ARCHIVED -  Telecom Public Notice CRTC 95-19

Telecom Public Notice

Ottawa, 20 April 1995

Telecom Public Notice CRTC 95-19

PHASE II COSTING ISSUES

I BACKGROUND

In Inquiry into Telecommunications Carriers' Costing and Accounting Procedures - Phase II: Information Requirements for New Service Tariff Filings, Telecom Decision CRTC 79-16, 28 August 1979 (Decision 79-16), the Commission established certain requirements for the costing and evaluation of proposed new services (the Phase II Directives).

In Review of Regulatory Framework - Targeted Pricing, Anti-Competitive Pricing and Imputation Test for Telephone Company Toll Filings, Telecom Decision CRTC 94-13, 13 July 1994 (Decision 94-13), the Commission established a service-specific imputation test to apply to all applications for toll rate reductions or new toll services by AGT Limited (AGT), BC TEL, Bell Canada (Bell), The Island Telephone Company Limited (Island Tel), Maritime Tel & Tel Limited (MT&T), The New Brunswick Telephone Company Limited (NBTel) and Newfoundland Telephone Company Limited (Newfoundland Tel). For the services in question, this imputation test replaced the Phase II requirement that proposed rates be compensatory on the basis that revenues from the service exceed causal costs.

In Review of Regulatory Framework, Telecom Decision CRTC 94-19, 16 September 1994 (Decision 94-19), the Commission approved, effective 1 January 1995, the splitting of the rate bases of the above-noted telephone companies into Utility and Competitive segments, with a risk adjustment to the allowed rate of return of the Utility segment, and the creation of a Carrier Access Tariff (CAT) providing for the recovery by the Utility segment of charges for contribution, start-up costs and access to bottleneck facilities. In addition, the Commission modified the imputation test established in Decision 94-13 to reflect the implementation of the CAT, and extended the application of the test to include Competitive Network (CN) and other service tariff filings.

By letter dated 14 November 1994, the Commission made Manitoba Telephone System (Manitoba Tel) subject to the requirements of Decision 94-13, as modified by Decision 94-19.

II PHASE II STUDY OUTPUT REQUIREMENTS

On 15 December 1994, Stentor Resource Centre Inc. (Stentor), on behalf of AGT, BC TEL, Bell, Island Tel, Manitoba Tel, MT&T, NBTel and Newfoundland Tel (the telephone companies), submitted a proposal to revise the output requirements for Phase II studies, in light of the regime established in Decision 94-19. The revised outputs would apply to Phase II studies filed in support of applications for the approval of both general and special facilities tariffs.

By letter dated 16 January 1995, the Commission granted interim approval to Stentor's proposed study output requirements, with two modifications, pending consideration of comments received in response to a public notice to be issued with regard to the proposal.

The Commission hereby initiates a proceeding to consider the proposed study output requirements, as modified and approved on an interim basis in the Commission's letter of 16 January 1995. The Commission also seeks comments on certain other Phase II costing matters, as described below.

III IMPACT OF THE REVIEW OF PHASE III

In Decision 94-13, the Commission noted that the outcome of the proceeding initiated by Review of Phase III, Telecom Public Notice CRTC 94-16, 16 March 1994, might have an impact on the costs calculated for the purposes of developing Phase II studies. Accordingly, the Commission directed AGT, BC TEL, Bell, Island Tel, MT&T, NBTel and Newfoundland Tel to provide a report on any such impact, and on any consequential changes to their Phase II manuals, within 30 days of the Commission's decision in that proceeding. These companies were directed to detail (1) any changes to the Phase II methodology or costing models resulting from the decision, and (2) plans for the implementation of any such changes.

On 18 November 1994, the Commission issued Review of Phase III of the Cost Inquiry, Telecom Decision CRTC 94-24 (Decision 94-24). The telephone companies to which the Decision applied subsequently reported that no changes would be required to the Phase II methodology or costing models.
The Commission seeks comment on their position regarding the impact of Decision 94-24 with respect to Phase II costing.

IV IMPACT OF THE SPLIT RATE BASE

A. Costing Requirements in a Split Rate Base Environment

Under the regulatory framework in place prior to Decision 94-19, one of the purposes of Phase II costing was to avoid, over the long run, any cross-subsidies flowing from basic monopoly services to competitive services.

Under the regulatory framework established in Decision 94-19, cross-subsidies from the Utility segment to the Competitive segment will be avoided by means of the split rate base. The primary use of Phase II costing for the purposes of the Competitive segment is as a component of the service-specific imputation test established in Decision 94-13, as amended by Decision 94-19. The purpose of the imputation test is to prevent anti-competitive pricing by ensuring that rates for telephone company interexchange services recover all causal costs, including charges for contribution, start-up costs and bottleneck services.

The Commission seeks comment on whether Phase II costing methodologies should differ for Utility and Competitive segment services, in light of the differences in the regulation of the two segments as set out in Decision 94-19. Any comments should be justified by reference to the different regulatory approaches for the two segments and the services offered by each.

B. Discount Rate

Under the transitional regime established in Decision 94-19, only the Utility segment is subject to rate of return regulation. Accordingly, the Commission will not be establishing an allowed rate of return applicable to the Competitive segment. However, for the imputation test, a discount rate is needed in order to determine the costs of individual services in the Competitive segment.

In a letter to Stentor dated 4 November 1994, the Commission noted that, as a result of the adoption of the split rate base, there is a need to establish a discount rate for the purposes of determining Phase II costs for the services in the Competitive segment. Stentor, on behalf of the telephone companies, provided its views on the appropriate determination of this discount rate by letter dated 5 December 1994. BC TEL provided some additional views by letter dated 7 December 1994.

The Commission seeks comment on (1) whether separate discount rates, based on the individual costs of capital of the Utility and Competitive segments, are required for the purposes of costing services in each of the two segments, and (2) how the appropriate costs of capital should be determined. The Commission notes that separate discount rates may not be needed, if the impact on study results is not expected to be material.

C. Removal of Costs Associated with Underlying Bottleneck Facilities

The Commission notes that the imputation test requires that the costs of underlying bottleneck services used by Competitive services be imputed at tariffed rates. In its letter of 4 November 1994, the Commission requested that Stentor describe the methodology to be used to identify the Phase II costs of the bottleneck services that are to be excluded from the resource costs supporting toll tariff filings. Stentor provided its response in its letter of 5 December 1994. The Commission seeks comment on Stentor's proposed methodology.

D. Company-Wide Cost Factors

In current Phase II methodologies, the telephone companies estimate certain causal costs (such as repair and maintenance, certain revenue and capital taxes, certain fibre and fixed structure costs and variable common costs) by applying company-wide factors to estimates of other costs.

The Commission seeks comment on (1) whether the current company-wide cost factors should be replaced with cost factors specific to each of the Utility and Competitive segments, (2) if so, how the segment-specific cost factors should be determined, (3) whether the definition of variable common costs should be expanded to capture any other costs that vary with the scale of operations, but are not currently included in the Phase II cost study process (for example, the telephone company's own use of telephone services), and (4) if so, how these other costs should be estimated.

V RELATED MATTERS

A. Phase II Directives

1. Revised Phase II Cost Study Output Requirements

The Commission seeks comment on what changes, if any, are necessary to the Phase II Directives as a result of Stentor's proposed study output requirements, as modified and approved on an interim basis in the Commission's letter of 16 January 1995.

2. Service Costing within the Utility and Competitive Segments

The Commission seeks comment on whether changes to the Phase II Directives are required in order to reflect the different regulatory approaches for the Utility and Competitive segments.

3. Changes to Plant Valuation

In their Phase II Methods and Procedures manuals, most of the Stentor companies have taken issue with two Phase II Directives relating to the costing of re-used equipment and the calculation of the terminal value of capital at the end of the study period. Both Directives require the use of the Net Book Value (NBV) adjusted for net salvage or retirement expense accruals.

The companies in question are of the view that these two directives are fundamentally wrong, although they follow them for the purposes of developing Phase II cost studies associated with tariff filings. In the opinion of the companies, (1) the appropriate value to include as an estimate of the cost for re-used equipment is the value of the plant in its next best alternative use, i.e., its opportunity cost, and (2) the appropriate value to include as an estimate of the terminal value of capital at the end of the study period is one calculated based on the Discounted Service Potential (DSP) method. The Commission notes that, assuming straight-line depreciation, differences between the DSP and NBV methods are due to the recognition of the time value of money. The Commission also notes that it has accepted the DSP method for the purposes of valuing plant under the regulatory regime applicable to Telesat Canada.

The Commission seeks comment on whether the relevant Phase II Directives should be changed, and if so, in what manner.

B. Costing of Software or Similar Shared Resources

Traditionally, telephone company network facilities have been primarily demand-sensitive and capacity-limited. In such situations, the use of existing facilities to carry the traffic of existing customers reduces available spare capacity and requires that additional facilities be provisioned to carry the traffic of other customers. Consequently, the costs of most facility investments, even those related to facilities previously installed, are causally assigned to individual units of traffic or to individual services.

Increasingly, expenditures (such as software investment) are related to facilities that are not capacity-limited, and do not vary regardless of the number of services or the traffic demand requiring the investment. The Commission notes that, in response to a Commission interrogatory with regard to Stentor Tariff Notice 18 (concerning revisions to Advantage Vnet), Stentor submitted that, once a software expenditure has been made, the costs of advancement for the subsequent use of the software are zero and therefore the causal costs are zero. The Commission notes that, under such principles, an initial software expenditure could be seen to be caused by the first service requiring the software. The above costing approach could therefore lead to services not being introduced, if the market would not permit the recovery of the costs from that first service (even if it would permit the recovery of the costs from a number of services using the investment).

The Commission seeks comment on (1) whether, and how, software costs such as those described above should be included in Phase II studies, and (2) if there are other costs of this nature that should be included, how such costs should be defined. The Commission notes that one possible method of including the above software costs, or costs with similar properties, in a Phase II cost study would be to develop and apply a cost factor, following an approach similar to that adopted by the Commission in Telecom Letter Decision CRTC 93-1, 27 January 1993, with respect to the costing of interoffice fibre cable.

VI PROCEDURE

1. The telephone companies are made party to this proceeding.

2. Other parties wishing to participate in this proceeding must notify the Commission of their intention to do so by writing to Mr. Allan J. Darling, Secretary General, CRTC, Ottawa, Ontario, K1A 0N2, fax: 819-953-0795, by 19 June 1995. The Commission will issue a complete list of parties and their mailing addresses.

3. Stentor's proposal on study output requirements and copies of any of the various letters noted in this Public Notice may be examined at the offices of the CRTC in the following locations:

Central Building
Les Terrasses de la Chaudière
1 Promenade du Portage
Room 201
Hull, Quebec

Bank of Commerce Building
1809 Barrington Street
Suite 1007
Halifax, Nova Scotia

Place Montréal Trust
1800 McGill College Avenue
Suite 1920
Montréal, Quebec

Standard Life Centre
121 King Street West
Suite 820
Toronto, Ontario

275 Portage Avenue
Suite 1810
Winnipeg, Manitoba

800 Burrard Street
Suite 1380
Vancouver, British Columbia

Copies of Stentor's proposal on study output requirements and of the letters in question may be obtained by any interested person upon request directed to:

Mr. Bryce C. Schurr
Director
Rates and Regulatory Support
Stentor Resource Centre Inc.
Document Control &
Distribution Centre
Floor 22 - 160 Elgin Street
Ottawa, Ontario
K1G 3J4
Fax: 613-781-3514

4. Parties may file comments on the issues raised in this Public Notice, serving copies on all other parties, by 19 July 1995.

5. Parties may file replies to any comments, serving copies on all other parties, by 18 August 1995.

6. Where a document is to be filed or served by a specific date, the document must be actually received, not merely mailed, by that date.

Allan J. Darling
Secretary General