nomdenet@venera.isi.edu (10/05/89)
The story below is from the Los Angeles Times of October 1, 1989,
in the Business Section (part IV), p. 1. Reprinted without permission.
Rewriting the Book on Phone Rates
by
Bruce Keppel
Times Staff Writer
(San Francisco) Charlotte Ford's cubbyhole of an office hardly
looks like a place where history is being written. But it is there,
nonetheless, that the 36-year-old administrative law judge distilled,
from thousands of pages of sometimes gnarly testimony, what may be the
most far-reaching regulatory proposal every made by the California
Public Utilities Commission.
What Ford has wrought on behalf of her bosses -- the five utilities
commissioners appointed by Gov. George Deukmejian -- is a 361-page
blueprint to overhaul regulation of the state's two biggest local
phone companies, Pacific Bell and GTE California.
One virtually certain result of this proposal, expected to be
approved Oct. 12 after some final tinkering by the commissioners, will
be lower basic phone rates next year. Another will be freedom for the
companies to shoot for higher profits and to enjoy unprecedented, if
limited, latitude in setting prices for optional telephone services.
The long-term payoff, if the system works as Ford conceived it,
will be a streamlined regulatory process that liberates the phone
companies to pursue technological advances that benefit the economy
and hold down prices for phone customers.
And although many consumer advocates are doubtful that those goals
will be realized, the PUC's push in telecommunications is expected to
foreshow a fundamental change in the way that the agency deals with
energy utilities, freight haulers and the other businesses that it
regulates.
"There has to be streamlined processing," said Commissioner John B.
Ohanian. "I envision the commission getting away from the
'micromanagement' of these companies. Instead, let's modernize the
way we regulate and synchronize it with the pace of change in the
business world."
At the top of the PUC's agenda is phone regulation. A number of
other states have similarly re-examined traditional phone regulation
but, with the possible exception of Vermont, California is proposing
the most comprehensive overhaul.
Simplified Process
With the new plan, gone will be the close surveillance of
management decisions made by Pacific Bell and GTE California -- a
prospect that delights both companies. Traditional rate-making
procedures now require the PUC to determine utility costs, a process
that requires poring over corporate books and second-guessing
management decisions to arrive at the amount of annual revenue that
the company will need to break even. The commission then adds to that
sum a maximum profit for the companies to shoot for but not exceed and
finally sets phone rates accordingly.
The Ford plan would authorize the PUC to continue setting prices
for basic telephone service, although it would simplify the way that
is done. It also would:
- Cap prices for such optional "enhanced services" as call forwarding
and let the companies lower charges if they wish, perhaps to increase sales
volume.
- Deregulate prices for the present handful of competitive services,
such as yellow pages advertising and, perhaps, maintenance of phone wires
in businesses and homes.
- Replace commission-imposed penalties for unnecessary investments and
excessive costs with financial incentives to reward efficiency.
To make this more flexible pricing system work with a minimum of
state intrusion, Ford created the most elaborate system so far of
"checks and balances" designed to protect shareholders and customers
alike. Yet, in California as in the other states tinkering with
regulatory reform, only the telecommunications investors and the
companies involved seem to support the changes.
Many customers -- including giant long-distance carriers such as
American Telephone & Telegraph and MCI, which depend on local phone
companies to complete their calls -- worry that loosened regulation
will mean service headaches. Ironically, AT&T recently was granted
greater pricing flexibility in its long-distance operations by both
state and federal regulators.
For the first year under the new regulatory setup, the PUC will
lower phone rates because both Pacific Bell and GTE California have
exceeded their currently authorized profit ceilings.
Productivity Factor
After that, and on Jan. 1 of every year from now on, the companies'
anticipated revenue figure will be adjusted for inflation, minus an
assumed reduction in operating costs due to belt tightening and
labor-saving technology.
Ford proposed what it {sic} calls a 4% "productivity factor."
Thus, if inflation boosted costs generally by 5%, only a 1% increase
would be passed on to telephone customers. "This productivity target
will challenge [the phone companies] to be at least 4% more efficient
in their operations than is the economy as a whole," she maintained.
A key question that the five commissioners must decide Oct. 12 is
whether Ford's 4% productivity factor is reasonable. The companies
argue that 4% is too ambitions, while the consumer lobby known as TURN
(for Toward Utility Rate Normalization) says it should be more like
7%. Moreover, TURN considers Ford's proposal to be "overwhelmingly
skewed in the utilities' favor," said executive director Audrie
Krause, a former Fresno Bee newspaper reporter who assumed her TURN
job last summer.
Under traditional regulation, Krause pointed out, the PUC limited
company profits, or rate of return, and required any excess earnings
to be refunded. The maximum profit margin for Pacific Bell currently
is 11.34% and 11.13% for GTE California.
Because a basic principle of Ford's plan is to strengthen the
profit motive, she set a target rate of return, based on her estimate
of current market conditions, of 11.75% for 1990. But she would let
the companies keep all earnings up to 12.75% to motivate them to
perform well, then would allow them to keep half of any additional
earnings up to a maximum of 16.75%
TURN considers each of these benchmarks, especially the 16.75%
maximum return, to be far too generous, and it also urged that if the
commission allows any profit sharing, consumers should get 60% of the
earnings involved, not 50% as Ford suggested.
In contrast to TURN's strong opposition, PUC President G. Mitchell
Wilk, who has worked closely with Ford as the commissioner responsible
for the case, hailed Ford's framework as "a win-win situation" for
customers and investors.
"It needs to be improved in some areas, filling in some gaps and
doing more balancing," Wilk said, but he defended the 4% productivity
factor as "a real stretch" for Pacific Bell and GTE California. He
termed TURN's opposition shortsighted, saying the 1984 breakup of the
Bell System and rapid technological changes have made reform
inevitable and probably overdue.
"Divestiture changed the regulatory framework for this industry,"
Wilk said. "We can't put our head in the sand and pretend we're
dealing with Ma Bell.
Carl Danner, Wilk's telecommunications adviser, said Ford's
framework creates necessary new incentives to reward efficiency and
get telephone employees "thinking the way we want them to think"
instead of trying to "put one over" on regulators by padding costs to
boost revenue.
"Our economy runs on these incentives," said Danner, who holds a
doctorate in public policy from Harvard University's Kennedy School of
Government. "To the degree that the phone companies are losing their
monopoly status, their world should begin to look more like that [of
the the competitive economy]. It's becoming untenable to do the other
form of regulation."
Terry L. Moore, who heads a PUC division representing utility
customers, agreed with TURN, however, that some of Ford's profit
targets are too generous and that the productivity factor is too low.
Still, Moore added that she is "in general comfortable with the
framework" that Ford devised. "The key is getting [rates] right at
the start."
William R. Ahern, a former RAND Corp. analyst who now is PUC
director of strategic planning, said Ford's framework also makes it
far more difficult for the phone companies to unfairly subsidize their
competitive ventures with profits from the basic phone business. If
successful on that score, Ford's plan would resolve a lot of
complaints already made by would-be competitors in such areas as
voice-mail services, privately owned pay phones and telephone wiring
repairs.
Commissioner Frederick R. Duda called the impending commission
decision "clearly historical" and one not to be confused with
deregulation. "This is not deregulation and it's not traditional
regulation," he said. "It's a compromise. And the question is
whether it will work and for how long.
"Marketplace reality has caught up with the system," Duda said.
Duda -- along with commissioners Ohanian, Wilk, Stanley W. Hulett
and Patricia M. Eckert -- has reservations on a number of details, but
all five seemed, in separate interviews last month, to be generally
pleased with the comprehensive plan.
For Ford, the telephone case represents by far the most complex
that she has handled. The Mississippi native, who holds a bachelor's
degree in mathematics and a master's degree in electrical engineering,
said her aim was to devise a framework that would work adequately even
when some of the forecases for the telephone business are off the
mark.
"We can be fooled by forecasts," Ford said recently as she sat in
her tiny office surrounded by volumes of hearing testimony and a stack
of comments on her framework. She said she tried to create "checks
and balances" within the framework to contain excessive earnings -- or
losses if the bottom falls out of the market -- within reasonable
limits.
That approach is also demonstrated, she said, by the way in which
implementation will give customers the first benefit in the form of an
immediate rate cut, in inflation-adjusted dollars, while shareholders
will get theirs later in the form of higher profits if their company
performs well.
In any case, she added, the commission will reassess the new system
in 1992.
Investment analysts generally warm to any attempt to allow market
forces to work within a regulated environment -- and especially to
shift from cost-based regulation to pricing regulation because of the
potential for higher earnings. Even so, Robert B. Morris III of
Goldman, Sachs & Co. foresees some potential problems for both
telephone customers and the companies themselves.
"It's a break from historical regulation," Morris acknowledged,
"but to me it doesn't appear that the commission has handed them they
keys to the kingdom."
Moreover, he added, there may be a drawback for consumers. By
dividing telephone offerings between tightly regulated basic telephone
service and flexibly priced enhanced telecommunications services,
Morris said, the new regulatory framework may interfere with the
smooth flow of new technology throughout California.
In other words, Morris said, some markets outside major
metropolitan areas might not get certain advanced services unless
regulators require them to. "Only markets that can pay for them will
get the services," Morris predicted.
To Ford, criticism and controversy come with the territory. "No
one's going to entirely like what you do," she said.
"And if someone does," she added, "it makes you wonder if you've
done the job."
Sidebar: Incentive-Based Rate Plan Takes Phased Approach
---------------------------------------------------------
The California Public Utilities Commission is expected this month
to adopt an incentive-based system for regulating Pacific Bell and GTE
California. As proposed, effective Jan. 1, the system would:
- Cut phone rates next year and then peg them in future years to a
cost- adjusted formula. This formula would limit price increases to
the rate of overall inflation minus 4% for assumed efficiencies due to
cost cutting and labor-saving technology. Thus, in a year in which
the cost of living increased 5%, telephone prices should rise no more
than 1%. If inflation rose less than 4%, phone prices would actually
be cut.
- Reorganize regulation so that the PUC still would set rates for
basic phone service, which on the local level remains a monopoly.
Prices for most optional calling features would be capped, but the
companies would be allowed to lower charges, within limits, if they
wished to encourage usage. Prices would be deregulated for such
services as yellow pages advertising where competitive alternatives
already exist.
- Authorize the PUC, as part of its rate-setting procedure, to
establish a target rate of return for the phone companies, the
companies could keep all profits for another percentage point, but
earnings in excess of 12.75% would be split evenly between customers
and the company. Earnings exceeding a 16.75% return would be
refunded. For phone customers, the refund would come as credits in
future bills.
In a final phase of the regulatory revision to be completed next
year, the proposal calls for the commission to revise all telephone
rates to reflect the new system. This "rate design" phase would
eliminate the bewildering array of credits and surcharges applied to
customers' bills. At that time, the proposal recommends that the PUC
scrap a 20-year-old $1.20 monthly fee for "Touch tone" service and
also expand the local service area in which unlimited calls can be
made at no extra charge from 8 miles to 12 miles.