VIII. NRF Incentives, Service Quality, and Competition
A. NRF Incentives and Service Quality, Positions of Parties
The parties dispute the impact of NRF incentives on service quality. TURN claims that NRF creates incentives to save money at the expense of service quality. It contends that NRF's emphasis on cost cutting and revenue enhancement has led to deterioration of service quality. It also believes the introduction of new technology affects service quality and may result in discrimination among technology "haves" and "have nots." It alleges that NRF creates incentives for the regulated utility to move functions outside the utility to an unregulated environment, which can leave regulated customers without adequate service. It disputes Pacific's claim that its other rates subsidize basic service, which Pacific claims minimizes its ability to cut costs for - and therefore undermine the quality of - basic telephone service. It does not believe that competition provides an incentive for good service quality. Finally, it believes that positive change will only result from active regulation in connection with NRF.
TURN points to evidence demonstrating that NRF incentives to cut costs and increase revenues have lowered service quality. TURN bases its allegations about repairs, installation and answer times on the reporting we discuss elsewhere in this decision. Concerning Pacific, TURN claims that the data show adverse impacts causing slow repairs, slow installation, slow telephone answer times, erroneous late payment charges, errors resulting from outsourcing company functions, charging for services that were formally free, and marketing abuses.
TURN relies on other formal Commission proceedings for its claims about late payment charges, outsourcing, service-charges, marketing abuses, and deteriorating service quality.
Similarly, ORA alleges that under NRF Pacific has "reduced [its] quality of service, grossly inflated staffing claims, . . . moved portions of the labor force out of California . . . , and had sustained facilities shortages. . . ."273
Pacific responds that these claims indicate fundamental disagreement with incentive-based regulation and that the criticisms do not belong here. Pacific states that in fact NRF gives it "strong incentives to provide high-quality service, to retain as many customers as possible, and thereby reduce the opportunity for competitors to `cream-skim' the most profitable, lower cost, and high-usage customers."274 It claims that the Commission adequately regulates service quality under NRF through its GO 133-B requirements and other monitoring reports, and that "[t]he Commission has not taken any steps to rescind NRF because . . . Pacific has consistently met or exceeded the Commission's benchmarks under GO 133-B."275
As it does for Pacific, ORA alleges that under NRF Verizon - albeit to a lesser extent than Pacific - has "reduced [its] quality of service, grossly inflated staffing claims, . . . moved portions of the labor force out of California . . . , and had sustained facilities shortages. . . ."276
TURN cites several specific problems with Verizon that allegedly support its claims about NRF. It states that "like its TRSAT, Verizon's BOAT was often below the GO 133-B standard, until shortly after the SBC/Pacific Bell merger decision, wherein the Commission stated that it would enforce the standards."277
Verizon responds that "Verizon's service quality results are compelling evidence that NRF gives strong incentives to provide high quality service." Thus, it agrees that we must examine its specific service quality results in order to determine the veracity of TURN's claims. However, Verizon also claims that NRF "encourages carriers to focus on service quality," citing several measures that Verizon has employed that go beyond the bare bones reporting that this Commission and the FCC require.278
B. Discussion: Incentives to Improve Service Quality Under NRF and Under Cost-of Service Regulation
A comparison of the incentives affecting service quality under rate of return regulation with those under NRF shows that although in a pure textbook world they are very different, in the real world they are in important respects very similar. Under rate of return regulation, as practiced in California, between general rate cases, a utility can keep all the cost savings that it can realize. Thus, traditional regulation provides substantial incentives to reduce service quality expenses between rate cases.
Two other features of rate of return regulation, however, tempered the incentive to cut expenses. If a utility had reduced its service quality expenses, between rate cases, a Commission would commonly set a lower revenue requirement at the next general rate case. In addition, if a service quality improvement required a capital investment, rate of return regulation provided an incentive to make the investment. On the other hand, service quality improvements that required additional labor carried only risk and no reward, until the next rate.
We also note that under cost of service regulation, this commission rarely systematically measured or assessed service quality during the first 60 years of rate regulation. Indeed, it was not until 1973 that the Commission first issued a General Order pertaining to service quality for telecommunications.279 -Based in part on these standards, in 1976, the Commission ordered Pacific to upgrade its service to curtail and reduce an increasing backlog of held service orders.280 In 1980, the Commission found that GTE California (now "Verizon") failed to meet GO 133 service quality standards, and reduced its return on equity by 0.5% until it met standards.281
In summary, we note that rate of return regulation, as practiced in California, contained little standardized measurement of service quality before 1973. Rate of return regulation permitted shareholders to obtain benefits from reductions in expenses between rate case periods. However, the utility had to balance this incentive to reduce expenses against a potentially lower revenue requirement in future rate cases. Rate of return regulation provided an incentive to earn a return on service quality capital investments. This could potentially lead to, what was often criticized as, "gold plating" of the network.
Under NRF, the regulatory and financial incentives were somewhat different. First, with the implementation of NRF regulation, the Commission adopted a systematic program for measuring and reviewing the quality of service offered by a telecommunications company. In 1994, as part of its triennial NRF review for Pacific and Verizon, the Commission examined the quality of telephone service under the NRF. 282 A comparison of the information reviewed in this proceeding and this decision, conducted under NRF, far exceeds all past reviews in scope and level of detail. Thus, we conclude that under NRF, regulation systematically examined service quality and thereby provided strong regulatory incentives to promote service quality.
NRF also changed the financial incentives that utilities faced concerning expenditures on service quality. Instead of keeping 100% of all reductions in expenditures between rate cases, additional earnings were subject to an elaborate sharing mechanism, with ratepayers receiving a share of the benefits arising from reductions in expenditures.283 Over time, however, the Commission eliminated sharing, and the financial incentives began to grow stronger than those of rate of return regulation for cost cutting. In particular, the periodic NRF reviews, unlike general rate cases, did not alter rates based on cost savings or capital expenditures. Thus, shareholders could realize the benefits from cost savings for a longer time than the typical three-year period between general rate cases. As commenters have pointed out, in the regulation of energy companies, this Commission commonly offset financial incentives to cut service quality with other financial incentives tied to service quality standards.284 This point is well taken, but it overlooks the myriad measures of service quality and standards adopted by this Commission and the FCC as the regulation of telecommunications markets moved to NRF or price cap regulation.
In addition, with the eventual opening of markets to competition by other local carriers and by wireless service, telecommunications customers had the ability to obtain telecommunications services from alternative carriers and from alternative technologies. Although this change was not a part of NRF, consumer choice is as much a part of the modern telecommunications market place as price cap regulation.
In summary, the implementation of NRF brought increasingly systematic and periodic reviews of the quality of service offered by telecommunications utilities. On the other hand, the economic incentives to reduce expenses became slightly stronger than those offered under cost of service regulation. Independent of NRF, changes in telecommunications technology and the opening of local markets gave consumers choices for the first time.
Finally, a theoretical analysis of incentives must take a back seat to our empirical results. As noted above, our examination of trends in service quality under NRF provided substantial evidence that service quality has improved, albeit with several problem areas that continued throughout the NRF period.
C. Effect of Competition on Service Quality - Positions of Parties
The parties express only nuanced disagreement about the effects of competition on service quality.
TURN notes that even assuming, arguendo, that competition is present in some of Pacific's markets - for example, in the California DSL market - there is no guarantee that service quality will be good. "The extant competitive pressures were not sufficient to force Pacific and its affiliate Advanced Services, Inc. (`ASI') to provide high quality Digital Subscriber Line (`DSL') service to the thousands of Californians who experienced the billing problems that led to the settlement agreement in C.02-01-007."285
For Verizon, TURN disputes any notion that competition necessarily improves service quality: "Their [Pacific and Verizon's] theoretical argument, such as it is, rests on the thin air of hypothetical `competition.'"286
Pacific's witness Hauser notes that "customers care about both service and price."287 He then proceeds to point out that Southwest Airlines has successfully competed in the air transport market with a low-quality, low-frill, but low-priced marketing strategy. Pacific claims that, "as competition increases, this incentive [to maintain service quality which does not adversely affect the demand for Pacific's competitive products] becomes `even more important.'"288 Thus, we note that Pacific's position is not a blanket argument that competition supports service quality.
D. Competition and Service Quality - Discussion
The positions of TURN and Pacific are consistent with our own Commission decision. As we observed in our recent Service Quality OIR:
It has now been over four years since we issued R.98-06-029 and nearly seven years since local exchange competition was authorized. We have concerns that our policies in pursuit of increased competition are insufficient to ensure high quality telephone service for all telephone subscribers, and especially for residential and small business customers.289
Thus, the key to determining how NRF regulation affects service quality is to look at and measure the performance of Pacific and Verizon, as we have done in this proceeding and to assess how customers perceive the quality of service, as we have done in the numerous surveys reviewed in this proceeding. As noted in our empirical sections above, our general conclusion is that Verizon has accumulated an across-the-board record of high service quality and strong customer satisfaction, while Pacific has a record of high service quality with several areas of weakness, but strong customer satisfaction. As a result, we find no evidence that NRF has had any adverse impact on service quality, and substantial evidence that under NRF California companies have achieved a record of service quality that exceeds that of comparable utilities.
Even if parties believed that competition requires high quality service (which they do not), there remains a factual question over whether there is adequate competition in the local service market to create incentives to improve service quality. In our recent decision allowing Pacific into the long distance market, we found that competition in this market is less than robust: "Local telephone competition in California exists in the technical and quantitative data; but it has yet to find its way into the residences of the majority of California's ratepayers."290
We note, however, that NRF introduced a regulatory regime to measure and review periodically the quality of service provided by Pacific and Verizon. Thus, NRF does not rely on the false assumption that competitive markets always produce high service quality, or the equally false assumption that local telecommunications markets are fully competitive. Instead, NRF created a series of regulatory and organizational incentives by increasing the attention given to measuring and reviewing the service quality records produced by Pacific and Verizon. We expect the parties to present recommendations in Phase 3B of this proceeding concerning how to build on the record of high service quality produced under NRF and to improve on those areas of weakness in service quality.
290 D.02-09-050, mimeo., at 263, available at http://www.cpuc.ca.gov/WORD_PDF/FINAL_DECISION/19433.doc.
