Position Paper

Assembly Bill 903 – Hector De La Torre
(Sponsored by Verizon Communications)

The California Cable and Telecommunications Association opposes Assembly Bill 903.

Verizon is sponsoring AB 903 (De La Torre) seeking to obtain an important exemption from California’s carefully crafted level-playing field statute governing franchising requirements. It wants to be permitted to provide its video product only in its own service area, where it has existing phone customers, not throughout the entire franchise area, as cable is required to do. The Legislature passed the level playing field statute to insure regulatory neutrality as video competition evolved. If Verizon Communications is to receive a Legislative exemption from California’s level playing field statute, the policy implications discussed below should be carefully considered so that all of the issues can be resolved in a holistic way.

Thus far, Verizon Communications and SBC Communications have added video to their bundle of services by partnering with satellite television providers, Echostar and DirectTV. Neither satellite provider has had an obligation to nor paid any taxes or fees to state or local governments. At the same time, satellite television providers have grown to 25% of the video market.

Now, both Verizon and SBC have announced their intentions to augment the relationships they have with Satellite service providers by providing video through their own telephone infrastructure, which they propose to enhance and make video capable.

But, neither SBC nor Verizon want to bear the same regulatory burdens borne by California’s cable operators and have developed business models that, while different, assume they will somehow escape having to adhere to the many prerequisites of a level playing field.

SBC contends that its television product, to be provided over IP networks, is totally unregulated. It openly admits that it intends to offer its video product to 90% of its high-income customers, but only 5% of its low-income customers throughout its vast service area. SBC believes it will have no obligation to local governments to dedicate channels for public, educational and governmental use, to pay franchise fees or taxes, or meet any of the other economic or social obligations that cable operators provide to communities throughout California in complying with the terms in their cable franchises.

Verizon, on the other hand, maintains at least at the state level that it is required to seek a local cable franchise when it begins providing video service over its networks, but it doesn’t want to do it with the same obligations of cable either. Further, Verizon does not believe that it needs a franchise in advance of deploying video equipment in spite of the fact that its State telephone franchise does not encompass video facilities or services. In contrast to its statements at the local and state levels, Verizon is supporting exemptions from franchising requirements altogether at the federal level.

As new technologies and new competitive entrants appear, there is a need to approach the profound policy implications in a holistic way so that regulations, taxes and fees can be equalized to the greatest extent possible, regardless of the technology used to provide services or how companies propose to organize themselves to provide telephone and video services, and so that government produces a vibrant competitive theatre as opposed to choosing predictable winners by skewing the field to one competitor or another.

AB 903’s author has indicated a willingness to convene the stakeholders in the competitive arena and develop policies that honor the stated objective of the sponsor while recognizing the legitimate concerns of consumers, incumbent providers, and local governments.

Furthermore, the Assembly Utilities and Commerce Committee Chair has indicated a strong intent to see to it that bills emerging from his purview reflect an honest effort to resolve concerns before sending them on to the Senate.

This sets the stage for the kind of consumer-centric policy dialogue that will be needed to ensure that California’s citizens have access to a telecommunications market place that is as regulation and tax neutral as possible.

Such a dialogue should begin with a review of California cable operator’s obligations as they provide video services under current federal, state and local regulations, which, among other things, require that:

• Cable must seek a franchise from a local government before it can begin installing its plant.
   
• Cable is required by local governments to serve universally throughout the franchise area as described by the franchising authority and is generally required to sequence the way it deploys its plant to avoid “cherry picking” or discrimination against lower socioeconomic or minority citizens.
   
• Cable pays up to 5.25% of its gross revenues in franchising fees to local governments, possessory interest taxes and in hundreds of California cities, a utility user fee that can often take the cable operator’s tax and fee burden as high as 18%.
   
• Cable must dedicate channels for public, educational and governmental use and in many cases is required to make capital expenditures and pay annual operational costs in support of these programs.
   
• Cable must seek local government approval for changes in ownership and periodic renewal of its franchise agreements.
   
• Cable must finance its plant deployment and system upgrades using risk capital, incurring significant debt.

This leads to a discussion of the policy issues raised when phone companies like Verizon and SBC seek to add video to their bundle of telecommunications services and become locally based competitors to incumbent cable operators.

Here are the issues that need to be resolved in a holistic fashion in order to insure that the level playing field is maintained, competition is promoted and the Legislature’s anti-redlining/ anti- cream skimming/ pro-universal service policies are preserved as telephone companies begin to provide cable services over their facilities:

1. Construction of a cable system without a franchise

Verizon is constructing its new fiber network without obtaining cable franchises from cities in which it has begun construction. This is a clear violation of state law, which requires a cable provider to obtain a franchise prior to the commencement of the construction of a cable system. When confronted with the allegation that it is violating state law, Verizon defends its actions by claiming that it is constructing its new video network pursuant to its authority granted by the PUC to construct facilities necessary for the provision of telephone service. Their State telephone franchise, however, does not cover this construction. And, contrary to Verizon’s claim, its existing copper network is perfectly adequate for the provision of telephone service including VoIP. Clearly Verizon is gaming the rules in order to evade franchising negotiations prior to constructing its network, requirements to which incumbent cable operators have adhered. This confers an unfair competitive advantage on Verizon, and the Legislature should clarify that Verizon must get a franchise prior to deploying facilities capbable of offering services subject to local cable jurisdiction.

2. The use of telephone subsidies by the ILECs to recover the costs associated with video upgrades threatens the viability of competition for the multichannel video service and for other services bundled along with video

• Cost allocation and the expansion of existing telephone subsidy programs

Verizon’s claim that its fiber roll-out is necessary for the provision of telephone service has ramifications that go beyond evading existing state franchise requirements. By characterizing the new network as a telephone upgrade. Verizon is declaring its intention to allocate most of the cost of the cable network to its regulated telephone operations.

By misallocating the costs of an investment undertaken for the purpose of providing cable service to its regulated telephone operations, Verizon will seek to recover the costs of this investment through telephone rates or by expanding the scope of existing telephone subsidy programs. However all of the revenues generated by the service will go directly to its shareholders. Thus, at a minimum, the Legislature should ensure that none of the investments undertaken for the purposes of providing video service or other services deemed competitive by the Commission are recovered through new or existing telephone subsidy programs. This means that in calculating telephone subsidy requirements on a prospective basis, the costs of the network upgrades undertaken primarily for the purpose of providing these services by excluded.

This not only necessary to insulate telephone customers from bearing the costs of these upgrades, it is necessary to promote fair competition. Because the cost of the new facilities will be booked to regulated accounts, prices for the video service will not necessarily reflect these costs. This will adversely affect competition not only in the cable market but the market for high-speed data and telephone service. Because services are increasingly being offered on a bundled basis, any component of the bundle prices below cost makes the entire bundle more attractive. In addition, by allocating the majority of the costs of the upgrades necessary for the provision of the video service to its regulated accounts, Verizon insulates its shareholders from much of the risk associated with entering the video business while it positions the stockholders to benefit from whatever upside may result.

• Existing subsidies

SBC and Verizon, in contrast to cable, receive explicit subsidies in the form of universal service payments and implicit subsides in the form of access charges, ostensibly to serve their high cost basic service telephone customers. High Cost Fund subsidies are available to the telephone companies throughout large portions of their service territories. For example, in the communities in which Verizon has obtained or is seeking a cable franchise, like Beaumont, Malibu and Murietta, it collects annual subsidies in the hundreds of thousands of dollars from the CPUC’s High Cost Fund alone.

While these numbers, by themselves, may appear insignificant, they are not insignificant on an aggregate basis. Because the high cost fund has not been reviewed in many years, large areas now well developed, qualify for this subsidy. Verizon is deploying or has plans to deploy fiber through out its service territory, including fast growing counties like Riverside. Today, Verizon collects approximately $44 million a year from the High Cost Fund and an additional $43.2 million in subsidy from the alleged subsidy portion of intrastate access charges. SBC collects approximately $341 million from the fund and another $132 million from access charges.

Thus, to the extent a telephone company provides cable service to customers only in a low cost or lucrative area of a given cable franchise, it gets the best of both worlds – continued subsidies for high cost telephone customers and the ability to limit risk and investment on the cable side by limiting the scope of the required build-out. In contrast, cable operators receive no subsidies to serve high cost cable customers but nonetheless provide service at averaged rates.[1]

With respect to telephony, while cable can enter telephone markets on a selective basis, it has limited access to the subsidies the ILECs draw from the Universal Service Fund, particularly in those circumstances in which it is a new entrant and has a limited telephone customer base. Indeed, one of the reasons the CPUC permitted new telephone entrants to limit their service territories was that the ILECs would be protected from the impacts of selective entry by virtue of the universal service support. In other words, to the extent they were saddled with the obligation to serve high cost customers at averaged rates, universal service funds made up the difference.

If Verizon now wants to serve only those areas of a cable franchise which are part of its telephone service territory, at a minimum, the restrictions currently in place on access to telephone subsidies by new entrants must be eliminated or reduced. Finally, pursuant to SB 1276, the Commission should review the existing High Cost fund as directed by the Legislature, to reduce the size and scope of the fund, which in its current form has become nothing more than a slush fund for the incumbents.

3. Pole issues

Rates: Verizon and SBC charge cable for access to their poles and conduits. Verizon and SBC will incur minimal costs to deploy plant necessary for the provision of cable service because their own access to existing poles and conduit is already covered in rates for telephone service. Moreover as a direct competitor to cable, Verizon and the SBC will have even more incentive than they currently have to extract as much as possible from cable for access to these facilities.

Terms and Conditions: In addition to rates, pole and conduit agreements include provisions regarding the terms and conditions of access to these facilities, including processing of cable’s pole upgrade applications. Thus the CPUC and the legislature must continue to ensure fair and nondiscriminatory access to telephone facilities.

4. Market Consolidation in the communications markets is transforming SBC and Verizon into communications behemoths who will dominate the market for local service, long distance, wireless, the enterprise market and the market for government contracts. Thus, the sheer size and scope of these companies renders the need for special treatment under the level playing field statute or any lesser economic or social obligations under local franchising unnecessary.

As noted above, the ILECs seek to evade franchise obligations that incumbent cable operators currently bear. While they claim that differential regulation is justified because they are not the dominant providers, the ILECs are harldly small fledgling companies that require special treatment in order to establish themselves in a new market. Rather, they are multi-billion dollar companies that have established customer bases in the areas they seek to serve. Moreover, the size and market power of these companies continues to grow by leaps and bounds. Together Verizon and SBC own controlling interests in the two largest cellular companies in the US. These companies hold over 50% of the market for wireless services which translates into over 90 million customers. Moreover, the recently announced acquisition of MCI by Verizon and AT&T by SBC will make these two companies the dominant providers in the highly lucrative enterprise market targeted at Fortune 1000 companies. Furthermore, they will become the largest providers of government contracts at both the state and federal level in the nation, as well as the dominant providers of long distance. Finally, theough these acquisitions, SBC and Verizon will acquire the residential customers of MCI and AT&T. Indeed, after the completion of these mergers the combined companies will hold well in excess of the current 95% share of the residential market for basic service they currently hold.

Their operations generate billions of dollars in free cash flow. Most of this money is paid out in dividends to shareholders. Even after the payout of dividends they still have free cash flow to invest. In contrast, cable companies hold a minimal share in the residential market for telephony and long distance, have no wireless assets, no share of the enterprise market and pay their shareholders no dividends. Indeed, to finance the $85 billion dollars in upgrades necessary to provide digital television, high-speed internet access and telephone service, cable companies went deeply into debt, Only now are some cable companies beginning to see a return on their investment. However, even these companies remain deeply leveraged. Thus to grant the incumbents special dispensation with respect to franchise obligations is to mistakenly identify Goliath as David and David ad Goliath. Finally, the franchise obligations that the ILECs seek to evade are not obligations that are associated with economic regulation of their operations.[2] Rather they are public service obligations that cable companies have willingly assumed when they enter the telephone business.

5. Red-lining/Cream skimming

Telephone companies must be required to build out the entirety of their service areas and be required to wire and serve in a sequence that does not discriminate against lower income or minority residents.

6. Securing a Franchise

Pursuant to Title VI of the Federal Telecommunications Act, all telephone companies using infrastructure in the rights of way in any manner to provide video services, must have a franchise from a local franchise authority and should secure it before upgrading its plant.

7. Franchise Fees and taxes

To the extent that they provide video, telephone companies should be subject to the same taxes and fees that are applicable to cable in each jurisdiction. It should be noted that local governments revenues are under attack because of the migration of cable customers to satellite service where no taxes or fees are paid. Federal law permits states to equalize tax and fee burdens among providers of like services and California should do so. This could restore over 100 million dollars in lost revenue to local governments.

8. Dedication of Channels for Public Education & Governmental Use (PEG)

Telephone companies should have to provide the same PEG services as cable in each jurisdiction and should compensate the cable operator and/or cities for the capital and operational costs attendant to these social obligations.

9. Equalized Franchise Burdens

Given Verizon’s and SBC’s size and their abilities to distort the competitive landscape either by manipulating the economics of their entry into video or through their bundle of voice, video, data and cellular service, if local franchising authorities grant more favorable franchise terms to a telephone company in any jurisdiction, provisions should be made to reopen the franchise agreement for appropriate parity adjustments on behalf of the incumbent operator. Such opportunity for reforming the franchise agreement is absolutely essential if the level playing field is to be maintained.

10. Equal Protection for All Participants

The level playing field statute should be strengthened and clarified so that no party can use the law to circumvent the Legislature’s intention to create equal burdens between cable operators and telephone companies under local franchises.

[1] If Verizon enters the portion of a cable franchise that is low cost or consists of lucrative customers, cable companies have no access to telephone like subsidies to make up the loss in revenues to competitors that it uses to cover the cost of service high cost customers. Indeed, a cable company can only make up this revenue by raising rates. This of course is infeasible both politically, because of market pressures, and because cable is required to charge the same rates throughout its franchise territory.

[2] In fact, the telephone companies will likely meet the “effective competition” test for video providers and therefore be exempt from economic regulations.