VII. Alternative Compensation Arrangements: Reciprocal Compensation Versus Bill-And-Keep

A. Parties' Positions

The ILECs propose that reciprocal compensation be eliminated for ISP traffic and replaced with a "bill-and-keep." Under bill-and-keep, the ILEC would bill its end-user (the subscriber) and cover its costs. The CLEC would do the same and bill its customer (the ISP)and cover its costs. The ILEC and CLEC would make no payments to each other. Pacific says it will continue to absorb costs to originate and transport ISP-bound traffic to CLECs, and would forego compensation from CLECs or its customers for such origination, transport, and switching costs. CLECs would continue to bill ISPs, and they would retain all of the revenues they collect. CLECs would not pay Pacific for the additional switching and transport costs of ISP-bound calls.

The ILECs claim that bill-and-keep provides for an equitable sharing of the burden of the FCC's exemption of ISPs from paying access charges. As a result of this exemption, neither originating nor terminating carriers can levy access charges on ISPs. Pacific argues that if the ISP exemption were not in place, carriers would be compensated by a meet-point-billing arrangement with access charges applying on both the originating and terminating side of the call. Pacific characterizes its proposal as a continuation of the meet-point-billing requirements, but with the exemption of the ISP from access charges, resulting in a "bill-and-keep" arrangement whereby the originating and terminating carrier each shoulders the burden for the portion of the call they carry.⁹⁶

Pacific points to various purported advantages to end users of bill-and-keep. End-user customers would not have to pay toll charges to access the Internet. CLECs would continue to have calls rated as local and at the same time have the calls routed to distant points of interconnection without paying Pacific for transport and tandem switching.

End-user customers would not have to provide additional funding to Pacific, or any other originating carrier, to finance reciprocal compensation payments CLECs.

Pacific also claims a level playing field would be created in the market place for ISP business. All LECs serving ISPs would use ISP revenues to cover their costs. Consistent with the FCC's ESP exemption, LEC costs that are not covered by charges to ISPs would be absorbed. LECs would not view residential customers as potential liabilities.

Pacific's witness, Dr. Harris, characterized bill-and-keep as "a reasonable compromise halfway between the long distance access charge scheme which would flow revenue back to PacBell, the originating carrier, and the current reciprocal compensation scheme which flows charges from PacBell to the CLEC serving an ISP." Dr. Harris testified that bill and keep would reduce the distortion that favors old-fashioned dial-up modems over advanced access technologies. Pacific still believes the adoption of bill and keep for ISP-routed traffic represents a subsidy from Pacific to the ISP because there is no intercarrier compensation, rather than having the ISP compensate the ISP's LEC/CLEC and Pacific Bell. Pacific claims that CLECs can cover (or already are covering) their switching costs by charges already levied on ISPs without reciprocal compensation payments from Pacific.

Pacific believes that under the Act, bill-and-keep arrangements are acceptable outcomes. Pacific argues that because Sections 251 and 252 do not mandate that reciprocal compensation be paid on ISP-bound calls; the Commission has the latitude to adopt a preferred outcome excluding ISP-bound calls from reciprocal compensation requirements. Since the FCC has exempted ISPs from paying carrier access charges, Pacific argues that costs need to be recovered from the users of the respective carrier services - ILECs from their end users and CLECs from their end users, including ISPs. Pacific claims that nothing in the law prohibits CLECs from recovering costs from ISPs through fees other than access charges.

The ILECs argue that the elimination of reciprocal compensation payments will merely eliminate certain CLECs' windfall profits, but deny that there is any evidence that the CLECs' financial viability would be threatened. Pacific points to statements made by ICG and Focal to investors and the financial community to the effect that they will be viable even without the reciprocal compensation they currently receive.

CLECs oppose the bill and keep alternative, arguing that it would prevent recovery of terminating costs from the originating caller that causes the costs to be incurred. CLECs argue that because the originating caller initiates the call to the ISP, the carrier of the originating caller should compensate for the cost of terminating the call to the ISP as a matter of economic fairness. Witness Selwyn argues that all local calls are undertaken on a "sent-paid" basis whereby the originating subscriber has paid to have the call delivered on an end-to-end basis.

The CLECs argue that bill and keep is particularly inappropriate due to the traffic imbalance in ISP-bound calls exchanged between competitive LECs and incumbent LECs. Focal argues that the traffic imbalance is precisely the reason why reciprocal compensation is needed. Adoption of bill-and-keep (the default arrangement if reciprocal compensation payments are eliminated) when traffic is not roughly balanced would preclude the LEC with the greatest volume of terminating traffic from recovering its transport and termination costs. Imposition of a bill-and-keep mechanism when traffic is imbalanced would be inconsistent with the FCC's rules on the matter. Specifically, the FCC concluded that bill-and-keep may only be imposed by state commissions where the traffic terminated on interconnecting LECs' networks is roughly equal and is expected to remain so.

B. Discussion

We find the bill-and-keep proposal a fair and workable alternative to reciprocal compensation. We view the transaction of ISP traffic as stemming from a contractual agreement between the customer of the CLEC - the ISP - and an end-user who subscribes to the ILEC's residential service. The end-user is first a customer of the ISP and then as consequence of that relationship he is a customer of the ILEC. The ISP's service to the end-user is to provide a medium of access to the Internet at fees the ISP sets. A missing link in this arrangement is a connection between the subscriber and the ISP. So the ILEC's network becomes the entry platform needed to transmit the call from the subscriber to the ISP's modem en route to the Internet. The customer of the ISP then becomes a subscriber to the ILEC for the local access line in order to complete its calls and reach the Internet. But we should note that the ILEC is not selling the subscriber access to the Internet and nor does it collect compensation for it. The subscriber pays the ILEC the same flat rate fees that were established for standard residential voice service, except that the service would now be used for a different type of communication.

On the other side, the ISP also has a contractual agreement with the CLEC for certain services that may include transport and delivery of this traffic from the ILEC to the ISP's modems so that the call can proceed to its ultimate destination, the Internet network. But we know based on the record before us that the ISP could make a similar agreement with the ILEC to transport and deliver the call from the subscriber to its modems obviating the need for the services of a CLEC. In which case, the ILEC, for example, could provide the necessary access to the ISP absorbing or passing costs to the ISP as it wishes. No reciprocal compensation issues arise out of that transaction as the record of this demonstrates. If, however, the CLEC is involved, it provides services, some of which could be transport and termination functions, to the ISP at a price the CLEC and the ISP determine. The subscriber in this arrangement is a customer of both the ISP and the ILEC.⁹⁷ And the CLEC has the ISP as a customer. But from a cost-causation point of view, it is the Internet end-user that causes the cost (for which CLECs' ask reciprocal compensation) to be incurred as a customer of the ISP to access the Internet rather than at the instant he makes a dial-up access as the customer of the ILEC. If there were no ISP to sell access to the Internet to this end-user, the customer would not incur the cost in question. The subscriber pays both the ILEC and ISP for services each provides; the ISP, for access to the Internet; and the ILEC, for access to the PSTN so that the customer connects to the Internet. We reject the notion that the end-user as a customer of the ILEC causes the cost and therefore the CLEC should be compensated for its transport and termination services. The CLECs' view conveniently ignores the fact that the end-user uses the ILECs services only to complete a transaction that it initiates with the ISP. The CLECs also ignore an apparent fact that before the end-user starts to use the ILEC's services and originates calls to send to the ISP, the ISP and the CLECs must have arranged to receive this call and transmit it to the Internet network. It defies commonsense and logic to say, after all this, that the cost causer is the end-user as a customer of the ILEC simply because the same person happens to be a user of both services. The fact is the ILEC stands to gain nothing from either the transaction between the end-user and the ISP or that between the ISP and the CLEC. If anything, the ILEC may be incurring additional costs to transport and terminate ISP-bound traffic even if we cease to order it to pay reciprocal compensation.

Under a bill-and-keep arrangement, the ILEC would bill the subscriber and keep the payments. The CLEC, if involved in this set up, would pick up the call from a certain point of its choosing and transmit it to the ISP modem for conversion into a packet switch protocol format to be sent to the Internet. The CLEC would bill the ISP and keep the payments. CLEC and ILEC exchange no compensation. To the extent the ILEC believes it incurs charges in origination and transport, it absorbs the cost. To the extent that the CLEC believes it incurs charges in transporting and termination of the call it can choose to either pass the cost on to the ISP based on its agreement with CLEC, or absorb the cost. We believe this arrangement is fair to the CLEC, ILEC, ISP, and the subscriber.

The bill-and-keep proposal is favorable in several respects given the inequities inherent in reciprocal compensation arrangement. Bill-and-keep recognizes the unique nature of dial-up access and is consistent with the general principles of cost causation, as described by Pacific's Witness Harris. Unlike reciprocal compensation, bill-and-keep does not require that we impose `taxes' on residential telephone subscribers, or adopt uneconomic policies that require LECs to subsidize reciprocal compensation payments using revenues from other unrelated services and products. Bill-and-keep would eliminate the unintended consequence that reciprocal compensation introduces for CLECs to shun residential customers in order to avoid making reciprocal compensation payments to other LECs. In other words, it enhances competition. Bill-and-keep is competitively neutral. It does not favor dial-up access to other forms of high-speed access services such as DSL, cable, and others, as does reciprocal compensation through subsidies. Finally, bill-and-keep does not create market distortions in the dial-up access market.

CLECs' arguments against bill-and-keep are not well founded. Bill-and-keep is permissible under the Act because Internet-bound traffic is non-local as we find in this order. Thus the Commission has the authority to adopt bill-and-keep as a preferred outcome in interconnection agreements. CLECs' argument that ISP-traffic cannot be accurately be accurately measured and thus cannot be segregated for billing purposes is unconvincing and unsupported by the record. CLECs have the means to identify the telephone numbers ISPs distribute to their customers for dial-up access. They should also know their customers. As we found in this record, the most active CLECs in this proceeding have revealed that many of their ISP customers collocate their modems in their spaces.⁹⁸ Moreover, if CLECs know who their customers are for the purpose of Form-10K filings and investor reports, surely they can identify them for bill-and-keep purposes when ordered.⁹⁹ CLECs and ILECs shall record and keep track of ISP-bound traffic that they transport and terminate for the purposes of bill-and-keep or otherwise as provided for in their interconnection agreements.