4. Current Status of the
Telecommunications Market

In order to propose changes that may have profound effects on California's telecommunications market, we believe it to be appropriate that we examine the current state, and how the CHCF-A's impact has evolved over time.

4.1. The FCC Data on
Trends in Telephony

Each year the FCC releases its latest data on telephony. According to the most recent report released in September 2010, the following trends are notable:

· The proportional expenditure on telephone services has remained flat. Approximately 2% of all consumer expenditures are devoted to telephone service. This percentage has remained virtually unchanged over the past 20 years, despite major changes in the telephone industry and in telephone usage. Average annual expenditures on telephone service increased from $360 per household in 1981 to $1,100 in 2008.³⁸ This increase can be explained by the fact that while in 1981, virtually, all telephone services were landlines, in recent years consumers have been subscribing to competitive technologies such as wireless cellular telephone services and VoIP. These new technologies are proving to be serious competition to traditional landline telephone service.

· Consumers spent less on landlines and more on wireless and Internet. Since the year 2000, personal expenditure on landline telephone services have declined while the cost of wireless telephone services and Internet Access Services have increased (also see Appendix F).³⁹

· Growth of Wireless Telephone Services. Prior to 2000, landline growth over time averaged about 3% per year, reflecting growth in the population and economy. Since 2000, the number of lines provided by landline carriers has declined, likely due to consumers substituting alternatives for their landline service, and some households eliminating second lines when they move from dial-up Internet service to broadband service.⁴⁰ The percentage of people who only subscribed to landline service dropped from 23.8% in 2007 to 14.9% in 2009, while those with only a wireless telephone increased from 13.6% to 24.5% in the same period.⁴¹ In 1984, there were 92,000 wireless subscribers in the U.S. In 2005, the number of wireless subscribers grew to 207 million. By the end 2008, the number had reached 270 million.⁴² California experienced wireless subscription growth from 25.5 million at the end 2005 to 32.18 million at the end of 2008.⁴³

· Growth of Local Telephone Competition by VoIP. Since 2002, cable companies and others have begun offering retail interconnected VoIP. This service enables voice communications over a broadband connection and allows users both to receive calls from and place calls to the public switched telephone network, like traditional phone service. The service represents a rapidly growing part of the U.S. voice services market. These services include nomadic offerings from companies like Vonage and Skype as well as fixed offerings from cable and telephone companies that own their own networks.⁴⁴ At the end of June 2010, California had 7.64 million residential switched access lines for ILECs and almost 615 thousand switched access lines for Non-ILECs. For the same period, ILEC customers purchased 264,000 VoIP services from ILECs and 2.2 million VoIP services from Non-ILECs.⁴⁵

4.2. The Commission Report on Affordability
of Basic Telephone Service

The California legislature through Senate Bill 780 directed the Commission to survey the affordability of basic telephone service in areas funded by the CHCF-B. In response, the Commission ordered in D.08-09-042 a statewide affordability survey. In September 2010, the Commission released its report to the Legislature on the Affordability of Basic Telephone. Given the similarities between populations served by the CHCF-A and the CHCF-B, it is reasonable to use the findings of the Commission study done on the CHCF-B population as a proxy to evaluate the demand for communications services in CHCF-A eligible service territories.

The following are study findings that we deem useful for this evaluation:

· California household telephone bills in 2010, after being adjusted for inflation, have not changed significantly since 2004.

· Data suggests there is a growing acceptance and use of wireless, VoIP and broadband services as a complement and/or substitute for traditional landline telephone service.

· Landline subscriptions are diminishing.

· Policies should take into account the availability and substitutability of alternative services such as wireless, VoIP and broadband services, and should be considered in any program redesign.

· Broadband service is increasingly important to households as it is the least likely service to be discontinued if bundled service rates increase.⁴⁶

The findings of this report look to be consistent with the trends identified in the FCC's Report on Telephony. Both sets of data suggest relative stability in billed telephone expenses, and both indicate a steady decrease in the number of landline telephones in favor of new voice communications technologies such as wireless telephones and VoIP. Therefore, if at all levels i.e. federal, state, and within the CHCF-B territories comparable trends are observed, we expect that customers in the CHCF-A areas would exhibit similar consumer behaviors.

4.3. The Communications Division Study
of Small Rural Telephone Companies

CD conducted a study of small rural telephone companies that receive the CHCF-A support versus small carriers that do not. This was done using carrier submitted annual reports from 2003-2009.⁴⁷ The findings indicate major disparities among small ILECs that receive CHCF-A support versus those that do not and yet continue to serve similarly situated rural communities. A summary of the findings are provided below:

· Gross revenues per access line were over two times higher on average for the CHCF-A carriers than for the Non-CHCF-A carriers.

· In 2009, the CHCF-A carriers earned four times more revenue per access line than the Non-CHCF-A carriers. Even with the CHCF-A fund support excluded, the CHCF-A carriers still earned gross revenues per access line that were two to three times more than their Non-CHCF-A counterparts.

· Net income per access line of the CHCF-A carriers was twice as much as their Non-CHCF-A counterparts on average.

· In 2009, the CHCF-A carriers earned over eight times as much net income per access line as the Non-CHCF-A carriers.

· Total operating expenses per access line for the CHCF-A carriers were two and a half times higher than the Non-CHCF-A carriers on average.

· In 2009, the CHCF-A carriers spent four times as much as the Non-CHCF-A carriers. Significant expenditures for the CHCF-A carriers versus the Non-CHCF-A carriers 2008-2009 are as follows:

· Five to six times more on corporate operating expenses;

· Two to three times more on plant specific expenses; and

· One and a half to two times more on Customer Operating expenses.

· On average, the CHCF-A carriers employed over two and a half times as much total plant in service (TPIS) per access line as the Non-CHCF-A carriers. In 2009, the CHCF-A carriers employed over eight times as much TPIS per access line as the Non-CHCF-A carriers. One factor contributing to this is that CHCF-A carriers have significantly more underground cable, while the Non-CHCF-A carriers have more aerial cable. Other significant capital investments by the CHCF-A carriers versus the Non-CHCF-A carriers are:

· They are investing three times more on Land and Support; and

· They are investing one and a half times more on Cable and Wire.

The study highlighted a clear distinction between the operating practices of carriers that receive CHCF-A support and those that do not. Carriers that received support were more profitable, yet far costlier to operate than those that did not. Additionally, carriers receiving funding from the CHCF-A, outspent the Non-CHCF-A carriers on capital infrastructure, most of which has applications beyond providing basic local telephone service and has the potential to provide unregulated services such as broadband and/or video services.

This study used multiple regression analysis to control for many independent variables such as topography/climate/location, customer density, carrier size, etc. to isolate the effect, if any, of receiving the CHCF-A funds. Analysis of various metrics confirmed that receipt of support from the CHCF-A has significant effects. For example, the marginal expense rate per access line, i.e. the cost of providing one additional access line, is nearly identical for similarly sized carriers who receive the CHCF-A subsidies and those that do not. However, carriers who receive CHCF-A support consistently spend substantially more per access line. We must question the causes of these differences and the implications for carrier funding through the CHCF-A.

At the very least, these findings suggest that a less efficient business model is being utilized by the small ILECs that receive support from the CHCF-A. Carriers receiving support funding from the CHCF-A program out spent Non-CHCF-A rural companies in renovation of facilities and in investment on new facilities. Yet, there is no indication that local telephone service is less readily available or less affordable for the customers who reside in territories serviced by the Non-CHCF-A carriers (also see Appendix I).

³⁸ Trends in Telephony, FCC, http://www.fcc.gov/Daily_Releases/Daily_Business/2010/db0930/DOC-301823A1.pdf, at 3-1.

³⁹ Ibid, Table 3.4.

⁴⁰ Ibid, at 7-1.

⁴¹ Ibid, Table 7.4.

⁴² Ibid, Table 11.1.

⁴³ Ibid, Table 11.2.

⁴⁴ Ibid, at 8-1.

⁴⁵ Local Telephone Competition Status As Of June 30, 2010. http://transition.fcc.gov/Daily_Releases/Daily_Business/2010/db0903/DOC-301310A1.pdf

⁴⁶ Staff Report to the California Legislature: Affordability of Basic Telephone Service, September 30, 2010. http://www.cpuc.ca.gov/NR/rdonlyres/383BBEA3-45F8-42E4-8582-70413539AC45/0/2010_Affordability_Report_Final_Sep_29_2010.pdf

⁴⁷ Carriers that did not receive funding from the CHCF-A were Happy Valley, Hornitos, Verizon West Coast, and Winterhaven.