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CRTC Price Cap Review – Oral Argument of consumer groups

MS LAWSON: Thank you, Mr. Chairman, Commissioners.

Thank you very much for the opportunity to present the views of residential telephone consumers in this very important proceeding, the outcome of which will not only effect the development of competition in this industry, but will also determine whether Canadian rate payers, as well as shareholders and competitors, enjoy the benefits of the new regulatory framework that you have worked so hard to construct.

ARC et al and BCOAPO et al have coordinated their arguments in this proceeding so as to avoid duplication. I’m going to begin by addressing the question of how you can best balance the interests of the various stakeholders under the new price cap regime.

Mr. Van Koughnett will then address two key issues for us: the relevance of ILEC earnings under price caps and the appropriate approach to quality of service under price caps.

Ms MacDonald will then focus on the important issues of market theory, consumer information and payphones.

Mr. Chairman, Commissioners, before you start in on your deliberations, you need to decide what this proceeding is all about. Is it about maximizing shareholder value and fostering robust investment in Canadian ILECs as The Companies would have you believe? Is it about getting rid of regulation and relying on economic theory to protect consumers as TELUS would have you believe? Is it about giving competitors a boost so that they can roll out their services more quickly and in more places as AT&T and CallNet have proposed? Or is it about getting rid of contribution as Rogers suggests?

Mr. Chairman, every single one of the industry proposals before you in this proceeding is patently self-serving. They all reflect a profit-maximizing mandate rather than a public interest mandate. Not surprisingly, the ILECs want to keep all the productivity gains from price caps to themselves, while CLECs want those gains to be funnelled their way. Neither of these approaches satisfies the Commission’s primary mandate of ensuring just and reasonable rates. Neither will result in healthy, sustainable competition.

As you have stated in this proceeding, the challenge before us is to balance the interest of the three main stakeholder groups: ILECs, CLECs and consumers. Balancing these three interests means ensuring on one hand that ILECs can earn a fair return on their utility rate base. On the other, that CLECs pay fair rates for the ILEC services they need and from the consumer perspective, that consumers pay fair rates for the ILEC services that they need.

In other words, this proceeding is above all about fairness. Fairness for all stakeholders, not just shareholders.

The Companies’ notion of an iron triangle of objectives rightly reflects the importance of each of these three stakeholder interests. However, it wrongly characterizes the interests of consumers in this proceeding as affordability.

Investment is another way of saying fair returns to ILECs. Competition is another way of saying fair rates to competitors. But affordability is not the same as fairness. Just because rates are affordable doesn’t mean that they are fair. ILEC and CLEC attempts to have you focus on affordability are simply transparent tactics designed to deny consumers their fair share of the productivity gains from price cap regulation. You should not be fooled.

The achievement of just and reasonable rates is surely the most central concern underlying price caps. Rates are not just and reasonable when they result in industry-wide excessive profits as they have over the past few years. They are not just and reasonable when they are established on the basis of consumer tolerance rather than on costs as the ILECs have proposed. They are not just and reasonable when they are maintained at artificially high levels in order to subsidize competition as proposed by some competitors.

In order to ensure that rates are just and reasonable under the price cap regime, two conditions must be satisfied. First the going in rates should provide ILECs with a reasonable opportunity, but not more than a reasonable opportunity, to earn a fair return in the first year of the regime. Secondly, the price cap index should reflect the expected trend in target costs such that ILECs continue to be able to earn a fair return, but no more than a fair return in future years of the regime.

Over the past four years, we have seen ILEC returns soar well above what any investor would consider a reasonable return, while consumers have faced ever-increasing rates and competitors have struggled to survive. Clearly something is wrong with the current price cap regime.

Rates that produce sustained, supernormal returns across the industry cannot be considered just and reasonable. It’s time to give something back to residential consumers.

Mr. Chairman, we are at a turning point in Canadian telecommunications. No longer is local residential service subsidized outside of high cost areas. No longer do you have to worry about an unsustainable contribution regime for residential rates in high cost areas. No longer is there any justification for increasing basic residential rates in either urban or rural areas. In fact, the empirical evidence on the record of this proceeding clearly shows that overall revenues from residential local service in non-high cost areas are not only compensatory but highly profitable to the ILECs.

Using the Commission’s approved Phase 2 costs of primary exchange service for Bell Canada and allowing for the recovery of service improvement plan costs as well as a 15 per cent mark-up, Bell is making 100 per cent margin on its local residential service in non-high cost areas in 2001. Even using Bell’s own new Phase 2 costs, the company is making a 40 per cent margin on these services.

Looking forward, Mr. Chairman, what do we see? We see continued declining costs and continued opportunities for ILECs to increase revenues, even assuming that competitors are able to make inroads into the local residential market.

The time has come to reflect these declining costs in rate reductions for already highly profitable local residential services. If expected productivity gains over the next price cap period are not reflected in residential rates, ILEC profits will simply continue to increase. This would be bad for consumers and bad for competition.

Mr. Chairman, competition is a preferred means to an end. It is not an end in itself. The end is a healthy, efficient industry with low prices and high quality of service throughout the country. If competition merely leads to higher prices, less reliable service and customer confusion, it will have been a failure.

Mr. Chairman, consumers have asked us to tell you that greater choice is not worth higher prices to them. It is your job to ensure that competition is allowed to develop where it is economic, at rates that meet public policy objectives, and at a pace that reflects the reality of this highly capital intensive, technology dependent industry.

As Mr. Grieve has said himself, “facilities-based competition in telecommunications is, by its very nature, slow, expensive and risky.” The public interest, Mr. Chairman, will not be served by efforts to prematurely kick start competition where it cannot be sustained in the long term.

Mr. Chairman, Commissioners, you have a choice to make in this proceeding. You can take measures to ensure that residential rates are just and reasonable as costs continue to decline and you can take measures to ensure that residential subscribers receive continued high-quality service. Or you can establish a regime that puts CLEC and ILEC interests ahead of the interests of residential subscribers.

Other stakeholders are calling for an unbalanced distribution of the benefits flowing from price cap regulation. At a time when declining costs and competition are supposed to be leading to lower rates, residential customers are counting on the Commission to do the right thing, to call a halt to basic rate increases and to start flowing some of the benefits of this new regulatory framework to residential consumers.

Thank you, Mr. Chairman, Commissioners. I will pass the microphone over to Mr. Van Koughnett.

MR. Van KOUGHNETT: Thank you, Mr. Chairman.

I’m pleased to have an opportunity to speak about ILEC earnings because it’s something that concerned from the time that I was brought on the case, which as you know was quite late, September 18, and I was briefed at our local Starbucks by a very fluffy bearded economist who works for Bell Canada who shall remain nameless.

And he explained to me that although originally when the price cap regime was first contemplated, not only in this jurisdiction but other jurisdictions, there had been some notion that it was tied to earnings but that I was yesterday’s man to think that was still the case. The new regime was, he explained, the price cap regime should not at all focus on earnings.

Well, you did not have the benefit of that particular conversation, Mr. Chairman, but we all enjoyed the benefit of speaking with and listening to Dr. Taylor who basically expressed the same view, suggesting that the Commissioners should exercise caution in looking at earnings.

This troubled me greatly, but one morning, Mr. Chairman, I believe I woke up understanding how to reconcile the competing considerations that have been put before you on this topic. I think it is really quite simply.

If you are absolutely confident, Mr. Chairman, that you set the correct productivity offset the first time round, then what Dr. Taylor says is absolutely correct, it would be profoundly wrong to look at the earnings of the ILECs. If you are confident that you did it right the first time, then it would flow that any above normal earnings by the ILECs would be because of their abilities to take full advantage of economies, to find new revenue streams. They have been brilliant and that is where the extra earnings come from.

But, Mr. Chairman, how can you be confident that you chose the right productivity offset the first time around. Other jurisdictions, and this one too I submit, necessarily chose a conservative number as the productivity offset.

In fact, to use the nomenclature of this case the Commission had an incentive to choose a low number and that is because of the asymmetric consequences associated with choosing the wrong number.

Let me explain. If you choose a low number all that happens is that we meet here today and we speak of high ILEC returns. If you choose too high a productivity offset figure for the first price cap regime the consequences are much worse. The ILEC returns are so low that the ILECs, operating in a very capital-intensive industry, are unable to attract capital on any reasonable terms. This would not be good for the country.

So why is it that we find that in the U.K. and in the U.S. and here the productivity offset figure the first time around was too low? Because the commissions in question were responding to the incentive, and indeed the opportunity, to set a low figure.

It is no great surprise, therefore, that one finds oneself in the position here today where the ILEC returns are high, the CLEC returns—if any, mostly non-existent—are extremely low, the total productivity factor numbers are high for the companies. Even the marginal cost approach of TELUS and The Companies shows that the productivity offset factor that was set the first time around was low.

Oftel has moved from a low number to 7.5; FCC has moved from a low number to 6.5. It is no great surprise that in this jurisdiction parties such as ARC et al are suggesting that the Commission should revisit and look to a higher number.

Fine. Why does one then focus one’s attention on earnings? Because, Mr. Chairman, you are still the economic regulator you always were. Your job is just and reasonable rates. Section 27 of the Telecommunications Act has not changed, the jurisprudence from the Supreme Court of the United States and from the Supreme Court of Canada has not changed, the shareholders of the ILECs are entitled to a reasonable opportunity to earn a fair rate of return. That is because if you fulfil that part of your job you are achieving, as close as is possible, a simulation of competitive markets.

In a fully competitive market the ILEC shareholders would achieve a rate of return comparable to industries in the unregulated sector. Dr. Taylor and I walked through in gory detail the equation, so to speak, by which rate base rate of return led the Commission inevitably to pay just and reasonable rates to a fair rate of return on average common equity for the ILECs.

That is still applicable today. No one has suggested in developing the price cap methodology that rate base rate of return is out of the window. Quite the contrary, price cap methodology is meant to get to the same place as rate base rate of return with the one exception, of course, that it provides an incentive, for the first time, for the companies to act efficiently. But the ultimate result is supposed to be the same.

Not only is it the case that your statutory duty is to achieve, for the ILEC shareholders, a reasonable opportunity to achieve a fair rate of return, but it is also the case that by focusing on earnings you also benefit customers, because by selecting, as one would in rate base rate of return, an opportunity for shareholders of the ILECs to achieve a fair rate of return, automatically it flows from the equation that declining costs mean declining prices for consumers.

Not only is that true but it is also fair to the third constituency identified in the Public Notice, namely the CLECs, for it diminishes the size of the war chest that the ILECs have, according, therefore, an opportunity to the CLECs—a level playing field, an opportunity to compete.

In fact, one might argue that this Commission has an analogous duty to the CLECs that it does to the ILECs: to the CLECs a reasonable opportunity for the shareholders to earn a fair rate of return—oh, sorry, to the ILECs; and to the CLECs an opportunity to compete on reasonable terms.

So a focus on earnings, just as it was under rate base rate of return, is in fact key to this case, provided always that you are not supremely confident that you set the right TFP offset number the first time.

I turn now to the issue of quality of service.

There is one lesson we learned from price caps and that is that the ILECs respond to an incentive to lower costs. This is great, but it needs to be counterbalanced by an analogous incentive to permit the companies an incentive to adhere to the Commission’s service quality standards.

Under rate base rate of return regulation the Commission could, and did on occasion, set rates at the low end of a range in a rate case. There were two particular instances of that, 1981 and 1982 for BCTel. That mechanism, which in those instances stripped from BCTel 75 basis points and 50 basis points of the rate of return. That mechanism is gone and gone forever, Dr. Taylor and I agreed, you will recall.

While the Commission has over the years developed extremely sophisticated measures for quality of service and yet now those measures are left a paper tiger. Mr. Park, on behalf of The Companies, admitted that in fact all that happens after the exception reports filed by The Companies after three months of poor service quality on a particular indicator, is an action plan as filed by the company and the company either pursues its action plan or it doesn’t and if it does perhaps the indicator comes back into conformance with the Commission’s standard and if it doesn’t nothing happens.

The best possible example, though, is TELUS Exhibit No. 14 which just rolled in last Friday. It was in response to Commission counsel, Ms Moore, seeking an explanation over and above the exception report filed by TELUS for four consecutive months of poor service quality on a particular indicator.

The exception report stated:

“Organizational and symptom process changes.” (As read)

So Ms Moore said “tell me more”. The exhibit that rolled in spent two pages talking about the needs of TELUS to meet its customers and to meet its customers demands, and to meet its customers demands means making changes in processes.

Well, it is very difficult to disagree with any of the words on those two pages, Mr. Chairman. But what kind of a position does this leave the Commission in? In essence, the Commission just says “Fine”.

Now, quality of service results have been drifting somewhat lower, Mr. Park agreed, in Canada over the last couple of years, and the evidence of Ms Alexander filed in this proceeding on behalf of ARC et al also suggests that the same is true in the U.S.

Now, I am not suggesting for a moment that this is caused by price caps, but I am saying that there is absolutely no disadvantage to putting a quality of service mechanism in place for this second price cap regime and there is quite a disadvantage to not doing so, and that is that all the quality of service indicators are left hanging out there without any particular means for enforcing them.

This case, therefore, constitutes a perfect opportunity to improve the price cap regime by introducing a quality of service mechanism.

Now, what of the design of the mechanism?

To be honest, Mr. Chairman, there is only one thing that matters and that is the quantum, the amount that is at stake. Fortunately, The Companies in 1503 have stated correctly the balance. I spoke with Dr. Taylor about that topic, as you may recall.

It has to be the case that the penalty is large enough that The Companies have an incentive to meet the quality of service standards rather than to just pay the penalty, as I pay a parking ticket, park where I wish sometimes.

Now, The Companies have put at risk $27.5 million for Bell. You recall I spoke to Mr. Park. It is kind of hard, I think, Mr. Chairman, to evaluate that raw number. Mr. Park said that was 0.3 per cent on a rate of return.

But as I mentioned to you, in the two Commission precedents that I was able to unearth—and I was on both of those cases as you know, Mr. Chairman—the Commission evaluated the penalty for BCTel for a continued failure to meet 4 and 5, respectively, indicators of the 23 indicators that were then in place at 0.5 per cent and 0.75 per cent, as I mentioned.

It could be the case that the rate of return rather than the actual number of dollars provides the best basis for this Commission to act as a starting point for the maximum number of dollars to put at risk. I say that because of the fact that there are so many differences across the companies that this commission regulates, different tax rates, different debt equity ratios, different ratios of revenue to capital.

Now, as it happens in this case, Mr. Chairman, AT&T has suggested 25 cents per NAS per indicator miss. The Companies suggested 5 cents. So that ratio of 5-to-1 suggested by AT&T would translate out, more or less, using Mr. Park’s evidence, to 1.5 per cent on the rate of return as the maximum penalty from which one would start.

Now, that is less than the State of Maine, that is less than the State of Vermont, but that may well be a good starting point for the Commission in this case.

I hasten to say it is unlikely that the penalty would ever be that great. Based on the quality of service reports that have rolled into the Commission over the last quarter century, it is quite unlikely that The Companies are going to be down on every single indicator and therefore it is quite unlikely that such a penalty amount would make it impossible for The Companies to raise capital on reasonable terms.

As for the rest of the mechanism, The Companies, and Ms Alexander testifying for us, agree that the penalty should be a one-time event, that it should be a line item credit that applies once the year’s results are toted up to the subscribers or record for the previous year. This is simpler and probably fairer to the company and fairer to the subscribers than the mechanisms of having the Q factor go forward.

In addition, parties, The Companies and Ms Alexander and ARC et al, agree that one should, insofar as is reasonable, parallel the Commission’s current indicators. Two of the Commission’s indicators currently do not have standards and the details as to whether those should apply to the scheme, and if so what the standards should be, we would advocate, should form part of a consumer rights proceeding which we would like to propose be an explicit follow-up item to this case. My learned colleague, Ms MacDonald, will expand on this concept in the latter portion of her argument.

Thank you, Mr. Chairman.

MS MacDONALD: Good morning, Mr. Chairman, Commissioners.

I am going to venture into the area of economic theory. I promise I will be short as I must say it is not my area of expertise.

I was struck by something which Dr. Weisman stated when he was on the stand. He stated that where consumers are perfectly informed the market sets quality levels, the market sets prices and provides the consumer with an ideal outcome from the perspective of economic theory.

Subsequently, Dr. Emerson had a discussion about the Nobel prize in economics and about the analysis of the problem of asymmetric information in competitive markets. Dr. Emerson agreed that markets don’t work perfectly and part of the problem is that markets are typically characterized where one party on the market will have better information than those on the other.

Putting this information together with TELUS’ proposal of accommodative entry policy led me to believe that their theory is fundamentally flawed. I say that because Dr. Weisman’s theory states that once accommodative entry policy is in place retail price regulation will only serve to distort the outcomes and instead TELUS rates should be allowed to rise to market levels, despite the fact that no market yet exists.

Now, the basic problem with these arguments is that they do substitute the existence of policy for the existence of competition and that is another fundamental mistake. This is because theory rarely accords with the reality and the reality here of customer inertia and the irrational behaviour of customers doesn’t accord with the theory of accommodative entry policy as postulated by Dr. Emerson.

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Now, Dr. Emerson actually admitted that he is no expert in the area of customer inertia. Accordingly, it would be a folly to abandon the retail price regulations on the basis of this pure economic theory which hasn’t taken into account the problems of customer inertia and customer irrational behaviour.

Accommodative entry policies are essential for competition to be achieved. However, they cannot suffice for regulation before competition has matured to the point of providing adequate market disciplines.

I then took that concept of consumer information and dealt with the topics that I had discussed with some of the witnesses in cross-examination. In the cross-examination, I believe that we proved that in the current system access to information is difficult to access on the part of the consumer. It is often in the control of the ILECs.

Some of the examples that we had provided were to look through the introductory telephone pages. They are quite thick and unwieldy. If you want customer information, you have to flip through different sections. You have to cross reference as to ensure that you get all the information and sometimes and often you will end up phoning the company in order to get the information. If the information is in the hands of the company and not in the hands of the consumers, it’s the companies that have the power in that relationship.

In order to balance out the power, customers have to be given information on their rights. They have to be given information on how to complain when those rights are breached.

One of the TELUS panels had stated that they prefer to have the discretion to deal with the customers on an individual basis and use that discretion on a case-by-case basis. We believe this is flawed from the perspective that customers will be getting different treatment in that scenario. Depending upon the customer service representative that you actually get, you may get one scenario as opposed to another. You may receive different information as opposed to another person.

Some persons will have difficulty advocating their rights. They may be elderly, immigrants, disabled, poorly educated or lacking in economic power. For these reasons we say that the introductory pages are not sufficient in order to provide consumers with information on their rights.

We also looked at the Terms of Service, and Bell’s Terms of Service are now 15 years old and Barbara Alexander had examined them and reported that she found they were overly broad, were not in a consumer friendly format and didn’t focus on key consumer rights.

TELUS’ Terms of Service, as you know, are written in plan language and customer research that they have undertaken and that they provided to us in an undertaking—pardon me—to Counsel Moore in an undertaking, show that people did actually prefer the plain language. However, the clarity notwithstanding, I believe that there is some problems with the fact that the General Terms of Service are different between some ILECs and others and I certainly had a concern that the balance of consumer rights and obligations on the part of the TELUS examples appears to be tipped in the favour of TELUS, particularly with regard to customer liability.

We believe that effective consumer information can be achieved through the Terms of Service and in fact must be achieved through the Terms of Services that contains the contractual terms. However, we also say that there should be a new document outlining consumer rights. We profess that the document should be consumer friendly, written without technical terms and in a format which is easy to understand.

We urge this Commission to initiate a consumer rights’ proceeding to identify those consumer rights and to create a consumer bill of rights. Simultaneously in that proceeding, we would like the Commission to review the General Terms of Service with a view to ensuring that they are written in plain language, and as well to review the balance of rights and responsibilities between consumers and between the companies.

Along with that, as suggested by Mr. Van Koughnett, you could establish the indicators for the two indicators which currently are not being reported on which includes community isolation outage frequency, consumer complaints and the soon to be implemented consumer—customer complaints resolved. As well, during that proceeding, you could establish the relationship between these three indicators and the incentive mechanism. In our written evidence we will outline this in further detail.

Finally, the issue of payphones has come up in this proceeding and it has provided our constituency with a great deal of concern. Payphones actually deal with two major subsets of people with low income. First, it deals with people that don’t have telephone service at all, which from the information that came out on cross-examination there would be approximately 163 households, we don’t know how many people that relates to, 163,000 households without phones, with over 60—just slightly over 60 per cent of those people relying on payphones.

The other people that rely on payphones are low income people that will use a payphone as their dominant form of public communication. So these are people that can’t afford the cell phone.

From the information that we have heard in this hearing, both TELUS and Bell say that the payphone industry is in decline. That gives us great concern as to what is going to happen to that industry and from our point of view there is a balancing of public policy goals that needs to be addressed with the issues of affordability of the payphones on one side with having payphones at all.

In Decision 98-8 the Commission had stated its intention to review the issue of public interest payphones in three years time, which actually is this year, from that and considering Bell’s evaluation of the possibilities for the future and the viability of the payphone service and the seriousness of the matter for our consumer groups, we urge the Commission to initiate that review in this issue with all the ILECs.

These are our submissions. Thank you very much for the opportunity to make them.

 

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