ALJ/DOT/tcg DRAFT Agenda ID #4615

Ratesetting

Decision DRAFT DECISION OF ALJ DUDA (Mailed May 13, 2005)

BEFORE THE PUBLIC UTILITIES COMMISSION OF THE STATE OF CALIFORNIA

Application of AT&T Communications of California, Inc. and WorldCom, Inc. for the Commission to Reexamine Shared and Common Costs and Non-Dedicated Transport in its Annual Review of Unbundled Network Element Costs Pursuant to Ordering Paragraph 11 of Decision 99-11-050.

Application 04-03-013 (Filed March 12, 2004)

OPINION DENYING REQUEST TO REEXAMINE

SHARED AND COMMON COSTS AND SHARED TRANSPORT

In Decision (D.) 99-11-050, the Commission set unbundled network element (UNE) rates for Pacific Bell Telephone Company (Pacific, d/b/a SBC California (SBC)). In that same decision, the Commission established a procedure by which Pacific, or carriers with which Pacific has entered into interconnection agreements, could annually nominate UNEs for reexamination of the adopted rate. (See D.99-11-050, mimeo. at 271, 272.) When nominating UNEs for review, carriers are required to set forth a summary of the evidence alleged to show that UNE costs have declined by at least 20% from the costs approved in D.98-02-106. (Id.)

In this application, AT&T Communications of California, Inc. (AT&T) and WorldCom, Inc. (now MCI) (collectively "Joint Applicants") request reexamination of SBC's shared and common costs and shared transport rates.

Shared and Common Costs

The shared and common cost markup, which allows SBC to recover overhead costs as part of its UNE rates, is currently set at 19%.¹ Thus, each of SBC's UNE rates set by the Commission includes a 19% adder. The markup is calculated by dividing an estimate of SBC's total shared and common costs (the numerator) by an estimate of total direct UNE costs (the denominator).² Joint Applicants contend that the current markup is inflated and quite outdated since it is based on 1994 vintage data. They maintain that a number of factors indicate it is virtually certain that SBC's shared and common costs have decreased by 20% or more since the markup was adopted in D.99-11-050.³

First, Joint Applicants contend that corporate mergers since 1994 have undoubtedly decreased SBC's overhead costs. According to Joint Applicants, SBC justified its 1997 merger with Pacific Telesis and its 1999 merger with Ameritech based on claims of substantial overhead cost savings. (A.04-03-013, p. 7.) In addition, SBC California has reduced its workforce 19.7% from 1994 to 2002. (Declaration of Thomas L. Brand and Arthur Menko, 2/27/04, p. 11.)

Second, Joint Applicants claim that projected overhead reductions are confirmed by an examination of SBC's publicly-available ARMIS⁴ data relating to corporate operations and network operations expenses, which Joint Applicants allege are the two largest components of the markup. Joint Applicants compare corporate operations expenses to total revenues less corporate operations expense, total access lines, and switched access lines. Joint Applicants also compare network operations expenses to Total Telephone Plant in Service, total access lines, and switched access lines. Joint Applicants claim these analyses show that corporate operations expenses have declined between 20.1% and 45.5% from 1994 to 2002 and network operations expenses have declined between 33.7% and 54.8% over the same time period. (See Brand/Menko Declaration, pps. 11-19.)

Finally, Joint Applicants contend that because the Commission has reexamined SBC's UNE costs in A.01-02-024 and consolidated cases (also known as the "2001/2002 Reexamination"), and UNE costs comprise the denominator of the markup calculation, the Commission must now review the numerator of the markup equation to ensure both components of the markup are current.

SBC opposes Joint Applicants' request to review the shared and common cost markup for several reasons. First, SBC states that Joint Applicants have not offered any calculations to show the effect of the alleged declines in overhead costs on the markup calculation. According to SBC, Joint Applicants take forecasts of merger savings out of context and incorrectly overestimate the extent to which merger savings relate to overhead and benefit SBC's California operations. In contrast, SBC maintains that merger cost savings have been spread across all SBC corporate entities and affiliates, and affect both direct UNE costs and shared and common costs. Thus, SBC does not agree that merger savings automatically translate into a decline in the shared and common cost markup.

Second, SBC contends that Joint Applicants' analysis using ARMIS data is flawed. The Commission itself noted the difficulty in using ARMIS data to estimate shared and common costs because ARMIS data cannot easily be compared to forward-looking cost estimates in a TELRIC analysis. As a result, ARMIS data can understate shared and common costs. (SBC Protest, 4/15/04, p. 5, citing D.99-11-050 pp. 69-70.) Moreover, SBC contends Joint Applicants' ARMIS analysis is not based on total corporate expenses or total network operations expenses. When these are reviewed instead, shared and common costs appear to have increased. (SBC Protest, p. 6.)

Finally, SBC contends that if Joint Applicants' allegedly flawed ARMIS analysis is recalculated using data for 2003 rather than 2002, the results show a 15% increase in overhead costs rather than a decrease. According to SBC, in order for the overall shared and common cost markup to have declined by 20%, the numerator in the calculation, i.e. total shared and common costs, would have needed to decline by more than any declines in the denominator, i.e. total direct UNE costs. Joint Applicants have not presented any evidence to show that overhead declines have been greater than declines in direct UNE costs.

Discussion

We agree with SBC that the preliminary evidence provided by Joint Applicants does not convincingly show how projections of merger savings and analyses using limited categories of ARMIS data translate into actual declines in shared and common costs. While Joint Applicants show declines in corporate operations expenses when compared to total revenues less corporate operations expenses, this analysis has several shortcomings.

The primary flaw in Joint Applicants' nomination is that while they argue that historical ARMIS data shows certain overhead expense categories have declined, they have not addressed the question whether total overhead expense reductions have exceeded declines in total direct UNE costs. This is the key factor in proving that the shared and common cost markup factor has declined. As can be seen by the markup equation, the markup is based on the relationship between total shared and common costs and total direct UNE costs. Joint Applicants merely allege the numerator in the markup calculation has decreased, without showing the relationship between the numerator and denominator. For the markup to be lower, shared and common costs would have to go down more than UNE cost declines. If both have declined by the same amount, the markup percentage would remain unchanged at 19%. Joint Applicants have not attempted to recalculate the markup factor to show that the markup is lower than 19%, nor have they offered any recommendation how the Commission would recalculate the numerator and denominator of the markup given that we have reexamined only some UNE costs, but not all of them.

In addition, we agree with the criticisms of SBC that it is unclear how historical ARMIS data for corporate operations and network operations expenses equate to the shared and common costs projected in the Commission's TELRIC inquiry in the prior OANAD. SBC validly criticizes Joint Applicants' analysis for using only limited categories of corporate operations expenses and not total expenses and for not using more recent 2003 data. Joint Applicants' analysis assumes a markup factor of 9.04% in 1994, declining to 6.45% in 2002. However, the Commission found in D.99-11-050 that SBC's markup factor was 19% (and later corrected the markup calculation twice, ultimately returning to the current rate of 19%). This alone shows that the proxy method Joint Applicants' use to calculate the markup differs drastically from the method used by the Commission in the prior OANAD proceeding, and Joint Applicants offer no explanation to bridge this gap.

We agree with SBC that while the merger of Pacific Telesis and SBC in 1997 and the merger of SBC and Ameritech in 1999 have no doubt led to cost savings through workforce reductions and other means, Joint Applicants have not shown that these savings accrue solely to overhead or California operations, or impact the relationship of overhead costs and total UNE costs.

Finally, the Commission most recently reviewed the markup percentage in D.05-03-026, where it addressed a remand of the markup calculation from the Ninth Circuit Court of Appeals. In that order, the Commission corrected its calculation and decreased the markup percentage to 19%. (D.05-03-026, p.17-19.) For these reasons, we decline to conduct a proceeding to review the shared and common cost markup at this time.

$901 Million (shared and common costs) = 19.4%, rounded to 19% $4.651 Billion (total direct UNE costs)