VI. Price Floors

Verizon's Proposal

In D.99-12-018, the Commission granted interim pricing flexibility to GTEC for its Category II services, based on a methodology using GTEC's pending OANAD cost studies. At that time, the Commission found that the delays in adopting UNE rates for GTEC had also delayed GTEC's Category II pricing flexibility and its ability to respond competitively to the retail pricing of packaged local service offerings to business customers. (D.99-12-018, mimeo., p. 11.)

Verizon explains that despite the Commission's decision to allow interim pricing flexibility, Verizon has been unsuccessful in exercising any pricing flexibility under this decision. Following D.99-12-018, Verizon filed Advice Letter 9354 requesting an interim price floor for its Zone Usage Measurement Service (ZUM),⁴² which was protested and never acted upon by the Commission. Verizon ultimately withdrew this advice letter in March 2002. In June 2002, Verizon submitted Advice Letter 10121, again requesting an interim price floor for ZUM based on the methodology adopted in D.99-12-018 and updated usage volumes and distributions. The Telecommunications Division suspended Advice Letter 10121 on July 18, noting Verizon's request for price floors in this proceeding and expressing concern that the advice letter might prejudge that request. As of this date, the advice letter has not gone into effect.

Verizon now requests that its Advice Letter 10121 should be allowed to go into effect and that the Commission should update the formula adopted in D.99-12-018 to set interim retail price floors for Verizon's other Category II services.⁴³ According to Verizon, the lack of price floors has prevented Verizon from meeting its competitors' ability to market bundled service offerings. Essentially, Verizon explains that in D.94-09-065 (the "IRD Decision"), the Commission required ILEC's to impute into their retail price floors the contribution based on the actual price paid by competitors for network elements that make up competing services. (IRD Decision, mimeo., pps. 217-218; 56 CPUC 2d 117, 234.) If any other prices are used, price floors will be either too high or too low and distort pricing signals. Thus, Verizon asks that, in accordance with the imputation requirements set forth in D.94-09-065, any interim UNE rates adopted by the Commission should replace the monopoly building block prices in the price floor calculation. In addition, Verizon suggests it be allowed to reduce the volume sensitive TSLRIC figure in the price floor formula, which is derived from Verizon's 1997 cost study filing, by the same percentage that the current UNE prices are reduced. (Verizon Response, 9/20/02, p. 26.)

Joint Commenters' Response

Joint Commenters oppose Verizon's request to update the price floor methodology to reflect any interim UNE prices that are adopted in this phase. They contend it is better to wait and set price floors when final UNE prices are adopted rather than run the risk that price floors based on interim prices may be too low. If that were to occur, Joint Commenters contend that fairness dictates a provision for reopening contracts between Verizon and its retail customers if they are based on price floors that are later adjusted upward. They also suggest that there are practical difficulties in setting price floors based on newly adopted interim UNE rates combined with TSLRIC estimates from 1996 or earlier. Rather than tangle with all of these problems, Joint Commenters suggest that the Commission should not set price floors until the permanent phase of this case.

Discussion

It is undisputed that the Commission set a methodology for calculating interim price floors in D.99-12-018. We find that the same reasons enumerated in that order as rationale for allowing interim price floors remain today. Specifically, GTEC has not yet been granted pricing flexibility to respond competitively to competitors' bundled local service offerings. We do not believe that it will prejudge this case if the Telecommunications Division lifts its suspension of Verizon's ZUM Advice Letter, although the Telecommunications Division should ensure that the advice letter is compliant with the methodology set forth in D.99-12-018.

The other issue raised by Verizon regarding price floors is whether Verizon should substitute interim UNE rates adopted in this order when calculating interim price floors for the remainder of its Category II services, and whether to adjust TSLRICs used in the price floor formula to mirror any UNE rate adjustments. We agree with Verizon that interim price floors should reflect the actual price paid by competitors for network elements, or monopoly building blocks, that make up the competing service. This comports with the Commission's analysis on imputation in the IRD Decision, which discussed the value of accurate pricing of monopoly building block components in promoting economic efficiency and fairness. (IRD Decision, 56 CPUC 2d 117, 234.) If we did not use the most current UNE rates, Verizon would have to calculate price floors for its services using its 1997 cost studies, which contain UNE rates much higher than those adopted today. This would result in a large disparity between the actual UNE rates paid by competitors and the rates used in the price floor formula. As a result, Verizon would not be able to price its retail services as low as competitors, thus distorting pricing signals and impeding competition.

The same analysis applies to the volume sensitive TSLRICs used in the price floor formula. Because we are adopting interim UNE rates through this order that are significantly lower than the UNE costs and TSLRICs filed by GTEC in 1997, we should allow Verizon to adjust the price floor formula as it has proposed to acknowledge the cost declines that are adopted in this order and to avoid distortions in pricing signals in the competitive market.

In summary, when Verizon calculates interim price floors using the methodology set forth in D.99-12-018, it should substitute the UNE rates adopted in this order for the rates contained in its previously filed OANAD cost studies and it should reduce the volume sensitive TSLRIC figure in the price floor formula, which is derived from Verizon's 1997 cost study filing, by the same percentage that its current UNE rates are reduced.

Joint Commenters suggest that some sort of true-up mechanism is necessary if these interim price floors are too low. In D.99-12-018, the Commission did not establish a true-up mechanism for interim price floors. Clearly, in the final phase of this case when the Commission sets final UNE rates for Verizon, new price floors will be adopted. At that time, any interim price floors will be replaced with new ones, but we will not institute any kind of true-up mechanism. We will, however, require Verizon to make clear in any contracts that it enters into with customers based on these interim Category II price floors that the prices in the contract are subject to change upon adoption of final price floors by the Commission in the later phase of this case.

In comments on the Draft Decision, Joint Commenters and Covad suggest that the Draft Decision errs in allowing Verizon to update its price floor methodology based on the adoption of interim UNE rates when Pacific's price floors were not adjusted. Verizon responds by noting that Pacific already has price floors in place based on Commission-approved cost studies, so adjustments to interim price floors are unnecessary. We agree with Verizon that the circumstances differ between Pacific and Verizon. Pacific's price floors are based on adopted TELRIC and TSLRIC cost studies, whereas the Commission has yet to establish price floors for Verizon using adopted cost studies. Therefore, it is appropriate to revise the methodology to calculate Verizon's interim price floors until such time as permanent cost studies are adopted for Verizon. There are no changes to the Draft Decision with regard to the price floor issue.