How Telephone Companies Make Money Doug Kitch Vince Wiemer Vince Wiemer

Discussion  Rate-of-Return Regulation  Revenue Requirement  Jurisdictional Separations  Cost Recovery  Local Rates  Access  The NECA Pools  Universal Service Funds

Rate-of-Return  A method of utility regulation that provides a company with an exclusive service area but limits their earnings  The utility earns a pre-determined rate-of-return on their utility investment plus recovers allowed operating expenses and income taxes

Rate-of-Return (cont’d)  RoR regulation was put in place to encourage the large investments required for utilities  Common for gas, electric, and telephone utilities  The amount of money that a RoR utility is entitled to earn is called their REVENUE REQUIREMENT

Revenue Requirement TThe authorized level of earnings allowed Telephone Property, Plant & Equipment - Accumulated Depreciation = Rate Base x Rate-of-Return % = Return on Rate Base + Operating Expenses + Income Taxes = REVENUE REQUIREMENT

Revenue Requirement (cont’d)  Rate-of-Return regulation means that more plant investment and more operating expenses result in more income (revenue requirement)

Revenue Requirement Example  RoR also means that over time, earnings will decrease as plant depreciates

Jurisdictional Separations  Telephone carriers are regulated by both state & federal government  State jurisdiction → local & state toll  Federal jurisdiction → interstate toll  So rate base and revenue requirement must be divided into their respective jurisdictions  Separations or “cost” studies are performed to accomplish this task

Separations Net Telephone Plant x Rate of Return + Operating Expenses = Total Revenue Requirement State & Local Revenue Requirement Jurisdictional Separations Interstate Revenue Requirement

Part 36: Separations Rules  Primary purpose of Part 36 is to assign “property costs, revenues, expenses, taxes and reserves between state and interstate jurisdictions”  Costs are categorized based on function and use of the related plant

Basic Studies  Four basic studies are performed to determine the use of facilities:  Traffic Study  Commercial Office Study  Central Office Equipment Study  Cable & Wire Facility Study  Then costs (plant balances & expenses) are allocated to jurisdictions based on these usage factors

Cost Recovery  Once the jurisdictional revenue requirements are determined, there is the issue of recovering the costs  Telephone companies have three revenue streams:  Local service rates from end-users  Access rates from long distance carriers Interstate and State access rates  Universal Service Funds from the Federal & state governments

Revenue Sources State & Local Revenue Requirement Jurisdictional Separations Interstate Revenue Requirement Interstate Access NECA Pools Intrastate Access USF Local Revenue Total Revenue Requirement

Universal Service & Rates  All rates are influenced by universal service  Universal Service is a policy that states that all Americans have the right to quality telecommunications services at affordable rates  Because of universal service, local telephone service in urban areas subsidizes rural service

Cost Recovery (cont’d)  Local Rates are set by State PUC  Access rates are determined by the cost of providing toll services (access costs)  Determined by cost study  Universal service funds make up most of the difference between the cost of providing local service and the local rate

Access Rates  Access costs vary for each telco Access cost ÷ Toll minutes = Access rate  For ease of administration, the National Exchange Carrier Association (NECA) produces one tariff for a large number of telcos

Access: NECA Pools  The telco charges the long distance company the tariff rate (the average access rate developed by NECA)  NECA pools the money and distributes it to the telco based on the telco’s individual costs  Determined from the cost study

Universal Service Funds  Universal service funds are government subsidies for local service in high cost area  The telco’s average cost per loop is calculated [rate base + operating expenses] ÷ number of lines and compared to the National Avg Cost per Loop (NACPL)  A percentage of the difference is received as a subsidy

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