Unified Intercarrier Compensation – An Old Problem 1980 FCC Tentative Access Plan (pre- divestiture) Found the wide variety of existing access compensation methods unreasonably discriminatory and sought to replace them with a unified method Blocked by opposition from those who would pay higher rates

2001 Unified Intercarrier Compensation NPRM “We are particularly interested in identifying a unified approach to intercarrier compensation.” “We also seek comment on the potential adoption of a bill-and-keep approach to reciprocal compensation payments... And the eventual application of bill and keep to interstate access charges.” No consensus or final order.

Problems with Current System Multiple compensation approaches have developed over time with each one based on a particular technology, service configuration, jurisdictional structure, and assumed charging pattern. The access charge system was designed to both provide compensation for services provided and to provide subsidies to particular carriers. Multiple systems create opportunities for arbitrage and incentives to route and classify traffic to take advantage of particular intercarrier compensation rates.

Access Charges Access charges were developed for the post- divestiture world to accommodate separate long distance and local companies, using circuit switched voice communications, with an assumed pricing structure of high per-minute prices paid by the customer to the long distance provider, and to maintain pre-divestiture long- distance revenue flows to local companies. The assumptions behind the access charge structure are inconsistent with current industry structure, technology, and pricing patterns.

Reciprocal Compensation Reciprocal Compensation was established by the Telecommunications Act of 1996 for the interconnection of local exchange carriers. The reciprocal compensation system encourages privately negotiated agreements between the interconnecting parties with state regulatory commission arbitration when private bargaining fails. As technological progress continues to reduce the significance of distance in telecommunication cost, the historical distinction between local and long distance traffic has become largely irrelevant. The “local” reciprocal compensation approach provides a useful template for developing a unified approach to intercarrier compensation.

Example – Reciprocal Compensation in Long Distance Consider a rural ILEC interconnecting with an large integrated company such as AT&T. Currently AT&T collects the long distance revenue and pays access to the ILEC. With reciprocal compensation, the ILEC terminates inbound traffic in exchange for the right to send traffic over the AT&T network. The ILEC gives up access revenue but gains long distance revenue, either as separate charges or as a component of an improved distance-insensitive service for its customers.

Bill and Keep Bill and keep (or peering) is reciprocal compensation with a rate of zero. In many interconnection arrangements, bill and keep accurately represents the mutual benefit provided to the interconnecting parties. The transaction cost savings compared to systems that require measuring and billing for all traffic can compensate for minor departures from cost causation. I do not believe that it is desirable to prescribe bill and keep (or any other specific set of interconnection rates) because of current or future situations where it would lead to poor results.

Private Bargaining Private bargaining is the foundation for a market-oriented system and should be utilized when feasible. Problems of terminating monopoly and the strategic use of interconnection to create or maintain monopoly power make it unlikely that private bargaining alone will consistently produce efficient interconnection and compensation agreements.

Arbitration The reciprocal compensation experience has shown that binding arbitration can play a critical supporting role to private bargaining. Parties have found high transaction costs in arbitrations before state commissions that in some cases resemble regulatory hearings. Economic theory suggests that contracts that more accurately reflect the goals of the parties can be developed with expert arbitrators than with general court enforcement because of the more detailed and precise information that can be utilized in the contract.

Scope of Reform Efforts over the past several years to develop a unified intercarrier compensation structure arose from problems of fitting newer services into old categories of local and long distance or interstate and intrastate. Current and future services (VoIP, Apple iPhone, Google G1) also cross boundaries between common carrier and information services. A unified structure should have a wide scope that can be applied easily to new services that cross old boundaries.

Proposed Reform Structure Abolish access charges and clearly separate universal service subsidies from intercarrier compensation. Build on the existing reciprocal compensation structure with private bargaining backed up by arbitration. Change arbitration from state regulatory commissions to panels of industry experts.

Transaction Cost Considerations Pure bargaining and arbitration can lead to high transaction costs as similar issues are negotiated and arbitrated multiple times. The FCC should specify a general framework of principles and default arrangements to guide the parties. Principles should include the presumption that exchange of traffic benefits both parties, that bill and keep often represents an efficient method of intercarrier compensation, and that intercarrier compensation should not be used for strategic advantage. Presumptions could be ignored by mutual agreement of the parties and could be overturned by arbitrators when a party provides evidence that they should not apply.

Industry Arbitrators The benefit is detailed experience and expertise which should reduce the cost of presenting cases to them and should allow more precise and relevant interconnection and compensation agreements. The problem is potential conflict of interest. While the problem of bias cannot be entirely overcome (even when the arbitrators are regulators), economic theory provides some guidance is structuring arrangements so that long term self-interest outweighs short-term incentives to act opportunistically.