13. Auction Mechanism to Establish High Cost Funding Levels

As various parties have observed, we recognize the limitations of relying on updated cost modeling to serve as the basis for B-Fund support levels. Not only is the cost modeling process time consuming and resource intensive, but it also requires the selection of a particular technology that is to be modeled. In the last decade, advances in communications technology have brought consumers many choices of voice providers using many technologies. It may not be in consumers' interests for government to select the technology for consumers through funding of B-Fund support. Rather than rely on a technology-specific cost proxy as a basis to determine high cost funding levels, we conclude that the superior long term solution is to move toward more market-based approaches that are not biased toward a particular carrier or technology. In particular, we intend to pursue implementation of a reverse auction as a means of determining the appropriate level of high cost support to meet universal service goals on a technology-neutral basis.

We determined in D.96-10-066 that, "if little or no [local phone] competition develops, then we may reconsider whether the use of an auction mechanism is appropriate for reviewing the subsidy amounts."¹⁶⁹ After holding a workshop in 1997 to investigate development of an auction mechanism, we found that existing legal and market conditions at that time were not suitable for an effectively functioning auction mechanism.¹⁷⁰ Commission staff concluded that conditions continued to be unsuitable in 1999.¹⁷¹ Legal concerns identified in 1997, and persisting in 1999, included the Commission's ability to restrict subsidy to the winning bidders, the ability to relieve incumbent LECs of their interconnection obligations, and the ability of the Commission to require exiting COLRs to sell facilities according to a specific pricing method.¹⁷²

The competitive concerns identified in 1997, and persisting in 1999, involved the lack of potentially interested bidders for less desirable service areas and lack of facilities-based local exchange competition at that time, with the expectation that such competition would arrive to remote areas at a much later time. Commission staff concluded in the Telecommunications Division 1997 Workshop Report that, without competition, an auctioning mechanism would not serve the public interest, and could enable ILECs' to "ratchet-up" the level of subsidy in those areas with the least amount of competition, which would result in an artificial inflation of the subsidy.¹⁷³

In comments in this proceeding, various parties suggest that the Commission take no action to implement a reverse auction until the FCC issues its own set of revised universal service rules which may provide guidance on this issue. We acknowledge that proposals for reverse auctions are currently being considered by the FCC as a vehicle to determine high cost support for the federal universal service program.¹⁷⁴ We intend to take into account any relevant ideas or proposals that may be developed by the FCC proceeding as we craft a reverse auction for use in our state B-Fund program.

Given the range and extent of competitive options that have developed over the past decade, however, we cannot simply delay moving forward to develop our own auction mechanism. California has not been afraid to innovate ahead of the federal government and other states. We believe that the time is right to revisit the concept of an auction as a superior means of determining the value of a high cost subsidy.

The purpose of an auction mechanism has been stated as allowing "a marketplace of competitive bidders to determine the economically efficient level of subsidy required to compensate a carrier for serving a high cost area."¹⁷⁵ In many contexts, "auctions have been used as a way to introduce market forces into the allocation of scarce resources."¹⁷⁶ A properly structured auction mechanism could drive down the cost of the subsidy for high cost areas to the extent that a competitor is more efficient than the current COLR in offering service to such areas. An auction mechanism would eliminate the need to revisit the issue of whether one particular cost proxy model is better than another, or to litigate updated cost studies, and would avoid the time and resource consuming aspects of litigating cost models. The auction mechanism also eliminates debates over what type of technology should be modeled since the bidder will take that factor into account in making a bid. Bidders will also have to consider all sources of revenues expected to be realized when they make their bids, not just basic service revenues. In this manner, a reverse auction will reflect more realistically all of the revenue sources associated with providing service over a basic access line in high cost areas.

In the next phase of this proceeding, we shall develop the record as a basis for implementing an auction mechanism to replace the current system based upon modeling of cost proxies of high cost support requirements. The auction mechanism will require development of a bidding process predicated upon appropriate parameters of acceptable COLR service. For example, we will consider if there is some minimum standard of reliable 911 service necessary for a carrier to qualify as a COLR. Does a competitor that requires end users to furnish terminating equipment other than a standard telephone qualify as a COLR? We also will consider whether, if the ILEC loses the COLR bid, the ILEC must then make its existing facilities in the designated area available to a new COLR. As one possible preliminary approach, we may consider selecting a limited area for a pilot project to test the operation of a reverse auction.

In comments on the Proposed Decision, certain parties advocate moving forward with the implementation of a reverse auction before proceeding with the updating of the high-cost proxies utilizing the HM 5.3 Model. Such parties believe that such a sequence makes more sense given the limitations of the HM 5.3 Model which can only calculate the costs of a traditional ILEC voice-centric technology. We acknowledge that a reverse auction is superior to the HM 5.3 Model because a reverse auction is technology neutral and forward looking. Moreover, parties such as DRA argue that in order to mitigate the risks that the HM 5.3 Model may produce anomalous results, parties should be allowed to propose how to cap the total investment calculation produced by the HM 5.3 Model to avoid excessive subsidies. Parties such as DRA and Time Warner also suggest other possible adjustments to the cost proxy to avoid excessive subsidies, such as limiting support only to the operations and maintenance costs for existing lines as derived from the model.

Verizon notes, however, that even if the implementation of the reverse auction were given priority, there would still need to be some kind of reasonable cost proxy to serve as an auction "reserve" or upper bound on bids that would be acceptable as the basis for payment of support levels. In addition, the Commission must select the geographic areas for which auctions would be held. Certain cost proxy determinations may be necessary as a basis to identify such areas where high costs exist based on updated data.

We will defer to the next phase of this proceeding the specific manner in which to sequence and prioritize the respective tasks involved in implementing the reverse auction and updating the relevant high-cost proxies, recognizing the limitations inherent in the HM 5.3 Modeling approach. In this way, we can properly assess the various considerations that are relevant in making an informed judgment concerning the proper sequence and coordination of the implementation of the reverse auction and cost proxy updates.

Moreover, while we affirm our goal to keep the cost proxy updating process streamlined and simplified, we will not rule out the possibility that certain limited adjustments to the modeling results, as certain parties suggest, may be warranted in order to arrive at an overall reasonable proxy given the limitations of the HM 5.3 model. We emphasize that we view the updating of cost proxies utilizing the HM 5.3 model as a transitional step toward the implementation of the reverse auction. Any trade-offs between modeling accuracy and additional workload must be weighed within the context of the limited timeframe within which such proxies would apply before the reverse auction took effect.

In the next phase of this proceeding, we shall provide further procedural guidance to parties concerning the appropriate guidelines for possible proposals to adjust the HM 5.3 model results to help ensure that the resulting cost proxies are reasonable as a basis for deriving B-Fund support levels until a reverse auction can be implemented. Our ultimate goal is a reverse auction, as we believe it to be the best method for delivering the most cost effective service in today's competitive telecommunications marketplace.

¹⁶⁹ D.96-10-066, mimeo. at 216.

¹⁷⁰ CPUC Staff Report, "Universal Service Report to the Governor and the Legislature: In Response to Pub. Util. Code § 739.3(e) and (f)" (Rel. December 1, 1999) at 8.

¹⁷¹ Id. at 9.

¹⁷² Id. at 9.

¹⁷³ CPUC Staff Report "Universal Service Report to the Governor and the Legislature: In Response to Pub. Util. Code § 739.3(e) and (f)" (Rel. December 1, 1999) at 9.

¹⁷⁴ The Federal-State Joint Board on Universal Service issued a public notice (FCC 07J-2) seeking comment on the use of reverse auctions.

¹⁷⁵ CPUC Staff Report "Universal Service Report to the Governor and the Legislature: In Response to Pub. Util. Code § 739.3(e) and (f)" (Rel. December 1, 1999) at 8.

¹⁷⁶ FCC Public Notice, "Federal-State Joint Board on Universal Service Seeks Comment on the Merits of Using Auctions to Determine High Cost Universal Service Support," WC Docket No. 05-337, at 2. See http://www.neca.org/wawatch/wwpdf/081406_1.pdf#search=%22auction%20mechanism%20telecommunications%22.