|
Telecom Decision
|
|
Ottawa, 13 July 1994
|
|
Telecom Decision CRTC 94-13
|
|
REVIEW OF REGULATORY FRAMEWORK - TARGETED PRICING,
ANTI-COMPETITIVE PRICING AND IMPUTATION TEST FOR TELEPHONE COMPANY TOLL FILINGS
|
|
I REQUESTS BY UNITEL AND SPRINT
|
|
In the proceeding initiated by Review of Regulatory
Framework, Telecom Public Notice CRTC 92-78,
16 December 1992 (the Regulatory Framework proceeding), Unitel Communications Inc.
(Unitel) requested in final argument that, on an interim basis, prior to the establishment
of a new regulatory framework, the current rules governing the consideration of new toll
services to be offered by the telephone companies and of rate reductions for their
existing services be amended as follows:
|
|
(1) Phase II costs should be made consistent with
adjustments to Phase III suggested by Unitel in conjunction with its request that there be
a 35% reduction in the contribution charges paid by competitors; and
|
|
(2) contribution should be included by the telephone
companies as a cost of providing the service in question.
|
|
Sprint Canada Inc. (Sprint) requested that the Commission
immediately adopt a moratorium on further Stentor member targeted long distance discount
plans, pending implementation of equal access and a new incentive-based regulatory
framework flowing from the Regulatory Framework proceeding.
|
|
In making its request, Unitel stated that the telephone
companies have aggressively used their dominant position in the long distance market to
target their competitors in the limited market segments that are open to competition.
Unitel submitted that this pricing strategy would not be possible if these markets were
characterized by effective competition. Unitel stated that it is made possible by
Stentor's overwhelming dominance, resulting from a number of factors including technical
barriers to entry into certain key market segments and a high degree of customer inertia
towards changing carriers. It was Unitel's position that the combination of these factors
enables Stentor to target massive price cuts in the relatively small market segments where
Unitel and other entrants can compete, while maintaining prices well above cost in the
segments where there is still a captive market.
|
|
Unitel submitted that the problems associated with
targeted pricing are made worse by the fact that the telephone companies are not currently
required to include contribution as an imputed cost in the Phase II cost studies that they
file to justify rate reductions or changes. Unitel stated that this enables the Stentor
companies to average contribution over various market segments, recouping more
contribution from residential and small business customers and less from discounted toll
services and 800 services. Unitel argued that competitors, on the other hand, cannot
pursue a similar strategy due to the barriers to entry and customer inertia in high
contribution markets.
|
|
Unitel submitted that contribution should be treated as a
cost for all telephone company services, as is the case for competitors. Unitel's view was
that long-run incremental cost plus average telephone company contribution applied at the
individual service level would provide a meaningful test for anti-competitive pricing
during the interim period prior to the implementation of a new regulatory framework.
Unitel's view was that, unless the telephone companies (like competitors) are required to
recognize contribution as a cost of providing their services, they will easily be able to
price below competitors and squeeze them out of the market. Unitel considered the
imputation of contribution to be an essential requirement to prevent the telephone
companies from competing unfairly, and stated that, without this type of interim
safeguard, many competitors would not survive the transition to workable competition.
|
|
Comments regarding targeted pricing, anti-competitive
pricing, the imputation of contribution and Unitel's and Sprint's requests were received
from various parties, including AGT Limited (AGT); British Columbia Old Age Pensioners'
Organization, Council of Senior Citizens' Organizations, West End Seniors' Network, Senior
Citizens' Association, Federated Anti-Poverty Groups of B.C. and Local 1-217 IWA Seniors;
Competitive Telecommunications Association; the Director of Investigation and Research,
Bureau of Competition Policy; Government of Ontario; National Anti-Poverty Organization;
Government of Quebec; Sprint; Stentor Resource Centre Inc., on behalf of BC TEL, Bell
Canada (Bell), The Island Telephone Company Limited (Island Tel), Maritime Telegraph &
Telephone Company Limited (MT&T), The New Brunswick Telephone Company Limited (NBTel)
and Newfoundland Telephone Company Limited (Newfoundland Tel); and Unitel.
|
|
II EXISTING FRAMEWORK
|
|
In Competition in the Provision of Public Long Distance
Voice Telephone Services and Related Resale and Sharing Issues, Telecom Decision CRTC 92-12, 12 June 1992 (Decision 92-12), the
Commission established criteria for granting interim ex parte approval to telephone
company competitive toll filings. Subject to any considerations concerning unjust
discrimination or undue preference, those criteria are:
|
|
(1) the proposed rates must be compensatory, on the
basis that revenues from the service exceed causal costs; and
|
|
(2) either:
|
|
(a) the proposed rates must result in an
insignificant reduction in contribution; or
|
|
(b) any significant reduction in contribution must
amount to the elimination of surplus revenues.
|
|
The "compensatory" test established in Decision 92-12 (i.e., paragraph (1) above) excludes
any provision for the imputation of contribution and is applied to a service as a whole.
|
|
The Commission recognized in Decision 92-12 that the telephone companies' implicit
contribution would vary across market segments, stating that "the use of an average
measure would likely encourage competitors to target those areas of the market that
generate an above average level of contribution. As a result, they might gain a larger
proportion of that market, while the respondents would be left with a larger proportion of
the low contribution market."
|
|
With respect to targeted pricing, the Commission stated
that:
|
|
(1) "subject to local rate impact
considerations, the Commission has found that plans by the respondent telephone companies
to introduce targeted rate reductions are in the public interest, particularly in light of
concerns about the competitiveness of Canadian business and bypass of Canadian network
facilities"; and
|
|
(2) "the Commission considers that targeted
discounts, such as those proposed by the respondents, represent a reasonable approach to
reducing long distance rates."
|
|
III TARGETED PRICING, ANTI-COMPETITIVE PRICING AND
THE IMPUTATION TEST
|
|
A. General
|
|
The Commission notes that, as long as the regulatory
framework for interexchange services involves something other than complete unconditional
forbearance, a test for anti-competitive pricing is necessary, either as a criterion for
approval of tariffs (in a tariffed environment) or as a test to resolve complaints (in a
de-tariffed environment). There are currently two basic options for such a test: (1) the
Commission's current approach, which requires that rates be compensatory in the sense that
revenues for each service must recover causal costs, and (2) a test that requires that
rates recover not only causal costs, but also contribution (i.e., an imputation test).
|
|
The Commission's approach to targeted pricing in Decision 92-12 essentially relied on market forces. In
other words, it relied on the assumption that, to the extent that the telephone companies
targeted reductions at particular market segments, they would leave other non-targeted
market segments exposed to price reductions by competitors and would make competitive
entry in the non-targeted segments more attractive. The Commission's approach was also
based on the assumption that contribution discounts would be sufficient to offset barriers
to entry across market segments. Under such a scenario, competitors could duplicate the
pattern of contribution across market segments implicit in the telephone companies' rates
by generating a traffic mix similar to that of the telephone companies, or could take
advantage of the telephone companies' targeting strategy by entering other, high
contribution market segments left exposed by the targeting. In addition, over time, one
would expect the telephone companies to respond to entry in the high contribution market
segments, with the result that the difference in contribution across market segments would
be moderated.
|
|
However, based on an examination of the market as it has
evolved since Decision 92-12, the
Commission considers that the contribution discounts established in that Decision, in
conjuction with the current regime for the approval of telephone company tariff filings,
are not sufficient to address concerns over targeted pricing, given barriers to entry and
customer inertia in the non-targeted market segments. From the perspective of a
competitor, contribution represents a tangible, albeit discounted, element of cost. Under
a scenario of unrestrained targeted pricing by the telephone companies, competitors could
be faced with a situation in which they must compete against telephone company prices that
embody a contribution amount that is lower than the competitor contribution cost in that
market segment, but where they are unable to generate sufficient contribution in the less
competitive (and higher contribution) markets to offset the lower contribution markets.
|
|
The Commission considers that, due to their previous
status as monopoly toll providers, the telephone companies have an established and
generally predominant share in all market segments. As a result, their traffic mix, the
presence of barriers to entry and the existence of customer inertia would permit them, on
a sustained basis, to recover contribution from the most highly contested market segments
at a level below the contribution amount per-minute per-end corresponding to line 10 of
the contribution calculations on page 198R of Decision 92-12 (the line 10 contribution amount).
Further, the Commission is of the view that, until barriers to entry and customer inertia
in all market segments have been reduced sufficiently to provide competitors with an
opportunity to compete equally, or until contribution is reduced to levels where potential
variations between high and low contribution market segments is minimal, recovery of
contribution by the telephone companies in specific market segments that is below the line
10 contribution amount would be inconsistent with a fair competitive environment. Until
such time, while recognizing that it will somewhat reduce telephone company pricing
flexibility, the Commission considers it necessary in order to ensure such an environment
that an imputation test be applied, either at the level of individual services or at the
level of each of the basic toll, 800 service and discount toll market segments.
|
|
In the Commission's view, the application of the
appropriate imputation test will ensure that rates are not anti-competitive. Therefore,
there should generally be no additional regulatory concerns with targeted pricing, absent
concerns over unjust discrimination, undue preference, or the impact on local rates. As a
result, the application of the test will have the additional benefit of permitting the
expeditious disposition of telephone company toll filings, provided that adequate
information is submitted in support.
|
|
However, there are several issues to be considered in the
design of an appropriate imputation test. These are:
|
|
(1) the level of aggregation at which the test should
be applied;
|
|
(2) the level of the contribution component;
|
|
(3) what exceptions, if any, to the requirement that
the test be met are appropriate; and
|
|
(4) the specific form of the test and related filing
requirements.
|
|
These issues are addressed below.
|
|
B. Level of Aggregation
|
|
As noted above, the Commission's view is that achievement
of a fair competitive environment requires that the imputation test be applied at the
level of either individual services or market segments. Recognizing the above, in the
Commission's view, there are two primary options for the imputation test:
|
|
(1) a requirement that revenues (or the average revenue
per minute) for each service equal or exceed the sum of Phase II causal costs and
contribution; or
|
|
(2) (a) a requirement that revenues (or the average
revenue per minute) for each service equal or exceed Phase II causal costs; and
|
|
(b) a requirement that revenues (or the average revenue
per minute) for each market segment as a whole equal or exceed the sum of Phase II causal
costs and contribution.
|
|
Option 1 entails the application of the imputation test at
the individual service level, while Option 2 entails the application of the test at the
market segment level. The Commission considers that there are two key considerations
bearing on the question of which option is preferable.
|
|
The first consideration is the degree of pricing
flexibility that the test would permit. A service-specific imputation test (Option 1)
would provide less pricing flexibility to the telephone companies, because they would not
be able to offset recovery of lower contribution from one service with rates that would
recover more contribution from other services in the same market segment (as they would be
able to do under Option 2). The Commission notes, however, that the trend, particularly in
the discount toll and 800 service market segments, is to define services more broadly,
grouping together what would previously have been considered separate services. Thus, any
restriction on pricing flexibility resulting from service level imputation, as opposed to
market segment imputation, may not be significant and may decline over time.
|
|
The second consideration is the regulatory burden
associated with the test. In this regard, the Commission notes that service-specific
imputation would require that only one test be performed, i.e., that the service recover
both its causal costs and the imputed contribution. Market-segment imputation would, in
the Commission's view, require that the telephone company demonstrate that two tests were
met, i.e., that each service recovers its causal costs and that the market segment as a
whole recovers its costs plus aggregate imputed contribution.
|
|
In addition, the information that would be required in
order for the Commission to have confidence in the results would be much greater in the
case of the market-segment imputation test, since, in the Commission's view, the
market-segment test results would be more sensitive to assumptions concerning relative
levels of demand for the various services within the market segment and the degree of
migration of demand from one service to another in response to changes in relative prices
for services within the market segment. Assumptions such as these are difficult to verify
in a rapidly changing competitive market. Current information requirements for toll
filings making use of estimates of migration between services and competitors are
extensive, and require the use of complex and highly judgmental models and sensitivity
analyses involving the various assumptions. As a result, they can give rise to controversy
and delay. Consequently, from the perspectives of practicality and regulatory
streamlining, the Commission considers that the service-specific imputation test is
preferable as a means to support tariff filings.
|
|
On balance, the Commission is of the view that the
service-specific imputation test (Option 1) is the preferred option. Given the trend
towards more broadly defined services, the Commission considers that this option provides
a reasonable balance between pricing flexibility and practicality of application.
|
|
In light of the above, effective the date of this
Decision, the Commission will require that the service-specific imputation test be applied
to all applications for toll rate reductions or new toll services on the part of AGT, BC
TEL, Bell, Island Tel, MT&T, NBTel and Newfoundland Tel, in place of the current
requirement that proposed rates be compensatory on the basis that revenues from the
service exceed causal costs. Since the application of the imputation test represents a
change in Commission policy, the requirement that the test be met will apply only to rates
approved after the date of this Decision. Thus, the Commission does not, as a result of
this Decision, envisage increases to toll rates that have already been approved.
|
|
Some parties suggested during the Regulatory Framework
proceeding that a service-specific imputation test would force price increases for
off-peak basic toll service. As noted above, the imputation test is to apply only on a
going-forward basis and, for this reason alone, would not force such price increases. In
addition, intra-company off-peak basic toll is not a service for the purposes of
service-specific imputation; rather, the service for the purposes of the imputation test
is intra-company basic toll in total. Specifically, the service definition to be used for
the purposes of the service-specific imputation test is the tariff definition (for
example, Advantage Preferred, Teleplus Subscription Service, Between Friends, Advantage
800, Advantage Vnet, etc.).
|
|
C. Level of the Contribution Component
|
|
In Decision 92-12, the Commission found it appropriate to
establish contribution discounts as a means of achieving competitive equity. Consistent
with that approach, the Commission considers that the undiscounted contribution amount
(i.e., the line 10 contribution amount) is the appropriate amount to be included in the
imputation test, rather than the discounted contribution amount that would have been paid
had a competitor carried the traffic.
|
|
A further issue with respect to the contribution component
of the imputation test relates to direct access lines (DALs). Pursuant to Decision 92-12,
competitors do not pay contribution on traffic originated or terminated on DALs. In
Decision 92-12, the Commission stated that directly applying a contribution charge to
traffic carried on DALs would be administratively difficult, if not impossible.
|
|
Given that finding, the Commission considers that, for the
purposes of the imputation test, contribution should not be included for telephone company
traffic originated or terminated on DALs (a telephone company DAL would be an access line
dedicated exclusively to a service or services in the Competitive Toll or Competitive
Network Phase III categories). In the Commission's view, an imputation test that imputed
contribution on the telephone companies' DAL traffic would be inconsistent with
competitive equity.
|
|
D. Exceptions to the Test
|
|
The Commission considers that below-cost pricing in the
case of market trials and promotions is generally not anti-competitive. Accordingly,
market trials and promotions will be exempt from the application of the imputation test,
on the condition that sufficient information is provided by the telephone companies to
demonstrate that the offering is a legitimate market trial or promotion of limited
duration. The Commission's general policy will be not to permit other exceptions to the
requirement that the imputation test be met.
|
|
E. Specific Form of the Test and Related Filing
Requirements
|
|
AGT, BC TEL, Bell, Island Tel, MT&T, NBTel and
Newfoundland Tel are directed to provide, effective immediately, imputation test
information with all tariff applications for toll rate reductions and new toll services,
as a replacement for item (4) of the Appendix to Information Requirements for Competitive
Toll Filings by the Telephone Companies, Telecom Letter Decision CRTC 93-12, 30 July 1993.
|
|
The Commission considers that the application of the
imputation test approved in this Decision should involve the use of the appropriate Phase
II study (excluding cross-effects), as modified to reflect the imputation of contribution
as a cost. The Commission will require that the test be applied for each company, unless
all revenues (both intra-company and non-intra-company) associated with the service in
question are subject to settlement, in which case a single Stentor study is appropriate.
|
|
The telephone companies are directed to identify the
imputed contribution component separately and to describe and justify their assumptions
concerning the proportions of telephone company traffic originating and terminating on
DALs.
|
|
The Commission notes that, given the sensitive nature of
cost information for competitive toll services, the information filed to demonstrate
whether or not the imputation test is met will likely be filed in confidence. In general,
the Commission considers this appropriate. However, in general, the Commission considers
that, at a minimum, the following should be placed on the public record:
|
|
(1) a statement as to whether or not the imputation test
is met and, if not, the justification for the proposed rates; and
|
|
(2) details of the method used to perform the imputation
test.
|
|
AGT raised the concern that Phase II does not represent an
appropriate incremental cost test for the purpose of determining whether or not a
competitive service is compensatory. AGT indicated that the costs produced by Phase II
studies would be acceptable if the variable common cost factor (VCCF) currently employed
in the analysis were removed. AGT was of the view that the inclusion of variable common
costs is inconsistent with the estimation of service-specific causal costs.
|
|
The Commission notes that the purpose of the Phase II
costing methodology is to estimate causal costs for individual services and that the VCCF
is intended to estimate costs causal to a service that it would be impractical to estimate
through some other means. In any event, the Commission is of the view that the Regulatory
Framework proceeding is not the appropriate forum in which to consider the details of the
variable common cost estimation methodology or the appropriateness of the inclusion of
such costs in the estimation of causal costs for individual services.
|
|
IV OTHER MATTERS
|
|
With respect to part (1) of Unitel's request, the
Commission notes that, in Review of Phase III, Telecom Public Notice CRTC 94-16, 16 March
1994, it denied Unitel's requested interim 35% reduction in the contribution charges paid
by competitors. However, the outcome of the Phase III review may have an impact on the
costs calculated for the purposes of Phase II. Therefore, AGT, BC TEL, Bell, Island Tel,
MT&T, NBTel and Newfoundland Tel are directed to provide a report on any such impact,
as well as any consequential changes to their Phase II manuals, within 30 days of the
Commission's decision in the Phase III review, detailing:
|
|
(1) any changes to Phase II methodology or costing models
resulting from the Phase III review decision; and
|
|
(2) plans for the implementation of the above.
|
|
In the Commission's view, this Decision addresses the
concerns related to targeted pricing underlying Sprint's request for a moratorium on
further Stentor member targeted long distance discount plans. Accordingly, the Commission
denies that request.
|
|
V STATUS OF THIS DECISION
|
|
In light of other determinations to be made in the
Regulatory Framework proceeding, this decision is interim and is subject to change in the
Commission's decision on the other issues in that proceeding.
|
|
The Commission notes that Manitoba Telephone System
(Manitoba Tel) was not subject to the Commission's jurisdiction when Public Notice 92-78
was issued and was therefore not made party to the Regulatory Framework proceeding. The
Commission's preliminary view is that it would be appropriate to apply the imputation test
to Manitoba Tel. Manitoba Tel is therefore directed to show cause, by 12 August 1994, why
it should not be made subject to this Decision. The company is to serve copies of its
submission on parties to the Regulatory Framework proceeding by the same date. Parties may
comment on Manitoba Tel's submission by 2 September 1994. Manitoba Tel may file a reply by
19 September 1994.
|
|
Allan J. Darling
Secretary General
|