VII. Price Floors

A. Background

As part of this proceeding, the Commission must establish price floors for Verizon's Category II services, i.e., those retail services offered by Verizon that are partially competitive because Verizon retains significant, though perhaps declining, market power. (See D.89-10-031 ("NRF Decision"); 33 CPUC 2d 43 at 125.) Price floors were intended to prevent incumbent local exchange carries such as Verizon from squeezing competitors out of the market by charging unreasonably low retail prices that deny a competitor purchasing inputs from the incumbent any reasonable opportunity to earn a profit.

The Commission's price floor methodology establishes minimum prices for the incumbent's retail services. These price floors recover what the incumbent charges competitors for any service components that the incumbent controls (referred to as "monopoly building blocks" or MBBs) plus all of the incumbent's relevant forward-looking costs for other components of the service. The requirement that price floors include the price of MBBs is known as the "imputation rule," which ensures that incumbents "impute" the price of any MBBs into the price of their own retail service just as if they purchased the MBB at the prevailing wholesale price. (33 CPUC 2d at 121.)

The Commission's original price floor formula was:

The Commission developed an alternate version of this formula known as the "contribution formula," which is:

In D.94-09-065, the Commission found that the original formula and the contribution formula achieve the same result and are algebraically equivalent. (56 CPUC 2d 117, at 233.) In D.99-11-050, the Commission set price floors for SBC using the contribution formula and designated loops, switching and white page listings as MBBs. (D.99-11-050, mimeo. at 206-7.)

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 1997 OANAD cost studies. Despite that decision, advice letters to implement Verizon's price floor proposals were unable to gain Commission approval. Finally, the Commission reexamined the interim pricing flexibility and implemented interim price floors for Verizon in D.03-03-033. In that order, Verizon requested, and the Commission approved, use of the volume sensitive TSLRIC figures in Verizon's 1997 cost study filing, along with updated UNE rates, in setting interim price floors. (D.03-03-033, mimeo. at 49-52.) The Commission found that because the interim UNE rates adopted in D.03-03-033 were significantly lower than the UNE costs and TSLRICs filed by GTEC in 1997, Verizon should substitute the new interim UNE rates and reduce the volume sensitive TSLRICs in the price floor formula by the same percentage that its current UNE rates are reduced. (Id., p. 52.)

In the sections that follow, we will first address a request by Verizon to modify the price floor formula. Following that, we will address the specific price floor proposals offered by the parties.

B. Petition to Modify MBBs

On April 1, 2005, Verizon filed a petition to modify the finding in
D.99-11-050 that switching is an MBB.43 Verizon states that the FCC's Triennial Review Remand Order (TRRO)44 eliminated the requirement that ILECs provide competitors with access to unbundled mass market switching, effective March 11, 2005, based on the conclusion that CLCs are not impaired in the deployment of switches and it is feasible for CLCs to use competitively deployed switches to serve mass market customers throughout the nation. (TRRO, para. 204.) Given this finding, Verizon requests the Commission remove switching as an MBB for price floor imputation purposes.

Verizon supports its request by explaining the Commission used a four point standard to classify MBBs in D.99-11-050. A facility was deemed "essential," and thereby an MBB, based on:

1) Control of the essential facility by a monopolist

2) A competitor's ability practically or reasonably to duplicate the essential facility

3) The denial of the use of the facility to a competitor, and

4) The feasibility of providing the facility [to the competitor]45

Verizon comments that when the Commission classified switching as an MBB, it explicitly recognized that "in time, this situation may change" based on growth in the number of CLC owned switches and greater access to collocation space. (Id., p. 237.) According to Verizon, the FCC's TRRO now finds switching does not meet the FCC's unbundling standard, citing a substantial increase in CLC switch deployment since 1999 and the conclusion that a lack of collocation space does not hinder CLCs ability to deploy competitive switches because an efficient competitor does not have to be collocated in every ILEC central office to serve customers in that wire center. (Verizon Petition to Modify D.99-11-050, 4/1/05, pp. 3-4, citing TRRO paras. 205, 206, and 224.) Verizon argues that if switching does not meet the FCC's unbundling standard, it cannot meet the essential facilities standard used by the Commission in D.99-11-050. Therefore, the Commission should remove switching as an MBB from the price floor formula. (Id., p. 4.) Verizon suggests this action will benefit consumers by removing artificial price umbrellas that inhibit robust price competition. (Id., p. 7.)

SBC supports Verizon's petition, noting the Commission has already found that not all UNEs are MBBs because they are not "essential to local competition." (SBC Response, 5/2/05, p. 1, citing D.99-11-050, mimeo. at 221.) Thus, SBC asserts that the test for MBBs is stricter than the test for UNEs, and that nothing found to fail the UNE test can be an MBB. Thus, the circumstances that led the Commission to deem switching an MBB are no longer valid. (Id., p. 2.)

ORA, TURN, Anew Telecommunications Corporation and Navigator Telecommunications (jointly Anew/Navigator) oppose Verizon's request. ORA and TURN recommend denial of Verizon's request, claiming not all affected parties have received notice and an opportunity to comment on the proposal.46 Rather, the Commission should open a rulemaking with all companies operating under the Commission's "New Regulatory Framework" (NRF)47 as respondents to consider California-specific data regarding switching. There, the Commission can assess local competition in California and access to mass market switching. ORA and TURN contend there is no link between the FCC's determination that switching is no longer a UNE and this Commission's adoption of certain facilities as MBBs. (ORA/TURN, 5/2/05, p. 5.) Instead, MBB findings require a factual analysis of market conditions in California. They maintain that recent evidence from the Commission's staff report to the FCC on TRO issues indicates "no CLC is currently providing mass market service, at service quality similar to the ILECs', using switching that is a substitute to ILEC switching, in any wire center in California." (Id., p. 9, citing the Commission's TRO Staff Report at 89.) Moreover, ORA and TURN assert the status of CLC switching will change drastically should acquisitions by SBC and Verizon of AT&T and MCI, respectively, receive approval. They estimate that the proposed mergers may remove as many as two-thirds of all CLC switches in the state. (Id., p. 10.)

Anew and Navigator agree with ORA/TURN that before taking any action, the Commission must consider that current state of competition in California, particularly in light of the proposed mergers. They contend the TRRO assumes collocation is established, but in California permanent collocation provisions were never completed. Thus, CLC remain subject to the ILEC's interpretation of collocation obligations, including inconsistent application of collocation rates among CLCs. (Anew/Navigator, 5/2/05, pp. 8-9.) Anew/Navigator assert that federal law does not preempt the Commission's ability to identify local switching as an MBB, as long as such regulations are not inconsistent with the Act. (Id., p. 10-11, citing 47 U.S.C. Section 251(d)(3).)

Verizon responds that the FCC removed switching from the UNE list based on a comprehensive analysis of market data, therefore switching cannot meet the "essential facilities" test for MBB qualification. Furthermore, the Commission's TRO staff report used "a lopsided methodology proposed by MCI that `screened out' some UNE-L competitors, including cable companies, in order to conclude that `there are no markets (defined by wire centers) that contain at least three CLECs with self-deployed switches providing UNE-L mass-market service.'" (TRO Staff Report, 10/4/04, pp. 8 and 62.) According to Verizon, the TRO staff report was never endorsed by the Commission and was rejected by the FCC, which found a substantial increase in CLC switch deployment since 1999 and no operational impairment for CLCs with respect to availability of collocation space. (TRRO, para. 224 and n. 619.)

We find that given the FCC's TRRO findings regarding mass market switching on a nationwide basis, switching no longer meets the "essential facilities" test we relied on in D.99-11-050. As the FCC found, competitors have the ability to duplicate switching facilities to serve customers. Therefore, we shall remove switching as an MBB and no longer require UNE switching prices to be imputed into the price floor formula. We will not explicitly address SBC's argument that if an item is not a UNE, it cannot meet the MBB test. There may be circumstances where the Commission, based on circumstances specific to California, finds that a facility is essential to local service even if it is not a UNE.48 With regard to switching, however, the FCC's extensive record regarding competitors' ability to duplicate switching facilities leads to our finding that switching does not pass the MBB test.

We disagree with the proposals of ORA/TURN and Anew/Navigator to review California market conditions regarding switching and collocation. The FCC has only recently performed a comprehensive review of switching and we will not revisit those conclusions at this time. Finally, we find Verizon gave proper notice of its petition to modify and interested parties have had adequate opportunity to comment.

C. Price Floor Proposals

1. Verizon

Verizon's initial cost filing in November 2003 included cost studies to support the calculation of price floors, but did not include actual price floor proposals. Verizon planned to submit a compliance filing containing proposed price floors after the Commission adopted UNE costs from Verizon's cost model. At the ALJ's request in a ruling of February 3, 2004, Verizon submitted a supplemental filing on February 17, 2004 to calculate price floors for over 125 retail services. On April 2, 2004, Verizon submitted Supplemental Panel Testimony on Recurring Costs with what Verizon claimed were minor changes to its UNE and price floor cost studies.

Verizon's proposed price floors are founded on the price floor methodology described in D.99-11-050 and applied to SBC. The components of that methodology are the volume sensitive TSLRIC of the given retail service, the TELRIC-based UNE price of the three designated MBBs if they are relevant to the retail service in question, and the volume-sensitive TSLRIC of the relevant MBB so that contribution can be determined. (VZ Supplement on Recurring Costs, 4/2/04, p. 16.) Verizon's TSLRIC cost estimates come from a set of retail cost studies that are part of the VzCost model. The retail cost studies use many, but not all, of the same inputs and assumptions used by Verizon to calculate UNE costs and prices. In particular, the retail cost studies use a lower cost of capital than the UNE cost studies. (Verizon Price Floor Rebuttal, 4/1/05, p. 13.)

2. MCI

In contrast to Verizon's price floor proposals, MCI recommends the Commission treat all existing UNEs as MBBs. (MCI/Murray, 1/28/05, p. 39.) MCI calls this the "sum of the MBBs" approach and maintains it is simply the original price floor approach, adopted in D.89-10-031, updated to use forward-looking costs of competitively provided components of retail services. To implement its sum of the MBBs approach, MCI proposes price floors based on the UNE rates calculated by HM 5.3, although it modifies some of the inputs to include general support costs. (MCI/Bryant, 1/28/05, pp. 4-5.)

According to MCI, it is reasonable to expand the list of MBBs to all UNEs because the Commission's determination in D.99-11-050 that there are only three MBBs is over five years old. Moreover, the FCC has scrutinized its UNE list in recent years to ensure they are both necessary to compete against an incumbent and that competitors are impaired without access to them. (Id., p. 39.) Finally, MCI contends its sum of the MBBs approach is consistent with D.04-11-022, in which the Commission reviewed price floors for SBC and specifically directed that UNE prices be used in determining the cost floor for basic service.49

3. AT&T

AT&T endorses MCI's approach to price floor calculations and asserts the Commission has the freedom to expand the list of MBBs beyond the three adopted in D.99-11-050. (AT&T, 4/1/05, p. 2.) AT&T supports MCI's interpretation of recent Commission action related to price floors, and notes that according to the Commission, price floor rules are fundamentally intended to ensure that "the prices charged to competitors" are included in the incumbents' rates. (D.04-11-022, mimeo. at 9-10.) Based on this quote, and the Commission's edict that "the UNE-P rate" must be used to develop the price floor for residential basic and business service, AT&T supports MCI's proposal to use UNE prices as the basis for Verizon's price floors. (AT&T, 4/1/05, p. 3.)

4. TURN

TURN supports use of the price floor methodology provided by JC witness Murray, but provides some modifications to the actual calculations based on updated inputs. (TURN, 4/1/05, p. 2.)

5. ORA

ORA alleges Verizon's price floor model suffers from the same maladies as the Verizon model devoted to UNE pricing. If the Commission cannot rely on Verizon's TELRIC cost studies for setting UNE rates, the use of Verizon's cost studies as a framework for setting price floors is questionable. (ORA, 1/28/05, p. 2.) According to ORA, Verizon's proposed TSLRIC price floors start from the same assumptions and inputs as Verizon's TELRIC model and flow through the Verizon model in a unified way until the TSLRIC calculations diverge from the TELRIC ones. Thus, any complications and problems with the UNE inputs and assumptions also affect the price floor outputs. (Id., p. 12.)

In addition, ORA criticizes Verizon for proposing increases in price floors over their current levels, and far above the current price for residential flat rate service.50 ORA claims it is not credible for Verizon to request a price floor increase when it has posted positive rates of return in the 12% to 20% range from 1997 to 2003. (Id., p. 4.)

In lieu of using the Verizon model for price floor purposes, ORA recommends the Commission adjust the interim price floors set in D.03-03-033 based on the percentage difference between Verizon's interim UNE rates and the final rates adopted in this order. (Id., p. 5.) Specifically, the Commission could adjust the volume sensitive TSLRIC figure in the price floor formula by the same percentage that its current UNE rates are adjusted, similar to the method used in D.03-03-033. (Id., p. 22.)

6. Discussion

The debate over price floors centers on which methodology to use. Verizon seeks to apply the method used for SBC, but MCI disagrees with Verizon's price floor calculations, asserting Verizon has not implemented the contribution formula correctly and alleging numerous flaws and inconsistencies in the components of Verizon's price floor proposals. Specifically, Verizon's access, UNE, and retail studies are not consistent, use differing methodologies, and the direct costs of MBBs and the corresponding components of retail services are not equal. (MCI, 1/28/05, p. 7.) As a result, the direct costs of MBBs in the Verizon UNE cost studies are generally higher than direct costs for the same functions in the retail cost studies. For example, Verizon's UNE cost studies use a higher cost of capital. Second, Verizon's retail cost studies reclassify many direct UNE costs as "shared," thus eliminating them from the retail cost studies.

Echoing the criticism by MCI, TURN contends Verizon's proposed price floors do not comply with forward-looking standards because Verizon has not properly calculated the TSLRIC component of the price floor formula. The VzCost model, which forms the basis of the TSLRIC retail cost studies, is flawed because it relies on embedded network design, includes embedded expenses, includes non-incremental portions of the network, and fails to develop service-specific retail costs. (TURN, 1/28/05, p. 2.)

In contrast to Verizon's approach, MCI suggests a new methodology where all UNEs should be converted into MBBs. Verizon implies MCI suggests this approach because HM 5.3 cannot support the traditional price floor formula. Specifically, HM 5.3 cannot identify the volume sensitive TSLRIC costs associated with retail services. Thus, the only price floor methodology that HM 5.3 is capable of implementing is the "sum of the UNEs" method that the Commission expressly rejected in D.99-11-050 on the grounds that simply adding UNE prices "results in price floors which include far more shared and common costs than any firm in a competitive environment would have to bear..." (Verizon, 4/1/05, pp. 3-4, citing D.99-11-050 mimeo. at 210.) Rather, D.99-11-050 found only three UNEs qualify as MBBs, namely loop, port, and white page listings. In Verizon's view, MCI inappropriately asks the Commission to disregard D.99-11-050. Furthermore, the MBB list should not be expanded at the same time that the FCC is reducing the number of UNEs. (Id., pp. 8-9, citing TRRO, para. 204.)

With regard to D.04-11-022, Verizon contends its conclusions do not override D.99-11-050 and render the contribution method obsolete. The explicit focus of D.04-11-022 was to maintain consistency with the principles of IRD and its progeny. (Id., p. 7, citing D.04-11-022 mimeo. at 4.) In other words, the only prices to competitors that should be included in price floor calculations are for those functions deemed to be MBBs, not all UNEs as MCI suggests.

ORA does not support the MCI approach of using the "sum of the UNEs" to calculate price floors, contending the Commission should have a more thorough record before changing price floor methods and should examine a "sum of the UNEs" approach for all NRF ILECs at the same time. ORA proposes a separate rulemaking or investigation for this purpose. (ORA, 4/1/05, p. 20.)

Quite simply, there are few good options before us. Theoretically, we could choose to mirror the price floor methodology and formula we used when setting price floors for SBC. However, in order to do so, we must use the VzCost model and its myriad inputs and assumptions that we have we have rejected for UNE costs. On the other hand, we can use MCI's approach which was explicitly rejected in D.99-11-050. Neither option is appealing.

First, we find it is unreasonable to adopt Verizon's proposed price floors. While we do not take issue with the contribution formula Verizon has used or its description of the methodology, we have rejected use of the Verizon cost model and its inputs and assumptions. We have not used the Verizon model to set UNE rates, and it would be improper to rely on it to set price floors, particularly when we have found Verizon's cost inputs and assumptions are not forward-looking.

Second, we are not persuaded by MCI's arguments to abandon the contribution method in favor of MCI's "sum of the MBBs" approach. JC acknowledge HM 5.3 does not calculate the volume-sensitive TSLRICs we need for the contribution price floor formula. It appears MCI proposes this alternative "sum of the MBBs" methodology to compensate for the lack of TSLRIC information in HM 5.3. Implicit in MCI's proposal is the concept of accepting all UNEs as MBBs. This idea was considered in D.99-11-050 and rejected.

While MCI and AT&T cite D.04-11-022 as support for using all UNE prices for price floors, we agree with Verizon that the Commission's instructions on price floor calculation in D.04-11-022 were intended to maintain consistency with the principles of IRD and do not override D.99-11-050 and its list of MBBs. While D.04-11-022 approves the "Total of the Floors" approach to add price floors together for bundles of retail services, it should not be construed as modifying how price floors are calculated. The direction that UNE-P rates should be used merely directs the use of updated UNE rates "using the imputation rules." (D.04-11-022, mimeo. at 27, Conclusion of Law 13.) Thus, if a UNE is a MBB under current imputation rules, its updated rate will figure into the price floor, but the list of MBBs is not expanded. Further, we agree with Verizon that given current market conditions and the FCC's recent refinement of the UNE list, it is inappropriate to enlarge the list of MBBs. We adhere to the MBB findings of D.99-11-050, as modified in this order to remove switching from the MBB list. We will not include all other UNE prices as MBBs in our calculation of price floors. Therefore, we reject MCI's proposed price floors.

Third, ORA proposes that for the interim, we should continue to use the same price floors adopted on an interim basis in D.03-03-033, with updates to reflect the new UNE prices adopted in this order. ORA suggests these interim price floors can remain in effect while the Commission orders Verizon to file new price floor studies or opens a further investigation into the use of MCI's approach for all ILECs. Given that we have rejected the Verizon cost studies and therefore reject using them for price floors, and that HM 5.3 does not provide the TSLRIC information we need for our price floor formula, ORA's interim proposal is appealing. Furthermore, we note that in the Commission's rulemaking assessing and revising its regulation of telecommunications utilities
(R.05-04-005), the Commission is considering, among other issues, whether to continue the price floor concept for partially competitive services. Without prejudging the outcome of that rulemaking, we acknowledge that changes to the current price floor system are under consideration. Therefore, it would be unreasonable to open a rulemaking on price floors as ORA suggests, or spend a great deal of resources perfecting the current price floor proposals of either Verizon or MCI.

Instead, we shall direct Verizon to file a compliance filing modifying the interim price floors adopted in D.03-03-033, as ORA recommends. Specifically, price floors shall be calculated using the same approach that was described in D.03-03-033 except that Verizon should substitute into its calculations the UNE rate adopted in this order for the loop monopoly building block. Verizon should also adjust the volume-sensitive TSLRIC data used in the price floor formula, similar to the adjustment ordered when interim price floors were adopted. (D.03-03-033, mimeo. at 52.) Specifically, the $13.94 average basic loop rate adopted today is 17.1% less than Verizon's former UNE rate of $16.81, the rate that was in effect when the 1997 cost studies were filed. Therefore, the loop's volume-sensitive TSLRIC should be reduced by this percentage.

Although ORA suggests a short extension of the interim price floors, we are inclined to adopt them on a more permanent basis. The interim price floors are based on cost studies that Verizon's predecessor GTE filed in 1997 -- cost studies that the Commission has never reviewed or approved. As noted in
D.03-03-033, Verizon itself proposed use of these price floors on an interim basis and has made do with them since March of 2003. They are based on cost studies that yielded UNE rates higher than those we adopt in today's order. It is reasonable to conclude that if the 1997 cost studies could somehow be modified to produce the UNE rates we adopt today, the corresponding price floors would be far lower than the interim price floors. Thus, we conclude that if anything, the interim price floors that we will now rely on permanently err on the high side. Indeed, Verizon's proposed price floors are much higher than the ones we put in place today. If Verizon was willing to compete with floors much higher than the ones we adopt herein, then it should be satisfied these price floors are not inflated and will not disadvantage Verizon in the competitive marketplace.

40 D.94-09-065 ("IRD Decision"), 56 CPUC 2d at 232.

41 "Contribution" has been defined by the Commission as the TELRIC-based price of an MBB minus the volume sensitive TSLRIC of the MBB. (D.99-11-050, mimeo. at 207.)

42 D.99-11-050, mimeo. at 267, Conclusion of Law 80.

43 Verizon claims it has good cause for filing beyond the one year deadline in Commission Rule 47(d), because the change in law at the federal level in 2005 is sufficient reason to waive the one year time limitation for petitions to modify.

44 In the Matter of Review of Unbundled Access to Network Elements, Review of the Section 251 Unbundling Obligations of Incumbent Local Exchange Carriers (WC Docket No. 04-313, CC Docket No. 01-338); Order on Remand, FCC No. 04-290, (rel. Feb. 4, 2005) ("TRRO").

45 D.99-11-050, mimeo. at 218.

46 According to Verizon, its petition was served on the service list for the Verizon UNE phase of OANAD where price floor issues are being addressed. Additionally, Verizon also served the parties in SBC's UNE Reexamination with its petition since that is the proceeding where SBC UNE issues have been considered on a going forward basis.

47 The NRF-regulated companies are SBC, Verizon, Surewest Telephone and Citizens Telecommunications of California.

48 Indeed, the Commission has noted that "the [FCC's] First Report and Order makes imputation a matter of state law and regulation..." (D.99-11-050, mimeo. at 232-233.)

49 See D.04-11-022, mimeo. at 6 and Attachment A at 1. MCI also cites Conclusion of Law 13 of D.04-11-022 which states:

50 While price floor calculations are proprietary, Verizon proposes a 129% increase in the price floor for residential flat rate service.

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