IX. Market Power as the Central Issue
Market power is the pivotal issue in this proceeding because the only criterion that Verizon needs to address for Verizon to obtain authority to re-classify its BRS and IWMP services from Category II to Category III is a demonstration of having "insignificant market power." By definition, a service is placed in Category III if it has been detariffed due to statutory requirements or federal preemption, or if the LEC shows that "it has or is expected to have insignificant market power in the provision of the service in each market it intends to service."10 Market power exists when a firm has the ability to hold its price profitably above competitive levels for a significant period of time.11 Because the services identified in this proceeding are not detariffed or preempted by the Federal Communications Commission, the burden of proof lies with Verizon to substantiate that it has or is expected to have "insignificant market power" for the services it wants reclassified to Category III.
Verizon evaluates the same factors used at the time we recategorized Pacific's repair of simple inside wire with two payment options, BRS and IWMP, as set forth in D.99-06-053. Those factors consist of the identification and assessment of the ease-of-market entry and exit for businesses that perform inside wire repair into the simple inside wire market and elasticity with regard to both supply of inside wire repairs and demand for inside wire repair.
TURN and ORA oppose Verizon's use of the same factors used for Pacific more than two years ago, contending the facts of the two cases are different. These parties believe that Verizon's case should be decided on its own merits and not with any special consideration for what was decided in the Pacific case.
We first addressed market power assessment factors in an investigation into the appropriate framework for considering whether and on what terms regulatory flexibility might be granted to AT&T Communications of California, Inc. (AT&T-C), the dominant firm in the inter-Local Access and Transport Area (LATA) market.12 That investigation resulted in the issuance of D.87-07-017 wherein optional approaches for measuring AT&T-C's market power were established. Those approaches were the Observation and Prediction approaches. That decision also authorized AT&T-C to file an application for nondominant interLATA carrier status using either the Observation or Prediction Approach.
D.89-10-031 left the responsibility of proposing market power criteria in the recategorization context to Pacific and Verizon. Subsequently, we weighed several factors when considering which guidelines should be used for measuring market power. We also identified what market power factors should be considered in evaluating a request to move a service into Category III. These factors included market share, ease of market entry and exit, facilities ownership, and growth capability of competitors. However, we declined to settle on definitive guidelines, holding that the determination of market power is service-specific.13
Unlike AT&T-C, Verizon has not had its own preliminary proceeding to determine which market power factors should be used in this proceeding. However, it does have the benefit of a Pacific proceeding, wherein specific factors were used in determining Pacific's market power for its repair of simple inside wire with two payment options. Those market power factors are ease of market entry and exit, supply elasticity, and demand elasticity.14
Verizon considers its services for the repair of simple inside wire comparable to those of Pacific being offered in areas contiguous to Verizon's service territory. This comparability of simple inside wire repair services has been confirmed and extended by ORA to other California LECs.15 Therefore, we must conclude that Verizon's repair of simple inside wire service is a service specific offering similar to that of other California LECs.
Given the comparability of the service, Verizon's use of the simple inside wire repair market power factors used for Pacific is consistent with D.90-04-031's service-specific market power criteria. They are reasonable indicators to assess Verizon's market power in this proceeding to the extent that they reflect Verizon-specific assumptions and information. This use of standard factors for service-specific offerings within California is no different than our use of generic financial modeling factors for determining a reasonable return on common equity for individual utilities.16 It is also consistent with the market power factors set forth in D.89-10-031, discussed in D.90-04-031, and used in D.99-06-053 for the service-specific repair of simple inside wire.
Verizon is using the appropriate factors to determine whether it has market power for the repair of simple inside wire. Having determined the appropriate market power factors, we next address the impact that ease of market entry and exit, supply elasticity, and demand elasticity criteria have on the repair of simple inside wire market.
A. Ease of Market Entry and Exit
The ease of market entry by competitors is dependent on the extent of technical expertise and capital requirements needed to repair simple inside wire. The ease of market exit by competitors is dependent on the extent to which capital investments required to enter the market can effectively be redeployed or sold in response to changes in market conditions.
Verizon states that it has insignificant market power with regard to ease of market entry and exit because of the minimal technical expertise and capital needed to establish a simple inside wire repair business. Verizon explains that the level of technical expertise required is merely a fundamental knowledge of installing and repairing simple inside wire that any certified electrician possesses and which can be competently performed on a "do it yourself" basis.
Verizon demonstrates its do-it-yourself position by using the results of business competitor and residential customer surveys it commissioned from an independent survey company, in which approximately 400 business and 400 residential customers participated. These surveys show that 16% of Verizon's business customers and 27% of its residential customers would themselves be likely or very likely to perform any required simple inside wire repair activities.
Verizon also conducted and commissioned other studies to demonstrate that a substantial number of alternative suppliers exist. For example, Verizon reviewed several hundred telecommunications businesses, over 8,500 electrical-contractor telecommunications business listings in Verizon's Superpages.com,17 and various Verizon telephone books. Verizon found that there are a large number of businesses already offering simple inside wire repair services to business and residential customers.
TURN and ORA do not dispute the level of technical expertise needed to establish a simple inside wire repair business or whether "do-it-yourselfers" actually exist. However, they do dispute whether a sufficient number of do-it-yourself persons exist to impact the market. We would also be concerned if do it yourself persons are the only competitors; however, this is not the case. Further, neither TURN nor ORA dispute Verizon's claim that other businesses offer simple inside wire repair service through advertisements.
The business competitor surveys were based on a simple random sampling telephone survey of approximately 400 electrical and telecommunications businesses from almost 4,000 such businesses listed in yellow page directories. The sample size was drawn to provide a 95% confidence level with a 5% margin of error.
We recognize that the results of surveys are not without limitations. We also recognize that surveys must be interpreted with care, particularly surveys concerning a competitive market. Only in monopoly markets can we have a comprehensive picture of everything that goes on. As an administrative agency, the interpretation of survey data falls well within our competence, and in light of that, we apply it in our assessment of survey evidence.
Verizon's initial business survey shows that 53% of the businesses surveyed would repair simple inside wire for business customers, of which 86% of that group are actually repairing simple inside wire. The follow-up business survey of 400 vendors conducted for Verizon based on the same statistical sampling process used for the initial vendor survey shows that 66% of the business survey respondents would repair simple inside wire for residential customers.18 This is consistent with the results of TURN's non-statistical random survey of other businesses willing to repair simple inside wire for residential customers.19
Verizon finds no capital barriers to enter or exit the market because the necessary tools to enter, which many electrical businesses already own, cost less than $1,000. Further, approximately two-thirds of the 400 businesses surveyed do not need additional tools or equipment for repairing simple inside wire.
TURN disputes Verizon's low capital cost assertion with regard to IWMP on the basis that the "thousands" of electricians and contractors that Verizon claims can enter the IWMP lack the scale of operation needed to compete with Verizon's existing service fleet in order to feasibly offer a low-cost monthly IWMP.
We recognize that businesses may need a service fleet to perform these services, as stated by TURN. However, the majority of responses to Verizon's business survey state that no additional equipment is needed. This demonstrates the alternative business supplier's ability to re-deploy existing fleets to handle simple inside wire repairs irrespective of prices Verizon may charge.
TURN and ORA also dispute Verizon's ease of market entry and exit claim on the basis that Verizon has a competitive advantage that effectively impedes or precludes competitors from entering the market. Their understanding of Verizon's competitive advantage is based on Verizon's ability to retain a practical monopoly on basic local exchange services within its service territory, which enables Verizon to maintain a dominant market share in the simple inside wire repair market. For example, in 2000, Verizon maintained a 16% IWMP share of its single-line business and CentraNet customers and a 68% IWMP share of its residential and landlord customers. However, the business survey shows that 11% of the alternative business suppliers currently offer an IWMP and that an additional 4% or 15% of the alternative business suppliers are willing to do so for business customers. No information is provided on what impact the alternative business suppliers have on the residential IWMP.
TURN and ORA contend that Verizon achieves its competitive advantage through its marketing services, incorporated into its process of taking a customer's order for basic telephone services, even though its tariffs require customers to be advised of alternative repair options. This is because Verizon is the recipient of its customers' "first calls" to report any trouble, of Verizon's ability to isolate where the problem exists prior to any repair, and of customers' perceived risk in calling an alternative supplier. Verizon does not charge its customers until after they are advised of repair rates, accept the charges, and Verizon's technician is on the premises and has performed the needed service.
Verizon has stated that the absence of any potential surprise or hidden charge for lengthy travel or call-out time may be a factor that makes the higher rate charged by the telephone company more attractive to customers, and that customers know that telephone company employees are trained and equipped to perform work on telephone wires efficiently.20 Verizon, responding to TURN's and ORA's competitive advantage concern, explains that it does inform customers as part of its process of taking a customer's order for basic telephone service that the customer may use competitive businesses for their simple inside wire repairs. Irrespective of these concerns, the business surveys do demonstrate that alternative business suppliers are widely used and are willing to repair simple inside wire.
TURN and ORA identified two additional factors as further evidence of both Verizon's dominant market power and barriers to entry into the repair sector of the simple inside wire market. They first point to Verizon's lack of desire to venture out of its service territory to compete against neighboring incumbents charging higher rates. However, the decision to offer its service nationwide, statewide, or locally is a management decision that is best made by the individual business. We have no intention of micro-managing Verizon. Verizon's lack of desire to venture out of a local area has no impact in determining the ease of market entry and exit.
The issue should be whether competitive business suppliers are willing to compete in Verizon's territory, even if they are not located within that territory. For example, TURN's non-statistical study of alternative business suppliers providing or willing to provide repair of inside wire under the two payment options in the small remote community of Legget found that "there are no competitive options at all for inside wire maintenance plans, while there are some firms willing to provide billable inside wire service to small business and residential customers.21 This demonstrates the willingness of alternative business suppliers to compete in the most remote areas of Verizon's territory. Although these alternative business suppliers are not necessarily located within the community or willing to offer IWMPs, they are willing to offer alternative BRS.
The second additional factor is that alternative business suppliers tend to charge for premise visits to customers, even if they are precluded from making repairs because the trouble exists on Verizon's side of the line. Alternative business suppliers have this ability. However, there is no evidence that this would preclude a business from entering the simple inside wire market.
In our 1997 local exchange competition decision,22 we concluded that any certified electrician could repair simple inside wire, that there is a relatively large base of qualified providers, and that there are relatively low barriers to enter the simple inside wire repair market. In our 1999 Pacific inside wire repair decision, D.99-06-053, we subsequently confirmed this existence of a relatively large base of qualified providers and ease of market entry and exit for this service. Irrespective of Verizon's ability to market its repair of simple inside wire service as part of its basic telephone customer ordering process, the large number of alternative suppliers and "do-it-yourselfers" demonstrates the existence of a variety of providers ready, willing and able to repair inside wire.
Nothing has changed. The evidence in this proceeding continues to demonstrate a minimal amount of technical expertise and little, if any capital,
are needed for the business of simple inside wire repair. The evidence also demonstrates the existence of a relatively large base of qualified providers ready and willing to repair simple inside wire and a smaller base of qualified providers willing to offer a maintenance plan. The evidence further demonstrates that Verizon's optional payment plans have no impact on the ease of market entry and exit. We can only conclude that there are minimal barriers to enter, expand, or to exit the market to repair simple inside wire. Those barriers are a minimal amount of training and little capital. Verizon has satisfied the ease of market entry and exit factor.
B. Supply Elasticity
Supply elasticity addresses the alternative business suppliers' willingness to enter the market or to expand its service. The higher the number
of businesses willing to enter, provide, or expand their services within a market
in response to a price change for those services, the higher the elasticity.
Verizon contends that supply elasticity is high because of the previously discussed low barriers to enter the market and the existence of a large base of qualified providers, as demonstrated by the results of its review of telephone books and the internet, where hundreds of telephone companies and thousands of contractors directly advertise that they provide or have the capability of providing these services.
As addressed in our prior "ease of market entry and exit" discussion, the initial telephone business survey conducted by an independent survey company shows that 53% of the businesses surveyed would repair simple inside wire for business customers, of which 86% already provide such service to businesses. Its follow-up business survey, consisting of a separate sample with the same number of business suppliers and based on the same criteria used for
its initial business survey, shows that 66% of survey respondents would repair simple inside wire for residential customers. Further, its Verizon customer surveys show that 16% of its business customers and 27% of its residential customers would likely repair their own simple inside wire.
Verizon concludes that the existence of such a large number of alternative suppliers and low cost to enter and expand into the market demonstrate that its customers would migrate to alternative suppliers if Verizon should increase its prices beyond competitive levels.
ORA does not contest the existence of a large number of alternative suppliers. However, TURN contends that Verizon fails to demonstrate supply elasticity because it has not demonstrated any actual supply flexibility.
A supply flexibility analysis would be helpful. However, we acknowledge that such an analysis is neither feasible nor expected because competitors do not freely disclose their respective marketing plans. Even regulated entities, such as Verizon, do not freely disclose their marketing data or plans, as evidenced by its filing of data under seal in this proceeding.
TURN also contends that Verizon has not demonstrated that
alternative suppliers could, would, or actually do sell IWMPs. We disagree. Verizon did identify, without providing any details, the name of an alternative supplier offering IWMPs.
The initial business survey shows that approximately 11% of the respondent businesses currently offer business customers the opportunity to subscribe to a monthly IWMP, and that an additional 4%, or 15%, of respondent businesses are willing to offer such a program to business customers. Although the percentages do not appear to be very large, the results show that alternative business suppliers do and are willing to provide business IWMP payment
options in competition with Verizon. The business survey also shows that there
is a relatively small demand for a business IWMP.
The business surveys conducted by an independent survey company did not seek to determine whether alternative business suppliers currently offer
or would be willing to offer IWMP options to residential or landlord customers. This may be, in part, because 68% of Verizon's residential and landlord customers currently subscribe to a Verizon's IWMP. Verizon has not established that alternative suppliers do or would provide this payment option to residential and landlord customers.
What about supply elasticity in the simple inside wire repair business? For business customers, Verizon is not proposing any price change in current rates. However, it is proposing to increase the ceiling rate for a rate element of its Business BRS by 18%, from $85 to $100 and to increase the ceiling rates for its Business and CentraNet IWMPs by 28%, from $1.95 to $2.50. Although the reasonableness of these ceiling rates are addressed in our subsequent ceiling rate discussion, we observe that a 18% to 30% increase in Verizon's rates established more than twelve years ago should not be a deterrent for alternative business suppliers offering a competitive service. This is especially true given Verizon's small share (26%) of the simple inside wire business market, as identified in our business end-user discussion. Even though Verizon intends to raise its business ceiling rates, the small share that Verizon maintains in the business market leads us to conclude that the price elasticity for supply that Verizon faces is high.
With regard to the residential market, Verizon is not seeking to change the current rates or ceiling rates for its BRS. Although it is not seeking to change its current rates for its Residential and Landlord IWMPs, it is seeking to increase the ceiling rates for this payment option by 84%, from $ .95 to $1.75 a month because its IWMP services are the lowest in America. The requested $1.75 monthly rate would still keep Verizon's rate the lowest of the other three States still regulating inside wire. Those other States are Arizona at $3.90 a month; Maine at $2.45; and New York at $2.10.
Given that the independent alternative business follow-up survey demonstrates that 66% of the alternative business suppliers would repair simple
inside wire for residential customers and that Verizon is not seeking to increase current rates for its residential customers, we must conclude that the supply elasticity in the simple inside wire repair market for residential customers remains high. However, there is a large unexplained disparity between alternative business suppliers' willingness to provide residential repair of simple inside wire and Verizon's actual market share. This is because Verizon maintains 74% of the residential simple inside wire market, of which 68% subscribe to its IWMP.
We are concerned that no evidence has been provided to demonstrate that Verizon is not the only provider of a residential and landlord IWMP. We are also concerned that a unilateral increase in the monthly charge for residential and landlord IWMPs would materially reduce, if not eliminate the IWMP payment option for residential and landlord customers. This concern is supported by the fact that we have received over three hundred letters throughout this proceeding from consumers, the majority of whom oppose such an increase, contending that they cannot afford such a large increase or would be compelled to discontinue Verizon's Residential IWMP. We continue a discussion of this concern in our residential end-user demand discussion.
Although Verizon has not demonstrated alternative business suppliers willingness to offer a IWMP as a pricing option for repairs of simple inside wire, we, nevertheless, conclude that Verizon has demonstrated that supply elasticity in the business and residential repair of simple inside wire market is high. Verizon has satisfied the supply elasticity criteria.
C. Demand Elasticity
Demand elasticity demonstrates the customers' willingness to change suppliers for service within a market in response to a price change for the service.
Verizon uses the results of the business and residential customer end-user surveys to demonstrate high demand elasticity in connection with the repair of simple inside wire. Similar to the business surveys, these surveys are each based on a random sample of 400 end-users. Verizon also provides the results of its own market demand calculations to support its contention of high demand elasticity. These market demand calculations are based on the assumption that the frequency with which simple inside wire repair is being used by subscribers of Verizon's IWMP is consistent with the frequency of repairs being used by its other customers. This usage factor is approximately once every six years for business customers and once every ten years for residential customers.
Similar to our recognition of the reliance we place on the results of Verizon's business surveys, Verizon's market demand calculations are not without limitation. Verizon's use of the actual repair experience of its IWMP subscribers to determine its share of customer demand for the service is not a precise measurement of customer demand. However, it is another factor we can use to evaluate Verizon's customer demand share of the simple inside wire market.
Verizon concludes that the end-user surveys and its market demand calculations demonstrate that its business and residential end-users are confident that alternative business suppliers can satisfy their needs for the repair of simple inside wire and that Verizon's end-users would change suppliers in response to a price change for the service.
Neither TURN nor ORA believe that Verizon has met its burden of proof to establish that demand elasticity exists. We address the end-user surveys and market demand calculations further by end-user category.
1. Business End-Users
The business end-user survey shows that 91% of Verizon's business end-users expect Verizon to repair their simple inside wire while 60% also expect electrical contractors to provide the repair service. These same business end-users expect other types of businesses to repair their simple inside wire as follows: 58% by other telephone companies; 35% by telecommunications businesses; 25% by building managers; and, 25% by self repair. The percentages do not add up to 100% because the business end-users stated their preference to use more than one business for their simple inside wire repairs.
The large percentage of business end-users recognizing Verizon's ability to provide repairs would be significant, if not for the fact that these business end-users identified multiple suppliers with similar results. Further, the actual results of Verizon's business demand calculations show that business end-users, for whatever reason, opted to use alternative business suppliers 76% of the time.23 This means that these end-user customers used Verizon 24% of the time. Of Verizon's 24% business end-user demand market share, 16% subscribed to Verizon's IWMP option and 8% used the BRS option. Clearly, Verizon does not have a significant business end-user demand market share.
The relatively large market share being satisfied by alternative business suppliers demonstrates that the business end-users are confident that their simple inside wire repair needs can be met by alternative business suppliers and that Verizon's prices are already competitive, if not high. Similarly, the large percentage of alternative business suppliers recognized by business end-users demonstrates high elasticity of demand in this market.
Given Verizon's low business market share and its intent to not raise its current and ceiling rates, except for the first billable Weekday hour of its Business BRS, the price elasticity of demand that Verizon faces is high. Without
a change in its service offerings, this high elasticity of demand is only expected to increase further. Verizon has satisfied the demand elasticity criteria for its business end-users.
2. Residential End-users
The residential end-user24 survey shows that 90% of the residential end-users expect Verizon to repair residential simple inside wire, while 63% also expect such service to be offered by electrical contractors, 61% by other telephone companies, 31% by telecommunications businesses, 31% by self-repair, and 19% by building managers.25 These results demonstrate that the residential end-users do not view any one entity or class of entity as being a predominant supplier of simple inside wire repairs and that they are aware of alternative business suppliers capable of meeting their needs, should residential end-users find a need to switch providers. In other words, residential end-users perceive the existence of high demand elasticity.
However, this perceived existence of high demand elasticity does not continue into the actual residential end-users demand market. Actual experience shows that only 26%, fewer than one-third of the residential end-users, currently rely on alternative business suppliers for their simple inside wire needs. The remaining 74% rely on Verizon's service, of which 6% rely on its BRS and 68% on its IWMPs.
The large percentage of end-users utilizing Verizon's optional IWMPs is in stark contrast with the survey results of Verizon showing that only 26%, or 70% of the approximate 36% survey respondents, acknowledge subscribing to a IWMP. With no explanation given for this large disparity between perceived and actual utilization, we can only conclude that a large number of residential end-users are not aware that they subscribe to a IWMP. To an extent this is confirmed through the more than 300 letters received from customers in protest of the application. Although a number of these letter writers assert that they will discontinue their residential IWMP, a majority of these protesters object to paying for a service that they seldom or never use. It is also a signal that this service may not yet be fully competitive. Regardless of the reason for the disparity, it is clear that the preference of residential end-users is for the optional IWMP.
With full competition, the substantial number of residential end-users would consider alternative business suppliers for its repair of simple inside wire. Because no alternative business suppliers offer an IWMP, these end-users would be required to migrate to the optional BRS. Absent evidence to demonstrate that these end-users would exercise choice when deciding whether to continue with Verizon or change suppliers, we must conclude that Verizon has not demonstrated residential or landlord demand elasticity.
Also, absent evidence to demonstrate that alternative business suppliers offer optional IWMPs and evidence to explain the disparity between residential end-users being aware of and actually subscribing to a IWMP, we should conclude that 68% of the residential end-users are captive customers of Verizon, leaving 32%, less than one-third, subject to the influence of competitive BRS service.
Verizon opposes the use of market share data in considering
whether it has market power. Verizon contends that market share data is not the market power standard used in prior Commission decisions and because the
data is based on historical evidence and ignores recent and ongoing changes in the market. As a general rule, we concur. However, in this case, residential end-users consider the optional IWMP to be their preferred choice and Verizon has not demonstrated recent and ongoing market changes that should be considered. With no other entity providing this preferred payment plan, residential end-users are restricted to Verizon's IWMP. If priced out of the
IWMP option, they are limited to the BRS for which there is insufficient information to assess demand elasticity.
It is clear from the record that the repair of simple inside wire for residential and landlord end-users is not a monopoly service. However, the record also demonstrates that these customers prefer the IWMP option over the BRS option. With Verizon maintaining a significant market share through its Residential IWMP and Landlord IWMP options, and lack of evidence demonstrating demand flexibility, we cannot conclude that residential and landlord demand flexibility exists in the simple inside wire repair market. Verizon has not met its burden of proof to substantiate the existence of
residential and landlord end-user demand elasticity in the simple inside wire market.
D. Conclusion
In summary, Verizon has demonstrated the ease of market entry and exit, and supply elasticity in the business and residential customers market for repair of simple inside wire. Verizon has also demonstrated business customers' demand elasticity in the market for repair of simple inside wire. However, it has not demonstrated residential customers' demand elasticity in the market for repair of simple inside wire.
Verizon's Business BRS, Business IWMP, and CentraNet IWMP should be reclassified from Category II to Category III service offerings. Because
Verizon has not met its burden of proof to substantiate that it possesses insignificant market power in the market for residential repair of simple inside wire, its Residential BRS, Residential IWMP, and Landlord IWMP should continue to be classified as Category II service offerings.
