1. TA 96 on pricing Prices for interconnection and for UNEs to be based on cost, to be nondiscriminatory, and may include a reasonable profit –Cost to be determined without reference to rate-of-return or rate-based proceeding Resale prices: on the basis of retail sales less marketing, billing, collection and other avoidable costs

2. So what is cost? Accounting cost or economic cost? Fully allocated cost or incremental cost?

3. Fully allocated historical cost Start with the $$$ in the company books Allocate all $$$ to the various services provided by the company

4. Fully allocated historical cost Total Investment and Expenses Local service State toll State access Interstate access Direct costs Indirect costs Overhead

5. Economic costs Forward looking (not historical) Incremental (additional costs)

6. Total Service Long Run Incremental Cost Study (TSLRIC) TSLRIC is equal to the firm’s total cost of producing all of its services assuming the service (or group of services) in question is offered minus the firm’s total cost of producing all of its services excluding the service (or group of services) in question.

7. TSLRIC Important points –Costs are looked at in the long run, so all relevant costs are variable –Only direct and shared costs are included Some allocation is necessary for shared costs Overhead costs are not considered –TSLRIC is used as a floor for pricing services Why?

8. Total Element Long Run Incremental Cost (TELRIC) Applies TSLRIC methodology to UNEs to set a basis for UNE prices TELRIC basically asks, “What is the forward looking cost of providing a UNE, assuming that all other network elements are produced at current levels?”

9. TELRIC Based on an efficient network model –Not based on actual ILEC costs –Efficient network model is based on the network that would be built today, using most efficient technology and most efficient engineering methods

10. Steps in a TELRIC study Identify forward looking investment Determine the utilization factor Divide by demand to get unit investment Multiply by the Annual Charge Factor

11. Points of Contention Study area selected—affects the level of averaging in the study –For example, for local loops, Wire center, census block, city block Network optimization –Do you use the current locations of wire centers or the optimum locations? Will increase costs if use current locations

12. Issues in arriving at an investment What should the utilization factor be? If you assume that you can only use an asset at 85% capacity, then you will increase the unit investment cost. What should demand be? The higher the demand, the lower the unit investment cost

13. Investment calculation Assume $100,000 piece of equipment Assume a 90% utilization factor Assume demand is 2,000 units ($100,000/90%) / 2,000 = $111,111 / 2,000 = $55.55

14. Annual Charge Factor (ACF) Translates investment into recurring costs ACF = Plant Specific Factor + Capital Carrying Charge –Plant Specific Factor and Capital Carrying Charge are also forward looking

15. ACF Plant specific factor –Support staff –Maintenance –Insurance –Floor space, plus other costs Capital Carrying Charge –Depreciation –Cost of capital (debt and equity) –Income taxes

16. Issues in arriving at the ACF What should depreciation be? –The shorter the depreciable life, the higher the percentage Ten year life = 10%; 20 year life = 5% What should the cost of capital be? –Covers both debt and equity capital Impact of risk is important

17. ACF example Plant Specific Factor = 10% Capital carrying charge = 30% Unit Investment = $55.55 ($55.55)*(10% + 30%) = ($55.55) * (40%) = $ 22.22 recurring costs

18. Supreme Court upheldTELRIC ILEC argumentCourt finding TELRIC formula should consider historical cost associated with providing a specific network element ILECs failed to demonstrate the unreasonableness of setting rates on a forward- looking basis TELRIC is needlessly complicated and impractical TELRIC rate proceedings are surprisingly smooth running TELRIC simulates but does not produce facilities-based competition $55 billion in competitive capital spending 1996-2000 says otherwise

19. Pro’s and Con’s Why are ILECs unhappy with Supreme Court decision? Why are CLECs pleased?