Dennis Weller Chief Economist Verizon Progress and Freedom Foundation 1 March 2007 Modernizing Universal Service: Meeting America’s Universal Service Goals in a Challenging Future in a Challenging Future

2 The World Has Changed t New competition, technology t Large companies forced to reinvent themselves t Change now coming to high cost areas 3Lines, minutes declining 3CETCs in two thirds of study areas t Challenge for universal service 3How to modernize the system for the future 3Adaptation, efficiency, market forces

3 Problems With the Current Fund t It’s not sustainable 3Total USF is now more than $7 billion 3Funding for competitive providers (CETCs) has grown from $20 million to more than $1 billion in five years. 3Contribution percentage has tripled from 3.16 % in 1998 to 9.7 % today.

4 Total Federal USF over $7.5 Billion in 2007

5 CETCs have driven recent fund growth

6 Problems With the Current Fund t Little incentive for companies to adapt, become efficient 3ILECs who spend more, get more 3When ILECs get more, CETCs get more 3Churn, instability of fund t Rate-of-return process does not provide the right response when the world changes 3What to do when lines and minutes go away? 3How to develop new business models or revenue streams?

7 Why an Auction? t Competitive bidding is the normal way for government to buy products and services 3Selects the most efficient provider 3Ensures the best terms for the public 3Transparent, open process t Brings market forces to bear on universal service t Provides a way to assign value to items not commonly traded

8 Verizon proposal: Step 1 t Stabilize the fund and create better incentives 3Cap the support amount based on current levels 3Separate caps for each study area 3Separate caps for wireline and wireless 3Provides starting point for auctions

9 Verizon proposal: Step 2 t Adopt a framework for auctions 3Administrative framework äAreas for bidding äNomination process äBidding cycles 3Auction design äA “clock-proxy” auction äTakes advantage of recent advances in auction design äPackage bids for groups of areas äSingle winner, flat amount of support äReserve based on capped support

10 Verizon proposal: Step 3 t Auctions for wireless CETCs 3Auction in each area with more than one wireless CETC 3Wireless CETCs account for most of growth in fund today 3Auction selects a single wireless provider of universal service in each area 3ILEC continues to receive its capped support 3Of 1439 study areas, 481 have more than one wireless CETC today t Auctions for wireline ETCs 3Auction in each area with a wireline CETC 3Auction selects a single wireline provider of universal service 3About 90 study areas today

11 Verizon proposal: Step 4 t FCC reviews auction experience t Considers changes in market, technology, customer acceptance t Considers appropriate next steps, including whether to extend auctions: 3One auction in which wireless and wireline ETCs participate – selects a single provider of universal service 3Representative bidding: use auction results to estimate support for ETCs whose support has not yet been set by an auction

12 Considerations in Design of Universal Service Auctions t How many winners? 3One 3More than one 3Endogenous 3All

13 Considerations in Design of Universal Service Auctions t Form of bid/payment? 3Per line 3Lump sum

14 Considerations in Design of Universal Service Auctions t Structure of auction? 3Single round/sealed bid 3Multiple round 3Combinatorial

15 Different Circumstances, Different Choices t GTE/Milgrom/Weller, Endogenous determination of winners 3Per-line bid/payment 3Single round/sealed bid t Verizon, Single winner 3Lump sum bid/payment 3Multiple rounds with package bidding

16 A Clock-Proxy Auction The Clock Phase t Auctioneer calls out price for each area 3Begins with reserve 3Prices linear, anonymous t Bidders indicate which areas they would serve at stated price 3Each bidder’s “package” is the list of areas where it said yes t Where there is more than one bidder, auctioneer calls out lower price in next round 3Activity rule 3Price decrement t Rounds continue until there is no more than one bidder for each area t Optimization after last round of bidding

17 A Clock-Proxy Auction The Proxy Phase t Begins with results of clock phase t Fine-tunes results 3Relaxes constraint on prices 3Allows better provision for complements t Each bidder submits valuations 3For any package t Proxy agents submit bids on bidders’ behalf 3On each bidder’s best package t Bidding ends when no further opportunities are available

18 Why not “winner takes more?” t Incentives to bid t Collusion t What is the auction supposed to determine? 3Difference between winning and losing t Distortion at the margin

19 Verizon proposal: A measured, balanced approach t Takes immediate steps to stabilize fund, improve incentives t Introduces auctions quickly where they can do the most good t Gives FCC flexibility to assess experience, decide how to extend auction to rural companies t Modernizes universal service 3To meet America’s universal service goals in a competitive future 3Consumers benefit from lower surcharges, new services 3A more efficient, market-oriented system