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Leasing the Loop: Telephone Service Resale in the Local Exchange

Fortnightly Magazine - July 15 1996

LEASING THE LOOP:

Telephone Service Resale in the Local ExchangeResellers want steep discounts, but local rates don't always cover costs. And reselling local lines provides little incentive

to upgrade the network.The Telecommunications Act of 1996 (Act) compels local exchange carriers (LECs) to sell telephone service to competitors (em who would then resell to the public at retail. Instead of constructing their own local distribution networks, competitors would buy local telephone service from the existing carrier at discounted rates. The competitor could then "resell" these services to customers (em presumably at prices below prevailing rates for the traditional LECs. In theory, competitors would attract enough of their own customers to generate funds to build their own networks.

Today, some five months after passage of the Act, several state public utility commissions are developing plans to authorize resale of local exchange service. In fact, all states must soon address the issue. Nevertheless, this mandated resale at discounted rates will not necessarily serve the public interest.

Resale is not a recent issue in telecommunications. The Federal Communications Commission (FCC) first allowed AT&T to lease its facilities in the 1920s; resale restrictions for its interstate toll services were removed in 1980.1 Now, resellers and other industry participants anticipate the same benefits from resale of local exchange services that they casually attribute to the resale of long-distance services.2

With the Act mandating local service resale, competitors of established LECs will demand wholesale price discounts large enough to permit resale of LEC services at prices comparable to (and, ideally, lower than) LEC retail rates. LECs will seek wholesale prices high enough to recover their costs. However, by design, certain local service rates (e.g., residential rates in rural areas) are lower than the costs of providing local telephone service. Discounting wholesale prices (without providing some offsetting financial support for universal service) will discourage new investment in physical network facilities and perhaps entirely preclude

facilities-based competitive entry in high-cost areas.

In New York, Rochester Telephone Co.'s "Open Market Plan" sets wholesale prices to competitive providers 5 percent below Rochester's retail rates. In Illinois, Ameritech offers competitors wholesale price discounts of 6 to 10 percent, with steeper term and volume discounts available.3 Pacific Bell's wholesale discounts in California are set at 17 percent for business lines and 10 percent for residential service.

To make competition work, while preserving universal service as prescribed by the Act, state and federal regulators must establish an appropriate set of wholesale prices that will reflect the characteristics of local exchange service.

Long Distance (em The Wrong Blueprint for Local Competition

Supporters of local exchange resale often point to lower prices and vigorous competition (em benefits which they say have emerged from the resale of long-distance, and which (they claim) may also ensue from resale of local services. Yet, the two products cannot be compared. Local and long-distance telephone service exhibit vastly different market structures.

Long-distance providers offer

a host of volume- and term-discounted pricing packages to resellers and customers alike. Steep discounts are possible because 1) toll prices historically have been inflated to help support low

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