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The FCC Reshapes the Telecom Industry
by Jim Surowiecki (Surowiecki)

NEW YORK, N.Y. (May 7, 1997) -- Deregulation, it seems, needs active regulation. At least that's one conclusion that can be drawn from the Federal Communication Commission's unveiling Wednesday of its new plan for the telephone industry. There are a host of competing interests, from long-distance companies anxious to move into new markets to rural residential consumers anxious to keep receiving phone service. The FCC produced a plan that should cut long-distance costs for most customers while raising rates for some small businesses and for individuals who have more than one phone line.

Most intriguingly, the commission followed through on its promise to facilitate access to the Internet. The new plan contains provisions that will allow every classroom and library in America to become wired in the near future at discounts of up to 90%. Up to $2.25 billion a year will be available from a fund created specifically for this purpose. And the money for the fund will be raised from surcharges on additional phone lines and from new fees on wireless and cellular carriers.

While the FCC has obviously been working on the plan ever since the passage of the 1996 Telecommunications Reform Act, it seems possible that the biggest breakthrough in formulating the new rules came last weekend. In the face of the expected FCC vote on a cut in access charges paid by long-distance companies, AT&T (NYSE: T) offered a dramatic cut in long-distance bills in exchange for a reduction in the access charges, which now cost as much as $25 billion each year.

AT&T, in negotiations with consumer groups, agreed to cut daytime and evening charges by 5% and night and weekend charges by 15%. While the changes seem relatively small -- particularly since they apply to the company's basic calling customers, and not those who use a discount plan like Reach Out America -- they would be Ma Bell's first rate cut in five years. While neither MCI (Nasdaq: MCIC) or SPRINT (NYSE: FON) came out with similar offers, both companies tie their rates closely to those of AT&T. In addition, AT&T promised that it would reduce rates again in 1998 if the FCC cut access charges one more time.

The paradox of the telecommunications industry, particularly in the wake of the 1996 legislation, is that competition takes place within a highly regulated environment. This stems not only from the genesis of the industry in the early 1980s court-ordered breakup of AT&T, but also from the foundation of all phone business in this country: the need to continue to provide cheap local service to every customer. The so-called "residential dial tone" requirement underlies the entire debate about the telecom industry, and sets the boundaries within which prices can be established. The current vogue for market forces is constrained, then, by Americans' demand that even rural customers have access to local service.

Reed Hundt, commissioner of the FCC, was unwavering in his insistence that whatever changes the plan created, the "subscriber line charge" paid by all customers would not rise in price. Reconciling that demand with the cut in access charges that both the commission and consumer groups wanted meant the shifting of costs to those people and businesses with additional phone lines and to the newer players in the industry like the wireless carriers.

AT&T's last-minute offer to slash rates, then, came as a boon to Hundt, since it meant that any cut in access charges would not be pocketed by the long-distance companies, as, at least according to the Baby Bells, has happened in the past. In an interview with The New York Times, which broke the story on Sunday, Hundt used unusually vivid language to describe the commission's battles with the nation's largest long-distance carrier. "We have been in a firefight with AT&T behind closed doors, and now the smoke has cleared," Hundt said. Today the FCC suggested that rates for 85% of residential customers would drop significantly over the next five years.

What was especially important about AT&T's offer was that for the first time it split consumer advocates and business groups, both of whom had been the most part skeptical about Hundt's plans. While business groups, particularly those representing small businesses, complained today that the new plan places an unfair burden on them, consumer advocates seem more enthusiastic about the plan than about anything the commission has done in years. Gene Kimmelman of Consumers Union called it "the first real long-distance cut in years" for the average consumer. He also expressed the hope that it might be the first step in a series of rate cuts.

Still, there has been bipartisan opposition to the new plan in Congress. Sen. John McCain, a Republican from Arizona, and Reps. Billy Tauzin (R-La.) and John Dingell (D-Mich.) wrote Hundt a letter after AT&T's announcement voicing their concern about the impact of access-charge cuts on local rates. "Any local telephone rate increases resulting from the [FCC's] actions to modify access charges would be sharply contrary to congressional intent in passing [the 1996 law]," they suggested.

The Baby Bells, meanwhile, have been even more vigorous in their criticism of Hundt's plan. BELL ATLANTIC (NYSE: BEL) termed AT&T's offer "a last-minute ploy" and an attempt to wangle a "sweetheart deal." Edward D. Young III, vice president of external affairs, said, "Federal rules already require significant access rate reductions in addition to the $9 billion in cuts over the last five years, much of which AT&T has pocketed. Rather than pass these previous cost savings on to its customers now, AT&T is going for a new and completely unlawful retroactive rate cut." More troubling, perhaps, Young added that the new plan would mean that long-distance customers would receive a small cut in price that "our customers" would end up paying for.

What remains unclear, then, is to what degree the Baby Bells will pass along the cuts in long-distance charges to their residential customers. Hundt's plan is intended to avert that possibility, and certainly the FCC retains enough regulatory authority to enforce the rules on the residential dial tone. But the curious nature of the phone industry makes it easier to pass along costs, particularly to residential customers, than in other businesses. Since there's no real competition -- at least not yet -- for the actual provision of the dial tone, the companies that control that dial tone have monopoly power (which is why regulation makes so much sense). Until real competition for the dial tone is a serious possibility, backing away from regulation in the name of fostering better service and better price would be a recipe for disaster.

From the perspective of AT&T, though, its willingness -- however forced by circumstance -- to make an offer of this magnitude might be seen as a welcome sign of life from a company that has, over the last year, appeared to have lost its way. Considering that last year AT&T fired 60,000 workers in an attempt to demonstrate its new competitive drive, the results have been painfully paltry. The performance of LUCENT (NYSE: LU) to take only one example, has made many investors wonder if AT&T's best elements have been lost in its many spinoffs. The offer might be seen, then, as an attempt to get back in the game, and to appear more active than reactive.

Still, it was clearly Hundt's pressure for change that provoked the long-distance rate cuts. The FCC has turned in an inconsistent performance over the last five years, and has missed crucial opportunities -- like the auction of digital wavelengths -- to reinvigorate the idea of public regulation. At the same time, both the FCC and the FTC have been more aggressive than many might have expected in 1992. In doing so, they have illuminated the delicate balance of market and government forces that continues to shape the national economy.

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