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The Vanishing LATA: Pricing Chasms and Clashing Markets for Toll Service

Fortnightly Magazine - July 15 1996

intra- and interLATA use did not qualify for price discounts from either carrier may benefit from aggregating intrastate toll demand and, in turn, use a single IXC. Residential customers with home computers will likely be offered package deals tailored to their combined voice and data consumption. These, however, are not purely empirical factors; they depend on pricing strategies.

The results in Table 3 suggest that AT&T faces asymmetric risks and rewards from reduced toll price. When we reduce AT&T's average price level to that of U S WEST, revenue impacts depend on the assumed demand elasticity. With a demand elasticity of -0.5, AT&T's toll revenues decline by about $1.5 million annually. If demand elasticity is -2.0, AT&T stands to gross about $4 million annually.

In contrast to AT&T, U S WEST stands to gain increased CAC revenues, regardless of demand elasticity, when AT&T's prices decline. A low demand elasticity would garner $1 million annually for U S WEST; a higher demand elasticity of -2.0 would collect an additional $5 million per year.

As suggested earlier, we believe the ultimate equilibrium price level will be, minimally, in the 10¢ range. That is, the above analysis, if flawed, assumes a conservatively high price equilibrium. And although the rate at which equilibrium will arrive as well as its

duration are unpredictable, we doubt that IXCs will sit on their laurels for long.

Policy Implications

The policy implications appear most significant for those states with substantial toll-rate disparities. Since we had no evidence of the cost of providing toll services, other than access charges, different toll cost functions will significantly alter our findings.

Suppose AT&T were to assert that its toll rates are cost based and that it would suffer financial loss from lower toll prices? How, then, could U S WEST further reduce its already lower toll rates without a subsidy? If the two firms have different cost functions, how can the firm with higher costs remain competitive when the two markets merge? If the firms have the same cost functions, and if U S WEST can cut its toll rates more, yet hold prices above cost, are interLATA toll markets really competitive? What keeps AT&T from further reducing residential MTS rates? Could interLATA toll rates be subsidizing interstate rates?

Our estimated impacts (see Table 3) are consistent with prior testimony and assertions made by U S WEST and AT&T. The strategic motives of LECs and IXCs to affect the direction of change for toll and local rates also clearly support past testimony. U S WEST consistently asserts that its toll rates subsidize local (residential) rates; AT&T consistently counters that assertion. Both positions are predictable and strategic.

Our analysis also reveals the degree to which revenues remain sensitive to the assumed decline in toll rates. The impacts, however, are asymmetric; they depend on the assumed elasticity of demand. U S WEST benefits from AT&T's declining prices regardless of demand elasticity, at least down to its own average price level. This outcome reflects increased carrier access sales to AT&T, combined with our assumption that AT&T's prices