When a Level Playing Field Isn't

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If the telecommunications market were a spectator sport, and its participants were competing in a stadium, the government would watch from the sidelines while communications competitors battled for customers and their dollars on a level competitive playing field.

But with such players as AT&T Inc. CEO Ed Whitacre and Time Warner Cable CEO Glenn Britt each calling for a perfectly flat field, you'll find there isn't one.

And typically, as competition forms, there is a definite tilt: New service players are given an advantage over established rivals by being allowed to avoid federal, state and even local taxation.

BARTON SENDS A BILL

Example No. 1: Voice services. Cable companies are now taking customers away from telephone companies by the millions, nationwide. Most of the upstarts, whether new entrants — or established outfits from another field, like cable operators — use a technology known as voice over Internet protocol. And, in the process, they can often make an end-run around federal taxes and requirements to contribute to rural communications through the nation's Universal Service Fund.

Example No. 2: Video services. Cable operators are likely to lose customers to telephone companies more rapidly, if a bill now working its way through the U.S. House of Representatives makes it into law. That bill, proposed by Rep. Joe Barton (R-Texas), would set up a boilerplate nationwide-franchise arrangement for new providers of wired-TV services, such as telephone giants Verizon Communications Inc. and AT&T Inc. These companies would avoid having to negotiate franchises community by community, which can bring in unnecessary costs, like public-access studios that don't get used.

Even with a recent amendment offering cable operators an exit route from local franchise agreements in areas where telcos also set up TV services, the bill would tilt the field toward faster rollout of services by new competitors.

The level playing field issue is moving beyond the wired world as new wireless broadband services come into play. At the CTIA Wireless trade show in Las Vegas last week, Sprint Nextel chief operating officer Len Lauer said regulation is a key issue to support the growth of wireless communications services and broadband data offerings.

Echoing much of the argument that wireline telcos are now wielding in support of a nation-wide video franchise bill, Lauer said it would be important to create regulations covering new wireless data services on a federal level, and “not by 50 different stares and 50 different levels.”

He added, “We've got to be very strong in our message going forward to Congress.”

VOICING DISPLEASURE

Defining the inequities in telecom regulations is no easy task, given the fact that telecom taxes, tariffs, fees and obligations are a snarl of bureaucratic red tape that varies from service to service, state to state. But Dan Hesse, CEO of Sprint Nextel's soon-to-be spun off Embarq local phone business, gave comparisons during a keynote speech at the TelecomNext trade show in Las Vegas in March.

Sprint now pays a 7-cent terminating-access fee and a 6-cent Universal Service Fund obligation on the typical 10-minute long-distance call, he said.

Set up in the 1930s to ensure telephone service was available to all Americans, the Universal Service Fund is administered by the Universal Service Administrative Agency. In 2005, it collected $6.52 billion in fees applied to long-distance and international calls among traditional, circuit-switched phone operators, and in turn distributed it to providers serving territories where the cost to provide service is high, as well as providers offering service to low-income demographics, rural health care systems and schools and libraries.

Projected Universal Service Fund collections are expected to top $7.3 billion in 2006, according to the agency.

By law, all telecommunications carriers that provide international or interstate calling services must pay into the fund. The fees are applied on a per-call basis, so larger carriers pay more into it than smaller regional incumbents. In 2005, the assessment applied to every applicable long-distance call was 10.9% of the revenue for those calls.

Customers sometimes see the charges for “universal service” on their bills, but the Federal Communications Commission does not require that line item.

But while Sprint makes contributions into the Universal Service Fund, many VoIP providers such as Vonage and Yahoo Voice avoid the assessment.

Hesse noted that VoIP players contribute nothing to the Universal Service Fund, often by terminating their long distance calls not into the incumbent phone provider's long-distance interconnection points, but through other competitive voice providers' local Internet access points. In doing so, the call can be classified as local and therefore exempt from the fund.

Instead, they pay only a local reciprocal compensation rate for transferring the call from their network to the other, a charge totaling a mere seven-hundredths of a cent per minute, by Hesse's count.

“We pay approximately 19 times more than that purely on regulatory arbitrage,” Hesse said. “And on top of this — on top of what I have just described — we have tax disadvantages. Telecom taxes average 17%, compared to general business taxes, which apply to cable companies and VoIP companies, which average about 6%. We find that our taxes and surcharges are typically more than double that of our competitors.”

Hesse even gave specific examples. In Mansfield, Ohio, Sprint pays taxes and surcharges that represent $20.79 on the average customer's bill , while Time Warner Cable pays only $7.17 for like services.

In Gardner, Kan., he said that fee total is $11.97, while a VoIP service provider also hunting for customers there pays only $1.98. Hesse didn't specify the VoIP provider in that example, but Time Warner is the cable operator in that market.

Since it initiated voice service in 2004, Time Warner Cable has paid into the Universal Service Fund at both the federal level and in the states that require it to do so, a spokeswoman for the operator said.

Cablevision Systems Corp. does not disclose how much of the $34.95 it charges for digital phone service goes to taxes. But taxes and fees on its $49.95 Family Cable TV package plus a $9.95 digital cable option — its minimum configuration for a digital customer — equal about $5, according to the operator.

But the Universal Service Fund is only one of a myriad federal, state and sometimes even local charges AT&T Inc. deals with and passes on to customers, according to Mike Balmoris, the telecom provider's spokesman for regulatory affairs.

In addition, to the Universal Service Fund, AT&T pays a 3% federal communications excise tax, a levy that stems from the Mexican-American War at the turn of the 20th Century.

Other charges that support 911 emergency calling services, local numbers portability support and Communications Assistance for Law Enforcement (CALEA) wiretap systems are paid by traditional and VoIP providers alike.

State fees and charges vary, but they can include 911 fund contributions for state and county governments, Balmoris said. Then there is the Telecom Relay Service to support communications for the hearing-impaired, state Universal Service Fund contributions, fees paid to state utilities commissions and municipal utilities fees. There are also state and local taxes that incumbent telephone operators and VoIP providers both pay.

In addition traditional carriers also have greater regulatory burdens in changing its prices. If it wants to lower a price for long-distance service, it has to file a tariff application with the state public commission involved, Balmoris said. Carrier of Last Resort obligations also require incumbent local-exchange carriers like AT&T to provide service to an entire service area, not just certain portions.

COMPETITIVE ARBITRAGE

As with other regional Bell operating companies, AT&T has its own VoIP service in CallVantage. So while the Bell operator does contribute to the Universal Service Fund on its traditional voice service, the company has taken the position that the existing federal requirements should not be extended to VoIP players.

“The regulations that were born out of the incumbent monopolies should not be transferred to new services such as VoIP with the exception of two things — Universal Service Fund and 911. 911 is a public safety issue, so that should apply to all VoIP providers, and USF service connectivity is just a bedrock communications principal,” Balmoris said.

The overriding problem for all of telecommunications regulation is: it still follows monopoly thinking in a marketplace where that no longer exists, according to analyst Scott Cleland.

Cleland, a longtime Beltway telecom political analyst and president of Precursor, an industry research and consulting firm, gave testimony before the Senate Judiciary Committee this fall on telecom regulation reform.

In the past, telecom law depended on which type of technology a provider was using — if the service was delivered via copper phone line, there was one set of rules, while another applied to cable, satellite and wireless players.

“My strong view is that all of these backward-looking laws that are now artifacts should be ripped out at the roots, because they are no longer relevant,” he said. “Not only is it competitive arbitrage, but the law now impedes development of the new technology, because everybody tries to jam today's technology into yesterday's technology silo.”

That is particularly true given that the rise of the Internet — which spans across all of these access technologies and in fact mixes them has thrown the rigid system of tax-by-connection type for a loop, Cleland said.

“It's just a massive opportunity for competitive arbitrage by everyone,” Cleland said. “Anybody that invades as a new entrant into formerly regulated businesses has the advantage. Cable had the advantage entering into voice, and the Bells could have the advantage getting into video.”

ROLLING VIDEO

That advantage for telcos could come in the form of the nationwide video franchise bill proposed by Barton, the House Energy and Commerce Committee chairman. The bill would give telcos a nationwide video franchise to offer service with automatic renewal for 10 years.

A recent amendment to the bill would allow cable operators to opt out of local franchising in communities where rival phone companies also are providing pay TV service, or where their longstanding franchises are no longer in effect.

Most likely to produce a tilt of the playing field toward telephone companies is the lack of a “buildout requirement” in the Barton bill.

That means that new entrants, such as Verizon or AT&T, could roll out their new TV services to just wealthy households, skimming the cream off any market.

“Given its sunken costs and the regulatory disparity, a cable operator would be so disadvantaged that it eventually [could be] forced to exit the entire franchise area … for reasons that had nothing to do with the marketplace inefficiency or competitive inferiority,” the National Cable & Telecommunications Association said last fall.

How much cream-skimming might take place remains to be seen. Verizon, for instance, just won unanimous approval to enter Hempstead, N.Y., a Long Island locality with more than 750,000 residents. Its median household income is $45,234, only about 5% above the state average.

Brad Evans, CEO of Cavalier Telephone Inc., has been quoted in Light Reading, a trade publication, as saying that “copper-based IPTV providers should be exempt from any requirements for a mandatory buildout.”

His contention? A requirement to build out to tall homes would make Internet protocol-based television investments “totally unfeasible.''

The video franchise regulations “are also increasingly outdated regulations,” Cleland said. “Franchises were brought into being because of a monopoly situation. And neither the cable companies nor the phone companies are monopolies any more — despite their name-calling every day.”

So instead of parallel regulations for telcos versus cable, Cleland advocates putting every pay TV provider on the same franchising page, in terms of the law.

“The best thing is to regulate down for everyone in a competitive market,” Cleland said. “Long-term, the trend line is, this is happening. There is a hands-off-the-Internet policy — don't tax the Internet. Broadband has been deregulated.

“So the clear trend is to regulate down, because the marketplace collectively makes much better decisions than government trying to pick winners and losers and pick technologies.”

But getting to a universal regulatory stance in which common requirements are applied to providers, regardless of the technology they use, “is going to take several years to get worked out,” Cleland said. “Unlike 1996, where there was remarkable bipartisan consensus, there is a remarkable lack of consensus today on any of these issues.”

<p>TILT: Telephone Taxes and Fees</p>

The franchising reform bill being shepherded by Rep. Joe Barton (R-Texas) does not require new video services suppliers to serve every household in a given city or market. That means a new entrant can serve just the highest-income families. Existing service providers, meanwhile, have sunk costs into serving every household, continue to be required to provide service to all households — and get fewer good-paying customers to pay the bills of operating their networks.

FAVORS: Telephone companies 

<p>TILT: Buildout Requirements</p>

Telephone call carriers pay termination fees to other carriers for calls that start on their networks but end elsewhere. By federal law, they also are required to pay into a Universal Service Fund, to finance phone service to rural parts of America. In Mansfield, Ohio, Sprint pays taxes and surcharges that represent $20.79 on a typical customer's bill, while Time Warner Cable pays only $7.17, according to Embarq CEO Dan Hesse.

FAVORS: Cable operators 

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