ARCHIVED - Transcript - Hull, QC - 2001/10/13
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FOR THE CANADIAN RADIO-TELEVISION AND
TRANSCRIPTION DES AUDIENCES DU
CONSEIL DE LA RADIODIFFUSION
ET DES TÉLÉCOMMUNICATIONS CANADIENNES
SUBJECT / SUJET:
Price Cap Regulation and Related Issues, pursuant to
Telecom Public Notice CRTC 2001-37/
Révision des Prix Plafonds et Questions Connexes, conformément
à L'Avis public Télécom CRTC 2001-37
|HELD AT:||TENUE À:|
Centre de Conférences
|October 13, 2001||le 13 octobre 2001|
In order to meet the requirements of the Official Languages
Act, transcripts of proceedings before the Commission will be
bilingual as to their covers, the listing of the CRTC members
and staff attending the public hearings, and the Table of
However, the aforementioned publication is the recorded
verbatim transcript and, as such, is taped and transcribed in
either of the official languages, depending on the language
spoken by the participant at the public hearing.
Afin de rencontrer les exigences de la Loi sur les langues
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Toutefois, la publication susmentionnée est un compte rendu
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participant à l'audience publique.Canadian Radio-television and
Conseil de la radiodiffusion et des
Transcript / Transcription
Price Cap Regulation and Related Issues, pursuant to
Telecom Public Notice CRTC 2001-37/
Révision des Prix Plafonds et Questions Connexes, conformément
à L'Avis public Télécom CRTC 2001-37
BEFORE / DEVANT:
|David Colville||Chairperson / Président|
|Ron Williams||Commissioner / Conseiller|
|Barbara Cram||Commissioner / Conseillère|
|Andrée Noël||Commissioner / Conseillère|
|Jean-Marc Demers||Commissioner / Conseiller|
|Stuart Langford||Commissioner / Conseiller|
|David McKendry||Commissioner / Conseiller|
ALSO PRESENT / AUSSI PRÉSENTS:
|Michel Spencer||Hearing Manager and Secretary / Gérant de l'audience et secrétaire|
|Legal Counsel / conseillères juridiques|
|HELD AT:||TENUE À:|
Centre de Conférences
|October 13, 2001||le 13 octobre 2001|
TABLE OF CONTENTS / TABLE DES MATIÈRES
|PAGE / PARA NO.|
|SWORN: DR. JEFFREY BERSTEIN||2450 / 15374|
|SWORN: MS MONA HALE||2450 / 15374|
|SWORN: DR. RICHARD EMMERSON||2450 / 15374|
|EXAMINATION BY / INTERROGATOIRE PAR|
|2449 / 15375|
|2454 / 15421|
City of Calgary
|2485 / 15602|
|2499 / 15700|
|2513 / 15810|
2536 / 15955
2546 / 16018
|Commission||2548 / 16032|
LIST OF EXHIBITS / PIÈCES JUSTICATIVES
|EXHIBIT NO.||DESCRIPTION||PAGE / PARA NO.|
|BELL CANADA-1||Bell response to Question No. 1 of CRTC Exhibit No. 1||2448 / 15360|
|BELL CANADA-2||Bell response to Question No. 2 of CRTC Exhibit No. 1||2448 / 15361|
|BELL CANADA-3||Bell Canada response to Question No. 3 of CRTC Exhibit No. 1||2449 / 15362|
|CRTC-33||CRTC undertaking to The Companies regarding interrogatory The Companies(CRTC) 25September01-4200||2497 / 15686|
|CRTC-34||CRTC Undertaking to TELUS regarding interrogatory The Companies (CRTC)25September01-4200||2498 / 15687|
|TELUS-9||CV of Dr. Jeffrey Bernstein||2498 / 15688|
|TELUS-10||CV of Ms Mona Hale||2498 / 15689|
|TELUS-11||CV of Dr. Richard Emmerson||2498 / 15690|
|BCOAPO ET Al-6||Telecom Decision CRTC 98-8||2498 / 15691|
|RCI-5||CRTC Order CRTC 2001-278||2498 / 15692|
|ARC-11||ARC et al response to CRTC Exhibit No. 8||2499 / 15693|
|AT&T-21||AT&T Response to CRTC Exhibit No. 12||2499 / 15694|
Hull, Quebec / Hull (Québec)
--- Upon resuming on Saturday, October 13, 2001
at 0900 / L'audience reprend le samedi
13 octobre 2001 à 0900
15356 THE CHAIRPERSON: Order, please, ladies and gentlemen.
15357 We will return to our proceeding now.
15358 Mr. Secretary, I don't know whether yesterday you had a bunch of exhibits to number or not. You probably did.
15359 MR. SPENCER: Thank you, Mr. Chairman.
15360 We have Bell response to Question No. 1 of CRTC Exhibit No. 1, which will be introduced as Bell Canada Exhibit No. 1.
EXHIBIT NO. BELL CANADA-1: Bell response to Question No. 1 of CRTC Exhibit No. 1
15361 MR. SPENCER: Bell response to Question No. 2 of CRTC Exhibit No. 1 will be introduced as Bell Canada Exhibit No. 2.
EXHIBIT NO. BELL CANADA-2: Bell response to Question No. 2 of CRTC Exhibit No. 1
15362 MR. SPENCER: Bell Canada response to Question No. 3 of CRTC Exhibit No. 1 will be introduced as Bell Canada Exhibit No. 3.
EXHIBIT NO. BELL CANADA-3: Bell Canada response to Question No. 3 of CRTC Exhibit No. 1
15363 MR. SPENCER: Thank you, Mr. Chairman
15364 THE CHAIRPERSON: Thank you, Mr. Secretary.
15365 I understand there has been an agreement to change the order of the cross-examination and that RCI will go first.
15366 So, Mr. Engelhart -- I'm sorry, I'm ahead of myself.
15367 Mr. Lowe.
15368 MR. LOWE: Thank you, Mr. Chairman.
15369 This is the TELUS Panel No. 2, that will speak to the X factor and financial and costing matters, including the level of mark-up.
15370 The panel is chaired by Mr. Willie Grieve. Joining Mr. Grieve, to his left is Ms Mona Hale, who is Vice-President, Comptroller, Consumer and Technology and Operations for TELUS. Ms Hale received her Chartered Accountant's designation in 1988. She has worked with a large national accounting firm, Revenue Canada and in the oil and gas industry.
15371 Also joining the panel, and closest to you, Mr. Chairman, is Dr. Jeffrey Bernstein. Dr. Bernstein testified at the last price cap hearing. He is a Professor of Economics at Carleton University and a Research Associate with the National Bureau of Economic Research.
15372 Beside Mr. Grieve is Dr. Emmerson. He testified before the Commission in the spit rate base proceeding on that benchmarking matter, you may recall, Mr. Chairman, and he is one of the world's leading experts in managerial and telecommunications economics. His CV is provided for the Commission.
15373 The backups are, closest to you, Tony Chow; beside Tony, Barb Sundquist; then Stephen Schmidt and Steve Parsons.
15374 Might we have the witnesses sworn in?
SWORN: DR. JEFFREY BERNSTEIN
SWORN: MS MONA HALE
SWORN: DR. RICHARD EMMERSON
EXAMINATION / INTERROGATOIRE
15375 MR. LOWE: Gentlemen, can you please confirm for me that your qualifications, as set out in the CVs filed with the Commission in this proceeding, are accurate?
15376 You can start on either end.
15377 DR. EMMERSON: Yes, they are.
15378 DR. BERNSTEIN: Yes.
15379 MR. LOWE: Ms Hale?
15380 MS HALE: Yes.
15381 MR. LOWE: Thank you.
15382 Dr. Emmerson, please confirm that Attachment 1 to CRTC-4200 and the evidence relating to costing filed in the follow-up proceeding initiated by Decision 2001-238, which has been brought into the record of this proceed, and related costing interrogatories were prepared by you or under your direction?
15383 DR. EMMERSON: Yes, they were.
15384 If my opportunity to make a correction just passed, I would like to mention now that there are two corrections to be made to these documents.
15385 MR. LOWE: Which corrections would you like to make?
15386 DR. EMMERSON: One correction of a numerical value in the Appendix B, page 4, June 8th. That correction is at page --
15387 MR. LOWE: Just for the record, this Appendix B is entitled, "Spare Capacity, Bill Utilization Factors and Loop Costs"?
15388 DR. EMMERSON: Yes, that is correct.
15389 MR. LOWE: Thank you.
15390 DR. EMMERSON: The correction is made at the centre of the page 4 of 7, where there is a reference to a value, "$36,000". That number should read "$18,000".
15391 That is the only correction I have to Appendix B.
15392 I do have a correction to Interrogatory Response 4200. The correction is to Attachment 1, page 5 of 6. Again, in the centre of the page, the second line of the paragraph that begins with, "A demand of...".
15393 There are three values to be changed there. The first value of "$500,000" should read "$600,000",
15394 The value "40 cents" should read "50 cents"; and
15395 We should delete the "$20,000" value on that line altogether. So that the corrected line would read:
"An estimate of $600,000 (50 cents x 1.2 million)." (As read)
15396 Those are my corrections.
15397 MR. LOWE: Thank you.
15398 With those corrections, is this evidence true and correct?
15399 DR. EMMERSON: Yes, it is.
15400 MR. LOWE: Thank you.
15401 Dr. Bernstein, was Appendix B to the TELUS evidence and related interrogatories dealing with the calculation of the X factor, and Appendix A dealing with the level of mark-up and the follow-up interrogatories in the proceeding initiated by 2001-238, authored by you?
15402 DR. BERNSTEIN: Yes.
15403 MR. LOWE: Were they prepared by you and under your direction?
15404 DR. BERNSTEIN: Yes.
15405 MR. LOWE: Is this evidence true and correct?
15406 DR. BERNSTEIN: Yes.
15407 MR. LOWE: Thank you.
15408 Mr. Grieve and Ms Hale, can you confirm that the remaining evidence and interrogatories allocated to this Panel 2 was prepared by your or under your direction?
15409 MS HALE: Yes.
15410 MR. GRIEVE: Yes.
15411 MR. LOWE: Is it true and correct, to the best of your knowledge?
15412 MR. GRIEVE: Yes.
15413 MS HALE: Yes.
15414 MR. LOWE: Thank you.
15415 The witnesses are available for cross-examination.
15416 THE CHAIRPERSON: Thank you, Mr. Lowe.
15417 Ms Sundquist, Ms Hale and gentlemen, welcome to our proceeding.
15418 Dr. Emmerson and Dr. Bernstein, welcome back to Canada.
15419 Now we will turn to the first party to cross-examine, RCI, Mr. Engelhart.
15420 MR. ENGELHART: Thank you, Mr. Chairman.
EXAMINATION / INTERROGATOIRE
15421 MR. ENGELHART: Good morning, Mr. Grieve, panel members.
15422 You would agree, Mr. Grieve, that in Decision 97-9, which designed the first price cap formula, the productivity offset was designed using the total factor productivity method. Correct?
15423 MR. GRIEVE: That Is my recollection.
15424 MR. ENGELHART: I wonder if you could refer, please, to TELUS(Calgary)40.
15425 MR. ENGELHART: On page 2 of 2 there is a listing of the -- in response to a request from the City of Calgary there is a listing of the total factor productivity estimates for Alberta and B.C.
15426 Just take a look, for example, at the total factor productivity for TCI for 1993. We have 7.64 per cent. Is that correct?
15427 MR. GRIEVE: That's right.
15428 MR. ENGELHART: We are going to keep looking at that, but if you could also grab RCI(CRTC)3100, in particular page 3 of 4. That was RCI(CRTC)3100, page 3 of 4.
15429 What we did there was we constructed the total factor productivity number using the same method the Commission used in 97-9 and using, in part, the data from that proceeding. As you can see in the third footnote, the third source:
"1996 Stentor price cap evidence, Table 2 for TELUS, BCTel and MTS, 1998 to 1995 TFP." (As read)
15430 So if we look at the 1993 number there for AGT, it's 10.7.
15431 Why was the total factor productivity number for AGT 10.7 in the last proceeding -- this is the 1993 TFP number and it was 10.7 then and now it is 7.6.
15432 Can you explain that?
15433 MR. BERNSTEIN: Yes, I could.
15434 There were a number of changes to the TFP model that were introduced for TELUS Alberta and TELUS B.C. In the TELUS Alberta case we introduced bad debts and settlement into revenues as a separate category, and also into expenses.
15435 The other major change was, we converted toll volumes from originating and terminating minutes to just originating minutes.
15436 MR. ENGELHART: So you have sort of retroactively changed the methodology so that the total factor productivity for AGT for 1993 is now 3 per cent lower than you measured it in 1996. Is that right?
15437 DR. BERNSTEIN: We improved the methodology based on new information.
15438 MR. ENGELHART: When did you do this?
15439 DR. BERNSTEIN: Approximately a year ago.
15440 MR. ENGELHART: For what purpose?
15441 DR. BERNSTEIN: To get the most accurate information possible.
15442 MR. ENGELHART: To use for what?
15443 DR. BERNSTEIN: To get the most accurate information possible as a measure of total productivity growth.
15444 MR. ENGELHART: For this proceeding?
15445 DR. BERNSTEIN: Just in general in this proceeding in particular. But let me add that we don't use total factor productivity growth to determine the X factor or the offset in the set of cap services for TELUS. So this total factor productivity is actually irrelevant to our "X" measure.
15446 MR. ENGELHART: And you didn't think it was worth mentioning in TELUS(Calgary)40 that you had changed the methodology?
15447 DR. BERNSTEIN: We didn't change the methodology. All we did was separate it out, bad debts and settlement, and changed the volume measure. So what we did was we just improved on the information.
15448 But, of course, as you see, you were able to determine the historical record as well as we provided the new numbers in this interrogatory.
15449 MR. ENGELHART: So you took bad debt out of the calculation. Is that what you did, in part?
15450 MS HALE: Perhaps if I could assist. What we did is for accounting policy changes that were introduced in, I believe, subject to check, 1998, where bad debts and settlements were no longer being reported as a contra revenue but were in our expenses, in order to make the data comparable in every year we adjusted prior years so that you could compare like to like, and, therefore, come out with an accurate total factor productivity.
15451 MR. ENGELHART: So you removed bad debt from your expense line?
15452 MS HALE: No, we in fact had bad debt and settlements included in our expense line consistently for all of the years that we are looking at for total factor productivity.
15453 MR. ENGELHART: What did you say you did with toll minutes?
15454 DR. BERNSTEIN: Toll minutes in the old Alberta model, the toll volumes were defined as originating and terminating. In the other Stentor companies at that time we discovered that toll volumes were measured as originating minutes. Indeed, in the old BCTel model toll volumes were defined as originating minutes.
15455 So we converted the Alberta model to conform with BCTel and the other Stentor members at that time by using originating minutes.
15456 MR. ENGELHART: So just by including a new definition of "toll minutes" and putting bad debt and revenue settlement in, your productivity in 1993 declined by 3 per cent from 10.7 to 7.6?
15457 DR. BERNSTEIN: Exactly. This goes to show the difficulty in measuring total factor productivity growth and how that total factor productivity growth is indeed a science as well as an art. In different ways in which one goes on and measures output and aggregates output, one can get dramatically different numbers.
15458 We saw this, for example, when the Commission was concerned with alternative ways of measuring total factor productivity growth leading up to Decision 92-12 when there was controversy over revenue-weighted versus cost-weighted total factor productivity growth measures and they were dramatically different numbers just by different ways of treating output and aggregating the outputs and the inputs into common measures.
15459 MR. ENGELHART: Let's compare the two tables again we have, then, for 1994. You told us in 1996 that TFP was 7 per cent and you told us that 1995 TFP was 3.9 per cent. Today that 7 per cent has shrunk to 4.1 and the 3.9 has shrunk to .41. Is that correct?
15460 DR. BERNSTEIN: That's correct.
15461 MR. ENGELHART: Let's have a look at BCTel. You told us before that it was 7.6 per cent in 1993 and now it is 2 per cent. Why is that?
15462 DR. BERNSTEIN: In the BCTel model, besides the adjustments in terms of bad debts and settlement expenses there was also an error that was found in the labour expenses. That was corrected. So there was actually an error in the old BCTel model in terms of labour expenses and the labour input.
15463 MR. ENGELHART: Let's have a look at some other figures which is, as you say, the way that you have calculated the productivity offset, which is using the unit cost method. This method is similar to the one that Bell Canada used.
15464 DR. BERNSTEIN: In general, yes.
15465 MR. ENGELHART: Please refer to page 29 of your evidence.
15466 MR. GRIEVE: Mr. Engelhart, is that Dr. Bernstein's evidence?
15467 MR. ENGELHART: It's the TELUS evidence. It's where the table of marginal costs are found, Table 3.2.
15468 MR. ENGELHART: This is the time series of numbers that you used to calculate your productivity estimate. Is that correct?
15469 DR. BERNSTEIN: The first two columns were used to calculate the X factor.
15470 MR. ENGELHART: All right.
15471 Now, please refer to TELUS(CRTC) -- we are going to keep referring to that table, but please turn to TELUS(CRTC)1107, in particular to page 2 of 3.
15472 You say in Section B, in the second paragraph:
"The marginal cost growth rate for the regulated industry pertains to residence primary exchange service and consists of the following:
(1) the marginal cost growth rate for Bell Canada over the period 1989 to 1995." (As read)
15473 So for 1989 to 1995 you used the Bell Canada marginal cost growth rates. Is that correct?
15474 DR. BERNSTEIN: That's correct.
15475 MR. ENGELHART: Could you please turn to The Companies(CRTC)105, Attachment 1, Supplemental, page 11 of 11:
"Soon this endless changing the interrogatories will come to an end and we will start to tie them all together." (As read)
15476 THE CHAIRPERSON: Mr. Engelhart, that last reference again?
15477 MR. ENGELHART: The Companies(CRTC)105, Attachment 1 supplemental, page 11 of 11. It's called Table 2.
15478 MR. ENGELHART: So you have said that you used the Bell numbers from 1989 to 1995, but for 1989 you have 4.97 per cent as the Bell number, Bell has 1.3 per cent. For 1990 you have 3.28 per cent for the Bell number and Bell has a 5.3 per cent productivity decrease. It goes on and on.
15479 The numbers are different and they don't seem to be different in any sort of consistent way. Can you explain these discrepancies?
15480 DR. BERNSTEIN: Table 3.2 was constructed as of the Bell numbers filing on May 30th. Subsequently Bell revised their unit cost numbers and this is the revised table that you see.
15481 Previously Bell's unit cost decreased average annually at about .7 per cent and these new numbers show that the average per cent unit cost change is in the order of 1.2 to 1.3 per cent annually. So these are revised figures. Table 3.2 uses the original figures.
15482 MR. ENGELHART: So I think when Bell originally filed their numbers they had an offset number of 3 per cent and then when they did the revision it went to 3.5. Is that right?
15483 DR. BERNSTEIN: That's the Bell-specific offset, yes.
15484 MR. ENGELHART: So shouldn't you be using the Bell numbers, the new Bell numbers, for your 1989 to 1995?
15485 DR. BERNSTEIN: In looking at the conditions and determining an industry-wide offset I think we have to think about it in terms of two sets of conditions.
15486 One is that the set of cap services among all the companies under price caps has to be the same.
15487 Secondly, the second condition, which is an extremely important condition, is that the operating characteristics, the territorial characteristics that each of the companies operate in has to be similar. These companies have to be treated symmetrically.
15488 When one receives a set of numbers in terms of the unit cost growth rates of -.7 per cent versus TELUS' specific number of -.5 per cent, these numbers per se are summary statistics and they summarize a number of different elements. Essentially they summarize four elements.
15489 The first element they summarize is the inflation associated with the things that the firms buy, the factors of production, the inputs.
15490 The second element that these unit cost figures summarize are the changes in the outputs and the diversity of outputs -- the quantity and diversity of outputs that these firms produce.
15491 The third element summarized are rates of technological change.
15492 The fourth element summarized by these figures are really network characteristics, density, loop length, et cetera.
15493 The Commission has recognized that a significant determination or significant driver of costs and, therefore, unit cost changes are network characteristics. The Commission recognized this in decision 95-21, the split rate base, it recognized it in 98-22 and it recognized it in 99-16, that essentially density, loop length, remote territories, rural areas, generate higher costs.
15494 These numbers speak to us. When one receives a number of -.7 per cent and then another number on a revision of -1.3 per cent, that is essentially a doubling of the unit cost changes, the average annual unit cost changes. That has to mean something.
15495 What it means potentially is that Bell and TELUS do not operate in similar operating characteristics. That says that there is a potential to think about territory-specific offsets for Canada, given these numbers, given the revised numbers.
15496 Indeed, the Commission has since recognized that density and these other factors are probative in determining cost, then I think that one has to think about the important differences between Bell and TELUS.
15497 If we just normalize these differences -- if we just normalized these differences in terms of size of the firm and add the Bell number of 3.5 and the TELUS number of 2.2, which is presented in 1107, we get an offset. Just normalizing for size not normalizing for density or these other features, we get a number of around 2.8 per cent.
15498 In that light, the 3 per cent offset is still an offset that is greater than the 2.8 per cent that just normalizes for the size of the two companies.
15499 There is a great deal of precedent for having territory-specific offsets. Indeed, in the United States where the same firm operates in many different States, there are State-specific offsets. So you could have Verizon operating in a number of different States and in each state there would be a different offset.
15500 It is for that reason that when the revised Bell figures came to me I think that at that point -- and also at that point I was working on the TELUS Quebec evidence, at that point I began to think about alternative offsets for Bell and TELUS based on the network and the operating characteristics of each of the companies.
15501 MR. ENGELHART: So let me summarize.
15502 When you filed this evidence you based your analysis on a time series that used the Bell numbers from 1989 to 1995. When Bell corrected their numbers you thought: If I use the correct Bell numbers I am going to get a number that is too big and so what I really should use is just the TELUS numbers alone, but instead I will just leave the wrong Bell numbers in.
15503 Is that what you are telling us?
15504 DR. BERNSTEIN: Sir, I never really worry about whether the number is too big or too small, I only worry about getting the correct number. When someone is presenting to me a set of figures, just as if they would be TFP figures -- let's not at this point be fooled by the decimal point.
15505 If someone said to me that productivity growth is 7 per cent and then they revised their figures and said: It is not 7 per cent, it is really 12 or 13 per cent, there has to be something significant in that revision and that is what I was looking for, the economic consequence of that revision.
15506 MR. ENGELHART: You have suggested in your previous response that you think using the TELUS only number would be perhaps appropriate. Is that what you are telling us today?
15507 DR. BERNSTEIN: No. I am saying that the 3 per cent is still a reasonable offset if I normalize for the size of Bell Canada and TELUS. Normalizing for that size I get a 2.8 per cent offset, and I am saying the 3 per cent is still an appropriate offset.
15508 The TELUS-specific offset for primary exchange services on the residence basket is 2.23 per cent. That is significantly lower than the 3 per cent.
15509 MR. ENGELHART: How many data points went into making up that TELUS 2.2 per cent?
15510 DR. BERNSTEIN: Six data points.
15511 MR. ENGELHART: Were you able to listen when I was discussing productivity offsets with Mr. Hariton?
15512 DR. BERNSTEIN: No, I wasn't listening.
15513 MR. ENGELHART: Mr. Hariton told this Commission that it is very dangerous to calculate an offset using a time series with a very small number of data points.
15514 Would you agree with Mr. Hariton's view?
15515 DR. BERNSTEIN: I absolutely do. This concerns me a great deal because the period 1995 to 2000 is well known to be, in the academic literature and the contemporary business press, an era of productivity resurgence in North America.
15516 So I am actually using a set of data points for which productivity is growing enormously. This has been documented by Dale Jorgenson in his presidential address to the American Economic Association in the March 2001 issue of the "American Economic Review".
15517 So I have this set of data which has productivity growing enormously, yet at the same time it is well established now that this productivity resurgence in North America will not persist. Over the next five years productivity will retard back to its at least historical level, perhaps even lower.
15518 Since I am projecting, I have to project these figures from 1996 to 2001 into the future. I think the 3 per cent is actually very dangerous, that it is potentially too high given what the academic and the business press is saying about the forthcoming decline in productivity growth rates.
15519 MR. ENGELHART: There is another source of data that you could have used which is the other half of TELUS, the BCTel part. Why is there absolutely no BCTel data used?
15520 DR. BERNSTEIN: I would have liked to have used the BCTel information, but unfortunately there was no documentation to the BCTel Phase 2 cost studies. There were just some studies. There was no documentation. There was no listing of assumptions. There was no way to verify. We could not verify any of those numbers.
15521 MR. ENGELHART: But BCTel did PARC studies along with Bell all those years. They were filed with the Commission. Why couldn't you use those PARC studies?
15522 DR. BERNSTEIN: It's not a question of just having the number. It's a question of being able to determine the assumptions, the methodology, all the details that go in behind the number. There was absolutely no documentation.
15523 MR. ENGELHART: Did you take a try at using the BCTel numbers?
15524 DR. BERNSTEIN: I went and searched out and tried to determine if I could. When I realized there was no assumptions, there was no documentation, it was just a set of numbers, as an academic doing work that relies on defensible assumptions and having work that couldn't be replicated by third parties, there was no way that I could use that information.
15525 MR. ENGELHART: Could you have a look, please, at TELUS(CRTC)1107, page 2 of 3(b).
15526 We have discussed the 1989 to 1995 numbers. Then the 1996 to 2001 you took Bell and you combined it with TELUS Alberta using a weighted average by using the residential NAS for Bell Canada and TELUS.
15527 Again, did this use the old Bell numbers not the new Bell numbers?
15528 DR. BERNSTEIN: Are you referring to the unit cost growth rates or the NAS?
15529 MR. ENGELHART: The unit cost growth rates.
15530 DR. BERNSTEIN: Yes.
15531 MR. ENGELHART: Can you tell us what weights you used, what residential NAS weights you used for those years 1996 to 2001?
15532 DR. BERNSTEIN: I used the share, the Bell NAS that they provided and the TELUS Alberta NAS. I can't recall year over year, but the average Bell weight was 72 per cent and the TELUS Alberta weight was 28 per cent.
15533 That also concerned me because Bell's market share in terms of weights is 58 per cent. So here I was heavily weighting Bell.
15534 MR. ENGELHART: Could you have a look at The Companies(CRTC)1107, page 2.
15535 THE CHAIRPERSON: Mr. Engelhart, that was The Companies(CRTC)1107, page --
15536 MR. ENGELHART: Page 2, Mr. Chairman.
15537 Bell states:
"While The Companies have provided estimates of residence primary exchange service unit cost changes based on Bell Canada's unit cost analysis presented in The Companies(CRTC)105, The Companies are unable to provide an estimate of the industry-wide unit cost changes that incorporate the TELUS estimates. This is because The Companies do not have TELUS estimates of historical residence primary exchange service unit cost changes derived based on TELUS data, nor estimates of TELUS residence NAS base which would be required to calculate a weighted average industry-wide offset.
However, the industry-wide offset based on the TELUS and Bell Canada information can be derived by the Commission based on the information filed in confidence with the Commission by TELUS and the results of Bell Canada's unit cost analysis filed in The Companies(CRTC)105 Revised 16 July 2001." (As read)
15538 We were confused. Why is Bell saying that they couldn't get access to your data?
15539 DR. BERNSTEIN: I'm equally confused. I sent it to them. Actually, I sent it to Mr. Hariton.
15540 MR. ENGELHART: Okay. Let's have a look at your study methodology. Let's have a look at TELUS(CRTC)1107, Attachment 1, page 2 of 5.
15541 MR. ENGELHART: This explains how you did your analysis and how you calculated your numbers and what you did to the adjustments that you made to the PARC studies before you calculated the unit cost changes.
15542 Let's have a look at the very bottom of TELUS(CRTC)1107, Attachment 1, page 2 of 5:
"The definition of the loop feeder working fill was changed in 1989 and, as a consequence, the average working fill factor increased. The earlier cost study results were adjusted to reflect this higher working fill." (As read)
15543 As I understand it, Dr. Bernstein, the feeder is that bundle of copper wires or that piece of fibre that comes out from the central office and goes to some sort of a node in a neighbourhood. Is that right?
15544 DR. BERNSTEIN: Yes.
15545 MR. ENGELHART: At some point the feeder gets full and then somebody has to go out and dig another trench and put in another cable or put in new opto-electronics or in some way put more capital into the network when you hit that fill point. Is that correct?
15546 DR. EMMERSON: May I respond to that? I have some experience in the area of fill factors.
15547 MR. ENGELHART: Sure.
15548 DR. EMMERSON: That is correct for at least much of the feeder portion of the network but not necessarily 100 per cent of it. There are some circumstances in which it is not cost-effective to make a second or third placement. But in the vast majority of cases you are correct.
15549 MR. ENGELHART: Right.
15550 So if you have a higher working fill factor, that means you send the trucks out less often and you become more productive. Is that correct?
15551 DR. EMMERSON: That's correct. But this particular change was actually a change in the measurement methodology, not a change in the operations of the company.
15552 MR. ENGELHART: So you are saying that the methodology had nothing whatsoever to do with what the folks are actually doing in the field?
15553 DR. EMMERSON: It certainly did have something to do with what the folks are doing in the field. But the change in measurement methodology had entirely to do with the numbers that were used in the denominator and the numerator, neither of which were affected by what is done in the field. It was a choice of using energized pairs rather than total pairs appearing in the central office that led to the numerical change in the fill factor.
15554 More importantly, I think the point of the exercise was to ensure that we did not contaminate the productivity measure with changes in definition of the fill, that a single fill factor methodology and measurement be used throughout the entire exercise so as to get a more pure estimate of the productivity factor.
15555 MR. ENGELHART: Could you give me that thing about the energized again?
15556 DR. EMMERSON: Yes. The change in the measurement of the fill factor that occurred was to not count all telephone lines appearing in the central office when calculating the percentage of working lines, but instead to calculate that percentage based on energized lines so that one, for example, would not include pairs that were not energized, stranded capacity, and the like. That led to a higher measurement of the fill factor.
15557 MR. ENGELHART: Just by changing that number, then, you will get a greater productivity?
15558 DR. EMMERSON: No. In fact, the purpose of the exercise was to avoid having any change in definition of a fill factor affect the measurement of productivity since it was just a definitional change, a change in a choice of denominators, in essence. You don't want to have those kinds of changes appearing as if they were productivity changes when they are not.
15559 So the purpose of the exercise was to have a single consistent measurement of fill throughout the entire time series that was used for measuring productivity.
15560 MR. ENGELHART: But say you hadn't gone back, say you had left it, just changed in 1989, that would make 1989 look unusually productive because of changing the definition -- 1999?
15561 DR. EMMERSON: No. What would happen is that because of the change in the way in which fill was measured, again think of it as nothing real happening in the field or in operations or in the company's practices, so there are no productivity changes going on, there are no efficiency changes going on. In that environment if one were to measure fill in one way in 1990 and a different way in a later part of the time series, that might look like a change in efficiency when it was really only a change in the choice of how fill was measured.
15562 So we used the same fill definition, the same fill throughout the entire time series.
15563 MR. ENGELHART: Let's have a look at the next one, at the top of page 3 of 5.
"The drop utilization was also changed in 1999 to represent more lines per residence to account for second line penetration. Adjustments were also made to earlier studies to reflect this change." (As read)
15564 Can you explain that one to me?
15565 DR. EMMERSON: Yes. Again, the measurement had assumed, in calculating drop fill, that there were now 1.25 lines per household. I believe that is the correct number, but I will check that and notify you if it is not -- 1.25 lines per household. That number was used again consistently throughout, again to have consistent assumptions so that productivity was not picking up changes in assumptions that were made in the middle of the time series.
15566 MR. ENGELHART: But presumably that assumption was changed, because it reflected the fact that you were selling a lot more second lines.
15567 DR. EMMERSON: The 1.25 line assumption in the drop, first of all, will lead to a negligible effect on the total, because the drop obviously is a very, very low number in the investment. So first it is going to have virtually no effect.
15568 Secondly, the important thing here is that the productivity be measured consistently again throughout the time series, not reflecting changes in definitions, changes in assumptions, and the like.
15569 MR. ENGELHART: No, but if you start selling more second lines, because the lines are already sitting there in the house, they were put in when the thing was built, it is a big improvement in productivity because now you are bringing in revenue, monthly revenue, just from turning up a second line that is already there.
15570 So it is going to show up as a productivity improvement, and it doesn't seem quite right to say: Well, I don't want that to show up as a productivity improvement so I will go back in my time series and pretend I was selling more second lines back then so that it is consistent.
15571 Aren't you doctoring the results to show that there is less productivity?
15572 DR. EMMERSON: What you are implying in your question is that because there are more second lines sold that there are changes in the fill factors that are occurring because of the sale of second lines. That is not generally the case.
15573 In general, fill factors tend to remain extremely stable over very long periods of time.
15574 For example, when one sells a second line in an urban area, or a third line and there is only one pair to the household, new drop is in put in. So that there is new plant placed, it isn't just using up existing plant. Similarly, when new neighbourhoods are built there is new plant put in place.
15575 For all of these reasons, fill factors tend to remain extremely stable over very long periods of time, and it isn't a matter of every second line sold somehow fills up more of the network and therefore is reflected in a change in productivity.
15576 MR. RYAN: But TELUS has been putting, I think, two or three lines to each house for years now. They haven't put one line to a house for decades, have they?
15577 DR. EMMERSON: I'm not suggesting that they put one line per house. What I'm suggesting is that the plant -- distribution plant, feeder plant -- is added every year and expanded.
15578 So one is not simply filling up an existing plant each time a second line is sold, one is filling up existing plant and simultaneously creating new plant. The net effect of the two is to have, as I said, very, very stable fill factors over long periods of time.
15579 MR. ENGELHART: Let's have a look at the paragraph under "Switch and Trunk Costs" on page 3 of 5. Let me read it to you:
"For all years except 1995, the switch and trunk cost was estimated using the local services costing system (LSCS). The details of the original 1995 cost analysis cannot be recreated and the change in costing methodology introduced in subsequent studies using the LSCS model make comparisons of the 1995 switch and trunk cost estimate to subsequent cost estimates misleading. To obtain a meaningful comparison of year over year changes, it was necessary to recalculate the 1995 cost using the 1996 cost, adjusted by the TPPI." (As read)
15580 So you said: Well, gosh, I don't know just how they came up with that 1995 number, so instead of using the 1995 number I will just use the 1996 number.
15581 Is that what you did here?
15582 MR. BERNSTEIN: No. We took the 1996 number and adjusted it by the telephone plant price index. In other words, we adjusted it accounting for the vintage effects and the inflation effects built into the TPPI, which is being built up from 1995 and earlier data.
15583 The 1995 study is indeed quite a dramatically different study than was undertaken by AGT and subsequently TELUS in future years.
15584 MR. ENGELHART: Okay, but for whatever reason you are telling us you didn't like the 1995 number so you put in a number which is based on the 1996, with some small inflation factor. Then you go back and you say: Okay. What's the difference between 1995 and 1996? Oh, it's just a small inflation factor.
15585 So we can't be very surprised that there is no great productivity improvement between 1995 and 1996, can we, given that the 1995 switch and trunk costs are just the 1996 costs with the inflation factor in there?
15586 MR. BERNSTEIN: A price index doesn't just control for inflation, it controls for inflation and vintage effect. So we are not just normalizing for inflation, but we are also accounting for productivity, that is vintage differences in the TPPI.
15587 If you would like, since we are interested in consistent methodology, if you like we could calculate the offset leaving out 1995 and just doing it for 1996 to 2001.
15588 MR. ENGELHART: The switch and trunk costs are a fairly substantial portion of the cost of primary exchange service, aren't they?
15589 MR. BERNSTEIN: It is about 22 per cent of the MEC.
15590 MR. ENGELHART: Let's take a look at, then, what these and other adjustments have done to our calculations.
15591 If we take a look at TELUS(CRTC)1107, page 5 of 5 of the attachment, let's take a look at that 1995 number. It is 37.69 under the filed MEC. This is the PARC study that you filed with the CRTC, 1995. It is 37.69. The 1996 number is 35.78.
15592 Would you agree with me, subject to check, that the 1996 unadjusted number is a 5.1 per cent decline from the 1995 number?
15593 MR. BERNSTEIN: Firstly, these are not PARC studies, these are Phase 2 studies, although the 1995 is not really the same kind of Phase 2 study.
15594 What you are doing by looking at the first column, before we do the arithmetic, is just looking at apples and oranges, grapefruit and tangerines, as you go down it.
15595 MR. ENGELHART: So we had a 5 per cent decline, then you did your adjustments, and that then shrunk to a 0.4 per cent decline. Is that right?
15596 MR. BERNSTEIN: The arithmetic seems to be correct, yes.
15597 MR. ENGELHART: Those are my questions.
15598 Thank you, gentlemen.
15599 THE CHAIRPERSON: Thank you, Mr. Engelhart.
15600 I believe the next party to cross-examine is the City of Calgary.
15601 Mr. Inlow.
EXAMINATION / INTERROGATOIRE
15602 MR. INLOW: Thank you, Mr. Chairman.
15603 I think for the most part these are going to be reasonably high-level cost questions, just to get some clarification of a few issues. So hopefully we can get through this quickly.
15604 Dr. Bernstein, the proposal you are making to go to marginal costs determine the X factor, that replaces the total factor productivity. Is the reason you are doing that is because you want to look at productivity growth in a more specific subset of the TELUS business than you would have done with total factor productivity?
15605 MR. BERNSTEIN: Essentially, yes.
15606 MR. INLOW: I take it conceptually what you would want to do ideally would be to take relevant data only from the business subset to which you were going to apply the X factor. Correct?
15607 MR. BERNSTEIN: That is correct.
15608 MR. INLOW: I believe both CAC and Calgary in an interrogatory requested whether you could provide any other regulatory agencies that you were aware of that had adopted the marginal cost approach. There wasn't a response to that specifically.
15609 Can I take that to mean that you are not aware of any that have explicitly adopted a marginal cost approach?
15610 MR. BERNSTEIN: No, not as yet. I am not aware of any yet.
15611 MR. INLOW: In terms of your own execution of this approach, I take it the data that you used was marginal cost growth rate for overall basic residential exchange services. Correct?
15612 MR. BERNSTEIN: Yes.
15613 MR. INLOW: Yes. So that would have included both high-cost and non-high-cost areas?
15614 MR. BERNSTEIN: That is correct.
15615 MR. INLOW: My understanding is that TELUS is proposing only that an X factor would be used in the high-cost areas. Correct?
15616 MR. BERNSTEIN: That is correct. Indeed, we view that since the potential productivity improvements are lower in high-cost serving areas, that indeed determining the X factor based on all residence primary exchange services, that we are overstating the X factor for high-cost serving areas.
15617 MR. GRIEVE: Mr. Inlow, I might just add one thing.
15618 As you know, the costs that are used to determine the primary exchange costs are at issue, at least in another proceeding. As we were looking at how to do the offset number for this proceeding prior to the rebanding decision, we had expected based on the Commission's decision in the contribution decision, and its public notice in the rebanding decision, to be using Decision 98-22 costs. So, of course, going into the development of this we expected that just about all residential bands would be included and would have this total productivity factor applied to them.
15619 As it has turned, with the Commission's rebanding decision, the recosting that was done in there, there were only three bands, according to that methodology, that would be high cost.
15620 MR. INLOW: Those would be Bands E, F and G?
15621 MR. GRIEVE: That's right.
15622 We also did a calculation of what the total factor productivity improvement would have to be by band in order to get from the Decision 98-22 costs to the ones in the rebanding decision. The numbers are in the teens, 14 or 16, something like that per cent per year total factor productivity improvement over five years to get to the CRTC's costs.
15623 MR. LOWE: All right.
15624 Dr. Bernstein, to turn back to your answer in a methodological sense, if I understand it you are saying that the operating or territorial characteristics of high-cost service areas are different than for non-high-cost. So from a point of view of approach, I take it you would not consider the overall residential examination of numbers to be appropriate to apply only to the high-cost areas. Correct?
15625 DR. BERNSTEIN: The approach would be the same. One would try to obtain Phase 2 cost information for those bands alone. But, of course, we have to obtain a time series, and the time series began in 1995 to 2001. The definition of bands and the structure of bands have changed over time, so the notion of high-cost bands, even using the Commission's cost, would, of course, not have existed in 1995 and 1996, et cetera.
15626 So you want to match as closely as possible the set of cap services with the available data. That is what we tried to do by using the Phase 2 costs for primary exchange services. Because we cannot just do this for one year, we have to get a consistent -- an intertemporally or dynamic consistent set of series.
15627 MR. INLOW: But it would be fair to say, then, in terms of actually coming up with a number using your methodology you are saying that you really don't have what you would consider the ideal type of data, which would have been the data only for the high-cost service area?
15628 You are simply saying: "I used the data for all of residential as a proxy for that, and I think it is an overestimate, but from an academic point of view it is also fair to say that is not a very good approach in terms of coming up with a number that is accurate", as opposed to saying: "This is a number that is more than what we think it would be if I could get an accurate number"?
15629 DR. BERNSTEIN: Both from a policy perspective and an academic perspective I think it is an excellent approach and it is extremely accurate.
15630 Because to undertake what you are suggesting, I would have to have a definition of Bands E, F and G going back from 1995 to 2001. So we are approximating very closely the unit cost changes of primary exchange services for TELUS. Indeed, we are getting very close measure to, essentially, the high-cost bands in the later years.
15631 This is dramatically different than using total factor productivity growth, which is an all-service measure, encompasses all the services, regulated and non-regulated, for the business, as well as all the inputs. What we are trying to do is get as close as possible to the cost, to the unit costs, of high-cost serving areas.
15632 Moreover, may I add that the marginal cost guideline or the incremental cost guideline is perfectly consistent with the notion of pricing services at Phase 2 costs plus an appropriate markup. Because, given the markup, the way prices would change when you price services at Phase 2 costs, would be precisely how the Phase 2 costs change. That is exactly the marginal cost guideline.
15633 So the marginal cost guideline is nothing but Phase 2 costing at an appropriate markup. Instead of looking at it at levels, you are looking at it at a change. That's all it is.
15634 MR. INLOW: But to come back to that answer, you are saying that the approach you have taken is an improvement because you have narrowed down the data from company-wide to residential. Correct?
15635 DR. BERNSTEIN: Correct.
15636 MR. LOWE: But then, in fact, you are taking that data and saying "I'm really applying that to only the high-cost areas."
15637 So even though in reality I will agree with you, you have narrowed the range of data that you have used from company-wide to a portion of the company, still, from the point of view of a high-cost area, you have used a broader set of data than applies to that area. Correct?
15638 DR. BERNSTEIN: In some sense, I am penalizing the company, because the Commission has recognized that high-cost serving areas -- indeed that is what the name implies, that is a high-cost serving area -- so that the potential productivity improvements in these bands is less than in other bands.
15639 So by the fact that I am using primary exchange services rather than high-cost bands alone, I am actually deriving an X factor which is higher than the one that I would derive if I had the data for high-cost bands primary exchange service.
15640 MR. INLOW: Dr. Bernstein, underlying that aren't you putting forward an assumption that simply because an area is more expensive to serve you can't gain higher productivity over time than you could in an area that is less expensive per subscriber to serve?
15641 Where does that assumption come from?
15642 DR. BERNSTEIN: When you have a band that has a higher cost, that means a higher Phase 2 cost. So if we think about that in year 2000 that Bands E, F and G have a higher cost, and then in year 2001 Bands E, F and G have a higher cost than Bands A, B, C and D, in each year that it has a higher cost that means that its productivity improvement is lower than in the non-high-cost bands. That is exactly what it means. The Commission has recognized this historically in three previous Decisions, 95-21, 98-22 and 99-16.
15643 So it is precisely when you have high-cost bands in year that difference between the cost of the high-cost area and the low-cost area is showing you the difference in the productivity improvements that are possible. So the productivity improvements that are feasible in lower-cost areas are greater than in higher-cost areas. That is, in part, what makes them higher-cost areas.
15644 MR. INLOW: Okay. Thank you.
15645 I thought you were making that as a generalized assumption. You are indicating that is based on actual data that you have looked at.
15646 DR. BERNSTEIN: Yes.
15647 MR. INLOW: Okay.
15648 Now, coming back to the issue of marginal costs, would it be fair to say that built into marginal cost is some element of fixed or common costs that needs to be recovered as well?
15649 DR. BERNSTEIN: I'm sorry, can you repeat that, please?
15650 MR. LOWE: In terms of your marginal cost analysis, I assume over time that the company needs to recover not only its true variable costs but they also need to recover some portion of fixed and common costs. Correct?
15651 DR. BERNSTEIN: In the marginal cost guideline there are no fixed and common costs. We are just tracking the change in the Phase 2 costs, which does not contain any fixed and common cost over time.
15652 MR. INLOW: Okay.
15653 One other question, perhaps to Ms Hale, on the topic of high-cost service areas. That is Bands E, F and G. If it is on the record we haven't been able to find it.
15654 But can you advise what the total subsidy requirement is for those high-cost areas in Alberta for the last full financial year?
15655 MR. GRIEVE: I'm sorry, for --
15656 MR. LOWE: What the total subsidy is for the --
15657 MR. GRIEVE: For those --
15658 MR. LOWE: -- high-cost area in Alberta, the three bands.
15659 MR. GRIEVE: For what year?
15660 MR. LOWE: For the last financial year. If you don't have that, if you could undertake --
15661 MR. GRIEVE: 2001?
15662 Mr. Inlow, that banding approach and those costs don't go into effect until 2002.
15663 The contribution mechanism that was established in Decision 97-9 that froze the contribution rate was then changed in 2001, January 1, from a per-minute charge to a revenue charge but kept the same contribution number for Alberta and B.C. in total.
15664 That was originally calculated on the basis of a utility segment shortfall. I'm not sure that there is any way of sort of allocating that between bands in the year 2001.
15665 As you know, what the Commission has done for the beginning of 2002 has made two significant adjustments to the amount of that contribution for TELUS.
15666 One is that the Commission went to Phase 2 plus 15 with the contribution calculation, then in the rebanding decision made another adjustment to the costs to get the contribution down -- I think it's in the $60-million range.
15667 So we are just under $400-million drop in revenue on the utility segment just from those two decisions.
15668 So I don't know how we would take -- I don't know how we would do it for the year 2001 for bands that is based on a different contribution mechanism. So perhaps you could suggest something to me and --
15669 MR. INLOW: No, that's fair enough. That's fine.
15670 DR. BERNSTEIN: Okay.
15671 MR. INLOW: Thank you.
15672 Finally, I note on your Web site that you had a download of a presentation that was made to a Toronto Corporate Debt Issuer Conference. I elected to tread into that because it was scheduled to be on September 11th. I don't know whether that conference actually went ahead or not.
15673 But there is a reference in there about TELUS Consolidated. There is a bullet in there that says:
"Reinvest in cash flow from stable ILEC business into growth areas of data, IP and wireless." (As read)
15674 Given the nature of that conference, was that being put forward as a financing methodology between the ILEC business and the other growth areas that were referred to?
15675 MS HALE: Not having been in attendance at that forum, I can speculate in terms of, I think, what was stated in that document.
15676 With respect to TELUS' strategy on a go-forward basis, it is to invest for the benefit of our customers in data, IP and wireless. That strategy is something TELUS is actively pursuing for the benefit of our customers. Our customers don't just buy local service, they buy a total package of services from us.
15677 So I believe that is really what that line is referring, is our overall strategy and what we at TELUS are trying to accomplish.
15678 MR. INLOW: All right. Thank you.
15679 Those are my questions, Mr. Chairman
15680 THE CHAIRPERSON: Thank you, Mr. Inlow.
15681 I think we will take our morning break now and reconvene at 10:30, by the clock on the back wall.
--- Upon recessing at 1015 / Suspension à 1015
--- Upon resuming at 1032 / Reprise à 1032
15682 THE CHAIRPERSON: Order, please, ladies and gentlemen.
15683 Mr. Secretary, I understand you have a number of exhibits to enter.
15684 MR. SPENCER: Thank you, Mr. Chairman.
15685 I have nine documents.
15686 The first document, CRTC Undertaking to The Companies regarding interrogatory The Companies(CRTC)25September01-4200 will be entered as CRTC Exhibit No. 33.
EXHIBIT NO. CRTC-33: CRTC Undertaking to The Companies regarding interrogatory The Companies(CRTC) 25September01-4200
15687 MR. SPENCER: CRTC undertaking to TELUS regarding interrogatory Companies(CRTC) 25September01-4200 will be introduced as CRTC Exhibit No. 34.
EXHIBIT NO. CRTC-34: CRTC Undertaking to TELUS regarding interrogatory The Companies (CRTC)25September01-4200
15688 MR. SPENCER: Mr. Bernstein's CV will be introduced as TELUS Exhibit No. 9.
EXHIBIT NO. TELUS-9: CV of Dr. Jeffrey Bernstein
15689 MR. SPENCER: Ms Hale's CV, TELUS Exhibit No. 10.
EXHIBIT NO. TELUS-10: CV of Ms Mona Hale
15690 MR. SPENCER: Mr. Emmerson's CV, TELUS Exhibit No. 11.
EXHIBIT NO. TELUS-11: CV of Dr. Richard Emmerson
15691 MR. SPENCER: Telecom Decision CRTC 98-8, BCOAPO et al, Exhibit No. 6.
EXHIBIT NO. BCOAPO ET Al-6: Telecom Decision CRTC 98-8
15692 MR. SPENCER: Order CRTC 2001-278, RCI Exhibit No. 5.
EXHIBIT NO. RCI-5: Order CRTC 2001-278
15693 MR. SPENCER: ARC et al response to CRTC Exhibit No. 8 will be introduced as ARC Exhibit No. 11.
EXHIBIT NO. ARC-11: ARC et al response to CRTC Exhibit No. 8
15694 MR. SPENCER: AT&T response to CRTC Exhibit No. 12 will be entered as AT&T Exhibit No. 21.
EXHIBIT NO. AT&T-21: AT&T Response to CRTC Exhibit No. 12
15695 MR. SPENCER: Thank you.
15696 THE CHAIRPERSON: Thank you, Mr. Secretary.
15697 We will turn to the next party to cross-examine then, AT&T Canada.
15698 Mr. Ryan.
15699 MR. RYAN: Thank you, Mr. Chairman.
EXAMINATION / INTERROGATOIRE
15700 MR. RYAN: Ms Hale, gentlemen, good morning.
15701 MR. GRIEVE: Good morning.
15702 MR. RYAN: Could we begin by you reminding us what the mission of TELUS Integrated is, please?
15703 MR. GRIEVE: TELUS Integrated was a separate company that operated in central Canada. Its mission was to enter the local market there -- local and the long distance market -- as a new entrant.
15704 MR. RYAN: I'm a bit confused, I confess, Mr. Grieve, already. When you say "was" --
15705 MR. GRIEVE: Yes. We had applied to the Commission for a forbearance order that would allow us to amalgamate TIC into TCI, the amalgamated BCTel and AGT et al, amalgamate the company into the same corporate entity and have it operate as a CLEC under the same CLEC rules in Ontario as other companies would.
15706 We had determined that we required a forbearance order to do that and we applied to the Commission for that and it was granted. On October 1st the companies were put together.
15707 MR. RYAN: What is the name by which you carry on the business you have been describing to me this morning at present then?
15708 MR. GRIEVE: The business in Ontario?
15709 MR. RYAN: Yes.
15710 MR. GRIEVE: TELUS.
15711 MR. RYAN: So there is no longer a separate corporate entity.
15712 MR. GRIEVE: TIC, that's right.
15713 MR. RYAN: So the references such as I see in TELUS(ATT)26June01-505 to TELUS Integrated Communications 2000 Inc., is that dated information then?
15714 MR. GRIEVE: It is, yes, as of October 1st.
15715 MR. RYAN: As of October 1st.
15716 MR. GRIEVE: Yes.
15717 That is subject to check. That was the date that it was supposed to happen.
15718 Okay, I'm told it did happen. That was a quick check.
15719 MR. RYAN: The mission you described when I asked you about TELUS Integrated, is that a mission that you are still carrying on through the parent company now in the markets that were previously the markets targeted by TELUS Integrated?
15720 MR. GRIEVE: Yes. It's not the parent TELUS Corporation, it is the operating company, TELUS Communications Inc.
15721 MR. RYAN: Has there been any change at all to the mission that you are pursuing in Ontario as a result of this corporate rearrangement?
15722 MR. GRIEVE: Not to my knowledge.
15723 MR. RYAN: So the information that we see in Group Telecom 13, your response to that interrogatory, that your target territory consists of major population centres in central and eastern Canada, that remains valid.
15724 MR. GRIEVE: Yes.
15725 MR. RYAN: Could you tell me where you actually have customers up and running today in that part of the world?
15726 MR. GRIEVE: I'm not sure I have that answer, but just a second.
15727 Mr. Ryan, is it in this interrogatory response and you are just asking me to repeat it or is it not?
15728 MR. RYAN: I don't see it in the interrogatory response. If you can read it from there, then that would --
15729 MR. GRIEVE: Okay.
15730 MR. RYAN: I can catch up with you.
15731 MR. GRIEVE: We have a revised version of this that was, I think, filed September 19th. This was in response to a Commission ruling --
15732 MR. RYAN: Yes.
15733 MR. GRIEVE: -- on disclosure.
15734 MR. RYAN: Right.
15735 MR. GRIEVE: It says:
"Territory: Central and Eastern Canada, including Toronto, Ottawa-Hull, London, Cooksville, Windsor, Kitchener and Hamilton." (As read)
15736 It is my understanding that we do have customers in each of those areas.
15737 MR. RYAN: Okay. Well, that's really what I was getting at.
15738 MR. GRIEVE: Yes.
15739 MR. RYAN: That's the target territory.
15740 You actually have customers up and running in each of those places you just mentioned?
15741 MR. GRIEVE: Yes. It's my understanding we do.
15742 MR. RYAN: Could you tell me how many customers you have up and running, in aggregate?
15743 MR. GRIEVE: I will have to take an undertaking on that and consider whether we might want to make a confidentiality claim on that, Mr. Ryan.
15744 MR. RYAN: Is there a distinct business unit within TCI that's charged with the mission previously carried out by TELUS Integrated?
15745 MR. GRIEVE: No, there is not. TELUS Integrated has been amalgamated into TCI. It does have employees in Ontario, but the way the company is structured, TCI is structured, it has different divisions for different customer markets, so there is a consumer division, a small and medium business division, a large business division.
15746 These all have different names, but for explanation purposes -- and a wholesale division. So what is happening is that the employees in Ontario who are focused on the small and medium business market would be in that division now that is headquartered in Calgary -- the small and medium business division which is headquartered in Calgary.
15747 MR. RYAN: Do I understand you to be saying, then that if I do ask you, for instance, how many employees you had dedicated to the CLEC business, you wouldn't necessarily be able to give me a precise figure because of the integrated nature of the company's operations now.
15748 MR. GRIEVE: That's correct.
15749 MR. RYAN: Can we now turn, please, to -- I think you are already there, Mr. Grieve, but TELUS(ATT)26June01-505 revised, which you indicated before you had in front of you.
15750 MR. GRIEVE: Yes.
15751 MR. RYAN: I think we will have to do a bit of updating of this as we go along.
15752 The question you were asked was to indicate which of certain specified functions were being provided inter alia to TELUS Integrated by the company. We see your revised response as produced pursuant to a direction you received form the Commission on August 8th in the answer here.
15753 Now, given that the company is now operated -- TELUS Integrated is effectively, for lack of a better word, integrated with TCI -- could you tell me how you provide the help desk functionality that the customers in Ontario that are receiving CLEC-type services from you, how that help desk functionality is provided?
15754 MS HALE: Perhaps if I could just clarify. In the question are you talking provided from a financial sense or from an actual operational perspective?
15755 MR. RYAN: I'm talking first from an operational perspective.
15756 Maybe I can make it a bit more concrete. If I am a customer of the company in Toronto receiving a CLEC-type service from you and I had a help desk inquiry, where is the help desk situated?
15757 MR. GRIEVE: We are not 100 per cent sure, Mr. Ryan, where that help desk is, so we will take an undertaking.
15758 MR. RYAN: Well, before we do that maybe it's worth going at the question this way: That help desk would provide support not just for the CLEC-type queries that I have referred to but would handle queries from any other aspect of the company's business as well. Is that right?
15759 MR. GRIEVE: I believe that is the case.
15760 MR. RYAN: Turning on to the next point, (ii) of that interrogatory, which refers to "Billing and Billing Support".
15761 If I am a customer for a CLEC-type function in Toronto, when I am billed would I receive a separate bill for that service from any other services I get from the company? Say I had a cross-Canada data network as well, it would be separate bills or a joint bill?
15762 MR. GRIEVE: I'm not sure, Mr. Ryan. It is possible that it would be the same bill. Whether it is actually done that way, I'm not sure.
15763 MR. RYAN: No reason, from your standpoint at least, to have separate bills any longer now that the two lines of business are folded in together.
15764 MR. GRIEVE: That's right, Mr. Ryan. I would agree with that. It's just that there may be a business reason, depending on which sales group is taking care of it.
15765 MR. RYAN: Turning finally to (iv), "Operational and Support Services", Is the answer essentially the same there, that is to say there is no way of separately identifying the people or the assets within the company that would be dedicated to providing operational support for your CLEC-type activities as distinct from, for example, this hypothetical data network that I, as a customer, am also receiving from you.
15766 MR. GRIEVE: I'm not sure if that is the situation at this moment, but that would generally be the case going forward.
15767 MR. RYAN: Ms Hale, is there any separate cost accounting undertaken by TCI to separate revenues and expenses associated with CLEC-type activities from the revenues and expenses generally of TCI?
15768 MS HALE: Prior to October 1st there were separate financial statements for TELUS Integrated Communications.
15769 MR. RYAN: At present is there any separate accounting done with respect to the activities that are branded CLEC-type activities?
15770 MS HALE: Sorry. With respect to your question, could you please repeat?
15771 MR. RYAN: Yes.
15772 Is there any way going forward post-October 1 for you to separate the cost in revenues associated with CLEC-type activities from other revenues and expenses of TCI, say on a division basis or a line of business basis or some other way?
15773 MS HALE: To be honest with you, given that the corporate amalgamation occurred October 1st, I'm not really sure of the accounting practices that will be used on a go-forward basis.
15774 Certainly prior to October 1st there were separate financial statements, both from a revenue and cost perspective.
15775 MR. RYAN: So you aren't in a position today to tell us whether there will be any way to measure the profitability on a stand-alone basis of your CLEC activities as distinct from the overall activities of TCI.
15776 MS HALE: No, not subject to check.
15777 However, just from a business perspective, certainly we would most likely track revenue from our customers nationally, regionally, out of region, so I would suspect there will still be a mechanism.
15778 MR. RYAN: But if I was a Toronto-based customer that, as I say, receives CLEC-type services from you, as well as a data network, are you expecting that you will be able to separately track for that customer, for instance, or similarly situated customers, the revenues and expenses associated with the CLEC-type services from the other types of services that that customer receives?
15779 MS HALE: As I stated previously, on a go-forward basis I am not sure of the specifics of the accounting for that.
15780 MR. RYAN: Certainly prior to October 1, as indicated in this interrogatory response, TELUS Integrated would habitually or typically have received services of the type I have just referred to, help desk, billing support, operational support, from TCI?
15781 MS HALE: Absolutely.
15782 MR. RYAN: Those were charged to TELUS Integrated on a cost recovery basis. Is that right?
15783 MS HALE: Yes, they were, as stated in Interrog 505.
15784 MR. RYAN: When we say "on a cost recovery basis", could you amplify what is meant by "cost recovery" in that context?
15785 MS HALE: In that context "cost recovery" means the cost plus a markup for overhead.
15786 MR. RYAN: Cost calculated on what basis, Ms Hale?
15787 MS HALE: Depending upon the nature of the service, if we were using labour it would be our standard labour rates with an overhead allocation built into that standard labour rate.
15788 MR. RYAN: When you refer to a markup you are talking about a markup to take account of overheads. Is that right?
15789 MS HALE: That's correct.
15790 MR. RYAN: Some sort of loading factor.
15791 MS HALE: Yes.
15792 MR. RYAN: Have you produced or are you going to produce separate financial statements for TELUS Integrated for the period ending October 1?
15793 MS HALE: Just as our normal course of business each month we produce financial statements, so we would have TELUS Integrated statements at October 1st or September 30th.
15794 MR. RYAN: So if the Commission were to ask you for those you would have something available to produce to them?
15795 MS HALE: If that was a request, they could be provided, yes.
15796 MR. RYAN: I say, "if the Commission were to ask", because I am assuming that if I were to ask I wouldn't get the same sort of friendly response that you would give to the Commission.
15797 MS HALE: That would be a correct assumption.
--- Laughter / Rires
15798 MR. GRIEVE: Mr. Ryan, if you have been following our ads, TELUS is friendly.
--- Laughter / Rires
15799 MR. RYAN: I got a bit discouraged when I heard, was it Ms Hale at the beginning of this proceeding on the telephone giving her report on your activities, so I have treated you much differently ever since, Mr. Grieve. You might have noticed I have been avoiding you in the hallway.
--- Laughter / Rires
15800 MR. RYAN: When, Ms Hale, you refer to your practice respecting cost recovery pre-October 1, was this cost recovery mechanism purely an internal accounting arrangement or were there actually bills issued and received between the parties?
15801 MS HALE: There was actually bills received between the parties.
15802 MR. RYAN: That would be the case for each of the activities that we have been referring to that are mentioned in 505?
15803 MS HALE: That's correct. It would only be in very rare circumstances where it would just be an accounting entry. I would say for 99 per cent of the services listed here there are actual bills produced.
15804 MR. RYAN: All right. Those are all my questions then.
15805 Thank you, Mr. Chairman.
15806 THE CHAIRPERSON: Thank you, Mr. Ryan.
15807 The next party, then, is CallNet.
15808 Mr. Koch.
15809 MR. KOCH: Thank you, Mr. Chairman.
EXAMINATION / INTERROGATOIRE
15810 MR KOCH: I have to say, I have always wondered whether a necktie limited my cross-examination ability, so today I will be able to either prove or disprove that theory.
15811 Good morning, panel members, Ms Hale, Mr. Grieve and doctors.
15812 Dr. Emmerson, as I understand it, you are responsible for Attachment 1 to Interrogatory Response TELUS(CRTC)4200. Is that correct?
15813 DR. EMMERSON: That is correct, yes.
15814 MR. KOCH: So you are the ice cream doctor.
15815 DR. EMMERSON: Yes, I'm the ice cream doctor.
15816 MR. KOCH: Just so everyone is clear on what we are dealing with, this is the interrogatory that the Commission asked of TELUS to elicit TELUS' response to a number of proposals that have been advanced, including the proposals being advanced by CallNet Enterprises and AT&T Canada. Correct?
15817 DR. EMMERSON: Yes, I believe so.
15818 MR. KOCH: Okay.
15819 This attachment, as I understand it, was prepared by you it says in its introduction:
"...to explain how Phase 2 costs are developed in order to demonstrate the consequences of providing incorrect markups for essential facilities and other competitor services." (As read)
15820 Then you use the example of an ice cream company to make it more attractive to those of us who like ice cream. Right?
15821 DR. EMMERSON: And certainly I have included applications to telecommunications in parallel with that, yes.
15822 MR. KOCH: Fair enough.
15823 I wonder if I could ask you to turn to your part that I like the title of, which is "Relevance to Telecommunications", which is actually at page 6 of the attachment.
15824 DR. EMMERSON: I have that.
15825 MR. KOCH: In the first paragraph, under "Relevance to Telecommunications", you state:
"Each telecommunications provider will face its own circumstances and have its own costs." (As read)
15826 Can we take it from that you would agree that we can't, without knowing more about particular providers, assume that for instance competitors won't have a lower cost structure than incumbents. Correct?
15827 DR. EMMERSON: That's correct. Each company will have their own unique cost structure based on a wide variety of factors. That is the point of that sentence.
15828 MR. KOCH: Then you go on and you talk about some of the factors that in your view preclude real telecommunications firms from achieving theoretical levels of cost efficiency.
15829 I was struck in reading this that this week they granted the Nobel Prize in economics to economists whose work in part dealt with the issue of the fact that markets are not perfect -- I think their issue was information to participants in the market -- but that markets don't always operate perfectly. Isn't that correct?
15830 DR. EMMERSON: That is correct, in particular with respect to the availability of information to firms and consumers, which is not always consistent with our perfect competition assumptions.
15831 MR. KOCH: Right.
15832 Mr. Grieve, I would like to talk to you for a moment about the sunset decision. I am referring of course to the decision of the Commission in which it determined to remove the five year sunset period for the mandatory unbundling and pricing of near-essential facilities.
15833 You are well familiar with that decision I expect.
15834 MR. GRIEVE: Yes, I am. I'm just looking to see if I have a copy with me.
15835 MR. KOCH: I take it you will agree with me that the Commission there recognized in its conclusion that even with the type of accommodative entry policies that you and your colleagues have been discussing -- in other words, Phase 2 costs and markup for essential facilities -- the reality is that competitors will need to build a critical mass before they are able to make the necessary investments in their own facilities.
15836 Is that not a fair summary of the Commission's conclusion in that case?
15837 MR. GRIEVE: I'm just trying to find the paragraph to which you are referring.
15838 MR. KOCH: It's paragraph 28. This may be the fourth time I am quoting from it. It is one of my favourites.
15839 MR. GRIEVE: I'm sorry to have not been here every time, Mr. Koch.
15840 MR. KOCH: I'm referring at the bottom of paragraph 28 to the last sentence, which reads:
"The Commission considers that not extending the current mandated access period for near-essential facilities would make it more difficult for entrants to acquire the critical mass of customers necessary to make entry and expansion of their own networks economic and would significantly limit the development of competition in the local exchange market." (As read)
15841 Do you see that?
15842 MR. GRIEVE: I see that, yes.
15843 MR. KOCH: Do you have an answer for my question?
15844 MR. GRIEVE: You will have to repeat the exact question.
15845 MR. KOCH: I will do my best. I don't have it typed out here.
15846 My question is whether or not you would agree with me that it is fair to summarize their conclusion as being a recognition that even with the accommodative entry policies that are near and dear to your heart, which include for instance the Phase 2 costing and markup for essential facilities, competitors will need to build a critical mass before they are able to invest in facilities.
15847 It is a pragmatic recognition by the Commission that, regardless of the pricing rules -- rather, in spite of the specific pricing rules, certain additional measures are required. Is that not correct?
15848 MR. GRIEVE: Well, that's certainly what the Commission said here. I don't remember the record of that proceeding very well, but it is what the Commission said.
15849 It seems to me that for investment you need money and there are many sources of money for those kinds of investments.
15850 I think there are a couple of reasons that we can look at why the Commission might have been concerned or was evidently concerned enough to extend the sunset rule.
15851 First of all, I think the fact that the toll market went to flat rate calling in 1998, as I mentioned yesterday, meant that the competitors who had gone to flat rate calling found themselves paying out an awful lot of cash and their average revenue per minute dropping very, very substantially.
15852 They were saved by the Commission in 2001 from that when the Commission went from a contribution charge that was based on a per-minute mechanism to a revenue charge, a significant improvement of about $187 million.
15853 It seems to me that, first of all, there was certainly a money issue for the competitors, especially the long distance competitors, who could have used those revenues if they hadn't gone to that method of charging.
15854 Secondly, as we have been stating throughout this proceeding, the price cap mechanism drove business prices down, so the revenues that might have been available but for the price cap mechanism for competitors to enter that market -- the market would have been more lucrative but for the price cap mechanism.
15855 And, in addition, the fact that the price cap mechanism did not allow residential rates to rise other than for things like exogenous factors.
15856 Those three things in total I think, in and of themselves, the implications of those three things, is what I think led the Commission to make this decision.
15857 I don't think you need to get all of your capital from local customers to reinvest in local. I think you can get your capital from other places. There was certainly an opportunity to do that and it was lost. Then the Commission has repaired that in its contribution decision for the year 2001, which I might add was a year earlier than certainly we expected the Commission to change the contribution mechanism, although we didn't have a problem with it.
15858 MR. KOCH: Which is all to say that is your explanation for the Commission's decision. I was simply asking you to confirm that their own stated -- and we can all read the decision -- reason for the conclusion is on the page and it reflects a pragmatic recognition that critical mass must be built before investment will be made in facilities.
15859 Is it your evidence that it doesn't reflect that pragmatic recognition, Mr. Grieve?
15860 MR. GRIEVE: Mr. Koch, the difficulty I have with the Commission's statement is that while critical mass may be required before one builds facilities in the local market, if that is all that one is doing, that is probably correct.
15861 If you have a situation where companies are operating in many different markets and have different opportunities to raise capital and gain market share, then zeroing in just on that market individually I think is probably not the full story.
15862 MR. KOCH: So the Commission is wrong? You disagree with the Commission's decision?
15863 MR. GRIEVE: I think there is more to what was going on than what is stated there.
15864 MR. KOCH: So this is not an honest reflection of their reasoning? Is that your evidence?
15865 MR. GRIEVE: I think this is exactly what the Commission meant to say.
15866 DR. EMMERSON: One comment I will make here, having a great deal of experience in this area, the Commission has acknowledged essentially one of three competitive local exchange carrier strategies. The one which they have recognized is assembling a critical mass of customers through unbundled elements, resale or some other mechanism, and then building facilities.
15867 There are, however, two other strategies which competitive local exchange carriers undertake which do not require that critical mass.
15868 MR. KOCH: Now, if one looks at the fact that sometimes practice interferes with the theory of cost efficiency as well as the Commission's pragmatic recognition that regardless of the pricing parties are going to have to build a critical mass before they go out and build these facilities, I am suggesting to you that the price of competitor services, as currently set, in spite of that price, and what you refer to as accommodative entry policies, Mr. Grieve, there may actually be reasons why competitors don't or can't build facilities. Isn't that correct?
15869 MR. GRIEVE: I think there are always reasons why individual competitors might not be able to build and there are reasons why individual competitors would be able to build, yes.
15870 MR. KOCH: And they are legitimate reasons, including the difficulties in raising money, some of the things that they have to do to acquire every customer that they gain. Those were reflected in the Commission's pragmatic analysis of what it should do to get competition moving in this market. Is that not correct?
15871 MR. GRIEVE: That is certainly what the Commission said.
15872 MR. KOCH: As I understand it, Dr. Emmerson, your example is meant to demonstrate, in part, that Phase 2 costs may underestimate the ILECs' real costs. Correct?
15873 DR. EMMERSON: Yes. Not just "may", "does" underestimate.
15874 MR. KOCH: I take it you would agree with the Chairman's remarks that there is as much art as science in Phase 2 costing and its application?
15875 DR. EMMERSON: I think I would balance it in favour of science over art, but there is certainly an element of both.
15876 MR. KOCH: I take it you would agree with me that the Phase 2 costing approach and its practical application in the real world could result in a overstatement of the ILECs costs?
15877 DR. EMMERSON: It can certainly result in overstatements, or understatements, but when these things are audited generally we find that they in fact are pretty good if the methodologies are sound, as they are in this case.
15878 MR. KOCH: It is not your evidence, it is not your position that Phase 2, in its application, cannot overstate costs?
15879 DR. EMMERSON: Costs can be overstated or understated depending on what kinds of errors one makes. Obviously errors in one direction or another will give you false answers, but -- if that is what you are asking.
15880 MR. KOCH: I would like to examine your example, then, and flip it around and assume for a moment that the Phase 2 cost study filed by an ILEC overstated the costs of facilities.
15881 You give an example, Dr. Emmerson, of an ice cream incumbent whose costs are 65 cents per pound but is forced to unbundle for less. Correct?
15882 DR. EMMERSON: Yes.
15883 MR. KOCH: In that example you indicate that -- maybe we could turn to page 6 of your Attachment 1.
15884 In the paragraph that starts with the word "Second", in the middle of the paragraph -- and again dealing with this example of their actual costs being 65 cents a pound and being required to unbundle access to the machine at roughly 37 or 38 cents per pound -- I am going to call it the ILEC -- you say that the ice cream ILEC is placed at a disadvantage vis-à-vis their retail competitors.
15885 The quote is:
"While the IICC faces real costs for its use of ice cream machines, their competitors see artificially low prices." (As read)
15886 That assumes again that the Phase 2 costing has understated the actual costs of the ILECs. Correct?
15887 DR. EMMERSON: Yes, that does make that assumption.
15888 MR. KOCH: Let's turn it around now.
15889 DR. EMMERSON: Okay.
15890 MR. KOCH: We are dealing with my assumption that it overstates the costs of the ILEC.
15891 Is it not true that in that case we could rewrite that sentence to say:
"While the IICC faces real costs for its use of ice cream machines, their competitors see artificially high prices." (As read)
15892 DR. EMMERSON: I will take that as a hypothetical, but I also will point out that the Commission has recognized in prior decisions quite the opposite, that it is in fact Phase 2 costs do understate costs.
15893 However, as a hypothetical I will continue with it.
15894 MR. KOCH: But you recognize in some cases the Commission has revised Phase 2 costs of specific services downwards substantially. That would suggest, would it not, that they were overstated in the first place.
15895 Is that not correct, Dr. Emmerson?
15896 DR. EMMERSON: I don't know the reasons for the changes in the Commission decisions, but I do not agree that costs were overstated when they were revised downward, no.
15897 MR. KOCH: Another consequence you cite in your ice cream example is that if the ICC's costs were higher than the unbundled price of ice cream machines, then -- and I think it is in the previous paragraph, it is the sentence starting at the end of the previous page:
"Indeed, no potential competitor could compete with IICC in the wholesale market, no matter how badly they wish to do so, since the regulatory process has priced this service below its costs." (As read)
15898 DR. EMMERSON: Yes.
15899 MR. KOCH: Do you see that?
15900 DR. EMMERSON: Yes, I do.
15901 MR. KOCH: When you say "its costs", are you referring to the costs of the service or the IICC's costs?
15902 DR. EMMERSON: This would be below the IICC's costs.
15903 MR. KOCH: And as we agreed at the beginning of my cross-examination, competitors' costs could in fact be lower than the IICC's costs. Correct?
15904 DR. EMMERSON: In this case they would be lower because they would be receiving, in essence, a subsidized unbundled element.
15905 MR. KOCH: I'm talking about a hypothetical competitor. You agreed with me at the outset of the cross-examination, Dr. Emmerson, that we could have a competitor with lower cost structure than an incumbent. Correct?
15906 DR. EMMERSON: Yes.
15907 MR. KOCH: And if a competitor had a lower cost structure than an incumbent, I am suggesting to you that even if the incumbent's wholesale prices understated the incumbent's real costs, that would not necessarily prevent a competitor with lower costs than the price set by the regulator from providing those wholesale services.
15908 DR. EMMERSON: I'm afraid I am missing components of your question.
15909 There are two potential sources of understatement of cost and I would like to be clear on which one you are referring to.
15910 One is, the competitor having a lower cost structure because it has an advantage of an artificially low price for an unbundled element that it does not itself provide.
15911 The second is, a competitor may have a lower cost structure because of the things both it and the incumbent provide are more efficiently provided by the competitor.
15912 If you could just tell me which of these two sources of lower cost you are referring to I think I can answer your question.
15913 MR. KOCH: What I'm suggesting is, we are talking about incentives -- first of all, the problem you posit is that the costing approach, a regulatory costing approach, could lead to an understatement of the incumbent's costs. Correct?
15914 DR. EMMERSON: That is correct, yes. That is one of the two sources of a lower cost structure I just referred to.
15915 MR. KOCH: Right. In that context you indicate in this sentence, as I understand it: Indeed, no potential competitor could compete with the incumbent in the wholesale market, no matter how badly they wish to do so, since the regulatory process has priced this service below its cost. But you agreed with me that its costs are the incumbent's costs.
15916 So I am suggesting to you that you could have a competitor with a lower cost structure than the price set by the regulator and that competitor indeed could compete in the wholesale market in those circumstances.
15917 DR. EMMERSON: Yes. If the efficiencies were sufficiently great, of course one could have a situation in which a competitor could compete. Take an extreme example, for example where it costs him nothing to do something. Obviously there would be no barrier to competing.
15918 MR. KOCH: In fairness, Dr. Emmerson, I wasn't suggesting to you a scenario where a competitor had no cost.
15919 In fairness, at the beginning of the cross-examination you agreed with me that a competitor could have a lower cost structure and that cost structure, would you not agree with me, could be lower than the cost set by the regulator for the wholesale services. Isn't that correct?
15920 DR. EMMERSON: My understanding of this --
15921 MR. KOCH: Is that correct?
15922 DR. EMMERSON: Let me just tell you my understanding and then I will see if it matches.
15923 MR. KOCH: Why don't you give me a yes or a no and then we will get your understanding.
15924 DR. EMMERSON: Ask the question one more time.
15925 MR. KOCH: That will be a challenge for me, but I will try it.
15926 The question is that even if the price set by the regulator for a wholesale input understates -- which is your proposition -- the actual incumbent's costs, that does not mean that it will shut out competitors who have cost structures that are better than the price set by the regulator, does it?
15927 DR. EMMERSON: That is correct.
15928 MR. KOCH: One of the other problems you cite at the conclusion of your example -- this is the second to last sentence in the first full paragraph on page 6 of 6 -- is your proposition that:
"IICC does not have the opportunity to price its retail services in such a manner as to make up for this shortfall." (As read)
15929 You are speaking again of the shortfall of either an understatement of its costs as a result of the Phase 2 process or, indeed, a situation under which it isn't able to recover a markup. Correct?
15930 DR. EMMERSON: That is correct. This is a classic case of what one would call predatory pricing, but not as a deliberate act on the incumbent's part but as a non-deliberate act because the price for the wholesale element was placed below cost.
15931 MR. KOCH: Mr. Grieve, in respect of imputation test as it applies to near-essential facilities today, you would agree with me that in respect of near-essential facilities you are not required to recover your markup, although that is in dispute in the current proceeding before the Commission. Correct?
15932 MR. GRIEVE: That's right, Mr. Koch.
15933 You can continue, but I do have something to add to what Dr. Emmerson said.
15934 MR. KOCH: In that case, as I understand your position, it is that you don't have to recover your markup from the specific services in order to meet that imputation test. You do not have to recover the specific markup from those same services. Correct?
15935 DR. EMMERSON: That's right. And there is a very good reason for that, Mr. Koch.
15936 We should understand, first of all, that what we are dealing with here in the pricing of essential facilities and the way the Commission prices unbundled facilities that it considers to be near-essential, is to recover Phase 2 costs plus a markup sufficient to recover embedded costs. At least that has been the tradition that -- it was what the Commission said basically was its purpose in Decision 97-8.
15937 The reason that is so important for us is that it really is the foundation for our own pricing. If we find a situation where we have to price those facilities below that cost, if we are required by regulation to do so, then we may find that the retail prices would drop and we would not have a reasonable -- because of the failure to recover those kinds of markups in the essential facilities we would find ourselves in a position of not having a reasonable opportunity to price in a competitive market at the retail level based on our own relative efficiencies to recover all of our costs.
15938 With respect to near-essential facilities or, more properly, non-essential facilities that are priced in that way, those are facilities that we know it is possible to have competition.
15939 The question for the Commission is whether we should be allowed to price those facilities down to Phase 2 costs in response to competition. As the Commission has heard many times over the last six to ten years in here, in a competitive market prices move towards their underlying costs, but they don't always go all the way to their underlying incremental costs.
15940 Nevertheless, if a competitor can come in and price below our price -- Phase 2 plus whatever the markup is to give an opportunity to recover embedded -- then we should be allowed to price down to that if they are more efficient and take our chances in the market of being able to recover those embedded costs and other costs somewhere else, if we can.
15941 So the difference between essential facilities and near-essential facilities is that we expect competition in the near-essential facilities and we need to pricing flexibility to be able to respond in the market in the wholesale market which, as you have heard repeatedly during this proceeding, is becoming very active.
15942 MR. KOCH: As I understand your position, Mr. Grieve, for purpose of your flexibility it is fine for you to recover your markup from a service other than the one we are discussing, but for purposes of, for instance, implementing CallNet's proposal, that is not an acceptable approach?
15943 MR. GRIEVE: Well, Mr. Koch, I think that the way the Commission set the rules in Decision 97-8 -- which, interestingly enough, was not something that I had thought of before they did it, the imputation rules -- that reflects the reality of their decision that there are some essential facilities and that there are some facilities that are not essential facilities.
15944 So when the Commission determined that imputation test, it was looking to make the market efficient, allow the market to respond so that there could be efficiencies passed through to customers and not have prices of the ILEC artificially held up as a result.
15945 MR. KOCH: You understand that under CallNet's proposal you would recover your markup by being permitted to keep your productivity gains, with the exception of those that you proposed to deal with in respect of your high-cost areas, but otherwise be permitted to keep your productivity gains across your enterprise. Correct?
15946 MR. GRIEVE: I think that is very interesting, Mr. Koch.
15947 MR. KOCH: Is that your understanding of our proposal?
15948 MR. GRIEVE: Yes, I do. I do understand that is your proposal, but I don't think it works.
15949 MR. KOCH: Thank you.
15950 Those are my questions, Mr. Chairman
15951 THE CHAIRPERSON: Thank you, Mr. Koch.
15952 So that completes the cross-examination from all the parties who had indicated they wished to do so.
15953 I will now turn to Commission Counsel Moore.
15954 MS MOORE: Thank you, Mr. Chairman.
EXAMINATION / INTERROGATOIRE
15955 MS MOORE: If you could first refer to your response to Interrogatory TELUS(CRTC)401.
15956 MS MOORE: In that response TELUS submits that there is no longer a need for Phase 3 split rate base or any other type of financial monitoring and reporting of the utility segment and that these consume significant company resources.
15957 Another party, in another interrogatory -- and I will just paraphrase their response, I don't think you need to turn to it --
15958 MR. GRIEVE: Is that another party?
15959 MS MOORE: I'm referring to ARC --
15960 MR. GRIEVE: Okay.
15961 MS MOORE: -- (CRTC)3400, but I will paraphrase.
15962 They say that some level of reporting under the price cap regime is clearly needed to assess the effectiveness of the regulatory regime and, in the absence of competition, to allow the Commission to ensure that rates are just and reasonable.
15963 Now, if we can assume for the sake of discussion that the Commission decides that some form of financial reporting is required in the next regime, whether there is an earnings sharing overlay or not, what type of reporting would TELUS propose as a replacement for Phase 3 SRB reports?
15964 MR. GRIEVE: There was one part of your question I didn't catch. Did you ask what type of reporting of earnings should be done or just what type of reporting?
15965 MS MOORE: What type of financial reporting.
15966 MR. GRIEVE: All right.
15967 MS MOORE: I think the part you didn't quite catch was I said "assuming that there was an earnings sharing overlay or not".
15968 MR. GRIEVE: If you are going to be looking at earnings you have to look at the earnings on something. That is the reality of it. You have split rate base now.
15969 We don't believe you need to do that. We think you need to focus on rates.
15970 I think it is very important to have a brief explanation of the concept of just and reasonable rates here, because I think it is used sort of interchangeably between a world of natural monopoly public utility and a world where the whole market has been opened to competition.
15971 The Chairman and I had a brief discussion yesterday about the history of just and reasonable rates and the revenue requirement.
15972 The difficulty going forward in determining whether rates are just and reasonable is that markets determine just and reasonable rates by definition. From our standpoint, what we are looking for here is an opportunity to recover our costs that are being and have been incurred under the obligation to serve, but we are not asking for any kind of guarantee. But we are asking that the underlying facilities that we provide to competitors are not priced at such a level that it makes it impossible for us to continue to recover our costs at the retail level.
15973 As I said yesterday, some of the proposal here are to that effect. They basically collapse the foundation of the system.
15974 When it comes to what kind of financial reporting could be done if you want financial reporting and earnings in those things, I think if you are going to do that you have no choice but to stay with something like that.
15975 A better measure might be something like looking at -- because we are moving to Phase 2 now, is get the Phase 2 costs right, get the markups right and start looking at Phase 2 costs perhaps by category, Phase 2 costs plus a markup, but that, unfortunately, would be an average markup.
15976 So if I could give you an example, let's take the business services market. If we were to do a Phase 2 cost study for all of the individual line business services today, mark them up by an average markup that would allow us an opportunity to recover embedded costs, in that situation you would look at the prices -- you could look at the prices there to see if they had gone, on average, above that. That doesn't mean that those prices would necessarily -- that any individual price would not necessarily above that.
15977 The difficulty with that, though, is that just in doing the Phase 2 study in the first place you are assuming a cost of capital that is a monopoly public utility cost of capital. In a competitive market you might very well find that the kinds of returns people expect in a much, much riskier enterprise would be higher.
15978 The Commission, by trying to set retail prices on that kind of a basis, using Phase 2 to arrive at a public utility kind of rate, might actually be pricing those services below what an equally efficient entrant might be able to achieve.
15979 So there are many dangers here in trying to move forward with these things.
15980 Finally, going back to split rate base, the difficulty there is that, as you know now with split rate base we have a situation where in the numbers being shown on the record for 2001, they don't take into account, of course, in TELUS's case, the $400 million in revenue that was lost as a result of the two decisions. So that has made a huge difference on the financial results for the utilities segment.
15981 You have other things going on there, other things going on with accounting changes and things like that whenever you do earnings. In a competitive market it is the prices that count and the margins between the wholesales services and the retail services.
15982 So, once again, we would like to recover on the wholesale services fully and let the retail prices find their market levels. That might mean a public utility kind of test on the utility segment might show over-earning, but over-earning in a public utility sense might be perfectly natural in a market that has so many risks.
15983 So there are many, many difficulties in trying to do what your question suggests. Those are just a few of them and those are my thoughts on it as a result of you having asked the question of someone else earlier.
15984 MS MOORE: Now, let's assume that the Commission does not implement an earnings sharing mechanism. In that type of scenario, would TELUS consider it preferable to replace Phase 3 split rate base reports with some type of financial statements that reflect total company results, given that the latter are likely less labour-intensive to produce?
15985 MS HALE: Ms Moore, if I may interject.
15986 With respect to earnings, as an accountant I guess I can understand and actually sympathize with the need to want to gravitate and look to earnings. But I think, as Mr. Grieve has said, we really have to look at what are we trying to measure on a go-forward basis.
15987 Under price caps earnings is one indication in terms of total company, but there are so many underlying drivers when you look at earnings. I think it would be more productive to look at prices, to look at revenue levels, to look at levels of competition, to look at Phase 2 costs, to get some consistency in terms of Phase 2 costs rather than just focus specifically on earnings.
15988 I think even if you look at the current price cap period that we have been under, if you look at TELUS earnings I don't think that tells the whole story. We have had high return on equity in the last couple of years, but that has had nothing to do with the price cap regime per se. It is because of tax treatments we have had, it is because of pension accounting change. So I think if you don't understand the drivers behind that you really aren't getting at the true picture.
15989 So I guess I would caution in terms of just looking at earnings and basing any kind of program going forward solely on the measurement of earnings for any company.
15990 MS MOORE: But I take it that is not a response to the question that I just asked, which is: Does TELUS see that if there were no earnings sharing mechanism imposed, would reporting on a total company basis in terms of financial statements be preferable to Phase 3 or split rate base?
15991 MS HALE: I guess in response to that specific question, certainly it would be preferable, but again I would caution, I'm not sure what you would do with that information. I guess that is the concern I was trying to highlight in the first instance.
15992 MS MOORE: Thank you.
15993 I would ask you now to pull up two volumes of the transcript. You will need Volume 6 and Volume 7.
15994 MR. GRIEVE: I have them. If you could direct me to the pages, please.
15995 MS MOORE: Certainly. In Volume 6 you will need pages 1683 and 1684, and in Volume 7 you will need page 1762.
15996 MR. GRIEVE: Okay.
15997 MS MOORE: Before we look at those specifically I will just contextualize this.
15998 In those pages I was discussing with Mr. Hariton various issues relating to productivity offset calculation using TFP methodology and input price differential. In our discussion I would like to assume that the Commission does impose telefactor productivity on an industry-wise basis and I really just want to explore what would be the appropriate input price differential.
15999 If we start in Volume 6, and if we look at the top of page 1684, ultimately -- at this time Mr. Hariton was going over an interrogatory response that RCI had prepared, but the bottom line at line 10791 he is explaining that in his view the appropriate input price differential for Bell and The Companies would be plus 0.4. Do you see that?
16000 DR. BERNSTEIN: Yes.
16001 MS MOORE: Then if we now turn to Volume 7 at page 1762, half way down the paragraph that starts at line 11225, Mr. Hariton noted:
"I haven't got the industry number because I don't know what TELUS' input prices are."
16002 So he was further elaborating that his 0.4 input price differential was strictly for Bell and The Companies because he felt that he didn't have the appropriate data to reflect on an industry-wide basis.
16003 What I would like to know is whether in your view TELUS' input price differential would be close to or the same as this number of .4 per cent. I am talking about a period of 1988 to 2000.
16004 DR. BERNSTEIN: I don't know that answer offhand. It's not something that I have looked at.
16005 MS MOORE: Could you undertake to provide me with a response on what TELUS' view of an appropriate input price differential would be for that period.
16006 DR. BERNSTEIN: Yes.
16007 MS MOORE: Thank you.
16008 MR. GRIEVE: Of course, we don't agree that the Commission should be using total company TFP for any purpose in this proceeding.
16009 MS MOORE: Of course. I understand that.
16010 In your undertaking response if you could please clearly outline all of the assumptions that you are relying on to derive that number?
16011 DR. BERNSTEIN: Yes.
16012 MS MOORE: Thank you.
16013 I also have another undertaking that I would like to request in respect of TELUS Integrated Communications, which I understand is now amalgamated, but I wonder if you could please provide the financial statements, including statements of cash flows for the year 2000 and for the first six months of 2001?
16014 DR. BERNSTEIN: Yes. We would be happy to provide that to you.
16015 MS MOORE: Thank you.
16016 Mr. Chairman, those are my questions, but my colleague has a few questions in the area of contribution.
16017 We just are going to have change chairs a little bit here, if you can bear with us.
EXAMINATION / INTERROGATOIRE
16018 MS TURMEL: Good morning.
16019 MR. GRIEVE: Good morning.
16020 MS TURMEL: I understand from your response to TELUS(CRTC)26June-1703C that you did not agree with using a maximum allowable rate rather than the actual rates for the subsidy calculation. Is that right?
16021 MR. GRIEVE: Yes, that is correct.
16022 MS TURMEL: In your view, will there be an incentive to maintain rates for high cost bands at the current level or at least in not exercising the full flexibility allowed since the difference will be provided through the subsidy?
16023 MR. GRIEVE: Let me answer the question this way. I know that there are three kinds of looks at this thing on the record.
16024 One is, we didn't say anything about it in our evidence.
16025 One is, one of the parties said there should be a maximum, that the contribution should be collected as though or pretending that the rate is something that it's not.
16026 Another party, I believe it's Bell, suggests that if you have pricing flexibility to raise a price under our proposal, for example $3.00 a year, and you don't raise it in that year, the contribution should be calculated as though we had raised it the $3.00
16027 Those are the three options on the record.
16028 Of course, AGT proposed in the last price cap case that the proposal Bell is making now is the one that should be adopted. We just didn't think of putting it in this time, so we would obviously agree with it.
16029 It would be if the rate is $26 today and we were allowed to raise it to $29 and we did not, and we left it at $26 or $27 or $28, that we would calculate the contribution assuming that the rate had been raised to $29.
16030 MS TURMEL: Thank you.
16031 Those are my questions.
16032 THE CHAIRPERSON: Thank you, counsel.
16033 I just have a couple of questions for Dr. Bernstein.
16034 There have been a number of references to the last time we had discussion about this issue and productivity offsets and the X factor. At that time you may recall that the Stentor member companies -- which then, if I'm not mistaken, included BCTel -- had come forward with a proposal for a single productivity offset for all of the companies whereas TELUS/AGT had a different proposal, I take Mr. Grieves point that there was considerable discussion with you, as I recall, Dr. Bernstein, about whether it should be a total company or the utility segment in terms of calculating total factor productivity.
16035 Now you have come forward with a proposal that would take a look at an X factor applying to just the high-cost areas, as you have indicated earlier today.
16036 I guess I'm wondering what your opinion would be about whether we should be considering -- let me go back again.
16037 One of the concerns that was raised at that time, in fact I raised it, with respect to The Companies was whether we should be considering separate X factors for separate companies, because at least anecdotally I had suspected that one company, for example, NBTel, may have already wrung out more productivity from its operations than some of the other companies had and whether we should be considering that and indeed considering separate productivity factors for each of the companies.
16038 I'm wondering what your opinion would be, whether we considered it on the utility segment or indeed in just the high-cost areas or bands, whether in fact we should be considering separate productivity adjustments for each company?
16039 DR. BERNSTEIN: Yes, sir. You were ahead of us. I agree fully that is a very strong consideration and very much consistent with previous Commission decisions.
16040 If one is looking at productivity growth rates one has to recognize, especially in a country like Canada with such distinct operating territory characteristics, that productivity growth rates have to indeed be different. Here we are aligning, in some sense, provincial characteristics with The Companies in some sense, although regional characteristics with The Companies.
16041 I think that one has to think very strongly about differential offsets and that is independent of the set of services that are capped. I agree with you, whether it is a utility segment or high-cost serving bands, we are proposing high-cost serving Bands E, F and G.
16042 From my research I have determined that X factors -- it is appropriate to think about X factors differentially for different companies.
16043 THE CHAIRPERSON: Just how granular should that get? I guess I'm thinking in the case of TELUS and the distinction between Alberta and British Columbia, and in particular the proposal that you have in front of us that we just look at the high-cost bands, why should we assume that we would have a similar X factor to apply across the TELUS territory?
16044 DR. BERNSTEIN: Well, I would say that there is probably more homogeneity, more standardization in the TELUS territory in terms of Alberta and British Columbia than in other territories in the country.
16045 But I take the point. It perhaps could be feasible to have differential offsets, even within the TELUS territory. That is, in some sense, perfectly consistent with the U.S. experience where, as I mentioned before, you have one company operating in different States with differential offsets. However, in that case the regulators are State-wide regulators.
16046 My only hesitation here is: How would one go about obtaining the data to determine that X factor?
16047 If I was given that exercise I think it would be difficult right now because the data is not available for the B.C. side but, you know, if that data was put together over time and we were talking about this 10 years hence, perhaps we would have that data and we can do that calculation.
16048 THE CHAIRPERSON: Well, if we are looking at, in the particular case of TELUS and B.C. and Alberta and if we are only going to look at the high cost bands as you suggest, would you expect that given the differences between the two companies and the mere fact of the amalgamation of those companies that the productivity gains would have changed simply by the fact of there is now one owner for the two operations, given the nature of the cost to serve those high-cost areas, that in fact we have the same productivity gains in the rural areas where they were different before?
16049 Wouldn't they still be, for the most part, different?
16050 DR. BERNSTEIN: At this point, yes, I agree, they would be different. However, in five or six years with the amalgamation it's hard to say if they would be different, but at this point yes, definitely they would be different.
16051 Of course, it's an empirical question, as I said before, that if one was able to obtain Phase 2 cost information with a sufficiently long time horizon of five or six years for the high-cost serving areas in the two separate territories, if the Phase 2 cost was delivered that way, then one could actually empirically determine if indeed the offsets were different.
16052 But right now, potentially, if they were different before, I would say that they would be different now.
16053 THE CHAIRPERSON: I appreciate that you are here working for TELUS and you may not be familiar with the Aliant operation at the other end of the country but, as you may know, we have in effect now four companies under the umbrella of the Aliant corporate structure.
16054 What would your opinion be in terms of whether we should be using one productivity offset for -- whether again it's on the utility sector or just if we accepted the TELUS proposal and applied it across the country -- whether we should use one productivity offset for all four companies -- and I don't know whether you would be familiar with the relative geographic differences that we have there -- or whether we should have separate ones for each company.
16055 DR. BERNSTEIN: Well, I'm not really familiar with those companies.
16056 I would say that my gut feeling is that it is probably more accurate to have an offset for those companies that is different from a nation-wide offset at this point, given the research that I have seen now between Bell and TELUS and TELUS and TELUS Quebec.
16057 Whether each of those companies should have different offsets from each other, I think that is basically the limit of my knowledge and I couldn't tell right now without doing a study on that.
16058 THE CHAIRPERSON: So the extent of your knowledge would suggest to us that we probably should have one for TELUS across both Alberta and British Columbia. If we were to accept the TELUS proposal, we would have one for the Aliant companies, one for Bell, one for MTS, one for Saskatchewan?
16059 DR. BERNSTEIN: That could very well be the case, and then one for the smaller companies and the very small companies.
16060 THE CHAIRPERSON: That's another proceeding.
16061 Okay. Thank you very much, Dr. Bernstein.
16062 DR. BERNSTEIN: You're welcome.
16063 THE CHAIRPERSON: Those are all our questions, then, for this panel.
16064 I want to thank you very much for your participation and indeed all the TELUS witnesses.
16065 That ends our business for the day.
16066 Mr. Secretary, do you have any more documents you wish to --
16067 MR. SPENCER: Do them Monday.
16068 THE CHAIRPERSON: Do them Monday, okay.
16069 So we will adjourn for the day.
16070 Just a reminder to everyone, those here and anyone who may be listening, we are starting at 8:30 a.m. on Monday.
16071 Starting Monday you are going to need photo IDs to get into any government building anywhere in Ottawa and elsewhere I gather.
16072 Thank you very much.
16073 We are adjourned for the day. We will see you Monday morning at 8:30.
--- Whereupon the hearing adjourned at 1145, to resume
on Monday, October 15, 2001, at 0830 / L'audience
est ajournée à 1145, pour reprendre le lundi
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