Common Cost Markup

Pacific's Position

Pacific maintains that the Commission need only make a simple arithmetical correction to the markup calculation to comply with the Remand Order. Specifically, Pacific states that given the Court's finding that the denominator of the markup calculation double-counted non-recurring costs, the Commission should subtract from the denominator the estimate of non-recurring costs that Pacific originally included in its estimate of total direct UNE costs. Since the Commission separately found in D.98-12-079 that non-recurring costs were $375 million, the original estimate of non-recurring costs that was included in the total direct UNE costs should be removed. Pacific explains that its original estimate for non-recurring costs was $583 million, but this figure was later revised downward to $537.8 million based on a "labor rate adjustment" of $45.5 million.⁸ Therefore, Pacific maintains that the Commission should now subtract $537.8 million from the denominator.

To support this approach, Pacific explains that in the Remand Order, the Court agreed with Pacific and found that the total direct UNE cost figure in the denominator of the markup calculation (i.e. $4.814 billion) was based directly on revised cost studies provided by Pacific after making Commission ordered adjustments that did not include removing the non-recurring cost estimate. (Remand Order, pps. 37-38.)

According to Pacific, once the non-recurring cost estimate of $537.8 million is appropriately subtracted, the denominator of the markup calculation would be reduced from the $5.189 billion⁹ set forth in D.99-11-050 to $4.65 billion. To recalculate the markup percentage, total shared and common costs of $996 million would be divided by $4.65 billion, yielding a markup percentage of 21.4%, which rounds down to 21%.

Pacific states that once this correction to the shared and common cost markup is made, the Commission should order revisions to both the permanent rates set in D.99-11-050 and the interim rates adopted in D.02-05-042 so that the recalculated markup can be corrected in UNE prices in all interconnection agreements between Pacific and other carriers.

Joint Applicants' and Other Competitive

Carriers' Positions

Contrary to Pacific's comments, Joint Applicants do not agree that any double counting has occurred and they notice their intent to appeal the Remand Order. They fundamentally disagree that the Commission can correct any double-counting error in the markup calculation through a simple mechanical adjustment to the denominator of the markup. Rather, Joint Applicants contend that a complete reexamination of the record from the OANAD proceeding is required before any adjustments can be made.

Joint Applicants maintain that Pacific's current position regarding the double-counting of non-recurring costs, and its position before the U.S. District Court, is directly contrary to statements of its cost expert, Richard Scholl, during the OANAD proceeding. According to Joint Applicants, Scholl testified under oath at a deposition that there were no non-recurring costs included in the recurring cost study used to calculate total direct UNE costs. (See Joint Applicants Comments, 8/28/02, Exh. D. "Deposition of Richard Scholl, 3/22/96" and Joint Applicants Reply Comments, 9/4/02, Exh. A.) Joint Applicants claim this testimony contradicts Pacific's current claims that the total direct UNE cost figure of $4.814 billion included $537.8 million in non-recurring costs.

Because of this contradiction, Joint Applicants argue that the Commission must now decide between three courses of action. First, the Commission could rely on the sworn deposition testimony of Pacific's own witness Scholl and thereby ignore Pacific's current claims regarding double-counting. This would result in no changes to the markup calculation. Second, the Commission could ignore Scholl's testimony and remove double-counting from the markup and from Pacific's UNE recurring costs.¹⁰ Third, the Commission could avoid deciding between these two contradictory positions entirely by instead removing any double-counting through an update to the markup using current cost data.

In support of this third option, Joint Applicants maintain that the only proper method to correct any double-counting is to set a new shared and common cost markup and new recurring costs, and prices, based on current cost data. They contend that Pacific's shared and common costs have significantly decreased since studied in 1994 because of SBC's 1997 merger with Pacific Telesis and its 1999 merger with Ameritech. Joint Applicants describe how SBC justified these mergers with forecasts that they would result in substantial overhead cost savings. Specifically, SBC claimed $1 billion in expense savings from the merger with Pacific Telesis and $1.7 billion in cost savings from the Ameritech merger. (Joint Applicants Comments, 8/28/02, pps. 17-18.) Moreover, Joint Applicants state that Pacific's own ARMIS¹¹ data for corporate overhead expenses show a decrease of 12% from 1994 to 2000. (Id.)

Joint Applicants contend that calculating shared and common, or overhead, costs is the least complex part of a recurring cost study since overhead costs are simply high level company expenses projected on a forward-looking basis. Joint Applicants propose a formula for this purpose that uses publicly available ARMIS data for a simple calculation that provides a ratio of overhead costs to total costs.¹²

XO and Allegiance express support for the Joint Applicants' position that the Commission should comprehensively review the shared and common cost markup calculation based on current data rather than simply making mathematical corrections to the former calculation.

Pacific opposes Joint Applicants' proposal that the Commission abandon its methodology for calculating the shared and common cost markup for a new method using ARMIS data. Pacific notes that aside from the mathematical error regarding double counting, the current methodology was upheld by the Court as fully consistent with the 1996 Telecommunications Act and FCC rules. Pacific states that Joint Applicants' proposal violates the FCC's TELRIC standards because it is based on an average of data for all Bell companies, it relies on historical rather than forward-looking data, and it uses revenues rather than costs as required by Section 252(d)(2) of the 1996 Telecommunications Act. (47 U.S.C § 252(d)(2)) Fundamentally, Pacific characterizes Joint Applicants as attempting to throw out the entire OANAD record and start over. Pacific states that Joint Applicants provide no basis for this "extraordinary suggestion" to cast aside the entire OANAD proceeding and recalculate everything.

Further, Pacific argues it is too late to raise arguments about mergers that took place prior to the adoption of the markup in D.99-11-050. According to Pacific, the current markup incorporates a forward-looking analysis that assumed Pacific would realize substantial future overhead savings. Pacific contends there is no reasoning to support the suggestion that the mergers have resulted in more savings than was built into the common cost figures used in D.99-11-050. (Pacific Reply Comments, 9/4/02, p. 11.)

With regard to the deposition testimony of its witness Scholl, Pacific implies that Joint Applicants are only attempting to "muddy the waters" with information outside the record of the original OANAD proceeding that is more properly the subject of an appeal of the Remand Order. Pacific states that Scholl's deposition was never introduced into the record of OANAD and the cost study he refers to in his testimony was superseded by a subsequent version that specifically delineated recurring and non-recurring costs.

Discussion

We regret that we find ourselves in the position of having to revisit the shared and common cost markup originally calculated in D.99-11-050. The parties and the Commission expended enormous effort to perform and analyze the cost studies that led to the 19% markup and the UNE prices ultimately adopted in that order. We do not wish to devalue the extraordinary efforts of so many people during the course of the OANAD proceeding by opening up old wounds, particularly to put a hasty patch over them. Indeed, we are hesitant to make these changes after the passage of so much time because there is a dangerous potential that, in presenting mere excerpts from spreadsheets, testimony, and all of the other components of the prior OANAD record, parties can now take bits of information, potentially out of context, to support vastly different outcomes years later. Nevertheless, the Remand Order, and its finding that the Commission could not adequately explain whether or how non-recurring costs were removed from Pacific's total direct UNE cost estimates, forces us to review the markup percentage and its origins.

Despite our hesitation at undertaking this exercise on an expedited basis, the principal question before us in responding to the Remand Order is whether we should make a simple and quick arithmetical correction to remove the double-counting found by the Court, or whether we should take a fresh look at the markup percentage based on current data. The first option, while quick and relatively simple, is complicated by the testimony of Pacific's own witness that there were no non-recurring costs included in calculations that underlie the adopted total direct UNE cost figure of $4.814 billion. The latter option, namely calculating an entirely new shared and common cost markup with current ARMIS data, holds some appeal because of the potential that Pacific's overhead costs have changed since cost studies were last performed based on 1994 data. On the other hand, there is no question that this endeavor would require more time and involve more resources than the mathematical correction proposed by Pacific. If we were to entertain entirely new markup methodologies, we need time to iron out the details.

Although both options are problematic, we refuse to see these two options as mutually exclusive. In view of the Remand Order, we will opt to make an immediate correction to the markup calculation made in D.99-11-050 to remove the double-counting found by the Court. At the same time, we realize that a complete review of Pacific's shared and common costs would be wise. Unfortunately, we cannot commit the resources at this time to such a resource-intensive endeavor.

Therefore, to comply with Remand Order, we find that we should promptly correct the denominator of the markup percentage that the Court found had double-counted non-recurring costs. Pacific has reasonably shown that the number we adopted for total direct UNE costs of $4.814 billion was based on its cost studies submitted in 1997 and revised by further filings. Pacific's original estimate included $583 million in non-recurring costs, which was later adjusted to $537.8 million based on a the "labor rate adjustment." We find that none of the revisions to the 1997 filing removed either this $583 million or $537.8 million in non-recurring costs that were included in the original total direct UNE cost estimate. Therefore, to remove double counting of non-recurring costs in the denominator of the markup, we should subtract the original $537.8 million estimate of non-recurring costs that is embedded in the $4.814 billion total direct UNE cost figure because it was replaced with the new amount of $375 million that was adopted in D.98-12-079.

When we perform this subtraction, the $4.814 billion figure is reduced to $4.65 billion,¹³ which becomes the new denominator in our calculation of the shared and common cost markup. To complete the markup calculation, we substitute the new figure of $4.65 billion into the formula we used in D.99-11-050. Specifically, we start with the $996 million in total shared and common costs for all UNEs,¹⁴ and divide by $4.65 billion in total direct UNE costs and non-recurring costs. This computation results in a markup of 21.4%, which consistent with prior Commission practice, rounds down to 21%.

We make this correction to the markup calculation despite Joint Applicants' numerous arguments that there was no double-counting in D.99-11-050. Principally, Joint Applicants rely on the conflicting deposition testimony provided in 1996 by Pacific's witness Scholl to argue against modifications to the markup. Pacific charges, and Joint Applicants do not deny, that the deposition was never introduced into the original OANAD proceeding. Despite this, Joint Applicants ask that it now be considered. We agree with Joint Applicants that Scholl's testimony contradicts Pacific's current position regarding double-counting of non-recurring costs because he states there are no non-recurring costs in the recurring cost study used to develop the $4.814 billion in total direct UNE costs.¹⁵ With all due respect to Mr. Scholl, his testimony is directly contradicted by the figures contained in the cost filings filed in 1997, which includes line items for non-recurring costs. We should not consider the Scholl testimony because it was not on the record of the original OANAD proceeding. Even if we did consider it, we would give greater weight to the actual cost filing that occurred after the date of the Scholl deposition than to deposition testimony taken a year in advance of that filing. We note that the Court relied on the actual cost filings when deciding the double-counting issue in the Remand Order and Scholl's testimony was never raised.

Further, Joint Applicants imply that the Commission must have converted some of what Pacific labeled non-recurring costs into recurring costs. Even if this were the case, there is no support in D.99-11-050 or elsewhere for this claim. Joint Applicants' assertions that Pacific did not prove there was double counting are more appropriate for an appeal of the District Court's Remand Order. If there were support for this contention, there would likely have been no Remand Order in the first place. The fact is that the Commission used Pacific's estimated total direct UNE costs as a starting point for the numbers used in the markup calculation. Pacific has sufficiently shown how the figure of $4.814 billion used in the markup calculation can be traced directly back to Pacific's original total direct UNE cost estimate of $4.83 billion.

As we stated above, we will make the correction described above to the denominator and increase the shared and common cost markup from 19% to 21%. This change shall be effective with this order. We will also endeavor to review Pacific's shared and common costs based on current information at some future date. We will not commit resources at this time to this effort, but we will consider it as we set our telecommunications priorities for the future. Although Joint Applicants would prefer that we take a fresh look at shared and common costs immediately, using their new methodology, we believe that consideration of their new methodology would be a complicated task and divert significant time and resources from other current priorities. We opt to make arithmetical adjustments to the method that we used in D.99-11-050 rather than undertake a fresh look at the markup right now. It is our view that the actions we take today, namely a quick correction coupled with a future review of the markup, are adequate and fully comply with the Remand Order. We will, however, not foreclose Joint Applicants from resubmitting their proposal when we review the markup at some future date.

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