /
10
11
12
13
14
15
16
17
18
19
20
21
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23
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2041
Bell, Reb 15A
AT&T
1 that U S WEST will avoid (e.g., Marketing Expense,
2 Uncollectibles, Billing and Collection, etc.). However,
3 considering the discount rates that have been ordered
4 thus far in other state jurisdictions, this may be
5 difficult to accomplish.
6 Q HOW MUCH YELLOW PAGE REVENUE SHOULD BE
7 IMPUTED TO U S WEST'S REVENUE REQUIREMENT IN IDAHO?
8 A Ms. Koehler-Christensen disclosed in her
9 rebuttal testimony that an annual Yellow Page Directory
10 imputation of approximately $3.9 million has been
11 embedded in U S WEST's rates. Because the documentation
12 to support this number was not included in her testimony,
13 I do not know if this amount is reasonable. The 1995
14 Revenue Sharing Statement disclosed that U S WEST made
15 $27.3 million in Yellow Page Directory Revenues in Idaho.
16 Q WHAT IS YOUR RECOMMENDATION FOR DETERMINING
17 THE AMOUNT OF YELLOW PAGE DIRECTORY IMPUTATION?
18 A Since the Revenue Sharing Plan has been
19 terminated in June 1996, the amount of Yellow Page
20 Directory revenue that should be imputed for Title 61
21 revenue requirement should be that which would be
22 reported if the Plan were to continue to be in effect for
23 all of 1996 minus any allocable expenses. The IPUC
24 should order U S WEST to provide the appropriate amount
25 of the imputation subject to verification by the IPUC
staff.
2042
Bell, Reb 16
AT&T
1 Q DOES THIS CONCLUDE YOUR REBUTTAL TESTIMONY?
2 A Yes, it does.
3
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2043
Bell, Reb 17
AT&T
1 (The following proceedings were had in
2 open hearing.)
3 MR. HARWOOD: Mr. Bell is available for
4 cross-examination.
5 COMMISSIONER SMITH: Thank you.
6 Ms. Hamlin, did you have questions for
7 Mr. Bell?
8 MS. HAMLIN: Yes, thank you.
9
10 CROSS-EXAMINATION
11
12 BY MS HAMLIN:
13 Q Dr. Bell, acknowledging that this is not a
14 Title 62 rate case, throughout the course of these
15 hearings the last several days, it has come up repeatedly
16 whether there is competition today in the existing local
17 market. Is it your position that there is competition in
18 the Title 61 basic local market today in Idaho?
19 A Not to any significant extent.
20 Q Turning to page 20 of your testimony, you
21 discuss U S WEST's ITAP proposal, your direct testimony.
22 A Yes.
23 Q Is it your position that this proposal is
24 too low or could you explain what your position is on
25 U S WEST's ITAP proposal?
2044
CSB REPORTING BELL (X)
Wilder, Idaho 83676 AT&T
1 A Well, if the ITAP proposal does not cover
2 cost of service after you take a look at the price for
3 the service and factor in some of the other revenue
4 sources for local service, it could have an
5 anti-competitive effect with respect to facilities-based
6 competition down the road.
7 Q Now, on page 19, you discuss U S WEST's
8 witness Owen's testimony about the usage structure for
9 measured service and the increase of the rate to $.03 per
10 minute at a three-hour call free allowance. Is it your
11 position that residential customer usage is expected to
12 decrease due to the introduction of the three-hour call
13 allowance?
14 A Well, that's hard to say without quite a
15 bit of information on the usage characteristics of the
16 customers who would subscribe to measured service.
17 Generally, the customers that subscribe to measured
18 service do so because they have relatively low usage.
19 It's a great plan, for example, for an airline pilot who
20 is married to a stewardess and they're away from home a
21 good deal of the time, but I don't believe that that
22 would have significant impact on usage based on the
23 limited information that's available.
24 Q On page 18 of your testimony, you discuss
25 the value aspects of service offerings between resellers
2045
CSB REPORTING BELL (X)
Wilder, Idaho 83676 AT&T
1 and wholesalers. Do you believe that competitors to
2 U S WEST will be able to offer basic local service at a
3 lower markup price?
4 A Is your question do I believe that resale
5 will provide price competition in provision of local
6 service?
7 Q Yes.
8 A To a limited degree, that would be
9 possible. I have with me an article that appeared in a
10 Denver newspaper about a reseller that's operating in
11 Denver and the U S WEST residential service rate is
12 $14.93. ICG is going to offer it at 14.79, so there's a
13 small difference for the residential customer, but then
14 for some of the vertical features customers might want,
15 U S WEST charges 4.50, ICG was going to charge $4.00.
16 For residential installation, U S WEST charged 35, ICG
17 was going to charge $25.00. In the business end,
18 U S WEST had $37.37 for a monthly rate; whereas, for ICG,
19 it was $34.23, so they do have some limited price
20 competition.
21 A lot of the competition will come in the
22 form of packaging and providing additional features for
23 customers. McCloud in Iowa currently has a prime line
24 offering which they are making available on a resale
25 basis in Des Moines and some other communities and
2046
CSB REPORTING BELL (X)
Wilder, Idaho 83676 AT&T
1 they're not getting a difference in price, particularly.
2 It's more a matter of bundling features together, like
3 local phone service and Internet or voice mail and
4 they've been up and running for about a month and I think
5 they've been attracting about 100 customers a day on the
6 basis primarily of features, so there will be some
7 consumer benefits associated with resale, limited price
8 impacts, a lot of feature impacts.
9 What will be lacking with just resale,
10 though, is the fact that on the supply side you won't
11 have competition, so it would be inappropriate to lessen
12 any of the regulatory constraints on U S WEST until there
13 is significant facilities-based competition available,
14 because they would continue to have the ability and the
15 economic incentive to discriminate against other
16 providers, to resellers absent regulatory controls, and
17 if they weren't subject to regulation, I think
18 Lord Acton's old dictum that power tends to corrupt and
19 power -- absolute power corrupts absolutely might come
20 into play.
21 MS HAMLIN: Thank you. I have no further
22 questions.
23 COMMISSIONER SMITH: Thank you,
24 Ms. Hamlin.
25 Ms. Ford.
2047
CSB REPORTING BELL (X)
Wilder, Idaho 83676 AT&T
1 MS. FORD: Thank you.
2
3 CROSS-EXAMINATION
4
5 BY MS. FORD:
6 Q Good morning.
7 A Good morning.
8 Q Mr. Bell, you just mentioned an article
9 from, I believe, the Denver Post?
10 A That is correct.
11 Q Would that be the same article that
12 discussed the situation whereby a Denver Post employee
13 called up ICG and TCG and requested residential service
14 and was denied both times because he wasn't a business
15 customer?
16 A That's right, and it's my understanding
17 that they claimed it was a start-up glitch and that they
18 would be accepting residential customers in the future.
19 I'm not -- I don't have a lot of firsthand knowledge on
20 the situation.
21 Q You would agree, wouldn't you, Mr. Bell,
22 that a subsidy occurs when the revenues from one service
23 or one group of customers is used to offset the cost of
24 providing another service to another group of customers
25 such that that second group of customers is not required
2048
CSB REPORTING BELL (X)
Wilder, Idaho 83676 AT&T
1 to pay the full cost of providing the service to them?
2 A Generally speaking, if a service is not
3 covering the economic, forward-looking economic, costs of
4 service provision, it is receiving a subsidy and that's
5 been one of the real problems we've had with access
6 charges, for example, over the years where the CCLC has
7 no cost associated with it, but just flows as a revenue
8 transfer to a local exchange company ostensibly for
9 subsidizing local service.
10 Q So your answer is yes, you agree with my
11 characterization of that situation as a subsidy?
12 A In a situation, if I followed it correctly,
13 where a service is not covering its forward-looking
14 economic cost of service, it is receiving a subsidy. It
15 has to be done with an economic cost of service and not
16 the allocated-type services that have been -- allocated
17 services, costs rather, based on historical accounting
18 records that have been provided in this case. You need
19 to look at forward-looking economic costs.
20 Q And could you turn to your testimony, your
21 direct testimony, at page 7?
22 A Okay.
23 Q And could you read the sentence beginning
24 on line 13 starting with "A system," just that sentence
25 there?
2049
CSB REPORTING BELL (X)
Wilder, Idaho 83676 AT&T
1 A "A system of subsidies from one group of
2 telecommunications services to the users of another group
3 of telecommunications services would violate each of
4 these criteria."
5 Q And could you turn to page 8 of your
6 testimony?
7 A Yes.
8 Q And could you read the sentence that begins
9 on line 4?
10 A "It is a matter of basic intercustomer
11 fairness that customers should, as a general rule, pay
12 the full cost of providing the goods and services that
13 they consume and benefit from."
14 MS. FORD: Thank you. That's all I have.
15 COMMISSIONER SMITH: Do we have questions
16 from the Commission?
17 COMMISSIONER NELSON: I don't. Thank you.
18 COMMISSIONER SMITH: Any redirect,
19 Mr. Harwood?
20 MR. HARWOOD: No redirect.
21 COMMISSIONER SMITH: Thank you for your
22 help, Dr. Bell.
23 THE WITNESS: You're quite welcome. It's a
24 pleasure being here again. Have a nice day.
25 (The witness left the stand.)
2050
CSB REPORTING BELL (X)
Wilder, Idaho 83676 AT&T
1 COMMISSIONER SMITH: Okay, I guess we're
2 now ready for Mr. Howell's final two witnesses. Before
3 we do that, shall we clear up the exhibits from
4 yesterday?
5 MR. HOWELL: Madam Chairman, you must have
6 been reading my mind. I would move that we admit those
7 exhibits that were marked and identified by the Staff in
8 our cross-examination.
9 COMMISSIONER SMITH: Mr. Howell, because
10 these were not consecutively numbered, I want to read my
11 list to make sure that the record is clear as to what
12 exhibits were there, so the list that I have includes
13 162, 163, 165, 166, 168, 171, 173, 174, 175, 176, 178,
14 179, 181, 183, 189, 193, 196, 199, 200.2, 200.5, 200.8
15 and 200.10.
16 MR. HOWELL: I think you've got them all.
17 COMMISSIONER SMITH: Okay, is there any
18 objection to the admission of these exhibits? No? Then
19 they will be admitted.
20 (Staff Exhibits Nos. 162, 163, 165,
21 166, 171, 173-176, 178, 179, 181, 183, 189, 193, 196,
22 199, 200.2, 200.5, 200.8 & 200.10 were admitted into
23 evidence.)
24 COMMISSIONER SMITH: Okay, any other
25 things, Ms. Hobson?
2051
CSB REPORTING COLLOQUY
Wilder, Idaho 83676
1 MS. HOBSON: I believe that we had
2 exhibit -- I'm not sure which one.
3 COMMISSIONER SMITH: How about 56?
4 MS. HOBSON: 56, I believe. We would move
5 the admission of Exhibit 56 at this time.
6 COMMISSIONER SMITH: Is there any objection
7 to the admission of Exhibit 56? Okay, it will be
8 admitted.
9 (U S WEST Communications, Inc. Exhibit
10 No. 56 was admitted into evidence.)
11 COMMISSIONER SMITH: I guess we're ready to
12 go forward. Mr. Howell.
13 MR. HOWELL: Staff would call its next
14 witness, Terri Carlock.
15
16 TERRI CARLOCK,
17 produced as a witness at the instance of the Staff,
18 having been first duly sworn, was examined and testified
19 as follows:
20
21 DIRECT EXAMINATION
22
23 BY MR. HOWELL:
24 Q Would you state your full name and spell
25 your last for the record, please?
2052
CSB REPORTING CARLOCK (Di)
Wilder, Idaho 83676 Staff
1 A Terri Carlock, C-a-r-l-o-c-k.
2 Q And who are you employed by and in what
3 capacity?
4 A Idaho Public Utilities Commission as audit
5 section supervisor.
6 Q Are you the same Terri Carlock that had an
7 opportunity to prefile direct testimony in this case on
8 November the 26th of last year?
9 A I am.
10 Q Did you also prepare Exhibits 127 and 128?
11 A That's correct.
12 Q Did you also prepare surrebuttal testimony
13 dated February 26th of this year?
14 A Yes.
15 Q Did you also have an opportunity to file a
16 revision to Schedule 12, page 2 of your Exhibit 128?
17 A Yes.
18 Q If I were to ask you the questions set out
19 in your -- well, let me back up. Do you have any changes
20 or corrections to your testimony and/or exhibits?
21 A No.
22 Q If I were to ask the questions contained in
23 your direct and surrebuttal testimony, would your answers
24 be the same today?
25 A They would.
2053
CSB REPORTING CARLOCK (Di)
Wilder, Idaho 83676 Staff
1 MR. HOWELL: Madam Chairman, with that, I
2 would move that Ms. Carlock's prefiled testimony be
3 spread upon the record as if read and her Exhibits 127
4 and 128 be admitted.
5 COMMISSIONER SMITH: If there is no
6 objection, it is so ordered.
7 (Staff Exhibit Nos. 127 & 128 were
8 admitted into evidence.)
9 (The following prefiled direct and
10 surrebuttal testimony of Ms. Terri Carlock is spread upon
11 the record.)
12
13
14
15
16
17
18
19
20
21
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24
25
2054
CSB REPORTING CARLOCK (Di)
Wilder, Idaho 83676 Staff
1 Q. Please state your name and address for the
2 record.
3 A. My name is Terri Carlock. My business
4 address is 472 West Washington Street, Boise, Idaho.
5 Q. By whom are you employed and in what
6 capacity?
7 A. I am employed by the Idaho Public Utilities
8 Commission as the Accounting Section Supervisor.
9 Q. Please outline your educational background
10 and experience.
11 A. I graduated from Boise State University in
12 May 1980, with a B.B.A. Degree in Accounting and in
13 Finance. I have attended the annual regulatory studies
14 program sponsored by the National Association of
15 Regulatory Utilities Commissioners (NARUC) at Michigan
16 State University. I chaired the NARUC Staff Subcommittee
17 on Economics and Finance and the Ad Hoc Committee on
18 Diversification. I have also attended various finance
19 conferences, including the Public Utilities
20 Finance/Advance Regulation Course at the University of
21 Texas at Dallas, the National Society of Rate of Return
22 Analysts' Financial Forums, the Regulatory Economics and
23 Cost of Capital Conference in Utah, and a Standard &
24 Poor's Corporation Telecommunications Ratings Seminar.
25 Since joining the Commission Staff in May 1980, I have
2055
USW-S-96-5 CARLOCK (Di) 1
11/26/96 Staff
1 participated in several audits, performed financial
2 analysis on various companies and have previously
3 presented testimony before this Commission.
4 Q. What is the purpose of your testimony in
5 this proceeding?
6 A. The purpose of my testimony is to present
7 Staff's recommendation in this proceeding for U S WEST
8 Communications, Inc. (U S WEST, USWC) related to U S WEST
9 Direct Directory (Directory) revenue and the cost of
10 capital. In connection with the cost of capital, I will
11 address the appropriate capital structure, the cost of
12 debt, the cost of equity and the overall rate of return.
13 I am sponsoring Staff Exhibit Nos. 127 and 128 in my
14 testimony.
15 Q. Please summarize your recommendations.
16 A. I am recommending an adjustment of
17 $8,645,032 for Directory. I am also recommending an
18 overall rate of return of 8.66% based on a return on
19 equity of 11.0%.
20 U S WEST DIRECT DIRECTORY (DIRECTORY) ADJUSTMENT
21 Q. Are you proposing an adjustment for the
22 Directory revenue?
23 A. Yes, I am proposing an Idaho Intrastate net
24 income adjustment of $8,645,032 for Directory.
25 Q. Did U S WEST include revenues from Directory
2056
USW-S-96-5 CARLOCK (Di) 2
11/26/96 Staff
1 advertising or yellow pages in this case?
2 A. No. In response to Production Request
3 ATT01- 023, U S WEST stated "U S WEST Communications
4 position is that there are no Yellow Pages Directory
5 revenues that are imputable, which is why there is no
6 test period adjustment."
7 Q. Please provide the history of Directory
8 revenues.
9 A. Directory operations have traditionally
10 been a source of revenues contributing to the Company's
11 revenue requirement to maintain basic exchange service at
12 reasonable rates and to support universal service. This
13 directory contribution has existed since well before the
14 Bell system breakup in 1984. The basic information
15 required to develop a telephone directory continues to be
16 readily available to the local telephone company. The
17 incumbent local exchange carrier (LEC) will maintain
18 unique access to names, addresses and telephone numbers
19 of all residents and businesses. This information that
20 constitutes the white page listings are now available to
21 any directory provider for a fee.
22 The proposed Modified Final Judgement (MFJ)
23 initially assigned directory operations to AT&T.
24 Following comments argued by the Bell Operating Companies
25 (BOCs), the National Association of Regulatory Utility
2057
USW-S-96-5 CARLOCK (Di) 3
11/26/96 Staff
1 Commissioners, and many state commissions for the BOCs to
2 retain the directory business, Judge Greene determined
3 directory operations and revenues should be retained by
4 the BOCs. In the MFJ decision issued August 24, 1982,
5 Judge Greene concluded that directory operations provide
6 a significant revenue source to offset local telephone
7 revenue requirements.
8 Q. Please explain why you believe an
9 adjustment for Directory revenues is appropriate.
10 A. Prior to divestiture, combined "Yellow
11 Pages" and "White Pages" directories were prepared and
12 distributed by the local phone company, in this case
13 U S WEST's predecessor (Mountain States Telephone and
14 Telegraph Company). The directory publishing assets were
15 included in the rate base of Mountain Bell from which
16 significant profits were available to satisfy the
17 Company's revenue requirement. These profits were
18 obtained as a result of the interrelationship among the
19 phone company, the telephone directory and its customers.
20 The telephone directory was and is considered by
21 customers as a telephone company service they receive as
22 a customer of the company.
23 The use of Directory revenues as a component
24 of local revenue requirement was clearly recognized by
25 Judge Greene in the MFJ. The MFJ court held that AT&T
2058
USW-S-96-5 CARLOCK (Di) 4
11/26/96 Staff
1 was not entitled to the publishing assets upon
2 divestiture and concluded the Bell Operating Companies
3 (BOCs) would retain those assets. The Directory revenues
4 were reserved to the BOCs (including U S WEST)
5 specifically because it is in the public interest for
6 Directory revenues to be available to defray some of the
7 cost of local service.
8 In prior rate cases, this Commission has
9 consistently included Directory revenues to satisfy
10 revenue requirement in setting local rates (General
11 Telephone Company of the Northwest, Inc., Case No.
12 U-1002-67; Mountain States Telephone and Telegraph
13 Company (now U S WEST), Case No. U-1000-63). More
14 recently, the Revenue Sharing Plan also included actual
15 southern Idaho Directory revenues for each year. No
16 evidence has been presented to support changing this
17 method of including Directory revenues to reduce revenue
18 requirement from local services.
19 Q. Do transactions between USWC and its
20 affiliates raise any special regulatory concerns?
21 A. Yes. The distinction between affiliate and
22 non-affiliate transactions is significant. Normally,
23 transactions between non-affiliates are presumed to be
24 reasonable when the utility demonstrates that it actually
25 incurred the expenditure. Parties challenging such non-
2059
USW-S-96-5 CARLOCK (Di) 5
11/26/96 Staff
1 affiliate transactions carry the burden to show that the
2 expenditures were unreasonable or imprudent. In
3 contrast, transactions between affiliated companies are
4 subjected to close scrutiny and the regulated utility has
5 the burden of proving the reasonableness of its affiliate
6 transactions. In this instance U S WEST Communications
7 transferred the Directory to an affiliate and therefore
8 has the burden of proving the removal of directory
9 advertising revenues was reasonable. U S WEST cannot
10 simply rely on the fact that a transfer of operations to
11 an unregulated affiliate occurred. If the Company fails
12 to produce substantial evidence of the reasonableness of
13 its affiliate transaction, then adjustments for
14 ratemaking purposes to maintain customer neutrality are
15 reasonable. This Commission and Idaho courts have
16 consistently followed this approach. Order Nos. 24443,
17 16945, 16829; General Telephone Co. v. Idaho PUC, 109
18 Idaho 942, 712 P.2d 651 (1986), Boise Water Corp. v.
19 Idaho PUC, 97 Idaho 832, 555 P.2d 163 (1976).
20 Q. Please explain the change in organizational
21 structure related to Directory services at U S WEST.
22 A. In 1984, the Directory assets were
23 transferred to U S WEST DIRECT (USWD), an unregulated
24 affiliate, and then included with U S WEST Media Group in
25 1995. As shown on Staff witness Faunce's Exhibit No. 102
2060
USW-S-96-5 CARLOCK (Di) 6
11/26/96 Staff
1 the Directory services, including yellow pages, are
2 organized as U S WEST Marketing Resources Group (USWMRG)
3 under U S WEST Media Group as a unit of U S WEST, Inc.
4 Although Directory services are now under USWMRG, I will
5 continue to refer to it as U S WEST Direct since this is
6 the way the accounting records are identified.
7 Q. Please explain Staff's position regarding
8 the transfer of an asset to an unregulated affiliate.
9 A. It is Staff's position that the effect on
10 customers should be neutral as to the transfer of any
11 asset when it is for the convenience of the Company that
12 the asset is transferred. This means that no rate
13 changes or revenue impact should result from the
14 transfer. To assure customer neutrality, revenues need
15 to be credited to USWC even though the assets were
16 transferred. The revenue adjustment amount should be
17 based on the difference between the revenues received
18 from the publication venture and the reasonable cost of
19 publication. Such an adjustment is necessary to prevent
20 utilities from removing profitable portions of the
21 business to an unregulated entity and leaving captive
22 utility customers with higher expenses of operations but
23 with no revenue source to satisfy the revenue
24 requirement.
25 Q. Please summarize the reasons for your
2061
USW-S-96-5 CARLOCK (Di) 7
11/26/96 Staff
1 adjustment.
2 A. The reasons for the Directory adjustment
3 can be classified in three areas:
4 1. The Directory revenue stream was granted to
5 the BOC to support local revenue requirement. There is
6 no supportable evidence to change this treatment.
7 2. USWD is an affiliate where the
8 reasonableness of all transactions must be justified by
9 the Company. U S WEST must demonstrate that the removal
10 of this revenue source from the regulated revenue
11 requirement is reasonable.
12 3. The Staff's Directory adjustment continues
13 to recognize the inherent goodwill value of name and logo
14 recognition with U S WEST. Based on USWD market research
15 in Idaho, the U S WEST Direct telephone directory
16 continues to be the primary directory referenced by
17 customers and advertised in by advertisers.
18 Q. With various areas of the
19 telecommunications business being classified as Title 62,
20 or not rate regulated, in southern Idaho, please explain
21 why Directory revenues should continue to support the
22 local Title 61 revenue requirement.
23 A. Even though U S WEST elected to deregulate
24 all of its services except basic local exchange services
25 under Idaho's Telecommunications Act of 1988, directory
2062
USW-S-96-5 CARLOCK (Di) 8
11/26/96 Staff
1 revenues continued to benefit local exchange customers in
2 the Revenue Sharing Plan process that was adopted in lieu
3 of a more formal and complicated cost allocation
4 methodology. The Commission stated:
5
The staff recommended language to
6 ensure that the Idaho jurisdiction
receives all Idaho-generated
7 directory advertising revenues plus
an allocation of national directory
8 advertising revenues. The Commission
finds that this is an appropriate
9 change to the plan. While U S WEST
has removed all of its directory
10 operation to a separate subsidiary,
the benefit of the directory revenues
11 themselves must continue to flow to
the regulated services of the
12 telephone operations. Bell operating
companies were allowed to retain
13 publishing functions and assets upon
divestiture from AT&T specifically
14 for the purpose of supporting local
exchange rates. U.S. v. AT&T, 552
15 F. Supp. 131 (D.D.C. 1982), Aff'd
Mem. Sub. Nom. Maryland v. U.S., 460
16 U.S. 1001 (1983). The Commission
finds that the inclusion of Idaho
17 directory revenues is essential for
the fair operation of the sharing plan.
18
Order No. 22738 at 10-11, Order No. 22738, dated
19 September 20, 1989, emphasis added.
20
21 Q. Please explain how you calculated your
22 proposed adjustment for Directory revenues.
23 A. I calculated the Staff recommended
24 adjustment by starting with the 1995 Southern Idaho
25 Directory Revenue used for Revenue Sharing. To reflect
2063
USW-S-96-5 CARLOCK (Di) 9
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1 operating costs including interest and taxes, I utilized
2 the USWD 1995 Net Income to Revenue ratio. This net
3 income to revenue ratio was calculated from the Income
4 Statement for USWD allocated to the southern Idaho
5 jurisdiction in the answer to Confidential Staff Audit
6 Response No. 63, Attachment A. I have also made a
7 reduction to allow USWD to retain a reasonable return on
8 its investment. These calculations are shown on
9 Confidential Staff Exhibit No. 127. My Directory
10 adjustment is $8,645,032.
11 Q. Are any adjustments required to reflect
12 payments received by USWC from USWD?
13 A. No adjustments are required for the
14 payments USWC received from U S WEST DIRECT for white
15 page listings and yellow pages billing and collection.
16 These payments are reflected in the revenues of USWC and
17 shown as an expense for USWD. The adjustment I have made
18 is reflected at the net income level so no double
19 counting has occurred and no adjustment is required.
20 Q. How should this adjustment be assigned to
21 southern Idaho intrastate Title 61?
22 A. Directory Revenues would be reflected in
23 Revenue Account 5230. As shown in response to Staff
24 Audit Request No. 6, Directory Revenues are assigned 100%
25 intrastate. This is consistent with the revenue sharing
2064
USW-S-96-5 CARLOCK (Di) 10
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1 practice. Since the benefit of directory revenues should
2 apply to basic local service rates, it should be assigned
3 100% to Title 61. Allocating a portion of the directory
4 revenues to Title 62 would provide an unfair advantage to
5 U S WEST over alternative providers of Title 62 services.
6 Q. Please explain why an allocation to Title 61
7 services doesn't provide an unfair advantage to U S WEST
8 since local services may be more competitive in the
9 future.
10 A. Title 61 services can become more
11 competitive. However, the directory revenue benefit can
12 be passed on to the local service customer no matter who
13 the local service provider is as long as U S WEST
14 facilities are resold. This should be addressed in a
15 separate and distinct case addressing unbundled rates.
16 This issue may be revisited when a strong
17 percentage of local service is not provided by facilities
18 owned by USWC or leased from USWC.
19 Q. Do other state regulatory jurisdictions
20 adjust Directory revenue?
21 A. Yes, in addition to Idaho, the following
22 states with U S WEST jurisdiction have adjusted Directory
23 revenues at some level: Washington, Oregon, Arizona,
24 Utah, New Mexico, Colorado and Iowa. Directory revenues
25 have also been adjusted for other telephone companies in
2065
USW-S-96-5 CARLOCK (Di) 11
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1 other jurisdictions. Some additional states that have
2 adjusted Directory revenues include California, Missouri,
3 Arkansas, Vermont, Kentucky, District of Columbia,
4 Florida, Wisconsin, Illinois and Louisiana.
5 In U S WEST's recent rate case in
6 Washington, the Utilities and Transportation Commission
7 recently concluded that:
8 Utilities, operating as natural
monopolies, may have the power
9 to operate for their own
corporate, interests, adversely
10 to the interests of ratepayers.
The Commission is charged with
11 protecting the ratepaying public.
One of the Commission's functions
12 has been to protect customers of
noncompetitive services from
13 utilities' self-dealing. Utilities
may have the power to subdivide the
14 integrated utility operations and
divest for their own organizational
15 goals or profit objectives any
discrete, divisible, and potentially
16 profitable aspect of that operation.
Imputation is entirely consistent
17 with the purpose of regulation as
a tool to minimize adverse effects
18 on such division and divestiture
when those circumstances occur.
19
WUTC Fifteenth Supplemental Order, at 37-38
20 (April 11, 1996) Docket No. UT-95-0200).
21
22 COST OF CAPITAL
23 Q. What legal standards have been established
24 for determining a fair and reasonable rate of return?
25 A. The legal test of a fair rate of return for
2066
USW-S-96-5 CARLOCK (Di) 12
11/26/96 Staff
1 a utility company was established in the Bluefield Water
2 Works decision of the United States Supreme Court and is
3 repeated specifically in Hope Natural Gas.
4 In Bluefield Water Works and Improvement
5 Co. v. West Virginia Public Service Commission, 262 U. S.
6 679, 692, 43 S.Ct. 675, 67 L.Ed. 1176 (1923), the Supreme
7 Court stated:
8
A public utility is entitled to such
9 rates as will permit it to earn a return
on the value of the property which it
10 employs for the convenience of the
public equal to that generally being
11 made at the same time and in the same
general part of the country on
12 investments in other business
undertakings which are attended by
13 corresponding risks and uncertainties;
but it has no constitutional right to
14 profits such as are realized or
anticipated in highly profitable
15 enterprises or speculative ventures.
The return should be reasonably
16 sufficient to assure confidence in the
financial soundness of the utility and
17 should be adequate, under efficient and
economical management, to maintain and
18 support its credit and enable it to
raise the money necessary for the proper
19 discharge of its public duties. A rate
of return may be reasonable at one time
20 and become too high or too low by
changes affecting opportunities for
21 investment, the money market and
business conditions generally.
22
23 The Court stated in FPC v. Hope Natural Gas Company, 320
24 U. S. 591, 603, 64 S.Ct. 281, 88 L.Ed. 333 (1944):
25 From the investor or company point of
2067
USW-S-96-5 CARLOCK (Di) 13
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1 view it is important that there be
enough revenue not only for operating
2 expenses but also for the capital costs
of the business. These include service
3 on the debt and dividends on the stock.
4 ... By that standard the return to the
equity owner should be commensurate with
5 returns on investments in other
enterprises having corresponding risks.
6 That return, moreover, should be
sufficient to assure confidence in the
7 financial integrity of the enterprise,
so as to maintain its credit and to
8 attract capital. (Citations omitted.)
9
10 The Supreme Court decisions in Bluefield
11 Water Works and Hope Natural Gas have been affirmed in In
12 re Permian Basin Area Rate Case, 390 U. S. 747, 88 S.Ct
13 1344, 20 L.Ed 2d 312 (1968), and Duquesne Light Co. v.
14 Barasch, 488 U. S. 299, 109 S.Ct. 609, 102 L.Ed.2d. 646
15 (1989). The Idaho Supreme Court has also adopted the
16 principles established in Bluefield Water Works and Hope
17 Natural Gas. See In re Mountain States Tel. & Tel. Co.
18 76 Idaho 474, 284 P.2d 681 (1955); Hayden Pines Water
19 Company v. IPUC, 122 ID 356, 834 P.2d 873 (1992); General
20 Telephone Co. v. IPUC, 109 Idaho 942, 712 P.2d 643
21 (1986).
22 As a result of these United States and Idaho
23 Supreme Court decisions, three standards have evolved for
24 determining a fair and reasonable rate of return:
25 (1) the Financial Integrity or Credit Maintenance
2068
USW-S-96-5 CARLOCK (Di) 14
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1 Standard; (2) the Capital Attraction Standard; and, (3)
2 the Comparable Earnings Standard. If the Comparable
3 Earnings Standard is met, the Financial Integrity or
4 Credit Maintenance Standard and the Capital Attraction
5 Standard will also be met, as they are an integral part
6 of the Comparable Earnings Standard.
7 Q. Have you considered these standards in your
8 recommendation?
9 A. Yes. These criteria have been seriously
10 considered in the analysis upon which my recommendations
11 are based. It is also important to recognize that the
12 fair rate of return that allows the utility company to
13 maintain its financial integrity and to attract capital
14 is established assuming efficient and economic
15 management, as specified by the Supreme Court in
16 Bluefield Water Works.
17 Q. What approach have you used to determine
18 the cost of equity for U S WEST specifically?
19 A. I have presented two methods: the
20 Discounted Cash Flow (DCF) method and the Comparable
21 Earnings method for industrial companies and utilities.
22 Q. Please explain the Comparable Earnings
23 method and how the cost of equity is determined using
24 this approach.
25 A. The Comparable Earnings method for
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USW-S-96-5 CARLOCK (Di) 15
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1 determining the cost of equity is based upon the premise
2 that a given investment should earn its opportunity cost.
3 In competitive markets, if the return earned by a firm is
4 not equal to the return being earned on other investments
5 of similar risk, the flow of funds will be toward those
6 investments earning the higher returns. Therefore, for a
7 utility to be competitive in the financial markets, it
8 should be allowed to earn a return on equity equal to the
9 average return earned by other firms of similar risk. The
10 Comparable Earnings approach is supported by the
11 Bluefield Water Works and Hope Natural Gas decisions as a
12 basis for determining those average returns.
13 I have analyzed the returns for utilities
14 and industrial companies in order to determine a fair
15 return for U S WEST. When determining the comparable
16 earnings rate, it is important that a cross-section of
17 various companies and industries be utilized in the
18 sample so that any possible effects of unusual
19 occurrences or monopoly powers are limited. It is also
20 important that any risk differentials between the
21 comparable earnings sample and U S WEST be resolved.
22 In my comparable earnings analysis, the
23 rates of return on common equity historically earned by
24 industrial firms were examined. The historical returns
25 earned by electric, gas and telephone utilities were also
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USW-S-96-5 CARLOCK (Di) 16
11/26/96 Staff
1 studied. Then, based upon current economic conditions,
2 the current cost of equity capital for industrial firms
3 on the average was estimated. Taking into consideration
4 the risk differentials between industrial companies and
5 utilities and those differentials as they specifically
6 relate to U S WEST, I estimated the current cost of
7 equity range utilizing the Comparable Earnings approach.
8 Q. Please explain your schedules reflecting
9 the historical rate of return earned for industrial firms.
10 A. Schedules 1 through 4 of Staff Exhibit No.
11 128 show the returns on common equity for the Business
12 Week Corporate Scoreboard over the last 10 years. The
13 industry category classifications were changed beginning
14 the first quarter of 1988. The current classifications
15 are reflected on each schedule.
16 Industrial returns tend to fluctuate with
17 business cycles, increasing as the economy improves and
18 decreasing as the economy declines. I have utilized a
19 three-year moving average to smooth the business cycle
20 effects and yearly fluctuations in the industrial rate of
21 return. Utility returns are not as sensitive to
22 fluctuations in the business cycle because the demand for
23 utility services generally tends to be more stable and
24 predictable. Schedule 1 reflects the returns earned for
25 periods ending the First Quarter of each year; Schedule 2
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USW-S-96-5 CARLOCK (Di) 17
11/26/96 Staff
1 reflects the returns for periods ending the Second
2 Quarter; Schedule 3 reflects the returns for periods
3 ending the Third Quarter; and Schedule 4 reflects the
4 returns for periods ending the Fourth Quarter of each
5 year. The returns for 1995 and 1996 reflect the effects
6 of the economic recovery and the adequate economic
7 conditions that continue.
8 For years ending the First Quarter (Schedule
9 1 of Staff Exhibit No. 128), the five-year average return
10 from 1992 through 1996 was 13.2%, and the three-year
11 average from 1994 through 1996 was 15.2%. The three-year
12 moving average for 1996 of 15.2% is greater than the
13 three-year moving average of 13.6% in 1995.
14 For years ending the Second Quarter
15 (Schedule 2 of Staff Exhibit No. 128), the five-year
16 average of 13.6% for 1996 is higher than the five-year
17 average of 12.4% for 1995. The three-year moving average
18 increases from 14.0% in 1995 to 15.6% in 1996.
19 For years ending the Third Quarter
20 (Schedule 3 of Staff Exhibit No. 128), the five-year
21 average from 1992 through 1996 was 13.9%, increasing from
22 12.6% in 1995. The three-year moving average from 1994
23 through 1996 was 15.8%, reflecting an increase from 14.5%
24 in 1995.
25 For years ending the Fourth Quarter
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USW-S-96-5 CARLOCK (Di) 18
11/26/96 Staff
1 (Schedule 4 of Staff Exhibit No. 128) the five-year
2 average return of 12.6% for 1996 is an increase from
3 11.7% in 1992. The three-year average in 1996 of 14.7%
4 increased from 12.6% in 1995.
5 This is a significant improvement in
6 reported returns causing large increases in the industry
7 composite compared to prior years.
8 Schedule 5 of Staff Exhibit No. 128 depicts
9 the returns for the years ending each quarter from 1987
10 through the Third Quarter of 1996 for the Corporate
11 Scoreboard composite returns, the three-year moving
12 average industrial returns, the utilities returns and the
13 telecommunications returns as reflected in Schedules 1
14 through 4. This graph shows the increase and decrease of
15 industrial returns through good and bad economic times of
16 business cycles.
17 Q. What is your estimate of the current and
18 near-future equity returns for industrial companies?
19 A. Based upon the three-year moving average
20 trend in industrial earnings and actual earnings
21 reflected on Schedules 1 through 5, Staff Exhibit No. 128
22 along with current economic conditions, I believe
23 industrial returns will be stable or decrease in 1997.
24 The 1995 inflation rate is 2.5% for the
25 consumer price index and 2.3% for the producer price
2073
USW-S-96-5 CARLOCK (Di) 19
11/26/96 Staff
1 index. The change in the inflation rate can be seen by
2 looking at the consumer and producer price indexes as
3 shown in Schedule 6 of Staff Exhibit No. 128. The change
4 in bond rates is illustrated in Schedule 7 of Staff
5 Exhibit No. 128, Moody's Average for Public Utility Bond
6 Yields. The yields are shown for "Aa", "A" and "Baa"
7 bonds from 1977 through October 1996. Prime interest
8 rates as shown in Schedule 8 of Staff Exhibit No. 128
9 have been stable at 8.25% since February 1, 1996. The
10 Federal Funds Reserve Rate is currently at 5.5%.
11 The Dow Jones Industrial Average Index
12 (DJIA) has fluctuated widely between the 1982 low of
13 776.92 on August 12, to a closing record of 6430.02 on
14 November 20, 1996. The Dow Jones Utility Average (DJUA)
15 reached a record high of 247.68 on April 16, 1993 and
16 closed at 234.63 on November 20, 1996.
17 I made a review of the actual earned
18 returns on equity for industrial companies, the decline
19 and improvement in the economy, changing inflation
20 and stock market conditions. Based upon these
21 considerations my estimate of the near future equity
22 capital returns for industrial companies is in the range
23 of 13.5% - 15.0%.
24 Q. How does the trend in utility returns
25 compare with the trend in industrial returns?
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USW-S-96-5 CARLOCK (Di) 20
11/26/96 Staff
1 A. Schedule 9 of Staff Exhibit No. 128 shows
2 the returns for the Moody's Electric Utilities since
3 1970. The returns in individual years may increase or
4 decrease from the prior year, but the three-year moving
5 averages show general movements in earned returns. There
6 has been a general downward trend in average electric
7 utility returns since 1986 as reflected in the three-year
8 moving average returns. In 1995, the three-year moving
9 average return is 9.8% while the five-year average return
10 is 10.4%.
11 The return on common equity for the Moody's
12 Gas Distribution Companies is shown in Schedule 10 of
13 Staff Exhibit No. 128. For the period ending 1995, the
14 annual return is 10.1% while the three-year average
15 return for the gas utilities is 11.3%.
16 The booked earned returns for the
17 Telecommunications Services Industry has increased from
18 15.0% in 1992 to 25.0% in 1996 (Value Line Investment
19 Survey, October 11, 1996). The average market to book
20 ratio for this industry is 3.4x. When the market to book
21 ratio is above 1, booked earned returns are greater than
22 the required cost of capital. Therefore the required
23 market realized return is significantly less than the
24 reported earned returns. If the relationship between the
25 returns and the market to book rate was directly
2075
USW-S-96-5 CARLOCK (Di) 21
11/26/96 Staff
1 proportional, the required cost of capital would be 7.4%
2 (25.0% divided by 3.4).
3 A review of electric, gas and telephone
4 utility returns provides a record of actual utility
5 returns earned in the past. The required return for
6 telephone utilities, and U S WEST specifically, can then
7 be estimated by reviewing current market changes and
8 considering any risk differentials between the different
9 types of utilities.
10 Q. Please explain the risk differentials
11 between industrial companies and utilities.
12 A. Risk is a degree of uncertainty relative to
13 a company. The lower risk level associated with
14 utilities is attributable to many factors. Utilities
15 continue to have limited competition for distribution of
16 utility services within the certificated area. With
17 limited competition for regulated services, there is less
18 chance of losses related to pricing practices, marketing
19 strategy and advertising policies. The market share may
20 decline as competition increases in various markets but
21 the probability of losses in regulated markets remains
22 small compared to industrial companies.
23 The competitive risks for telephone
24 companies continue to change with The Telecommunications
25 Act of 1996. Even with the removal of legal barriers to
2076
USW-S-96-5 CARLOCK (Di) 22
11/26/96 Staff
1 local competition, telephone companies maintain
2 substantial market power from the existing network. This
3 market power limits the competitive risks for the
4 incumbent LECs. While U S WEST may have increased
5 competition in select local markets, the existing market
6 power advantages retained by U S WEST will limit
7 competition for several years. The competitive risks for
8 gas and electric utilities have also changed with the
9 increase in non-utility generation and open transmission
10 access.
11 Competitive risks are less for U S WEST
12 than for many telephone companies, partially due to the
13 rural nature of the service area and also the market
14 power advantages. The demand for utility services of
15 U S WEST and other BOCs is relatively stable compared to
16 that of unregulated firms and even non BOC telephone
17 service providers.
18 Under regulation, utilities are generally
19 allowed to recover, through rates, reasonable, prudent
20 and justifiable cost expenditures related to regulated
21 services. Unregulated firms have no such assurance.
22 Utilities in general are sheltered by regulation for cost
23 recovery risks on regulated services, making the average
24 utility less risky than the average unregulated
25 industrial firm.
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USW-S-96-5 CARLOCK (Di) 23
11/26/96 Staff
1 Q. Please explain the targeted stock issue for
2 U S WEST, Inc.
3 A. This transaction is explained best by Value
4 Line in the October 11, 1996 Value Line Investment
5 Survey.
6 On November 1, 1995, each share of
U S WEST, Inc.'s stock was divided
7 into one share of U S WEST Communi-
cations Group Common Stock and one
8 share of U S WEST Media Group Common
Stock.... These two classes of stock
9 were established in order to allow
investors to "track" the performance
10 of each group's operations.
11
12 I have utilized the data for U S WEST
13 Communications Group for Company specific data in my cost
14 of capital evaluation. Although I have used data
15 specific to U S WEST Communications Group, the risk
16 analysis and market data continue to reflect some impact
17 from U S WEST Media Group since "[t]here is no legal
18 separation between the assets and liabilities of the two
19 groups, and it is possible for events affecting one to
20 carry over to the other." (Value Line Investment Survey,
21 October 11, 1996)
22 Q. Have you compared U S WEST directly with
23 other telephone utility companies?
24 A. Yes. Schedule 11 of Staff Exhibit No. 128
25 shows U S WEST and other telephone companies that meet
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USW-S-96-5 CARLOCK (Di) 24
11/26/96 Staff
1 the following Value Line Investment Survey criteria:
2 1. Industry code for Telecom Services.
3 2. Safety of 1, 2 or 3 where 1 is the
4 highest rank and 3 is average (U S WEST's safety rank is
5 1).
6 3. Beta of .50 - 1.10 where the market
7 equals 1.00 (U S WEST's Beta was .75 before the targeted
8 stock issue).
9 Of the 20 companies besides U S WEST
10 meeting these criteria, 10 companies have a safety rating
11 of 1 and only 3 companies in the group have Betas less
12 than or equal to .75. Higher Betas reflect more risk.
13 Therefore, U S WEST is less risky than the sample group.
14 The financial statistics shown on page 2 of
15 Staff Exhibit No. 128, Schedule 11, include the
16 price/earnings ratio for the last 12 months, average
17 annual dividend yield, common equity ratio, booked
18 percent earned on common equity, percent payout ratio and
19 market to book ratio. These financial statistics shown
20 on page 2 of Staff Exhibit No. 128, Schedule 11, show the
21 Telecom Services group average compared to U S WEST.
22 Q. Based upon your analysis of industrial
23 returns, utility returns, and current economic
24 conditions, what is your estimate of the cost of equity
25 capital for U S WEST based upon the Comparable Earnings
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USW-S-96-5 CARLOCK (Di) 25
11/26/96 Staff
1 method?
2 A. When utilizing the Comparable Earnings
3 method, the risk differentials between industrial
4 companies, utilities and telecommunication service
5 providers, particularly U S WEST, must be considered.
6 Utility returns, in comparison to industrial returns, may
7 be ranked by classifying the utility services according
8 to risk levels. Utility groups are less risky than
9 industrial companies. Because an average utility company
10 is less risky than an average industrial company, its
11 cost of equity capital range would be less.
12 U S WEST is less risky than an average
13 telephone utility company partially due to lower
14 competitive risks and regulatory risks as discussed
15 previously. These lower risks produce a lower business
16 risk for U S WEST than for other telephone services
17 companies. Therefore, the cost of equity capital would
18 be less for U S WEST than that of both an average
19 telephone services utility and that of an industrial
20 company.
21 Using the Comparable Earnings approach, my
22 estimate of the current cost of equity capital for
23 U S WEST is in the range of 11.0% - 12.0%. This range is
24 developed by reviewing the most recent utility and
25 telecommunication services returns as shown in the
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USW-S-96-5 CARLOCK (Di) 26
11/26/96 Staff
1 Corporate Scoreboard for 1996 (Ex. 128, Sch. 1-5);
2 current market to book ratios; the three-year average
3 returns of 9.8% ending 1996 for the Moody's Electric
4 Utilities (Ex. 128, Sch. 9); and three-year average
5 returns of 11.3% ending 1996 for the Moody's Gas
6 Distribution Utilities (Ex. 128, Sch. 10). The safety
7 ratings and Betas for the comparable telephone companies
8 (Ex. 128, Sch. 11, pg. 1); comparable telephone earnings
9 shown on page 2 of Schedule 11, the market indicators
10 (Schedules 6 - 8 of Ex. 128) and the industrial returns
11 (Schedules 1 - 5 of Ex. 128) were utilized to predict the
12 reasonable required return.
13 Q. You indicated that the Discounted Cash Flow
14 method is utilized in your analysis. Please explain this
15 method.
16 A. The Discounted Cash Flow (DCF) method is
17 based upon the theory that (1) stocks are bought for the
18 income they provide (i.e., both dividends and/or gains
19 from the sale of the stock), and (2) the market price of
20 stocks equals the discounted value of all future incomes.
21 The discount rate, or cost of equity, equates the present
22 value of the stream of income to the current market price
23 of the stock. The formula to accomplish this goal is:
24
25
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USW-S-96-5 CARLOCK (Di) 27
11/26/96 Staff
1 D1 D2 DN PN
Po = PV = ------- + ------- +...+ ------ + ------
2 (1+ks)1 (l+ks)2 (1+ks)N (1+ks)N
3
Po = Current Price-
4
D = Dividend
5
ks = Capitalization Rate, Discount Rate, or
6 Required Rate of Return
7 N = Latest Year Considered
8
9 The pattern of the future income stream is
10 the key factor that must be estimated in this approach.
11 Some simplifying assumptions for ratesetting purposes
12 can be made without sacrificing the validity of the
13 results. Two such assumptions are: (1) dividends per
14 share grow at a constant rate in perpetuity; and,
15 (2) prices track earnings. These assumptions lead to the
16 simplified DCF formula, where the required return is the
17 dividend yield plus the growth rate (g):
18
D
19 ks = -- + g
Po
20
21 Q. What is your estimate of the current cost
22 of capital for U S WEST using the Discounted Cash Flow
23 method?
24 A. The current cost of equity capital for
25 U S WEST using the Discounted Cash Flow method is
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USW-S-96-5 CARLOCK (Di) 28
11/26/96 Staff
1 between 9.33% - 12.03% during various time intervals
2 over a 52-week range, as shown on Schedule 12, page 1 of
3 2, Staff Exhibit No. 128. I believe the six-month
4 average price (May 1996 - October 1996) is the most
5 appropriate time interval to use. This average price
6 reflects current investor expectations without being
7 subject to daily market fluctuations, as would be the
8 case if the price on a specific date were used. The
9 average price of $31.21 results in the 10.15% to 11.02%
10 range. The price of $30.375 on November 20, 1996 results
11 in a DCF return of 10.32% to 11.21%. I have used an
12 11.0% to 12.0% range as the most appropriate estimate
13 under the Discounted Cash Flow method for use in this
14 case. This is the upper end of the range of
15 reasonableness for the DCF method.
16 Q. How is the growth rate (g) determined?
17 A. The growth rate is the factor that requires
18 the most extensive analysis in the DCF method. It is
19 important that the growth rate used in the model be
20 consistent with the dividend yield so that investor
21 expectations are accurately reflected and the growth rate
22 is not too large or too small.
23 I have used an expected growth rate of
24 3.5% - 4.0%. This expected growth rate was derived
25 from an analysis of various historical and projected
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USW-S-96-5 CARLOCK (Di) 29
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1 growth indicators, including growth in earnings per
2 share, growth in cash dividends per share, and growth in
3 book value per share for U S WEST (Staff Exhibit No. 128,
4 Schedule 12, page 2).
5 The targeted stock issue limits the
6 historical data to proforma estimates for 1994 and
7 1995. The historical growth factors are significantly
8 lower than the projected growth factors for earnings per
9 share and book value per share. I have placed more
10 weight on the projected growth factors in this case.
11 Therefore, I believe the 3.5% - 4.0% growth factor will
12 be high in the near future but reasonable for time
13 periods over five years.
14 Q. You have utilized an adjusted dividend yield
15 to determine the required return with the DCF method.
16 Please explain.
17 A. The adjustments I have made to arrive at the
18 adjusted dividend yield for the DCF method recognize
19 the quarterly compounding of dividend growth in the
20 growth factor and direct issuance or flotation costs
21 for stock issuances. Market pressure should not be
22 reflected in the flotation cost adjustment. I have
23 used a 2.0% flotation cost rate based on past Company
24 issuances as a reasonable flotation cost over time to
25 be included in the DCF analysis. This 2% flotation
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1 cost is derived from Cummings Exhibit 15.
2 Q. Please explain the quarterly compounding.
3 A. The Commission has allowed for quarterly
4 compounding in prior cases (originally adopted in Order
5 No. 23420, Case No. BOI-W-90-1). I have adjusted the
6 growth rate in this case to reflect the impact of
7 quarterly compounding of the dividend. The dividend
8 growth rate, compounded for quarterly payments, is used
9 to calculate the required return in the DCF method.
10 Staff Exhibit No. 128, Schedule 12, page 1 shows the
11 3.5% - 4.0% growth rate compounded to reflect quarterly
12 dividend payments resulting in an annual effective
13 growth rate of 3.513% - 4.015%.
14 Although it is true that dividends are paid
15 quarterly and not annually, I do not believe that the
16 quarterly adjustment is necessary for the DCF method.
17 The quarterly adjustment I made increases the DCF
18 return by .013% - .015%. Quarterly DCF models
19 basically compound the dividend yield for timing
20 differences of quarterly payments then add the
21 incremental growth rate. The compounded rate assumes
22 that the Company is responsible for reinvestment
23 payments the investor will receive by reinvesting
24 his/her dividends. The investor has the option to
25 reinvest the dividends in U S WEST Communications Group
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1 stock or in some other security.
2 Q. Please explain the adjustment to reflect a
3 2.0% issuance expense or flotation cost factor to
4 calculate the dividend yield in the DCF calculation?
5 A. The 2.0% is based on the issuance expenses
6 incurred by U S WEST as shown on U S WEST witness
7 Cummings Exhibit 15, page 1. Issuance costs are
8 relevant expenditures to consider in the cost of equity
9 determination for new issuances. Direct issuance or
10 flotation costs impact the actual price received by the
11 Company for stock sold. The funds received amount to
12 the stock price less the issuance costs. To reflect
13 these costs, the dividend yield is adjusted in the DCF
14 method.
15 A specific allowance for market pressure is
16 not appropriate. Investors determine the price they
17 are willing to pay for stock at the time of issuance.
18 I do not believe it is appropriate to make an allowance
19 for price fluctuations as a result of this competitive
20 process. I have used the 2.0% allowance as reasonable
21 over time.
22 Q. What capital structure have you used for
23 U S WEST to determine the overall cost of capital?
24 A. I have utilized the actual capital structure
25 at December 31, 1995 consisting of 62% long-term debt
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1 and 38% common equity as shown on Schedule 14 of Staff
2 Exhibit No. 128. This capital structure is appropriate
3 to use for ratemaking purposes in this case and is the
4 same capital structure as reflected on financial
5 statements used by investors and rating agencies.
6 Q. Please explain the difference between the
7 capital structure you recommend and the capital structure
8 utilized by U S WEST witness Cummings.
9 A. Mr. Cummings adjusts the actual capital
10 structure to eliminate for ratemaking purposes the
11 impact from write-offs taken related to the
12 discontinuance of Financial Accounting Standards Board
13 Statement of Financial Accounting Standards (SFAS) No.
14 71 "Accounting for the Effects of Certain Types of
15 Regulation." The primary write-off relates to SFAS
16 No. 106, "Employers' Accounting for Postretirement
17 Benefits Other Than Pensions" and SFAS No. 112,
18 "Employers' Accounting for Postretirement Benefits."
19 The return on equity recommendation is based on market
20 required returns so the capital structure utilized
21 should be based on ratios utilized by investors and
22 rating agencies.
23 Q. Are you indicating that SFAS Nos. 106 and
24 112 should not be recognized for ratemaking purposes?
25 A. No. The revenue requirement impact of SFAS
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1 Nos. 106 and 112 related to the expense and
2 amortization have been reflected in the Staff's revenue
3 requirement recommendation by Staff witness Schneider.
4 Inclusion of these expenses in the revenue requirement
5 does not necessitate the adjustment of the capital
6 structure. To maintain consistency between the market
7 data used to establish the recommended return on
8 equity, the actual capital needs to be utilized to
9 develop the authorized overall rate of return. Again,
10 this is important since the actual capital structure is
11 utilized by investors to evaluate the price each
12 investor is willing to pay for stock of U S WEST
13 Communication, Inc. Value Line reports the actual
14 capital structure in the Value Line Investment Survey.
15 Q. What are the costs related to the capital
16 structure for debt?
17 A. The embedded cost of debt is 7.23% as of
18 December 31, 1995. The 7.23% cost of debt is reflected
19 on Schedule 13, Staff Exhibit No. 128, pages 1 & 2.
20 This schedule reflects the actual cost of debt for U S
21 WEST Communications, Inc. as of December 31, 1995. The
22 last line on page 2 of Schedule 13 adjusts the cost of
23 debt for the additional Debt Call Premiums that were
24 wrote off on the books. These premiums are amortized
25 over the life of the new issue for ratemaking purposes.
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1 The debt cost adjustment (Staff Exhibit 128, Schedule
2 13) and the amortization (U S WEST witness Wright,
3 Exhibit No. 25, page 9 of 21, adjustment 20) allows U S
4 WEST to recover these costs of refinancing in the
5 revenue requirement.
6 Q. Why have you used an adjusted debt cost to
7 reflect a write-off for debt call premiums when you
8 used the actual capital structure after the write-offs?
9 A. Using the adjusted debt cost is consistent
10 with allowing, for ratemaking purposes, the expenses
11 related to SFAS Nos. 106 and 112. The adjustment
12 allows U S WEST to recover the actual costs.
13 Q. You indicated the cost of common equity
14 range for U S WEST is 11.0% - 12.0% under the Comparable
15 Earnings method and 10.15% - 11.02% under the
16 Discounted Cash Flow method. What is the cost of
17 common equity capital you are recommending?
18 A. The fair and reasonable cost of common
19 equity capital I am recommending for U S WEST is in the
20 range of 11.0% - 12.0%. Although any point within
21 this range is reasonable, the return on equity granted
22 would not normally be at either extreme of the fair and
23 reasonable range.
24 Q. What point estimate are you recommending?
25 A. Normally I would recommend the midpoint of
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1 the range, 11.5%, as the point estimate. However, I am
2 recommending a point estimate of 11.0% to recognize the
3 service quality problems primarily addressed by Staff
4 witness Hart. The 11% return on equity point estimate
5 utilized is based on: (1) a review of the market data
6 and comparables shown on the schedules in Staff Exhibit
7 No. 128; (2) U S WEST's stock price and risk
8 characteristics shown on Staff Exhibit No. 128,
9 Schedule 11 and (3) the service quality problems.
10 Q. What is the overall weighted cost of
11 capital you are recommending for U S WEST?
12 A. I am recommending an overall weighted cost
13 of capital in the range of 8.66% - 9.04% as shown on
14 Schedule 14, Staff Exhibit No. 128. For use in
15 calculating the revenue requirement, a point estimate
16 consisting of a return on equity of 11.0% and a
17 resulting overall rate of return of 8.66% was utilized.
18 Q. What do you propose that the Commission do
19 to encourage the Company to improve its service quality
20 performance?
21 A. Staff recommends that the return on equity
22 used in the determination of the Company's revenue
23 requirement be the minimum return within the range of
24 reasonable returns. This would still allow the Company
25 to obtain a return on their investment that is within
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1 the range of reasonableness, but at the lower end of that
2 range.
3 The reduction in revenue requirement would
4 be in effect until the Company could provide evidence
5 that it has returned service quality to an acceptable
6 level. The service quality problems are discussed in
7 greater detail in Staff witness Hart's testimony.
8 Q. Why are you recommending this approach?
9 A. The Commission has used this type of
10 approach in the past to recognize the failure of a
11 company to provide adequate service (Case No. U-1002-67,
12 Order No. 21443), as well as recognize superior service
13 (Case No. SOU-W-94-1, Order No. 25785; Case No.
14 U-1025-48, Order No. 19902).
15 Q. Does this conclude your direct testimony in
16 this proceeding?
17 A. Yes, it does.
18
19
20
21
22
23
24
25
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1 Q. Please state your name and address for the
2 record.
3 A. My name is Terri Carlock. My business
4 address is 472 West Washington Street, Boise, Idaho.
5 Q. Are you the same Terri Carlock that has
6 previously filed testimony in this case?
7 A. Yes, I am.
8 Q. Please summarize the issues you address in
9 this surrebuttal testimony.
10 A. I discuss the continued reasonableness of
11 the directory revenue adjustment of $8,645,032 in this
12 proceeding. I explain why the cost of capital range and
13 capital structure that results in the recommended overall
14 rate of return of 8.66%-9.04% as presented in my direct
15 testimony continues to be reasonable despite the rebuttal
16 testimony of Company witness Cummings and changes I have
17 made. I also discuss impacts on cash flow.
18 U S WEST DIRECTORY (DIRECTORY) ADVERTISING
19 Q. Has U S WEST Direct changed its name since
20 filing your direct testimony?
21 A. Yes. U S WEST Direct was organized under
22 U S WEST Marketing Resources Group as part of U S WEST
23 Media Group. Since December 1996, U S WEST Marketing
24 Resources Group has transitioned to the current name of
25 U S WEST Dex, Inc (Dex). Dex remains part of U S WEST
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1 Media Group.
2 Q. USWC transferred the Directory business to
3 a separate affiliate, U S WEST Dex, and USWC states that
4 no imputation of Directory revenues should be made by
5 this Commission in this case. Is it appropriate for
6 revenue producing businesses and assets associated with
7 Directory to be transferred from the regulated entity to
8 a separate non-regulated entity without payment?
9 A. No. It was and still is inappropriate to
10 transfer revenue producing business lines and assets or
11 the revenues associated with those assets to another
12 entity without payment. The payment should be made based
13 on the level of revenues to be produced. This payment
14 could be a one time payoff or a series of payments over
15 time. In the case of the directory advertising, the
16 revenue imputation should be continued until a payoff has
17 been established.
18 Q. Is it true that the provision of white
19 pages and directory exclusions (non-published/non-listed)
20 are required Title 61 services?
21 A. Yes. U S WEST is required to provide white
22 pages directory listings under Title 61 basic services.
23 In addition directory exclusions are and have been Title
24 61 services. See Order No. 22416.
25 Q. How is the directory advertising linked to
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1 the white pages directory listings?
2 A. Directory advertising, commonly referred to
3 as yellow pages, is directly linked to the white pages
4 listings because the advertisers rely on use of the
5 directory by customers, primarily Title 61 local service
6 customers, to provide advertising benefits.
7 Advertising revenues are used to offset the
8 costs of providing the essential product, in this case
9 the white pages listings. This is consistent with
10 advertising sources used for other products, i.e.,
11 television programs are produced, and magazines and
12 newspapers are printed and sold at a lower price than
13 would otherwise be possible due to advertising revenues.
14 Q. Please expand on the relationship between
15 basic telephone service and yellow pages directory
16 advertising.
17 A. The relationship between telephone service
18 and directory advertising is mutually beneficial. The
19 directory advertising in the yellow pages would be of no
20 value if the telephone network did not exist. The
21 publication and distribution of telephone directories has
22 been part of the local telephone company's service
23 obligation as a basic local exchange service (i.e., Title
24 61), and the revenues from the directory publishing
25 advertising have been used to defray the Company's
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USW-S-96-5 CARLOCK (Surr) 3
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1 revenue requirement and maintain affordable telephone
2 rates. The presence of local service telephone customers
3 and the use of U S WEST's name and logo in directories
4 increases the value of the directory advertising. The
5 value of the directories is connected directly to the
6 Title 61 regulated operations of U S WEST.
7 Q. Is the recognition of goodwill associated
8 with the name and logo precluded from Title 61
9 regulation?
10 A. No. Any goodwill associated with the name
11 and logo is not precluded from an assignment to Title 61
12 services.
13 Q. Have you made a specific adjustment to
14 recognize goodwill associated with the name and logo of
15 U S WEST?
16 A. I have not made a specific adjustment in
17 this case. I simply recognize the goodwill associated
18 with the name and logo as one reason why a one-time
19 payment or continued revenue imputation associated with
20 directory advertising should be made in this case.
21 Q. Company witness Koehler-Christensen on page
22 16 of her rebuttal testimony indicates that if the
23 directory operations remained with USWC the expenses of
24 publishing, printing and distributing the directories
25 would have remained on the USWC books. Is this a valid
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1 reason to deny the directory revenue imputation?
2 A. No. As shown on Proprietary Exhibit No. 127
3 (direct testimony) the revenues were reduced by the
4 expenses in my adjustment. The reduction for expenses,
5 including expenses for publishing, printing and
6 distributing the directories, were included in the
7 calculation to determine the directory adjustment. The
8 validity of these expenses was not questioned for this
9 adjustment. I simply accepted the expenses as booked and
10 deducted them from the revenues as booked.
11 Q. Have you considered payments for the white
12 pages listings and billing and collection in your
13 analysis?
14 A. Yes. The Idaho white pages listings revenue
15 of $188,068 (Response to Production Request No. 266)
16 along with billing and collection revenues of $205,386
17 for southern Idaho (Response to Production Request No.
18 267) were included in revenues for this case. The
19 expenses related to the white pages listings along with
20 the payments for billing and collection are included as
21 an expense on the books of U S WEST Direct, now U S WEST
22 Dex, and reflected as a reduction in the directory
23 advertising adjustment I recommend.
24 Q. On page 19, lines 10 - 13 of USWC witness
25 Koehler-Christensen's rebuttal testimony she states:
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02/26/97 Staff
1 "An important factor in considering this market share
2 data, is that Dex's yellow pages are advertised in and
3 used by other than USWC customers, so the revenues earned
4 by Dex are not entirely from customers of USWC." Do you
5 consider the source of advertising revenues to be the
6 important point here?
7 A. It is important only in the sense that the
8 source of revenue is derived from the purpose of the
9 directory advertising. The revenues come from the
10 advertisers and the advertisers continue to advertise in
11 the directory due to the draw and response from local
12 service customers using the directory.
13 Q. Do you agree with USWC witness Koehler-
14 Christensen (page 22, line 18 through page 23, line 2)
15 that it is no longer appropriate to use the profits of
16 the competitive yellow pages advertising business to
17 subsidize rates and deter the development of economically
18 efficient competition in the basic local exchange market
19 in Idaho.
20 A. As previously discussed, I believe it
21 continues to be appropriate to impute revenues or in the
22 alternative, to impute a one-time payment for the
23 business lines and assets transferred out of the
24 regulated entity to an affiliated entity. The payment
25 should be based on business expectations or market price.
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USW-S-96-5 CARLOCK (Surr) 6
02/26/97 Staff
1 I do not agree that the level of competition for local
2 exchange services is at a point that imputation of
3 directory advertising will deter the development of
4 competition in the basic local exchange markets. The
5 reason I don't agree with this statement is that the
6 current level of planned competition revolves around
7 resale facilities as stated in my direct testimony and
8 the testimony of Staff witness Selwyn. When facilities-
9 based competition is present, the imputation of directory
10 revenues will need to be revisited to determine if it is
11 still appropriate and, if competition is present, how
12 directory revenues should be allocated to the end
13 customer. A transfer payment could resolve this issue
14 now.
15 Q. Do you agree that the directory publishing
16 business in southern Idaho is competitive?
17 A. Not entirely. The directory publishing
18 services are available from many sources in southern
19 Idaho. The penetration rates for directories other than
20 U S WEST Dex are minimal. U S WEST directories continue
21 to exist at customer locations even if another directory
22 is also utilized. The areas where the market share for
23 U S WEST Dex is smaller are in the areas where the
24 community of interest draws the users of the directory to
25 other exchanges. These exchanges are consistent with the
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02/26/97 Staff
1 areas where this Commission recently ordered EAS
2 including Blackfoot, Pocatello, Boise, Nampa/Caldwell and
3 Twin Falls. Currently alternative directories in these
4 areas cover a larger service area but still retain a
5 minority market share. It would be reasonable to expect
6 the market share for U S WEST Dex to remain stable or
7 increase in these areas as EAS is implemented and the
8 directories reflect the EAS service area. This expansion
9 of EAS in the three large regions will enhance the value
10 of the directory advertising. I have not made an
11 adjustment for this enhanced value in my recommended
12 directory adjustment.
13 Q. Do the market share ratios at U S WEST Dex
14 reflect competition in the directory advertising
15 business?
16 A. Although there is limited competition in the
17 directory advertising business in Idaho, U S WEST Dex
18 continues to maintain market dominance. This market
19 dominance is primarily due to the historical nature of
20 directory advertising and the direct tie to the local
21 service. Title 61 requires that each customer (except
22 exclusion services) receive a white page listing and that
23 each customer receive a telephone directory as part of
24 basic service.
25 Q. Does imputation of the directory revenue
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USW-S-96-5 CARLOCK (Surr) 8
02/26/97 Staff
1 adjustment that Staff has reflected in local rates and
2 ultimately in the resale rates for local competitors
3 provide a competitive advantage to any local service
4 provider?
5 A. No. The inclusion of the directory revenue
6 adjustment does not provide an advantage to one supplier
7 over another. The end user customer will receive the
8 benefit no matter which entity provides the local
9 service. This is reasonable at least for the period of
10 time that local service providers utilize resale options.
11 Q. Will local service competition decrease the
12 benefits seen by directory advertisers of advertising in
13 the U S WEST Dex directory?
14 A. Local service competition will probably not
15 impact the benefit received by advertising in the
16 U S WEST Dex directory. The value of the directory will
17 continue to be high since the circulation of the U S WEST
18 Dex directory remains directly related to the number of
19 telephone subscribers in the coverage area. The number
20 of subscribers in the area will not diminish because some
21 subscribers take local service from competing carriers.
22 These customers still would have access to and could
23 utilize the U S WEST directory.
24 Q. Should directory advertising be compared
25 with other forms of advertising?
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USW-S-96-5 CARLOCK (Surr) 9
02/26/97 Staff
1 A. No. Directory advertising is a unique
2 service provided to advertisers in the sense that it is a
3 directory book that is available for a continuous period
4 of time, usually a year, and users often refer to it to
5 determine availability of services and locate the phone
6 number or place of business associated with that service.
7 Other forms of advertising are often limited in duration,
8 focus on price advertising as well as availability of
9 products and/or services. Staff witness Selwyn also
10 discusses this issue.
11 Q. Referring to Exhibit No. 33A, USWC witness
12 Koehler-Christensen focuses on the market share decline
13 for yellow pages from 7.2% in 1991 to 6.3% in 1995. Is
14 this the most relevant data on this exhibit?
15 A. I do not believe so. It is more relevant
16 to note that other media also experienced a decrease in
17 market share; such as for newspaper, broadcast TV and the
18 other category. It is also important to note that the
19 actual advertising revenues for yellow pages continues to
20 increase each year. The advertising rates in Idaho
21 (Response to Production Request No. 263) over the past
22 ten years have increased each and every year. The rate
23 of increase is greater than inflation in every year
24 except 1987 and 1988. I believe these items are more
25 important than the overall advertising market share for
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USW-S-96-5 CARLOCK (Surr) 10
02/26/97 Staff
1 yellow pages compared to other advertising media.
2 Q. Do directory revenues continue to be
3 imputed in other jurisdictions?
4 A. Yes. Other jurisdictions continue to
5 impute directory advertising as support for local service
6 revenues, although U S WEST Communications has challenged
7 this policy.
8 Q. Should a transfer price be implemented if
9 it is determined that all of the directory services,
10 including the advertising revenues be removed totally
11 from Title 61 rates?
12 A. Yes. If the directory advertising is
13 removed totally from Title 61 rates and the revenue
14 imputation is no longer allowed, a one time transfer
15 price or a phase in of the transfer price would be
16 appropriate.
17 COST OF CAPITAL
18 Q. USWC witness Cummings addresses several
19 errors in your testimony. Do you agree that these are
20 errors?
21 A. Exhibit No. 128, Schedule 12, page 2 of 2
22 reflects an error in the historical growth figures.
23 These errors are corrected and updates are included for
24 January 10, 1997 growth estimates as reflected on Revised
25 Exhibit No. 128, Schedule 12, page 2 of 2. These updates
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USW-S-96-5 CARLOCK (Surr) 11
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1 do not change my ultimate growth and return on equity
2 recommendations. The other "errors" identified by Mr.
3 Cummings are actually differences of opinion rather than
4 errors.
5 Q. Is it reasonable to analyze historical
6 returns along with expected returns?
7 A. Yes. Investors utilize both historical
8 returns and expected returns when analyzing the projected
9 stock performance for an individual stock. They are very
10 seldom used in isolation.
11 Q. Company witness Cummings describes
12 comparable risk on page 3, lines 8-13 of his rebuttal
13 testimony. Do you agree with this description of
14 comparable risk?
15 A. Yes.
16 Q. Do you agree with his statement on lines 13-
17 17 that you have confused comparable earnings with
18 comparable risk and that comparable earnings is a
19 meaningless construct for investors?
20 A. No, I do not agree with these statements.
21 Investors evaluate the risk of an investment. They also
22 evaluate the returns earned by companies of comparable
23 risk. Hence the phrase "investors expect comparable
24 earnings for comparable risk." The different use of
25 terminology has no impact on the analysis or ultimate
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1 recommendation.
2 Q. On page 4, lines 11-16, USWC witness
3 Cummings provides definitions for return on common equity
4 and investor total return. Do you agree with these
5 definitions?
6 A. I agree with the definitions but I do not
7 agree with the characterization that return on common
8 equity is not the proper measure for analysis by
9 regulators. Regulated utilities do not have dividends
10 set by the regulators, this is a board of directors/upper
11 management decision. Stock appreciation is determined in
12 the market for each individual stock and ultimately for
13 the market in total. These items reflect returns in the
14 marketplace but can not be set by regulators. A
15 conversion from market to book must be made since
16 regulators make decisions based on book data. Return on
17 common equity is the correct book accounting measure for
18 regulators to consider.
19 Q. USWC witness Cummings (page 8, lines 12-28)
20 quotes several of your statements related to the risk of
21 USWC. He then states there is no evidence to support the
22 generalities that U S WEST is less risky than other
23 telephone service providers. Is risk analysis an exact
24 science?
25 A. No, risk analysis is not an exact science
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1 where each factor can be precisely quantified. Risk
2 analysis includes a review of relationships in the broad
3 sense that often contains generalities. Just as there
4 are no direct facts reflecting these risk areas, there is
5 no evidence to prove they are not important and relevant
6 considerations in general. The Beta for U S WEST of .75
7 that I utilize in my recommendation reflects less risk
8 than the either telephone group average cited by USWC
9 witness Cummings of .79 (page 10, line 6) or .82 (page
10 10, line 13).
11 Q. USWC witness Cummings states on page 9,
12 lines 9-11 that "the staff position in this proceeding
13 would deny USWC the recovery of a significant portion of
14 its cost expenditures." Do you agree with this
15 statement?
16 A. No. The Staff position in this case does
17 not deny USWC recovery of its cost expenditures, Staff is
18 simply assigning these costs to the appropriate business
19 lines/services. USWC is free to recover these costs from
20 those non-Title 61 services.
21 Q. USWC witness Cummings contends "For the
22 quarterly dividend compounding adjustment to the DCF
23 model, Ms. Carlock mistakenly adjusts the growth rate."
24 Is this a mistake?
25 A. It is not a mistake but is different than
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USW-S-96-5 CARLOCK (Surr) 14
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1 the traditional quarterly dividend compounding adjustment
2 referred to by Mr. Cummings. When the quarterly dividend
3 compounding adjustment was accepted by this Commission,
4 adjusting the growth component was the methodology that
5 was adopted. Rather than arguing the reasonableness of
6 either method at this time, I note that making this
7 change does not change the ultimate return on equity
8 range of 11% - 12% that I have recommended.
9 Q. USWC witness Cummings (page 12) criticizes
10 the growth rate estimate of 3.5% - 4% that you have
11 utilized in your DCF calculation. What growth rate do
12 you believe is reasonable in light of Mr. Cummings'
13 remarks?
14 A. After updating and correcting growth factors
15 for USWC I still believe a growth rate in the range of
16 3.5% - 4% is reasonable in this proceeding. My revised
17 Exhibit No. 128, Schedule 12, page 2 of 2 reflects
18 updated and corrected growth factors for USWC, both
19 historical and projected.
20 Investors realize growth in dividends and
21 stock appreciation. The projected growth in dividends
22 can be individually reviewed. The stock appreciation
23 must focus on other factors. Growth in book value
24 impacts changes in revenues and ultimately the growth in
25 earnings. Growth in earnings then impacts the potential
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USW-S-96-5 CARLOCK (Surr) 15
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1 dividend growth. Therefore all three of these factors
2 are important to analyze when projecting the expected
3 growth rate to use in the DCF analysis.
4 The historic two-year growth factors in 1996
5 show negative growth in earnings per share, zero growth
6 in dividends and 7.34% growth in book value per share.
7 The three-year growth factors for 1997 reflect current
8 growth in earnings per share of 1.09%, zero growth in
9 dividends, and growth in book value per share of 6.6%.
10 The projected growth rates, estimated to 1999-2001,
11 reflect 5% growth in earnings per share, zero growth in
12 dividends, and 6% growth in book value.
13 Q. Mr. Cummings uses a growth factor of 6%
14 based on IBES projections. What growth rate does IBES
15 currently project for USWC?
16 A. Response to Production Request No. 327
17 states "The most recent IBES consensus forecast for long
18 term growth for U S WEST Communications is 5.0%."
19 Q. How does this relate to your recommended
20 growth factors?
21 A. The historical growth rates for USWC are
22 restated for 1994 forward because U S WEST, Inc. divided
23 its stock into U S WEST Communications Group and U S WEST
24 Media Group on November 1, 1995. Although this is a
25 short time frame for historical results, it is still
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USW-S-96-5 CARLOCK (Surr) 16
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1 important to look at the actual results for the
2 individual stock of U S WEST Communications Group rather
3 than only a comparable group as utilized by Mr. Cummings.
4 The average growth rates shown on Revised
5 Exhibit No. 128, Schedule 12, page 2 of 2 are consistent
6 with the IBES growth rate over the corresponding time
7 periods. The average historical two-year growth rate is
8 2.17%, the average current three-year growth rate is
9 2.56%, the average projected growth rate to 1999 - 2001
10 is 3.67% and the IBES long term growth rate is 5%. The
11 averages show the continued growth expectations for
12 longer periods of time.
13 Q. You updated the growth factors. Have you
14 also updated the stock price in the dividend yield to
15 remain consistent?
16 A. The current stock price on February 25, 1997
17 of $36.625 falls within the 52-week price range. Because
18 the current price of $36.625 is less than one dollar
19 below the 52-week high of $37.50 and the numbers are
20 within the ranges shown, I have not revised Exhibit No.
21 128, Schedule 12, page 1 of 2.
22 Q. What would the results of the DCF method be
23 if this Commission accepted the quarterly dividend
24 compounding adjustment as proposed by USWC witness
25 Cummings but utilized the 3.5% - 4% growth range you
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1 propose?
2 A. The range under the DCF method would be
3 9.52% - 12.36% as shown on the top half of USWC Rebuttal
4 Exhibit No. 32A. This range compares to my recommended
5 return on equity range of 11% - 12%. My rate
6 recommendations remain reasonable.
7 Q. Is it true that your cost of equity range
8 recommendation is based primarily on the DCF method?
9 A. Yes.
10 Q. Is the DCF method market based?
11 A. Yes.
12 Q. Do you still believe the capital structure
13 utilized by investors and market analysts for ratings is
14 reasonable to use for ratemaking purposes?
15 A. Yes. If USWC were a smaller company, the
16 capital structures for financial and ratemaking purposes
17 would be the same. It is primarily because of the size
18 of USWC and its allocation process that the regulatory
19 reporting capital structure and the actual financial
20 structure differ.
21 Q. Does the regulatory capital structure
22 actually track the combination of debt and equity used to
23 finance assets?
24 A. No. These sources of funds can not actually
25 be traced unless it is a project financing for a single
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USW-S-96-5 CARLOCK (Surr) 18
02/26/97 Staff
1 project. The regulatory capital structure is calculated
2 by USWC matching the financings outstanding with the
3 assets using an allocation process developed for this
4 purpose. Although workpapers were provided, this is the
5 first time this Commission has formally reviewed the
6 method of allocation used by USWC since the merger of
7 Mountain States Telephone & Telegraph, Pacific Northwest
8 Bell and Northwestern Bell. There is insufficient
9 evidence to show this allocation is reasonable.
10 Q. Does the rate base match the capital
11 structure?
12 A. No. The rate base does not match the
13 capital structure due to capital supplied by other
14 sources, (i.e., customers, tax advantages, etc.) and all
15 net income or retained earnings adjustments.
16 Q. Should the separation of funding continue?
17 A. No. USWC is a merged entity operating in a
18 competitive environment for all services except local
19 exchange services. Even these services are expected to
20 enter the competitive arena in the future. The funding
21 requirements are driven by reasons other than Title 61
22 services. Debt issued by USWC since the merger comprises
23 more than 85% of the existing outstanding debt. The
24 remaining 15% consists of low cost debt and debt issued
25 in anticipation of the merger by the three operating
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USW-S-96-5 CARLOCK (Surr) 19
02/26/97 Staff
1 companies. The low cost debt remaining from Mountain
2 States Telephone and Telegraph (the predecessor of the
3 Idaho operations) is less than 4% of the total funded
4 debt outstanding. The remaining Mountain States
5 Telephone and Telegraph issues (approximately 2.7% of the
6 total funded debt outstanding) was issued in May and June
7 of 1990. It can be argued that these issuances, along
8 with similar issuances by Pacific Northwest Bell and
9 Northwestern Bell, provided funding for the merger.
10 These should be considered requirements for USWC and not
11 attributed to the individual operating company.
12 It is reasonable to look at the total USWC
13 funded debt to determine the cost of debt for the
14 following reasons:
15 1. The level of funding remaining from the
16 Mountain States Telephone and Telegraph operating company
17 is only an approximate 4%. This is not a significant
18 percentage to continue the allocation of funds.
19 2. The funding requirements are being
20 driven by reasons other than providing Title 61 services.
21 Since the allocation is based on the old operating
22 companies and does not reflect the type of service being
23 funded, this process only adds expense without adding
24 benefit for Title 61 customers.
25
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02/26/97 Staff
1 3. Expansion of competition will continue
2 to move the focus of funding requirements away from Title
3 61 services.
4 Without this allocation of funding
5 requirements, the capital structure and cost of debt will
6 reflect total operations, as is the case for all but
7 USWC, and can be more easily verified.
8 Q. USWC witness Cummings (rebuttal testimony,
9 page 22, lines 15-19) states your cost of debt
10 calculation of 7.23% is flawed because it "does not
11 include other long term debt and capital leases." Do you
12 agree that the other long term debt and capital leases
13 are properly included in the capital structure?
14 A. No. Although it is appropriate to include
15 some types of other long term debt in the capital
16 structure, that is not true in this case. The other long
17 term debt in this case includes contracts with IBM and
18 Nebraska affordable housing fund partners. These items
19 are not appropriate types of long term debt to include in
20 the capital structure.
21 Capital leases are not appropriately
22 included in the capital structure because the cost of the
23 lease, including interest, is included in the results of
24 operation as an expense to calculate the revenue
25 requirement. The cost of debt calculation reflects
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USW-S-96-5 CARLOCK (Surr) 21
02/26/97 Staff
1 interest costs that are not already included in the
2 revenue requirement.
3 Q. USWC witness Cummings also states your
4 recommended cost of debt rate of 7.23% is flawed because
5 you have not properly reflected discount, premium and
6 issuance expenses (rebuttal testimony, page 23, lines 1-
7 4). Do you agree with his statement?
8 A. No. I have adjusted the stated cost of
9 debt for discounts, premiums and issuance expense in a
10 manner consistent with prior Commission orders. The
11 interest expense calculated on stated rates is divided by
12 the outstanding debt balance adjusted for the unamortized
13 premiums, discounts and issuance costs to determine the
14 "effective" cost of debt. The most recent determination
15 of the cost of debt using this methodology was approved
16 in Case No. IPC-E-94-5, Order No. 25880.
17 USWC witness Cummings adjusted the interest
18 expense for the amortization of premiums, discounts and
19 issuance expenses. Either method is appropriate but not
20 both.
21 Q. On pages 25-26 of rebuttal testimony, USWC
22 witness Cummings claims it is inappropriate to adjust the
23 return on equity by a service quality adjustment. Do you
24 agree?
25 A. No. As stated in my prefiled direct
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USW-S-96-5 CARLOCK (Surr) 22
02/26/97 Staff
1 testimony an adjustment for management decisions such as
2 service quality are within the Commission's discretion
3 when setting the allowed return on equity. Staff witness
4 Hart addresses the service quality issue problems. The
5 adjustment I have recommended of 50 basis points has
6 precedent in prior Commission orders as identified in my
7 direct testimony. This adjustment results in an allowed
8 return on equity that is within the reasonable return on
9 equity of 11% - 12% that I recommend.
10 Q. USWC witness Cummings states in rebuttal
11 testimony page 26, lines 19-21 "Ms. Carlock's
12 recommendation denies USWC the opportunity for a fair
13 return because of the hypothetical capital structure
14 incorporated into her recommended overall return." Do
15 you agree?
16 A. No. The capital structure I recommend is
17 not hypothetical as previously discussed, it is the
18 actual financial structure. It will not provide an
19 unreasonable return on investor supplied capital as a
20 result of the capital structure. The converse of Mr.
21 Cummings' argument could also be made, if the allowed
22 return on equity is based on the allocated regulatory
23 structure developed by USWC, an excessive return on
24 equity would be allowed.
25 Q. What is your recommendation to the
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USW-S-96-5 CARLOCK (Surr) 23
02/26/97 Staff
1 Commission?
2 A. My recommendation remains the same as shown
3 on Exhibit No. 128, Schedule 14. I recommend an allowed
4 return on equity range of 11% - 12% with an overall rate
5 of return range of 8.66% - 9.04%. The point
6 recommendation remains an 11% return of equity with and
7 overall rate of return of 8.66%.
8 CASH FLOW
9 Q. In her rebuttal testimony, pages 14-17,
10 U S WEST witness Wright claims that the Staff-proposed
11 revenue requirement in this case would seriously degrade
12 the Company's Idaho intrastate cash flow. Did you review
13 her cash flow presentation?
14 A. Yes, I did and found several problems with
15 it. First, she performed her analysis at the Idaho
16 intrastate level and did not distinguish between Title 61
17 and Title 62 cash flows. By so doing, she ignores the
18 fact that Title 62 services currently account for
19 approximately 60% of intrastate revenues. Consequently,
20 she is making an unequal comparison between the total of
21 Title 61 and Title 62 together and Title 61 by itself.
22 Second, she does not take into consideration
23 that the Staff case is predicated on an different
24 allocation of costs between Title 61 and 62 services.
25 Although the Staff has not developed an revenue
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USW-S-96-5 CARLOCK (Surr) 24
02/26/97 Staff
1 requirement for Title 62 services, it is possible that
2 the Company may need to raise its Title 62 prices to
3 cover its true Title 62 costs. In using total intrastate
4 construction expenditure requirements, she does not
5 segregate the use of funds necessary to provide Title 61
6 services from investments the Company chooses to make for
7 Title 62 services. Staff witness Baldwin addresses the
8 allocation of new investment in her testimony.
9 Third, Ms. Wright does not adjust her
10 calculation to take into account the fact that Idaho
11 customers have provided significant funding amounts to
12 cover the costs of Company investment over the past 10
13 years (e.g., Tech Plus and Tech II). The $45.606 million
14 provided by ratepayers for Tech Plus and Tech II
15 investments represents 49.6% of the total Staff
16 recommended rate base for Title 61. Customers have
17 provided cash flow up front in return for reduced cash
18 requirements over the life of the plant they financed.
19 For this reason, one would expect cash flow to be lower
20 than might otherwise be expected.
21 Finally, Ms. Wright utilizes the total
22 amount of interest and dividends reflected for Idaho
23 Intrastate purposes. In addition to the concerns
24 addressed above in the first concern, the level of
25 dividends are also a concern. When the stock was divided
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USW-S-96-5 CARLOCK (Surr) 25
02/26/97 Staff
1 November 1, 1995 into U S WEST Communications Group and
2 U S WEST Media Group, the level of dividends did not
3 change. It could be argued that the dividend level for
4 U S WEST Communications Group would be less than the
5 dividend level for U S WEST Media Group. Additionally, a
6 distinction between Title 61 and Title 62 is not made.
7 Therefore, the dividend amount shown in Ms. Wright's cash
8 flow Exhibit 43D and 43E are probably not the correct
9 amounts to utilize.
10 For all these reasons, Ms. Wright's
11 arguments with respect to cash flow should be dismissed.
12 Q. Does this conclude your surrebuttal
13 testimony?
14 A. Yes, it does.
15
16
17
18
19
20
21
22
23
24
25
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02/26/97 Staff
1 (The following proceedings were had in
2 open hearing.)
3 MR. HOWELL: As I had mentioned earlier or
4 last week, Ms. Carlock is the last witness supporting the
5 second settlement and stipulation, Exhibit 48, and just
6 to finally put enough evidence in the record supporting
7 that stipulation, I have a few more questions.
8 COMMISSIONER SMITH: Okay.
9
10 DIRECT EXAMINATION
11
12 BY MR. HOWELL: (Continued)
13 Q What issues pertaining to your testimony
14 were contained in the second stipulation?
15 A The directory yellow pages, depreciation
16 impacts, including the depreciation reserve deficiency,
17 EAS revenue and cost impacts, the capital structure, and
18 the cost of debt.
19 Q And after you address those five settlement
20 issues, are there any issues in your testimony which
21 remain in dispute?
22 A Yes, the issues dealing with the cost of
23 equity remain in dispute.
24 Q What is the revenue requirement impact
25 after the -- if this Commission were to accept the second
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1 settlement and stipulation, Exhibit 48?
2 A Staff's current revenue requirement is
3 reflected on revised Exhibit 101, page 1, and it shows a
4 negative $18.347 million.
5 Q And is the date for the last revision of
6 that exhibit March 17th of this year?
7 A I believe the last revision was actually
8 March 14th.
9 Q Would it be March 13th?
10 A March 13th, 1997.
11 Q Please describe the stipulation as it
12 relates to directory yellow pages.
13 A In my direct and rebuttal testimony, I
14 argued that the Title 61 revenue requirement must be
15 reduced by $8.7 million associated with imputing revenue
16 from the Idaho directory operations. U S WEST did not
17 take into consideration any revenues associated with the
18 directory yellow pages business. This issue has been a
19 controversial subject in many regulatory jurisdictions
20 and in state legislatures, including Idaho, throughout
21 the U S WEST 14-state territory.
22 The Commission Staff and the Company have
23 agreed upon an adjustment which will provide a transition
24 for U S WEST Title 61 customers. U S WEST agrees that
25 upon establishing a retail rate for Title 61 business and
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CSB REPORTING CARLOCK (Di)
Wilder, Idaho 83676 Staff
1 residential customers in this case that it will provide a
2 credit on all Title 61 lines in service in the amount of
3 $1.00 per month for a period of 12 months beginning on
4 the effective date of the rates established in this
5 proceeding. This credit will pertain only to lines in
6 service for the provision of Title 61 services in each
7 month and equates to approximately $4.2 million.
8 This agreement, if adopted by the
9 Commission, will represent a complete and total
10 settlement between the Company and the Commission Staff
11 of the issues relating to directory advertising for
12 U S WEST Communications.
13 Q Moving on to the second issue, please
14 describe the settlement of depreciation.
15 A The Staff in its direct and rebuttal
16 testimony advocated use of lives authorized by the
17 Commission in 1988, rejection of the ELG methodology, and
18 proposed that any reserve deficiency be recovered over
19 the remaining lives of the assets. U S WEST's direct
20 case proposed adoption of certain shortened asset lives
21 and the use of the ELG methodology in calculation of
22 depreciation expense. U S WEST also proposed that a
23 reserve deficiency calculated through use of the
24 Company's proposed lives be identified and amortized over
25 a period of three years, thereby increasing Title 61
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1 expense.
2 To settle these disputed issues, the Staff
3 and the Company agreed as follows: Staff agrees to use
4 the U S WEST's proposed asset lives and the use of ELG
5 methodology in calculating depreciation expense for
6 Title 61 ratemaking. U S WEST agrees to make an
7 adjustment to write off the intrastate and the Title 61
8 reserve deficiency for regulatory purposes in this case
9 and will book the adjustment over a three-year period
10 without any revenue requirement impact.
11 It is expressly understood this agreement,
12 if adopted by the Commission, will represent a complete
13 and total settlement of the Company's claim to this
14 Title 61 reserve deficiency.
15 Q Would you explain the EAS adjustment
16 reflected in the stipulation?
17 A Yes. U S WEST proposed two adjustments to
18 the test year to recover the cost of establishing the
19 three regional calling areas approved by this Commission
20 in Case No. USW-S-96-4. Staff initially recommended an
21 adjustment based upon TELRIC costs to determine the cost
22 of implementing the EAS regions. After reviewing
23 additional data provided by the Company, the Staff
24 accepts the Company's EAS cost adjustments.
25 First, the Staff and the Company agree to
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1 recommend that the Commission use available revenue
2 sharing funds beyond the $1.5 million cap already
3 stipulated to in the 96-4 case to offset the necessary
4 plant improvements up to $3.7 million. For ratemaking
5 purposes, the new facilities funded by revenue sharing
6 dollars will be added to plant in service and offset as
7 an adjustment to accumulated depreciation.
8 Second, the Staff also agrees with
9 U S WEST's estimated shift in costs associated with
10 separations, this is the shift in toll minutes to local
11 minutes, thereby increasing rate base by $8.306 million
12 and increasing operating expenses by $3.048 million.
13 Third, for comparison purposes, the Staff
14 agreed to reflect the pro forma revenues from the EAS
15 rates established in 96-4. This reduces the incremental
16 revenue requirement by $10.286 million, and with this
17 agreement, the costs of the EAS will be reflected in base
18 rates.
19 Q Please describe the settlement of the
20 capital structure and the cost of debt.
21 A U S WEST's direct testimony proposed a
22 capital structure based upon the regulatory books
23 consisting of 44.4 percent debt and 55.6 percent equity.
24 Staff's direct testimony advocated the use of a capital
25 structure based upon the Company's financial books which
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1 included financial adjustments not included in the
2 regulatory books. U S WEST and Staff also advocated
3 slightly different costs of debt for use in the
4 calculation of the Company's overall rate of return.
5 The Staff and the Company have agreed to
6 settle these issues. The Staff will accept U S WEST's
7 proposed debt/equity ratio and U S WEST will accept
8 Staff's cost of debt of 7.23 percent and remove Wright's
9 adjustment No. 20 for the amortization of the debt call
10 premium.
11 Q Can you explain to the Commission why this
12 settlement is reasonable and in the public interest?
13 A Yes. The settlement of these 18 issues is
14 reasonable and in the public interest when taken as a
15 whole. The individual components were reviewed and
16 evaluated based upon the strengths of both the Staff and
17 the U S WEST positions. The overall impact of the second
18 settlement and stipulation is to move Staff's revenue
19 requirement to a negative $18.347 million and decrease
20 U S WEST's revenue requirement to $15.509 million. The
21 disputed issues in this case are reduced and the revenue
22 requirement difference between the Staff and U S WEST is
23 also reduced from approximately $70 million difference in
24 direct to $33.8 million.
25 MR. HOWELL: And with that, Madam Chairman,
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1 I would make this witness available for cross.
2 COMMISSIONER SMITH: Okay, thank you
3 Mr. Howell.
4 Mr. Alke.
5 MR. ALKE: Thank you, Madam Chair.
6
7 CROSS-EXAMINATION
8
9 BY MR. ALKE:
10 Q Good morning, Ms. Carlock.
11 A Good morning.
12 Q Will you agree that a rate of return
13 analyst should strive to base his or her opinions on a
14 cost of equity capital upon objective measurements?
15 A Whenever there are objective measurements
16 available, yes. There are many instances where there are
17 various circumstances and conditions that must be
18 evaluated that cannot be directly quantified, but they
19 are still important for the overall analysis.
20 Q You would agree, then, similarly that a
21 rate of return analyst should strive to minimize the use
22 of subjective judgment in arriving at a cost of equity
23 recommendation?
24 A The overall recommendation should minimize
25 subjective measurements. The total analysis should
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Wilder, Idaho 83676 Staff
1 include those subjective measurements as well as the
2 specific quantifiable items.
3 Q Are you familiar with Dr. Roger Moren's
4 book "Regulatory Finance" published by Public Utility
5 Reports in 1994?
6 A I have seen the book.
7 Q Will you accept that Dr. Moren is a
8 nationally-acknowledged expert on regulatory finance and
9 determining the cost of equity capital?
10 A He has published quite a few articles and
11 has been in this area for quite some time, yes.
12 Q Would you agree that your opinion in this
13 case is based upon a comparable earnings analysis and a
14 discounted cash flow analysis, both of which you
15 performed on November 26th of 1996?
16 A That is correct, I did perform those. I
17 have also looked at current statistics and information to
18 see whether that needed to be reviewed and that
19 recommendation is still reasonable at this time.
20 Q And I agree with you. In fact, that was
21 one of my points, or would be one of my points, is you
22 did not perform a new comparable earnings analysis or a
23 new discounted cash flow analysis in your February 26th
24 surrebuttal testimony, did you?
25 A I did not, no.
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1 Q Now, would you agree that the results of
2 your DCF analysis indicate a cost of equity capital for
3 U S WEST of between 10.15 and 11.02 percent? And I
4 believe you can find that on page 35 of your testimony,
5 line 15.
6 A I see what you're referring to. That is
7 based on the average price for May 1996 through
8 October 1996 and based on that average price, that is the
9 range. The total range that's referred to in
10 Schedule 12, page 1 of 2, Exhibit No. 128, is a broader
11 range based on the price range over a 52-week and the
12 current price of $35.00 would fall within that price
13 range.
14 Q And, Ms. Carlock, you interpreted the
15 results of your comparable earnings analysis as an
16 indication that the cost of equity capital to U S WEST
17 was in the range of 11 to 12 percent, did you not?
18 A That is correct.
19 Q Now, normally, you would have selected the
20 midpoint or higher of the cost of equity capital under
21 your DCF and comparable earnings analysis, would you not?
22 A After determining the range that I
23 recommend to the Commission, unless there are extenuating
24 circumstances, I would normally recommend the midpoint.
25 Q Or higher?
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CSB REPORTING CARLOCK (X)
Wilder, Idaho 83676 Staff
1 A I don't know that I would go higher. That
2 would depend on the extenuating circumstances. It would
3 depend on what you were looking at whether you went above
4 the midpoint or below the midpoint. The main purpose is
5 to establish a reasonable range.
6 Q You testified, did you not, in a recent
7 Boise Water case, Docket BOI-W-93-3, on the cost of
8 equity capital?
9 A I did.
10 Q And in that case, you identified a range of
11 cost of equity capital for Boise Water of 10.0 to 11.0
12 and you recommended 10.5 as your cost of equity
13 recommendation?
14 A That sounds like what I recommended.
15 Q And you testified in an Idaho Power case,
16 IPC-E-94-5, on the cost of equity capital, did you not?
17 A Yes, I did.
18 Q And in that case, you identified the range
19 of the cost of equity capital for Idaho Power of being
20 between 10.0 and 11.0 and you recommended a cost of
21 capital of 10.75 percent?
22 A I did.
23 Q Now, in this case, you recommend a return
24 of only 11 percent to penalize U S WEST for providing
25 what you believe to be inadequate service.
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Wilder, Idaho 83676 Staff
1 A I don't look at it as a penalty. I look at
2 it as being a fair return within the recommended range
3 and it is an indication to the Company that the Staff,
4 and if accepted by the Commission, that they do not
5 believe their efforts in these areas are adequate.
6 Q You don't consider a deduction of 50 basis
7 points from your typical cost of capital recommendation
8 to be a penalty?
9 A I don't see it as a penalty. As long as it
10 falls within the reasonable range that is for the
11 company, the reasonable range in this case of 11 to
12 12 percent, it does not provide a penalty. That is a
13 reasonable area that the Commission Staff could recommend
14 to the Commission something that is acceptable. It does
15 reduce the revenue requirement.
16 Q Ms. Carlock, you expressly testify in this
17 docket, do you not, that you are selecting the low point
18 of your range to punish U S WEST for having inadequate
19 service?
20 A I did not say that I was punishing U S WEST
21 for inadequate service. I said that it was an adjustment
22 to reflect the poor service.
23 Q On page, beginning on page, 35, line 25 of
24 your testimony, you state, do you not, and I quote,
25 "Normally I would recommend the midpoint of the range,
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CSB REPORTING CARLOCK (X)
Wilder, Idaho 83676 Staff
1 11.5 percent, as the point estimate. However, I am
2 recommending a point estimate of 11.0 to recognize the
3 service quality problems primarily addressed by Staff
4 witness Hart"?
5 A That's correct, but that does not mean that
6 it's a penalty.
7 Q Would you agree that it costs U S WEST more
8 to provide telephone service to a U S WEST customer in
9 rural Idaho than it does to provide service to a U S WEST
10 customer in urban Idaho?
11 MR. HOWELL: I'm going to object to the
12 question. I believe it's beyond the scope of this
13 witness' direct testimony.
14 COMMISSIONER SMITH: Mr. Alke.
15 MR. ALKE: Madam Chair, this witness has
16 expressly testified on page 23 of her testimony that
17 U S WEST is less risky than other telephone companies
18 because it serves such a large rural area. I believe I'm
19 entitled to probe the basis for this witness' opinion
20 that U S WEST is less risky because it serves a large
21 rural area.
22 COMMISSIONER SMITH: Okay. I'll allow you
23 to probe that area, Mr. Alke.
24 MR. ALKE: Thank you.
25 Q BY MR. ALKE: Do you need the question,
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Wilder, Idaho 83676 Staff
1 again?
2 A Please.
3 Q Would you agree that it costs more to
4 provide telephone service to a U S WEST customer in rural
5 Idaho than it does to provide service to a U S WEST
6 customer in urban Idaho?
7 A According to some of the cost information
8 that I have seen, that is the way that the numbers would
9 show. I don't know that your comparison to page 23
10 relative to that is a correct analysis, though.
11 Q Ms. Carlock, would you agree that the more
12 rural customers connected to a telephone system the
13 greater the spread between the average cost of providing
14 service per access line and the cost of providing an
15 access line to an urban customer located close to the
16 central office?
17 A It would depend actually on the level of
18 that spread, but if you assume that rural customers cost
19 more to serve than the urban customers, the spread would
20 be greater in the rural areas.
21 Q Right. Now, are you familiar with the
22 interconnection and pricing provisions of the federal
23 Telecommunications Act of 1996?
24 A Only to a very, very limited extent.
25 Q Would you agree, however, that under the
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1 Telecommunications Act of 1996, a company, for example
2 like AT&T, has the right to use U S WEST's facilities to
3 provide competing local exchange service?
4 A In a broad sense, yes.
5 Q And would you agree that AT&T gets to
6 purchase local exchange service from U S WEST at
7 wholesale for purposes of resale?
8 A Yes, and that the rate would have to be
9 established.
10 Q In fact, as you said or just indicated, the
11 wholesale rate that AT&T would pay U S WEST is the retail
12 rate established by this Commission less a discount for
13 avoided costs such as marketing?
14 A I'm not familiar with what discounts might
15 go into that.
16 Q Would you agree that an economically
17 rational competitor like AT&T will resell U S WEST's
18 local exchange services in areas that are costly to
19 serve, such as rural Idaho?
20 A Would you repeat that?
21 Q Would you agree that an economically
22 rational competitor like AT&T will resell U S WEST's
23 local exchange services in areas that are costly to
24 serve, such as rural Idaho?
25 A That would depend on what the rate was that
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1 they could purchase those services for if they were going
2 to actually resell and I have not looked at those numbers
3 to see whether that would be what a rational company
4 would do.
5 Q You know, though, that U S WEST's local
6 exchange rates as established by this Commission are
7 established on an average basis?
8 A Yes.
9 Q So wouldn't you agree that just basic
10 economic rationality would dictate that a competitor
11 would resell U S WEST's local exchange service in the
12 area that is costly for U S WEST to serve, such as rural
13 Idaho?
14 A The difference as far as a competitor might
15 be looking at, it would be what their cost of resale is.
16 The analysis that I would think that they would look at
17 would be what is the difference between the U S WEST rate
18 in those areas and what they can purchase that service
19 for and then resell it.
20 Q Will you agree that an economically
21 rational incumbent local exchange company -- excuse me,
22 strike that. Will you agree that a company like AT&T if
23 it is economically rational will have an opportunity to
24 install or own facilities in low-cost urban areas to beat
25 U S WEST prices that are established on an average cost
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1 basis by this Commission?
2 A I have part of your question. Could you
3 repeat it so I can get the second part?
4 Q You bet. Will you agree that an
5 economically rational competitor such as AT&T will have
6 an opportunity to install their own facilities in
7 low-cost urban areas to beat U S WEST prices established
8 on an average cost basis?
9 A When you're assuming that they're going to
10 become facilities-based, that might be one of the
11 instances that they would look at.
12 Q Would you agree that incumbent local
13 exchange carriers which serve large rural areas under
14 average pricing are substantially at risk of losing their
15 urban customers to a facilities-based competitor which
16 targets the low-cost urban customer?
17 MR. HOWELL: Madam Chairman, I'm going to
18 object. I fail to see how this is really tying into cost
19 of equity.
20 COMMISSIONER SMITH: Mr. Alke.
21 MR. ALKE: Again, Madam Chair, critical
22 point of this witness' opinion is that U S WEST is less
23 risky than the average telephone company because it
24 serves a large rural area and the cross-examination I'm
25 conducting I think establishes that exactly the opposite
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1 is true, that the larger the rural area you serve the
2 more risky you are and I believe I'm entitled to probe
3 this witness', the basis for this witness' opinion where
4 she seeks to distinguish U S WEST, the riskiness of
5 U S WEST on the basis of the size of the rural area it
6 serves.
7 COMMISSIONER SMITH: I think we probably
8 would be more comfortable if we just directly go for that
9 issue.
10 MR. ALKE: Okay.
11 Q BY MR. ALKE: Will you agree, Ms. Carlock,
12 -- strike that. In your discussion of your comparable
13 earnings model, you indicate that the use of a broad
14 cross-section of companies will eliminate the possibility
15 of reflecting unusual circumstances.
16 A I use a broad section to be as a check for
17 the overall reasonableness, yes.
18 Q And will you agree that removing the effect
19 of unusual circumstances is sometimes called removing the
20 possibility of measurement error?
21 A You're trying to limit the error factor.
22 Q And a similar statement can be made with
23 respect to a discounted cash flow analysis, can it not?
24 A As far as trying to limit any error
25 factors?
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1 Q Isn't it true that many analysts believe
2 you should use a sample of companies, a sample of
3 comparable risk companies, in a DCF analysis to remove
4 the possibility of measurement error when looking at
5 simply a single, stand-alone company?
6 A When looking at it for a comparison, that
7 is correct. Now, as far as setting rates for a set
8 individual company, it is reasonable to look at that
9 company's DCF analysis as well as looking at a sample.
10 Q And Dr. Moren in his book at page 201
11 specifically states, does he not, that "confidence in the
12 reliability of the estimate of equity cost can be
13 enhanced by estimating the cost of equity capital for a
14 variety of risk equivalent companies. Such group
15 comparisons not only act as a useful check on the
16 magnitude of the cost of equity estimate obtained from a
17 single company, but also mitigate any distortion
18 introduced by measurement errors in the two components of
19 equity return; namely, dividend yield and growth"? And
20 if you'd like to check the book, you certainly may.
21 A I would like to see what he's talking
22 about.
23 MR. ALKE: May I approach the witness?
24 COMMISSIONER SMITH: Certainly.
25 (Mr. Alke approached the witness.)
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1 MR. ALKE: Since it was my book, I marked
2 the quote in little red hash marks.
3 THE WITNESS: Yes, he is talking about
4 using comparable companies as a check and to determine
5 whether the recommendation would be reasonable.
6 Q BY MR. ALKE: Will you -- you performed
7 only a Company specific DCF in this case?
8 A I did perform a Company specific DCF, but I
9 utilized comparable companies to determine whether those
10 inputs appeared reasonable to me.
11 Q Because you only used a Company specific
12 DCF, you necessarily had to rely on your comparable
13 earnings model to validate the results of your Company
14 specific DCF? That was your cross-check to the DCF was
15 the comparable earnings study?
16 A I also looked at individual components that
17 would go into the DCF as they related to comparable
18 companies.
19 Q Now, will you agree that your comparable
20 earnings analysis indicates that the near future equity
21 capital returns for all companies will be in the range of
22 13.5 percent to 15 percent?
23 A I believe that's the number that I
24 utilized.
25 Q Okay. And your opinion on the required
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Wilder, Idaho 83676 Staff
1 equity returns for your industry composite is based upon
2 the objective measurements set forth in your Schedules 1
3 through 4 of Exhibit 128?
4 A Would you repeat that, please?
5 Q Your opinion on the required equity returns
6 for your industry composite is based upon the objective
7 measurements set forth in your Schedules 1 through 4 on
8 Exhibit 128?
9 A That was part of the information that I
10 reviewed, Schedules 1 through 4.
11 Q Would you turn to Schedule 1 of your
12 Exhibit 128, please?
13 A Okay.
14 Q Now, at the bottom of the page, at the
15 bottom of the exhibit, you have five-year average
16 13.2 percent, three-year average 15.2 percent. Do you
17 see that reference?
18 A That is correct.
19 Q That was the measure you used, was it not,
20 to determine that the range of equity costs for your
21 industry composite was between 13.5 and 15 percent?
22 A Those two numbers were not what I used.
23 That was only part of it. I utilized the trend in the
24 earnings over a period of time as well as looking at the
25 changes in the five-year averages and the three-year
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1 averages over the different quarters.
2 Q Now, using your Schedule 1, if you'd keep
3 that in front of you, Schedule 1 of 128, again, the
4 objective measurement on your Schedule 1 for the required
5 equity returns for the entire composite of industrial
6 companies, that was 13.2 to 15.2 percent; correct?
7 A The five-year average shown on Schedule 1
8 is 13.2. The three-year average is shown as 15.2. The
9 number that I utilized is the 13.5 to 15 percent range
10 that does not come straight off of that exhibit.
11 Q You raised the lower limit by 30 basis
12 points and you lowered the upper limit by 20 basis
13 points, you shrunk the range slightly?
14 A As I said, that range does not come off of
15 that schedule. That is only one of the factors that was
16 used to determine the range.
17 Q Will you agree, Ms. Carlock, that your
18 Schedule 1 indicates that the range of equity costs for
19 telecommunications companies is between 15.0 percent and
20 16.1 percent? If I calculate a five-year moving average
21 for telecommunications and a three-year moving average
22 for telecommunications, the same as you did for the
23 industry composite, the numbers I would get for
24 telecommunications would be 15.0 percent and 16.1
25 percent, would it not?
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1 A Those may be the actual calculated
2 averages. I have not calculated those myself. I would
3 accept those numbers, but I do not accept the premise
4 that that's the range for telecommunications because the
5 range that I used for the industry as a whole was not
6 based on those two averages.
7 Q Now, that same schedule indicates that the
8 range of cost of equity for electric and gas calculated
9 on the same basis, five-year average and three-year
10 average, the range for electric and gas according to your
11 Schedule 1 would be 10.68 percent to 10.76 percent?
12 A That may be the five-year and the
13 three-year average, but that's not the range that I would
14 establish.
15 Q Now, your estimate of the cost of equity
16 capital for U S WEST using your comparable earnings model
17 is 250 to 300 basis points lower than the cost of equity
18 you estimated for your industry composite; correct?
19 A I did not estimate the telecommunications
20 line in the manner that you did, so if that's what you're
21 comparing, I would have to say no.
22 Q No, let's back up. You misunderstood my
23 question.
24 A Okay.
25 Q Your estimate of the cost of equity capital
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Wilder, Idaho 83676 Staff
1 for U S WEST under your comparable earnings model, 11 to
2 12 percent --
3 A Okay.
4 Q -- that's 250 to 300 basis points between
5 the 13.5 percent and the 15 percent range of equity costs
6 that you developed for your industry composite, just
7 simple math.
8 A Yes.
9 Q Okay. Now, isn't it true that you based
10 that 250 to 300 basis point drop upon your subjective
11 review, my choice of words, subjective review, of the
12 earned returns for the industry composite, 13.5 to
13 15 percent, telecommunications in excess of 15 percent,
14 the three-year average for gas, 11.3 percent, and the
15 three-year average for electric, 9.8 percent?
16 A All of those components were part of the
17 analysis that I made.
18 Q And in fact, if I asked you to show me a
19 schedule in your testimony where you objectively
20 calculated that there was a 250 to 300 basis point risk
21 differential between your composite and U S WEST, you
22 could not show me such an exhibit, could you?
23 A There is not an exhibit, no. The
24 comparable risk earnings review that I did is primarily
25 used by me as a check on the DCF and when I came up with
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1 DCF returns that were lower than the range that I thought
2 was reasonable for the comparable, then I took that into
3 account.
4 Q Would you agree, Ms. Carlock, that it is
5 possible to objectively measure a risk differentiated
6 result for U S WEST from your industrial composite using
7 the capital asset pricing model?
8 A If you can accept all of the assumptions
9 going into that model, yes.
10 Q Can we use for purposes of today 6.8
11 percent as a reasonable approximation of the risk free
12 rate? And what I did was I had Mr. Cummings give me the
13 30-year T-bill rate last week. He said it was 6.8
14 percent.
15 A That's in the range, that's correct.
16 Q Isn't it true that under the capital asset
17 pricing model if the risk free rate is 6.8 percent, the
18 13.5 percent to 15 percent cost of equity for your
19 industrial composite indicates a risk premium for
20 your industrial composite of between 6.7 percent and
21 8.2 percent?
22 A I will accept your math, but I don't accept
23 the premise necessarily.
24 Q Okay. Now, the beta or relative risk of
25 your composite would be 1.0, wouldn't it, it's the whole
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1 market?
2 A For the market, it is 1.
3 Q So the beta for your Schedule 1, 128, is
4 1.0; correct?
5 A For the market as a whole.
6 Q Right. Now, you indicated in your
7 testimony that you believe U S WEST had a beta of .75;
8 correct?
9 A That's correct.
10 Q And isn't it true that under the theory of
11 beta, what a beta of .75 means is that if the market goes
12 up 10 points or down 10 points, then the price of
13 U S WEST's stock goes up only 7.5 points or down 7.5
14 points?
15 A In relative terms, that's correct.
16 Q In relative terms. Now, isn't it true that
17 if the risk premium for companies with a beta of 1 is 6.7
18 percent to 8.2 percent over the risk free rate, then the
19 risk premium for a company with a beta of .75 is
20 three-quarters of that amount or 5.0 to 6.0 percent?
21 A I do not have my calculator, so I will
22 accept your math.
23 Q And I did it a few times, so I think you
24 can trust me on the math. Will you agree that adding a
25 risk premium of 5.0 to 6 percent, which is the risk
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Wilder, Idaho 83676 Staff
1 premium we would associate with U S WEST if it has a beta
2 of .75, and using your industrial composite cost of
3 equity that adding that risk premium to the risk free
4 rate of 6.8 yields a cost of equity estimate for U S WEST
5 of between 11.8 and 12.8 percent?
6 A I dropped one of the figures in there.
7 You'll have to repeat that.
8 Q Okay, risk premium is 5.0 to 6.0 percent
9 and we were using a risk free rate of 6.8 percent, that
10 gives us a cost of equity for U S WEST of 11.8 to 12.8,
11 does it not?
12 A If you could accept the premise that those
13 are directly calculable, then the math is correct. I
14 have some problems with some of those assumptions.
15 MR. ALKE: Thank you. I have no more
16 questions, Madam Chair.
17 COMMISSIONER SMITH: Mr. Harwood, do you
18 have questions?
19 MR. HARWOOD: Just one, Madam Chair.
20
21 CROSS-EXAMINATION
22
23 BY MR. HARWOOD:
24 Q Ms. Carlock, you mentioned that the Staff
25 and the Company have settled the yellow pages issue?
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Wilder, Idaho 83676 Staff
1 A That's correct.
2 Q And I believe the settlement would call for
3 a credit to customers of $1.00 per month for one year?
4 A Yes.
5 Q And I believe you gave a figure of
6 $4.2 million which would comport with the total amount of
7 that credit?
8 A That's an approximate based on the current
9 level of customers at this time.
10 Q Okay, and how did you arrive at that
11 $4.2 million figure?
12 A We looked at the total 61 customers and
13 multiplied it by the $1.00 credit and I don't have the
14 number of customers at this time. I did not actually
15 calculate that myself.
16 Q And how did you come up with the $1.00
17 credit figure, then?
18 A That was part of the overall stipulation as
19 to what seemed reasonable.
20 Q Is it possible that you took your original
21 proposal, which is $8 million and change, and just
22 divided it in half?
23 A That's not what we did, but it turns out to
24 be that type of a calculation if you look at it that way.
25 MR. HARWOOD: That's all the questions I
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Wilder, Idaho 83676 Staff
1 have. Thank you.
2 COMMISSIONER SMITH: Thank you. Do we have
3 questions from the Commission? Commissioner Nelson.
4 COMMISSIONER NELSON: Just briefly, thank
5 you.
6
7 EXAMINATION
8
9 BY COMMISSIONER NELSON:
10 Q I did not get when you were going through
11 your stipulation what your stipulation was on EAS. Could
12 you repeat that for me?
13 A Yes. On EAS, the Staff agreed to
14 recommend to the Commission using more revenue sharing
15 money to put in the additional investment, so instead of
16 the $1.5 million cap, it would go up to $3.7 million and
17 that would be booked in the same way that we booked other
18 investments from revenue sharing.
19 The second piece would be that we accepted
20 the shift in costs with separations, that's the shift of
21 the toll minutes to the local minutes, and that increased
22 rate base by $8.306 million and increased the operating
23 expenses by $3.048 million, and then third --
24 Q Just a second. Okay; so rate base
25 increases 8.3 million and operating expenses increase
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Wilder, Idaho 83676 Staff
1 3 plus a little, 3 million plus?
2 A Correct.
3 Q Okay.
4 A And then for comparison purposes, we
5 included the pro forma revenues from EAS so that we were
6 not on two different bases and that pro forma revenue was
7 $10.286 million.
8 Q That was just for comparison?
9 A Primarily, yes. We were having trouble
10 comparing the Staff's revenue requirement with the
11 Company's because of the difference in the EAS
12 assumptions.
13 Q Okay. When the gentleman from U S WEST was
14 here talking about cost of equity the other day and he
15 stated that the growth rate that he would use today was
16 4.5 percent, how does that compare with your
17 recommendation?
18 A My recommendation is a growth rate of
19 3.5 to 4 percent, so it is a percent or a half percent
20 lower depending on which number you use.
21 Q And what did you base your number on?
22 A I based my number on actual U S WEST
23 information and it's primarily from Value Line. I looked
24 at the earnings per share growth, the dividends per share
25 growth, the growth in book value per share and the
2146
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Wilder, Idaho 83676 Staff
1 projections for those numbers, also, and came up with an
2 average that was lower than that range and I felt that
3 the earnings and ultimately dividends would increase
4 above the average.
5 Q And what did -- was it Mr. Cummings, is
6 that his name?
7 A Mr. Cummings.
8 Q What did he base his on?
9 A He used primarily the IBES growth rate of
10 6 percent.
11 Q What's IBES?
12 A Investment broker exchange -- I'd have to
13 look it up.
14 Q He's using a composite --
15 A It's a composite growth rate, yes.
16 Q Well, is it fair to base your growth rate
17 on the existing rate of return of U S WEST when they're
18 in asking for an increase based on changed circumstances?
19 A I utilized the historical as well as the
20 projections and then compared that with what some of the
21 comparables might be, so I felt that it was reasonable.
22 It is less than what Mr. Cummings has used and also what
23 IBES is predicting at 4.5 percent.
24 COMMISSIONER NELSON: Okay, thank you.
25 COMMISSIONER SMITH: Commissioner Hansen.
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Wilder, Idaho 83676 Staff
1 EXAMINATION
2
3 BY COMMISSIONER HANSEN:
4 Q Mrs. Carlock, do I understand from your
5 Exhibit 48 and your earlier comments that the Staff and
6 U S WEST agreed to a settlement of yellow pages and that
7 agreement is $1.00 per month, U S WEST agrees to $1.00
8 per month, per customer for a period of 12 months?
9 A That's correct.
10 Q And how -- in total dollars, what does that
11 come out to?
12 A We estimated that it would be approximately
13 $4.2 million and that's based on current customer levels.
14 Q And that's just for the one year; is that
15 correct?
16 A That's for the one year, yes.
17 Q Could I have you turn to your direct
18 testimony on page 4 and have you read line 5 through 7?
19 A Page 4, lines 5 through 7?
20 Q Yes.
21 A "Judge Greene concluded that directory
22 operations provide a significant revenue source to offset
23 local telephone revenue requirements."
24 Q Could I have you now turn to page 5 and on
25 line 5 starting with "it" and read there through line 7?
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Wilder, Idaho 83676 Staff
1 A "It is in the public interest for directory
2 revenues to be available to defray some of the costs of
3 local service."
4 Q Okay, and then lastly, could I have you on
5 page 5 starting with line 15 with "no" read through
6 line 18?
7 A "No evidence has been presented to support
8 changing this method of including directory revenues to
9 reduce revenue requirement from local services."
10 Q I guess with those three statements that
11 you made in your testimony, my question would be how
12 could a settlement for one year of $4.2 million be in the
13 public interest over the long haul? I guess I could see
14 it in the public interest for one year, but how do you
15 see that in the public interest for any duration of time?
16 A In looking at it from my personal standing,
17 I looked at the stipulation as a whole and that is what
18 made it reasonable. The directory credit provides a
19 transition from the existing regulatory imputation of
20 directory to no imputation of directory revenues and it
21 appeared that that was probably the direction that we
22 ultimately would go, so that transition seemed
23 reasonable.
24 Q So would you say that first statement that
25 you read in regard to Judge Greene saying that it
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Wilder, Idaho 83676 Staff
1 provides a significant revenue source, you really don't
2 agree with that, then; is that right?
3 A I do agree with that statement, yes, that
4 it has provided a significant revenue source and should
5 continue to provide a source until there is competition
6 and looking forward, the one-year stipulation was a way
7 of making that transition.
8 Q So you believe, then, that competition then
9 should eliminate that as a source of revenue for the
10 Company; is that correct?
11 A I believe that when there is competition in
12 the local markets, and there's going to be a question of
13 when competition exists, to me, it has to be significant
14 competition and facilities-based competition before I
15 would say that there is no directory imputation that
16 would be reasonable as a revenue source. Looking forward
17 as part of the stipulation, even though I thought that
18 that competition was further out than one year, this does
19 provide a transition.
20 COMMISSIONER HANSEN: Okay, thank you.
21 That's all I have.
22
23
24
25
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Wilder, Idaho 83676 Staff
1 EXAMINATION
2
3 BY COMMISSIONER SMITH:
4 Q Just following up on that, I guess, has
5 there been any intervening event that made you believe it
6 was better to settle this and get a transition?
7 A Yes, the current legislation had a lot to
8 do with that.
9 Q And what would that do?
10 A That would eliminate the revenue imputation
11 and in my mind it only left open the question of should
12 there have been some value transferred when the assets
13 were actually transferred and so that's why a transition
14 seemed reasonable to me.
15 COMMISSIONER SMITH: Okay, thank you.
16 Do you have redirect, Mr. Howell?
17 MR. HOWELL: No, ma'am.
18 COMMISSIONER SMITH: Thank you for your
19 help, Ms. Carlock.
20 (The witness left the stand.)
21 COMMISSIONER SMITH: Let's take a
22 ten-minute break.
23 (Recess.)
24 COMMISSIONER SMITH: All right, let's go
25 back on the record. Mr. Howell.
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1 MR. HOWELL: Ms. Hamlin.
2 MS. HAMLIN: Staff would call Bill Eastlake
3 to the stand.
4
5 BILL EASTLAKE,
6 produced as a witness at the instance of the Staff,
7 having been first duly sworn, was examined and testified
8 as follows:
9
10 DIRECT EXAMINATION
11
12 BY MS. HAMLIN:
13 Q Could you please state your name and spell
14 your last name for the record?
15 A My name is Bill Eastlake, E-a-s-t-l-a-k-e.
16 Q And by whom are you employed and in what
17 capacity?
18 A I'm employed by the Public Utilities
19 Commission as a telecommunications analyst.
20 Q Are you the same Bill Eastlake that filed
21 direct testimony on November 26th, 1996, consisting of
22 43 pages with Exhibits 129 through 134?
23 A I am.
24 Q And surrebuttal testimony on February 22nd,
25 1997, and again on February 26th, 1997, consisting of a
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Wilder, Idaho 83676 Staff
1 total of 25 pages with Exhibits No. 149 and 150 through
2 152 with revised Exhibit 131?
3 A That's correct.
4 Q And you also filed a revised exhibit
5 yesterday consisting of two pages which was Exhibit 151,
6 page 1 and 2?
7 A That's correct.
8 Q Do you have any changes to your testimony?
9 A I do not. I would point to the fact that
10 there was a small typographical change on page 34 of my
11 direct. There was a sheet that was sent to all parties
12 at that time. That is the only change.
13 Q Why don't you point out that change?
14 A There was -- a demon put a strange word
15 in. It said "a $32.00 study." It should have said "a
16 TSLRIC study."
17 COMMISSIONER SMITH: Would you do that
18 again, please?
19 THE WITNESS: Page 34, line 2, direct
20 testimony. It says "Staff has found, in a $32.00 study,"
21 the "32" should be deleted and the acronym "TSLRIC"
22 should be replacing it.
23 COMMISSIONER SMITH: Oh, mine is fixed.
24 THE WITNESS: Okay.
25 MS. HAMLIN: Could we go off the record for
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Wilder, Idaho 83676 Staff
1 a second?
2 COMMISSIONER SMITH: Sure.
3 (Off the record discussion.)
4 COMMISSIONER SMITH: Okay, let's go back on
5 the record.
6 MS. HAMLIN: With that, Madam Chairman, I
7 ask that the testimony and attached exhibits be spread
8 upon the record.
9 COMMISSIONER SMITH: If there is no
10 objection, we will spread the prefiled direct and
11 rebuttal testimony of Mr. Eastlake upon the record as if
12 read and admit Exhibits 129 through 134 and 149 through
13 152.
14 (Staff Exhibit Nos. 129 - 134 and
15 149 - 152 were admitted into evidence.)
16 (The following prefiled direct and
17 surrebuttal testimony of Mr. Bill Eastlake is spread upon
18 the record.)
19
20
21
22
23
24
25
2154
CSB REPORTING EASTLAKE (Di)
Wilder, Idaho 83676 Staff
1 Q. Please state your name and business address
2 for the record.
3 A. My name is Bill Eastlake. My business
4 address is 472 W. Washington, Boise, Idaho.
5 Q. By whom are you employed and in what
6 capacity?
7 A. I am employed by the Idaho Public Utilities
8 Commission as a Telecommunications Analyst.
9 Q. Please describe your educational background
10 and work experience.
11 A. I received an H.A.B. (Honors Bachelor of
12 Arts) with emphasis in classics and economics from Xavier
13 University in 1965 and completed graduate course work and
14 general examinations for the Ph.D. program in economics
15 at Ohio State University in 1969.
16 I taught undergraduate economics at Boise
17 State University from 1969 through 1976, with two years
18 on leave as a Fulbright Exchange Professor at Cuttington
19 College in Liberia. I have also taught various economics
20 courses part-time at Boise State University, College of
21 Idaho, and Ohio State University.
22 In 1978, I took a position with the Idaho
23 Office of Energy as an energy economist, with
24 responsibility for energy conservation planning and for
25 economic feasibility analysis of geothermal and other
2155
USW-S-96-5 EASTLAKE (Di) 1
11/26/96 Staff
1 alternative energy proposals. When the office became a
2 division of the Idaho Department of Water Resources in
3 1981, I became responsible for the Idaho Water Resource
4 Board's financial programs, loans and grants as well as
5 industrial revenue bonds for water projects. With the
6 demise of the bond program in 1983, I assumed
7 responsibility for the design and implementation of a
8 statewide energy conservation loan program. In addition,
9 I provided economic analysis in support of policy
10 decisions concerning water rights, water planning, and
11 agricultural water uses. I was Staff Economist at the
12 Idaho Public Utilities Commission (IPUC; Staff) from 1989
13 through mid-1994, performing support services as an
14 economist for the telecommunications, audit and
15 engineering sections. I have appeared as a Staff witness
16 specializing in conservation and resource planning in
17 cases involving electric, gas and water utilities.
18 Between September 1994 and August 1995 I served as an
19 energy policy analyst with the Idaho office of the
20 Northwest Power Planning Council and with the Washington
21 State Energy Office.
22 I. INTRODUCTION
23 Q. What is the purpose of your testimony?
24 A. My testimony will cover several areas.
25 First, it will provide another perspective on the claims
2156
USW-S-96-5 EASTLAKE (Di) 2
11/26/96 Staff
1 made by U S WEST Communications, Inc. (Company; USW) as
2 background to its rate proposal. Second, it will provide
3 commentary and analysis of specific parts of USW's rate
4 proposal. Third, it will provide suggestions on a rate
5 design to achieve the Staff's recommended revenue
6 requirement, with a recommendation that specific rates be
7 set only after the revenue requirement and general
8 principles for a proposed design have been set by the
9 Commission.
10 a. General background
11 Q. Do you have some introductory comments
12 about the broad issues in this case?
13 A. Putting all technicalities aside, I believe
14 this case represents USW's attempt to remain whole in the
15 face of ensuing competition. USW sees itself as the only
16 entity capable of sustaining Idaho's telecommunications
17 infrastructure. Idaho's infrastructure is sound and was
18 assembled largely by USW, but pro-competitive legislation
19 at the national level will not assure incumbent
20 monopolies of their current position.
21 Things are not now, nor are they likely to
22 ever become, quite as bad as USW's doomsday predictions
23 for its own fate:
24 ...any vestige of the local exchange
telephone monopoly has been eradicated
25 by a stroke of the Congressional
pen... USW response to the petition
2157
USW-S-96-5 EASTLAKE (Di) 3
11/26/96 Staff
1 of MFS Communications Company, Inc.,
for arbitration of interconnection
2 rates, terms, and conditions,
Washington Utilities and Transportation
3 Commission, Docket UT-960323, page 1.
4 If USW can effectively compete, and I
5 believe it can, it will continue to be a player. But it
6 will not be the only player and, indeed, may not continue
7 to be the dominant player. Neither this Commission nor
8 the State of Idaho can or needs to ensure that USW
9 remains predominant. That decision will be made by
10 markets.
11 Q. What are the two main issues in this case?
12 A. First is cost recovery, especially
13 depreciation. Second is which customers bear that
14 burden.
15 This case is about the rectitude of giving
16 USW recovery of all the costs it might have recovered
17 under continued monopoly regulation. USW argues that it
18 needs to depreciate its investments faster to keep up
19 with the practices of its present competitors and that it
20 needs to recover the resulting depreciation reserve
21 deficiency in three years, lest those costs be stranded
22 by competitive forces.
23 What USW takes for granted, that all its
24 stranded costs should be recovered, amounts to asking for
25 "a disposition that violates the way the American people
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USW-S-96-5 EASTLAKE (Di) 4
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1 believe their economic system should work." Charles M.
2 Studness, "Stranded-cost Recovery: It's Un-American,"
3 Public Utilities Fortnightly, July 15, 1996, p. 43.
4 According to Mr. Studness, investments "stranded" by
5 competition often carry a questionable pedigree and form
6 part of "the residue of a system that allowed utilities
7 to earn healthy returns despite widespread inefficiencies
8 and abysmal technological progress." Studness, p. 44.
9 What USW also takes for granted is that
10 money to invest in its system to meet new competition
11 should come from captive customers in non-competitive
12 market sectors (Title 61). Such a stance is predictable
13 and was the subject of a caution by former Colorado PUC
14 Chairwoman Edythe Miller a few years ago:
15 Telcos raise issues of technological
advance and obsolescence to support
16 their case for increasing the rate and
speed of recovery of depreciation of
17 current plant. They have been largely
successful in this matter before regu-
18 latory bodies, thereby increasing cash
flow. It is a matter of some concern
19 that modernization of the telecommunica-
tions plant not become an instrument of
20 cross subsidization, which would be the case
given construction of a platform primarily
21 for the benefit of the user of premier
services, underwritten by captive core
22 consumers whose need for and use of these
services will be minimal or nonexistent.
23 Edythe Miller, "Some Market Structure and
Regulatory Implications of the Brave New;
24 World of Telecommunications", Journal of
Economic Issues, Vol. XXVII, No. 1, March
25 1993, page 21 (italics added).
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USW-S-96-5 EASTLAKE (Di) 5
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1 Q. What is the Company attempting to do in
2 this case?
3 A. The Company is making business decisions to
4 protect what it sees as its own best interest in the face
5 of potential competition. It is, in the words of
6 Company-cited experts Harris and Yao, acting thus:
7 Further, when competing in an emerg-
ing market, or when public policies
8 have radically changed the rules of
the game, firms try to shape the compe-
9 titive battleground to favor their
particular assets. From Exhibit A to
10 Comments of U S WEST, Inc. to the Federal
Communications Commission in CC Docket
11 96-98, dated May 16, 1996.
12 The Company's stance tries to capture the
13 best of two worlds. U S WEST wants to recover all its
14 costs from the old regulated monopoly world at the same
15 time it wants freedom to earn all it can in the new
16 competitive environment. The Company is not approaching
17 the current reform of the telecommunication market
18 offering some sort of quid pro quo, indicating a
19 willingness to give up some small portion of its return
20 on regulated services as the price of entry into the
21 competitive markets it has always sought to enter.
22 Perhaps the same effort that is now being
23 engaged in exacting every possible return from the
24 regulated customer for past investments could be more
25 profitably spent on forward-looking strategies for
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USW-S-96-5 EASTLAKE (Di) 6
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1 ensuring that USW remains the predominant
2 telecommunications provider to customers who for the
3 first time will have some real choice in the matter.
4 Q. What is your reaction to the Company's
5 claim that it is somehow disadvantaged relative to its
6 potential competitors, by having to cover both embedded
7 costs from past investments and forward-looking costs
8 from new investments?
9 A. I believe this concern is misplaced. There
10 is no real sense in which USW is forced to cover more
11 costs than its competitors. Especially for the provision
12 of Title 61 services to its regulated customers, USW is
13 in the enviable position of being able to provide
14 necessary services from an existing and partially
15 depreciated rate base. The ability to serve customers at
16 low cost from an existing rate base rather than to face
17 the necessity of making expensive new investments is what
18 every competitor seeks.
19 Q. What is the biggest flaw in USW's rate
20 proposal?
21 A. It fails what some pundits call the "front
22 page" test (e.g., it sounds preposterous), as evidenced
23 by a variety of comment letters received at the
24 Commission. Customers can hardly believe that USW has
25 been willingly selling them basic local exchange service
2161
USW-S-96-5 EASTLAKE (Di) 7
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1 at half of its real cost, since it always had the means
2 to pass on to customers its prudent and necessary
3 expenses. Customers can hardly believe that USW, the
4 incumbent monopolist with an ubiquitous network, is in
5 serious jeopardy from potential competitors, who face
6 enormous start-up costs to seek new customers. Customers
7 find perplexing the assertion that USW needs to raise
8 rates to prepare for competition --- they have been
9 brought up on the folklore that competition will lower
10 costs for everyone.
11 An ordinary customer summarizes these
12 concerns well in a July 31, 1996, FAX to Commissioner
13 Nelson, commenting on the upcoming telephone rate
14 increase for business service by U S WEST:
15 I see U.S. West asking us business
customers to subsidize their
16 investments/expenses because of in-
creased competition due to the
17 Telecommunications Act of 1996.
18 Q. Do you have a final observation concerning
19 the public image raised by this USW filing?
20 A. I fear the USW proposal provides for
21 customers and the general public a sober preview of what
22 ordinary Title 61 ratepayers may expect from the
23 competitive era. Ordinary customers' sense of
24 hopefulness on the arrival of competition may be chilled.
25
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USW-S-96-5 EASTLAKE (Di) 8
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1 b. Specific economic issues
2 Q. The Company refers often to the "subsidy"
3 inherent in local exchange rates? Is there a unique
4 meaning to the word subsidy?
5 A. In economic theory, it usually refers to the
6 payment needed to cover losses incurred by a declining
7 cost natural monopoly when it produces output at the
8 socially optimal level of production. In more general
9 terms it means a grant or gift to assist an enterprise
10 deemed advantageous. In even looser terms, there is a
11 subsidy whenever one person's loss is another's gain,
12 regardless of actual cost coverage.
13 Everyone seems to define subsidy
14 differently. Merely defining a service as subsidized if
15 it fails to recover all its direct costs, as USW seems to
16 do with basic local exchange service, really ignores the
17 basic question, that is, whether the sharing of joint and
18 common costs is essentially fair. A caution from
19 James C. Bonbright is in order:
20 But in any attempt to develop sound
principles of ratemaking, the undesir-
21 ability of subsidized services can not
properly be taken for granted as the
22 starting point for the theory of utility
rates. Instead, the merits or demerits of
23 a subsidy should be subject to careful
analysis. James C. Bonbright, "Principles
24 of Public Utility Rates," Columbia
University Press, New York, 1961,
25 page 51 (italics added).
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USW-S-96-5 EASTLAKE (Di) 9
11/26/96 Staff
1 Q. What does economic theory say about
2 subsidies and the likely direction in which they will
3 flow?
4 A. All the incentives are to overprice non-
5 competitive services, as noted in an introductory piece
6 on competitive services by Ben Johnson Associates on its
7 homepage:
8 (http://www.microeconomics.com/essay/compserv.html,
9 page 2). One would naturally attempt to charge more than
10 cost to those customers without alternatives, Title 61
11 customers, and use the excess to subsidize customers in
12 unregulated markets for Title 62 services.
13 Q. Is there more concrete support for this
14 theoretical concern over the flow of subsidies from
15 regulated to unregulated services?
16 A. Idaho Code 62-613 expressly forbids a
17 subsidy that flows in this direction, to wit:
18 "a telephone corporation may not subsidize telecommuni-
19 cations services which are subject to this chapter" by
20 those services subject to Title 61. In Washington,
21 another U S WEST state, there is similar concern
22 expressed in WA RCW 80.36.300 as formal policy:
23 "(4). Ensure that rates for non-competitive
24 telecommunication services do not subsidize the
25 competitive ventures of regulated telecommunications
2164
USW-S-96-5 EASTLAKE (Di) 10
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1 companies."
2 Q. Has concern over subsidies been noted by
3 Staff in recent cases involving USW?
4 A. Yes, in several places. At page 22 of
5 Staff Comments in Case No. USW-S-94-3, Staff noted the
6 need for review of the Company's rate base since "a
7 potential exists for subsidization of Title 62 services
8 with Title 61 revenues." In the Report of Earnings
9 Investigation Test Year 1992, dated May 25, 1994, at page
10 18, Staff notes an incentive to allocate a
11 disproportionate amount of common costs to Title 61 and
12 notes that "if Title 62 services were completely
13 competitive, this incentive would be even greater."
14 Q. Why is it likely that in Idaho such
15 subsidization does occur?
16 A. The distinction between Title 61 and Title
17 62 services created by the Idaho Telecommunications Act
18 of 1988 made it nearly inevitable. Every company
19 producing Title 62 services has a chance to earn whatever
20 the market will bear on provision of such services.
21 Absent effective competition, there is little reason for
22 a company to provide services for the minimum price
23 required to cover cost.
24 In addition, there is every incentive for a
25 firm anticipating competition in Title 62 services to
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USW-S-96-5 EASTLAKE (Di) 11
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1 begin to cut its cost of providing such services wherever
2 possible by shifting some of those costs to Title 61
3 services. Costs judged to be necessary for provision of
4 Title 61 services can be covered fully by regulated
5 rates, leaving Title 62 costs lower and thus giving Title
6 62 more flexibility to cut prices should that be demanded
7 for competitive reasons.
8 Q. How are the Company's claims at odds with
9 theory on the direction of subsidy flows?
10 A. The Company claims Title 62 earnings
11 subsidize Title 61 services. Yet all incentives seem to
12 go in the opposite direction. One wonders why the
13 Company would allow profits from its competitive
14 businesses, where it can earn what the market will bear,
15 to be diverted to support local exchange services, where
16 regulation provides a legal right to coverage of
17 prudently-incurred costs.
18 Q. Is USW unilaterally against all forms of
19 subsidy in the pricing of telecommunication services?
20 A. Evidently not. An August 1, 1996, News
21 Release for attribution to Sol Trujillo, President and
22 CEO of U S WEST Communications, Inc. about the newly
23 released FCC order on competitive rules seems to make it
24 apparent that though USW, in cases like this, rails
25 mightily against subsidies, the Company only dislikes
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USW-S-96-5 EASTLAKE (Di) 12
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1 certain kinds of subsidies:
2 The FCC's decision not to allow
sudden reductions in access charges
3 is prudent. These access charges
contribute $800 million a year
4 toward keeping basic service afford-
able in our fourteen states and
5 customers would feel the impact
of their loss (italics added).
6
7 Many believe that access charges are above costs, so
8 there is "subsidy" involved. This subsidy is evidently
9 OK, because it enhances USW revenues.
10 Q. If there is no clear meaning for subsidy
11 and the direction of subsidy claimed by the Company is
12 counter to what one would expect on theoretical grounds,
13 shouldn't the Company bear a strong burden of proof?
14 A. When the Company so obviously finds it
15 fruitful to raise rates to its non-competitive customers
16 so that it can compete effectively in its competitive
17 markets, it must conclusively prove that it is doing
18 something other than simple profit-maximization, charging
19 more to those whose demand is inelastic because of the
20 lack of substitutes.
21 Q. What about the Company's claim that it
22 wants to reprice local service in order to move in the
23 direction of more correct economic pricing, as will be
24 required in future competitive markets?
25 A. The Company claims it is trying to bring
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USW-S-96-5 EASTLAKE (Di) 13
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1 local rates into compliance with the economic pricing
2 rule that price should be set to cover costs. However,
3 the costs it chooses to use for reference here are not
4 economic opportunity costs, the forward-looking marginal
5 costs of economic theory. The costs the Company prefers
6 for a benchmark are its historical embedded costs. In
7 economic theory, if not in the future competitive world,
8 those costs are nearly irrelevant and are certainly not
9 the proper reference point for future pricing decisions.
10 This is a logical flaw in the Company's case.
11 Q. Why is Staff using embedded costs in its
12 case?
13 A. In the interest of providing the Commission
14 with testimony that is properly comparable, Staff has
15 chosen to restrict itself to the embedded cost proposal
16 that was filed. Otherwise, the Commission's task in
17 weighing evidence would be like comparing apples and
18 oranges.
19 Staff realizes that future decisions in the
20 wake of the Telecommunications Act of 1996 (e.g., on
21 interconnection) will be based on some variant of
22 forward-looking costs. Staff feels that this is not the
23 appropriate venue to argue different cost models.
24 c. General policy considerations
25 Q. Are the issues in this case new ones?
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USW-S-96-5 EASTLAKE (Di) 14
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1 A. No. They are virtually identical to ones
2 discussed the last time USW had a major rate case. In
3 July 1983, in Case No. U-1000-63, USW (then Mountain
4 Bell) asked for authority to earn an additional $34
5 million dollars, mostly from increases in basic exchange
6 rates based on dramatic changes "that will shortly be
7 occurring in the telecommunications industry" (Order
8 No. 18188, page 2).
9 Q. Why did the Company ask for large increases
10 in basic exchange rates?
11 A. The Company asserted that basic exchange
12 service was priced below cost, which the Commission
13 interpreted to be the result of the Company's "insisting
14 that basic exchange customers should bear the entire cost
15 of the telephone systems backbone plant while other
16 services ... are provided a `free ride' when using this
17 plant" (Order No. 18188, page 13). Staff countered with
18 a different view of cost allocation and the Commission
19 concurred with the Staff conclusion that "there is no
20 evidence to support the Company's contention that basic
21 exchange service is `subsidized' by toll or any other
22 service" (Order No. 18188, page 16) and that "it is
23 appropriate for non-basic services...to be priced at
24 levels that generate the maximum reasonable contribution
25 to joint and common costs in order to minimize local
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USW-S-96-5 EASTLAKE (Di) 15
11/26/96 Staff
1 exchange rates" (Order No. 18188, page 24).
2 Q. Why was the Company asking for such a large
3 increase to its overall revenue requirement?
4 A. The Company foresaw major changes as a
5 result of settlement of the antitrust suit against
6 Western Electric and AT&T and in decisions of the FCC.
7 New competition would require alteration to the old
8 regulated way of life. Yet in Order No. 18188 (Case
9 No. U-1000-63), the Commission found that estimates and
10 predictions being discussed were too speculative for
11 ratemaking purposes, and chose to "decide the revenue
12 requirement and allocation in this case based on the
13 present circumstances of the Company" (Order No. 18188,
14 page 2).
15 Q. Do you see any differences between that
16 prior case and the current one?
17 A. The most significant one is that
18 technological change has brought all sorts of new
19 products into the telecommunications world. However, as
20 a result of a choice available under the Idaho
21 Telecommunications Act to all telephone companies but
22 chosen by USW alone, most of those products belong to
23 unregulated Title 62 services and are outside the scope
24 of this case. Passage of the federal Telecommunications
25 Act of 1996 would seem to herald a more definite step in
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USW-S-96-5 EASTLAKE (Di) 16
11/26/96 Staff
1 the direction of competition than was the case in the
2 early 1980's with the breakup of AT&T, but USW is
3 currently involved in appeals of the very Act it claims
4 will require the sorts of new competitive responses
5 outlined in its current rate proposal. In short, the
6 eventual outcome and market responses required of USW are
7 still quite unpredictable.
8 II. ANALYSIS OF USW RATE PROPOSALS
9 Q. How would you characterize USW's rate
10 proposal?
11 A. USW claims this proposal is about
12 simplification, that the new rate structure would be
13 simpler for both Company and regulators to administer and
14 that it would be easier for customers to understand.
15 Beyond all the rhetoric, the USW proposal
16 calls for a monumental rate increase. USW wants to raise
17 rates for two reasons: 1) to position USW advantageously
18 for the new competitive world by allowing it to recover
19 quickly its past costs and 2) to hinder competition by
20 making resale more expensive for potential competitors.
21 USW wants to recover its previous investments while it
22 still has captive regulated ratepayers to assure
23 recovery. USW wants to put the burden of that recovery
24 on local exchange customers by removing from local
25 exchange rates the putative "subsidy", e.g., by nearly
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USW-S-96-5 EASTLAKE (Di) 17
11/26/96 Staff
1 doubling rates for most customers.
2 Q. Why have you done further analysis of the
3 characteristics and impacts of USW rate proposals
4 contained in this case?
5 A. Because I thought it important to look
6 beyond USW pronouncements about enhancing customer choice
7 and preparing for competition to the impact on specific
8 classes of customers. Ms. Owen's testimony, at page 3,
9 provides an overview of the proposed changes. In it, she
10 mentions "simplifying" residence and business local
11 measured service, "simplifying" residency non-recurring
12 charges, consolidation of rate groups, and "restructure"
13 of vacation rates. At page 4, she mentions how it is
14 easier for the customer to understand a single $.03 per
15 minute charge and notes that the customer no longer has
16 to determine whether the call is within their exchange or
17 to some other exchange. She even notes her "belief that
18 the proposal outlined above accomplishes the
19 simplification that customers want."
20 Beyond the favorable surface impression
21 created by words like "simplify" and "enhance" lies stark
22 reality. This proposal represents a huge rate increase
23 for most residential customers, roughly a doubling (100%
24 increase) for the monthly flat rate, with a range for
25 other residential rates of 41% to 445%.
2172
USW-S-96-5 EASTLAKE (Di) 18
11/26/96 Staff
1 A column of Exhibit No. 131, page 2, calculates the
2 specific percentage increase for each individual
3 residential and business rate. The only rate increases
4 for business are relatively small, 6% to 20%, and apply
5 to customers being moved from Rate Groups 1 and 2 to Rate
6 Group 3. The analysis that follows takes a harder look
7 at USW rate changes to point out what would really happen
8 to Title 61 ratepayers as a result of U S WEST's proposed
9 rate changes.
10 Q. What sort of analysis have you done here?
11 A. I have simply taken the USW numbers provided
12 and rearranged them to highlight the incremental impact
13 of individual pieces of the proposed rate increase. For
14 its part, USW did not attempt to portray either the
15 magnitude of its proposed increases or the conceptually
16 separable impacts of many of the parts of the rate
17 proposal. The Company also separated its analysis of
18 rate elements, thereby making it more difficult to
19 assemble an accurate picture of the net result. For
20 example, Company witness Owen discusses the decrease in
21 residential revenues associated with the proposed change
22 in per-minute-price of measured service on page 5, yet
23 refers to someplace "later in the testimony" for the
24 impact of the increase to the basic monthly charge.
25 Q. What was the primary tool of analysis for
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USW-S-96-5 EASTLAKE (Di) 19
11/26/96 Staff
1 examining the separate impacts?
2 A. I used the Company's response to Staff
3 Production Request No. STF01-029, showing the spread
4 proposed for the $38.2 million revenue requirement
5 requested by the Company. Staff workpapers are
6 spreadsheets that mirror the Company's Confidential
7 Exhibits B and C of that response and, for purposes of
8 this analysis, use exactly the same number of access
9 lines claimed by the Company. The revenue impacts noted
10 below are provided for comparative purposes only.
11 Access line counts used here are those
12 provided in Company spreadsheets in response to Staff
13 Production Request STF01-029, showing derivation of the
14 rate spread. These line counts are lower (by some 10,000
15 residential and business lines combined) than the counts
16 provided in the revenue sharing cases and ordinarily used
17 for ratemaking. This results in U S WEST's proposed rate
18 spread generating about $1 million more than the revenue
19 requirement of $38.2 million. Staff will utilize the
20 larger number of access lines from revenue sharing for
21 its own rate design comments later in the testimony.
22 a. Consolidation of rate groups
23 Q. Turning to the Company's proposal to
24 consolidate rate groups for all Title 61 residence and
25 business customers, what does your analysis show?
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USW-S-96-5 EASTLAKE (Di) 20
11/26/96 Staff
1 A. Using current rates and moving Rate Groups
2 1 and 2 to the current Rate Group 3 would, in addition to
3 the change noted above for measured service, move the
4 basic monthly residential charge from $10.11 (Rate Group
5 1) or $11.01 (Rate Group 2) to $12.00 (Rate Group 3), a
6 19% increase for former Rate Group 1 customers or a 9%
7 increase for former Rate Group 2 customers. The
8 percentage increases vary with the class of service,
9 reaching as high as 57% for the limited ITAP plan.
10 Taking into account all residential service, rate group
11 consolidation will cost residential customers $1,288,002.
12 That results in an annual increase of $13.70 per
13 residential access line in rate groups 1 and 2 only. The
14 revenue impacts of rate group consolidation are detailed
15 as part of Exhibit No. 129.
16 For business customers, rate group
17 consolidation increases individual rates from 9% to 20%
18 depending on class of service and on rate group. For all
19 business classes, rate group consolidation will cost
20 about $752,421. That amounts to an annual increase of
21 $35.39 per business access line in rate groups 1 and 2.
22 The derivation of these amounts is also detailed in
23 Exhibit No. 129.
24 b. Overall revenue impact
25 Q. What is the net impact of the proposed rate
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USW-S-96-5 EASTLAKE (Di) 21
11/26/96 Staff
1 increase on all business and residential customers?
2 A. USW's proposed rate design generates its
3 desired revenue requirement target of $38.2 million by
4 raising $37.4 million (97.9%) from residential customers
5 and $.795 million (2.1%) from business customers.
6 Exhibit No. 129 shows the way in which that increase is
7 distributed between residential customers and business
8 customers. Though most rate classes are affected, about
9 94% of the increased revenue from residential customers
10 comes from those using the flat monthly rate (1FR).
11 Among business customers, 53% of the much smaller
12 increased burden is concentrated on the flat monthly rate
13 (1FB).
14 It should be pointed out that the overall
15 revenue impact noted in Exhibit No. 129 includes the
16 separable impacts outlined in the previous questions
17 relating to measured service and to rate group
18 consolidation.
19 c. Business/residence rates
20 Q. How has the balance between business and
21 residence contributions to Title 61 revenue been altered
22 by the Company's proposal?
23 A. Even with the higher rates for business,
24 residential customers pay through their current rates
25 about 64% of revenues, with business customers
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USW-S-96-5 EASTLAKE (Di) 22
11/26/96 Staff
1 contributing some 36%. With the rates proposed by the
2 Company, the residential share rises to 77% and the
3 business share falls to 23%. That shift in percentage
4 contributions means that residences would pay $12.8
5 million more, and businesses $12.8 million less, than if
6 their relative contributions stayed the same as at
7 present (See Exhibit No. 130).
8 Q. Company witness Owen, at page 10, points out
9 that there is a "significant pricing disparity" between
10 residential and business service that should be reduced.
11 Do you agree with this characterization?
12 A. No. First, as to the disparity in prices,
13 the current ratio of the basic monthly business rate
14 (1FB) to the basic residential rate (1FR) is 2.59. USW
15 proposes to reduce that ratio to 1.38 by raising the
16 monthly residential rate and leaving the business rate
17 the same, along with consolidating all classes of
18 customers into the same rate group. The ratio of the
19 various business rates to the basic residence rate will
20 fall by approximately the same percentage, about 46%.
21 Exhibit No. 131, page 1, shows the percentage increase in
22 rates for 1FR and 1FB customers proposed by the Company.
23 In addition, Exhibit No. 131, page 2, shows current and
24 proposed ratios of all relevant residential and business
25 rates to the 1FR rate.
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USW-S-96-5 EASTLAKE (Di) 23
11/26/96 Staff
1 The current ratio, with business rates
2 roughly twice residential rates, has been around for a
3 long time and its existence has not been a bone of
4 serious contention in previous cases. This disparity
5 applies similarly across different companies and
6 different states. This Commission has ruled various
7 times on the reasonableness of such a disparity, see for
8 example GTE Case No. U-1002-62 (Order No. 22464) or USW
9 Case No. U-1000-63 (Order No. 18188). Order No. 18188,
10 at page 31, reads:
11 "The Commission finds that it is
generally appropriate to impose
12 higher rates for business exchange
service than residential. Business
13 service has different usage patterns
and typically has a higher cost and
14 value than residential service."
15 Q. Do you agree with witness Owen's claim that
16 business and residence are "essentially the same
17 service?"
18 A. Not really. Given uncertainty about
19 appropriate cost allocation procedures, Staff does not
20 believe that the Company has made a clear showing that
21 the differing business and residence investment costs
22 cited to show that a business line might be cheaper than
23 a residence line make use of costs solely associated with
24 Title 61 business. More importantly, there are many
25 additional and relevant dimensions to the question of
2178
USW-S-96-5 EASTLAKE (Di) 24
11/26/96 Staff
1 "sameness", none of which Owen has chosen to discuss.
2 Without any discussion of these items, Staff does not
3 believe it is, as Owen claims at page 10, "logical to
4 assume these prices should be brought closer together."
5 Q. What are some of these other dimensions and
6 how might they temper the discussion of what is "logical"
7 about the relationship between residence and business
8 rates?
9 A. Usage patterns are likely of importance.
10 Business customers make more calls than residential
11 customers and they make them during what are most likely
12 peak usage periods during the day. Value of service
13 considerations deserve some mention. Businesses have to
14 have a phone, vital to their existence for contact with
15 customers and vice versa. One would expect that FAX
16 transmissions have added further to business usage
17 recently. Couple that with the fact that basic phone
18 service is an insignificant portion of any businesses'
19 total costs and you have clear evidence of inelastic
20 demand.
21 Q. Are business customers receiving a rate
22 decrease?
23 A. No. Their rates are staying the same
24 except for consolidation of Rate Groups 1 and 2 into 3.
25 The only decline involved is a relative decline in the
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11/26/96 Staff
1 relationship of business to residential rates, brought on
2 by a drastic increase in residential rates.
3 Q. Do you agree with witness Owen's
4 observations on page 12 that arbitrage opportunities are
5 a problem that needs correcting?
6 A. No. For small businesses of the type that
7 are under consideration here, there has always been some
8 difficulty in distinguishing businesses from residences
9 and in preventing the use of residential accounts for
10 business purposes. That situation will be no worse than
11 before, since there is no proposal to increase the rate
12 disparity. Raising prices for residential customers as a
13 way to reduce the relative rate disparity and dissuade
14 arbitrage is hardly a fair way to treat the majority of
15 honest customers as the Company attempts to deal with
16 those customers who try to take advantage and slip a
17 business in under residential rates.
18 Q. Is cutting the business-residence rate ratio
19 a step that is required by new competitive forces?
20 A. Hardly. First, as Staff witness Selwyn
21 points out in his testimony, the Company has not made a
22 compelling showing that there is viable and effective
23 competition at present, or even in the very near future.
24 Second, while it is a truism that competitors will
25 attempt to "cherry pick" customers from the incumbent
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11/26/96 Staff
1 local exchange companies, they will go after big, high-
2 volume business customers. Title 61 business customers,
3 with less than five lines, are hardly going to be the
4 targets of serious competitive inroads. In that sense,
5 business customers are really very much like residential
6 customers. They are small users, with relatively small
7 bills, probably unlikely and unable to do much shopping
8 around. They are not the sorts of customers a business
9 would feel pressured to court in order to keep their
10 trade.
11 Q. What is Staff's recommendation concerning
12 the business-residence price ratio?
13 A. That it remain as it currently stands. The
14 Company's desire to extract maximum revenues from its
15 regulated service customers to prepare for future
16 competition is self-serving but understandable. What is
17 not understandable is why it should choose to except
18 small business customers from the fate it hopes to visit
19 on residential customers. There are simply no good
20 theoretical reasons to begin treating Title 61 business
21 customers differently at this time. If rates need to go
22 up, business rates need to go up along with residence
23 rates.
24 d. Measured service
25 Q. What are the various parts of the proposed
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USW-S-96-5 EASTLAKE (Di) 27
11/26/96 Staff
1 "simplification" of measured service and their relative
2 impacts?
3 A. There are three elements: usage, rate
4 group consolidation, and flat monthly charge. The first
5 is elimination of the difference in usage charges between
6 inter- and intra-exchange calls. This increases the
7 price of all measured intra-exchange usage from $.02 to
8 $.03 per minute. Though it includes a 3-hour free call
9 allowance, it also eliminates time of day discounts.
10 According to Company estimates, only 33% of residential
11 measured service customers will exceed the free allowance
12 and pay for minutes of usage. But even for the two-
13 thirds of residential customers whose usage falls within
14 the 3-hour free allowance, the increase in the flat
15 monthly charge is at least $9.37 (from the current $6.13
16 to the proposed $15.50). That increase in the monthly
17 charge would have purchased between 312 minutes ($9.37
18 divided by $.03) and 468 minutes ($9.37 divided by $.02),
19 far more than the 180 minutes covered by the allowance,
20 even without accounting for time of day discount. There
21 are about 7400 residential measured service customers and
22 2400 business measured service customers. Savings to the
23 two-thirds of residential customers is estimated at about
24 $108,632. For business customers, to whom the 3-hour
25 call allowance does not apply, the impact is estimated to
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USW-S-96-5 EASTLAKE (Di) 28
11/26/96 Staff
1 be about an $59,747 increase. With the addition of
2 public access lines, this impact becomes about $80,000.
3 Q. What is the second element of the measured
4 service rate change?
5 A. Second is the consolidation of Rate Groups
6 1 and 2 into Rate Group 3. Current rates for Rate Groups
7 1, 2 and 3 are $5.19, $5.64, and $6.13, respectively.
8 Moving all measured service customers to Rate Group 3 at
9 current rates would cost residential measured service
10 customers an additional $15,532. The rate groups for
11 measured service business customers pay $13.15, $14.38,
12 and $15.69. Moving all to Rate Group 3 at current rates
13 would cost business measured service customers an
14 additional $12,842.
15 Q. What is the third element of the measured
16 service rate proposal?
17 A. Finally, the third part is the change in
18 the monthly flat charge. This increases from $6.13 to
19 $15.50 for residential customers and from $15.69 to
20 $17.00 for business customers.
21 The revenue increase due to the flat rate
22 usage element is $833,377 for residential customers and
23 $37,922 for business customers.
24 Combining the three separable rate elements
25 of measured service generates an annual revenue increase
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11/26/96 Staff
1 of about $740,277 (or $100 per access line) for
2 residential measured service customers. For business
3 customers, the revenue increase is about $130,764
4 (or $54 per access line). Exhibit No. 132 outlines both
5 these impacts.
6 e. Reduction of non-recurring charges for installation
7 Q. Company witness Owen, at pages 23-24 of her
8 Direct Testimony, proposes to "simplify" the structure
9 and raise the price of non-recurring installation
10 charges, making it "easier to understand" and thereby
11 "meeting customer needs." Do you agree with her
12 characterization of these changes?
13 A. No. The price rise of $1 appears slight
14 (3.3%) when compared to the current charge of $30.
15 However, the $31 proposed charge covers not one but two
16 lines, effectively lowering the cost of two lines by 48%
17 or the cost per second line by 96%.
18 Q. Why is this important?
19 A. Because I believe the Company's explanation
20 of this proposed price change is somewhat misleading.
21 The Company estimates that this "increase" will result in
22 a decline of $140,822 in revenues from recurring charges,
23 due to an 8% decline in the number of such charges
24 incurred. Put another way, it expects 8% less new
25 installations as customers put in a second line for the
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USW-S-96-5 EASTLAKE (Di) 30
11/26/96 Staff
1 mere $1 charge, rather than the $30 it cost them before.
2 Staff suspects, with no way of proof, that
3 the demand for second lines is sufficiently responsive to
4 create a much larger demand. Staff witness Baldwin
5 comments on the already striking growth in second lines
6 over the last five years and quantifies it in Exhibit
7 113, Table 2. In other words, many more people might
8 accept the Company's offer of putting in a second line
9 simultaneous with the first line for only an additional
10 $1. This would result in an estimated reduction greater
11 than 8%, thus making the Company's estimate of revenue
12 loss understated. One reason the Company seems
13 unconcerned with the estimated "loss" may be that the
14 additional recurring revenue from stimulation of second
15 line growth will at least offset the revenue decline from
16 installation charges. The Company has chosen not to
17 estimate the revenue gain that would spring from this
18 growth. Logically, no estimate of revenue gain should be
19 provided, since the Company claims it does not even cover
20 the costs of providing a local exchange access line.
21 Q. What are Staff concerns with this
22 particular pricing proposal?
23 A. Staff is concerned that this pricing
24 proposal is in fact a sort of promotional discount that
25 could lengthen the installation interval and create a
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11/26/96 Staff
1 shortage of facilities and further non-recovery of costs.
2 Somewhat similar concerns were aired in Case
3 Nos. MTB-T-89-4 and again in USW-T-91-8.
4 To Staff's expressed concern in those cases that the
5 number of held orders might rise as a result of such
6 promotions, the Company "insisted that it would not
7 propose promotional offerings if such offerings were
8 likely to affect its level of service." (Order
9 No. 24034, page 3). In light of the Company's service
10 quality problems outlined in the testimony of Staff
11 witness Hart, Staff wishes to reiterate its concern about
12 this subject.
13 Staff believes that reducing the charge for
14 the second line will actually raise revenue for the
15 Company and may impede efforts to improve service
16 quality. Consequently Staff recommends rejection of the
17 Company's proposal to reduce non-recurring installation
18 charges for the second line.
19 f. Rates for privacy listings
20 Q. The Company makes no mention of this issue.
21 Why has Staff chosen to address it?
22 A. The Commission incorporated Case No.
23 USW-S-96-2 (the Hoffman complaint) into this general rate
24 case. In that case, Mr. Hoffman objected to the monthly
25 fee, or recurring charge, associated with privacy
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1 listings. His primary objection was based on USW's taped
2 admission to him that there was little or no Company
3 activity on a monthly basis to justify a regular monthly
4 charge. In response to the formal petition that
5 initiated the case, USW claimed that the recurring charge
6 had been in place at least 25 years and that the same
7 structure was in use by Bell Operating Companies in all
8 50 states. The Company admitted the charge was not based
9 on cost of service on an individual basis, but was part
10 of an overall rate design that allowed the Company to
11 earn its revenue requirement.
12 Q. What concerns has the Commission voiced
13 concerning this issue in previous cases?
14 A. In Order No. 22839 the Commission noted that
15 "not publishing or listing telephone numbers...creates
16 burdens on other customers..." p. 3. In Order No. 19956
17 (Case No. U-1000-82) at page 4, the Commission declared
18 that the cost of maintaining privacy should be borne by
19 the person who desires it. The old arguments that extra
20 directory assistance (DA) calls merited the monthly
21 charge no longer hold because DA calls are individually
22 billed at $0.60 per call and classified as a Title 62
23 service.
24 Q. Has the Company made any attempt to provide
25 cost justification for these charges in response to the
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11/26/96 Staff
1 Hoffman complaint?
2 A. No. Staff has found, in a TSLRIC study
3 submitted in response to Staff Production
4 Request STF01-037 concerning another issue, a recurring
5 cost study for privacy listings that contains almost
6 miniscule costs. That study mentions seven different
7 categories of expenses included in the costs, but there
8 is no mention of a cost impact on directory assistance.
9 Q. Will you comment on the overall revenue
10 impact of recurring charges for privacy listings and also
11 on the level of such charges in other states?
12 A. The Company currently receives about $1.4
13 million annually from recurring charges for non-listed
14 and non-published numbers, with the great majority coming
15 from residential rather than small business customers.
16 For the fourteen states in which USW serves, the average
17 recurring charges for non-listed and non-published
18 services are $1.47 and $2.45 per month respectively (see
19 Exhibit No. 133). Current USW Idaho monthly charges are
20 $2.50 for non-listed and $4.00 for non-published. A
21 Bellcore response supplied to Staff by USW found a range
22 of from $.15 to $3.95 and from $.30 to $4.00 respectively
23 across all states.
24 Q. Does Staff have a recommendation for the
25 level of recurring charges for privacy listings?
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1 A. Because there is no specific cost that
2 needs to be covered by recurring charges, and because
3 USW's current charges are high relative to other states
4 and other USW service areas, Staff recommends cutting the
5 recurring charge significantly, to the monthly charges of
6 $1.50 for non-listed and $2.50 for non-published. These
7 rates are roughly the average USW charges for its
8 fourteen states. Using year-end 1995 numbers for
9 residences and businesses subscribing to privacy
10 services, this would generate revenues of approximately
11 $962,000, or $524,649 less than is collected under the
12 current rates.
13 Q. Is there any way to offset the revenue
14 decline by readjusting other privacy charges?
15 A. No. Upward adjustments could theoretically
16 be made to the non-recurring initial charge for privacy
17 listings to help offset the decline in recurring charges
18 and keep the Company roughly revenue neutral. This might
19 avoid adding new burden to the rates of the Title 61
20 customers who do not subscribe to privacy listings.
21 Given the small number of privacy listings, however,
22 there is no real potential to offset the substantial
23 decline in recurring revenues ($524,000) with an increase
24 in the non-recurring fee.
25
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11/26/96 Staff
1 The burden to be passed on to other
2 customers would range from about $.12 to $.35 per month
3 per customer, depending on whether the recurring charges
4 were cut to $1.50 and $2.50 or eliminated entirely.
5 g. Vacation rates
6 Q. Has Staff done a customer-focused analysis
7 of the proposed changes to vacation rates?
8 A. Yes. The proposed changes to vacation
9 rates call for a flat monthly charge of $10 instead of
10 using 50% of the flat rate and a cut in the nonrecurring
11 suspend-restore charges from $40 to $15. These changes
12 are made to "greatly simplify the price" and make it
13 easier to understand. The revenue losses from the change
14 are a combined $23,000 annually from both residences and
15 businesses, an insignificant amount which would be spread
16 to the rest of Company customers. Since the revenue
17 impact is very small, there seems no objection based on
18 the burden to other customers.
19 However, Staff has done analysis that
20 indicates this change to the structure of vacation rates
21 leads to a relatively large reduction in a hypothetical
22 individual customer's bill. That reduction appears
23 particularly unwarranted in a rate proposal where nearly
24 all other rate changes lead to substantial increases in
25 customer bills.
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11/26/96 Staff
1 Exhibit No. 134 details a comparison of
2 bills for a residential customer under three possible
3 rate options: flat rate, measured rate, and vacation
4 rate. Staff used the assumption that the vacation rate
5 was suspended for seven months and in active use for five
6 months. Staff also used an option in which the customer
7 chose a measured rate alternative for the entire year,
8 that is, the customer would pay for additional measured
9 usage during five months but would pay only the flat
10 monthly charge for seven months when the premises were
11 not in active use. In addition, for calculation of this
12 measured rate alternative Staff assumed that customers
13 use 320 minutes per month.
14 Q. What were the results of Staff's analysis?
15 A. Using these assumptions, with the existing
16 rate structure a customer choosing the vacation rate
17 saves 1.4% over flat rate bill. Choosing measured rate
18 service using the same assumptions, this customer could
19 save 15.6%. Customers apparently choose the vacation
20 rate over measured service so that phone service is
21 disconnected during their absence, avoiding the
22 possibility of unauthorized use of their phone. Using
23 measured service, customers would not be in jeopardy of
24 actually losing their access line during the suspend and
25 restore process, as has happened in isolated
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USW-S-96-5 EASTLAKE (Di) 37
11/26/96 Staff
1 circumstances to vacation rate customers.
2 Under the Company's new rate proposal, the
3 vacation rate results in a 26.9% saving over flat rates.
4 Again, measured service would provide an even larger
5 savings than vacation rates, but the margin of difference
6 is now quite small. Testing the new proposed structure
7 of vacation rates with the old basic rates also leads to
8 large savings of about 22%. The major cause for the
9 substantial percentage decline is the decline in the
10 suspend-restore charge from $40 to $15.
11 While the proposed change appears very
12 favorable to vacation rate customers, measured rates
13 still appear to offer bigger savings and they do not
14 create any additional costs (however small) to be
15 allocated to other customers. Vacation rates affect only
16 some 65 or so residence customers per month, plus less
17 than 10 business customers.
18 Q. What is Staff's recommendation on vacation
19 rates?
20 A. Staff recommends that vacation rates be
21 abolished and their function be served through the use of
22 measured rates. This will require the Company to provide
23 better information as to the advantages and availability
24 of a measured service option. For those who worry about
25 their phone line still being "in service" while they are
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11/26/96 Staff
1 absent, the Company should suggest they simply unplug
2 their phone and store it out of harms way. The Staff
3 recommendation is very much in line with the Company's
4 desire to simplify the rate structure --- dropping a
5 service option entirely is the ultimate step toward
6 simplification.
7 Q. Do you have an alternative recommendation?
8 A. If the Commission wishes to preserve the
9 vacation rate, it should retain the current structure.
10 The proposed vacation rate creates an uncalled for
11 windfall, when most other residential customers face
12 large proposed increases, to a very small group of
13 customers.
14 III. EXPENSE ADJUSTMENT
15 a. Changes to reflect newly-approved local calling areas
16 Q. What adjustments were necessitated by the
17 recent Commission order approving three new local calling
18 areas?
19 A. The addition of the local calling areas
20 approved in Case No. USW-S-96-4, Order No. 26672,
21 introduces two necessary Staff adjustments to the
22 Company's proposal in this case. Order No. 26672 already
23 allotted $1.5 million of revenue sharing funds to help
24 offset the capital costs associated with implementation
25 of EAS. To the extent the Company incurs costs above
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11/26/96 Staff
1 that amount, they are to be included in the Company's
2 rate base.
3 Second, the costs associated with the change
4 in calling from toll to local, and the resulting call
5 stimulation, must be shifted to local expenses so the
6 Company can be compensated for these costs. Using the
7 Company's actual local switching cost results in
8 switching expenses of $1.8 million, as estimated by Staff
9 in Confidential Exhibit No. 101, page 10.
10 Q. Has the Staff shifted any plant or other
11 expenses as a result of the EAS order?
12 A. No, the expenses calculated by Staff are
13 based on the Company's own TELRIC study with the
14 Company's calculation of joint and common costs included
15 and should fully compensate them for this shift in
16 calling.
17 b. Elimination of the rural zone credit
18 Q. What does Staff recommend with respect to
19 the elimination of the rural zone credit?
20 A. By the terms of the recent EAS Order, rural
21 zone credits are to be phased out upon implementation of
22 local calling areas.
23 c. Disposition of remaining revenue-sharing funds
24 Q. What should be done with the remaining 1995
25 revenue sharing funds?
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11/26/96 Staff
1 A. The recent EAS case allocated monies for a
2 variety of specific purposes, leaving a balance of
3 approximately $10 million. That money should be returned
4 directly to customers in the form of a per access line
5 credit over a four-month period. The balance of the
6 funds for the last payment will not be known until the
7 Company completes implementation of the EAS regions and
8 the payment of rural zone credits ends. When that amount
9 is calculated, the final payment can be made.
10 IV. PROPOSED RATE DESIGN
11 Q. What is the result of Staff's investigation
12 of the revenue requirement proposal submitted by U S WEST
13 in this case?
14 A. Staff's investigation of the Company's
15 earnings and expenses has resulted in a recommended
16 reduction of $32 million in revenue requirement.
17 Q. Does Staff have a specific rate design
18 proposal for reducing revenue requirement by $32 million?
19 A. It makes a big difference to rate design
20 that the Company's proposal calls for a large revenue
21 requirement increase, as opposed to Staff's call for an
22 equally large decrease. It makes no sense to treat the
23 dollars identically, as if the minus sign is only a
24 convention of mathematics. A large proposed rate
25 increase may require a set of very important
2195
USW-S-96-5 EASTLAKE (Di) 41
11/26/96 Staff
1 considerations to make sure that increased burdens are
2 equitably shared. A large proposed rate decrease entails
3 perhaps an entirely different set of criteria. In fact,
4 such a major decrease in revenue requirement almost
5 avoids the usual need to concern oneself with tradeoffs
6 of one group's welfare for that of another. With so
7 large a proposed decrease, every customer can benefit
8 substantially.
9 Any change in revenue requirement in this
10 case should be handled as simply as possible, without
11 radical redesign of the rate structure or drastic
12 alteration of the terms and conditions of various service
13 offerings.
14 Q. Does Staff have any general proposals
15 to offer for guidance in this filing?
16 A. Staff suggests two general principles
17 for application in any rate design that implements
18 Staff's proposed reduction. One is that existing rate
19 ratios within the various residential rates and within
20 the various business rates be preserved, for instance,
21 preserve the existing ratio ($6.13/$12.00=.51) that
22 relates the residential measured service rate to the
23 basic 1FR rate. The ratio of 1FB to 1FR should remain at
24 2.5:1 and the ratio of trunks to 1FB should be targeted
25 at 1.5:1. Staff would support this position.
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11/26/96 Staff
1 Second, Staff suggests in light of its
2 proposal that a revenue reduction is appropriate, that
3 the Company proposal to consolidate the per-minute charge
4 for measured service be accepted. However, Staff
5 recommends that the single rate applicable to measured
6 service be $.02, the lower of the two current applicable
7 rates, rather than $.03, the rate suggested by the
8 Company.
9 Third, Staff recommends that some sort of
10 differential be preserved to distinguish in-region from
11 out-of-region calls, pursuant to the Commission's recent
12 EAS Order.
13 The major point is that it is speculative
14 at this juncture to try to design a specific rate
15 structure capable of reducing revenues by $32 million.
16 Staff's primary purpose is to set guidelines to use when
17 a revenue requirement is decided and actual rates must be
18 calculated.
19 Q. Does this conclude your direct testimony?
20 A. Yes, it does.
21
22
23
24
25
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11/26/96 Staff
1 Q. Please state your name and business address
2 for the record.
3 A. My name is Bill Eastlake. My business
4 address is 472 W. Washington, Boise, Idaho.
5 Q. By whom are you employed and in what
6 capacity?
7 A. I am employed by the Idaho Public Utilities
8 Commission as a Telecommunications Analyst.
9 Q. Have you previously submitted testimony in
10 this proceeding?
11 A. Yes, I submitted pre-filed direct testimony
12 on behalf of the Staff of the Idaho Public Utilities
13 Commission on October 26, 1996.
14 Purpose
15 Q. What is the purpose of your testimony at
16 this time?
17 A. I am responding to rebuttal testimony
18 offered by U S WEST witnesses Owen, Wright and Wozniak in
19 several areas: (1) transition from interim EAS regional
20 rates to permanent rates; (2) U S WEST characterization
21 of Staff's direct testimony in this case; (3) the extent
22 of local exchange competition and its impact on prices;
23 (4) my analysis of U S WEST's original rate proposal; (5)
24 my stance on specific rate design issues; and (6), I will
25 present Staff's formal rate design proposal.
2198
USW-S-96-5 EASTLAKE (Surr) 1
2/22/97 Staff
1 1. Transition for interim EAS regional rates to
permanent rates
2
3 Q. It appears that the Company's requested
4 revenue requirement has been reduced from $38.2 million
5 in its direct case to $28.3 million in rebuttal
6 testimony. Has the revenue requirement been reduced?
7 A. Not entirely. The "reduction" is misleading
8 because the Company has embedded approximately $12
9 million of EAS revenue as a result of implementing the
10 three EAS local calling regions that is only partially
11 offset by its adjustment to reflect EAS costs. About $10
12 million is attributed to the "interim" $3.62 monthly
13 increase for residential customers located within the
14 regional calling areas. Another $1.8 million is
15 attributed to consolidation of rate groups.
16 Q. Why do you refer to the EAS monthly
17 increase of $3.62 as an "interim" rate?
18 A. In Case USW-S-96-4 the Commission
19 authorized the creation of three EAS calling regions.
20 The Commission anticipated that this rate case would be
21 completed before the EAS regions would be operational.
22 Realizing that the rate case would establish "permanent"
23 rates including the cost of the new EAS, the Commission
24 established an interim EAS rate structure. In Order No.
25 26672, page 22, the Commission stated:
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USW-S-96-5 EASTLAKE (Surr) 2
2/22/97 Staff
1 ...because an order in the
rate case is likely to predate the
2 implementation of EAS service, the
customer rates proposed by the
3 Stipulation may never become effective.
The Stipulations rate and credit
4 provisions will be superseded by the
rates the Commission establishes in the
5 rate case.
6
7 The Commission affirmed this understanding
8 on reconsideration in Order No. 26728, page 3, where it
9 stated:
10 ...the evidence clearly demonstrated
that the proposed rates would become
11 a nullity as a result of the Commission's
review of rates in U S WEST's pending
12 rate case.
13 The Company also acknowledged the temporary
14 nature of the EAS rate structure. U S WEST witness
15 Wozniak stated that "these are interim prices" (Tr. at
16 page 475) and admitted that rates and the rate design
17 from the rate case "will entirely supersede the
18 stipulated rates proposed here for the EAS
19 implementation." (Wozniak, Reb, page 12). The $3.62
20 figure has no formal basis in cost and is not relevant
21 for rate setting in this case. The $3.62 EAS rate will
22 be recovered from revenue sharing funds until permanent
23 rates are issued pursuant to a final order in this case.
24 Subsequent testimony at page 22 below provides further
25 details on recommended disposition of remaining revenue
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USW-S-96-5 EASTLAKE (Surr) 3
2/22/97 Staff
1 sharing funds.
2 Q. How should the costs of EAS be calculated
3 in this case?
4 A. EAS costs have three elements. First,
5 implementation of EAS requires the Company to install new
6 plant in the regions. As part of the EAS case U S WEST
7 and Staff proposed that $1.5 million in available Title
8 61 revenue sharing funds be used to defray the cost of
9 the new plant. The Company now calculates that $3.707
10 million in plant improvements is necessary. Consequently
11 the Staff and the Company propose to satisfy this
12 additional funding requirement ($2.207 million) with
13 available revenue sharing monies. This plant investment
14 should be fully depreciated on the Company's books.
15 Company estimates of this cost are found in workpapers
16 for Ms. Wright's adjustment #28. Since this cost is
17 fully offset by revenue sharing funds, it is not included
18 in Staff adjustments found at page 10 of Exhibit No. 101.
19 Q. What is the second component of the EAS
20 costs?
21 A. Converting former toll minutes to local EAS
22 minutes causes a shift in jurisdictional separations. The
23 Company calculates this results in a net increase to rate
24 base of approximately $7.45 million, subject to audit, as
25 shown in Ms. Wright's workpapers for adjustment #27.
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USW-S-96-5 EASTLAKE (Surr) 4
2/22/97 Staff
1 Q. What is the third element of EAS cost?
2 A. The new plant and usage will increase
3 operating expenses by $3.047 million. This total adds
4 the $183,000 maintenance expense from Ms. Wright's
5 adjustment #28 to the total operating expenses of $2.864
6 million from adjustment #27.
7 Q. Do you accept these later two EAS cost
8 adjustments by the Company?
9 A. Staff accepts the separations impacts
10 calculated by the Company, but the separations impacts
11 need to be further adjusted to split intrastate amounts
12 between Title 61 and Title 62. The adjustments will
13 reflect Staff allocation factors rather than the
14 Company's. To accomplish this, Staff first used Company
15 allocation factors to take plant amounts back to the
16 intrastate level, then applied its own Title 61
17 allocation factors to recalculate the appropriate Title
18 61 amounts. These adjustments are found on page 10 of
19 Exhibit No. 101.
20 Staff's adjustments to plant cost result in
21 a decline in EAS increment to rate base from $7.451
22 million to $5.292 million. Staff's adjusted plant cost
23 amount is entered at line 10 of Exhibit No. 101, page 1.
24 Similar Staff adjustments to operating expenses result in
25 a decline from $3.047 million to $2.129 million, an
2202
USW-S-96-5 EASTLAKE (Surr) 5
2/22/97 Staff
1 amount carried to line 28 of Exhibit No. 101, page 1.
2 Accepting the Company's cost estimate and
3 the proposed separations impact on rate base allows
4 withdrawal of my TELRIC-based cost adjustment at line 28
5 of Exhibit No. 101 and page 10.
6 2. U S WEST's characterization of Staff direct testimony
7 Q. Do you believe U S WEST witness Wozniak's
8 rebuttal fairly characterizes Staff's comments from
9 earlier earnings investigations?
10 A. No. Mr. Wozniak (Reb, page 3, line 7)
11 characterizes Staff's revenue requirement proposal as
12 surprisingly "extreme" based on his reading of Staff
13 comments in recent earnings investigations that
14 U S WEST's earnings appear reasonable.
15 Reading more than just selective quotations
16 cited by U S WEST clearly hints of Staff uncertainty,
17 centered around the unexamined question of cost
18 allocation. For instance, in the same Staff comments (in
19 Case No. USW-S-94-3) quoted by the Company, the next line
20 below the quote on the same page, contain a section
21 dealing with "rate base concerns." A few lines down,
22 Staff notes that "... one cannot be sure no subsidization
23 is occurring if the rate base has not been determined to
24 be necessary, used and useful to the basic local service
25 ratepayer." On the following page, Staff goes on to say
2203
USW-S-96-5 EASTLAKE (Surr) 6
2/22/97 Staff
1 that "For the future, though, there is less security that
2 plant investment will not be an issue." The fact that
3 Staff compared and contrasted several rough allocation
4 methods as alternatives to the current revenue-sharing
5 plan indicated that this was also a source of concern
6 that could develop in a future rate case. In other
7 words, Staff had reservations associated with the
8 reasonableness of U S WEST earnings.
9 Q. Is it appropriate for U S WEST to suggest
10 the Commission should not constrain its vision to "a
11 Title 61 vacuum" (Wozniak, Reb, page 4, lines 14-15)?
12 A. Staff believes this case covers just Title
13 61 services. Perhaps that justifies Mr. Wozniak's
14 implication that Staff's comments limit the scope of its
15 proposal for Commission action. However, a major issue
16 in this case is the allocation of costs between Title 61
17 and Title 62, required as a result of the Idaho
18 Telecommunications Act of 1988. Acceptance of a revenue
19 sharing plan as an alternative form of allocation
20 postponed the difficult and detailed allocation of costs
21 between Title 61 and Title 62. This is the first time
22 the cost allocation issue has been formally reviewed by
23 the Commission.
24 Staff posed interrogatories seeking data
25 about both Title 61 and Title 62 costs on the assumption
2204
USW-S-96-5 EASTLAKE (Surr) 7
2/22/97 Staff
1 that one needs to be familiar with the total to
2 understand the relationship of its parts. Certain
3 interrogatories were met by Company responses that such
4 requests were about Title 62 unregulated services and
5 thus would not lead to admissible evidence in this formal
6 Title 61 proceeding. Exhibit No. 149 provides examples
7 of such responses. In refusing to provide such
8 information, the Company itself was attempting to operate
9 in "a Title 61 vacuum."
10 Q. U S WEST witness Wright (Reb, pages 13-14
11 and Exhibit 43B) offers two calculations as evidence that
12 Staff's allocation is unreasonable and that the basic
13 residential rate needs to go up. Will you comment on
14 each?
15 A. First, based on her application of my rate
16 design guidelines to Staff's proposed revenue
17 requirement, she calculates a 1FR rate of about $6.50 and
18 uses it to argue that Staff's allocation is unreasonable
19 since it produces "unreasonable results." There are two
20 responses to this charge.
21 I deliberately did not make such a
22 calculation because a proper rate would include
23 provisions for the approved EAS regions but complete data
24 was currently unavailable. (Staff did make a preliminary
25 EAS adjustment for added switching costs on line 28 of
2205
USW-S-96-5 EASTLAKE (Surr) 8
2/22/97 Staff
1 Exhibit No. 101, page 1.) It was irrelevant to make such
2 a formal rate calculation then, and it is irrelevant to
3 discuss such a calculation done by someone else now.
4 Second, determining what is a "reasonable"
5 rate should not be prejudiced by looking at a single
6 number. Staff is attempting to produce a reasonable
7 allocation of costs between Title 61 and Title 62 and
8 from that allocation will flow an appropriate level of
9 Title 61 rates. Comparison to historical rates may not
10 be the proper standard for judgment of what is reasonable
11 in this case.
12 Q. Is the change in the Consumer Price Index a
13 proper standard for escalation of the 1FR rate as Ms.
14 Wright suggests (Reb, page 14, and Exhibit 43C)?
15 A. Over long periods like the 37 years since
16 1958, the validity of any index is clearly suspect. A
17 service itself often changes qualitatively and
18 substitutes come into being so people no longer buy
19 exactly the same product. The mathematical calculation
20 done by Ms. Wright is technically correct, but
21 irrelevant. The CPI itself is now under attack for the
22 same reasons and the current debate suggests it
23 overstates reality by about 1.5% per year. Over 37
24 years, that overstatement is sizable. Furthermore, lower
25 service quality might actually deserve stable (falling in
2206
USW-S-96-5 EASTLAKE (Surr) 9
2/22/97 Staff
1 real terms) prices.
2 Q. Company witness Owen (Reb, page 18, lines
3 15-20) charges it is unreasonable to suggest U S WEST
4 wants to subsidize Title 62 services with Title 61
5 revenues. Is this characterization of your testimony
6 accurate?
7 A. No. The testimony, especially on pages
8 11-12, makes generic references to the way in which a
9 split between regulated and unregulated services provides
10 clear economic incentives to shift costs between Title 61
11 and Title 62. Prior earnings investigations by Staff
12 also note such an incentive.
13 Whether or not there is subsidization is
14 utterly dependent on the way in which costs and revenues
15 are allocated between regulated and unregulated services.
16 Ms. Owen seems to suggest that any allocation of loop
17 cost to unregulated services is improper. This case will
18 determine the ultimate allocation and from that will flow
19 the answers to questions of subsidy.
20 Q. Does Ms. Owen (Reb, page 25, lines 19-22)
21 properly interpret your quotes from Order No. 18188
22 concerning the subsidy issue?
23 A. No. I cited two passages from that Order
24 at page 15 of my direct testimony. She concentrates on
25 the first of my quotes which she says "clearly shows" that
2207
USW-S-96-5 EASTLAKE (Surr) 10
2/22/97 Staff
1 the Commission was trying to use non-basic services to
2 minimize the level of local exchange rates. She ignores
3 the next pages of that same Order, also cited in my
4 direct testimony on page 15, in which the Commission
5 clearly said "there is no evidence to support the
6 Company's contention that basic exchange service is
7 `subsidized' by toll or any other service."
8 3. Extent of competition and its impact on price
9 Q. What do you mean when you talk about
10 competition in this case?
11 A. Competition must be limited to Title 61
12 regulated companies that provide residential and small
13 business exchange service. Counting all
14 telecommunications service providers as competitors only
15 serves to distract attention from the relevant group of
16 Title 61 providers.
17 The distinction between Title 61 providers
18 and Title 62 providers is crucial to this case. The
19 Company seems to cite the distinction when useful and
20 gloss over it at other times. U S WEST fails to note
21 clearly that the only services for which there is
22 "effective" competition in Idaho are Title 62 long
23 distance services that are not at issue in this case.
24 Q. Does the "sheer number" of providers cited
25 by Ms. Owen (Reb, page 4, lines 8-18) provide proof of
2208
USW-S-96-5 EASTLAKE (Surr) 11
2/22/97 Staff
1 the existence of competition for local services?
2 A. No! A look at the Yellow Pages
3 advertisements cited reveals that most of the firms in
4 her cited source are not Title 61 telecommunication
5 service providers. Specific pages (843-49 of the
6 December 1996 edition) referenced by the Company contain
7 information about many sorts of telephone business, like
8 cabling and installation, coin and cards, communications
9 service, equipment dealers and suppliers and service, and
10 long distance. All of these are Title 62 services or are
11 not regulated at all. Of the six and one-half pages the
12 Company cites as evidence of competition, some 20% of the
13 space is covered by U S WEST's own ads, without counting
14 its own number listings under several categories. Only a
15 dozen entries are listed as telephone companies and none
16 are currently offering Title 61 services in competition
17 with U S WEST.
18 Q. Does Exhibit 40B and its discussion (Owen,
19 Reb, page 7) provide additional support for claims of
20 competition for U S WEST?
21 A. No. The Dime-Line (VARTEC) example is a
22 poor one because it is clearly about competition in Title
23 62 services. The advertising flyer fails to mention
24 U S WEST but does make reference to AT&T. Despite the
25 clear inference it applies to calls anywhere, the
2209
USW-S-96-5 EASTLAKE (Surr) 12
2/22/97 Staff
1 footnotes clearly say it applies to INTERstate calls. As
2 a matter of fact, a company like VARTEC would prefer not
3 to make INTRAstate calls, since its rates offer little
4 margin over U S WEST access charges.
5 Q. How does U S WEST choose to define
6 competition?
7 A. Inconsistently, as suits the purpose at
8 hand. At page 34, lines 19-24, of her rebuttal
9 testimony, Ms. Owen says resellers aren't true
10 competition, only companies that provide their own
11 infrastructure (facilities-based providers) are. But as
12 explained above in her assertion about the "sheer number"
13 of competitors, most of the putative competitors she
14 cites are not facilities-based competitors but are
15 resellers of some description, for services other than
16 Title 61.
17 Q. Can Ms. Owen sustain her disagreement, at
18 page 23-25 of her rebuttal testimony, with your assertion
19 that new entrants face large investment requirements as
20 an obstacle to entry?
21 A. No. At page 17, lines 17-18, she expresses
22 clear preference for facilities-based carriers, saying
23 that competition cannot be "just a repackaging of
24 incumbent's services." Then at lines 20-23, she admits
25 that "development of facilities-based entry is
2210
USW-S-96-5 EASTLAKE (Surr) 13
2/22/97 Staff
1 difficult." Given that inconsistency of definition, it
2 is difficult to decide just what sort of entrants are
3 under consideration. If entry of new firms is really
4 without serious financial obstacles, it would seem that
5 there might be more numerous Title 61 competitors.
6 Q. Does your assertion concerning large
7 investment needs require empirical validation?
8 A. Not really, since economic theory suggests
9 that a high-technology, capital-intensive business like
10 telecommunications has serious initial capital
11 requirements that may be an obstacle to the entry of new
12 firms. In this case, my assertion seems clearly labeled
13 in the testimony as a paraphrase of what customers might
14 think, rather than a formal hypothesis.
15 Q. Ms. Owen at page 3 and at page 27 takes
16 exception with your testimony that competition drives
17 prices downward. Is this a fair characterization of your
18 testimony?
19 A. My testimony never formally expresses such
20 a view. On page 8 of my direct testimony, I mention
21 specifically as "folklore" that competition will reduce
22 costs for everyone. Staff actually shares general
23 agreement with the statement found in Owen's rebuttal
24 testimony at page 33, that competition eventually drives
25 prices toward underlying costs. However, that is not the
2211
USW-S-96-5 EASTLAKE (Surr) 14
2/22/97 Staff
1 point of argument between Company and Staff witnesses.
2 We can agree on the tendencies of competition, but we do
3 not agree on the level of costs.
4 4. Analysis of U S WEST's original rate proposal
5 Q. U S WEST witness Owen, pages 28-32, finds
6 several reasons to criticize the way you analyze the
7 U S WEST rate proposal outlined in its direct testimony.
8 She charges that your analysis doesn't address either the
9 phase-in of rates or the ITAP provisions. Why did you
10 leave them out?
11 A. I chose to analyze the proposed rate
12 increase by treating the entire difference between
13 current and proposed rates in order to show the true
14 magnitude of the increase anticipated. U S WEST provided
15 adequate analysis of the three separate phases but failed
16 to analyze the cumulative impact of all three phases. My
17 analysis added a useful perspective on the cumulative
18 impact of the U S WEST rate increase.
19 I did examine carefully the details of the
20 U S WEST ITAP proposal but found no need for further
21 comment. The overall financial impact of the proposed
22 ITAP changes was small and its spread to other ratepayers
23 was at an acceptable level, as evidenced in Exhibit No.
24 150, the Company's response to my question in Staff
25 Production Request STF01-031.
2212
USW-S-96-5 EASTLAKE (Surr) 15
2/22/97 Staff
1 Q. Did you ignore the $3.19 reduction in
2 charges for rural zone customers?
3 A. No. Page 40, lines 18-20 of my direct
4 testimony, notes that rural zone charges are to be phased
5 out upon implementation of EAS. The impact of this
6 change in rural zone charges was not formally treated in
7 the Company's rate spread or in my analysis of it. It
8 would be misleading to treat any such change, which Owen
9 agrees is not part of this particular case, as if it
10 creates an impact that will be separable and noticeable
11 to customers other than the directly affected rural
12 customers. The new revenue requirement resulting from
13 this case will be spread across all customers in a single
14 rate change. That $3.19 reduction may be offset or
15 supplemented, in whole or in part, by other forces that
16 result in the final rate from this case.
17 Q. Is it fair to charge you with not using the
18 proper rate group consolidation (inside or outside of EAS
19 regions) in your analysis?
20 A. Hardly. I used the consolidation of Rate
21 Groups 1 and 2 into Rate Group 3, just as the Company had
22 in the rate spread of its original proposal supplied in
23 response to Staff Production Request. Some customers
24 previously in Rate Groups 1 and 2 are moved into the "in
25 region" group as a consequence of their inclusion in an
2213
USW-S-96-5 EASTLAKE (Surr) 16
2/22/97 Staff
1 EAS. Other customers, those remaining in former Rate
2 Groups 1 and 2, become the "out region" group. All
3 residential customers now pay former Rate Group 3 rates
4 ($12.00 instead of $10.11 or $11.01) as their base rate.
5 To reiterate, I did not formally model EAS
6 for direct testimony so there was no formal consolidation
7 into just two groups. As Ms. Owen notes at page 31 of
8 her rebuttal testimony, I did recommend consolidation
9 into just two groups, one inside and one outside of the
10 new EAS regions, and final rate design will make use of
11 two groups.
12 5. Specific rate design issues mentioned by Owen
13 Q. Turning first to the business-residence
14 ratio, Ms. Owen says your direct testimony at pages 22-23
15 shows that residential customers do not pay their fair
16 share of costs. Is that an accurate characterization of
17 your testimony?
18 A. No. My references are all to revenues and
19 are meant only to point out the major shift in revenue
20 responsibility from business customers to residence
21 customers in the Company's proposal. I neither made nor
22 intended any reference to costs in that discussion.
23 Q. Ms. Owen, at page 38 of her rebuttal
24 testimony, notes that you failed to provide any evidence
25 that business customers have more usage than residential
2214
USW-S-96-5 EASTLAKE (Surr) 17
2/22/97 Staff
1 customers. Do you have evidence for that assertion?
2 A. I avoided citation of the evidence due to
3 its asserted confidentiality. I made use of data on 1FR
4 and 1FB customers from Company SLUS studies, provided in
5 a TSLRIC Study of Residential and Business Exchange
6 Recurring and Non-recurring Costs, 1996, from the
7 Company's Confidential Response to Staff Production
8 Request STF-01-036.
9 Q. In arguing for a change in the business-
10 residence price ratio and elsewhere U S WEST seems to
11 assert this ratio is a form of social pricing based on
12 considerations like value of service and sustainable only
13 under regulation but not under cost-based competition.
14 Is this an accurate rendering of the difference between
15 regulated and competitive markets?
16 A. This is a curious reversal of concepts by
17 U S WEST and is thus a source of likely confusion when
18 local phone service considers moving from a regulated
19 world to a competitive one. A competitive market is
20 cost-based mostly in the sense that costs provide a floor
21 below which competition cannot drive the price on a
22 permanent basis. In markets, firms look first to demand
23 and to value of service considerations. They try to sell
24 products and services for whatever the market will bear.
25 Only if and when they meet effective competition must
2215
USW-S-96-5 EASTLAKE (Surr) 18
2/22/97 Staff
1 they reduce prices toward the eventual floor set by
2 costs. Costs enter only through the "invisible hand" of
3 Adam Smith, not by the conscious design of producers.
4 Competitors do not try to set prices at cost, but
5 ultimately they may be forced to do so.
6 Regulation, on the other hand, is driven
7 primarily by cost. Most service is cost-plus, and the
8 challenge is to document that whatever costs are incurred
9 are done so in a prudent manner. Given that premise,
10 prices are set high enough to cover costs. Only
11 incidentally are real marketing considerations such as
12 willingness-to-pay brought into the equation.
13 The point is that value of service
14 considerations are not a relic of a regulated world, but
15 a normal part of the everyday competitive world.
16 Certainly costs are important in competitive markets, but
17 other considerations like value of service also have a
18 role in setting prices.
19 Q. The Company's case for not raising business
20 rates seems based on its perception that only cost of
21 service can be used as the basis for competitive rates.
22 Does the Company adhere cleanly to that position?
23 A. No. If the Company believed business was
24 so clearly cheaper to serve than residence, it might have
25 actually proposed a reduction in business rates rather
2216
USW-S-96-5 EASTLAKE (Surr) 19
2/22/97 Staff
1 than just a freeze at current levels. In addition, the
2 discussion of privacy listings (Owen, Reb, page 44, lines
3 16-18) makes it clear that value-added services still
4 have a place in U S WEST pricing strategy --
5 "...customers value that need enough to pay the current
6 price..."
7 Q. Has your position on the business-residence
8 ratio been altered as a result of reading the Company's
9 rebuttal testimony?
10 A. No. I believe it is unfair to impose a
11 revenue increase of the magnitude proposed by the Company
12 only on residential customers.
13 Q. Ms. Owen says your position on measured
14 service in unclear. Can you clarify your position?
15 A. In direct testimony at page 28, I pointed
16 out that the proposed increase in the monthly charge
17 would more than offset the reduction from the 180 minute
18 free usage allowance. In passing, I note that the
19 Company's rebuttal testimony proposes for measured
20 service customers both a lower EAS adder ($2.00 versus
21 $3.62 for flat rate customers) and a lower measured rate
22 than was proposed in direct testimony. This helps
23 overcome one of the concerns with the proposal. Ms. Owen
24 is correct that I accept the Company's proposed structure
25 for measured service with the 180 minute free allowance.
2217
USW-S-96-5 EASTLAKE (Surr) 20
2/22/97 Staff
1 Since Ms. Owen agrees with my proposed reduction of the
2 per minute usage charge to $.02, there are no remaining
3 disputed issues and I agree with the Company on the newer
4 structure combined with the lower per minute rate.
5 Q. Are there any remaining issues with the
6 installation charge?
7 A. No. The Company has expressed willingness
8 to drop the proposed increase in installation charges and
9 I accept this offer.
10 Q. Have you altered your position on the issue
11 of privacy charges?
12 A. Yes. Considering Ms. Owen's points, it is
13 not appropriate to transfer to non-subscribers of privacy
14 listings the burden willingly shouldered by customers who
15 perceive sufficient value of service to purchase privacy
16 listings. I withdraw my suggestion to reduce the charges
17 for both types (non-listed and non-published) of privacy
18 services.
19 Q. What is your position on the Company's
20 vacation rate proposal?
21 A. I am concerned because the proposed
22 restructure provides significant benefits to a very small
23 number of customers against the backdrop of major
24 increases in rates for the great majority of customers.
25 I concede that the service is valuable to some customers
2218
USW-S-96-5 EASTLAKE (Surr) 21
2/22/97 Staff
1 and the restructure has negligible revenue impacts on
2 those other customers. While I cannot endorse the
3 Company's proposal, I will not oppose it.
4
5 /
6
7 /
8
9 /
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
2219
USW-S-96-5 EASTLAKE (Surr) 21A
2/22/97 Staff
1 6. Staff's rate design proposal
2 Q. How was your rate design proposal created?
3 A. Beginning with a base revenue from the test
4 year, Staff used a spreadsheet to derive a set of rates
5 that generated a proposed revenue such that the
6 difference between base year revenue and the proposed
7 revenue matched the negative amount of revenue
8 requirement (-$26.010 million) from Exhibit No. 101.
9 Staff's proposed rate design freezes current
10 relationships between various rates to the same ratios as
11 current, e.g. business (1FR)/residence (1FB) ratio of
12 2.59. The rate design also makes use of two different
13 rate groups, one "in region" and one "out region" of the
14 new EAS areas. The differential between the two new EAS
15 rate groups amounts to $1.00 under Staff's rate proposal.
16 Q. What rates does Staff recommend to achieve
17 the recommended revenue requirement change?
18 A. Exhibit No. 151 details Staff's proposal for
19 the Title 61 residence and business rates affected. The
20 exhibit consolidates several specific rate classes (noted
21 in bold type) under general types of services, based on
22 the sharing of a common rate. Page 1 covers residential
23 rates, the most important being the 1FR rate that applies
24 to flat rate residential use and generates some 94% of
25 base revenue. Page 2 covers business rates, the most
2220
USW-S-96-5 EASTLAKE (Surr) 22
2/22/97 Staff
1 important being the 1FB rate that applies to flat rate
2 business use and generates some 53% of business use (83%
3 when the AFK rate, additional flat lines, is added).
4 Page 3 of Exhibit No. 151 shows a comparison
5 between Staff's proposal and the Company's proposal as
6 they relate to the current base. This exhibit is meant
7 to highlight the major shift of revenue responsibility
8 from business to residences that results from the
9 U S WEST proposal and to point out that the Staff rate
10 proposal would preserve the business-residence proportion
11 as it now exists.
12 Q. What sort of adjustment does Staff propose
13 for the remaining revenue sharing funds?
14 A. Staff has prepared Exhibit No. 152 to trace
15 the derivation of the amount still left for final
16 distribution. It starts with the remaining balance as
17 noted in Order No. 26672, subtracts additional funds
18 designated to cover the investment costs of EAS
19 implementation, subtracts the amounts required to fund
20 credits to offset the $3.62 EAS interim rate for the
21 three regions, and arrives at a remaining balance for
22 disposition of $5.28 million as of July 1.
23 Q. What does Staff suggest be done with that
24 balance?
25 A. Staff makes note of Order No. 26672, page
2221
USW-S-96-5 EASTLAKE (Surr) 23
2/22/97 Staff
1 22, that "both U S WEST witness Wozniak and Staff witness
2 Cusick recommended any remaining revenue sharing funds be
3 used as billing credits for the customer rates ultimately
4 established in the rate case." Since that balance is no
5 longer accruing interest, Staff recommends a single
6 credit of the entire amount due each Title 61 customer.
7 Dividing the available $5,280,062 by the 353,426
8 customers in the base year gives a one-time credit amount
9 of $14.94.
10 Q. Does this conclude your surrebuttal
11 testimony in this proceeding?
12 A. Yes, it does.
13
14
15
16
17
18
19
20
21
22
23
24
25
2222
USW-S-96-5 EASTLAKE (Surr) 24
2/22/97 Staff
1 (The following proceedings were had in
2 open hearing.)
3 MS. HAMLIN: Then, with the permission of
4 the Chair, I have a few clarification questions.
5 COMMISSIONER SMITH: Certainly.
6
7 DIRECT EXAMINATION
8
9 BY MS. HAMLIN: (Continued)
10 Q Mr. Eastlake, there's been some questions
11 about the treatment of EAS in this case. Could you
12 outline Staff's current treatment of EAS?
13 A Yes. As noted by Ms. Carlock earlier,
14 treatment of EAS is one of the issues in the settlement
15 agreement and that portion of the settlement agreement
16 was designed to make Staff's approach mirror that of the
17 Company with the aim of allowing easier comparison
18 between the separate revenue requirements. Those costs
19 of EAS are broken down into two elements, changes to
20 operational expenses and changes to rate base and they're
21 included at lines 10 and line 30 of Staff revised
22 Exhibit 101. There is also a minor adjustment included
23 in deferred income taxes and included in line 7.
24 Q Would you point out to us where those EAS
25 revenues are on Exhibit 101?
2223
CSB REPORTING EASTLAKE (Di)
Wilder, Idaho 83676 Staff
1 A They are found at line 41 and they amount
2 to 10.286 million. Part of that amount, about
3 8.69 million, is directly associated with the interim EAS
4 surcharge of $3.62. The remainder, about 1.59 million,
5 is associated with consolidation of the three rate groups
6 into two rate groups, one inside and one outside the EAS
7 regions.
8 Q Will you explain why EAS revenue was added
9 to Staff's Exhibit 101 in this way and how the amount was
10 derived?
11 A The purpose was to make Staff's case
12 comparable to the Company's case. The amount was
13 derived, the 10.286 million was derived, in the
14 workpapers accompanying Ms. Wright's adjustment 27. The
15 additional revenues, this 10.286 million, consequent on
16 implementation of EAS are included as known and
17 measurable adjustments to the other elements utilized in
18 determination of revenue requirement. The interim EAS
19 surcharge defined in Order 26672 and utilized here is
20 that $3.62 amount and that can be thought of as comprised
21 of two parts.
22 The smaller part, $.76, is the amount which
23 when spread across all customers within the EAS regions
24 generates the same amount of money, $2.3 million roughly,
25 that was formerly collected in rural zone charges. The
2224
CSB REPORTING EASTLAKE (Di)
Wilder, Idaho 83676 Staff
1 remaining amount of the 3.62, the larger piece, $2.86, is
2 more properly thought of as the amount directly
3 associated with the creation of EAS regions and it's also
4 defined in the Order, so the calculated amount of EAS
5 revenue in that $10.286 million is based really on the
6 net amount of $2.86 rather than the full $3.62, since
7 $.76 of the 3.62 merely offsets the decline in the rural
8 zone charge.
9 Q After addition of the adjustment to the
10 revised 101 for EAS costs and revenues, what is the
11 Staff's incremental revenue requirement?
12 A The amount calculated after these pro forma
13 adjustments for EAS is as shown at line 48 on Exhibit 101
14 and it's 18.34 -- minus $18.347 million. That negative
15 adjustment represents overearnings and must be subtracted
16 from current base revenues, and the important point here
17 is that the pro forma revenues include adjustment for
18 EAS, so the current base revenue from which we're going
19 to subtract incremental revenue requirement should
20 contain a similar adjustment.
21 Q And what is the appropriate 1FR base rate
22 for this calculation?
23 A The Company has utilized 15.62; $12.00, the
24 1FR rate, $12.00 basic rate, plus the entire $3.62
25 interim EAS surcharge. Staff agrees that that correct
2225
CSB REPORTING EASTLAKE (Di)
Wilder, Idaho 83676 Staff
1 base rate is 15.62, but there needs to be an adjustment
2 so that only the amount included in pro forma revenue
3 adjustments is carried forward as an addition to base
4 revenues. Inclusion of the $.76 without some offset
5 results in overstatement of the base by about
6 $2.3 million. This overstatement of the base would carry
7 $2.3 million too much forward into rates indefinitely.
8 Q And what adjustment has Staff made to
9 correct this?
10 A The adjustment that I've made takes the
11 Company's most recent estimate of base revenues as
12 provided in an Excel spreadsheet, EXHBEAS2.XLS, that was
13 provided by Ms. Owen on Friday, I believe. I have taken
14 that spreadsheet and in places where 3.62 was used to
15 calculate base revenues, I have inserted $2.86, so I've
16 subtracted the $.76 or adjusted for $.76 that way. That
17 adjustment removes what I believe to be the $2.3 million
18 overstatement of the base and allows calculation of new
19 rates.
20 Q Has Staff calculated new rates after making
21 this adjustment?
22 A Yes, and they've been supplied to the
23 parties in revised Exhibit 151, pages 1 and 2. The new
24 1FR rate within the EAS regions is $10.17. The amount
25 for 1FR rates outside the region is $8.82. It's less by
2226
CSB REPORTING EASTLAKE (Di)
Wilder, Idaho 83676 Staff
1 $1.35 which we believe to be the cost difference
2 associated with EAS.
3 Q And how was the EAS cost derived?
4 A By calculation using the pro forma
5 adjustments to rate base and operating expenses and then
6 spreading them over the number of customers who would pay
7 the EAS adjustment during the test year.
8 MS. HAMLIN: Thank you. With that, I offer
9 my witness for cross-examination.
10 COMMISSIONER SMITH: Ms. Hobson.
11 MS. HOBSON: Thank you.
12
13 CROSS-EXAMINATION
14
15 BY MS. HOBSON:
16 Q Mr. Eastlake, when I tried to get prepared
17 for this morning, it occurred to me that there have been
18 a lot of changes in the relative positions of the parties
19 since your original direct testimony was filed, and so I
20 thought I would try to start out this morning on a high
21 note and see if we've got a list of things we agree on at
22 this point.
23 A That's fine.
24 Q First of all, as I understand it, you have
25 agreed that the local measured rate -- U S WEST has
2227
CSB REPORTING EASTLAKE (X)
Wilder, Idaho 83676 Staff
1 agreed that the local measured rate should be $.02 per
2 minute and Staff has agreed that that $.02 per minute can
3 be charged for minutes for all local measured service
4 customers; isn't that right?
5 A That's right.
6 Q And Staff has further agreed that the
7 restructure of the local measured service product to
8 include 180 minutes as a free allowance is acceptable to
9 Staff?
10 A That's correct.
11 Q Secondly, I believe Staff and U S WEST
12 agree that we can now move to two rate groups within the
13 State of Idaho, those being customers contained in one of
14 the large EAS regions and those outside the EAS regions?
15 A Correct.
16 Q And furthermore, we agree that the
17 customers inside the EAS region should pay a higher rate
18 than those outside, although there is a disagreement as
19 to what that differential should be?
20 A That's correct.
21 Q And as you have just indicated, we have
22 reached a stipulation on how the costs of providing,
23 incremental costs of providing, EAS should be calculated
24 in this case?
25 A That's correct.
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Wilder, Idaho 83676 Staff
1 Q And U S WEST and the Staff have agreed to
2 use revenue sharing funds to fund the new plant that is
3 going to be required for EAS implementation?
4 A That's correct.
5 Q Now, as I understand it, the use of revenue
6 sharing funds in connection with that particular
7 investment will require the Company to purchase the
8 investment, put it into place and then immediately offset
9 the booking for that investment with equal and opposite
10 offsetting depreciation so that there is a zero rate base
11 increase associated with the use of those funds?
12 A That is my understanding, yes.
13 Q And am I also correct in understanding that
14 there is no other expectation on the part of the Staff
15 with regard to other benefits that the Company is to
16 forego or other benefits the Company is to provide in
17 connection with using revenue sharing dollars for that
18 purpose? All we're required to do is simply offset it
19 with depreciation; is that right?
20 A You're talking solely about the amount of
21 new investment?
22 Q Correct.
23 A Yes.
24 Q And based upon your testimony in your
25 surrebuttal at page 15, I believe that the Staff agrees
2229
CSB REPORTING EASTLAKE (X)
Wilder, Idaho 83676 Staff
1 to at least work with U S WEST on the possibility of
2 extension of the ITAP program to customers below age 60
3 and to spread the additional costs associated with
4 extending ITAP to remaining customers.
5 A That is also correct.
6 Q U S WEST had originally provided a
7 suggested change to its installation charge structure and
8 U S WEST has withdrawn that so at this point Staff and
9 U S WEST have no disagreement on the installation
10 charges?
11 A That's correct.
12 Q And originally Staff had suggested that it
13 would be appropriate to reduce the charges for privacy
14 listings, but if I understand your surrebuttal testimony
15 correctly, Staff has now withdrawn that suggestion and is
16 continuing with U S WEST to -- with the same privacy
17 listing rates that are currently in the tariff?
18 A That's correct.
19 Q And finally, there may be others, but this
20 is the list I came up with, Staff has agreed not to
21 oppose U S WEST's vacation rate proposal restructure?
22 A That's right.
23 Q Now, I would like to direct your attention
24 to page 5 of your direct testimony.
25 A I have that.
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CSB REPORTING EASTLAKE (X)
Wilder, Idaho 83676 Staff
1 Q And at page 5, you quote an article written
2 by a Dr. Studness stating that, this is on line 4 of
3 page 5, investments stranded by competition often carry a
4 questionable pedigree and form part of "the residue of a
5 system that allowed utilities to earn healthy returns
6 despite widespread inefficiencies and abysmal
7 technological process." That's your testimony regarding
8 Dr. Studness' article; isn't that true?
9 A Yes, it is.
10 Q Isn't Dr. Studness' article addressing the
11 electric industry?
12 A It is indeed addressing the electric
13 industry. I believe the general points are applicable to
14 regulated monopolies across the board.
15 Q Well, Dr. Studness talks about things like
16 uneconomic power production and nuclear decommissioning
17 costs, among others, to support the point that he is
18 making in his article.
19 A Yes, but they're qualitatively no different
20 from copper in the ground, analog switches. In
21 generality, I think the same points apply to both.
22 Q Well, Dr. Studness never mentions the
23 telecommunications industry in his --
24 A He does not.
25 Q So if we were to draw a parallel from those
2231
CSB REPORTING EASTLAKE (X)
Wilder, Idaho 83676 Staff
1 words in his article to the telecommunications industry,
2 we would have to look to you and not to Dr. Studness for
3 that parallel, wouldn't we?
4 A I don't believe so. I think the stranded
5 cost issue is one of certainly differing degrees of
6 importance perhaps between the nuclear industry and the
7 hydropower industry or between the nuclear industry and
8 the telecom industry, but any time you're moving out of a
9 regulated world and into a competitive world, the
10 question of stranded costs and some of the points that
11 he's got here are relevant to discuss. I was not
12 attempting to assert that U S WEST had a record of
13 abysmal progress and not attempting to point this
14 specifically.
15 Q And my only point is that the parallel
16 that's being drawn is by Mr. Eastlake and not by
17 Dr. Studness who didn't talk about the telecom industry
18 in this context.
19 A I do believe he was talking about moving
20 from regulation to competition and --
21 Q In the electric industry.
22 A If you were to ask him, I think he would
23 say it applies elsewhere. The article is about the
24 electric industry.
25 Q The article you quoted is about the
2232
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Wilder, Idaho 83676 Staff
1 electric industry, nothing else; correct?
2 A I won't add your "nothing else." Had I
3 thought it was only applicable to the electric industry,
4 I would not have included it.
5 Q On page 6, line 13 of your testimony, you
6 state, "U S WEST wants to recover all its costs from the
7 old regulated monopoly world at the same time it wants
8 freedom to earn all it can in the new competitive
9 environment." Now, with the second stipulation under
10 which U S WEST agreed not to seek recovery of any of its
11 reserve deficiency in rates, would you agree that that
12 observation is no longer accurate with regard to
13 U S WEST?
14 A I believe I already agreed in response to
15 U S WEST's Production Request 59 of me that I would
16 comfortably drop the word "all" and that the sentence
17 would stand as it was, but I do agree generally that the
18 answer is yes to the question that you specifically
19 asked.
20 Q Well, the question I specifically asked
21 referred to your testimony with the word "all" in it, so
22 don't you agree that with the stipulation in this case
23 and the agreement by U S WEST to not recover any reserve
24 deficiency from Title 61 ratepayers that this statement
25 is no longer applicable?
2233
CSB REPORTING EASTLAKE (X)
Wilder, Idaho 83676 Staff
1 A With the subtraction of the reserve
2 deficiency issue, "all" is no longer operative. What I
3 was pointing out was that I had already answered your
4 interrogatory saying that "all" was perhaps
5 inappropriate.
6 Q And, Mr. Eastlake, you understand that
7 unless we discuss them or move the admission of
8 interrogatory responses that they're not necessarily
9 before the Commission?
10 A I always forget that, thank you.
11 Q On page 7 of your direct testimony, you're
12 discussing U S WEST's position as compared with
13 competitors and at line 15 you make the statement, "The
14 ability to serve customers at low cost from an existing
15 rate base rather than to face the necessity of making
16 expensive new investments is what every competitor
17 seeks." Is that your testimony?
18 A That is what it says, yes.
19 Q Isn't this ability for every -- isn't this
20 an ability that every competitor has under the federal
21 Telecommunications Act when it is given the opportunity
22 to have resale?
23 A I don't believe so at all. If they were an
24 existing telecom carrier, they would have a certain
25 amount of existing, already depreciated, low cost rate
2234
CSB REPORTING EASTLAKE (X)
Wilder, Idaho 83676 Staff
1 base with which to serve customers. As resellers, that
2 would not be true to the same extent.
3 Q Don't resellers have the ability to serve
4 customers at low cost from an existing rate base rather
5 than to face the necessity of making new investments when
6 they purchase services from U S WEST and resell them?
7 A This sentence was not meant to consider
8 resale at all. Simplest answer.
9 Q Okay, and likewise, on page 8, line 6, when
10 you refer there to the enormous start-up costs to seek
11 new customers, you have to be talking about
12 facilities-based competitors and not resellers; isn't
13 that true?
14 A It's a matter of degree, but, yes, I was
15 primarily talking about facilities-based competition
16 there.
17 Q On page 9 of your testimony, you begin a
18 discussion of the concept of subsidy and you cite James
19 Bonbright in a 1961 article saying essentially, if I've
20 understood it, that subsidy is not necessarily bad in
21 utility rates. Does that summarize that quotation?
22 A I believe that's correct.
23 Q Given that the article was written in 1961,
24 isn't it fair to say that Mr. Bonbright wasn't addressing
25 the same deregulated market conditions that U S WEST is
2235
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Wilder, Idaho 83676 Staff
1 currently facing at this point?
2 A I don't believe so. That's like -- this is
3 theory. I mean, it's like saying Adam Smith is wrong
4 because the world is different today. This was not -- it
5 was a generic assertion about subsidy as a concept, not a
6 specific assertion about any particular industry either
7 in 1961 or in 1995. I don't believe the passage of time
8 deletes the force of this statement.
9 Q But Mr. Bonbright was not contemplating a
10 situation such as U S WEST faces in Idaho at this point
11 in time where part of its services are economically
12 regulated and part of its services are economically
13 unregulated and it is required to present a cost
14 allocation methodology for the Commission to consider in
15 setting rates; isn't that true?
16 A Well, the point I was making generically
17 here is that I think as I -- I was quite surprised,
18 actually, to find that as I looked at the formal economic
19 theory, I had a tough time finding anything that dealt
20 directly with the issues we're talking about here and as
21 I pointed out in the testimony, the discussion of
22 subsidy, the definitions of subsidy, all actually seem to
23 be about a different situation.
24 Q But since the Idaho statute specifically
25 prohibits Title 61 services from subsidizing Title 62
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Wilder, Idaho 83676 Staff
1 services, that subsidy necessarily is bad, isn't it? I
2 mean, it's illegal.
3 A I believe so and all of our discussion, I
4 think, it's a -- to my mind, it's a negative of the case
5 as a whole that all of our discussion about subsidy, I'm
6 afraid, is tossing around very, very different
7 definitions and I'm not sure that any one of us has the
8 correct definition of that term.
9 Q Including you?
10 A Including me.
11 Q Well, let's see if we can make some
12 progress toward consensus on that point. Isn't it true
13 that to decide whether a subsidy is actually taking place
14 that you need to look at two things, at least two
15 things: the cost associated with providing the service
16 and the price charged for that service?
17 A I think generally that's true. The
18 difficulty is deciding what is the appropriate cost
19 level, primarily.
20 Q So in other words, if Title 62 services are
21 being sold above cost, however we decide to define cost,
22 then they are not being subsidized; isn't that right?
23 A I missed the first reference. You said
24 Title 62?
25 Q Title 62 services, if they're being sold
2237
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Wilder, Idaho 83676 Staff
1 above cost, however you choose to define cost, then they
2 are not being subsidized?
3 A I cannot answer that question without
4 taking my definition of cost which I think is probably
5 different from your definition of cost.
6 Q Please go ahead and take your definition of
7 cost.
8 A I believe the Company's charge that there
9 is a subsidy going from 62 to 61 is based on the
10 assertion not that 62 is not covering its costs but that
11 61 isn't.
12 Q Well, Mr. Eastlake, just to help us through
13 this discussion, I'm trying to now explore what I believe
14 is the position often taken by Staff witnesses in this
15 case, including yourself, if I'm correctly reading you,
16 that Title 61 services are subsidizing Title 62
17 services.
18 A I don't believe -- yeah, I don't believe
19 we've generally talked about that issue. We have
20 preferred instead to simply put in the appropriate costs,
21 generate a new revenue requirement and see what comes out
22 at the end without directly getting into the argument
23 about what is the specific cost of the local loop, what
24 is the specific cost of local exchange service and the
25 like. You know, I do believe generally that there is a
2238
CSB REPORTING EASTLAKE (X)
Wilder, Idaho 83676 Staff
1 subsidy from 61 to --
2 Q You -- go ahead.
3 A -- that there is a subsidy and it's
4 consequent on the fact that costs are underallocated to
5 Title 61 and overallocated to -- excuse me, overallocated
6 to 61 and underallocated to 62.
7 Q And so my question to you was given that
8 you're taking that position, isn't it true that if
9 Title 62 services are being sold above their cost, as you
10 define cost, appropriate cost, then they are not being
11 subsidized; isn't that right?
12 A I would find that question easier arranged
13 from the other side of the equation, from Title 61,
14 but --
15 Q But you're make the allegation that
16 Title 62 services are being subsidized by Title 61 and my
17 point is in order to make that assertion, you have to be
18 looking at not only the costs associated with Title 62,
19 but the price charged for Title 62 services to reach that
20 conclusion, do you not?
21 A I'm having trouble following your logic
22 here.
23 MS. HOBSON: My I approach the witness?
24 COMMISSIONER SMITH: Certainly.
25 (Ms. Hobson approached the witness.)
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Wilder, Idaho 83676 Staff
1 MS. HOBSON: For the record, I have handed
2 Mr. Eastlake an excerpt from Order No. 24506 from
3 Case No. USW-S-92-1. The caption is in the matter of
4 reviewing U S WEST Communications' southern Idaho revenue
5 sharing plan for the completed 1991 sharing year and the
6 appropriate disposition of the 1991 revenue sharing funds
7 subject to the Commission's jurisdiction, and to put this
8 in historic context, I call this the Tech II Order.
9 Q BY MS. HOBSON: Mr. Eastlake, would you
10 please read the highlighted portion of page 30 which I
11 have provided to you?
12 A Yes. "In general terms, the existence of a
13 cross-subsidy can only be determined if the relevant
14 costs for Title 62 and 61 services are known. U S WEST
15 asserts that the test for identifying cross-subsidization
16 is to determine whether Title 62 services are priced
17 below the relevant cost of providing those services.
18 U S WEST brief at 12. Such a practice, commonly referred
19 to as predatory pricing, is prohibited by federal and
20 state anti-trust laws."
21 Q You can state the citation.
22 A "We find that Idaho Code 62-613 prohibits
23 U S WEST from subsidizing Title 62 below cost sales with
24 revenues from its Title 61 services."
25 Q Thank you. Mr. Eastlake, doesn't that
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CSB REPORTING EASTLAKE (X)
Wilder, Idaho 83676 Staff
1 indicate that the Idaho Commission has previously
2 determined that in order to establish that Title 62
3 services are being subsidized by Title 61 that there has
4 to be a showing that Title 62 services are being sold
5 below cost enabled with the revenues from its Title 61
6 services?
7 A I cannot read it that way.
8 Q Do you want to try one more time with that
9 last sentence that's highlighted?
10 A Well, I'm in perfect agreement with that
11 last sentence, that the code section 62-613 prohibits
12 subsidizing Title 62 services with Title 61, with
13 revenues from Title 61 services.
14 Q But it says "Title 62 below cost sales,"
15 does it not?
16 A The code does not say that.
17 Q I'm asking what the Order says,
18 Mr. Eastlake.
19 A I believe the inclusion of below cost sales
20 is -- it's in the Order. I don't believe the code
21 section reads that. I'm more familiar with the code
22 section than I am with this particular Order.
23 Q So are you suggesting that the Commission
24 has misinterpreted the law in its prior Order?
25 A No, I'm suggesting that the below cost
2241
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Wilder, Idaho 83676 Staff
1 sales piece, terminology does not in my mind need to be
2 there.
3 Q Okay, directing your attention to page 11
4 of your testimony -- give me just a second here.
5 (Pause in proceedings.)
6 Q BY MS. HOBSON: I'm sorry, I must have the
7 wrong page reference here, but you make the statement in
8 your testimony somewhere, and maybe you can help me find
9 it if this sounds familiar to you, that you believe it is
10 inevitable that Title 61 services are subsidizing
11 Title 62 services. Do you recall making that statement?
12 A There's something, yeah, there's something
13 generally in there. What I think I said throughout this
14 was that there's a -- that the only sensible way in which
15 I can conceive of a subsidy is in the fashion that's
16 directly prohibited by 62-613, that subsidies
17 theoretically can only go from 61 to 62. A rational
18 business would never run a subsidy the other way, and I
19 have spent a long time trying to figure out why it is
20 that the Company asserts the opposite, what is to me a
21 technically preposterous kind of situation, and I think
22 the answer is the theoretical case that you would never
23 want to use unregulated revenues to subsidize regulated
24 is kind of on the basis that the unregulated revenue
25 stream is actually in a competitive market where there's
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CSB REPORTING EASTLAKE (X)
Wilder, Idaho 83676 Staff
1 no potential for generating a surplus to make a
2 contribution back to 61.
3 My answer now to the question of how
4 U S WEST could hold this position I think is that on the
5 62, the unregulated side, it really isn't very
6 unregulated at this point. I mean, it's not truly
7 competitive. I don't know how you want to say that, so
8 there is the possibility of U S WEST earning some
9 contribution, something bigger than cost on the 62 side,
10 which theoretically would be available to push back to
11 61.
12 Q Well, and let me see, Mr. Eastlake, if I
13 can further help you understand why it might be happening
14 and that is U S WEST is not, in your term, an
15 economically rational Company in the sense that it gets
16 to choose what it charges for Title 61 services, is it?
17 A That is correct.
18 Q The Commission has set that rate and so
19 whether or not it is a rational rate, that's the only
20 rate the Company is allowed to charge until we go through
21 a proceeding like this and hopefully have a rate change?
22 A That's correct.
23 Q On page 11, line 14 --
24 A Are we on direct?
25 Q We are on direct, yes.
2243
CSB REPORTING EASTLAKE (X)
Wilder, Idaho 83676 Staff
1 A Okay.
2 Q -- you're asked the question, "Why is it
3 likely that in Idaho such subsidization" -- and now we're
4 talking about what you're saying, the Title 61
5 subsidizing Title 62 and you're asked the question, "Why
6 is it likely that in Idaho such subsidization does
7 occur?" And I wanted to dwell on your choice of verbs
8 because that suggests that the subsidization is happening
9 right now rather than what I would take to be a different
10 point that subsidization could occur if the Commission
11 doesn't get cost allocation right later on at the end of
12 this case. Am I reading it correctly, then, that you are
13 answering this question with the idea that it's currently
14 occurring?
15 A No, my assertion or the line of questioning
16 that starts with the question at line 14 is not meant to
17 be a factual assertion about the relationship between
18 costs and revenues for 61 or 62. It was meant to be a
19 general assertion about the way subsidy would naturally
20 flow from 61 to 62 and not vice versa.
21 Q So what you're really doing, if I correctly
22 understand you, is you're describing the way the
23 incentives would operate in your view if U S WEST were
24 permitted to charge whatever it chose for its 61 and 62
25 services?
2244
CSB REPORTING EASTLAKE (X)
Wilder, Idaho 83676 Staff
1 A That's correct, and I believe it's
2 important to point out the incentive without making -- I
3 mean, I indeed am not making a factual assertion, but I
4 think it's important in this case to point out the
5 incentive, because the incentive leads to all sorts of
6 different considerations about how cost allocation could
7 or should be carried out.
8 Q Well, would you mind reading your testimony
9 at lines 18 through 23?
10 A "Every company producing Title 62 services
11 has a chance to earn whatever the market will bear on
12 provision of such services. Absent effective
13 competition, there is little reason for a company to
14 provide services for the minimum price required to cover
15 cost.
16 In addition, there is every incentive for a
17 firm anticipating competition in Title 62 services to
18 begin to cut its cost of providing such services wherever
19 possible by shifting some of those costs to Title 61
20 services."
21 Q So isn't it your position that the
22 incentive to shift costs to Title 62 [sic] is that
23 Title 62 services, that at this point Title 62 services,
24 are pretty much within U S WEST's control to prices they
25 choose?
2245
CSB REPORTING EASTLAKE (X)
Wilder, Idaho 83676 Staff
1 A I'm sorry, you said the incentive to shift
2 Title 62 costs.
3 Q I'm sorry, shift costs to Title 61 from
4 62 --
5 A All right.
6 Q -- is because U S WEST can charge pretty
7 much whatever the market will bear on Title 62; isn't
8 that what that testimony says?
9 A That is correct, yes, the incentive is
10 pushed that direction.
11 Q But isn't it really true that the higher
12 U S WEST can set its prices for Title 62 services, the
13 less likely they are to be subsidized?
14 A I'm back to the mental block I had a moment
15 ago with your phrasing of the question. Would you try
16 the question again?
17 Q The higher that U S WEST can set its prices
18 for Title 62, doesn't that decrease the likelihood that
19 Title 62 prices are subsidized?
20 A Yes.
21 Q Now, moving into a competitive environment
22 where U S WEST is not able to set its prices for Title 62
23 services as high, in other words, that competition is
24 forcing the Company closer to its Title 62 costs,
25 wouldn't such a shift, a shift downward in Title 62
2246
CSB REPORTING EASTLAKE (X)
Wilder, Idaho 83676 Staff
1 revenues, have an impact on the Company's ability to
2 subsidize those rates only if there was a change in the
3 Title 61 revenue or to put it more simply --
4 A Okay.
5 Q Go ahead.
6 A You first.
7 Q All right, the allocation in and of itself
8 doesn't make any difference unless there is a
9 corresponding increase in revenue; isn't that true?
10 A I can't agree that the allocation doesn't
11 make any difference. I mean, the allocation is the basis
12 from which assertions about the relationship between
13 price and cost, about what the costs of 61 and what the
14 costs of 62 really are. The nut of that question is the
15 cost allocation question.
16 Q It is in the rate setting environment, but
17 I'm talking now outside the rate case, outside an
18 environment where Title 61 rates are going to change,
19 allocating costs here or there on the books isn't going
20 to make any difference as to whether something is
21 subsidized, is it?
22 A I don't understand the question.
23 Q Well, what I'm trying to get at is that you
24 have made the statement that the subsidy of Title 62 by
25 Title 61, if not occurring -- I mean, I think you've made
2247
CSB REPORTING EASTLAKE (X)
Wilder, Idaho 83676 Staff
1 the statement that it is already occurring.
2 A I have not made the statement that it is
3 occurring.
4 Q So at this point, then, are we safe to
5 conclude that you believe that as we sit here today
6 Title 61 services are not subsidizing Title 62 services?
7 A I cannot make that statement either.
8 Q Well, doesn't it have to be one or the
9 other?
10 A I believe U S WEST's charge that such
11 subsidy is occurring is based on a cost allocation which
12 is ultimately 10 years old and that I think that view
13 would be different based on the kind of cost allocation
14 that's being proposed by Staff in this case.
15 Q I'm going to have to pursue that a minute,
16 which is why do you say that the U S WEST cost allocation
17 is 10 years old?
18 A That's the last time we had a rate case.
19 Q Okay. Well, historically in Idaho, has the
20 Commission previously been presented with a specific cost
21 of service study for residence or basic business service,
22 do you know?
23 A I don't know the answer to that.
24 Q So you don't have any reason to disagree
25 that basic residence prices in Idaho have always
2248
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Wilder, Idaho 83676 Staff
1 previously been set by first determining a revenue
2 requirement and then pricing all of the other services
3 which were within the Commission's jurisdiction to price
4 and leaving only a residual for Title 61?
5 A I have heard that characterization of the
6 way in which pricing has historically been done and I
7 think it's fairly accurate, but even that, it depends on
8 the underlying set of costs. I mean, the costs from
9 which that starts in determination of revenue requirement
10 are a set of allocated costs which in my mind can and
11 probably do or should change over time, so what may have
12 been a correct answer sometime in the past may not be
13 appropriate today.
14 Q When the Commission last set basic
15 residence or basic business rates, it was not presented,
16 nor was it necessary for the Commission to look at an
17 allocation of costs between basic residence and small
18 business service and other services offered by the
19 Company, was it?
20 A That is correct because it was not a 61/62
21 split.
22 Q And is it your belief based upon your
23 understanding of ratemaking in this jurisdiction prior to
24 the present case that basic residence and basic business
25 service were -- prices were historically set by this
2249
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1 Commission to provide subsidy to other services like toll
2 or custom calling features?
3 A I don't believe they were set specifically
4 to do subsidy.
5 Q So isn't it the case that this is the
6 first time U S WEST has presented a cost of service
7 case for a price increase for Title 61 service since the
8 Title 61/Title 62 distinction was created?
9 A I think that is accurate.
10 MS. HOBSON: Are we going to break here
11 soon?
12 COMMISSIONER SMITH: Well, we will have
13 lunch.
14 MS. HOBSON: I'm at a good stopping point
15 and I'm not going to be able to conclude within 20
16 minutes or so.
17 COMMISSIONER SMITH: Okay. Why don't we
18 come back at 1:15.
19 (Noon recess.)
20
21
22
23
24
25
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