Soft Tactics for Hard-Nosed Goals

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Time Warner Cable is not known as a legal pussy cat. It takes tiger claws to keep aggressive regulators and frivolous law suits from swamping the business.

So it came as something of a surprise when word spread that Time Warner had adopted a non-confrontational approach with state regulators during the rollout of digital telephone service, another byproduct of its $5 billion capital-spending program designed to move beyond plain vanilla analog cable fare.

Time Warner made a simple decision. It told state officials that because it wanted to enter the phone business with as little hassle as possible, it would meet all regulatory conditions that apply to new entrants.

“To our business people, the important thing was to get out there into the marketplace and not fight about what’s the right regulatory classification,” says Time Warner Cable general counsel Marc Lawrence-Apfelbaum. “I think [the states] were happy to have us come in and happy to have us file.”

It didn’t have to be that way. Time Warner could have insisted that its brand of voice-over-Internet protocol (VoIP) telephony is an interstate information service, a regulatory creature in federal law that is beyond the scope of state authority. VoIP pioneer Vonage Holdings Corp. adopted that hostile approach with the states, leading to litigation with Minnesota regulators in a dispute that is now before the Federal Communications Commission.

Time Warner, opting to be classified as a telecommunications service provider, agreed to provide emergency 911 service; pay into universal service; compensate carriers for terminating traffic; comply with federal wiretapping laws; and obey a host of state consumer-protection measures related to billing and termination of service. In all, these requirements add between $4 and $8 a month to a consumer’s bill.

As an upstart in telephony, Time Warner was allowed to set its own prices. “Our rates are not regulated, because we are a competitive company,” explains Julie Patterson, Time Warner Cable’s chief counsel for voice services. “We do file tariffs, but we are not rate regulated.”

Time Warner’s strategy is paying off. It is offering its Digital Phone service in 24 markets in 11 states and is positioned with other cable companies to become the most potent facilities-based competition that the Baby Bells have seen in a century — a goal of the Telecommunications Act of 1996 that has largely gone unmet.

The company’s marketing is uncomplicated: flat-rate pricing and tons of free features.

Time Warner Digital Phone customers pay $39.95 a month for a service that includes unlimited calling within the U.S. and numerous popular features at no additional cost, such as call waiting, caller ID, voicemail and ID block. These features, also called vertical services, can cost a Baby Bell customer, depending on usage patterns, just as much as the monthly fee for single-line dial-tone service.

In Maine, Time Warner had signed up 18,000 customers to Digital Phone as of June 30, 2004. The company has not released subscriber data in other markets.

The potential returns from VoIP for Time Warner and other cable companies are huge. In August, The Yankee Group predicted that 17.5 million U.S. households will switch to VoIP by the end of 2008, with cable companies grabbing 56% of the market by the end of 2005.

“Although Vonage dominates the market, cable MSOs will take the lead quickly,” Yankee Group’s report says.

Stan Wise, a member of the Georgia Public Service Commission and president of the National Association of Regulatory Utility Commissioners, applauded Time Warner’s conciliatory approach with the states. “I absolutely do [agree with the approach], and I think they are going to go forward [with VoIP deployment],” Wise says. “If something goes wrong, they can always come back and say, 'Hey, we’d love to keep rolling out this wonderful new product, but here’s where we see the problems as we go forward.’”

Scott Cleland, a telecommunication analyst with Precursor in Washington, D.C., says Time Warner was being pragmatic because states have the resources to wage legal battles in courtrooms across the country. “It’s the only way they could do it,” Cleland says. “Don’t fight city hall when you are going to lose.”

In its discussions with the states, Time Warner included one caveat: Although it would comply with state regulation now, it could not guarantee the same cooperation in the future. That was a reference to the fact that the FCC is conducting a rulemaking that could substantially lessen state authority over VoIP providers.

The agency has already barred the states from regulating one VoIP provider, Pulver.com, a computer-to-computer service that is free, does not connect with landline phones, and does not require telephone numbers. The FCC also tentatively concluded that certain Web-based VoIP providers do not have to comply with the Communications Assistance to Law Enforcement Act (CALEA), a federal wiretapping law.

The big question now is: What will the FCC say about cable companies like Time Warner, whose for-a-fee VoIP service does not use the public Internet but interconnects with the circuit-switched network?

The federal-state regulatory matrix involved is complicated. FCC chairman Michael Powell wants to keep VoIP deregulated, but states fear he will adopt policies that siphon subsidies from the existing circuit-switched network. For decades, state policies have directed funds to rural phone carriers to keep phone service affordable in high-cost areas.

State regulators are also concerned that federal preemption would deny them the authority to require Time Warner and other VoIP providers to support state universal service programs or pay intrastate access charges when traditional phone carriers handle incoming VoIP calls. At least 21 state universal service programs would be put at risk if the FCC preempts state regulation of VoIP.

“We would be concerned if we did not have jurisdiction over these entities that are doing business in our states, touching phone lines. And they impact our universal service and the cost of rural telephone providers,” says Wise of the Georgia PSC.

Regulatory changes that drain support for universal service, causing rural phone rates to rise, are political dynamite because lawmakers on Capitol Hill do not want to be inundated with complaints about rising phone bills. On the other hand, if retail phone rates approached true economic cost, new competitors might be tempted to compete against the monopoly provider.

Senior FCC officials have said the agency’s first decision, expected in a few months, would involve the critical jurisdiction issue. If the FCC classified VoIP as an interstate-information service, states would lose authority to impose regulations on Time Warner’s Digital Phone service that the FCC hadn’t approved in advance.

Despite state concerns, federal preemption would assure uniformity and predictability as opposed to a patchwork scheme varying from state to state. “We do think that, going forward, some lighter form of regulation — more set at the federal level — makes sense for VoIP,” Lawrence-Apfelbaum says. “For new entrants like us, does it make sense ideally to have a framework where there is inconsistent state regulation, where there is potentially inconsistent even more local regulation? Probably not.”

The FCC’s next move would involve federal regulatory obligations on VoIP providers. Apart from obligations, cable companies providing VoIP also want certain rights from the FCC, such the ability to interconnect with phone incumbents and protections from exorbitant pole-attachment fees. Those rights are not guaranteed today for Internet service providers.

Many of the obligations the FCC is expected to adopt have already been embraced by Time Warner. The company has endorsed support for universal service, and it has no intention of discontinuing services that protect public safety, such as 911 service. “As [Time Warner chairman and CEO] Glenn Britt our boss says, 'We all live here too,’” Lawrence-Apfelbaum says.

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